-- Posted by Neil H. Buchanan
Each time I teach the basic Federal Income Taxation course, I have the mixed pleasure of teaching the famous case of Eisner v. Macomber. The 1920 case is included in nearly every tax law casebook, although it is not clear why. Our income tax system includes something called the "realization doctrine" (which I will explain momentarily), and Macomber is a foundational case in that area of law. Even so, the Supreme Court's reasoning in Macomber is so muddled -- one might even say, so ridiculous -- that the case is arguably more trouble than it is worth, in the context of trying to teach tax law. (The case is bad on tax, and simply embarrassing on constitutional law.)
Why do I continue to teach the case, as I did again just this week? In part, I do so because everyone else does so. Macomber is one of those cases that should be part of the shared knowledge of everyone who has studied the income tax. That might not be a good thing, but I am in no position to change that reality. Given the frustratingly daffy reasoning of the case, however, every professor who teaches it has to come up with some way to make it more than merely another exercise in laughing at the Supreme Court.
Many cases are difficult to teach because the facts are so idiosyncratic. Especially with older cases, the likelihood is that the technologies and social norms that drove the parties' actions are, at best, quaint. In such cases, the best pedagogical choice is to soft-pedal the facts and focus on the legal rule that emerges. In Macomber, by contrast, the facts are so current and so relevant to today's policy debates, that the case can motivate students to think about current legal debates more productively.
First, however, it is best to return to the realization doctrine. The U.S. income tax includes a rule that says that increases in the value of property -- even though they are clearly income, because they make a person richer -- are not taxed until they are "realized." Setting aside huge complications, that means that you do not pay tax on your gains until you sell the property for cash. So, if I own a piece of land, and it starts to rise in value because the local government re-zones the area for residential development, I do not have to pay tax on the gains until -- that is, unless -- I sell the land. Similarly, if I bought shares in Apple a generation ago, I do not have to pay income tax on the gain unless I sell the shares.
But I will have to sell the shares some day, because I need money to live, right? Not necessarily. If I know that I will pay tax on any realized gains, it will usually be better to borrow against the value of my property (at very low interest rates, because the loans will be backed by rock-solid collateral). It is, therefore, possible to put off paying tax on any gains on my property holdings, essentially forever. By contrast, I can avail myself of the tax advantage of losses by selling any property that has gone down in value at any time, reducing my taxable income.
When I explain this to my students, it becomes necessary to explain why dealings in property -- which are, of course, almost entirely matters that affect only high-income people -- are so tax-favored. Beyond the cynical explanations, the textbook justifications for the realization requirement are: (1) It is often difficult to put a value on property, in the absence of a sale, (2) It is often difficult for a taxpayer to raise the funds necessary to pay their tax bill, without selling the property itself that gave rise to the tax liability; and sometimes that property is difficult to sell, or is indivisible, and (3) property that has gone up in value might later go down in value, making it arguably wasteful to tax people this year and then give them refunds next year.
All of which are very plausible explanations, depending on the facts on the ground. Which is why Macomber's facts are so useful, even though the case is almost a century old. There, the taxpayer was holding shares of Standard Oil of California stock, which were traded on the New York Stock Exchange. The total value of the shares was $800,000, which is in the $10-$20 million range in today's dollars (depending on how one chooses to account for inflation and economic changes).
This makes the taxpayer in that case, Myrtle Macomber, the anti-poster child for realization. It is easy to determine the value of the shares, even if she never sells them, because they are traded on one of the most transparent markets in the world. If her tax bill were to force her to sell some of the property to raise cash, she could easily sell a fraction of her shares. Finally, if her remaining shares go down in value, then she could take a deduction for the losses in subsequent years.
All of which makes Macomber still fun to teach. Even so, it has always seemed odd to then say, "But, the realization doctrine still applies to people like Macomber, apparently because other kinds of property transactions justify the realization doctrine. Macomber and people like her essentially get a tax break, because we refuse to notice that their property transactions do not match up with the policy justifications of the realization doctrine."
Until now. Last month, someone finally declared that the emperor was naked. A tax lawyer named David S. Miller, writing in The New York Times, proposed a "Zuckerberg Tax," which would be called the "Myrtle Macomber Tax," if tax nerds ruled the world. Miller's op-ed precisely tracked the mismatch between the justifications of the realization doctrine and holders of big chunks of widely-traded stock, like Myrtle Macomber and Mark Zuckerberg (and Warren Buffett, and so on).
While much is being made of Zuckerberg's wealth, due to the first-time sale of FaceBook shares to the public, the op-ed points out that Zuckerberg is completely in charge of his tax fate. He apparently plans to sell $5 billion of his stock in the company, which will result in tax liability of roughly $2 billion. He will pay the taxes from the proceeds of the stock sale, leaving him a paltry $3 billion in after-tax cash. Lest we think that Mr. Z is being taxed at "Buffett Tax" rates or above, the op-ed reminds us that Zuckerberg has another $23 billion in shares on which he will pay zero tax. He has been accumulating this wealth for the past decade or so, paying no tax in any year. That he will pay any tax at all is his choice.
Moreover, anyone who dies with unrealized gains on their property can pass the property to his heirs, income-tax free. If Zuckerberg's heirs were to receive his $23 billion in FaceBook stock, they could sell those shares the next day under rules that would allow them to say that they had received no income from the deal. This is, among other things, one of the poorly understood justifications for the estate tax. The realization doctrine thus allows income from property to be shielded from income tax for decades, at which point the estate tax is the only thing that keeps the gains from being entirely exempt from taxation.
There is, in the current political environment, no traction for the Zuckerberg/Macomber tax. For that matter, there is no traction for anything that would collect more tax revenue. Even so, Miller's proposal reminds us that we have, for the last century, been giving a pass to a group of taxpayers who never should have been able to take advantage of the realization doctrine. If equity means anything in tax law, this is an area that is ripe for fundamental change.