Background
To Baxter, the 50% versus 70% maximum marginal tax rates meant the difference of $178,000. At first, Baxter refused to pay,. His Certified Public Accountant, E.J. Maddocks, advised Baxter that to avoid potential penalties and interest, Baxter should instead pay the tax asserted by the government, and later sue the government for a tax refund.
The preliminary issue presented to the trial court was whether Baxter, as a professional gambler, was engaged in a "trade or business" for federal income tax purposes. If Baxter was engaged in a trade or business, then his income would be taxed at what was then a maximum rate of 50% for "personal service income" (as that term was defined in the Internal Revenue Code at the time). If, however, Baxter was not engaged in a trade or business, the income would not be "personal service income," and the maximum tax rate would be 70%. The tax law at the time defined "personal service income" to be "earned" income within the meaning of what was then section 911(b) of the Internal Revenue Code. The court noted that "if Baxter derived his gaming income actively from his expenditure of time, energy, and skill rather than passively from his use of his property, then his gaming income constitutes 'earned income'."
The trial court analyzed two alternative tests for determining whether an activity constitutes a "trade or business" for federal income tax purposes: the "goods and services" test, and the "facts and circumstances" test. The government conceded that if the "facts and circumstances" test was the appropriate test, then Baxter's activity would constitute a trade or business, resulting in the lower tax rate and a lower tax liability.
Read more about this topic: Baxter V. United States
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