Regarding the "861 Position"
The "Section 861" (or "Source Rules") position attempts to argue that only the earnings of non-Americans-- or those of Americans which are received from non-American locations-- are taxed under the federal revenue laws. In large part, this 'theory' is adopted due to its advocate's failure to recognize that the "income" tax is an excise tax. (The cheap little fraud discussed here has also contributed considerably to the adoption of this erroneous 'theory'.) Unfortunately, like the arguments that "wages" are not "income", "income" only means corporate profits, and too many other potentially dangerous misunderstandings, the '861 position' has been widely embraced.
The Short And Easy Commentary
Note: The terms “non-resident alien”, “United States”, “U.S. citizen” and “income”, which will be featured prominently in the following discussion, DO NOT mean what the 861 position would have them mean. But, because one of the characteristics of this misunderstanding is its selectively decreeing that certain sections of the law are real (operative sections) and others are not (as suits the needs of its own internal 'logic'), to point out the actual legal meaning of these terms would be futile. Thus, I must use the argument’s own context to reveal its inconsistencies. But that is sufficient.
The ‘861’ argument has an intractable hold on many, and is of such a character as to defy a simple straightforward presentation of obvious facts, such as that the provisions of section 861 and 862 (which originate in section 217 of the Revenue act of 1921) apply only to ‘non-resident aliens’, as is clearly stated in the law:
Section 213. That for the purposes of this title (except as otherwise provided in section 233 [Gross Income Of Corporations Defined]) the term gross income-
(a) includes gains, profits, and income derived... from any source whatever.
c) In the case of a nonresident alien individual, gross income means only the gross income from sources within the United States, determined under the provisions of Section 217
Maintaining that the ‘non-resident aliens’ referred to above means ‘non-Americans’ and that ‘within the United States’ means ‘within the 50 states and all federal territories and possessions’ the proponents of this argument have erected an elaborate fabrication by which they argue that 213, cited above, REALLY means: In the case of Americans and resident aliens, as well as non-resident aliens, gross income means only the gross income from sources within the United States, determined under the provisions of Section 217, having figured out a way of selectively acknowledging or deploying certain snippets of statutes and regulations to thereby exempt “U.S. citizens” from the income tax. Indeed, the construct renders 213 a virtual nullity.
The whole of this argument hinges on this initial refusal to recognize that everything having to do with ‘source’ distinctions is invoked only in connection with income received by ‘non-resident aliens’ (and entities operating businesses in the territories and possessions, which should be understood as included by reference from this point on). Rather, the argument theorizes that the subordinate section 217 reaches back and modifies the meaning of the phrase ‘whatever source’ in the prior section 213 (represented by section 61 in the current code), so as to make 213 subordinate to 217, as in:
"Therefore, the meaning of “income from whatever source derived” (the general definition of “gross income” in Section 61) is limited by Section 861 and following sections, and the related regulations." (From ‘Taxable Income’ by Larken Rose)
It is argued that this is necessary in order to preserve the Constitutionality of the income tax-- without accounting for the fact that the act of 1913, for instance, declared the income tax to apply to all income “arising or accruing from all sources in the preceding calendar year to every citizen of the United States” without the benefit of section 217, yet was sustained by the Supreme Court throughout an intense series of challenges to its Constitutionality over the next 8 years.
As an example of the distortions arising from this stubborn perspective, the argument offers this as evidence of its contentions:
"For example, in all three major printings of Title 26 (the "United States Code,"
the "United States Code Annotated," and the "United States Code Service"), Section 61 itself has crossreferences similar to the following:
Income from sources -
Within the United States, see section 861 of this title.
Without the United States, see section 862 of this title." "
It is clear in the light of what the statutes actually say in 213 and 217 that this code representation means, “For specifications relating solely to the subset of the general term income known as “income from sources”, pursuant to section 872 (the code representation of 213(c)), see sections 861 and 862”. But the 861 framework will not admit this simple understanding.
In a truly breathtaking example of the blinders imposed by this view, the Rose version of this argument, after spending several hundred words arguing that the provisions of 217 reach back to modify (or nullify) those of 213 and establish themselves as the dominant rule as to the income of Americans and resident aliens (as noted above), declares:
"While the significance of Section 861 and the related regulations may be obvious, the point needs to be thoroughly proven, since most tax professionals concede that Section 861 and the related regulations are not about the income of United States citizens living and working exclusively within the United States."
So the argument asserts at length that 861 etc. DOES have to do with the income of United States citizens living and working exclusively within the United States, and then allows as how even “most tax professionals concede that Section 861 and the related regulations are not about the income of United States citizens living and working exclusively within the United States”. Indeed. They not only concede it, they would shout it from the rooftops.
What they would NOT concede is that, because a subordinate section creates a special class whose “gross income” is statutorily subdivided into that from sources “within the United States” and that from sources “without the United States”, therefore specifications elsewhere that no such distinctions are to be drawn, as in, “the term gross income-
(a) includes gains, profits, and income derived... from any source whatever
are to be disregarded, or that the ‘sources’ listed for the special class are the limits to which the general and explicitly unlimited class must be confined. But this is the essence of the 861 argument.
Of a piece with the contortions already mentioned is the argument’s need to dismiss clearly contradictory evidence. Thus we find the following, also in the Larken Rose presentation of the position:
(Subtitle C "employment" taxes, sometimes called "Social Security" taxes, are independent of the income tax and are not dealt with by this web site. ...)
However, the relevant law says, for instance:
Subtitle C taxes are clearly not 'independent' of the "income" tax-- in fact, they are explicitly taxes on "income". However, because the '861 argument' proponents cannot think of any way to torture the 'within the United States' and 'without the United States' rules into an imagined application to these particular "income" taxes, they simply refuse to acknowledge them (a fault of which the "income only means corporate profit" people are also guilty, for basically the same reason).
I mentioned earlier that the proponents of the 861 position misunderstand many of the key terms used in the statutes with which they concern themselves. "Income", for instance, is misunderstood to mean 'earnings'; "non-resident alien" is misunderstood to mean 'non-American'; and "without the United States" is misunderstood to mean 'outside the 50 states and all federal states, territories and possessions'. Plugging these erroneous definitions into the structure of 217 instructively reveals their nature: Because the provisions of 217 address the "income" of "non-resident aliens" from “without the United States”, we are faced-- within the context of the 861 argument-- with the absurd suggestion that what Congress meant by those provisions, for instance, was to legislate that the "income" (earnings) of a Frenchman (a “non-resident alien”) originating in France (“without the United States”) is generously relieved of a U.S. federal tax burden! (The French, and the rest of the world, we presume, heaved a great sigh of relief in 1921 at the passage of this act.)
The reality is that the ‘source’ rules originated as a component of reciprocal tax treaties secured with various other jurisdictions, as is exemplified by this portion of section 872 (dealing with income from “without the United States”):
The further reality is that, within the tax law (codified at 26 USC 7701), citizens of the several States are “non-resident aliens” to the “United States” (which fact is irrelevant as far as determination of "income"-- taxable or otherwise-- is concerned), and the “United States” means only areas under exclusive federal control, such as the District of Columbia and federal offices, fortresses, territories and possessions. "Income", as elaborately and explicitly defined by the Supreme Court, means only ‘the benefit of federal privilege’ (measured by the dollars with which it is realized), rather than “all that comes in”. If those exploring the '861 argument' simply plug these facts into their thinking, they will find that suddenly the law makes perfect sense, is consistent and harmonious, and relieves citizens of the several States earning their money in the private sector from all “income” tax liability without any tricks, effort, or complexity.
I will close by inviting those who still harbor doubts to review the record of Americans charged over the years with tax crimes, particularly those involving failure to file and the like, rather than the variety in which evasion is charged. (Evasion generally involves a stipulation on the part of the accused, by way of a return, as to the character of certain receipts as being "income", while underreporting the amount.) Try to find any case in which the indictment or criminal information includes charges specifying that the accused was a 'non-resident alien' who had received earnings from 'within the United States'; or was a 'U.S. citizen' who received earnings from 'without the United States'. If the 861 argument is sound, EVERY case charging failure to file or the like must contain such elements in the charges, because, according to the argument, it is only those meeting these specifications who are required to file returns or pay the tax, and all indictments must allege all the elements of the offense. You will find that all the cases that you review DO contain the elements consistent with the truth about taxation in America as explained in 'Cracking the Code', but I do not believe that you will find any consistent with the 861 argument.
The actual statutes which 861 etc., represent:
Revenue Act of 1921
(Re-enacted in the 1928 Revenue Act as well with insignificant changes, before its very distorted and misleading reproduction in the IRC’s of 1939, 1954 and 1986.)
Section 213. That for the purposes of this title (except as otherwise provided in
section 233 [Gross Income Of Corporations Defined]) the term gross income-
The “861” argument possibly reveals the origin of its error with its very name, a mere code section rather than the law that section represents (or, in this case, misrepresents). Treating code sections as law is an easily made and widely-shared mistake. In this case, rather than leading to despair as it often does, it misleads to an erroneously positive conclusion. Because of this mistake, the research leading to the construction of the argument overlooked the fact that the actual law at 213(c), by exclusively and explicitly identifying non-resident aliens as those to whom 217's rules (codified at 861, 862, and others) apply, simultaneously excludes other categories of persons from those rules.
What the statute clearly says is: "Gross income" (for purposes of determining “taxable income”) generally means "..." , but in the case of non-resident aliens, and others receiving "income" from federal possessions-- and only in the case of those classes of persons-- it is limited to "income" associated with the sources listed in 217(a). This is the reason why 217 exists-- if the special classes identified in 217(a) were not being treated uniquely, 217 (and consequently, 861, etc.) would not exist. The misconception arises from the fact that the specification that 217’s provisions only apply to non-resident aliens and federal possession “income” recipients has been moved, in the code, to section 872, out of immediate view. But it is still the law. (The meaning of “nonresident alien” will be addressed a little further on).
The argument, having established its expectations with the initial misunderstanding, then perceives available evidence in the light of that error. It is, however, obliged to strain the plain words of the sections upon which it seizes, in order to find the expected meaning. For example, at one point the argument cites 26 CFR 1.861-8, which declares that, “The rules contained in this section apply in determining taxable income of the taxpayer from specific sources and activities under other sections of the code, referred to in this section as operative sections.” This is pretty easily understood as saying that “it is in (and only in) those sections designated as “operative sections” that these rules will apply”. The 861 argument finds in this language, apparently based on the common meaning of ‘operative’, that only “operative sections” of the law are operative in any respect at all, in other words, that sections not identified as “operative sections” are a nullity. It intends thereby to find support of its proposition that only externally-sourced receipts are actually taxed, which would perhaps appear true, if the qualifying elements in the section’s language are disregarded.
Unfortunately, not only is this position unsupportable on its face, it is contradictory of a substantial part of the argument’s own previous observations, correctly pointing out that custom-defined terms are not to be understood as having the conventional meaning of the words of which they are composed. Furthermore, the argument itself immediately draws our attention to a refutation of this position, proceeding to cite 26 CFR 1.861-8(f)(1) (where 26 CFR 1.861-8 has indicated the list of “operative sections” is located), which says, “The operative sections of the Code which require the determination of taxable income of the taxpayer from specific sources or activities and which give rise to statutory groupings to which this section is applicable include…”. If the term “operative sections” had the meaning which the argument prefers, this regulatory portion would read, “The operative sections of the Code, which require the determination of taxable income of the taxpayer from specific sources or activities and which give rise to statutory groupings to which this section is applicable, include…”. You will note the commas.
The argument also overlooks some of the implications of context. For example, it references Sec. 1.861-1 of 26 CFR and makes much of the section’s language “…determine the sources of income for purposes of the income tax”, but without observing that the section is located within the portion of the regulations identified as dealing with the application of the tax to non-resident aliens. The regulations are entirely subordinate to the statute, and are incapable of expanding its meaning at all, so this is irrelevant, but as in the matter of rules of construction, it shows how the argument suffers from a tendency to seek evidence to cite which satisfies a preconception, while ignoring that which is contradictory. Viewed without the lens of that preconception, it is easy to understand the cited language as implying the qualification, “when such determinations are indicated as appropriate”. This is particularly so when the language is part of the regulatory implementation of a statute specifically providing for such determinations-- for the specified classes of non-resident aliens and citizens receiving “income” from federal possessions.
In fact, a great deal is made, in the 861 argument, of selected headings, locations, section titles, etc., to suggest or infer the credibility of its interpretation of the meaning or purpose of the “source rules”, virtually all of which must be disregarded. Not only is the code an irrelevancy, as declared by the House Office of Law Revision Counsel:
Certain titles of the Code have been enacted into positive law, and pursuant to section 204 of title 1 of the Code, the text of those titles is legal evidence of the law contained in those titles. The other titles of the Code are prima facie evidence of the laws contained in those titles. The following titles of the Code have been enacted into positive law: 1, 3, 4, 5, 9, 10, 11, 13, 14, 17, 18, 23, 28, 31, 32, 35, 36, 37, 38, 39, 44, 46, and 49.,
clarified by the Government Printing Office:
NOTE: Of the 50 titles, only 23 have been enacted into positive (statutory) law. These titles are 1, 3, 4, 5, 9, 10, 11, 13, 14, 17, 18, 23, 28, 31, 32, 35, 36, 37, 38, 39, 44, 46, and 49. When a title of the Code was enacted into positive law, the text of the title became legal evidence of the law. Titles that have not been enacted into positive law are only prima facie evidence of the law. In that case, the Statutes at Large still govern.
and internally referenced by section 7806 (individually enacted):
Sec. 7806. - Construction of title
(b) Arrangement and classification
No inference, implication, or presumption of legislative construction shall be drawn or made by reason of the location or grouping of any particular section or provision or portion of this title, nor shall any table of contents, table of cross references, or similar outline, analysis, or descriptive matter relating to the contents of this title be given any legal effect.,
but the meaning and purpose of the source rules is, again, clearly and unequivocally spelled out in plain language in the law, at 213(c) and 217(a). Thus, such translations and interpretations amount to an effort to not only find what is not there, but to contradict what is.
Though citing, and acknowledging the meaning of, section 7806, the argument nonetheless proceeds to ignore it, according-- in particular-- great significance to the title of Part I of Subchapter N- “Source rules and other general rules relating to foreign income”. This is taken as evidence that “income” only comprises gains received from foreign entities and that the source rules apply to all “income”, rather than being understood just as it reads: “Foreign income has its own special rules, and this is where they are found.”
The former interpretation is reflective of what might be the argument’s basic tautology-- having assumed that “income” can only be foreign (in an effort to square its perfectly accurate perception that private-sector, union-state persons cannot Constitutionally be directly taxed, with the apparently contradictory construction of the “income” tax as represented in the code), the argument deduces from this title that, therefore, source rules applicable to foreign “income” are applicable to all “income”. Conversely, the argument presupposes that the source rules apply to all “income”, and therefore derive from the Part’s title that all “income” must be foreign. Together, in fact, these mutually defensive and fully reversible assumptions and deductions constitute the whole of the 861 argument. The title of Part I of Subchapter N is an awkward statement of the part’s contents-- in light of the actual statute behind the section, it would be better put as, “Source rules and other general rules relating to the income of foreigners, or that received by citizens while within foreign jurisdictions.”
In any case, even if the code were taken as the law itself, there is no reasonable basis for assuming that the existence of a reference to a particular specification of "income from sources within the United States", found anywhere and in any form, is intended to apply to YOU (read: any particular person), absent language to that effect. It clearly DOES NOT apply to you when a specification of those to whom it DOES apply is provided, and you are not included. (The question of just who IS a nonresident alien will be addressed a little further on).
Contrary to a central assertion of the 861 thesis, Congress was under no legal obligation to identify carefully circumscribed "sources" in order to remain within its Constitutional limits-- it had already accomplished that from the very beginning of the "income" tax in 1862 by legislating in conformity to the limited legal meaning of “income”, a meaning considerably broader than has been suggested by some researchers in the past, but far more limited than the government’s preferred general misconstruction as “all that comes in”. In fact, even that far back, in the first iteration of the “general definition of income” (as opposed to the particular definitions of “income” found elsewhere in this and subsequent revenue acts, where the word does not appear), the “source” reference is deployed in such a fashion as to demonstrate its lack of special significance or underlying association with foreign “income” or persons:
“Sec. 90. And be it further enacted, That there shall be levied, collected, and paid annually, upon the annual gains, profits, or income of every person residing in the United States, whether derived from any kind of property, rents, interest, dividends, salaries, or from any profession, trade, employment, or vocation carried on in the United States or elsewhere, or from any other source whatever,”
The revenue Act of 1913, to which the 1921 act is more directly supplemental, put is this way:
“That there shall be levied, assessed, collected and paid annually upon the entire net income arising or accruing from all sources in the preceding calendar year to every citizen of the United States, whether residing at home or abroad, and to every person residing in the United States, though not a citizen thereof, a tax of 1 per centum per annum upon such income, except as hereinafter provided; and a like tax shall be assessed, levied, collected and paid annually upon the entire net income from all property owned and of every business, trade, or profession carried on in the United States by persons residing elsewhere.”
All of the above having been said, the foundational intuitions of the 861 argument’s proponents are sound. Congress is indeed circumscribed in the reach of its taxing power; it does confine itself accordingly; and it does do that in a fashion designed (or allowed) to be misunderstood. But the mechanism is not the “source rules”, or anything else requiring assumptions as to meaning, or inferences, implications, and suggestions.
Having openly imposed the tax upon federal workers and those conducting federally-connected business, as well as certain licensed activities, Congress has also established a clever scheme by which other Americans are led to create or leave unchallenged legal evidence that they belong to one of those groups, allowing the IRS to assert that their earnings comprise “income” subject to the tax. It is for this reason that every business in America is “encouraged”-- almost, though not quite, at bayonet point-- to sign documents declaring the amount of “wages as defined at section 3401” (remuneration of federal officers and employees) paid to their workers, rather than just “wages”, or “money”. It is for this reason that every American business is similarly “encouraged” to submit to the IRS documents alleging that all payment of greater than $600 made to other businesses or contractors constitute “gains, profits, or income” paid in the course of the remitter’s “trade or business” (defined within the law as meaning “the performance of the functions of a public office”). There is no program in place attempting to generate evidence that the average American is receiving earnings from Europe.
Indeed, even when circumstances require the laying of cards on the table, so to speak, the premises of the 861 argument are entirely ignored. No effort is made by the government to secure admissions from, or to present evidence against, the target of a tax prosecution to the effect that he or she received “income” from Canada or Mexico or other foreign “sources” (or is a “nonresident alien”) in order to establish the government’s claims. On the other hand, a great deal of effort indeed is devoted to securing admissions, or presenting evidence, regarding the target’s receipt of “income”, period, without regard to its “source”. And such evidence takes the form of, and such admissions are based upon, the W-2’s and 1099’s and other documents used to facilitate the scheme to which I referred above.
Coincidentally, within the context produced through the tax law’s custom definitions, citizens of union-states are indeed non-resident aliens, relative to the federal government. Within that context, the extremely narrow meaning of “United States” informs the 217 rules so as to make them generally consistent with the legal meaning of “income”-- but still leaves such citizens mired in the scheme outlined above. Thus, unless that legal meaning of "income" is understood and invoked, most will still find their earnings, under those rules, subject to tax... Regardless, the making of that case has not been attempted within the 861 argument. It should be, for it would be much stronger as a consequence (although still wrong), but even then only if the legal nature of "income" is incorporated at a fundamental level.
Practically speaking, though, whether one is or is not a nonresident alien is generally moot. Most actual “income” is paid within the “United States”, and most of that which is alleged to have been received by private-sector, union state citizens is alleged to have been paid from within the “United States” as well. Overcoming the allegation of having been paid such “income” eliminates the issue of one’s citizenship or residency status.
Finally, I hope it will be understood that I take no pleasure in presenting this information regarding the 861 argument. The perspectives which inspired that argument-- that government must be limited in power, and unrestricted direct taxation is incompatible with that principle-- are enlightened, and the spirit which developed it is courageous and determined to uphold the rule of law. However, there are brave and worthy souls risking much upon its accuracy today, and I feel that they may suffer for that decision. It is my hope that making this critique available will spare some of these patriots needless harm.
You’ve got to look deeper than the code if you want the liberating truth.
Comments Regarding Other Misunderstandings Of The Law