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Tame Your Taxes: History of the Internal Revenue Service

Today’s topic is A Short History of the Internal Revenue Service.

The original Constitution prohibited the direct taxation of its citizens. Article 1, Section 9 is excerpted here: “No Capitation, or other direct, Tax shall be laid.” Maybe the Founding Fathers were wiser than they are perceived today? They perhaps believed what John Marshall (4th Chief Justice of the US) later penned. “The power to tax is the power to destroy.”

I found it interesting that the first federal agency to be assigned with the collection of “taxes” was the Revenue-Marine, which was recommended by the Secretary of the Treasury Alexander Hamilton. The Revenue-Marine was established by an act of Congress on August 4,1790. In order for the fledgling country to remain viable, it needed a source of income. Since direct taxes were specifically forbidden by the Constitution, Congress saw tariffs on imports as the answer.  

However, this income did not immediately happen because of low compliance and rampant smuggling. The Revenue-Marine was formed to serve as an armed customs enforcement service. This legislation provided funding for ten cutters (fast ships with a shallow draught) to be constructed and assigned to major ports.

Because the US Navy was mothballed after the War of Independence, the Revenue-Marine cutters were the country’s only armed ships from 1790 to 1798. The purpose of the Revenue-Marine was expanded to include intercepting illegal slave ships after the Slave Trade Act of 1794.

During the wars of 1812, Civil War, and Mexican American War, Revenue Marine cutters served under the US Navy. On July 31, 1894 the service was renamed Revenue Cutter Service. The Coast Guard Act (Jan 28, 1915) combined the US Revenue Cutter Service with the US Life-Saving Service to form the new United States Coast Guard. In summary, the purpose of the Revenue-Marine morphed from collection of taxes (tariffs) into the US Coast Guard.  

The first income tax was passed during the Civil War, as an expedient way for the Union to fund the war. In 1862, the first Commissioner of Internal Revenue was appointed. This is considered the direct link to the present IRS. But, ten years later, the war was over, and the income tax was repealed.

In 1894, Congress saw an income tax as a simple solution to the financial demands of the day, so another income tax became law. However, the Supreme Court overturned that law ruled that an income tax was unconstitutional.

In the early 1900s, Members of Congress and other government officials saw world events and anticipated what we now know as World War I. So, Congress authored the 16th Amendment to the Constitution on July 2, 1909. It was ratified and became law on February 3, 1913.  

The original 1913 tax return was 3 pages and one page of instructions. The US Tax Code is now 77,000 pages. If you count all the IRS Regulations, Rulings and Tax Court cases, the number of pages increases to millions.

In 1913, only the wealthiest 10% of the population was required to file a tax return. A 1% tax was assessed on annual incomes exceeding $3,000 with an additional 6% surtax on the ultra-wealthy (incomes exceeding $500,000). Most citizens didn’t pay income tax, nor were they required to file. Before World War II only rich people had to file tax returns. Yet today, only a small percentage of people don’t need to file a return.

During Prohibition (1919), the Volstead Act charged the Commissioner of Internal Revenue with the primary responsibility for enforcing Prohibition. Al Capone, the notorious gangster, ended up spending 11 years in prison for tax evasion. After, Prohibition was repealed in 1933, the IRS started enforcing alcohol and tobacco taxes, and later administered the National Firearms Act.

In 1942, during WWII, the Revenue Act was passed by Congress. It increased the tax rate and number of citizens who were required to pay taxes. The Current Tax Payment Act (1943) introduced payroll withholding and quarterly payments to make the payment of income tax less noticeable and required employers to be unpaid tax collectors. That “pay as you go” system is still in effect today.

In the 1950’s the Bureau of Internal Revenue was renamed Internal Revenue Service. All current income tax law is based on the Internal Revenue Code of 1954. On August 16, 1954, the 1954 Code replaced the 1939 Code as Title 26 of the United States Code. The tax rate on incomes in excess of $200,000 was 91%.

The next major revision of the tax code was the Internal Revenue Code of 1986. The parts of the 1954 Code that weren’t changed were incorporated into the Tax Reform Act of 1986. The next major change was the recent Tax Cuts and Jobs Act (TCJA), which made several key revisions to the tax code, but it expires at the end of 2025. At that point, some of the provisions of the tax code will have been on the books for 71 years.

Here is a famous quote by the highly esteemed Judge Learned Hand:

“Anyone may arrange his affairs so that his taxes shall be as low as possible; he is not bound to choose that pattern which best pays the treasury. …”

Therefore, structuring one’s affairs and finances to legally reduce one’s tax bill is permitted. It is not unpatriotic. It makes sense.

Aric Schreiner, CPA, PFS, is managing member of Columbia CPA Group, LLC.


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