Detailed Explanation of Income Source
My original submission on the Four Tax Source subject resulted in considerable response that
has been helpful in further unraveling Internal Revenue Code taxing authority, and approaches
that can be used to attack various situations. Thurston Bell, Larken Rose and Sean O’Hara made
some of the more noteworthy criticisms and supplemental suggestions. Due largely to Sean’s
contribution, I’ve revamped the Four Tax Source for use with the 1040, 1040X or other return
someone might have need to file either to satisfy special circumstance or recover whatever has
been paid in through payroll deduction or whatever.
Of particular note, Sean brought the Form 8275 to my attention. The memorandum that follows is
intended to serve as an attachment for “Detailed Explanation” (Parts II & IV). The Form 8275 is
then attached to whatever return is filed much as the various Form 1040 schedules. The
memorandum cites “substantial authority” and “good faith and reasonable cause” standards cited
in regulations. These standards should avoid arbitrary penalties.
Originally I intended to use the Four Tax Source memorandum to support the Form 9452 Filing
Assistance Program worksheet. This particular worksheet is for your own records, it isn’t
designed to send to IRS, but if you have it in your records, it will support your conclusion that you
aren’t required to keep books and records, file returns and the like. The memorandum can be
easily adapted to support the Form 9452 worksheet, then in the event you receive a CP-515
notice or something to that effect notifying you that you haven’t filed a return, the worksheet and
memorandum can be returned with a short cover letter.
Thurston uses the Form 4852 to amend or correct erroneous W-2 or 1099 reports. I haven’t gone
through the exercise of completing one, but cursory review of the form suggests that it is the
proper form for that purpose.
All three forms, and instructions for each, can be downloaded from the IRS web site.
Thurston made a spirited argument relating to gross income “source” as being the sole issue, but
at that point, hadn’t taken information from the Treasury Financial Manual into account. As it turns
out, the U.S. Supreme Court distinguishes between “income” and “wages”, too, so I strengthened
the original position without necessarily doing injury to the “source” position Thurston, Larken,
and others have done such a good job on. There is an amount of reconciliation when we grasp
implications of insular possession “source” at 26 CFR § 1.861-8(f)(1)(D)-(H), and the drug link (26
U.S.C. § 7327; 26 CFR § 403) via the China Trade Act corporations at § 1.871-8(f)(1)(I).
It is useful to have a firm grasp of underlying Federalism principles. In general, the scheme
applies to (1) government personnel (privilege tax, etc.), and (2) territory and insular possessions
of the United States, exclusive of States of the Union. This is the basic distinction between the
Chapter 1 income tax (income from insular possessions and foreign sources), and Chapter 24
“income” tax on wages (the “public money” privileges, including “credit”).
Also, it helps to understand that the term “income tax” is a categorical, not a specific tax
designation. All “income tax” is excise tax. Normal tax, inheritance tax, Social Security tax, tax on
wages, tax on gambling winnings, etc., are all income taxes. The tax may issue against
designated “items” of income from specified “sources” of income. Government employment is the
source designated by Chapter 24 of the I.R.C. I’m currently of the opinion that 26 CFR § 1.8618(f)(1)(D)-(H) further restricts the reach of I.R.C. §§ 3401 et seq., so I have leanings in Thurston
and Larken’s direction, but I’m inclined toward pragmatics for the moment. As a first step, we
need to concentrate on extricating private enterprise from IRS tyranny.
The various critiques, even if some were a tad sharp, proved useful.
Continuing comment is welcome.
Dan Meador
Detailed Explanation of Income Source
(Form 8275 Part IV Supplement)
Material Facts Relating to Income
The following material facts are applicable to this explanation of income source:
1. I am a citizen and resident of Oklahoma, which is a State of the Union.
2. All earnings and other income for the calendar year originated in Oklahoma or one of the
other States of the Union.
3. I did not have foreign source income, income from the District of Columbia, or income from
an insular possession of the United States.
4. At no time was I employed by United States Government, the government of the District of
Columbia, or the government of an insular possession of the United States.
5. No income was derived from a public works contract with United States Government (40
U.S.C. § 270a).
6. No income was derived from a China Trade Act corporation.
Basis of Determination
Determination for disclosure purposes has been made by subjecting material facts above to a
review of Internal Revenue Code taxing authority. This explanation is intended to comply with the
substantial authority standard at 26 CFR § 1.6662-1(d):
“(d) Substantial authority -- (1) Effect of having substantial authority. If there is substantial
authority for the tax treatment of an item, the item is treated as if it were shown properly on the
return for the taxable year in computing the amount of the tax shown on the return. Thus, for
purposes of section 6662(d), the tax attributable to the item is not included in the understatement
for that year. (For special rules relating to tax shelter items see § 1.6662-4(g).)
“(2) Substantial authority standard. The substantial authority standard is an objective standard
involving an analysis of the law and application of the law to relevant facts. The substantial
authority standard is less stringent than the more likely than not standard (the standard that is
met when there is a greater than 50-percent likelihood of the position being upheld), but more
stringent than the reasonable basis standard as defined in § 1.6662-3(b)(3). The possibility that a
return will not be audited or, if audited, that an item will not be raised on audit, is not relevant in
determining whether the substantial authority standard (or the reasonable basis standard) is
satisfied. Standards of good faith and reasonable cause must be applied as due diligence effort
is being made to comply with law. These standards are set out at 26 CFR § 1.6664-4(a):
“(a) In general. No penalty may be imposed under section 6662 with
respect to any portion of an underpayment upon a showing by the taxpayer
that there was reasonable cause for, and the taxpayer acted in good
faith with respect to, such portionÖ”
Income Sources Subject to Federal Taxing Authority
This explanation briefly treats the four “sources” of income that might be construed as reportable
and therefore taxable “gross income”. The four are as follows: The “gross income” defined at § 61
of the Internal Revenue Code (Chapter 1), self-employment income in Chapter 2, the family of
social welfare taxes in Chapter 21, and Federal personnel tax in Chapter 24.
These taxes all fall in the general category of “income tax”, which is a general classification, not a
specific tax. On page 2580 of the Congressional Record-House, for March 27, 1943, Mr. F. Morse
Hubbard, a former legislative draftsman in the Treasury Department, provided the following
definition of income taxes:
“The income tax is, therefore, not a tax on income as such. It is an excise tax with respect to
certain activities and privileges, which is measured by reference to the income which they
produce. The income is not the subject of the tax: it is the basis for determining the amount of
tax.”
Since income tax is an excise rather than a direct tax, it obviously does not apply to direct return
from enterprise necessary to provide a living, but only to interest, rents, and other forms of profit,
or to enterprise construed as a privilege rather than a right. This is made clear by 1945 Treasury
regulation 29.21-1:
“Sec. 29.21-1 Meaning of net income.
“The tax imposed by chapter 1 is upon income. Neither income exempted by
statute or fundamental law, nor expenses incurred in connection
therewith, other than interest, enter into the computation of net income
as defined by section 21 [now I.R.C. § 62]Ö”
Where the four income “sources” treated in this memorandum are concerned, only the
government personnel tax in Chapter 24 of the Internal Revenue Code is potentially applicable in
States of the Union. In particular, the income tax in Chapter 1 of the Code is applicable only to
nonresident aliens and foreign corporations with United States source income.
Where the Chapter 1 income tax is concerned, the “source” of “gross income” (I.R.C. § 61)
determines whether or not any given “item” of income is taxable. The cross reference at I.R.C. §
61 is as follows (Copied & pasted from the 1996 edition of the U.S.C. distributed by the
Government Printing Office):
“CROSS REFERENCES
Capital gains and losses, see section 1201 et seq. of this title. Guaranteed payments to partner
for services or use of capital considered as made to one not member of partnership for purposes
of this section, see section 707 of this title.
Income from sources Within the United States, see section 861 of this title.
Without the United States, see section 862 of this title.”
The gross income “source” for Chapter 1 of the Internal Revenue Code is determined in Treasury
regulations by 26 CFR § 1.861-8(f)(1) for citizens and residents of the United States, including
domestic corporations. Other than the following applications, Chapter 1 income tax applies only to
United States “source” income for nonresident aliens and foreign corporations. Regulation 1.8618(f)(1) determines Chapter 1 and related gross income “source” for citizens and residents of the
United States follows:
“The operative sections of the Code which require the determination of taxable income of the
taxpayer from specific sources or activities and which gives rise to statutory groupings to which
this section is applicable include the sections described below.
(i)
(ii)
(iii)
(iv)
Overall limitation to the foreign tax creditÖ
[Reserved]
DISC and FSC taxable incomeÖ [international and foreign sales corporations]
Effectively connected taxable income. Nonresident alien individuals and foreign corporations
engaged in trade or business within the United
StatesÖ
(v) Foreign base company incomeÖ
(vi) Other operative sections. The rules provided in this section also apply in determining—
(A) The amount of foreign source itemsÖ
(B) The amount of foreign mineral incomeÖ
(C) [Reserved]
(D) The amount of foreign oil and gas extraction incomeÖ
(E) (deals with Puerto Rico tax credits)
(F) (deals with Puerto Rico tax credits)
(G) (deals with Virgin Islands tax credits)
(H) The income derived from Guam by an individualÖ
(I) (deals with China Trade Act corporations)
(J) (deals with foreign corporations)
(K) The amount of income from the insurance of U.S. risksÖ
(L) (deals with countries subject to international boycott)
(M) (deals with the Merchant Marine Act of 1936)” [26 CFR §
1.861-8(f)(1)]”
Where taxes in Subtitle A of the Internal Revenue Code are concerned, an “employee” may
generally avoid these taxes with notice to an “employer” in compliance with the regulation for
“Claiming to be a person not subject to withholding” at 26 CFR § 1.1441-5(a) (1997 edition):
“(a)Individuals. For purposes of chapter 3 of the Code, an individual’s
written statement that he or she is a citizen or resident of the United
States may be relied upon by the payer of the income as proof that such
individual is a citizen or resident of the United StatesÖ”
The second authority is Chapter 2 self-employment tax (26 U.S.C. §§ 1401-1403).
Self-employment tax does not rely exclusively on the § 61 gross income definition. The
implementing regulation for § 1402 is in 26 CFR § 1, but there are no general application
regulations for §§ 1401 & 1403 (See Parallel Table of Authorities & Rules). While there are
regulations published in 26 CFR, Part 1 for other Chapter 2 sections, they have limited
geographical application, seemingly in the District of Columbia and insular possessions. This
chapter is strictly territorial as it is linked with the social welfare taxes of Chapter 21 at 26 U.S.C.
§§ 1401 & 1402(b). The definitions at 26 CFR § 31.3121(e)-6 govern geographical application.
Where the regulation for § 1402 is in 26 CFR Part 1, application is necessarily under Chapter 1,
i.e., is restricted by the gross income “source”, which includes income from foreign sources or
insular possessions only. See particularly, 26 CFR § 1.861-8(f)(1)(iv)(E)-(G) above.
The third potential tax is under Chapter 21 authority, the Social Security or employment tax and
attending taxes. This is geographically controlled by definitions at 26 CFR § 31.3121(e)-6 and 26
U.S.C. § 3121(e). Whether mandatory or voluntary, the Chapter 21 employment taxes can apply
to private enterprise within the geographical United States and a citizen of the geographical
United States, as defined at 26 CFR § 31.3121(e)-6(b). A citizen of the geographical United
States can presumably participate in the scheme regardless of where he lives. The definitions at
26 CFR § 31.3121(e)-6 are as follows:
“(a) When used in the regulations in this subpart, the term “State” includes the District of
Columbia, the Commonwealth of Puerto Rico, the Virgin Islands, the Territories of Alaska and
Hawaii before their admission as States, and (when used with respect to services performed after
1960) Guam and American Samoa.
“(b) When used in the regulations in this subpart, the term “United States”, when used in a
geographical sense, means the several states (including the Territories of Alaska and Hawaii
before their admission as States), the District of Columbia, the Commonwealth of Puerto Rico,
and the Virgin Islands. When used in the regulations in this subpart with respect to services
performed after 1960, the term “United States” also includes Guam and American Samoa when
the term is used in a geographical sense. The term “citizen of the United States” includes a
citizen of the Commonwealth of Puerto Rico or the Virgin Islands, and, effective January 1, 1961,
a citizen of Guam or American Samoa.”
Social welfare taxes are easy to dispose of. In 1935, the U.S. Supreme Court held the following
regarding Congress’ limitation of authority over activities within the Union, making conclusive
statements regarding government benefits programs:
“The catalogue of means and actions which might be imposed upon an employer in any business,
tending to the satisfaction and comfort of his employees, seems endless. Provision for free
medical attendance, nursing, clothing, food, housing, and education of children, and a hundred
other matters might with equal propriety be proposed as tending to relieve the employee of
mental strain and worry. Can it fairly be said that the power of Congress to regulate interstate
commerce extends to the prescription of any or all of these things? It is not apparent that they are
really and essentially related solely to the social welfare of the worker, and therefore remote from
any regulation of commerce as such? We think the answer is plain. These matters obviously lie
outside the orbit of congressional power.” (Railroad Retirement Board v. Alton Railroad Co.,295
U.S. 330, 55 S. Ct. 758 (1935))
Taxing one for the benefit of another is not among the constitutionally enumerated powers today
any more than it was in 1935, so per the Tenth Amendment, Congress does not have authority to
impose the social welfare scheme in States of the Union. As the definitions at 26 CFR §
31.3121(e)-6 demonstrate by application to Alaska and Hawaii prior to admission to the Union,
but not after, social welfare taxes in Chapter 21 of the Internal Revenue Code have never applied
to States of the Union and the American people in general.
The fourth potential tax source at issue is Federal personnel tax in Chapter 24, “employee”
defined at 26 U.S.C. § 3401© and “employer” at § 3401(d):
“© Employee. For purposes of this chapter, the term “employee” includes an officer, employee, or
elected official of the United States, a State, or any political subdivision thereof, or the District of
Columbia, or any agency or instrumentality of any one or more of the foregoing. The term
“employee” also includes an officer of a corporation.
“(d) Employer. For purposes of this chapter, the term “employer” means
the person for whom an individual performs or performed any service, of
whatever nature, as the employee of such personÖ”
The last two tax sources do not necessarily rely on the definition of gross income at I.R.C. § 61.
Generally speaking, they are the two presumed under auspices of IRS collection activity, as these
are the taxes linked to qualified State, county and municipal income taxes. If and when there is no
Federal income tax liability, there is no State income tax liability.
For purposes of withholding at the source, taxes in Chapters 21 & 24 of the Internal Revenue
Code are lumped together by the definition of “employment taxes” at 26 CFR § 31.6302-1(e):
“(e) Employment taxes defined. (1) For purposes of this section, the term “employment taxes”
means—
(i) The employee portion of the tax withheld under section 3102;
(ii) The employer tax under section 3111;
(iii) The income tax withheld under sections 3402 and 3405, except income tax withheld with
respect to payments made after December 31, 1993, on the following—
(A) Certain gambling winnings under section 3402(q);
(B) Retirement pay for service in the Armed Forces of the United States under section 3402;
(C) Certain annuities described in section 3402(o)(1)(B); and
(D) Pensions, annuities, IRAs, and certain other deferred income under section 3405; and
(iv) The income tax withheld under section 3406, relating to backup withholding with respect to
reportable payments made before January 1, 1994.
(2) The term “employment taxes” does not include taxes with respect to Chapter 24 wages for
domestic service in a private home of the employer, unless the employer is otherwise required to
file a Form 941 under § 31.6011(a)(4) or (5). In the case of employers paying advance earned
income credit amounts, the amount of taxes required to be deposited shall be reduced by
advance amounts paid to employees. Also, see § 31.6302-3 concerning a taxpayer’s option with
respect to payments made before January 1, 1994, to treat backup withholding amounts under
section 3406 separately.”
The distinction between the Chapter 1 income tax and wages, i.e., two different taxes, or tax
sources, is recognized in several court cases, with Commissioner v. Kowalski, 434 U.S. 77 (1977)
among them:
“The income tax is imposed on taxable income, 26 U.S.C. § 1. Generally, this is gross income
minus allowable deductions. 26 U.S.C. § 63(a). Section 61(a) defines as gross income “all
income from whatever source derived” including, under § 61(a)(1), “[c]ompensation for services.”
The withholding tax, in some contrast, is confined to wages, § 3402(a), and § 3401(a) defines as
“wages,” all remuneration (other than fees paid to a public official) for services performed by an
employee for his employer, including the cash value of all remuneration paid in any medium other
than cash.
“The two concepts—income and wages—obviously are not necessarily the same. Wages usually
are income.”
The Department of Treasury has been helpful in unraveling the longstanding income tax scam via
Internet. Possibly the greatest treasure posted on the Department of the Treasury network is the
Treasury Financial Manual, produced by the Financial Management Service. Volume I, Part 3,
Chapter 4000 prescribes the process by which Federal employee taxes are to be collected by the
agency, then transferred to IRS:
“Section 4010 - SCOPE AND APPLICABILITY
This chapter prescribes procedures for (1) withholding and depositing Federal income, social
security, and medicare taxes on wages paid to civilian and military employees; (2) for filing tax
returns with the Internal Revenue Service (IRS); and (3) for filing income tax statements with the
Social Security Administration (SSA).
“For information beyond the scope of this chapter, refer to IRS Publication 15, Circular E,
Employer’s Tax Guide, or an IRS office. Circular E describes employer tax responsibilities;
explains withholding, depositing, and reporting requirements; and paying taxes. It explains the
forms your employees must use and those you must send to the IRS and SSA.
“Withheld Federal taxes will be transferred to the IRS using the FEDTAX application of the
Government-On-line Accounting Link System (GOALS). Any Federal agency that has not been
established on FEDTAX should contact GOALS Marketing, Financial Management Service
(FMS), on FTS 874-8788 or 202-874-8788.”
Withholding of qualified State, county and local taxes, in accordance with 31 CFR § 215, is then
prescribed in Volume I, Part 3, Chapter 5000, here in part:
“Section 5010 - SCOPE AND APPLICABILITY
“This chapter provides instructions for withholding State, city, or county income taxes when an
agreement has been reached between a State, city, or county and the Secretary of the Treasury.
Agreements between the Secretary of the Treasury and States, cities, or counties prescribe how
Federal agencies withhold State, city, or county income or employment taxes from the
compensation of Federal employees and Armed Forces members. (See 31 CFR 215 at
Appendix 1).
“A list of States that have entered into agreements, and designated State tax offices to receive
inquiries, is included as Appendix 2. A list of cities and counties that have entered into
agreements, the type of tax to be withheld for each city or county, and the designated city or
county tax offices to receive inquiries is included as Appendix 3. A list of States, cities, and
counties with other-than-standard agreements is at Appendix 4.”
Administration of I.R.C. Chapter 24 tax, qualified State, county and local taxes, and other Federal
personnel obligations, is under authority of 5 U.S.C. §§ 5512-5520a, not generally or exclusively
under Subtitle F of the Internal Revenue Code. The Internal Revenue Service should never come
into direct contact with employees except on the rare occasion an employee would file for a
special refund for overpayment of employment tax in the event he is employed by two or more
foreign employers in the course of the year, or he is due a refund from the employer and the
employer refuses to pay. Normally a Federal employer is responsible for collecting
underpayments or refunding overpayments to the employee, and is supposed to repay taxes
erroneously collected from an employee. See 26 CFR § 31.6413(a)-1 in particular. In the event
an employee is employed by two or more foreign employers and happens to over-pay
employment tax, he may secure direct refunds by filing a Form 1040 return (See particularly 26
CFR §§ 31.6071(a)-1(a)(4) & 601.401(d)(4)), but the only other mandatory use of Form 1040
appears to be for withholding agents who withhold the Chapter 1 income tax from earnings of
nonresident aliens. This is set out in Treasury Decision 2313:
“Under the decision of the Supreme Court of the United States in the case of Brushaber v. Union
Pacific Railway Co., decided January 24, 1916, it is hereby held that income accruing to
nonresident aliens in the form of interest from the bonds and dividends on the stock of domestic
corporations is subject to the income tax imposed by the act of October 3, 1913. “
Note how in this case an “item” of income (interest) is subject to the income tax when paid to
nonresident aliens, because that is one of the legal “sources” of taxable income. Treasury
Decision 2313 continues:
“The responsible heads, agents, or representatives of nonresident aliens, who are in charge of
the property owned or business carried on within the United States, shall make a full and
complete return of the income therefrom on Form 1040, revised, and shall pay any and all tax,
normal and additional, assessed upon the income received by them in behalf of their nonresident
alien principals.”
Finally, the 1040 Form does not comply with Paperwork Reduction Act mandates as the OMB
number is not listed for any of the taxing and liability statutes for Chapters 1, 2, 21 & 24 as a
mandatory return, so the defense at 5 CFR § 1320.6(b) is absolute. IRS has no administrative or
judicial remedies; the defense can be raised at any time.
If the employee has a delinquent or defaulted liability to the United States, the employer is
supposed to try to work things out. If that fails, the General Accounting Office, as general agent of
the Treasury, is supposed to certify the obligation. If GAO, as general agent of the Treasury,
verifies an obligation yet the employee refuses to pay, the Attorney General, in his capacity as
Solicitor of the Treasury, may initiate litigation for collection (See 5 U.S.C. § 5512 & attending
notes). Litigation for collection of delinquent tax, as well as other obligations to the United States,
must proceed in compliance with the Federal Debt Collection Procedure Act in Chapter 176 of
Title 28 (28 U.S.C. §§ 3001, et seq.).
Requirements for the W-2 and 1099 are mentioned in various chapters of Volume I of the
Treasury Financial Manual, so these are copies of “employee” or contract agent returns, where
the “employer” is required to withhold, keep books and records, report, etc. The employer is
required to keep books and records, to withhold where applicable, to report and to pay whatever
tax is due. The W-2 is the employee’s copy of the applicable portion of an employer’s
consolidated return, and the 1099 is applicable to public works contracts with Federal agencies.
Virtually all Subtitle C administrative regulations, and Chapters 21 & 24 withholding requirements,
are in 26 CFR Part 31. An employee isn’t required to keep books & records, file returns, etc.,
except in special circumstance (See particularly, 26 CFR § 31.6001-1(d)). The employer is
responsible for increasing or decreasing withholding, making refunds, and initially determining
liability.
An additional liability under Chapter 21 & 24 may colorably be contracted where private
enterprise contracts public works. See 40 U.S.C. § 270a.
Appropriate IRS Corrective Procedure
Per I.R.C. § 6001(a), 26 CFR §§ 1.6001-1(d) & 31.6001-6, and Delegation Order No. 24, the
district director or another authorized officer may provide notice of what books and records I must
keep, and what returns I must file. Delegation Order No. 24 (Rev. 1), effective May 12, 1980,
authorizes the following officers to provide notice:
“The Assistant Commissioner (International) and District Directors of Internal Revenue are hereby
authorized to require any person, by notice served upon him, to keep such records as shall show
whether or not such person is liable for tax under the Internal Revenue Code of 1954.”
There is no provision for this authority to be redelegated to IRS personnel below district directors.
In the alternative, IRS personnel with appropriately delegated authority may disclose Internal
Revenue Code taxing and liability statutes, along with applicable regulations, for whatever
Internal Revenue Code taxing authority is applicable to me. All such notice will be verified and
under Internal Revenue Service seal (Rule 44, F.R.Civ.P. & Rule 902, Federal Rules of
Evidence).