Larken Rose
The 861 evidence can be simplified
Wed Jun 18 03:19:04 2003
208.152.73.79

The 861 evidence can be simplified (perhaps slightly over-simplified) into two steps:
http://home.earthlink.net/~pab66/Larken/larken04-02-03.html

1) 26 USC § 861(b) and 26 CFR 1.861-8 describe when DOMESTIC income is taxable, and;

2) Those sections do NOT show the domestic income of the average American to be taxable.
Conversely, there are two basic steps to the status quo proponents' arguments AGAINST the evidence:
1) You shouldn't look at 861!

2) 861 shows your income to taxable anyway!
These are the two "hills" to overcome on the propaganda battlefield. While both claims are untrue, I'm happy to say that many defenders of the (incorrect) conventional wisdom are now abandoning the first one. Perhaps this is because it borders on insane to claim that people should NOT use 861(b) and 1.861-8 to determine their "taxable income from sources within the United States," in light of what the regulations actually say. Again, here is where you can look them up, and some citations to read: http://www.access.gpo.gov/nara/cfr/waisidx_02/26cfr1v9_02.html

1.861-1(a)(1) and 1.861-1(b)
1.861-8(a)(1)
1.863-1(c)
1.862-1(b) Treasury Decision 6258--one of the first official statements by the Treasury Department concerning Section 861--also makes it rather looney to claim that most people should IGNORE the sections. Here is a scan of that Decision:

http://www.taxableincome.net/exhibits/td6258.html

You can probably see why many tax "experts" are now giving up their attempts to argue that you shouldn't look at 861. Instead, they are backed into Step #2: claiming that 861 DOES show your income to be taxable.

(Interestingly, to my knowledge IRS Chief Counsel has NEVER made such an argument, because they know the history of the law, and how doomed they would be if they AGREED that 861 and its regs are where you should look. More ignorant government bureaucrats, like Evan Davis at the DOJ, boldly and cluelessly blunder into #2.)

It is that second step that I want to address in this message. Thanks to some sleight-of-hand by government lawyers over the last 80 years, Section 861 by itself gives the impression that ALL domestic income is taxable. (The Tax Division of the DOJ is ignorant enough that they have been arguing just that in court.) But further investigation shows that is not the case.

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26 USC § 861(a)(3) and 26 CFR § 1.861-4

Let's use a common example, to keep this as simple as possible. Suppose you are a U.S. citizen, and you do work in the 50 states and get paid for it. (I expect that is true of most of you on this list.) Some status quo proponents will point to the following, and claim that they mean that your compensation IS taxable.

"(a) Gross income from sources within United States The following items of gross income shall be treated as income from sources within the United States:...
(3) Personal services
Compensation for labor or personal services performed in the United States; except... [exception for nonresidents temporarily in the country] (b) Taxable income from sources within United States
From the items of gross income specified in subsection (a) as being income from sources within the United States there shall be deducted the [allowable deductions]. The remainder, if any, shall be included in full as taxable income from sources within the United States." [26 USC § 861]

"Sec. 1.861-4 Compensation for labor or personal services.
(a) In general.
(1) Gross income from sources within the United States includes compensation for labor or personal services performed in the United States irrespective of the residence of the payer, the place in which the contract for service was made, or the place or time of payment; except... [exception for aliens temporarily in the U.S.]" [26 CFR 1.861-4] If that's all you look at, it sure LOOKS like all domestic "compensation for services" is taxable, doesn't it? (Again, IRS Chief Counsel does NOT argue this, because they know better than to step into that trap.)

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To get to the truth, we must dissect Section 861, and find out what it's for and how it works. A good way to do that--and the way that courts often use to decide what CURRENT law means--is to go back in time and see what the OLDER statutes and regulations said. Here is the statutory predecessor of Section 861:
"(a) In the case of a nonresident alien individual or of a citizen entitled to the benefits of section 262, the following items of gross income shall be treated as income from sources within the United States:...
(3) Compensation for labor or personal services performed in the United States;... (b) From the items of gross income specified in subdivision (a) there shall be deducted the [allowable deductions]. The remainder, if any, shall be included in full as net income from sources within the United States." [Section 217 Revenue Act of 1925] Huh?!?! As you can see, it's very similar to what the current Section says 861, except that first phrase. What happened to "In the case of a nonresident alien individual or of a citizen entitled to the benefits of section 262..."?!?! Why isn't it still there?

Back then, one was only "entitled to the benefits of section 262" if "80 per centum or more of the gross income of such citizen... was derived from sources within a POSSESSION of the United States" (Section 262, Revenue Act of 1925). Therefore, I doubt anyone would want to argue that Section 217 was saying that compensation for services performed in the U.S. is taxable for ALL U.S. citizens. People can theorize about what some OTHER section might have said, but Section 217 obviously was NOT talking about YOUR domestic compensation (unless you get most of your income from federal possessions, such as Guam or Puerto Rico).

So where did that first phrase go? Has ALL domestic compensation become taxable since 1925? To understand, we must see how all the pieces fit together.

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There are a couple different things that Section 861 and following (and related regulations) do. First, Section 861 and following give the so-called "source rules," which tell which kinds of income are considered DOMESTIC income, and which are considered FOREIGN income. Here is a breakdown of the relevant sections:
Section 861 - Income from WITHIN the U.S.
subsection 861(a) - Domestic "gross income"
subsection 861(b) - Domestic "taxable income" Section 862 - Income from WITHOUT the U.S.
subsection 862(a) - Foreign "gross income"
subsection 862(b) - Foreign "taxable income" Section 863 - Combination income (partly within & partly without) Under these "source rules" ALL income--whether taxable or not--is categorized as either DOMESTIC income ("income from sources within the United States") or FOREIGN income ("income from sources without the United States"). Section 861 "allocates" certain types of income as being domestic income, and Section 862 "allocates" certain types of income as being foreign income. In the case of combination income, Section 863 and related regulations give various rules about how to segregate "combination" income into "within" and "without."

Again, it's important to note that ALL OF THE INCOME ON THE PLANET is categorized by these rules as either domestic or foreign. The IRS loves to say that the "source rules" do not exempt the domestic income of citizens. True. They don't exempt ANY income for ANYONE. That doesn't mean all income is TAXABLE, of course.

For example, some will point to 861(a)(3) (and 1.861-4) shown above, which talks about compensation for services performed in the U.S. Those people then conclude that ALL such domestic compensation must be TAXABLE. Trouble is, if they looked at 862(a)(3) as well, that would see that all compensation for services performed OUTSIDE of the U.S. is included there. The same is true of 861(a)(1) and 862(a)(1), regarding domestic and foreign INTEREST. ALL "interest" is either one or the other. Again, ALL income is either included as DOMESTIC income, or as FOREIGN income (including income for which the convoluted "allocation and apportionment" rules of Section 863 apply).

Is all income--domestic and foreign--taxable for everyone? Of course not, and every tax professionals know it. The purpose of the "source rules" is NOT to exempt ANYTHING from taxation, but merely to distinguish between what is domestic income and what is foreign income.

The NEXT step is what the "conventional wisdom" crowd refuses to acknowledge.

After determining what income counts as domestic, and what counts as foreign, the next step is to find out what domestic income is TAXABLE, and what foreign income is TAXABLE. What 26 CFR § 1.861-4 (above) means is that compensation for services performed in the U.S. is considered DOMESTIC income (regardless of where the employer is, where the check comes from, etc). But then one must go to 26 CFR § 1.861-8 to find out what domestic income is actually TAXABLE.

(Note: Even the "general rules" of 861(b) and 862(b), concerning taxable income from within the U.S., and taxable income from outside of the U.S., don't exempt ANY income for ANYONE. They basically just reflect the general definition of "taxable income" (26 USC § 63), by saying that from the "gross income" (domestic or foreign), appropriate deductions are to be subtracted, and what's left over is "taxable income" (domestic or foreign). If these "general rules" were all that is needed to determine taxable income, then ALL THE INCOME ON THE PLANET would show up as being taxable, which obviously is not the case. The REGULATIONS under 861(b) (namely, 1.861-8) describe--though in a rather mangled way--how all the pieces fit together, and describe when domestic income and foreign income are actually TAXABLE.)

In the 1925 statute (Section 217 shown above), it was painfully obvious who could actually have taxable domestic income. In the current maze, it's not nearly so easy. (Those who have seen Step Six of "Theft By Deception" know how it came to be so hard to follow; it was no accident.) There is quiet a collection of "legalese" phrases which were DESIGNED to be confusing--almost nonsensical--such as "operative sections," "specific sources," "classes of gross income," "statutory groupings," etc. Here is my attempt to simplify the mess, without making this message too enormous (which it already is):
1) An "operative section" is a section of the statutes which describes a certain type of commerce, and gives the rules about the taxability of such commerce, and any special applicable rules. For example, Section 871(b) is an "operative section," and it says that nonresident aliens doing business in the U.S. "shall be taxable" under Section 1. It also says that nonresident aliens are taxed ONLY on income they receive which is connected to doing business in the U.S. (Section 871(a) deals with other U.S.-source income of nonresident aliens, but I don't need to address that here.)

2) When the regulations talk about a "specific source or activity," they mean a type of commerce addressed in an "operative section." So, for example, a nonresident alien doing business in the U.S. is the "specific source or activity" described in Section 871(b).

3) A "class of gross income" consists of the "items" of income listed in Section 61, such as compensation, interest, rents, dividends, etc. These may or may not be TAXABLE (see 1.861-8(a)(3) and 1.861-8(b)(1)), depending on the type of commerce from which the "items" derive.

4) A "statutory grouping" means the gross income from one of those specific types of commerce (a "specific source or activity"), such as the income nonresident aliens receive from engaging in business in the U.S.
To jump to the punchline, if you don't have a "statutory grouping" of gross income, meaning income from one of the "specific sources" described in the "operative sections" listed in 1.861-8(f)(1), then SECTION 1.861-8 DOES NOT SHOW YOUR INCOME TO BE TAXABLE.

Again, Section 217 from 1925 (shown above) doesn't use ANY of the above "legalese" terms. It just say that for CERTAIN people, certain kinds of income are considered domestic income, and are to be included as TAXABLE domestic income (after deductions). Tracing the law forward, we can see that the application of the law did not change, but it has become more and more difficult to understand what it actually means.
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This message is already overgrown, so I'm just going to stop there. When I'm more awake, I may take another shot at explaining this. It's not easy, since it was DESIGNED to confuse people. But here is a sort of synopsis of points to remember:
1) The geographical "source rules" do not exempt ANY income from taxation; instead, they categorize ALL income as either domestic or foreign.

2) The next step is to determine when domestic income (or foreign income) is actually TAXABLE, and for that, one must look to the regulations (primarily 26 CFR § 1.861-8), and to the other statutes of Subchapter N, which describe which "specific sources and activities" actually produce TAXABLE income.

3) The domestic income of most Americans is not included in any "specific source or activity," or any taxable type of commerce described in Subchapter N, because it is NOT TAXABLE.
I hope that cleared something up for someone, and I hope it didn't trigger too many migraines.

Sincerely,

Larken Rose
larken@taxableincome.net
http://www.theft-by-deception.com 

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