                        T.C. Memo. 2006-77



                      UNITED STATES TAX COURT



    KENNETH DAVID PERRY AND LINDA RUTH PERRY, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 619-04, 18226-04.           Filed April 18, 2006.



          Ps’ claimed net capital losses were disallowed to the
     extent they exceeded $3,000, on authority of sec. 1211(b),
     I.R.C. 1986.

          Held: This limitation does not prevent the taxes
     imposed by secs. 1 and 55, I.R.C. 1986, from being taxes on
     income within the meaning of the Sixteenth Amendment to the
     Constitution.


     Kenneth David Perry and Linda Ruth Perry, pro sese.

     Roger W. Bracken, for respondent.

                        MEMORANDUM OPINION

     CHABOT, Judge:   Respondent determined deficiencies in

individual income tax against petitioners in the amounts of
                                - 2 -

$2,465 for 2001 and $21,233.37 for 2003.1   On their 2003 income

tax return, petitioners claimed a $14,543.74 refund on account of

excess withholding.   Respondent acknowledged the prepayment, but

withheld refund or credit of this amount.   On brief, petitioners

renew their claim for refund.

     After concessions by petitioners, the issue for decision is

whether the $3,000 capital loss allowance limitation of section

1211(b) keeps the sections 1 and 55 taxes from being taxes on

income, within the meaning of the Sixteenth Amendment to the

Constitution.2

                            Background

     The instant cases were consolidated for trial, briefing, and

opinion.   They were submitted fully stipulated; the stipulations

and the stipulated exhibits are incorporated herein by this

reference.

     When the petitions were filed in the instant cases,



     1
       $252 of the 2003 determined deficiency is alternative
minimum tax under section 55; the remaining amount for 2003 and
the entire amount for 2001 are section 1 income tax.

     Unless indicated otherwise, all section and subtitle
references are to sections and subtitles of the Internal Revenue
Code of 1986 as in effect for the years in issue.
     2
       Initially, petitioners also disputed whether the Congress
intended the $3,000 limitation to apply to real economic losses.
However, on reply brief, petitioners specifically abandon the
Congressional intent issue and ask us to determine only “whether
Congress exceeded its power granted in Amendment XVI of the US
Constitution.” See infra note 4.
                                 - 3 -

petitioners resided in Fairfax, Virginia.

     Table 1 shows selected items from petitioners’ timely filed

income tax returns (Forms 1040) for 2001 and 2003.

                                Table 1

Item--Line on 2001 (2003) Form 1040          2001           2003

      7.    (7)     Wages                 $253,598.43    $267,398.35
      8a.   (8a)    Taxable interest           226.05         154.35
      9.    (9a)    Ordinary dividends         217.85         189.11
     13.    (13a)   Capital gain or
                     (loss)                 (9,256.63)   (60,641.96)
     33.    (34)    Adjusted gross income 244,785.70     207,099.85
     39.    (40)    Taxable income         221,055.33    179,709.47
     58.    (60)    Total tax               61,222.00     40,749.63
     59.    (61)    Withholding             57,196.78     55,293.37
     70.            Amount owed              4,025.22
    (70a)           Overpayment to be
                      refunded                             14,543.74

     In 2001, petitioners realized and recognized a long-term

capital loss in the amount of $9,256.63, as they claimed on their

2001 tax return.3    In 2003, petitioners realized and recognized a

net long-term capital loss of $60,641.96, as they claimed on

their 2003 tax return.

     In the notice of deficiency for each year, respondent

disallowed the claimed capital loss deduction for that year to

the extent the loss exceeded $3,000, and also made consequential

adjustments to itemized deductions and (for 2003) personal

exemption deductions.    Also, the 2003 adjustments resulted in a


     3
       The parties’ stipulation that the loss was 1 cent less
than our finding is evidently a typographical error, as shown by
their stipulations as to petitioners’ proceeds and adjusted
basis.
                                - 4 -

determination of a $252 alternative minimum tax.    Petitioners do

not contest the mathematical correctness of respondent’s

computations.

                              Discussion

1.   The Parties’ Contentions

      Respondent maintains that the Sixteenth Amendment to the

United States Constitution “permits Congress to impose ‘taxes on

incomes, from whatever source derived’.”   Further, “Congress,

within its sole discretion, may determine the extent to which, if

at all, taxpayers may claim deductions from income they are

required to report.”   Finally, respondent contends--

           Petitioners have not shown, however, as they
           must, that sections 165(f) and 1211(b)
           violate constitutional guarantees of due
           process and equal protection or breach the
           authority granted to the Congress pursuant to
           the Sixteenth Amendment to the Constitution.

      Petitioners respond that respondent’s references to

deductions miss the point that “a capital loss is an income item.

A capital loss is not a deductible expense item.”   By disallowing

that part of the loss that exceeds $3,000, petitioners contend,

respondent is taxing petitioners on “income that does not exist.

Petitioners believe that Section 1211(b) violates the power

granted Congress in the Sixteenth Amendment, and if the Court

agrees, it should rule accordingly.”

2.   Summary and Conclusion

      The Constitution does not require all income items to be
                               - 5 -

treated identically.   Capital gains and losses are treated

differently from other income items in several respects,

generally more favorably than most other income items.   The

section 1211(b) limitation does not cause the sections 1 and 55

taxes to fall outside the sweep of the Sixteenth Amendment.

      We agree with respondent’s conclusion.

3.   Analysis

      Article I, section 8, of the U.S. Constitution gives to the

Congress the “Power To lay and collect Taxes”.   Under sections 2

(cl. 3) and 9 (cl. 4) of article I, “direct” taxes must be

apportioned among the States in proportion to census populations.

The Sixteenth Amendment has the effect of overriding the direct-

tax-apportionment requirement with respect to “taxes on incomes,

from whatever source derived”.4   Section 61 provides as follows:


      4
       Thus, the Sixteenth Amendment is properly a limited
removal of a limited restriction on the Congress’s broad power to
tax income; the Sixteenth Amendment is not the source of the
power to tax income. See, e.g., Eisner v. Macomber, 252 U.S.
189, 205-206 (1920); Simmons v. United States, 308 F.2d 160, 166
n.21 (4th Cir. 1962); Penn Mutual Indemnity Co. v. Commissioner,
32 T.C. 653, 659-666 (1959), affd. 277 F.2d 16, 19-20 (3d Cir.
1960). As a result, even if a tax does not qualify as an income
tax, that merely leads to whether the tax in question is a
“direct” tax; if the tax in question is not a direct tax, then
the tax in question still does not have to be apportioned.

     Petitioners contend they should be allowed to deduct the
entire amounts of their realized and recognized capital losses,
in accordance with their tax returns. For petitioners to
prevail, they might have to persuade us of all the following:
(1) The limitation of section 1211(b) causes the sections 1 and
55 taxes to not be income taxes under the Sixteenth Amendment;
                                                   (continued...)
                               - 6 -

          SEC. 61. GROSS INCOME DEFINED.

               (a) General Definition.--Except as
          otherwise provided in this subtitle,
          [subtitle A, relating to income taxes] gross
          income means all income from whatever source
          derived, including (but not limited to) the
          following items:


                    (1) Compensation for services, including
               fees, commissions, fringe benefits, and similar
               items;
                    (2) Gross income derived from business;
                    (3) Gains derived from dealings in property;
                    (4) Interest;
                    (5) Rents;
                    (6) Royalties;
                    (7) Dividends;
                    (8) Alimony and separate maintenance
               payments;
                    (9) Annuities;
                    (10) Income from life insurance and endowment
               contracts;
                    (11) Pensions;
                    (12) Income from discharge of indebtedness;
                    (13) Distributive share of partnership gross
               income;
                    (14) Income in respect of a decedent; and
                    (15) Income from an interest in an estate or
               trust.

               (b)   Cross References.--

                    For items specifically included in gross
               income, see part II (sec. 71 and following). For



     4
      (...continued)
(2) the sections 1 and 55 taxes as limited by section 1211(b)
constitute direct taxes that must be apportioned; and (3) full
deductibility of capital losses is the preferred way to save the
entire income tax from invalidation.

     Because we hold that petitioners have failed to persuade us
as to the first of these three items, we do not explore the
second and third items.
                               - 7 -

                items specifically excluded from gross income,
                see part III (sec. 101 and following).

     A.   Different Categories of Income

     Nothing in the text of the constitutional provisions

requires all income categories to be treated identically, or

requires all income categories to be added together or offset, in

the case of losses in one or more categories.

     United States v. Hudson, 299 U.S. 498 (1937), was a suit for

refund of a 50-percent tax imposed on profits from transfers of

interests in silver bullion.   In the course of the Supreme

Court’s analysis, the Court held that this was an income tax and

further held as follows (299 U.S. at 500):

             It is not material that such profit is
           taxed, along with other gains, under the
           general income tax law, for Congress has
           power to impose an increased or additional
           tax if satisfied there is need therefor.
           Patton v. Brady, 184 U.S. 608, 620-622.

     Wilson Milling Co. v. Commissioner, 138 F.2d 249 (8th Cir.

1943), affg. 1 T.C. 389 (1943), involved an “unjust enrichment

tax” imposed by the Revenue Act of 1934, ch. 277, 48 Stat. 680.

The Circuit Court of Appeals dealt with the taxpayer’s

constitutional challenge as follows (138 F.2d at 251):

                But the petitioner asserts that Congress
           was without power to impose an unjust
           enrichment tax upon a person in a year when
           his operations as a whole resulted in a loss,
           which is to say, in effect, that Congress, in
           such a situation, may not segregate a
           particular type of income and impose a
           special tax upon it. The Supreme Court,
                               - 8 -

           however, has held that Congress may enact a
           special income tax act and “impose an
           increased or additional tax” upon certain
           profits, although they are also taxable under
           the general income tax law. United States v.
           Hudson, 299 U.S. 498, 500 * * *. It is our
           opinion that, since Congress may impose an
           additional tax upon a particular type of
           income received by a taxpayer, it may do so
           regardless of whether or not his operations
           as a whole for the entire taxable year result
           in a profit taxable under the provisions of
           the general income tax law. * * *

     Consistent with the foregoing, under present law many

categories of income are treated differently from other

types of income.   For example, wages (sec. 61(a)(1)) received

with respect to most kinds of employment are subject to taxes

under section 3101 (F.I.C.A. taxes), in addition to the section 1

taxes on income.   Self-employment income (sec. 61(a)(2)) is

subject to taxes under section 1401 (self-employment taxes), in

addition to the section 1 taxes on income.   Premature

distributions from certain types of annuities (sec. 61(a)(9)) and

retirement arrangements (sec. 61(a)(11)) are subject to

additional taxes under several subsections of section 72.    In

each of these instances, the base of the specially taxed category

of income is not reduced by losses from other categories of

income.

     B.   Capital Gains and Losses

     Section 1 imposes income taxes on individuals.   Over the

years, section 1(h) has provided limitations of various sorts on
                                  - 9 -

the income tax as applied to net capital gains (see sec.

61(a)(3)), such that the marginal tax rates on net capital gains

ordinarily are less than the marginal tax rates on other types of

income.    More recently, section 1(h)(11) has provided similar

beneficial treatment to “qualified dividend income”.     See sec.

61(a)(7).

     Section 1655 provides generally for the treatment of losses



     5
         Section 165 provides in pertinent part as follows:

     SEC. 165. LOSSES.
                 (a) General Rule.--There shall be
               allowed as a deduction any loss
               sustained during the taxable year
               and not compensated for by
               insurance or otherwise.

               *      *     *     *       *   *     *

                     (c) Limitation on Losses of
                   Individuals.--In the case of an
                   individual, the deduction under
                   subsection (a) shall be limited
                   to--
                             (1) losses incurred in a
                        trade or business;
                             (2) losses incurred in
                        any transaction entered into
                        for profit, though not
                        connected with a trade or
                        business; and

               *      *     *     *       *   *     *

                     (f) Capital Losses.--Losses from
                   sales or exchanges of capital
                   assets shall be allowed only to the
                   extent allowed in sections 1211 and
                   1212.
                                - 10 -

in determining the base for the section 1 income tax.    Section

165 limits the allowance of capital losses to what is allowed in

sections 1211 and 1212.

     Section 1211(b) allows, for individuals, capital losses only

to the extent of capital gains, plus no more than $3,000.6

     Section 1211(a) provides a much more limited capital loss

allowance for corporations.    Section 1212 provides for capital

loss carrybacks and carryovers; those rules are in general more

generous to corporations than to individuals.    Respondent noted

petitioners’ eligibility for capital loss carryovers treatment;

petitioners do not claim eligibility for carryback treatment.

     As a result of the foregoing, although capital gains and

losses are thrown into the mix of income categories that result


     6
         Section 1211(b) provides as follows:

                  SEC. 1211. LIMITATION ON CAPITAL
                  LOSSES.

              *     *     *     *        *   *       *

                    (b) Other Taxpayers.--In the case
                  of a taxpayer other than a
                  corporation, losses from sales or
                  exchanges of capital assets shall
                  be allowed only to the extent of
                  the gains from such sales or
                  exchanges, plus (if such losses
                  exceed such gains) the lower of--
                       (1) $3,000 ($1,500 in the case
                    of a married individual filing a
                    a separate return), or
                       (2) the excess of such losses
                    over such gains.
                               - 11 -

in “taxable income”, for many purposes capital gains and losses

are treated differently from other categories of income.

     It is apparent from the foregoing that over the decades the

Congress has chosen to treat capital gains and losses differently

from other categories of income; this category of income has been

only partially integrated into the section 1 ground rules.

     C.   “Income That Does Not Exist”

     Petitioners claim that the effect of the $3,000 loss

limitation is to tax them on “income that does not exist.”    They

are mistaken.    Petitioners are being taxed under section 1 only

on the aggregate of the other categories of income that they in

fact realized, recognized, and reported--their income that does

exist.    Supra table 1.

     The tax treatment of capital losses has varied over the

years.    As discussed in Davis v. United States, 87 F.2d 323 (2d

Cir. 1937), section 23(r) of the Revenue Act of 1932, ch. 209, 47

Stat. 169, 183, allowed losses from the sale or exchange of

stocks and bonds held for less than 2 years only to the extent of

gains from the sale of such securities.    The taxpayer in Davis

had $13,285 of what we now would call short-term capital losses,

which was greater than the amount of his net taxable income.    87

F.2d at 324.    The taxpayer contended that, as a result, he did

not have net income for the taxable year, so that his “net

taxable income” was not income, and thus the tax on his net
                                 - 12 -

taxable income was not a Sixteenth Amendment-permitted income

tax.    87 F.2d at 324-325.

       The Circuit Court of Appeals analyzed the situation as

follows (87 F.2d at 325):

                 While the computation of income is made
            with due and necessary regard to periods of
            time, which are established years either
            calendar or fiscal, it cuts altogether too
            fine to say that true, and therefore taxable,
            income can only be ascertained by putting
            together all the profit and loss transactions
            of the period and determining net income
            accordingly regardless of the fact that they
            may in whole or in part be quite unrelated
            except for the time element and the fact that
            they were those of the same taxpayer. If,
            for instance, a separate and distinct
            transaction during the year results in a net
            realized gain to the taxpayer in and of
            itself, income which is taxed has been
            received, but Congress may, or may not, have
            allowed deductions which as a matter of
            computation will relieve that income in whole
            or in part from the taxation to which
            otherwise it would be subject. * * *

Accordingly, the Circuit Court of Appeals upheld the

constitutionality of the section 23(r) limitation.

       To the same effect is White v. Commissioner, 37 B.T.A. 1106

(1938).    The taxpayer sustained a net loss in his securities

trading.    37 B.T.A. at 1109.   After discussing Davis v. United

States, supra, we stated in White as follows (37 B.T.A. at 1110-

1111):

              This petitioner, however, asserts that the
            deduction he seeks is not a statutory
            deduction, but falls within the first
            classification of deductions made by the
                        - 13 -

    court in the Davis case, wherein the court
    speaks of taking from all receipts “certain
    necessary items like cost of property sold”,
    and contends that the respondent’s action
    denies him the right to deduct from gross
    receipts the cost of all items purchased by
    him in the conduct of his business. In other
    words petitioner denies that he can have
    income in any amount until he has recovered
    his aggregate cost, and his entire argument
    is based upon the proposition that the denial
    of the right to reduce gross receipts by
    aggregate cost creates income where none in
    fact exists and, therefore, makes the
    application of 23(r) unconstitutional as to
    his business.
       That portion of petitioner’s argument
    relative to the denial of his right to use
    cost is answered in part by the court in the
    Davis case, supra, wherein it states that a
    net gain realized by a taxpayer from a
    separate and distinct transaction constitutes
    income that may, or may not, be subject to
    tax depending upon whether the Congress has
    allowed deductions which as a matter of
    computation will relieve that income in whole
    or in part from taxation, and by the further
    statement that “net income for any taxable
    period need not necessarily be the same as
    net taxable income for that period, and the
    variation may be to the extent that Congress
    has seen fit either to allow, to limit, or to
    deny deductions within its control as a
    matter of grace.” (Emphasis supplied.) The
    facts in this proceeding illustrate the truth
    of the court’s observations. This petitioner
    as a matter of fact lost money upon the basis
    of his operations over the entire year, and
    if all his losses were deductible he could
    have no statutory net income. However, in
    the absence of a statutory right to reduce
    other income by losses from stock
    speculations, and in view of the specific
    limitation of 23(r), petitioner’s computation
    must show a statutory net income subject to
    tax. * * *

The foregoing disposes of all of petitioners’ contentions,
                              - 14 -

including the asserted constitutional distinction between a

“capital loss” and “a deductible expense item.”

     Our analysis has dealt with the tax imposed by section 1.

The same analysis applies to the section 55 alternative minimum

tax, which is part of the 2003 determined deficiency, and which

was not separately argued by the parties.

     Petitioners do not contend that the $3,000 limitation of

section 1211(b) is unconstitutional for any other reason,

including constitutional guarantees of due process and equal

protection.   We do not decide theoretically possible

constitutional questions unless they are properly presented and

must be resolved in order to decide the case before us.     Kessler

v. Commissioner, 87 T.C. 1285, 1293-1294 (1986) (and cases there

cited), affd. without published opinion. 838 F.2d 1215 (6th Cir.

1988).

     In light of the foregoing,


                                    Decisions will be entered

                               for respondent.
