America's oddest tax dodge.

Commentary about business and finance.
July 30 2003 6:44 PM

America's Oddest Tax Dodge

Can Section 861 of the Internal Revenue Code save you from income taxes?

Last week, the federal government sued three businesses in California and Colorado to force them to withhold payroll taxes from their employees' paychecks. This is the latest chapter in a bizarre fight between the feds and adherents of what is known as the "Section 861 argument" or the "861 position."

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Despite Attorney General John Ashcroft's well-documented prudery, the campaign isn't a crusade against people who delve too deeply into the Kama Sutra. Rather, it's an effort directed against a band of determined tax law enthusiasts who, the Justice Department and federal courts say, willfully misinterpret a section of the Internal Revenue Code in order to duck taxes.

Tax law is a field that naturally attracts people with the ability and desire to endlessly parse words, clauses, and definitions. Adherents of Section 861—as in Section 861 of Title 26 in the U.S. Code—exhibit these extraordinary Talmudic capabilities. Rather than deny the constitutionality of federal income taxes or the legitimacy of the Internal Revenue Service, as some cruder tax protesters do, 861 protesters have attempted to ferret out contradictions within the text of the famously convoluted tax code and beat the government at its own game. (One 861 advocate's call to arms is titled: "Section 861: The Law They Hope You Never Read.")

Larken Rose is one of the primary exponents of the 861 position. Long suspicious of the federal income tax, Rose, who with his wife operated a small transcription service in Abington Township, Pa., began to examine various arguments against it in the 1990s. He found most of them illogical, until he stumbled on Section 861.

As detailed in his 79-page report, the code contains general definitions of what constitutes gross income and taxable income. At first blush, they appear to apply to virtually all income earned by just about everybody. But certain regulations and portions of the law that describe when domestic and foreign income are taxable undermine that commonly held view, Rose claims. "The regulations say that only income from specific types of commerce, all of which have some kind of connection to international commerce or federal possessions, are taxable," says Rose. In other words, if you don't engage in foreign trade or work in a U.S. possession such as the Northern Mariana Islands, your earnings shouldn't be subject to the federal income tax.

The tightly reasoned and plentifullysourced tract, which relies heavily on complicated disquisitions on the placement of the word "the" and the definition of "source," is a form of what Walter Olson,asenior fellow at the Manhattan Institute, calls "folk law": legal claims that "bubbled up without any encouragement from the legal professions."

Lawyer Bernard Sussman less charitably describes this and other arguments in an online casebook as "Idiot Legal Arguments." Indeed, according to the New York Times, one of the defendants in last week's 861 lawsuits, James Molen, who co-owns a floral shop in Chico, Calif., "is part of a movement that contends that court actions in which names are typed in all capital letters, as the case filed yesterday was, are not valid." The theory, rejected by courts many times over, is that by typing a person's name in all capitals, the courts are essentially describing a new entity, unrelated to the individual to whom they mean to refer. (ee cummings' standing under such a regime is unclear.)

For his part, Larken Rose—who is thoroughly logical—dismisses the all-caps argument, as well as the theories of Irwin Schiff, who argues that there is no law requiring U.S. citizens to pay income taxes.

A generation ago, 861 adherents might have quietly avoided filing 1040s and escaped detection. Furtive, small-scale practitioners of activity that is illegal but largely harmless—like smoking pot—generally escape prosecution. Those who do so loudly, however, invite legal trouble. And 861 followers like Rose have been doing the equivalent of holding a marijuana smoke-in at a public park. Rose has approached the IRS to discuss his views and has posted the transcript of one such meeting on his site. He has sold "somewhere between 14,000 and 15,000 legal copies" of the video Theft by Deception. "I know there are a bunch of bootlegs that are out there," he adds. (It wouldn't surprise "Moneybox" to learn that there exists among those who refuse to pay federal income taxes a high propensity to copy intellectual property.) And at least 100,000 copies of the Rose's "Taxable Income" report have been downloaded.

By courting controversy and thumbing their nose at the law, the folk lawyers are striving to become folk heroes. And thanks to the Justice Department's increasingly vigorous efforts to clamp down on their activities, they may succeed. The feds have declared it a "a priority to pursue promoters of frivolous and fraudulent tax schemes." Last May, Larken Rose's house was raided by the Internal Revenue Service.

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