Taxation of income in the United States has been practiced since colonial times. Some southern states imposed their own taxes on income from property, both before and after Independence. The Constitution empowered the federal government to raise taxes at a uniform rate throughout the nation, and required that "direct taxes" be imposed only in proportion to the Census population of each state. Federal income tax was first introduced under the Revenue Act of 1861 to help pay for the Civil War. It was renewed in later years and reformed in 1894 in the form of the Wilson-Gorman tariff.

Legal challenges centered on whether the income tax then in force constituted a "direct tax". In the Springer v. United States case of 1881, the Supreme Court upheld the tax regime then in force. A 1894 statute was ruled unconstitutional in the case of Pollock v. Farmers' Loan and Trust Company.Pollock v. Farmers' Loan & Trust Co., , affirmed on rehearing, In response, the Sixteenth Amendment, proposed in 1909 and becoming law in 1913, cancelled the "apportionment" requirement for income taxes. Federal income tax was thereupon reintroduced in the Revenue Act of 1913. In the case of Brushaber v. Union Pacific Railroad Company (1916), the 1913 Act was ruled to be constitutional. A separate excise tax was also imposed on corporations.

Subsequent legal actions were concerned with what should be counted as "income" under the 1913 Act. In Eisner v. Macomber (1920), the Supreme Court ruled that proportionate stock dividends were not taxable as income, on the grounds that the dividend income was not "severable" from the capital holding from which it was derived. Later decisions, however, have tended to limit this view of "severability," and to uphold the federal statutes as exertions of the power of Congress to tax.

History through 1916

Early history

The first attempt to tax income in the British colonies not yet the United States was in 1643 when several colonies instituted a "faculties and abilities" tax. Tax collectors would literally go door to door and ask if the individual had income during the year. If so, the tax was computed on the spot. The income tax raised little revenue, and was viewed as a supplement to more traditional forms of property taxation.Edward R. A. Seligman, The Income Tax, p. 368 (Macmillan & Co. 1911).

Constitutional provisions

Article I, Section 8, Clause 1 of the United States Constitution (the "Taxing and Spending Clause"), specifies Congress's power to impose "Taxes, Duties, Imposts and Excises," but Article I, Section 8 requires that, "Duties, Imposts and Excises shall be uniform throughout the United States."US Constitution.net

In addition, the Constitution specifically limited Congress' ability to impose direct taxes, by requiring that direct taxes be imposed in proportion to each state's census population. It was thought that head taxes and property taxes (slaves could be taxed as either or both) were likely to be abused, and that they bore no relation to the activities in which the federal government had a legitimate interest. The fourth clause of section 9 therefore specifies that, "No Capitation, or other direct, Tax shall be laid, unless in Proportion to the Census or enumeration herein before directed to be taken."

Taxation was also the subject of Federalist No. 33 penned secretly by the Federalist Alexander Hamilton under the pseudonym Publius. In it, he explains that the wording of the "Necessary and Proper" clause should serve as guidelines for the legislation of laws regarding taxation. The legislative branch is to be the judge, but any abuse of those powers of judging can be overturned by the people, whether as states or as a larger group.

Early colonial and state income taxes

In the early 18th century and well into the 19th century, a number of the southern colonies and states adopted an income tax modeled on the tax instituted in England. The British theory was that you tax the income from property, and not the property itself; thus, sales of property were not subject to taxation.Income Tax Act 1799 (39 Geo. 3. c. 13). This first income tax in England was instituted in 1799 by William Pitt to help finance the Napoleonic wars.

First income tax law In order to help pay for its war effort in the American Civil War, the United States government imposed its first personal income tax, on August 5, 1861, as part of the Revenue Act of 1861. Tax rates were 3% on income exceeding $600 and less than $10,000, and 5% on income exceeding $10,000.Revenue Act of 1861, sec. 49, ch. 45, 12 Stat. 292, 309 (Aug. 5, 1861). This tax was repealed and replaced by another income tax in the Revenue Act of 1862.Sections 49, 51, and part of 50 repealed by Revenue Act of 1862, sec. 89, ch. 119, 12 Stat. 432, 473 (July 1, 1862); income taxes imposed under Revenue Act of 1862, section 86 (pertaining to salaries of officers, or payments to "persons in the civil, military, naval, or other employment or service of the United States ...") and section 90 (pertaining to "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. ... ")

After the war when the need for federal revenues decreased, Congress (in the Revenue Act of 1870) let the tax law expire in 1873.Revenue Act of 1870, Pub. L. No. 164, 41 Cong, 2d Sess., Ch. 255 (July 14, 1870). This statute extended the income tax for only two years, 1871 and 1872. However, one of the challenges to the validity of this tax reached the United States Supreme Court in 1880. In Springer v. United States, the taxpayer contended that the income tax on his professional earnings and interest income on bonds violated the "direct tax" requirement of the Constitution. The Supreme Court concluded that the tax of which Mr. Springer complained (i.e. a tax on professional earnings and on interest from bonds) was within the category of an excise or duty, and was neither a capitation tax (based on population) nor a property tax. The court also concluded that direct taxes, within the meaning of the Constitution, were only capitation taxes and taxes on real estate.

Second income tax law

In 1894, a Democratic-led Congress passed the Wilson-Gorman tariff. This imposed the first peacetime income tax. The rate was 2% on income over $4000, which meant fewer than 10% of households would pay any. The purpose of the income tax was to make up for revenue that would be lost by tariff reductions.Charles F. Dunbar, "The New Income Tax," Quarterly Journal of Economics, Vol. 9, No. 1 (Oct., 1894), pp. 26-46 in JSTOR This was a controversial provision, and the law actually passed without the signature of President Grover Cleveland.26 Cong. Rec. 8666 (1894), as cited in Sheldon D. Pollack, "Origins of the Modern Income Tax, 1894-1913," 66 Tax Lawyer 295, at 306, Winter 2013 (Amer. Bar Ass'n).

"Direct" income tax unconstitutional: Pollock v. Farmers' Loan Trust Company

Once again, a taxpayer challenged the legality of the income tax. In Pollock v. Farmers' Loan and Trust Company (1895), Charles Pollock sued the corporation in which he owned stock, contending that the corporation should never have paid the income tax because the tax was unconstitutional. In this case, the tax was paid on income from land. Pollock argued that since a tax on real estate is a direct tax, a tax on the income from such property should be a direct tax as well. Because the Constitution prohibited a "direct tax" unless the tax is apportioned, Pollock argued that the unapportioned income tax should be declared unconstitutional. The "direct tax" argument had also been used by Springer in 1880, but now the Court focused more closely on the wording in the Constitution. The provisions were Article I, Section 8, Clause 1, which provides that "all Duties, Imposts and Excises shall be uniform throughout the United States"U.S. Const. Art. I, § 8, cl 1. and Article I, Section 9, Clause 4, which provides: "No Capitation, or other direct, Tax shall be laid, unless in Proportion to the Census or Enumeration herein before directed to be taken.U.S. Const. Art. I, § 9, cl 4.

In effect, the latter clause required any direct tax to be based on a census. For example, if the government desired to raise $10 million and New York had 20% of the total U.S. population at that time, then New York would be required to raise $2 million. If New York had 1 million residents, each resident would owe $2 in taxes. Obviously, a tax based on income could not achieve such proportionality, since incomes differed across individuals.

This time, the Court stated that "although there have been, from time to time, intimations that there might be some tax which was not a direct tax, nor included under the words 'duties, imposts, and excises,' such a tax, for more than 100 years of national existence, has as yet remained undiscovered, notwithstanding the stress of particular circumstances has invited thorough investigation into sources of revenue." In other words, the federal taxing power consists of four categories: direct taxes, duties, imposts and excises (with the latter three categories sometimes called simply "indirect taxes").

In a 5–4 decision on April 8, 1895, the Court ruled that the unapportioned income tax on income from land was unconstitutional. On May 20, 1895, the Court expanded its holding to rule that the unapportioned income tax on income from personal property (such as interest income and dividend income) was also unconstitutional. This decision partially overturned the ruling in Springer v. United States.

The Court held that taxes on the rents or income of real estate, on personal property, or on the income of personal property (e.g. interest and dividends), were direct taxes within the meaning of the Constitution, and therefore had to be apportioned. In Springer, the Court had held that direct taxes within the meaning of the Constitution were only capitation taxes and taxes on real estate. Therefore in Pollock, the Court overruled a portion of the Springer decision by expanding the definition of direct taxes. The portion of the Springer decision that was not overruled by the Court in Pollock was the portion of the holding that applied to taxes on professional earnings. Since apportionment of income taxes is impractical, the Court's decision had the effect of prohibiting a federal tax on income from property. The power to tax real and personal property, or that such was a direct tax, was not denied by the Constitution. Due to the political difficulties of taxing individual wages without taxing income from property, a federal income tax was impractical from the time of the Pollock decision until the time of ratification of the Sixteenth Amendment (below).

Thus, the 1894 tax law was ruled unconstitutional and was effectively repealed.

Modern income tax

In 1909, fifteen years after Pollock, Congress took two actions to deal with their increasing revenue needs.

1. Corporate excise tax. First, Congress passed a corporate excise tax. The amount of the excise was set at 1% of each corporation's income exceeding $5,000. In 1911, the U.S. Supreme Court upheld this corporate excise as constitutional in Flint v. Stone Tracy Company, in which the court ruled that the tax was an excise upon the privilege of doing business in corporate form.

2. Sixteenth Amendment. More importantly, in 1909 Congress proposed the Sixteenth Amendment. This amendment reads as follows:

The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.U.S. Constit. amend XVI.