James v. United States (366 U.S. 213)/Concurrence-dissent Whittaker

by Charles Evans Whittaker

Mr. Justice WHITTAKER, whom Mr. Justice BLACK and Mr. Justice DOUGLAS join, concurring in part and dissenting in part.

The starting point of any inquiry as to what constitutes taxable income must be the Sixteenth Amendment, which grants Congress the power 'to lay and collect taxes on incomes, from whatever source derived * * *.' It has long been settled that Congress' broad statutory definitions of taxable income were intended 'to use the full measure of (the Sixteenth Amendment's) taxing power.' Helvering v. Clifford, 309 U.S. 331, 334, 60 S.Ct. 554, 556, 84 L.Ed. 788; Douglas v. Willcuts, 296 U.S. 1, 9, 56 S.Ct. 59, 62, 80 L.Ed. 3. Equally well settled is the principle that the Sixteenth Amendment 'is to be taken as written and is not to be extended beyond the meaning clearly indicated by the language used.' Edwards v. Cuba R. Co., 268 U.S. 628, 631, 45 S.Ct. 614, 615, 69 L.Ed. 1124. ^[1] The language of the Sixteenth Amendment as well as our prior controlling decisions, compels me to conclude that the question now before us-whether an embezzler receives taxable income at the time of his unlawful taking-must be answered negatively. Since the prevailing opinion reaches an opposite conclusion, I must respectfully dissent from that holding, although I concur in the Court's judgment reversing petitioner's conviction. I am convinced that Commissioner of Internal Revenue v. Wilcox, 327 U.S. 404, 66 S.Ct. 546, 90 L.Ed. 752, which is today overruled, was correctly decided on the basis of every controlling principle used in defining taxable income since the sixteenth Amendment's adoption.

The Chief Justice's opinion, although it correctly recites Wilcox's holding that 'embezzled money does not constitute taxable income to the embezzler in the year of the embezzlement' (emphasis added), fails to explain or to answer the true basis of that holding. Wilcox did not hold that embezzled funds may never constitute taxable income to the embezzler. To the contrary, it expressly recognized that an embezzler may realize a taxable gain to the full extent of the amount taken, if an when it ever becomes his. The applicable test of taxable income, i.e., the 'presence of a claim of right to the alleged gain,' of which Wilcox spoke, was but a correlative statement of the factor upon which the decision placed its whole emphasis throughout, namely, the 'absence of a definite, unconditional obligation to repay or return (the money).' 327 U.S. at page 408, 66 S.Ct. at page 549. In holding that this test was not met at the time of the embezzlement, the Wilcox opinion repeatedly stressed that the embezzler had no 'bona fide legal or equitable claim' to the embezzled funds, ibid.; that the victim never 'condoned or forgave the taking of the money and still holds him liable to restore it,' id., 327 U.S. at page 406, 66 S.Ct. at page 548; and that the 'debtor-creditor relationship was definite and unconditional.' Id., 327 U.S. at page 409, 66 S.Ct. at page 549. These statements all express the same basic fact-the fact which is emphasized most strongly in the opinion's conclusion explaining why the embezzler had not yet received taxable income: 'Sanctioning a tax under the circumstances before us would serve only to give the United States an unjustified preference as to part of the money which rightfully and completely belongs to the taxpayer's employer.' Id., 327 U.S. at page 410, 66 S.Ct. at page 550. (Emphasis added.)

However, Wilcox plainly stated that 'if the unconditional indebtedness is cancelled or retired taxable income may adhere, under certain circumstances, to the taxpayer.' 327 U.S. at page 408, 66 S.Ct. at page 549. More specifically, it recognized that had the embezzler's victim 'condoned or forgiven any part of the (indebtedness), the (embezzler) might have been subject to tax liability to that extent,' id., 327 U.S. at page 410, 66 S.Ct. at page 550, i.e., in the tax year of such forgiveness.

These statements reflect an understanding of, and regard for, substantive tax law concepts solidly entrenched in our prior decisions. Since our landmark case of United States v. Kirby Lumber Co., 284 U.S. 1, 52 S.Ct. 4, 76 L.Ed. 131, it has been settled that, upon a discharge of indebtedness by an event other than full repayment, the debtor realizes a taxable gain in the year of discharge to the extent of the indebtedness thus extinguished. Such gains are commonly referred to as ones realized through 'bargain cancellations' of indebtedness, and it was in this area, and indeed, in Kirby Lumber Co. itself, that the 'accession' theory or 'economic gain' concept of taxable income, upon which The Chief Justice's opinion today mistakenly relies, found its genesis. In that case, the taxpayer, a corporation, had reduced a portion of its debt, with a corresponding gain in assets, by purchasing its bonds in the open market at considerably less than their issue price. Mr. Justice Holmes, who wrote the Court's opinion, found it unnecessary to state the elementary principle that, so long as the bonds remained a fully enforceable debt obligation of the taxpayer, there could be no taxable gain. However, when the taxpayer retired the debt by purchasing the bonds for less than their face value, it 'made a clear (taxable) gain' and 'realized within the year an accession to income' in the amount of its bargain. 284 U.S. at page 3, 52 S.Ct. at page 4.

This doctrine has since been reaffirmed and strengthened by us, see e.g., Helvering v. American Chicle Co., 291 U.S. 426, 54 S.Ct. 460, 78 L.Ed. 891; Commissioner of Internal Revenue v. Jacobson, 336 U.S. 28, 69 S.Ct. 358, 93 L.Ed. 477, and by the lower federal courts in numerous decisions involving a variety of 'bargain cancellations' of indebtedness, as by a creditor's release condoning or forgiving the indebtedness in whole or in part, ^[2] or by the running of a Statute of Limitations barring the legal enforceability of the obligation. ^[3] In none of these cases has it been suggested that a taxable gain might be realized by the debtor at any time prior to the effective date of discharge, and as Wilcox recognized, there is no rational basis on which to justify such a rule where the debt arises through embezzlement.

An embezzler, like a common thief, acquires not a semblance of right, title, or interest in his plunder, and whether he spends it or not, he is indebted to his victim in the full amount taken as surely as if he had left a signed promissory note at the scene of the crime. Of no consequence from any standpoint is the absence of such formalities as (in the words of the prevailing opinion) 'the consensual recognition, express or implied, or an obligation to repay.' The law readily implies whatever 'consensual recognition' is needed for the rightful owner to assert an immediately ripe and enforceable obligation of repayment against the wrongful taker. These principles are not 'attenuated subtleties' but are among the clearest and most easily applied rules of our law. They exist to protect the rights of the innocent victim, and we should accord them full recognition and respect.

The fact that an embezzler's victim may have less chance of success than other creditors in seeking repayment from his debtor is not a valid reason for us further to diminish his prospects by adopting a rule that would allow the Commissioner of Internal Revenue to assert and enforce a prior federal tax lien against that which 'rightfully and completely belongs' to the victim. Commissioner of Internal Revenue v. Wilcox, supra, 327 U.S. at page 410, 66 S.Ct. at page 550. The Chief Justice's opinion quite understandably expresses much concern for 'honest taxpayers,' but it attempts neither to deny nor justify the manifest injury that its holding will inflict on those honest taxpayers, victimized by embezzlers, who will find their claims for recovery subordinated to federal tax liens. Statutory provisions, by which we are bound, clearly and unequivocally accord priority to federal tax liens over the claims of others, including 'judgment creditors.' ^[4]

However, if it later happens that the debtor-creditor relationship between the embezzler and his victim is discharged by something other than full repayment, such as by the running of a Statute of Limitations against the victim's claim, or by a release given for less than the full amount owed, the embezzler at that time, but not before, will have made a clear taxable gain and realized 'an accession to income' which he will be required under full penalty of the law to report in his federal income tax return for that year. No honest taxpayer could be harmed by this rule.

The inherent soundness of this rule could not be more clearly demonstrated than as applied to the facts of the case before us. Petitioner, a labor union official, concededly embezzled sums totaling more than $738,000 from the union's funds, over a period extending from 1951 to 1954. When the shortages were discovered in 1956, the union at once filed civil actions against petitioner to compel repayment. For reasons which need not be detailed here, petitioner effected a settlement agreement with the union on July 30, 1958, whereby, in exchange for releases fully discharging his indebtedness, he repaid to the union the sum of $13,568.50. Accordingly, at least so far as the present record discloses, petitioner clearly realized a taxable gain in the year the releases were executed, to the extent of the difference between the amount taken and the sum restored. However, the Government brought the present action against him, not for his failure to report this gain in his 1958 return, but for his failure to report that he had incurred 'income' from-actually indebtedness to-the union in each of the years 1951 through 1954. It is true that the Government brought a criminal evasion presecution rather than a civil deficiency proceeding against petitioner, but this can in no way alter the substantive tax law rules which alone are determinative of liability in either case.

There can be no doubt that until the releases were executed in 1958, petitioner and the union stood in an absolute and unconditional debtor-creditor relationship, and, under all of our relevant decisions, no taxable event could have occurred until the indebtedness was discharged for less than full repayment. Application of the normal rule in such cases will not hinder the efficient and orderly administration of the tax laws, any more than it does in other situations involving 'bargain cancellations' of indebtedness. More importantly, it will enhance the creditor's position by assuring that prior federal tax liens will not attach to the subject of the debt when he seeks to recover it.

Notwithstanding all of this, The Chief Justice's opinion concludes that there is no difference between embezzled funds and 'gains' from other 'illegal sources,' and it points to the fact that Congress, in its 1916 revision of the 1913 Income Tax Act, omitted the word 'lawful' in describing businesses whose income was to be taxed. The opinion then cites United States v. Sullivan, 274 U.S. 259, 47 S.Ct. 607, 71 L.Ed. 1037, in which it was held that, under the revised statute, gains from illicit traffic in liquor must be reported in gross income, since there is no 'reason why the fact that a business is unlawful should exempt it from paying the taxes that if lawful it would have to pay.' Id., 274 U.S. at page 263, 47 S.Ct. at page 607. (Emphasis added.) That theory has been the primary basis for taxing 'unlawful gains of many kinds' which the prevailing opinion today recites, such as black market profits, gambling proceeds, money derived from the sale of unlawful insurance policies, etc. ^[5] For, even if lawful, the gains from such activities would clearly not be exempted from taxation. However, as applied to embezzled funds, the holding in Sullivan contradicts, rather than supports, the Court's conclusion today. Obviously, embezzlement could never become 'lawful' and still retain its character. If 'lawful,' it would constitute nothing more than a loan, or possibly a gift, to the 'embezzler,' neither of which would produce a taxable gain to him.

There is still another obvious and important distinction between embezzlement and the varieties of illegal activity listed by the prevailing opinion-one which clearly calls for a different tax treatment. Black marketeering, gambling, bribery, graft and like activities generally give rise to no legally enforceable right of restitution-to no debtorcreditor relationship which the law will recognize. ^[6] Condemned either by statute or public policy, or both, such transactions are void ab initio. Since any consideration which may have passed is not legally recoverable, its recipient has realized a taxable gain, an 'accession to in come,' as clearly as if his 'indebtedness' had been descharged by a full release or by the running of a Statute of Limitations. As we have already shown at length, quite the opposite is true when an embezzlement occurs; for then the victim acquires an immediately ripe and enforceable claim to repayment, and the embezzler assumes a legal debt equal to his acquisition.

To reach the result that it does today, The Chief Justice's opinion constructs the following theory for defining taxable income:

'When a taxpayer acquires earnings, lawfuly or unlawfully, without the consensual recognition, express or implied, of an obligation to repay and without restriction as to their disposition, 'he has received income which he is required to return, even though it may still be claimed that he is not entitled to retain the money, and even though he may still be adjudged liable to restore its equivalent.' North American Oil Consolidated v. Burnet, supra, 286 U.S. 417, at page 424, 52 S.Ct. 613, at page 615, 76 L.Ed. 1197. In such case, the taxpayer has 'actual command over the property taxed-the actual benefit for which the tax is paid,' Corliss v. Bowers, supra. This standard brings wrongful appropriations within the broad sweep of 'gross income'; it excludes loans. When a law-abiding taxpayer mistakenly receives income in one year, which receipt is assailed and found to be invalid in a subsequent year, the taxpayer must nonetheless report the amount as 'gross income' in the year received. United States v. Lewis, supra; Healy v. Commissioner, supra.'

This novel formula finds no support in our prior decisions, least of all in those which are cited. Corliss v. Bowers, 281 U.S. 376, 50 S.Ct. 336, 74 L.Ed. 916, involved nothing more than an inter vivos trust created by the taxpayer to pay the income to his wife. Since he had reserved the power to alter or abolish the trust at will, its income was taxable to him under the express provisions of § 219(g), (h) of the Revenue Act of 1924, 26 U.S.C.A. §§ 166, 167. North American Oil Consolidated v. Burnet, 286 U.S. 417, 52 S.Ct. 613, 615, 76 L.Ed. 1197, is the case which introduced the principle since used to facilitate uniformity and certainty in annual tax accounting procedure, i.e., that a taxpayer must report in gross income, in the year in which received, money or property acquired under a 'claim of right'-a colorable claim of the right to exclusive possession of the money or property. Thus, in its complete form, the sentence in North American Oil from which the above-quoted fragment was extracted reads: 'If a taxpayer receives earnings under a claim of right and without restriction as to its (sic) disposition, he has received income which he is required to return, even though it may still be claimed that he is not entitled to retain the money, and even though he may still be adjudged liable to restore its equivalent.' Id., 286 U.S. at page 424, 52 S.Ct. at page 615. (Emphasis added.) But embezzled funds, like stolen property generally, are not 'earnings' in any sense and are held without a vestige of a colorable claim of right; they constitute the principal of a debt. Of no significance whatever is the formality of 'consensual recognition, express or implied' of an obligation to repay. By substituting this meaningless abstraction in place of the omitted portion of the North American Oil test of when a receipt constitutes taxable income, the prevailing opinion today goes far beyond overruling Wilcox-it reduces a substantial body of tax law into uncertainty and confusion. The above-cited case of United States v. Lewis, 340 U.S. 590, 71 S.Ct. 522, 95 L.Ed. 560, decided 19 years after North American Oil, demonstrates the truth of this. For there we said:

'The 'claim of right' interpretation of the tax laws has long been used to give finality to (the accounting) period, and is not deeply rooted in the federal tax system. * * * We see no reason why the Court should depart from this well-settled interpretation merely because it results in an advantage or disadvantage to a taxpayer.' 340 U.S. at page 592, 71 S.Ct. at page 523.

The same principle was reiterated and applied in Healy v. Commissioner, 345 U.S. 278, 73 S.Ct. 671, 97 L.Ed. 1007.

The supposed conflict between Wilcox and Rutkin, upon which The Chief Justice's opinion seeks to justify its repudiation of Wilcox, ^[7] has been adequately treated in the opinion of Mr. Justice BLACK, and I agree with him that those cases were fully intended to be, and are, reconcilable, both on their controlling facts and applicable law. If the unnecessarily broad language used in the Rutkin opinion has misled any of the lower federal courts in their understanding of the principles underlying Wilcox, we should clarify their understanding at this time, and continue our adherence to 'a prior doctrine more embracing in its scope, intrinsically sounder, and verified by experience.' Helvering v. Hallock, 309 U.S. 106, 119, 60 S.Ct. 444, 451, 84 L.Ed. 604.

Notes

1  'A proper regard for its genesis, as well as its very clear language, requires also that (the Sixteenth) Amendment shall not be extended by loose construction * * *. Congress cannot by any definition (of income) it may adopt conclude the matter, since it cannot by legislation alter the Constitution, from which alone it derives its power to legislate, and within whose limitations alone that power can be lawfully exercised.' Eisner v. Macomber, 252 U.S. 189, 206, 40 S.Ct. 189, 193, 64 L.Ed. 521.

2  See, e.g., Spear Box Co. v. Commissioner, 2 Cir., 182 F.2d 844; Helvering v. Jane Holding Corp., 8 Cir., 109 F.2d 933; Pacific Magnesium, Inc., v. Westover, D.C.S.D.Cal., 86 F.Supp. 644.

3  See, e.g., Schweppe v. Commissioner, 9 Cir., 168 F.2d 284; North American Coal Corp. v. Commissioner, 6 Cir., 97 F.2d 325; Securities Co. v. United States, D.C.S.D.N.Y., 85 F.Supp. 532.

4  26 U.S.C. §§ 6321-6323, 6331, 26 U.S.C.A. §§ 6321-6323, 6331; Bankruptcy Act, § 64, sub. a, 11 U.S.C. § 104, sub, a, 11 U.S.C.A. § 104, sub. a. Moreover, R.S. § 3466 (1975), now codified in 31 U.S.C. § 191, 31 U.S.C.A. § 191, pertaining to state insolvency proceedings against debtors, commands that 'the debts due to the United States shall be first satisfied.' We long ago established that the term 'debts' in this statute includes delinquent federal taxes. Price v. United States, 269 U.S. 492, 499-500, 46 S.Ct. 180, 181, 70 L.Ed. 373. And even though the tax claim of the Government may be only a general lien, with notice thereof not yet filed in the proper local office pursuant to 26 U.S.C. § 6323, 26 U.S.C.A. § 6323, we have held that it must be accorded priority over the claims of all prior general lienholders, under R.S. § 3466, 31 U.S.C. § 191, 31 U.S.C.A. § 191. United States v. City of New Britain, 347 U.S. 81, 84-85, 74 S.Ct. 367, 369-370, 98 L.Ed. 520; United States v. Gilbert Associates, 345 U.S. 361, 366, 73 S.Ct. 701, 704, 97 L.Ed. 1071; United States v. State of Texas, 314 U.S. 480, 488, 62 S.Ct. 350, 354, 86 L.Ed. 356. See Mertens, Law of Federal Income Taxation, § 12.103, note 67; Id., §§ 54.10-54.56.

5  See cases cited in Rutkin v. United States, 343 U.S. 130, 137, note 8, 72 S.Ct. 571, 575, 96 L.Ed. 833. See also United States v. Bruswitz, 2 Cir., 219 F.2d 59; Steinberg v. United States, 2 Cir., 14 F.2d 564; Barker v. United States, 26 F.Supp. 1004, 88 Ct.Cl. 468; Silberman v. Commissioner, 44 B.T.A. 600.

6  Restatement, Contracts, § 598; 6 Corbin, Contracts, §§ 1373 et seq. (1951). That the rule applies even as to 'unlawful insurance polices' is undoubted. Patterson, Essentials of Insurance Law (2d ed. 1957), § 43, at 186.

7  I cannot agree with The Chief Justice's assertion that Wilcox has been 'thoroughly devitalized' by Rutkin. See, e.g., the recent case of United States v. Peelle, D.C.E.D.N.Y.1958, 159 F.Supp. 45. There the Government sought to enforce liens for federal income taxes claimed to be due on items of 'income' aggregating $678,461.22, which the taxpayer had embezzled from his corporate employer during the years 1945 through 1949. The items in question consisted of customers' payments intended for the corporation, and had been embezzled by the taxpayer and kept by him in secret bank accounts. In 1951 and 1952, he discharged his indebtedness by making full restitution of the embezzled funds to the corporation. The corporation, which used the accrual method of accounting, paid deficiencies which the Government determined in its 1945-1949 income tax returns, based on its accrued right to receive the embezzled customers' payments in those years. Not satisfied with this, the Government took the position that the payments were taxable twice during the same years-once to the corporation when it accrued the right to receive them, and again to the embezzler when he diverted them into the secret bank accounts. Had this effort at double taxation succeeded, the Government's combined tax claims would have been far in excess of the amount being taxed.

In rejecting the Government's argument that the embezzler received taxable income at the time of the embezzlements, the District Court relied wholly upon the decision which the Court today overrules, Commissioner of Internal Revenue v. Wilcox, supra.