To set the context, the government is responding to the plaintiff's claim that compensatory damages for nonphysical injury (mental distress and loss of reputation) are not income, and thus not taxable, because they were intended merely to make her whole; that is, to put her back in the condition she was in before she was harmed. Since her mental well-being and reputation are not taxable, plaintiff argued, neither should her compensation be considered taxable income. In other words, there was no gain because the award was merely a "return of capital."
The government responds that "A return of capital is excludable from income only to the extent of the taxpayer's 'basis' in the property.... Because taxpayer here does not have a basis in her 'human capital,' all damages received on account of an injury thereto are an accession to wealth."
In other words, selling labor for money is not like selling stock as far as the government (and its courts) are concerned. The "basis" of a share of stock is its original purchase price, and the tax is computed on the difference between that price and the later sale price. But the basis of labor (human capital) is zero (in the government's view). Therefore wages are all gain, and the government may tax the entire amount. As the petition puts it:
But the human capital analogy merely supports the notion that an individual might be entitled to damages for nonphysical injures in the first instance. At issue here, however, are the tax consequences of the receipt of those damages, and, in that context, tax concepts must be considered. That taxpayer may have only been returned to the status quo ante does not answer the far different question whether, for tax purposes, she received income subject to tax. . . .Here's where the footnote comes in:
Any determination to exclude such damages from income is not required by the Constitution or driven by tax considerations, but is one of policy based upon value judgments.... Such determinations are the sole province of Congress....
The human capital concept has also been advanced to support the contention, frequently made by adherents of the tax protest movement, that wages are not income within the meaning of the Sixteenth Amendment, on the ground that wages constitute nothing more than the return of personal capital exhausted by one's labor. That argument has been uniformly rejected as frivolous. E.g., United States v. Connor, 898 F.2d 942,943-44 (3d Cir. 1990); Coleman v. Commissioner, 791 F.2d 68, 70 (7th Cir. 1986. [Emphasis added.]As I've pointed out before, every claim the tax-denial movement makes shrivels to nothingness when examined even halfway closely. We won't get rid of income taxation by legal sleight of hand.