The tax fraud trial of Wesley Snipes began this week in Florida, and the actor faces up to 16 years in prison for his failure to file tax returns between 1999 and 2004, or pay tax on the estimated $38 million he earned in that period.
Snipes faces an uphill battle, as few succeed in convincing juries of a genuine, good-faith belief that he or she had no obligation to pay income taxes. Snipes has relied on the "§ 861" argument, which asserts that only items listed in Section 861 of the Internal Revenue Code are taxable, and therefore, the domestic income of U.S. citizens is not taxable.
If only. All income, earned inside and outside the country, of U.S. citizens is taxable under Sections 1, 61, 63, and others. Section 861, and accompanying regulation 26 C.F.R. § 1.861-8, list what income is earned "inside" the country, and that's relevant only to non-residents and foreign corporations because they only pay tax on domestic income. The list doesn't really matter for U.S. citizens, because they are taxed on all income, whether it is earned domestically or foreign.
Even putting that aside, among the taxable items on the § 861 list is "[c]ompensation for labor or personal services performed in the United States." § 861(a)(3). So any income earned in the United States is taxable even under Section 861. IRS regulations re-iterate this point, stating:
"In general, all citizens of the United States, wherever resident, and all resident alien individuals are liable to the income taxes imposed by the Code whether the income is received from sources within or without the United States."
26 C.F.R. § 1.1-1(b). § 861 advocates argue that regulation § 1.861-8 (which provides more detail on types of income that are to be treated as "domestic") overrides § 861(a)(3), but laws always override regulations.
Courts have conducted a similar analysis in reviewing the § 861 argument, and those who rely on it to avoid income taxes routinely face fines and imprisonment. The taxpayer often gets much harder than scammer who gives him or her fraudulent advice. For a list of cases and penalties, see here.
The Internal Revenue Code is long and complicated, and we at the Tax Foundation work for a tax system that is simple and transparent, and doesn't inhibit our economy with excessive burdens on individuals. But we're not there yet. If someone tries to convince you that there's no obligation to pay income taxes, remember that if it sounds too good to be true, it often isn't true.
If anybody ever wonders why tax reform is so difficult to accomplish, one need look no further than the website of the National Association of Realtors®, which is featuring on the front page a podcast where its president, Dick Gaylord, talks about how "politics is our business." You would think real estate is their business, but then again, the NAR's primary mission appears to be to influence policy in order to get Congress to pass friendly legislation. In a word, the NAR is what economists call a rent-seeker.
It's sad that people believe that more special tax breaks are needed for housing. The Congressional Budget Office has calculated that capital income derived from owner-occupied housing has a -5.1 percent effective tax rate. That's right, a negative tax rate. In other words, the tax code is subsidizing housing.
But the fact that we are over-invested in housing thanks to the tax code leads to a kind of catch-22 in terms of rhetoric because then the Realtors® and other special interests in housing (e.g. NAHB) can make claims on how housing is a vital part of the American economy, citing how many "jobs they create." And therefore, they can argue that their industry is worthy of even more subsidies and friendly policies.
This is nothing new. It's the famous "what is seen versus what is not seen" problem of the political economy. They make these claims about the importance of real estate as if everyone would be homeless and the real estate agents would be begging on the street corners if not for the special tax treatment they are receiving. The fact of the matter is that more people would be renting and real estate agents would be doing something else, possibly making less as they would no longer be extracting rents from taxpayers and consumers. But that does not necessarily mean social welfare would be less. In fact, it would be higher, albeit distributed in a different (and fairer) manner.
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