In the previous installment of Huddleston Tax Weekly, brief reference was made to the case of Pollock v. Farmers’ Loan & Trust Company of 1895. The opinion in this case – which was a landmark decision in its time – held that the power granted by the Wilson-Gorman Tariff Act of 1894 to collect an income tax on interest, dividends and rents was unconstitutional. The opinion set forth in Pollock was effectively nullified by the sixteenth amendment, but if not for this amendment Pollock certainly would be regarded among the most important decisions in U.S. history. Given its significance as a historical matter, let’s look at the Pollock case in greater detail.
As we learned previously, the Wilson-Gorman measure imposed a 2 percent tax on income above $4,000. This tax was implemented in order to cover the deficit created from the reduced tariff rates put in place by the measure. After the measure was passed, the Farmers’ Loan and Trust Company (the defendant) announced to its shareholders that, in addition to paying the tax required by the law, it would furnish the names of the shareholders liable for the tax to the collector. Pollock (the plaintiff) owned only ten shares of stock in Farmers’ Loan, but he brought suit against the company to prevent it from paying the tax.
Article 1, Section 2, Clause 3 of the U.S. Constitution holds that direct taxes are permissible but they must be apportioned among the states of the union based on population. If a tax is found to be classifiable as direct, then it must contain a provision to be properly apportioned in accord with this rule.
The court (Supreme Court of the United States) ruled that the income tax imposed by the Wilson-Gorman act was a direct tax because of its substantial impact on personal property (i.e. stocks, bonds, etc.). Since it was a direct tax, it needed to be apportioned consistent with constitutional requirements. And because it was not apportioned in this manner it was invalid.
Pollock was an extremely important opinion because, in effect, it substantially curtailed the taxing power of the Congress. If every tax on income derived from property is regarded as a direct tax, then the rule of apportionment would need to be abandoned entirely to collect any tax other than excise taxes. This is precisely the function served by the sixteenth amendment: the sixteenth amendment holds that direct taxes need not be subject to the traditional rule of apportionment.
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