A taxpayer (Taft) received corporate stock by gift after December 31, 1920. The donor had acquired the stock earlier at a cost of approximately $1,000. By the time of the gift, the stock had appreciated to about $2,000. The donee later sold the stock for approximately $5,000. Under the Revenue Act of 1921, Congress provided that for property acquired by gift after December 31, 1920, the donee's basis for computing gain would be the same as it would have been in the donor's hands (a carryover basis). Applying that rule, the Commissioner computed the donee's gain as $4,000 (amount realized minus the donor's $1,000 cost), rather than $3,000 (amount realized minus the $2,000 fair market value at the time of the gift). The donee paid the tax, claimed a refund, and then brought suit, arguing that taxing her on appreciation that accrued before she owned the property violated due process and was beyond Congress's power to tax "incomes" under the Sixteenth Amendment.
May Congress constitutionally require a donee to use the donor's basis for computing gain on the sale of gifted property—thereby taxing the donee on appreciation that accrued prior to the gift—consistently with the Sixteenth Amendment and the Fifth Amendment's Due Process Clause?
Under the Revenue Act of 1921 (including § 202(a)(2)), when property is acquired by gift after December 31, 1920, the donee's basis for determining gain upon a subsequent sale is the same as in the donor's hands (carryover basis). Congress may constitutionally tax the donee on the entire gain realized upon sale, measured from the donor's basis, including pre-gift appreciation, without violating the Fifth Amendment or exceeding the Sixteenth Amendment's authorization to tax incomes.
Yes. The Court upheld the statute and the Commissioner's computation: the donee is taxable on the full gain measured from the donor's basis, including appreciation occurring before the gift.
The Court reasoned that the taxable event is the realization of gain upon sale, not the mere holding of appreciated property. When the donee sold the stock, income was realized within the meaning of the Sixteenth Amendment, and Congress could choose the measure of that income. Requiring the donee to step into the donor's shoes for basis purposes is a rational and permissible method of measuring the gain realized on sale. It prevents obvious tax avoidance that would occur if donors could escape tax on accrued appreciation by transferring property to others just before disposition. The statute did not impose a tax on the act of receiving the gift; rather, it prescribed how to compute gain upon a later realization event. Nor was the statute retroactive or arbitrary: it applied only to gifts made after December 31, 1920, and the sale—the moment of realization—occurred after enactment. The donee accepted the gift subject to the burdens that Congress validly attached by law, including the carryover basis. The Constitution does not guarantee a particular method of measuring income so long as Congress stays within its power to tax incomes and does not violate due process. Because the total gain realized on sale could be measured from the donor's basis without offending constitutional limits, the assessment was sustained.
Taft v. Bowers entrenches the carryover basis rule for inter vivos gifts and validates its constitutional underpinnings. The decision remains central to modern tax practice, now codified in IRC § 1015, and it underscores how basis rules combat tax avoidance by preventing donors from cleansing accrued gains through gratuitous transfers. For students, the case is a touchstone for understanding realization, basis, anti-abuse policy, and the scope of Congress's taxing power under the Sixteenth Amendment.
Taft v. Bowers confirms that Congress may constitutionally employ a carryover-basis regime for inter vivos gifts and tax the donee on the full gain realized upon sale, measured from the donor's original cost. By focusing on realization at disposition and allowing basis to carry over, the Court endorsed a coherent way to capture income that would otherwise escape taxation through gratuitous transfers.