On January 24, 1916, the U.S. Supreme court decided in Brushaber v. Union Pacific Railroad, 240 U.S. 1 (1916), that federal income tax was constitutional. The decision occurred shortly after the passage of the 16th Amendment to the U.S. Constitution in 1913, which declared that the U.S. Congress could levy (i.e. impose) a federal income tax. So, if you can actually believe it, prior to 1913 there was no federal income tax (absent a brief period during the Civil War)! So, how did this case and ruling come about?

In Brushaber, the plaintiff was a stockholder of the defendant Union Pacific Railroad company. The plaintiff brought a lawsuit against Union Pacific for paying the income tax. The plaintiff argued that the tax violated the Fifth Amendment's prohibition against the government taking property without due process of law. The Court found against Brushaber and held that the tax was constitutional.

In particular, the Court stated that: (i) the 16th Amendment removed the requirement that income taxes had to be apportioned among the states based on population; (ii) federal income tax does not violate the 5th Amendment's prohibition against the government taking property without due process of law; and (iii) federal income tax does not violate Article I, section 8 of the U.S. Constitution (known as the uniformity clause).

Prior to Brushaber and the 16th Amendment, Congress still had the authority to tax income but conflicting Court decisions dating back the Civil War left open how direct and indirect taxes were allowed. For example, in Pollock v Farmer's Loan and Trust, 157 U.S. 429 (1895), the Court disallowed federal tax on income from real property. The tax was designed as an indirect tax, but the Court ruled that the tax was a direct tax and subject to apportionment. So, what’s the difference between a direct tax and indirect tax?

In short, a direct tax is a tax paid directly by individuals to the government. Examples of direct taxes include income tax and property tax. In other words, the tax is taken directly from the individual by the government (e.g. when an individual fills out a 1040 form to pay his or her personal income tax). In contrast, an indirect tax is a tax which is not directly taken from individuals by the government. For example, an indirect tax includes a sales tax, which is a tax you pay when you buy something. So, assume you purchase a new phone for $100 and pay a 7% sales tax. The phone will cost you $107 and the $7 in sales tax will be held by the phone company and eventually paid to the government. As you can see, the tax is not directly paid to the government. First, the tax is paid to the phone company, and then the company pays the government.

The Brushaber case and 16th Amendment allowed Congress to levy (i.e. impose) a federal income tax without regard to appointment on people regardless of whether the tax was a direct or indirect tax.

Since January 24, 1916, the Internal Revenue Service has been authorized by the Court to collect federal income taxes. We’ve only got a few more years until we reach the 100th anniversary of the Brushaber decision which enforced federal income tax. I’m sure we’re all very thankful for that…