INCOME TAX LAW AND ACCOUNTING BY GODFREY N. NELSON Certified Public Accountant, State of New York Member the New York Bar PUBLISHED BY GODFREY N. NELSON 52 BROADWAY, NEW YORK COPYRIGHT, 1917 BY GODFREY N. NELSON PREFACE Since the enactment of the Corporation Excise Tax of 1909, and the Federal Income Tax Law, applicable to both individuals and corporations, effective March 1, 1913, the writer has pre- pared, and advised with regard to, many income tax returns of corporations and individuals. The preparation of returns almost invariably necessitated the analysis and subdivision of book ac- counts as commonly kept in order to conform them to the classification prescribed by these laws. To obviate the neces- sity of analyzing and rearranging accounts and to facilitate the preparation of returns was the first thought that actuated the writing of this book. To make it more helpful there have been included rulings of the Treasury Department and court decisions on the most important items of income and expenses. The writer makes no pretence at having produced a law book and at no time had that aim in view. This is intended merely to serve the purpose of a practical guide to those who, either for themselves or others, are called upon to prepare returns. Statements contained herein are predicated : first, upon the Income Tax Law enacted September 8, 1916, which was retroactive and took effect as of January 1, 1916; second, upon rulings by the Treasury Department thereon; and third, upon such rulings and court decisions under the Excise Tax of 1909 and the Income Tax Law of 1913, which are consistent and not in conflict with the requirements of the present law. An expression of gratitude is due to various officials and officers of Internal Revenue of the Treasury Department at Washington and New York for the courtesies shown to the writer in matters submitted to them, but this acknowledgment should not be construed as an endorsement by them of the contents of this book. The writer also acknowledges the help- fulness of the Income Tax Service of the Corporation Trust Company, the index to which was especially useful as a ready reference to Treasury Decisions. Mention should also be made of Mr. Henry Campbell Black's treatise on the law of " Income Taxation " under Federal and State laws, to which the writer has referred. The arrangement of subjects is not co-ordinate throughout, but the order of the statute and the returns of net income have been followed as nearly as practicable. GODFREY N. NELSON. New York City, December 16th, 1916. 357347 TABLE OF CONTENTS Chap- ter Pages I. INCOME TAX AS APPLIED TO INDIVIDUALS I. General Provisions : Who is subject to tax Division and Rates of Tax Normal Addi- tionalTax Year Etc 9-10 II. Returns of Individuals : Return, defined Who is required to make return Husband and wife Fiduciaries Agent under power of attorney Heirs and legatees Citizen re- siding abroad Return by agent To whom return is made Due date of filing Exten- sion of time Penalty, failure to file When Internal Revenue Officers may make return Penalty, false return Due date of payment of tax Penalty, delayed payment Return of nonresident alien Residence, defined Claims for refund of taxes Statute of limitations Etc 10-16 III. Income of Individuals : Income, defined Duty to ascertain share, undivided surplus of corporation Dividends, insurance com- panies Annuities Damages, inj uries Ac- cident insurance Dividends, generally Dividends earned prior to March 1, 1913 Stock dividends Cash value, stock divi- dendsSales of " rights "Exchange of stock Return of capital to stockholders Interest on Government obligations Income of estates Salary paid by stock Bonuses Money equivalent Rental value " In trade" When professional fees are return- able Promissory notes Property acquired by gift Income of clergyman Insurance agents Trustees Pensions Profit, sales of capital assets Fair market price of securi- ties " Fair market price," generally Etc. . . 16-24 IV. Deductions allowed to Individuals : Specific exemptions Individuals, unmarried, mar- ried, head of family, nonresident alien Estates Head of family, defined Ward Cestui que trust Necessary expenses In- 4 TABLE OF CONTENTS Chap- ter Pages I. terest Taxes Local assessments Income tax paid Water rates Losses " Not in trade" Loss, defined "In trade," defined Bad debts Depreciation Depletion Gas and oil wells, mines Improvements Re- storing property Replaced buildings Dam- - age suits Judgments Insurance reserve Premiums Accrued interest on bonds Commissions paid real estate agent Cam- paign expenses Stock assessments Ali- mony Living expenses Nonresident aliens Etc 24-31 V. Tax withheld at source: Individuals, corpo- rations and partnerships Normal tax In- terest, bonds and mortgages of corpora- tions License required by collectors Tax- free bonds Scrip certificates Commercial paper of corporations Compulsory deduc- tions Specific exemption, how obtained Penalty, false representation Deductions and refund tax withheld in excess Rentals Bank interest Real estate agent Travel- ing expenses of salesmen Commissions paid salesmen Profit sharing bonuses Indem- nity to withholder Return of tax withheld Nonresident aliens Exemption from with- withholding on income of nonresident alien corporations Alien individuals Etc 31-39 VI. Farms and farmers : Income from farms Prepaid farm expenses Shares Losses Live stock Condemned live stock Farm machinery Depreciation Books of account Farm maintained only for recreation Etc 39-41 II. INCOME TAX AS APPLIED TO PARTNERSHIPS VII. General partnerships: Returns by partners Partnerships Income, when accrued With- holding of tax Dividends to partnership Expenses Life insurance premiums Etc... 42-43 VIII. Limited partnerships : Form of return required "Limited partnership," defined Distribu- tion of profits Etc 43-44 TABLE OF CONTENTS 5 Chap- ter Pages III. INCOME TAX AS APPLIED TO CORPORATIONS IX. General Provisions : Domestic corporations Foreign corporations Rate Tax year Specific exemption Foreign income Etc... 45-46 X. Returns of corporations : Form of return Domestic corporations Foreign corpora- tions Calendar year Due date When last filing day falls on Sunday or Holiday Re- turn, by whom executed When tax pay- ablePenalty, delayed payment Fiscal year of corporation, illustration When tax payable, fiscal year Extension of time Penalty, failure to file Penalty, false, fraudulent return Penalty, refusal, neglect Return prepared by Commissioner of In- ternal Revenue Second assessment Pub- licity Apportioning income 1916 Incom- pletely organized corporations Foreign branches Holding companies Subsidiary companies Receivers of corporations In- terstate commerce corporations Books of account Etc 46-53 XI. Exempt organizations : List of all classes of corporations and organizations exempt from tax Doubtful as to exemption Withhold- ing tax at source Foreign organizations Close Corporations Etc 53-56 XII. Income of corporations: Net income Gross income of corporations, manufacturing, mercantile, miscellaneous, centracting, in- surance companies, mutual companies Gross income all sources Dividends re- ceived Cash Property Sales of capital assets Property acquired prior to March 1, 1913 Interest, sinking funds Real estate development corporation Instalment businesses Assessments, paid-up capital stock Premium, sale of capital stock Etc. 56-61 XIII. Deductions allowed to corporations : Deduc- tions, generally Losses When deduc- tible Property acquired before March 1, 1913 Depreciation Depletion Timber O TABLE OF CONTENTS Chap- ter Pages III. lands Bad debts Reserve, bad debts Re- serve, insurance companies Contingent and secret reserves Suspense items Sinking funds Reserve, discounts on sales Inter- est, generally Interest, indebtedness se- cured by collateral Interest, preferred stock Bonds Amortization of bonds Premium on bonds Organization expense Local benefits Bonuses, gratuities Sal- aries, National guardsmen Pensions De- falcation, embezzlement Foreign corpora- tionsEtc 61-67 IV. DEPRECIATION Deductions from income Methods of com- puting Reserves Diverting reserves Rates Buildings Building repairs Ad- ditions, betterments Leased property Buildings erected by tenant Furniture and Fixtures Dwellings Farm buildings De- pletion Machinery General and special machinery Boilers, engines Repairs and replacements Shafting Tools Miscellane- ous equipment enumerated Laundry equip- ment Patterns Patents Copyrights Auto trucks Horses, stable equipment Good will Stocks and bonds Trademarks Brands Stock on hand 68-85 V. BOOKKEEPING SUGGESTIONS PREPARATION OF IN- COME TAX RETURNS OF CORPORATIONS Methods of bookkeeping Books of account, best guide Examination of books by Inter- nal Revenue Officers Accruals, prepayments Distribution of accounts Sales Return sales Allowances Discounts allowed Dis- counts received Rebates Purchases Freight on sales and purchases Inventories Rentals Royalties Interest received Interest paid " Debenture bonds " Divi- dends received Sundry income Labor, wages and commissions Fuel, light and power Ordinary repairs Salaries of offi- TABLE OF CONTENTS 7 Chap- ter Pages V. cers Miscellaneous accounts Customs, du- ties Withholding tax Report of withhold- ing corporation Bad debts Prevalent causes justifying charging off Loss by fire Sales, capital assets Depreciation and depletion Taxes Treatment of taxes with- held on books of recipient of income and payer of income Capital stock Interest bearing indebtedness Merchandise account Profit and loss account Dividends de- clared Reconciliation of return with books Manufacturing corporation operating cost- system Etc "86-111 VI. INFORMATION REQUIRED TO PREPARE RETURN OF NET INCOME OF MERCANTILE CORPORATION Limitation of accruals Tabulation showing wherein each item should be entered in the return proper and supplementary statement Etc 112-118 VII. PREPARATION OF INDIVIDUAL INCOME TAX RETURN Method of bookkeeping Income tax with- held at source Separate returns, husband and wife Return of merchant Illustration, method of computing gross profit Interest received, classified Salaries, wages and commissions Professions Business, trade, commerce Rents Fiduciaries Partner- ship profits Royalties Sundry sources Dividends Necessary expenses Interest paid Taxes Losses " Losses in trade " Bad debts Depreciation Depletion Il- lustration, method of computing normal and additional tax Etc 119-128 APPENDIX A FEDERAL INCOME TAX LAW ENACTED SEP- TEMBER 8, 1916 129-160 APPENDIX B FEDERAL CAPITAL STOCK TAX LAW ENACTED SEPTEMBER 8, 1916, AND TREASURY RULINGS THEREON. 161-171 APPENDIX C LIST OF INTERNAL REVENUE COLLECTORS IN THE UNITED STATES 172-176 INDEX ..177-205 INCOME TAX LAW AND ACCOUNTING Amended Law Who is Subject to Tax Division of Tax CHAPTER I INCOME TAX AS APPLIED TO INDIVIDUALS 1. GENERAL PROVISIONS The Federal Income Tax Law was amended by " an act to increase the revenue and for other purposes," enacted September 8, 1916. Every citizen of the United States, irrespective of his place of residence, at home or abroad, and every resi- dent of the United States, shall pay the tax upon his entire net income received from all sources, in the pre- ceding calendar year; and every non-resident alien shall pay the tax upon his entire net income received from all sources within the United States; less the credits and exemptions to which such persons shall, respectively, be entitled under the law. The tax on the income of individuals is composed of two parts, designated the " normal tax " and the " addi- tional tax." Normal Tax The normal tax imposes the fixed annual rate of 2 per cent, upon the entire net income of individuals, except, 1. Income derived from dividends on the capital stock or net earnings of corporations, joint stock companies or associations, or insurance companies, on which the normal tax is paid by such companies or associations. 2. The personal exemption of $3,000 per annum to the unmarried person and $1,000 additional to the head of a family, or to a married man with a wife living with him, or to a married woman with a husband living with her, provided, however, that only $4,000 shall be allowed to both husband and wife from their aggregate income. 10 INCOME TAX LAW AND ACCOUNTING The additional tax is imposed upon all net income of the individual, including that received as dividends on capital stock or from net earnings of corporations, joint stock companies or associations, or insurance companies, in excess of $20,000, upon the progressive scale, as fol- lows: From $20,000 to $40,000 1 per cent. 40,000 to 60,000 2 " " 60,000 to 80,000 3 " " 80,000 to 100,000 4 " " 100,000 to 150,000 5 " " 150,000 to 200,000 6 " " 200,000 to 250,000 7 " " 250,000 to 300,000 8 " " 300,000 to 500,000 9 " " 500,000 to 1,000,000 10 " " 1,000,000 to 1,500,000 11 " " 1,500,000 to 2,000,000 12 " " In Excess of $2,000,000 13 " " The calendar year comprises the tax year. The foregoing tax rates, normal and additional, apply to the entire net taxable income received by every person in the calendar year 1916, and every calendar year there- after. II. RETURNS OF INDIVIDUALS. A " return " is the statement or report of income upon which the Government bases the assessment of income tax. The return required of individuals is known as Form 1040, Revised. Every person having received an income, irrespective of source, of $3,000 or more, within the year, must make and file a return. The fact that a person's employer withholds the tax and pays the same does not relieve the employee of making an individual return. The same is true of persons whose entire income is in the form of dividends. Or, if the combined income of a person, in- cluding salary and dividends, or any other combination of sources, aggregates $3,000 or more within the year, RETURNS OF INDIVIDUALS 11 the recipient thereof must make and file a return. Per- sons receiving less than $3,000 in the year are not re- quired to make a return unless especially demanded by the Commissioner of Internal Revenue. No Obligation There is no obligation upon the part of the Govern- Qovernment m ^ n t to seek out those who are taxable or to send the to Send Out necessary blank to those of whom a return is required. It is incumbent upon the individual to obtain the blank from the Collector of his district if he is required, under the law, to file a return. Return by Income of the husband and wife, if not living apart, Husband and , . Wife may be returned in one report. If the aggregate income of both husband and wife ex- ceeds $4,000 a return of their combined incomes must be made, even though neither one separately has an in- come of $3,000 per annum. When separate returns are made the exemption of $4,000 may be prorated by agree- ment between them but the aggregate exemption de- ducted shall not exceed $4,000. When the income of husband and wife exceeds $20,000 per annum, they should make separate returns because the additional or surtax is computed on the separate income of each individual. Returns of All persons and corporations acting in a fiduciary Fiduciaries capacity, such as guardians, trustees, executors, admini- strators, receivers, conservators, must make and render a return of net income of the person, trust or estate for whom or which they act (Form 1041, Revised) and are subject to all the provisions in regard thereto that apply to individuals. Where there is more than one person or corporation acting in a fiduciary capacity, the return of one is sufficient, provided that such return is a complete report upon all income received. An executor or administrator is required to make a return of the income received by the decedent for the period from the first day of January to the date of the decedent's death. (Form 1040 Revised.) 12 INCOME TAX LAW AND ACCOUNTING Agent Acting A person acting under a power of attorney is not con- Under Power strued to be a fiduciary and is not required to render of Attorney r *' t return ot receipts and disbursements in his representative capacity. Should he, however, have title to property, from which there is income, irrespective of actual own- ership, he must make return of such income. A prop- erty owner cannot conceal his income by assigning it to a representative for the purpose of escaping the tax. Where there is a transfer of vested interest in property the transferee must include in his return not only such part of income as has been paid to the principal but the undistributed portion as well. Income to Where the beneficiaries receive regular incomes from an estate, the respective shares to be distributed shall be the amount returnable and subject to the tax. Form of The return of individuals must be made under oath Return on tne f orm (1Q4Q Revised) provided by the Govern- ment. Return by If, by reason of illness, absence or non-residence, a Agent person is unable to render a return in due time, then the return may be made by an agent having knowledge of the affairs of such person whose return he makes. Such agent is subject to all penalties provided for erro- neous, false or fraudulent returns. Citizens The fact that an American citizen resides abroad and Residing pays an income tax to the country wherein he resides. Abroad Must * J Make Return does not excuse him from paying an income tax in the United States. He is required to make a return of all his income to the Collector in the district of his legal residence or principal place of business in the United States. If a citizen, residing abroad, has no residence or place of business in the United States, his return should be made to the Collector of Internal Revenue, Baltimore, Maryland. KETUKNS OF INDIVIDUALS 13 ReturnT 1 A tfUC and accurate return of net income must be iufade 11 ' filed with the Collector of Internal Revenue for the dis- trict in which the person has his legal residence or prin- cipal place of business, or if there be no legal residence or place of business in the United States, then with the Collector of Internal Revenue, Baltimore, Maryland. S U FiIing te The return for the y ear ending Dec. 31, 1916, must be filed on or before March 1, 1917, and the return for each calendar year thereafter must be filed on or before March 1st next succeeding such calendar year. Tfme n to FnI In Case of inabilit y, occasioned by sickness or busi- Return "ess, to file a return in due time (March 1) application for extension of time should be made in writing to the Collector, on or before the day on which the return becomes due, for an extension of time; such extended time cannot exceed thirty days from March 1st except that the Commissioner of Internal Revenue (Washing- ton) has authority to grant a further reasonable exten- sion of time, in meritorious cases, to persons traveling or residing abroad. Fernet Failure to file returns may be due to one of two rea- File Return sons > or both : delinquency or refusal. In case of mere delinquency, where there is no willful intent to violate the law, it seems that the Collector may accept offers in compromise in lieu of specific penalties imposed by the law. Where, however, there is a refusal or willful intent to violate the law, an offer of compromise will not be accepted in lieu of the specific penalty. Any person that refuses or neglects to make a return of annual net income, who is subject to a tax by provision of law, is liable, under the law, to a penalty of not less than $20 nor more than $1,000. "In case of any failure to make and file a return or list within the time prescribed by law or by the Col- lector, the Commissioner of Internal Revenue shall add to the tax 50 per centum of its amount except that, when a retunj is voluntarily and without notice from 14 INCOME TAX LAW AND ACCOUNTING the Collector, filed after such time and it is shown that the failure to file it was due to a reasonable cause, and not to willful neglect, no such addition shall be made to the tax." When The Commissioner of Internal Revenue in cases of Revenue refusal or neglect to make a return, or in case of an Officers May erroneous, false, or fraudulent return having been made, ^ as ^ e "S^t to make a return m behalf of the party taxable at any time within three years after said return is due or has been made, and the assessment made by the Commissioner in such case shall be payable by such person, or persons, immediately upon notification of the amount of such assessment. False Return Penalty Due Date of Payment Penalty for Delayed Payment of Tax Return of " Any individual * * * required by law to make, render, sign or verify any return who makes any false or fraudulent return or statement with intent to defeat or evade the assessment required by this title to be made, shall be guilty of a misdemeanor, and shall be fined not exceeding $2,000 or be imprisoned not exceeding one year, or both, in the discretion of the court, with the costs of prosecution." The Commissioner of Internal Revenue is required, on or before the first day of June of each year, to notify all taxable persons of the amount that they have been assessed. The tax becomes payable on 15th day of June. After ten days' notice by the Collector, there will be added to the unpaid taxes interest at the rate of one per cent, per month from the time that the tax became due and an additional penalty of five per cent, of the amount of the tax. In order to obtain the benefit of the personal exemp- t * on ' a non " res ^ ent alien must file, or cause to be filed, a true and accurate return of all income received from all sources within the United States regardless of whether such income is less than $3,000 in the year. But a non-resident alien is not required to include in his re- RETURNS OF INDIVIDUALS 15 Residence Defined Alien turn income derived from sources without the United States. " Residence " has been held to be " That place where a man has his true, fixed and permanent home and prin- cipal establishment, and to which, whenever he is absent, he has the intention of returning; and indicates perman- ency of occupation as distinct from lodging or boarding, or temporary occupation." An alien, temporarily residing in the United States or employed therein for a definite time, who has the inten- tion of leaving upon the termination of his employment or mission, is deemed not to be a resident of the United States for purposes of the income tax. An alien, however, who has his principal place of busi- ness, or who is permanently employed in the United States, though his domicile be without the United States, is deemed to be a " person residing in the United States, though not a citizen thereof * * *." Claims for refund of taxes after assessment has been fixed, should be made on Form 46, to which should be attached the receipt for taxes paid sought to be recovered. Claims for abatement of taxes or penalties must be made on Form 47. Each of these claims must be sup- ported by the affidavit of party aggrieved, and by affi- davit of the Collector or Deputy Collector of the district in which the claim is made. The present income tax law provides that claims for the refund of taxes paid under the excise act of August 5, 1909, and the income tax act of October 3, 1913, which have been rejected by reason of the statute of limitation in existence prior to September 8, 1916, may be reopened, provided that such claims for refund involve a review of the return on which the claim is made. This ques- tion was ruled upon in T. D. 1 2396, dated November 1, "T. D." refers to rulings issued by the Treasury Department at Washington. 16 INCOME TAX LAW AND ACCOUNTING 1916, containing a letter written to the Collector of In- ternal Revenue, Los Angeles, California, as follows: " This office is in receipt of your letter of the 26th ultimo, asking for a ruling as to whether, under section 14, paragraph A, of -the act of September 8, 1916, claims for refund which have once been rejected by the com- missioner because of the statute of limitation in existence at that time may be reopened. The portion of section 14 referred to is in the following words : " ' Provided, That upon the examination of any return of income made pursuant to this title, the act of August 5, 1909, * * * and the act of October 3, 1913, * * * if it shall appear that amounts of tax have been paid in excess of those properly due, the taxpayer shall be per- mitted to present a claim for refund thereof notwith- standing the provisions of section 3228.' " This office is of the opinion that claims can now be made for refund under that provision. Claims rejected can also be reopened if the question involves an exami- nation of the return. The power does not extend to other claims whose adjustment does not necessitate an examination of the return." Income Defined Undivided Surplus of Corporation III. INCOME OF INDIVIDUALS. Income, for the purpose of the tax, comprehends rev- enue and income from all sources, as follows: gains, profits, salaries and wages received, including income from professions, vocations, business, trade, commerce, sales, dealings in or use of real and personal property, rents, interest, dividends, securities, transactions of any business for gain or profit and income derived from any other source whatsoever. Although the law provides that the taxable income of an individual shall include the share to which he would be entitled as stockholder or otherwise of the gains and profits, if divided or distributed, whether divided or dis- INCOME OF INDIVIDUALS 17 tributed or not, of all corporations, joint stock com- panies or associations, or insurance companies, yet it does not impose upon the stockholder the duty of ascer- taining his share of an undistributed surplus. Where a surplus is accumulated beyond the reasonable needs of the business, such unreasonable accumulation shall be prima facie evidence of a fraudulent purpose to escape the tax. " But the fact that the gains and profits are. in any case permitted to accumulate and become sur- plus shall not be construed as evidence of a purpose to escape the said tax in such case unless the Secretary of the Treasury shall certify that in his opinion such accu- mulation is unreasonable for the purposes of the busi- ness. When requested by the Commissioner of Internal Revenue, or any district collector of internal revenue, such corporation, joint stock company or association, or insurance company shall forward to him a correct state- ment of such gains and profits and the names and ad- dresses of the individuals or shareholders who would be entitled to the same if divided or distributed." Dividends of Dividends paid by a life insurance company on a Insurance policy that has not matured are not taxable as income, Companies whether paid by cash or deducted from current pre- miums. Dividends paid on a paid-up policy, however, should be treated the same as stock dividends, free from the normal tax and only taxable when the person receiving the same has an annual income of over $20,000. Annuities ' The amount paid under a life insurance, endowment, or annuity contract is not income when returned to the person making the contract, either upon the maturity or surrender of the contract; but the amount by which the sum received exceeds the sum paid and coming into the hands of the person making the contract and payment is income. When the settlement under such a contract is made in more than one payment each pay- 18 INCOME TAX LAW AND ACCOUNTING Damages, Injuries Accident Insurance Dividends Dividends Declared Payable in Securities ment will be considered as being composed of interest and a proportionate part of the principal. Where the entire annuity is composed of an interest return upon the principal sum paid therefor, the entire -annuity is income." (T. D. 2090.) Amounts received from a railroad company as reim- bursement for expenses occasioned by an accident, are not considered income subject to tax. Amounts received, however, in compromise or settlement of an action for " pain and suffering " is held to be such income as is taxable, as " gains or profits and income derived from any source whatever." (T. D. 2135.) Money received by an injured person under an acci- dent policy of insurance is, for income tax purposes deemed to be income. Payment to a beneficiary, how- ever, of the proceeds of an accident insurance policy, upon death of the insured, is not taxable as income. Corporations pay the tax of 2 per cent, on their entire net income. Hence, dividends paid out of said net earn- ings are free from the normal tax in the hands of stock- holders. But a person whose entire income is composed of dividends is not absolved from making a return, if the aggregate thereof is $3,000 or over within the year. Dividends declared payable in securities should be stated in the return of the stockholder at the cash value of such securities. The cash value is measured, primarily, by the amount charged to surplus account on the books of the corporation declaring the dividend. For example, dividends declared payable in Anglo-French bonds at 95, will be returnable by the recipient, for in- come tax purposes, at the aggregate amount of such bonds received, computed at $95 on each $100 of the par value thereof. INCOME OF INDIVIDUALS 19 Dividends 1913 Stock Dividends Cash Value of Stock Dividends Dividends paid out of earnings of a corporation ac- crued prior to March 1, 1913, are not subject to the additional or surtax. Stock dividends paid by a corporation are subject to the income tax based on the cash value of such stock. It has been held that the cash value of stock dividends shall be the amount represented by the stock distributed as dividends charged to surplus account, except where part of such surplus has been accrued prior to March 1, 1913. In the latter case the cash value is such of " the proportionate share of the surplus accrued to the paying corporation since March 1, 1913, as is represented by the stock distributed, or ordered to be distributed." Sales of Sales of " rights " to subscribe to capital stock, ac- Income cruing to stockholders in the case of new issues, are deemed to be income. Exchange of Stock An exchange of one share of stock of a corporation for two shares of stock of another corporation, both having the same par value, does not constitute taxable income until the stock received in exchange is sold ; then the profit will be the difference between the selling price and the purchase price of stock first acquired. Return of Payments made to stockholders of a liquidated or dis- StocMiolders s l ve d corporation as prorata return of capital is not taxable, but any payments out of the surplus of a cor- poration accrued since March 1, 1913, shall be returned as income. Interest on Interest upon the obligations of a State, or any Obligations political subdivision thereof, or upon the obligations of Not Taxable the United States or its possessions, or securities issued under the provisions of the Federal farm loan account of July 17, 1916, are exempt, by law, from the income tax. 20 INCOME TAX LAW AND ACCOUNTING Income Received by Estates Salary Paid by Stock Bonuses Salaries Money Equivalent "Income received by estates of deceased persons during the period of administration or settlement of the estate, shall be subject to the normal and additional tax and taxed to their estates." This is true also of income from any kind of property held in trust, including that on accumulated income held in trust for the benefit of " unborn or unascertained persons, or persons with con- tingent interests and income held for future distribution under the terms of the will or trust." In such cases, ex- cept where the beneficiary makes the return, the executor, administrator or trustee shall make a return and be as- sessed on such income, less the exemption allowed to estates during administration. Salary paid in the capital stock of a corporation is taxable as income based on its cash value. Bonuses received from employers in the nature of addi- tional compensation and not as gratuities are taxable as income of the recipient. (See page 100.) Salaries need not be returned as income until actually received. Any money equivalent received by an employee, in lieu of money compensation, is returnable as income at the value thereof. Rental Value Rental value of living quarters furnished to an em- ployee is held to be income and should be included in the return of the individual at the value thereof. Income Not in Trade When Returnable All profits or income whether made " in trade " or otherwise, are taxable income. (See " Deductions," page 26.) Fees for professional services need not be returned as income until received. Promissory notes, however, re- ceived in payment of such fees shall be deemed to be in- come received. INCOME OF INDIVIDUALS 21 Promissory Notes Property Acquired by Gift Clergymen Insurance Agents Rents Compensation of Trustee Pensions Where income is computed on the basis of actual re- ceipts and disbursements, a promissory note is deemed payment of an account and is returnable as income. In the event that such note is not paid, it is deductible as a loss when actually ascertained to be worthless. Property acquired by gift is not taxable, but the in- come accruing therefrom after receipt of such gift is in- come and subject to the tax. Property acquired by gift and thereafter sold at an advance of the value when gift was received, yields a profit of the difference between the selling price and such value, that is taxable as income. If such property was acquired prior to March 1, 1913, then the profit will be the difference between the selling price and the fair market value as at March 1, 1913. Fees received by clergymen, in addition to salary com- pensation, for any form of service, are construed to be taxable income. Commissions received on renewal premiums are tax- able income in the year received by the agent. The premium on a policy of insurance received by an insur- ance agent on account, or in payment of commission, in lieu of cash, is deemed to be income. Rent should be included in the return of the landlord for the year in which it is actually received, irrespective of when it accrued or became due. Compensation received by a trustee covering a period of years and not paid or reported as income until ma- turity of trust, has been held to be returnable in the year received and deductions therefrom may not be pro- rated over the years of the trusteeship. Only deduc- tions applicable to the year income is returned are allowable. Pensions received from the United States Government are deemed to be taxable income. 22 INCOME TAX LAW AND ACCOUNTING Profit on Profit on the sale of capital assets is returnable as in- Caplta^Assets come - The profit on sales of capital assets acquired prior to March 1, 1913, is the excess of the selling price over the fair market price or value of such property as of March 1, 1913. In the case of property acquired since that date the profit is the selling price in excess of the cost. If the capital asset is one on which depreciation has been charged off, it is reasonable to assume that such depreciation should be taken into consideration in de- termining the profit or loss. For example, a machine purchased on January 1, 1914, for $1,000 on which de- preciation was charged off at the rate of 10 per cent, per annum for years 1914 and 1915, sold on January 1, 1916, for $850, would show a profit of $50, derived as follows : Selling price $850 00 Cost $1,000 00 Less Depreciation charged off (20%) 200 00 800 00 Profit ; $50 00 The law itself makes no mention of depreciation charged off prior to the time of sale, nor has there, as yet, been any ruling on the question. From an account- ing point of view, however, there is only one logical con- clusion, and that is to deduct whatever depreciation had previously been charged off before determining the profit or loss, provided that repairs and renewals had been charged against revenue and not against the reserve for depreciation. Should repairs have been charged against the reserve, then the cost of such repairs would be a re- duction of the depreciation deducted from the cost of the machine ; in determining amount of profit on the sale. Assuming, in the above example, that repairs and re- newals cost $25, the result would be as follows : INCOME OF INDIVIDUALS 23 Selling price $850 00 Cost $1,000 00 Deduct : Depreciation charged off (20%) $200 00 Less Repairs 25 00 175 00 825 00 Profit $25 00 Computing For the purpose of ascertaining the profit or loss, for Loss on" income tax purposes, arising in connection with prop- Property erty which was acquired prior to March 1, 1913, the pro- Prior 1 to rating of actual time property has been held should be March 1,1913 ascertained in years and months, a fractional part of a month being counted as a whole month when the frac- tion is fifteen days or more and discarded when the frac- tion is less than fifteen days. (T. D. 2291.) Fair Market In determining the fair market price or value for the Value ^f purpose of ascertaining the profit or loss on the sale of Securities stocks or bonds acquired prior to March 1, 1913, where such stocks or bonds are dealt in on the exchange, it has been stated by the Commissioner of Internal Revenue in a letter to the Corporation Trust Co., dated November 21, 1916, that such fair market price would be the average price at which such securities sold on March 1, 1913, and not the price at which they sold at any particular time of the day. The acceptability of market quotations is, never- theless, conditioned upon the same being the " fair market price or value/' Fair Market No particular basis or method of computation has Price or Value -111 i_ i /> >u r 1 as of been prescribed by which to fix the fair market price March I, or va i ue " f or the purpose of ascertaining the profit or Generally loss on property acquired prior to March 1, 1913. The 24 INCOME TAX LAW AND ACCOUNTING price or value of property should be determined upon all the relevant facts governing the particular case. Profit Defined Profit, for income tax purposes, has been defined as the difference between the selling price and the cost, where the selling price is more than the cost. Specific Exemption Specific Exemption, Nonresident Alien Head of Family Defined IV. DEDUCTIONS ALLOWED TO INDIVIDUALS. The specific or personal exemptions, deductible under the amended law, as compared with those under the old income tax law, have been liberally extended. They are as follows : Unmarried person $3,000 per annum Married person, living with husband or wife 4,000 " Head of family 4,000 " Nonresident alien (obtainable only by filing true and accurate return) : Single person 3,000 " Married person 4,000 " Estate of deceased person during pe- riod of administration 3,000 " The single or married status of a person at the close of the year determines the amount of the specific exemp- tion. A nonresident alien is not entitled to the specific ex- emption on his income until the end of the year and then only if he makes and files a true and accurate re- turn of his total net income received from all sources within the United States. " When one or more individuals are dependent, either in whole or in principal part, for their actual support and maintenance upon another who by reason of some legal or moral obligation controls and provides for such indi- viduals, the one who assumed the support, maintenance and control of the others is, for Federal income tax DEDUCTIONS ALLOWED INDIVIDUALS 25 Personal Exemption Ward Cestui que Trust Exemption Estate Necessary Business Expenses Deductible purposes, held to be ' a head of a family ' and entitled to the specific exemption of $4,000 * * *." A guardian or trustee is allowed to deduct a personal exemption of his ward, or cestui que trust, of $3,000, or, if married, $4,000. The estate of a deceased person during the period of administration thereof, is entitled to an exemption of $3,000. A citizen or resident of the United States in comput- ing his net income is allowed as deductions from gross income, all necessary expenses paid in carrying on his business or trade. Personal, living, or family expenses are not deductible. Interest ^11 interest paid within the year on his indebtedness Paid on " Indebtedness is deductible. . Deductible Taxes Taxes paid within the year including those imposed Deductible by authority o f a s tate> the United States, or its terri- tories, or possessions, or any foreign country are de- ductible. Those imposed under authority of any State include county, school district, municipality, or other taxing subdivision, except assessments for local benefits. Taxes paid by an individual or corporation on securi- ties, to make them tax-free, are not deductible items. Local Not 68 S Deductible Income Tax Deductible Taxes paid in the nature of local benefits, such as grading, paving, sidewalks, sewerage, etc., are not de- ductible. These are deemed to be capital expenditures on the theory that the improvement increases the value of the property affected thereby. The amounts paid to the Collector and the amounts withheld at the source on account of the income tax are allowable deductions from income, as expenses, in the year in which the taxes are paid to the Collector of In- ternal Revenue. 26 INCOME TAX LAW AND ACCOUNTING Water Rates Water rates on business or rented property may be de- ducted as "necessary expenses." They should not be deducted as taxes. Losses " Losses actually sustained during the year, arising from fires, storms, shipwreck, or other casualty, and from theft, when such losses are not compensated for by in- surance or otherwise " are deductible. Losses Not in Under the old income tax law (1913) the deduction Trade f l sses sustained outside of the taxpayer's business or trade were not deductible. He was required to account for profits and income from all sources, but was prohib- ited from deducting any losses not incurred in trade. The amended law, however, provides that in " any trans- actions entered into for profit, but not connected with his business or trade, the losses actually sustained therein during the year to an amount not exceeding the profits arising therefrom " are deductible. This provision would apply to stock speculations, real estate operations and any speculative venture which is not embraced in the ordinary business or trade of the taxpayer. Loss Defined By rulings of the Treasury Department, loss has been defined as the difference between the selling price and the cost, where the selling price is less than the cost. Losses in One According to the English income tax law, an indi- Deductible vidual engaged in two businesses cannot deduct the loss from Income in one from the income of another. That is not so under our income tax law. The loss sustained in one is deductible from the profit of the other; but the person must be actually engaged in the businesses or trades. In Trade " ' In trade ' is synonymous with business. Defined " Business " has been defined as " That which occupies and engages the time, attention and labor of any one for the purpose of livelihood, profit DEDUCTIONS ALLOWED INDIVIDUALS 27 or improvement; that which is his personal concern or interest; employment, regular occupation, but it is not necessary that it should be his sole occupation or employ- ment. "The doing of a single act incidentally or of neces- sity, not pertaining to the particular business of the per- son doing the same, will not be considered engaging in or carrying on the business." (T. D. 1989.) Bad Debts " Debts due to the taxpayer actually ascertained to be worthless and charged off within the year " are deduct- ible. (See "Bad Debts," page 103.) Depreciation A reasonable allowance for the exhaustion, wear and tear of property, arising out of its use or employment in the business or trade, is deductible. In order to render depreciation deductible it must be entered in the books of account in such way that it effects a reduction of the asset account to which it is applicable. This may be accomplished by establishing a Reserve for Depreciation Account or by actual reduction of the asset account itself. The preferable method is to create a re- serve account, except, perhaps, with respect to properties that are replaced often. When the depreciation deducted equals the cost of property depreciated, or in case of purchase prior to March 1, 1913, the fair market value as of that date, then no further deduction will be allowed. (See Chap- ter IV, on Depreciation, page 68.) Depletion " In the case of oil and gas wells a reasonable allow- WeHs ance f r ac tual reduction in flow and production to be ascertained not by the flush flow, but by the settled pro- duction or regular flow " is a deductible item. When such allowance, however, aggregates the capital original- ly invested, or in case of purchase prior to March 1, 1913, the fair market value as of that date, then no fur- ther allowance for depletion will be deductible. 28 INCOME TAX LAW AND ACCOUNTING Depletion of A reasonable allowance for depletion of mines will be Mines deductible, not to exceed, however, the market value in the mine of the product thereof, which has been moved and sold during the year for which the return and compu- tation are made. As in the case of oil and gas wells, no further allowance for depletion will be allowed when the aggregate thereof equals the capital originally in- vested, except that in case the property was acquired prior to March 1, 1913, then no deduction will be allowed in excess of the fair market value of the property as of that date. Improve- No deduction is allowed for any amount paid out for Deductible new buildings, permanent improvements or betterments made to increase the value of any property. Restoring Replaced No deduction is allowed for amounts expended to restore property or for making good the exhaustion thereof for which an allowance is or has been made. (See page 77.) A loss sustained by the voluntary removal of a build- ing, for the purpose of erecting one more modern, is not deductible from a return of net income, but such loss may be added to the cost of the new building. Buildings Where a dilapidated building is taken down by order b^o?dw-of n of a builclm g department of the Government, acting Government under authority of a statute, because such building is a menace to public safety, the owner thereof for the loss sustained might, under some circumstances, be entitled to a deduction of the difference between the cost of the building (exclusive of land) and a reasonable allow- ance for depreciation for the years of its existence. Damage Suits The test as to the deductibility of an amount paid Judgment j n compromise or settlement of a claim, or cause of action, for personal injuries is, whether the liability was incurred " in trade." A payment in settlement of a suit DEDUCTIONS ALLOWED INDIVIDUALS 29 for injuries caused by a delivery truck of a corporation or individual used " in trade " would be deductible, whereas, damages paid for injuries caused by the pri- vate automobile of an individual would not be deductible. Insurance A reserve or fund set aside by either an individual FundTfot r or corporation for insurance purposes is not a deductible Deductible item. But an actual loss sustained and charged to such reserve or fund may be deducted. Fire insurance premiums on a rented dwelling, not occupied by the owner, are deductible. Usually bonds are sold at a price, plus accrued in- terest to the date of sale. Such accrued interest, paid by the purchaser, is deductible by him as interest paid. Commission paid to a real estate agent for collecting rents and management of property is an allowable de- duction. Fire Insurance Premiums Accrued Interest on Bonds Purchased Deductible Commission Paid Real Estate Agent Deductible Political Campaign Expenses Life Insurance Premium Stock Assessments Alimony Living and Household Expenses Premium on Fidelity Bond Deductions Nonresident Alien Contributions to the campaign expenses of a political party have been held not to be deductible from income. Premiums paid on life insurance policies of the in- sured are not allowable deductions. Stock assessments are held to be investments of cap- ital and not deductible. Alimony is not a deductible expense. The law does not permit of deduction of personal, liv- ing and family expenses. Where an employee pays the cost of a fidelity bond incident to his employment, he may deduct the cost thereof. In computing net income of nonresident aliens, the following deductions are allowed: Necessary expenses of carrying on business or trade within the United States. 30 INCOME TAX LAW AND ACCOUNTING " The proportion of all interest paid within the year by such person on his indebtedness which the gross amount of his income for the year derived from sources within the United States bears to the gross amount of his income for the year derived from all sources within and without the United States, but this deduction shall be allowed only if such person includes in the return required by section eight, all the information necessary for its calculation." All taxes paid within the year imposed by authority of the United States, a State, or any political subdivision thereof, not including assessments for local improve- ments. Losses actually sustained during the year in trade con- ducted in the United States, and losses of property with- in the United States arising from fires, storms, ship- wreck, or other casualty, and from theft, when such losses are not compensated for by insurance or other- wise. The losses of nonresident aliens sustained in trade or speculative transactions not in trade, on property ac- quired prior to March 1, 1913, shall be determined on a basis of the fair market price or value of such property as of March 1, 1913. Losses sustained in transactions not connected with his business or trade arising in the United States within the year not exceeding the profit derived therefrom. Bad debts sustained in business or trade within the United States, ascertained to be worthless and actually charged off within the year. A reasonable allowance for depreciation and deple- tion of property within the United States sustained dur- ing the year arising out of its use or employment in business or trade, to the same extent and with the same limitations as are applicable to properties of citizens and resident aliens. Credit for the amount of normal tax paid or with- held at the source, including that on dividends and any TAX WITHHELD AT SOURCE 31 Withholding Tax Normal Tax Withheld Deduction of Tax from Interest on Bonds and Mortgages of Corporations other income on which the normal tax is exempt or paid at the source. Specific exemptions, provided a true and accurate re- turn is made and filed in due time. V. TAX WITHHELD AT SOURCE. The provisions of law requiring the withholding of tax by payers of income applies only to the normal tax and is not applicable to corporations formed under the laws of the United States or any State or Territory thereof, and copartnerships composed of citizens or resi- dent aliens of the United States. For the calendar year 1916, the law provides that only 1 per cent, shall be withheld, the recipient of income to account for the remaining 1 per cent. On and after January 1, 1917, the entire normal tax of 2 per cent, shall be withheld.. The amount of the normal tax shall be deducted and withheld and paid to the Government from all fixed and determinable annual and periodical gains, profits and income derived from interest upon bonds and mort- gages or deeds of trust or other similar obligations of corporations, joint-stock companies, associations and insurance companies, irrespective of when paid, annu- ally or at shorter or longer periods, although such in- terest does not amount to $3,000 per annum. Likewise, the amount of such tax shall be deducted and withheld from coupons, checks or bills of exchange for or in payment of interest upon bonds of foreign countries and upon foreign mortgages or like obligations; also, from coupons, checks or bills of exchange in payment of any dividends upon the stock or interest upon the obligations of foreign organizations, associations and insurance companies engaged in business in foreign countries. " And the tax in such cases shall be with- held, deducted and returned for and in behalf of any person subject to the tax hereinbefore imposed, al- 32 INCOME TAX LAW AND ACCOUNTING License Required by Collectors of Certain Foreign Income Tax Free Bonds though such interest or dividends do not exceed $3,000, by: 1. "Any banker or person who shall sell or otherwise realize, coupons, checks or bills of exchange, drawn or made in payment of any such interest or dividends (not payable in the United States). 2. "Any person who shall obtain payment (not in the United States) in behalf of another, of such dividends and interest by means of coupons, checks or bills of ex- change, and also 3. "Any dealer in such coupons who shall purchase the same for any such dividends or interest (not pay- able in the United States), otherwise than from a banker or another dealer in such coupons." "All persons, firms, or corporations undertaking as a matter of business or for profit the collection of for- eign payments of such interest or dividends by means of coupons, checks, or bills of exchange shall obtain a license from the Commissioner of Internal Revenue, and shall be subject to such regulations enabling the Government to ascertain and verify the due withholding and payment of the income tax required to be withheld and paid as the Commissioner of Internal Revenue, with the ap- proval of the Secretary of the Treasury, shall prescribe ; and any person who shall knowingly undertake to col- lect such payments as aforesaid without having obtained a license therefor, or without complying with such regu- lations, shall be deemed guilty of a misdemeanor and for each offense be fined in a sum not exceeding $5,000, or imprisoned for a term not exceeding one year, or both, in the discretion of the court." The law does not recognize tax free covenants in bonds. " In the case of bonds or other indebtedness which have been issued with a guaranty that the interest payable thereon shall be free from taxation, no deduc- tion for the payment of the tax herein imposed, or any TAX WITHHELD AT SOURCE 33 Scrip Certificates Withholding Tax on Commercial Paper of Corporations Compulsory Deduction at Source on Income in Excess of $3,000 other tax paid pursuant to such guaranty, shall be allowed." " Scrip certificates issued by a corporation to its stock- holders in lieu of dividends, such scrip certificates bear- ing interest and redeemable at a specified time not longer than one year from date of issue, are not corporate obligations similar to bonds, mortgages, or deeds of trust, and the interest payable thereon will not be subject to withholding except when the amount thereof payable to an individual in a calendar year exceeds $3,000. Pay- ment in scrip is held to be equivalent to payment in cash, and when the amount of interest paid on such scrip to any one individual in a calendar year is in excess of $3,000 the tax must be withheld and accounted for in excess of exemption claimed." (T. D. 2090, as amended by T. D. 2152.) " Interest payments on ordinary, bankable commercial paper of corporations, payable to individuals, are subject to withholding at the source only when the payment to any one individual within a taxable year exceeds $3,000. On all other obligations of corporations, etc., payable to individuals, interest payments are subject to withhold- ing regardless of the amount of interest payment. "A simple promissory note not exceeding one year in time, is not ' similar to bonds, mortgages or deeds of trust of corporations/ and the interest on such a note is not subject to withholding except when the amount of interest thereon, payable to an individual in any one year is in excess of $3,000 or when the interest thereon is payable to a nonresident alien, in which latter case the tax should be withheld, regardless of the amount of interest payment." (T. D. 2090.) Except on income derived from dividends on capital stock or net earnings of corporations, the normal tax shall be withheld at the source on all payments to indi- viduals in excess of $3,000 for any year, on all gains, 34 INCOME TAX LAW AND ACCOUNTING profits and income, less the personal exemption, where a certificate of exemption has been filed with the payer. This provision is applicable to " all persons, firms, co- partnerships, companies, corporations, joint stock com- panies or associations and insurance companies, in whatever capacity acting, including lessees or mortgagors of real or personal property, trustees acting in any trust capacity, executors, administrators, receivers, conserva- tors, employers and all officers and employees of the United States, having the control, receipt, custody, dis- posal or payment of interest, rent, salaries, wages, premiums, annuities, compensation, remuneration, emolu- ments or other fixed or determinable annual or periodical gains, profits and income of another person." All those required to withhold at the source, as above indicated, are made personally liable for such tax as they are required to withhold. The taxes withheld should be reported on Form 1042 Revised, and filed annually with the Collector on or before March 1st of each year. Specific No person shall receive the benefit of the personal ex- Exemption ern ption except where he or she shall file, not less than Obtained thirty days prior to the day on which the return is due, with the person who is required to withhold and pay the tax, a signed notice in writing, claiming the benefit of such exemption (Form 1007 Revised) ; thereupon no tax shall be withheld upon the amount of such exemp- tion. Penalty for Any person who knowingly makes a false statement or Re^resenta- ^ se re P resentat i n ; ^ or the purpose of obtaining any tion allowance or reduction by virtue of a claim for exemp- tion, either for himself or for any other person, will be liable to a penalty of not exceeding $300. Certificate The certificate of exemption filed by an individual with Exem tion ^ e P a y er ^ mcom e shall be filed with the return of such paying debtor. (Form 1007 Revised.) TAX WITHHELD AT SOURCE 35 A person to become entitled to the benefit of any de- duction of normal tax withheld at the source in excess of the taxpayer's liability for normal tax, or for refund of amount of excess tax withheld, must, not less than thirty days prior to the day on which the return of his income is due, either : 1. " File with the person who is required to withhold and pay tax for him, a true and correct return (Form 1008 Revised) of his gains, profits, and income from all other sources, and also the deductions asked for, and the showing thus made shall then become a part of the return to be made in his behalf by the person required to withhold and pay the tax, or " Likewise make application for deductions to the Collector of the district in which return is made or to be made for him." (Form 1008 Revised.) In cases where the allowable deductions are known at the time of receipt of fixed, annual, or periodical income by individuals, whose income is subject to withholding of tax, it has been provided by T. D. 2412, released for publication December 15, 1916, that "the person en- titled to and receiving such income may file with the person, firm, or corporation making the payment, a cer- tificate (Form 1088), under penalty for false claim, stat- ing the amount of such deductions and making a claim for an allowance of the same, whereupon there shall be no withholding upon the amount of such claim and such certificate shall become a part of the return to be made in behalf of the person making the claim. When because of such claim no tax shall have been withheld, the cer- tificate nevertheless shall be forwarded, with letter of transmittal, to the Collector of Internal Revenue for the District in which the withholding agent resides." On rent payable to an individual in excess of $3,000 per annum, the normal tax must be withheld at the source of payment. 36 INCOME TAX LAW AND ACCOUNTING Where a tenant rents two or more pieces of property and the total rental exceeds $3,000 per annum the normal tax must be deducted and withheld, less, of course, the specific exemption if claim therefor is made in due time. Interest on Interest on bank balances is returnable in the year Bank credited by the bank. The tax on such interest, how- Account . ever, even m excess of $3,000 per annum, is not subject to be withheld at the source. Real Estate Agent Shall Not Withhold Tax Withheld Deductible by Individual Traveling Expenses Paid by Salesmen Salesmen's Commissions Profit Sharing Bonuses A real estate agent collecting rents for a landlord shall not withhold the normal tax even in excess of $3,000. He stands in the position of the landlord and receives collections for and in behalf of such landlord. (T. D. 2090.) All taxes withheld at the source shall be an allowance in the return of the person on whose income such tax has been or is to be paid at the source. Where a salary is paid to a salesman out of which he is required to pay his traveling expenses, the tax should not be withheld at the source. Irregular or indefinite income as to amount and time of accrual, such as commissions earned by a salesman, are not subject to withholding at the source, except where such commission can be definitely determined, as in the case where it is based on sales. Wherever a commission is definitely determinable the normal tax should be with- held. Where both a salary and commission are paid, the tax withheld should be based on both inclusive, less personal exemption of the recipient. This is true also of amounts paid as " profit-sharing " or bonuses. The tax on the bonus should be withheld in the year that it is paid or credited, not necessarily in the year, on the income of which, such bonus was computed. TAX WITHHELD AT SOURCE 37 Indemnity to Withholding Party Return of Income Tax Withheld at Source Withholding Tax Nonresident Alien Provision for Exemption from Withholding Tax on Income of Nonresident Alien Corporations The law indemnifies those who withhold the normal tax at the source against liability to the person on whose income the deduction is made. The normal tax withheld by corporations on salaries and compensation of officers and employees, in excess of $3,000, must be reported in Form 1042 Revised. This return should accompany the return of annual net in- come. Failure to file such form (1042 Revised) makes the corporation subject to the penalty imposed for fail- ure to make return in due time. Although the law does not specifically so state, it may reasonably be inferred from a consideration of all the provisions bearing upon the withholding of tax on in- come of nonresident alien individuals, that the payers of such income should withhold the normal tax thereon irrespective of amount paid, except in the case of divi- dends. The law provides that the normal tax is to be withheld at the source of payment from income derived within the United States by nonresident alien firms, co-partnerships, companies, corporations, joint-stock companies or asso- ciations and insurance companies that are not engaged in business or trade within the United States and have no office or place of business therein. " The income of such nonresident alien corporations, etc., which is subject to the withholding provisions of the law is that derived from ' interest on bonds and mort- gages or deeds of trust or similar obligations of domestic or other resident corporations, joint-stock companies or associations, and insurance companies/ regardless of amount. "And likewise the withholding provisions of the law ' shall be made applicable to income derived from divi- dends upon the capital stock or from the net earnings of domestic or other resident corporations, joint stock com- 3S INCOME TAX LAW AND ACCOUNTING panics or associations, and insurance companies by non- resident alien companies, corporations, joint-stock com- panies or associations, and insurance companies not en- gaged in business or trade within the United States and not having any office or place of business therein,' re- gardless of amount. " Including and from and after September 9, 1916, and to and including December 31, 1916, the normal income tax will be withheld from such income at the rate of 1 per cent on the amount thereof. Including and from and after January 1, 1917, the normal income tax will be withheld from such income at the rate of 2 per cent on the amount thereof. " To enable debtor corporations, etc., in the United States to distinguish between nonresident alien corpora- tions, etc., which have and those which do not have * any office or place of business ' in the United States and also to enable such nonresident alien corporations, etc., as have an ' office or place of business ' in the United States, to claim exemption from withholding of the normal in- come tax at the source on their income from sources within the United States, as specified by the statute, a certificate * * * " has been provided known as Form 1086. " The normal income tax on the character of income herein specified and payable to nonresident firms, copart- nerships, corporations, etc., will be deducted, withheld, and paid to the proper officer of the United States Gov- ernment authorized to receive it, unless the corporation, etc., entitled to the payment shall file * * * " such certificate (under penalty for false claim) and only those non-resident firms, corporations, etc., which have an " office or place of business " in the United States can use such certificate. " The corporations, etc., which are permitted to use the certificate herein provided are required to make and render a return of income to the collector of internal revenue for the district in which FARMS AND FARMERS 39 they have their office or place of business * * *. (T. D. 2374 ) Farms and Farmers Defined Income from Farms Prepaid Farm Expenses Deductible Farming on Shares Farm Expenses Deductible in Year Paid VI. FARMS AND FARMERS. " The term ' farm' as herein used embraces the farm in the ordinary accepted sense, plantations, ranches, stock farms, dairy farms, poultry farms, fruit farms, truck farms and all lands used for similar purposes; and foi the purposes of this decision all persons who cultivate, operate or manage farms for gain or profit, either as owners or tenants, are designated as ' farmers.' "All gains, profits, and income derived from the sale or exchange of farm products, whether produced on a farm or purchased and resold by a farmer, shall be in- cluded in the return of income for the year in which the products were actually marketed and sold; and "All allowable deductions, including the legitimate expenses incident to the production of that year or future years, may be claimed in the return of income for the tax year in which the right to such deductions shall arise, although the products to which such expenses and de- ductions are incidental may not Rave been sold or ex- changed for money; or a money equivalent, during the year for which the return is rendered. " Rents received in crop shares shall likewise be re- turned as of the year in which the crop shares are re- duced to money or a money equivalent, and "Allowable deductions, likewise, shall be claimed in the return of income for the tax year to which they apply, although expenses and deductions may be incident to products which remained unsold at the end of the year for which the deductions are claimed. 40 INCOME TAX LAW AND ACCOUNTING Loss in Value of Farm Products Held for Advance Live Stock Purchased Loss by Death of Live Stock Deductible Receipts for Condemned Live Stock Farm Machinery Not Deductible Depreciation Allowed on Farm Property " When farm products are held for favorable market prices, no deduction on account of shrinkage in weight or physical value, or losses by reason of such shrinkage or deterioration in storage, shall be allowed. " Cost of stock purchased for resale is an allowable deduction under the item of expense, but money ex- pended for stock for breeding purposes is regarded as capital invested, and amounts so expended do not con- stitute allowable deductions except as hereinafter stated. " Where stock has been purchased for any purpose, and afterwards dies from disease or injury, or is killed by order of the authorities of a State, or the United States, and the cost thereof has not been claimed as an item of expense, the actual purchase price of such stock, less any depreciation which may have been previously claimed, may be deducted as a loss. Property destroyed by order of the authorities of a State, or of the United States, may, in a like manner, be claimed as a loss. " But if reimbursement is made by a State or the United States, in whole or in part, on account of stock killed or property destroyed, the amount received shall be reported as income for the year in which reimburse- ment is made. " The cost of farm machinery is not an allowable de- duction as an item of expense, but the cost of ordinary tools may be included under this item. " Under the sixth deduction enumerated in Paragraph ' B/ providing for ' a reasonable allowance for the ex- haustion, wear, and tear of property arising out of its use or employment ' * * *, there may be claimed a reasonable allowance for depreciation on farm buildings (other than a dwelling occupied by the owner), farm machinery, and other physical property, including stock purchased for breeding purposes ; but no claim for depre- FARMS AND FARMERS 41 Farmers Books of Account Farm Maintained Only for Recreation elation on stock raised or purchased for resale will be allowed. " Farmers who keep books, according to some ap- proved method of accounting, which clearly show the net income, may prepare their returns from such books, although the method of accounting may not be strictly in accordance with the provisions of this decision. "A person cultivating or operating a farm, for recrea- tion or pleasure, on a basis other than the recognized principles of commercial farming, the result of which is a continual loss from year to year, is not regarded as a farmer. In such cases, if the expenses incurred in con- nection with the farm are in excess of the receipts there- from, the entire receipts from sale of products may be ignored in rendering a return of income; and the ex- penses incurred being regarded as personal expenses will not constitute allowable deductions in the return of in- come derived from other sources." (T. D. 2153.) 42 CHAPTER II Partners INCOME TAX AS APPLIED TO PARTNERSHIPS VII. GENERAL PARTNERSHIPS Persons conducting business in partnership shall be liable for income tax only in their individual capacity. Returns by Partnerships are not required to make returns except Partnerships w j ien specifically ordered to do so by the Collector of Required Internal Revenue. In such case, the return should be prepared on Form 1065. The individual members of the partnership are re- quired to include in their returns their prorata share of the earnings of partnerships as shown by the books of account, whether such earnings were distributed or not. Income When Accrued " It is held that the income from a partnership accrues to the individual partner at the time his distributive in- terest is determined and reducible to possession. In the returns of income made by individuals for the calendar year, therefore, there should be included such income accruing from the business of partnerships for their business years as may have been definitely ascertained by means of a book balance, whether distributed or not. In other words, members of partnerships are required to make returns of income like other individuals for the calendar year, and should include in their returns'' the net proceeds of their interest in partnership profits as- certained at the end of the business year falling within the calendar year for which the individual return is being rendered." (T. D. 2090.) Partnership Income due to a partnership is not subject to the with- Sub/ed: to holding of normal tax at the source, because a partner- Withholding ship, apart from its members, is not taxable. PARTNERSHIPS 43 Dividends to Partnership Credits on Individual Returns of Partners Partnership Expenses Life Insurance of Partners Limited Partnership Partnership earnings must include dividends on the capital stock of corporations, joint-stock companies, or associations, or insurance companies owned by the part- nership. From the net distributive interests reported by the partners " there shall be excluded their proportionate shares received from interest on the obligations of a State or any political or taxing subdivision thereof, and upon the obligations of the United States and its pos- sessions, and all taxes paid to the United States or to any possession thereof, or to any State, county or taxing subdivision of a State, and * * * for the purpose of computing the normal tax there shall be allowed a credit * * * for their proportionate share of the profits derived from dividends." None of the expenses of a partnership shall be de- ducted from the return of net income of an individual. " Premiums paid on life insurance taken out by a partnership upon the lives of individual members of such partnership, constitute allowable deductions in ascertain- ing the net earnings of the partnership. However, when such policies mature, or upon the death of the insured partner, the amount received as life insurance should be included in the gross income of the partnership." (T. D. 2090.) VIII. LIMITED PARTNERSHIPS. In the administration of the income tax law it has been ruled that a limited partnership, with respect to its income, is subject to the provisions of law applicable to corporations; that is to say, a limited partnership must make its return on the blank provided for corporations (Form 1031 Revised), and must pay the normal tax as shown thereby. Partnerships are required to prepare and file lists of the persons receiving from them compensation in ex- cess of $3,000 per annum (Form 1042 Revised). 44 INCOME TAX LAW AND ACCOUNTING A limited partnership is one having one or more " special partners " whose liability is limited to the amount invested. It is created by complying with the State laws providing for that form of partnership. The usual requirements are that such partnership file certain certificates stating: the name of firm under which the limited partnership is to be conducted, its principal place of business, the general nature of the business intended to be transacted, the names of all general and special partners and their respective residences, the names of the special partners and the amount of capital con- tributed by each of thern, and the time that such partner- ship shall commence and terminate. A limited partnership can only be created by comply- ing with requirements of the statute of the State under which it is created. Profits " The profits of limited partnerships making returns Limited m ^ ie same manner as corporations make returns will Partnerships , * * V ^ ,. < be treated the same as dividends of corporations and will be returned in the returns of individuals in the same manner as are dividends upon the stock of corporations ; that is to say, the dividends received from such limited partnerships will not be subject to the normal tax in the hands of the members of the partnership receiving the same." (T. D. 2137.) 45 CHAPTER III. INCOME TAX AS APPLIED TO CORPORATIONS. IX. GENERAL PROVISIONS. Income of The Federal income tax will be levied, assessed, col- O^anJzecf 15 ^ ecte( ^' anc ^ P a ^ annually upon the total net income from in United all sources, received in the preceding calendar or fiscal year, 1 by every corporation, joint-stock company or asso- ciation, or insurance company, organized in the United States. Income of The tax will be paid annually by every corporation, Corporations J omt -stock company or association, or insurance com- pany organized under the laws of any foreign country, upon the total net income received from all sources within the United States in the preceding year, " includ- ing interest on bonds, notes or other interest-bearing obligations of residents, corporate or otherwise, and including the income derived from dividends on capital stock or from net earnings of resident corporations, joint- stock companies or associations, or insurance companies whose net income is taxable under this title." Rate The tax upon the income of corporations is 2 per cent. Tax Year The calendar year comprises the tax year, except that corporations may designate their own fiscal year by complying with certain requirements as to notice to the Collector, etc. See page 47. Beginning The rate of 2 per cent, is applicable to the entire cal- endar year of 1916 and every year thereafter. 1 A return for the fiscal year of a corporation, when other than the calendar year, is only acceptable after compliance with re- quirements in connection therewith. See page 47. 46 INCOME TAX LAW AND ACCOUNTING No Specific Exemption of Net Income Foreign Income Taxable Under the Corporation Excise Tax of 1909, net in- come of corporations to the amount of $5,000 per annum was exempt. No such provision is contained in the present income tax law. All net income of corporations is subject to the tax of 2 per cent. A corporation organized in the United States, or any possession of the United States, must include in its re- turn income from all sources, whether derived in the United States, its possessions, or in foreign countries. Form of Return Return of Domestic Corporation Return of Foreign Corporation Returns Must be Made for Calendar Year Unless Otherwise Authorized Due Date of Return X. RETURNS OF CORPORATIONS. All corporations, domestic and foreign, are required to make returns on Form 1031 Revised, except insurance companies, whose returns are made on Form 1030 Re- vised. The return of a domestic corporation shall be made to the Collector of the district in which is located its principal office, or where its books of account and other data are kept, from which the return is prepared. In the case of a foreign corporation, the return should be filed with the Collector of the district in which is located' its principal place of business in the United States, or if it has no principal place of business, office or agency within the United States, then with the Col- lector of Internal Revenue at Baltimore, Maryland. Returns made for any period other than a calendar year, except where the corporation has given due notice to the Collector of Internal Revenue, in compliance with requirements of law, will not be accepted by the Col- lector. All returns shall be filed with the Collector on or before the 1st day of March of each year unless the fiscal year of the corporation has been designated in the manner prescribed, in which case the return must be RETURNS OF CORPORATIONS 47 When Last Filing Day Falls on Sunday or Legal Holiday Execution of Returns When Tax Payable Delayed Payment Penalty Returns for Fiscal Year of Corporation filed within sixty days after the close of such designated fiscal year. When the due date of filing a return, March 1st, or where an extension has been obtained, the last day of such extended time, falls on Sunday or a legal holiday, the last due date will be the day next following such Sunday or legal holiday. In case the return is trans- mitted by mail it should be posted in ample time to reach the Collector's office " under ordinary handling of the mails, on or before the date on which the return is thus made due in the office of the Collector." " The return shall be sworn to by the President, Vice- president or other principal officer, and by the Treasurer or Assistant Treasurer." Corporations making returns on the basis of the cal- endar year will be notified of the amount of their assess- ments on or before the first day of June of each year and the amount of said assessment shall be paid on or before the fifteenth day of June. To any sum or sums due and unpaid after ten days' notice and demand thereof by the Collector, there shall be added interest at the rate of one per cent, per month upon said tax from the time the same became due, and a further penalty of five per cent, on the amount of the tax unpaid. A corporation whose fiscal year is not the calendar year, may make its return on the basis of its fiscal year by complying with prescribed requirements. The desig- nated fiscal year must end on the last day of some month. The corporation shall give notice to the Collector of the district in which its principal office is located, at any time not less than 30 days prior to March 1st of the year in which its return would be filed if made upon the basis of the calendar year. Although not required under the law, it is advisable to obtain the consent of the 48 INCOME TAX LAW AND ACCOUNTING Fiscal Year When Tax Payable Extension of Time to File Return Failure to File Return Penalty Collector before proceeding to file returns for any period other than the calendar year. Illustration : The fiscal year of a corporation ends on June 30th. It has made its returns say, for the year 1915 based on the calendar year (January 1st to Decem- ber 31st, 1915). In order now (December 1st, 1916), to obtain permission to make its return on the basis of its fiscal year (June 30th) it must serve notice on the Collector not later than 30 days prior to March 1st, 1917 (on or before January 29th, 1917). Its return for six months ended June 30th, 1916, must be filed on or be- fore March 1st, 1917, and the return for year ending June 30th, 1917, must be filed within sixty days there- after (on or before August 29th, 1917). From that time on its annual return will be made for each year ending June 30th, which return must be filed within 60 days, i. e., on or before August 29th. The tax under the designated fiscal year becomes due and payable 105 days after the last due date upon which it is required to file the return, which, in the illustration cited, would be December 12th of the same year that the return is made. Section 3176 of the revised statute provides that: " If the failure to file a return or list is due to sickness or absence, the collector may allow such further time, not exceeding thirty days, for making and filing the return or list as he deems proper." Application for such exten- sion should be made to the Collector on or before the first day of March. Section 14 (c) provides, further, " That the Commis- sioner of Internal Revenue shall have authority, in the case of either corporations or individuals, to grant a reasonable extension of time in meritorious cases, as he may deem proper." In case of failure to file a return within the time pre- scribed by law or by the Collector, the Commissioner of RETURNS OF CORPORATIONS 49 Internal Revenue shall add fifty per cent, of the amount of the tax. When a return is voluntarily, and without notice from the Collector, filed after the due time, and it is shown that the failure to file the return was due to a reasonable cause and not to willful neglect, no such addi- tion shall be made to the tax. In case a false or fraudulent return is willfully made, the Commissioner of Internal Revenue shall add to the tax one hundred per cent, of its amount. Section 3176 of the revised statute further provides that " The amount so added to any tax shall be collected at the same time and in the same manner and as part of the tax unless the tax has been paid before the discovery of the neglect, falsity, or fraud, in which case the amount so added shall be collected in the same manner as the tax." Section 18 of the income tax law further states that " Any individual or any officer of any corporation, joint- stock company or association or insurance company re- quired by law to make, render, sign or verify any return who makes any false or fraudulent return or statement with intent to defeat or evade the assessment required by this title to be made shall be guilty of a misdemeanor, and shall be fined not exceeding $2,000 or be imprisoned not exceeding one year, or both, in the discretion of the court, with the costs of prosecution. Section 14 (c) contains the provision that " If any of the corporations, joint-stock companies or associations, or insurance companies aforesaid shall refuse or neglect to make a return at the time or times hereinbefore speci- fied in each year, or shall render a false or fraudulent return, such corporation, joint-stock company or associa- tion, or insurance company shall be liable to a penalty of not exceeding $10,000." In cases of refusal or neglect to make return, and in cases of erroneous, false or fraudulent returns, the Commissioner of Internal Revenue shall, upon the dis- 50 INCOME TAX LAW AND ACCOUNTING Second Assessment Recovery of Amount Paid covery thereof, at any time within three years after such return is due, make a return upon information obtained as provided for by existing law. The assessment, based upon a return so made, shall become due and payable immediately upon notification of the amount thereof. " When a second assessment is made in case of any list, statement, or return, which in the opinion of the collector or deputy collector was false or fraudulent, or contained any understatement or undervaluation, no tax collected under such assessment shall be recovered by any suit unless it is proved that the said list, statement, or return was not false nor fraudulent and did not con- tain any understatement or undervaluation ; but this sec- tion shall not apply to statements or returns made or to be made in good faith under the laws of the United States regarding annual depreciation of oil or gas wells and mines." (Section 3225, revised statute.) The contents of returns of net income constitute a public record, open to inspection " only upon the order of the President under rules and regulations prescribed by the Secretary of the Treasury and approved by the President." Designated A corporation that has designated its own fiscal year Year shall P a ^ a tax on ^ ie P r P r tion of the total net income Apportioning returned for the fiscal year ending prior to December 31, Iorl9l6 1916 > which the P eriod between January 1, 1916, and the end of such fiscal year bears to the whole of such fiscal year; that is to say, a corporation, the fiscal year of which ends on November 30, 1916, shall pay a tax of 1 per cent, (under the old law) on 1/12 of its net income of said fiscal year, for the month of December, 1915, and 2 per cent, on 11/12 of said income, for period from January 1 to November 30, 1916. Thereafter it will pay at the rate of 2 per cent. Publicity of Returns RETURNS OF CORPORATIONS 51 Corporations Incompletely Organized AH Existing Corporations Must Make Returns A corporation which has not been completely organ- iJd, that is to say, has not accepted the charter granted it, and has transacted no business, is relieved of the necessity of making a return as a corporation until its organization has been completed. The fact that a corporation has received no income no excuse for failure to make return. The duty to make a return depends upon corporate existence and not upon receipt of income. Colons In the event that * sh uW not be possible for a cor- Maintaining poration to obtain from its foreign branches the neces- BrSes sary data from which to make a complete and accurate report, it is advisable to prepare and file a tentative re- turn showing, in so far as obtainable, the income from all operations of such company, to which should be at- tached a memorandum to the effect that, by reason of inability to obtain 'the necessary information in due time the income reported does not include income from all sources. Such report should be marked " Tentative Re- When the necessary data is received an amended return, so marked, should be filed, and the assessment will then be fixed thereon. Collectors of Internal Revenue are permitted to accept tentative returns in cases other than that mentioned above (foreign branches) where true returns cannot be rendered in due time or within the extended time as provided by law. The practice, however, should only be resorted to when it is unavoidable. Returns of Holding Companies " In a case wherein a holding company actually takes up each month on its books its proportionate share of the earnings of the underlying companies, such holding company will be required to include in its gross income the amounts thus taken up regardless of the fact that the same may not have been actually paid to it in cash. The fact that the underlying companies credit to the 52 INCOME TAX LAW AND ACCOUNTING Returns of Subsidiary Companies Receivers, Trustees, Assignees holding company the amount of earnings to which it is entitled on the basis of the stock it holds, together with the fact that the holding company takes up on its books the amount thus credited; renders it incumbent upon the holding company to return these amounts as income, re- gardless of the fact that the underlying companies needed these earnings and used them in making extensions and improvements and in furtherance of their business. Ex- penditures for such extensions and improvements being chargeable to the property account of the subsidiary companies are not deductible from the gross income and will therefore not have the effect to reduce the earnings to their respective shares of which the stockholders are entitled." (Supplement to Black on Income Taxes.) The existence of a corporation is sufficient to compel the rendering of a return of net income. The fact that a subsidiary company has had no income and no expenses does not excuse it from making a return. In case there has been neither income nor expenses, the return should specifically state such facts. It is quite usual for a subsidiary company to keep its books and maintain its principal office at a place other than where its operations are conducted. In such case, as where the subsidiary company's office is maintained in the place where the holding company has its office, the return should be made in the district of the place where its books of account are kept. It is customary for subsidiary companies to transmit to the parent company all of its earnings after deduct- ing its expenses. Such income received by the parent company is construed to be dividends by the subsidiary company, subject to tax in the return of the parent com- pany, as well as in the return of the subsidiary. Receivers and trustees in bankruptcy, and assignees, who are operating the property or business of corpora- tions that are subject to the income tax must make re- EXEMPT ORGANIZATIONS 53 turns of net income for such corporations. Corporations in the hands of receivers, trustees or conservators are subject to the income tax and must make returns. Returns It has been ruled that corporations required to keep Commerce their books according to a uniform system of accounting Corporations prescribed by the Interstate Commerce Commission, may supply the information called for by Form 1031 " by classes rather than giving the items in detail, classifying the income and expenditures in the same manner as Is required as to these items by the Interstate Commerce Commission." Books of "A corporation, joint-stock company or association, Corporations or insurance company, keeping accounts upon any basis other than that of actual receipts and disbursements, unless such other basis does not clearly reflect its income, may, subject to regulations made by the Commissioner of Internal Revenue, with the approval of the Secretary of the Treasury,' make its return upon the basis upon which its accounts are kept, in which case the tax shall be computed upon its income as so returned." (See Chapter V, " Preparation of Income Tax Return," page 86.) Appreciation An increase in the book value of assets to conform Income w * tn appraisal values, or for any other purpose, does not render such increase taxable as income. XL EXEMPT ORGANIZATIONS. Exempt Xhe following classes of corporations and organiza- tions" 1 ' tions are exempt from requirements of the income tax law except the withholding of normal tax at the source, and reporting and paying the same to the Government. (See: Exempt corporations subject to withholding, page 55.) Fi rs t Labor, agricultural or horticultural organization; Second Mutual savings bank not having a capital stock represented by shares; 54 INCOME TAX LAW AND ACCOUNTING Third Fraternal beneficiary society, order, or associa- tion, operating under the lodge system or for the exclusive benefit of the members of a fraternity itself operating under the lodge system, and pro- viding for the payment of life, sick, accident, or other benefits to the members of such society, order, or association or their dependents; Fourth Domestic building and loan association and co- operative banks without capital stock organized and operated for mutual purposes and without profit; Fifth Cemetery company owned and operated exclu- sively for the benefit of its members; Sixth Corporation or association organized and op- erated exclusively for religious, charitable, scientific, or educational purposes, no part of the net income of which inures to the benefit of any private stock- holder or individual; Seventh Business league, chamber of commerce, or board of trade, not organized for profit and no part of the net income of which inures to the benefit of any private stockholder or individual; Eighth Civic league or organization not organized for profit but operated exclusively for the promotion of social welfare ; Ninth Club organized and operated exclusively for pleasure, recreation, and other nonprofitable pur- poses, no part of the net income of which inures to the benefit of any private stockholder or member; Tenth Farmers, or other mutual hail, cyclone, or fire insurance company, mutual ditch or irrigation com- pany, mutual or co-operative telephone company; or like organization of a purely local character; the income of which consists solely of assessments, dues, and fees collected from members for the sole pur- pose of meeting its expenses; EXEMPT ORGANIZATIONS 55 Eleventh Farmers', fruit growers', or like association, organized and operated as a sales agent for the pur- pose of marketing the products of its members and turning back to them the proceeds of sales, less the necessary selling expenses, on the basis of the quan- tity of produce furnished by them; Twelfth Corporation or association organized for the exclusive purpose of holding title to property, col- lecting income therefrom, and turning over the en- tire amount thereof, less expenses, to an organiza- tion which itself is exempt from the tax imposed by this title; or Thirteenth Federal land banks and national farm-loan associations as provided in section twenty-six of the Act approved July seventeenth, nineteen hundred and sixteen, entitled " An act to provide capital for agricultural development, to create standard forms of investment based upon farm mortgage, to equalize rates of interest upon farm loans, to fur- nish a market for United States bonds, to create Government depositaries and financial agents for the United States, and for other purposes." Fourteenth Joint-stock land banks as to income derived from bonds or debentures o-f other joint-stock land banks or any Federal land bank belonging to such joint-stock land bank. Exempt Under the language of the income tax act of 1913 it Subject^ 115 was he ^ that exem P t corporations and organizations Withholding were exempt from all provisions of the law. Under the present law, however, enacted September 8, 1916, it has been ruled by the Commissioner of Internal Revenue that the fourteen different kinds of exempt corporations and organizations named in the law are relieved only from the tax on their income, and " that said corporations and organizations are required to answer under all the other provisions of the statute as to withholding and making returns of tax withheld." 56 INCOME TAX LAW AND ACCOUNTING Organiza- tions Doubtful as to Exemption Foreign Organiza- tions Close Corporation In all cases where there is a question of doubt as to whether an organization is or is not exempt, it is rec- ommended that a special ruling be obtained from the Commissioner of Internal Revenue. The application for such ruling should be accompanied by an affidavit stat- ing: (a) The purpose and nature of the organization (b) The source erf its income (c) The disposition of its income (d) Whether or not any of its net income will inure to the benefit of any private stockholder or individual. It has been ruled that foreign as well as domestic cor- porations and organizations enumerated in the exempt list are included therein. A so-called " close corporation," which usually consists of members of a family, is not such corporation as is ex- empt from the requirements of the income tax law. Net Income Gross Income XII. INCOME OF CORPORATIONS. The term " net income " as used in the income tax law with respect to corporations, may be denned as the " gross income " less deductions allowed by law. " Gross income of manufacturing companies shall con- Manufactur- si st of the total sales of manufactured goods during the in 2 year covered by the return, increased or decreased by Corporations J . , , , . - . J the gain or loss as shown by the inventories of finished and unfinished products, raw material, etc., at the be- ginning and end of the year. To this amount should be added the income, gains, or profits from all other sources as shown by the books of account." (Art. 104, Reg. 33 1 ) (See: Manufacturing Corporation operating Cost- system, page 110.) 1 Refers to regulations issued by the Treasury Department. INCOME OF CORPORATIONS 57 Gross " Gross income of mercantile companies shall include Mercantile the tota ^ merchandise sales during the year, increased Corporations or decreased by the gain or loss as shown by the inven- tories of merchandise at the beginning and end of the year for which the return is made ; to this amount should be added the income, gains, or profits derived from all other sources as shown by the books of account." (Art. 105, Reg. 33.) Gross " Gross income of miscellaneous corporations consists Miscel- * ^ e tota * reven ue derived from the operation and man- laneous _ agement of the business and property of the corporation making the return, together with all amounts of income, including the income, gains, or profits from all other sources, as shown by the books of account." (Art. 106, Reg. 33.) Gross " In the case of a large contracting company, which Contracting nas numerous uncompleted contracts which probably, in Corporations some cases, run for periods of several years, there does not appear to be any objection to such corporation pre- paring its return in such manner that its gross income will be arrived at on the basis of completed work that is to say, on jobs which have been finally completed and payments made during the year in which the return is made. If the gross income is arrived at in this method, the deductions from gross income should be limited to the expenditures made on account of such completed contracts." (T. D. 2161.) Gross " It will be noted from these definitions that the gross From 1 !!! income embraces not only the operating revenues, but also Sources income, gains, or profits from all other sources, such as rentals, royalties, interest, and dividends from stock owned in other corporations * * *, also profits made from the sale of assets, investments, etc." (Art. 107, Reg. 33.) 58 INCOME TAX LAW AND ACCOUNTING Gross Income Insurance Companies Mutual Companies Dividends Received by Corporation Dividends Payable in Securities Profit on Sales of Capital Assets " Gross income of insurance companies consists of the total revenue derived from the operation of the business^ including income, gains, or profits from all other sources, as shown by the entries on the books of account within the calendar or fiscal year for which the return is made, except as modified by the express exemptions of the articles which apply to mutual fire, mutual marine, and life insurance companies." (Art. 97, Reg. 33.) Mutual associations or companies, such as, fire, em- ployers' liability, workmen's compensation, casualty in- surance companies, that require their members to make premium deposits to provide for losses and expenses, are not required to return as income any portion of the premium deposits returned to policyholders. Income from all other sources, however, including that received from its members as premium deposits, retained by the companies for purposes other than the payment of losses and expenses and reinsurance reserves, is returnable as income. The income received by corporations in the form of dividends of other corporations is subject to tax in the hands of the company paying the same, as a part of its net earnings, as well as in the hands of the corporation receiving the same. Hence, there is a double tax on divi- dends paid to a corporate stockholder. Dividends may be declared payable in cash or the equivalent of cash. Where dividends are declared pay- able in securities of another corporation or of a foreign government, the value placed upon such securities should be the fair cash market value thereof as at the time the dividend is declared. Profit or income from the sale of capital assets is sub- ject to the income tax and must be included in the return of corporations. INCOME OF CORPORATIONS 59 Sales of For the purpose of ascertaining the gain derived from Acquired the sa ^ e or otner disposition of property, real, personal Prior to or mixed, acquired before March 1, 1913, the fair market March 1st, price Qr value of such p roperty as o f March 1, 1913, shall be the basis for determining the amount of such gain derived. For method of computing profit or loss on properties acquired prior to March 1, 1913, see page 23.; Interest on Interest received on sinking funds or from any in- Sinking vestment of reserve funds, shall be accounted for as Funds income. Income of A real estate development corporation, ordinarily, does Development not realize a profit until the property or properties of Corporation suc h company have been developed. During the time of such development certain carrying charges are in- curred, as interest, taxes, insurance, etc. Inasmuch as it would work an injustice to compel such company to deduct carrying charges as current expenses during the period of development, when the property derives no profit, it has been ruled that all such carrying charges may be added to the cost of the property. During the time of development the income from the sale of lots, or parcels, may be deducted from the total cost of land, including the initial cost plus carrying charges and the corporation will return no profit until the amount of sales, or contracts of sales, exceed the prime cost of property plus carrying charges. In the case of a contract of sale of land on the in- stallment plan of payments by a development company, the gross amount to be paid by the installment purchaser is deemed income and is returnable, for income tax pur- poses in the year that the contract of sale is made. Should the purchaser default in payment, the amount of such default may be deducted as a loss sustained by rea- son thereof. 60 INCOME TAX LAW AND ACCOUNTING Income Instalment Businesses Generally Premium Sale of Capital Stock Assessment of Paid-up Capital Stock Not Income Corporations and individuals selling merchandise on the installment plan, or on " lease contracts/' are required to make their returns of gross income on the basis of the gross amount of contracts of sales made during the year. In other words, the gross amount to be paid by the cus- tomer under a contract for the sale or " leasing " of mer- chandise is construed to be the amount on which the gross profit is computed for income tax purposes. Uncol- lected accounts, less salvage value of goods returned, if any, may be charged at the end of the year as bad debts. This principle is applicable to all kinds of installment businesses, as, for example, piano, furniture, clothing concerns, etc. " The amount received by a corporation for the orig- inal issue and sale of its capital stock is held to be the capital of the corporation. In cases where the stock, as originally issued, is sold at a price greater or less than the par value, neither the premium nor the discount will be taken into account in determining the net income of the corporation for the year in which the stock is sold. This is purely a capital transaction and the income is neither increased nor decreased by reason of the sale, per se, of the stock at a price greater or less than its par value." (T. D. 2090.) Where a corporation sustains a deficit (impairment of capital) at the close of a year, which the stockholders propose to make good by voluntary contribution, such contribution or assessment is not income to the corpora- tion. In a letter to Dorman & Dana, New York, dated February 21, 1916, Commissioner W. H. Osborn ex- pressed himself as follows : " It is therefore the present opinion of this office that the amounts paid by the stock- holders pursuant to this so-called voluntary assessment, are to all intents and purposes, if not in fact, additional payments for the stock which they hold, that is to say, such payments are simply an addition to the capital DEDUCTIONS ALLOWED CORPORATIONS 61 stock of the company. Since amounts paid for or on account of capital stock issued do not constitute income within the meaning of the Federal income tax law, it is held that these payments represent voluntary assess- ments upon the stock held by the individual stockholders and do not constitute income to be returned for the pur- pose of the income tax." XIII. DEDUCTIONS ALLOWED TO CORPORATIONS. Deductions " All the ordinary and necessary expenses paid within Corporations t ^ ie vear m ^ e mamt enance and operation of its busi- ness and properties " are deductible from gross income of corporations. All losses actually sustained and charged off within the year, not compensated for by insurance or otherwise, are deductible item's. Loss Losses not compensated by insurance must be deducted Qnly^n from the return of net income for the year in which Year the loss was sustained. This ruling has been upheld by Sustained . . , . ,. f , the courts and is strictly enforced. Deductible Profit or Loss on Property Acquired Before March I, 1913 Depreciation Deductible For the purpose of computing the profit or loss from the sale of property of a corporation, acquired prior to the incidence of the law, March 1st, 1913, such proper- ties shall be valued as of that time at the fair market price thereof. This applies to both real and personal property. A reasonable allowance for the exhaustion, wear and tear of physical properties of a corporation arising out of its use or employment in the business or trade is de- ductible in the year that such depreciation is sustained. The amount deducted must be actually charged off upon the books of the corporation. (See " Depreciation," page 68.) 62 INCOME TAX LAW AND ACCOUNTING Depletion of Oil and Gas Wells Depletion of Mines Depletion of Timber Lands Bad Debts Reserves for Bad Debts This deduction is considered in Chapter IV on Depreciation, page 75.) Under the amended law the provision of the income tax act of 1913, limiting the charge for depletion of mines to " 5 per cent, of the gross value at the mine of the output for the year " has been repealed, and there has been substituted the provision that a reasonable al- lowance for depletion thereof will be permitted, " not to exceed the market value in the mine of the product thereof, which has been mined and sold during the year for which the return and computation are made " under rules and regulations to be prescribed by the Secretary of the Treasury. Inasmuch as the operating conditions of mines are so materially different, the rate of depletion should be com- puted on a basis that~will provide for the particular re- quirements of each case. The rules and regulations men- tioned in the law may be had upon application to the Commissioner of Internal Revenue, Washington, D. C. The rate of depreciation on timber lands by reason of depletion of such properties, may be such as to return to the corporation, or individual, when the timber has been exhausted, the capital originally invested, or in case of purchase made prior to March 1st, 1913, the fair market value as of that date. The income tax law does not provide specifically, with respect to corporations, for the deduction of bad debts or uncollectible accounts. The officers of the Govern- ment, however, having the administration of the law in charge, have ruled that the same may be deducted as losses. (See page 103.) To provide for doubtful and anticipated bad debts, by establishing a reserve for that purpose, has always been considered good accounting practice, but such re- serve is not deductible from an income tax return. Ac- DEDUCTIONS ALLOWED CORPORATIONS 63 Sinking Fund Reserves Reserve for Discounts on Sales Interest Deductible counts receivable, to be deductible from income, must actually have been ascertained to be worthless. Besides, an account, to be deductible, must be actually written off in the period for which it is deducted. Amounts added to reserve funds of insurance compa- nies, as required by law, are not deductible from a re- turn of net income. Reserves set aside for contingencies, or so called " se- cret reserves " are not deductible from returns of annual net income. Charging capital expenditures to operating expenses is specifically prohibited. Items held in suspense, pending an event, are not de- ductible from income for income tax purposes. Amounts set aside out of profits, or reinvested, for the purpose of redeeming outstanding bonds payable, are not deductible from taxable income. The redemption of bonds is a capital expenditure. Discounts on sales of commodities dealt in are only deductible to the amount actually allowed to customers. A reserve for cash discounts, the establishment of which is approved by modern accounting, being anticipatory and not actual, is not deductible from income. A corporation is allowed as a deduction interest paid within the year on such an amount of indebtedness as does not exceed the sum of: (a) The entire amount of the paid-up capital stock outstanding at the close of the year, or if no capital stock, the entire amount of capital employed in the business at the close of the year, and (b) One-half of its interest-bearing indebtedness then outstanding. This subject is more fully dealt with on page 93. 64 INCOME TAX LAW AND ACCOUNTING Interest on Indebtedness Secured by Collateral, etc. Interest on Preferred Stock Interest on Bonds of Corporation Amortization of Discount on Bonds The interest paid during the year on indebtedness wholly secured by collateral, the subject of sale in the ordinary business of a corporation, joint-stock company or association, is deductible as an expense of doing busi- ness. Collateral, which may be the subject of sale in the ordinary business of a company, refers to commodities in which the company deals. Real estate, in this sense, could only be the subject of sale in the case of a corpo- ration engaged in the buying and selling of real estate. This applies to both tangible and intangible property se- cured by collateral, but limits the amount of indebtedness on which the interest may be computed to the actual value of such property collateral. In the case of Anderson vs. Forty-two Broadway Co. (209 Fed. 991 and 213 Fed. 777 reversed by U. S. Sup. Ct. Oct., 1915) (T. D. 2261), it was held under the Cor- poration Excise Tax, that a real estate company owning and operating an office building, under mortgage, could not deduct the interest paid on such mortgage as a gen- eral expense, under item 4 (a) (Form 1031) but only in item 6 (a), which made it subject to the limitation of law as to deductibility of interest. For limitation of deductible interest under present law see page 93. Interest on any form or class of capital stock is not deductible from an income tax return. The fact that preferred stock is " guaranteed " or cumulative as to interest, does not make it deductible. Interest paid on outstanding bonds of a corporation is deductible in item 6 (a) of Form 1031 Revised. Where bonds are held by trustees, however, for the benefit of the issuing corporation, interest paid thereon is not deductible. " In the case of a corporation selling its own bonds at a discount, the amount of the discount should be pro- rated over the life of the bonds and the proportionate part of such discount applicable to each year during the DEDUCTIONS ALLOWED CORPORATIONS 65 life of the bonds, constitutes an allowable deduction from the gross income of such year. The deduction from gross income in the case of twenty year bonds, would be one-twentieth of the aggregate amount of the discount on the bonds sold." (T. D. 2137.) Where, however, bonds were sold at a discount prior to the incidence of the income tax law, and such dis- count had been charged off on the books of the corpora- tion, then such discount or any part thereof, shall not again be deducted from the gross income. Premium In cases where bonds are purchased at a premium, such Purchased premium may be prorated over the remaining life of the bonds, so that only the redemption value thereof appears upon the books when the bonds mature. Organization The organization and incorporation expenses of a new Expense enterprise are usually charged to a separate account in the ledger. If such expenses amount to a considerable sum it is not unusual to prorate the same over a period of years, according to the judgment of the board of di- rectors. There appears to have been no ruling upon the acceptability of this method to the Treasury Depart- ment. Although the law specifically limits deductions to " the ordinary and necessary expenses paid within the year in the maintenance of its business and operations," it may reasonably be assumed, by analogy, that such ex- penses may be apportioned over a period of time. The account is, properly, a prepaid expense (sometimes called deferred asset) and in character, is quite similar to pre- paid expenses that are proratable over fiscal periods. Local Taxes for grading of property, paving, sewerage and similar local improvements are capital expenditures and not deductible from income. Taxes Paid Taxes paid by a corporation as tenant of rented prop- by Tenant shoul(1 be deducted in the return as rent paid. 66 INCOME TAX LAW AND ACCOUNTING Bonuses, Bonuses in the nature of gratuities for which no serv- Gratuities, . i j i j , M 1 , , . , . Gifts lce ls rendered are not deductible, but bonuses paid m the nature of compensation for extra services rendered are deductible. See page 100. Salaries of A corporation continuing to pay the salary of an em- Guardsmen ployee doing duty as a National Guardsman in the serv- ice of the United States is permitted to deduct the salary paid to such employee in its return of annual net income. Pensions Amounts paid to retired employees or to their families, or those dependent upon them, in the nature of pensions, are deductible from gross income as expenses. Income Income tax paid is deductible as taxes in the year paid. Tax Paid Salesmen's It has been held that salesmen's expenses in the nature Expenses Q en t e rtainment of customers, incurred for business pur- poses, are deductible items. Defalcation Losses sustained by reason of defalcation or embezzle- ment ment are deductible items. It has been held, however, in the case of United States vs. The Cleveland, Cincinnati, Chicago and St. Louis Railway Co., decided February 23, 1916, in the U. S. District Court, Southern District of Ohio, that such losses shall be deductible only in the year that the defalcation or embezzlement occurs. Should such loss or losses not be discovered until a subsequent year they would not then be deductible. " The time of discovery of a loss bears no relation to the date the loss was sustained. The loss was sustained when the theft occurred, although the defendant did not know at the time of the depletion of its assets." Deductions A foreign corporation is allowed to deduct: All ordi- Allowed . , ..,. ., Foreign narv an d necessary expenses actually paid within the Corporations United States; losses actually sustained within the year in its business or trade, within the United States, not compensated for by insurance, or otherwise ; also, reason- DEDUCTIONS ALLOWED CORPORATIONS 67 able allowance for depreciation and depletion of proper- ties within the United States. The deductions allowed to foreign corporations as necessary expenses, actual losses, depreciation and de- pletion, are the same as those allowed to a domestic cor- poration, except that only such expenses, losses, deprecia- tion, depletion, etc., as occur in connection with the busi- ness of such foreign corporation within the United States are allowed. The provisions with respect to permanent improve- ments, betterments and expense of restoring property, are applicable to foreign corporations. The amount on which interest is allowed to foreign corporations shall not exceed such part of the entire paid-up capital stock outstanding at the close of the year, and one-half of its interest-bearing indebtedness then outstanding, " which the gross amount of its income for the year from business transacted and capital invested within the United States bears to the gross amount of its income derived from all sources within and without the United States." Taxes paid by a foreign corporation within the United States are deductible, not including those assessed against local benefits. 68 CHAPTER IV DEPRECIATION Depreciation Depreciation is a deductible allowance in the ascer- from UCtiblC tainment of net income for tax purposes. It should Income represent, as nearly as possible, the actual deterioration of such physical properties as are susceptible of wear and tear and decrease in value by the efflux of time. In a broad sense of the word depreciation means a reduction in value and may be applied to all kinds of property. As used in the income tax law, however, it is applicable only to tangible property, such as is " subject to wear and tear, exhaustion and obsolescence." Hence, depreciation will be allowed as a deduction from revenue only on physical properties, such as buildings, fixtures, machinery, etc. All depreciation to be deductible must be actually charged off in the books of account in the period for which it is claimed. Methods of There are several methods of computing rates of de- preciation, the most common of which are: 1. By equal instalments. 2. On diminishing values. The first method is ordinarily used where the prop- erty depreciated has no residual value, and the second one where the property has a residual value. Charging off equal instalments is most commonly employed with re- spect to all properties, whether they have a residual value or not, and only that method has as yet been sug- gested or approved by rulings of the Treasury Depart- ment or court decision in connection with deductions from income tax returns. In a publication issued by the Federal Trade Com- mission recently, on the subject of " Fundamentals of a Cost System for Manufacturers," both methods are DEPRECIATION 69 approved in the following language : " There are sev- eral methods of determining the amount of deprecia- tion. One is to estimate the scrap value and deduct this figure from the original cost. The difference is then divided by the estimated life of the machine in years, and the result is the annual depreciation on that machine. A modification of this method which is not quite as sim- ple, but really affords no difficulty, is after ascertaining the amount to be charged off during the life of the ma- chine, to determine a percentage which, when applied to the net book value of the machine, will leave only the scrap value of the machine on the books at the expira- tion of its estimated life. " To illustrate : If the initial cost of a machine and equipment is $1,000 and the estimated scrap value is $200, with an estimated life of ten years, then $800 is the amount that must be charged into cost during that period, or $80 per year. To attain this result, by using the net value of the machine as a basis, a rate of 15 per cent, would be necessary, which would make the depreciation 15 per cent, on $1,000, or $150 the first year; 15 per cent, on $850, or $127.50 the second year, etc. The advantage of this method in the interest of normal costs is, that the decrease in depreciation charges is ordi- narily offset by an increase in repairs." Where reserves for depreciation are used in conjunc- tion with the " Diminishing Value Method " the amount of the reserve set aside in past periods should be de- ducted from the asset account before the depreciation is computed thereon. Reserve for The most approved method of double entry bookkeep- Depreciation m ^ f avors the establishment of reserves for deprecia- tion instead of reducing the balances of the asset account in the ledger. This is accomplished by journal entry, made either monthly or at the end of the fiscal period, just prior to closing the books of account, as follows: 70 INCOME TAX LAW AND ACCOUNTING Depreciation $250.00 To Reserve for Depreciation of Furniture and Fixtures $250.00 Depreciation at 10% per annum on Furniture and Fixtures for the year 1916. (Book value cost -$2,500.) The Depreciation Account is closed into Profit and Loss Account and the Reserve for Depreciation, a nega- tive account, 1 remains open. In the Statement of Assets and Liabilities the Reserve for Depreciation is deducted from the asset account and extended at the net amount, as follows: Furniture and Fixtures $2,500 00 Less Reserve for Depreciation (10%) 250.00 $2,250.00 Although not essential, it is advisable to keep a separate reserve account for each class of assets, as : Reserve for Depreciation of Furniture and Fixtures, Reserve for Depreciation of Machinery, Reserve for Depreciation of Buildings, etc. This separation renders more accessible the amount of deduction from the respective asset ac- counts, when preparing the balance sheet. A Reserve for Depreciation must be kept separate and distinct from other reserve accounts and reserve funds. A reserve fund is an amount set aside for the purpose, among others, of providing an available asset (cash or readily convertible investment) for a present or future obligation, as a renewal of plant and machinery. The creation of such fund does not incur the reduction of surplus or profit because it is not an expense; it is not created by a reduction of revenue, but merely a conver- sion of profits or surplus. Hence, a reserve fund set aside for amortization of bonds, or to provide quick 1 A negative account is one that is neither an asset nor a lia- bility; it qualifies an asset account, as, for example, Furniture and Fixtures. DEPRECIATION 71 assets for any other purpose, is not a competent deduc- tion in an income tax return. Nor are reserve accounts properly deductible except in so far as they are a reduc- tion of the value of an asset. A reserve account appear- ing on the liability side of a balance sheet, unless rep- resented by a specially invested fund in the assets, is offset by all the assets in the balance sheet. But a " Reserve for Depreciation " is, technically, neither a reserve fund nor reserve account, because it has been charged against revenue and has reduced the surplus. To be a true reserve it should not reduce the revenue or surplus. Therefore, a " Reserve for Depreciation " is nothing more than an " allowance for depreciation " and should never be stated on the liability side of a balance sheet. It is nothing more than a negative account, a re- duction of the book value of a particular asset, and should be deducted in the Statement of Assets and Lia- bilities from the asset to which it refers. Hence, under rulings in connection with the income tax, a so-called " Reserve for Depreciation " shall not be diverted to any purpose except " making good the loss sustained by reason of wear and tear, exhaustion or ob- solescence of the property with respect to which it was claimed." Depreciation may only be charged off up to the cost of the property depreciated. Should depreciation, for any reason, have been charged off in excess of such amount, then such excess shall be reported as income (Art. 132, Reg. 33). Rates of The law does not prescribe rates of depreciation be- Depreciation cause these depend upon the kind and class of property, and upon the conditions under which the property is used. Fixing rates of depreciation is more or less ar- bitrary at best. The fairness of rates of depreciation, deducted in re- turns of net income, are questions of fact, and not of law; that is to say, such questions at issue in a court 72 INCOME TAX LAW AND ACCOUNTING of law would, ordinarily, be submitted to a jury for determination. Technical rate fixing is a question on which there are diversified opinions, even amongst the best engineers. But engineers have suggested rates for various classes of properties that work out fairly accurately for all practical purposes. The rates mentioned herein are sug- gestive only. They are based upon the experience of engineers and accountants. Buildings In the case of Hyman Cohen vs. John Z. Lowe, Jr., Collector (decided July 18, 1916), tried before a jury in the United States District Court for the Southern District of New York, Judge Grubb stated that, in his opinion, depreciation on a building should be based upon the number of years " the building would remain in a condition to be habitable for the uses for which it was constructed and used * * *. The annual deprecia- tion would be an amount represented by a fraction hav- ing one (the tax year) for the numerator and the number of years, representing the ascertained life of the build- ing, as the denominator." Hence, a building, estimated to remain habitable and fit for the purposes for which it was erected for a term of forty years, would suffer an annual depreciation of 2y 2 per cent. In the Cohen case, just cited, the plaintiff (owner of building) claimed a depreciation of 5 per cent, for the tax year (1913). The Collector of Internal Revenue allowed only 3 per cent., and the plaintiff brought an action to enforce his claim of 5 per cent. The jury brought in a verdict that they considered 3 per cent, an adequate allowance. The building in question was a New York' apartment house. Depreciation is allowed only on the cost of buildings and improvements, not on the land. For depreciation and other purposes, buildings and land should be carried in separate accounts in the ledger. If the separate cost of buildings, as apart from the land, is not ascertainable, then the separate value of improvements, as shown by DEPRECIATION 73 Building Repairs Additions Betterments Additions to Leased Property the real estate tax assessments, may be used, or, the value of buildings and improvements may be estimated as at March 1, 1913, if then in existence, " provided that the value placed upon such buildings shall not be in excess of the cost of such buildings, less an amount measuring the depreciation which had previously been sustained." To measure the fairness of the amount on which de- preciation has been deducted on buildings, in returns of net income, Internal Revenue Inspectors have made com- parison with the amount of fire insurance carried thereon. But that, for obvious reasons, is not a fair comparison. The question of rate of depreciation must always be determined upon the conditions governing each particular case. The rate on brick buildings varies from \ l / 2 to 5 per cent, per annum, according to construction and use to which buildings are put. A factory building, wherein manufacturing of heavy machinery is carried on, may suffer a larger depreciation than 5 per cent, per annum. It is reasonable to assume that frame buildings are subject to a larger rate of depreciation than brick or con- crete buildings, because of having a shorter period of usefulness. The rates on frame buildings will vary from 2 l / 2 to 7 l /2 per cent., according to construction and uses, and may run higher in some cases. In estimating the life of a building for the purpose of determining upon a rate of depreciation, it must be as- sumed that the property is maintained in proper repair. The cost of repairs and expenses of upkeep are deductible items in a return of net income. Additions to buildings or any expenditure that consti- tutes an increase in the investment therein, such as per- manent improvements and betterments, are not de- ductible. A person or corporation holding premises as lessee, for a term of years, requiring the tenant by terms of the lease to make all repairs and improvements, if any, has 74 INCOME TAX LAW AND ACCOUNTING Buildings Erected by Tenants Furniture and Fixtures Dwellings the right to deduct the improvements as well as repairs from his or its gross income. Such improvements should be prorated over the period of the lease. The repairs, however, may be deducted as current expenses. The cost of buildings erected by tenants on leased ground, which, upon expiration of the lease, revert to the landlord, may be prorated over the period of the lease and deducted as an expense of doing business. The amount charged off (prorated) should be deducted in the return of net income of a corporation as rent paid. Ordinarily business concerns capitalize amounts paid for furniture, fixtures and office equipment; that is to say, they establish a Furniture and Fixture Account in the ledger and charge purchases of that class of assets to such account. This class of property depreciates from 5 to 25 per cent, per annum ; 10 per cent, is the usual charge where renewals are added to the account. An uncommon practice is to charge off the entire cost of renewals of furniture and office equipment as a cost of doing business. This method, in the case of Mutual Benefit Life Insurance Company vs. Herold (198 Fed., 199) was approved. It was there held that " Renewals of office furniture and equipment " were " expense of maintenance " deductible in the ascertainment of net income. As this decision deals only with " renewals " of such equipment it would not apply to the first cost. Furniture, fixtures and office equipment should be car- ried in a separate ledger account from office supplies. Office equipment represents a fixed asset, whereas office supplies is an expense account. Depreciation on a dwelling (residence) occupied by the owner himself is not deductible; on dwellings that are held for investment, however, by both individuals and corporations, a reasonable charge for depreciation is allowed. " Reasonable allowance for the wear and tear of DEPRECIATION 75 Farm Buildings Depletion of Mines Depletion, Oil and Gas Wells Timber Lands Machinery property arising from its use for rental purposes may be claimed as a deduction, but no claim for depreciation should be made on account of any amount of expense of restoring property or making good the exhaustion thereof for which a deduction is claimed elsewhere in the return." (Letter by Commissioner of Internal Revenue to the Corporation Trust Co., Feb. 26, 1916.) Depreciation on farm buildings, other than those oc- cupied by the owner himself, may be deducted from income. (T. D. 2090.) A reasonable allowance for depletion of mines, not to exceed the market value in the mine of the product thereof which has been mined and sold during the year for which the return and computation are made, will be allowed. When the allowance authorized shall equal the capital originally invested or in case of purchase made prior to March 1, 1913, the fair market value as of that date, no further allowance for depletion shall be made. In the case of oil and gas wells a reasonable allowance for actual reduction in flow and production to be ascer- tained not by the flush flow, but by the settled production or regular flow. As in the case of mines, when the allow- ance authorized for depletion shall equal the capital originally invested, or in case of purchase made prior to March 1, 1913, the fair market value as of that date, then no further allowance shall be made. The rate of depreciation on timber lands should be such as to return to the owner, when the timber has been exhausted, the capital originally invested therein, except if the property was acquired prior to March 1, 1913, the fair market value as of that date. There are so many different classes and kinds of ma- chinery that it would be well nigh impossible to fix a rate of depreciation that would uniformly apply to all classes. L. R. Dicksee, an English accountant of recognized 76 INCOME TAX LAW AND ACCOUNTING ability, in his work on " Depreciation, Reserves and Re- serve Funds," has suggested annual rates of depreciation on machinery, based on diminishing values, as follows : General machinery 7y 2 to 10 per cent. Special machinery 10 to 25 per cent. To facilitate the computing of depreciation on a variety of classes of machinery, it is advantageous to classify them according to expected life, and then to compute the depreciation on each class accordingly. The scrap or residual value of machinery should be taken into consideration in arriving at rates of deprecia- tion. There is a diversity of opinion as to the rate of depre- ciation to which engines and boilers are subject. Dicksee suggests annual rates, on a diminishing value, as follows : Engines (in general) 10 to \2y 2 per cent. Boilers \2 l / 2 to 20 per cent. George M. Craven, whose tables of depreciation have been adopted by commissions passing upon rate cases, and who errs on the conservative rather than the liberal side, based on cost (not diminishing value) per annum, suggests the following rates : Steam engines 3 to 6.6 per cent. Boilers 3.5 to 10 per cent. Composite opinions, however, are that engines and boilers, if maintained in a proper state of repair, which necessarily must be assumed, should last, in the absence of unfavorable conditions, about ten years, and would be subject to an average depreciation of 10 per cent, per annum. If unfavorable conditions prevail, they would naturally be replaced oftener and the rate of deprecia- tion would be proportionately higher. Article 131 of Treasury Department Regulations No. 33 states that " Incidental repairs which neither add to the value of the property nor appreciably prolong its DEPRECIATION 77 life, but keep it in an operating condition, may be de- ducted as expenses." Notwithstanding the apparent clearness of this regulation, there have been many con- troversies between Collectors of Internal Revenue and taxpayers as to what constitutes " incidental repairs." Rulings on the subject have recommended the establish- ment of reserves for depreciation and directed that to such reserve accounts should be charged " the cost of re- newing or replacing the property with respect to which the depreciation is claimed." But it is not intended that " incidental repairs " that merely " keep it in operating condition " shall be so charged, because, under the above regulation, such expenses are separately deductible from income. The main object and purpose of charging off depre- ciation is not to provide a fund out of which to make repairs, but in the case of a machine, for example, to provide for the replacement of such machine when it has served its usefulness. The income tax law contemplates more than a mere renewal and repair reserve because it specifically permits the deduction of "All the ordinary and necessary ex- penses paid within the year in the maintenance and operation of its business and properties * * *," as well as " a reasonable allowance for the exhaustion, wear and tear of property arising out of its employment in the business or trade." These are separate and distinct provisions, first for necessary expenses, which must in- clude repairs, and, second, for depreciation. It may be true in respect to a machine, or any other property, which is periodically wholly rebuilt, that the depreciation is very small, but that it suffers some de- gree of depreciation is axiomatic. Whether, however, the cost of such renewals should be charged to the re- serve for depreciation or to an expense*account, should depend upon the adequacy of the rate of depreciation charged off. Hence, in fixing upon rates of depreciation 78 INCOME TAX LAW AND ACCOUNTING Shafting Tools Miscella- neous Equipment it should be predetermined whether renewals will be charged against the reserve for depreciation or to an expense account. Regardless of which method is adopted the accumulation of depreciation reserved should be such an amount as will return to the corporation or individual the cost of the property upon the termination of its usefulness. Shafting, based upon a diminishing value, has beefi estimated to suffer depreciation at the rate of 5 to 7^ per cent, per annum. Small tools should be charged to a separate account in the ledger. Physical inventories should be taken pe- riodically and the account written down to the amount of such inventory. The difference between the book value and the physical inventory value should be charged to depreciation, and in the course of time it should be pos- sible to determine upon an average rate of depreciation that will answer all practical purposes. Such average rate should, however, from time to time, be verified by physical inventories. This principle may be applied to all items that are being constantly used up and replaced. In as much as the rates of depreciation suggested by Craven have been adopted by various industrial concerns and commissions, they are worthy of consideration. They are, however, by many, considered too low and are stated here only as suggestive of the most conservative annual rates : Shop Equipment 3 to 15 per cent. Motors 4 to 10 per cent. Storage Batteries 5 to 1 1 per cent. Belted Generators 3.3 to 10 per cent. Switchboards, etc 2 to 10 per cent. Wires and Cables 2 to 6.6 per cent. Steam Piping 3.5 to 10 per cent. per cent. Steam Turbines Auxiliaries . 5 to 9 5 to 10 per cent DEPRECIATION 79 The equipment of laundries is, ordinarily, subject to an annual depreciation of from 7j^ to 15 per cent, of the cost. Patterns are made of so large a variety of materials and used so differently, that each case will have to be decided according to the particular requirements. Pat- terns that are continuously used and must be replaced often may properly be charged off at once as a cost of production. Special patterns should always be charged direct to the job for which they were made. Dicksee suggests annual rates, based on diminishing values, of 25 to 33 1/3 per cent. But there can be no obligation on the part of the manufacturer to capitalize any expenditure unless it is unquestionably a capital expense. Accountancy maintains (some accountants to the con- trary notwithstanding) that where there is a reasonable doubt as to whether an expenditure is a capital or ex- pense item, it should be charged against revenue. That precludes questionable items entering a balance sheet, and indicates a business policy with which no law should be at variance. Patents are issued in the United States for a period of seventeen years. It is customary for manufacturing corporations, operating under patent rights, to capitalize all direct expenses in connection with obtaining patents either by their own application to the Patent Office or by purchase. In case the corporation itself procures the patent, it has the right to deduct depreciation annually at the rate of 1/17 of the total cost, including experimental work, cost of models and drawings, fees of the Patent Office, legal expenses, and all direct charges in connection there- with. If the patent is purchased by the corporation, then the depreciation would be based on the cost thereof and 80 INCOME TAX LAW AND ACCOUNTING Copyrights Auto Trucks the rate would be fixed according to the length of time that the patent had still to run; for instance, a patent purchased for $10,000, that had been issued seven years prior to its purchase, having a remaining life of ten years, would be subject to an annual depreciation of 10 per cent, of the cost, amounting to $1,000. This amount would be a competent annual charge against gross in- come. The principles stated with respect to patents are true also as to copyrights, except that copyrights are issued for the period of twenty-eight years. A more conserva- tive method, in the case of copyrights, however, is to estimate the period of salability of the subject of copy- right and prorate the amount to be charged off accord- ingly. Automobile trucks deteriorate according to the sever- ity of the use to which they are subjected. The life of a motor, used for trucking purposes, receiving rea- sonable care and properly maintained, may be estimated to be from three to six years. As with other property, the rate of depreciation is fixed according to its life. The life of an auto truck is such a length of time as it re- mains fit for the purpose for which it was acquired. The annual rate applicable to auto trucks will vary from 15 to 50 per cent. Based on a replacement value, the heaviest depreciation occurs during the first year, and it is not uncommon to write off as much as 50 per cent, of the cost during that time. Thereafter the rate would not exceed 25 per cent, per annum. The most accurate and conservative method is to appraise motor trucks at the end of each year and to write off the shrinkage in value during the year for which the return of net income is computed. This method, being based on actual facts, cannot be objection- able for income tax purposes. All costs of repairs, replacements or parts, tires, over- DEPRECIATION 81 hauling, painting, supplies, gas, oil, licenses and insur- ance, in connection with auto trucks are deductible ex- penses in the return of net income. Depreciation on horses varies so widely that each con- cern should work out its own table of experience for depreciation purposes. Rather than to guess at an arbi- trary rate of depreciation, it is advisable to revalue horses at the end of each fiscal period. The loss in value during the tax year may then be deducted as deprecia- tion, and, in the course of time, it will be possible to formulate, fairly accurately, the rate of depreciation to which horses, in the particular business, are subject. It may be said that, ordinarily, the rate of depreciation on horses will vary from 15 to 25 per cent, of their cost. Stable equipment usually suffers a depreciation of from 7^4 to 15 per cent, per annum. Depreciation on good will is not allowed, because it is an intangible asset that cannot suffer loss by reason of " wear and tear " or " obsolescence." From an account- ing point of view, the practice of " writing down " the book value of good will is not an unusual one in periods of prosperity. Its purpose is, primarily, to reduce the book assets to tangible properties and thereby give the balance sheet a healthier appearance. The practice, although commendable, and perhaps a sign of conserva- tive management, does not permit of a deduction in the income tax return. As a matter of bookkeeping, such a charge would be a reduction of Surplus Account and not of Profit and Loss Account for any particular period of time. No rule for charging off good will can be laid down, because in a flourishing business, the good will is of pro- portionate value and should not, in theory, be reduced; whereas, in periods when no profits are being earned, the value of good will diminishes, but then there is no profit out of which to reduce the Good Will Account. 82 INCOME TAX LAW AND ACCOUNTING Hence, at best, the reduction of good will is a purely arbitrary matter that bears no relation to an income tax return. Investments Stocks and bonds fluctuate in value. A downward Stocks and fluctuation, if permanent, may be said to be deprecia- Bonds t j on> b ut 5^ i s not deductible for income tax pur- poses. Losses to become deductible must be actually sustained by completed and closed transactions. A mere reduction in book value by direction of a board of direc- tors, or even an order by the State or Federal Banking Department, to reduce or write off securities, does not establish a loss that constitutes a deduction from taxable income. " Losses of this character are only ascertainable when the securities mature, are disposed of, or canceled." (T. D., 2152.) No arbitrary reduction of capital assets on the books of a corporation or individual shall justify a deduction from income for tax purposes. Conversely, the appre- ciating, or " writing up," of capital assets to conform, for instance, with appraisal values, does not make such increase taxable as income. (Baldwin Locomotive Works vs. McCoach, 221 Fed., 59.) There must be an actual realization of the enhanced value by a sale for cash, or its equivalent, in order to make the increase taxable as income. Theatrical Theatrical costumes may be depreciated. The rate should be based on the life of garment or time allowed for production of play, whichever is the shorter. Obso- lescence is an important element for consideration in de- termining the life of a costume. Wearing apparel, serv- ing both the purpose of personal and theatrical use, may not be depreciated for the purpose of income tax. Trademarks Neither trademarks nor brands, acquired by purchase Brands or otherwise, are subject to depreciation, and no allow- ance for income tax purposes will be made thereon. DEPRECIATION 83 In the case of resale of trademarks or brands, a loss actually sustained would be deductible, as a capital loss. A profit, on the other hand, would be returnable as in- come. If the trademark or brand was acquired prior to March 1, 1913, then the profit or loss in the sale thereof would be computed on the basis of the fair market value as of that date and not on the basis of cost. This applies to the sale of all capital assets acquired prior to the incidence of the income tax law, March 1, 1913! The cost of registering trademarks and brands, being nominal, should be included in the expense of doing business. Should such an item be capitalized it would not be deductible as an expense in a subsequent year. By rulings of the Treasury Department no allowance for depreciation is permitted on inventories of stock on hand. It has been held " that depreciation will not be allowed in the return or inventory, on merchandise, as the same will be reflected in the income in the year of its disposal." Also, as directed in the supplementary statement of the return, " In case the annual gain or loss is determined by inventory, merchandise must be inventoried at the cost price * * *." This is based upon the theory that no actual loss is sustained until the goods are sold. These rulings are contrary to the well settled prin- ciples of accounting, that when the market value of mer- chandise is less than the cost, the market value should prevail for inventory purposes. A merchant who commits an error of judgment in buying merchandise should be permitted to apportion his loss over the periods during which he is obliged to carry the unsalable goods in stock. In some lines of business the ruling will work a hardship. Publishers, for example, who must carry slow selling stock from year to year, a large part of which eventually proves un- salable, will be piling up inflated and exaggerated in- 84 INCOME TAX LAW AND ACCOUNTING ventories of stock on hand, if computed at cost. No law should encourage the overstatement of values of assets because such overstatement affects the rights of credi- tors who rely on the representations of financial state- ments as a credit basis. Besides, under State laws, the overstatement of assets is punishable as a misrepresenta- tion of facts. Nor is the ruling that inventories must be computed at cost consistent with conservative business methods. It is noteworthy that the Federal Trade Commission in a pamphlet issued on July 15th, 1916, entitled " A Sys- tem of Accounts for Retail Merchants " for the purpose of " Aiding retail merchants to improve their accounting methods " on the subject of depreciation, states : " No merchant can be said to be managing his business prop- erly unless adequate provision is made for depreciation." As to depreciation on merchandise, under the title of " Profit and Loss Account " it says : " A physical inven- tory should be taken at least once a year. The basis should be cost with conservative deduction for obsolete and shelf-worn goods." A perusal of the proforma Pro- fit and Loss Account, contained on page 18 of the pamph- let, discloses a deduction from inventory designated " Less Stock Depreciation " of an amount equal to 5 per cent, of the inventory which concededly was based on cost. The only danger that the depreciation of inventories would involve in connection with income tax returns, is the possible manipulation of merchandise values. As in the case of depreciation of capital assets, fixed rates could not be prescribed to cover all cases, but manipulation of inventories for the purpose of showing a smaller gross income than was actually earned could be prevented by requiring detailed information as to how the inventory was computed, rate of depreciation deducted, etc. Until there has been a court adjudication upon the prescribed ruling of computing inventories, stock on hand DEPRECIATION 85 should be valued at cost. In cases where the inventory, taken at cost, results in an inflated or overstated " net in- come," it is recommended that the individual or company aggrieved place all the facts of his or its case in writing before the Commissioner of Internal Revenue, Washing- ton, D. C, or the collector of his or its district, and ask for a special ruling thereon. 86 CHAPTER V BOOKKEEPING SUGGESTIONS PREPARATION OF INCOME TAX RETURNS OF CORPORA- TIONS Methods of The amended law contains a provision in regard to the Bookkeeping keeping of accounts, as follows : "A corporation, joint stock company or association, or insurance company, keeping account (s) upon any basis other than that of actual receipts and disbursements, un- less such other basis does not clearly reflect its income, may, subject to regulations made by the Commissioner of Internal Revenue, with the approval of the Secretary of the Treasury, make its return upon the basis upon which its accounts are kept, in which case the tax shall be com- puted upon its income as so returned." The same provision is made with respect to the ac- counts of individuals. This permits the individual or corporation, that em- ploys a method of bookkeeping from which a return cannot be prepared in the prescribed form, to render the report according to the method of bookkeeping employed, provided only that the books from which the return is made reflect the correct income. The return, however, must, in every case, be made on the blank provided by the Government, with full and complete explanations as to the method employed. The dominant and foremost requisite in the prepara- tion of income tax returns is TO REPORT THE FACTS. The method employed to arrive at the facts is of considerable importance, but secondary. A vari- ance from the prescribed classification of income and expenses may be unavoidable; a deliberate disregard of the facts, by either omission or declaration, is tantamount to misrepresentation. BOOKKEEPING SUGGESTIONS 87 The income and expenses should be classified as pre- scribed by the return unless the nature of the business is such that it does not permit of such classification or un- less the books of account are kept in conformity with regulations of some department of the Government re- quiring the keeping of books according to " uniform systems of accounting," as in the case of corporations coming under the Interstate Commerce Commission. The books must be so kept that each and every item set forth in the return of annual net income may be readily verified by an examination of the books of account. Books of " The books of a corporation are assumed to reflect Account Best the facts as to, its earnings, income, etc. Hence they Income will be taken as the best guide in determining the net in- come upon which the tax imposed by this act is calcu- lated. Except as the same may be modified by the pro- visions of the law, wherein certain deductions are limited, the net income disclosed by the books and verified by the annual balance sheet, or the annual report to stockhold- ers, should be the same as that returned for taxation." (Regulations 33, Article 183.) Examination of Books by Internal Revenue Officers " For the purpose of verifying any return, made pur- suant to this act, the Commissioner of Internal Revenue may, by any duly authorized revenue agent or deputy collector, cause the books of such corporation to be examined, and if such examination discloses that the corporation is liable to tax in addition to that previously assessed, or assessable, the same shall be assessed and shall be payable immediately upon notice and demand. For the purpose of such examination, the books of cor- porations shall be open to the examining officer, or shall be produced for this purpose upon summons issued by any properly authorized officer." (Regulations 33, Ar- ticle 186.) 88 INCOME TAX LAW AND ACCOUNTING Although there has, as yet, been no ruling upon any phase of accounting under the present income tax law, it is clear that corporations or individuals keeping ac- counts upon the plan of accruing income and expenses or deferring prepayments, may now prepare their returns accordingly. From an accounting viewpoint this is the only correct method whereby the true profit or loss of a business may be deduced. But the method, if employed, must be used consistently and with limitation. In no case shall an expense account for a tax year or fiscal year be charged with a greater amount than is actually incurred or accrued therein and for which the business has re- ceived value in such fiscal or tax year; that is to say, no deduction shall be made of an amount in excess of that actually chargeable against the operations of the year (fiscal or calendar) for which the return is made. Prepayments may be deferred, that is, such part of ex- penses as are prepaid may be deducted from expenses and treated as " deferred assets " or " prepayments " in the balance sheet. The accounts most commonly accrued or deferred are interest, taxes, insurance, rents, salaries, commissions and income taxes withheld, but the principle is applicable to all classes of income and expenses. No accruals shall be deducted from income unless they appear upon the books of account and represent ex- penses actually incurred or accrued during the year. Wherever the expressions " actually paid " or " paid during the year " appear herein, when applied to indi- viduals or corporations keeping their accounts upon the " accrual basis," such accruals are comprehended therein. Apart from facilitating the preparation of income tax returns, bookkeeping suggestions would be out of place here. But a great deal of time and work may be saved to the bookkeeper and to the executive who is responsible for the contents of the report, by employing a method of bookkeeping that will, without analysis of accounts, BOOKKEEPING SUGGESTIONS 89 Return Sales present to immediate view in a trial balance, the compo- nent parts called for by the income tax return. This can be accomplished only by a suitable distribution of accounts of income and expenses, assets and liabilities. Sales Merchandise sales should be credited to a separate account in the ledger. Where departmental accounts are kept, the ledger should contain a separate sales account for each department or each class of commodity. The sales called for by the supplementary statement of the income tax return under " Gross Income from Opera- tions " should be the net sales, i. e., gross sales (amounts charged to customers) less returns, allowances and dis- counts allowed on sales. Goods returned by customers should be charged to a separate account unless they are, in aggregate, so small a proportion of the sales that a separate account would not be justified. If no separate account is kept, the re- turns should be charged to Sales Account. The advan- tage of a separation which bears no relation to the preparation of a tax report is that a monthly trial bal- ance discloses, at a glance, the proportion of returns to the volume of sales. As stated under " Sales," goods returned by custom- ers should, for the income tax report, be deducted from amount shown by Sales Account (Gross Sales). Allowances Ordinary allowances on goods sold, such as claims by reason of breakage, short shipment, overcharges, de- fective goods, etc., should be charged to an Allowance Account and deducted from sales for the income tax return. Exceptional allowances, such as unrecovered shipments lost in transit, for which the shipper is re- sponsible and cannot recover from the transportation company, should be charged to an account that by its title is descriptive of its contents, as " Goods Lost in Transit," and should be stated in the income tax return and supplementary statement in item 5 (a). All losses, 90 INCOME TAX LAW AND ACCOUNTING Discounts Allowed Discounts Received Rebates to be deductible from the income tax return, must be charged off in the year sustained. " Discounts allowed " on sales should be charged to an account bearing that title. " Discounts received " on goods purchased should be credited to a separate account so entitled. For income tax purposes discounts allowed to customers are a reduction of the gross sales, and discounts received, as a trade allowance or for prepay- ment of goods purchased, are a reduction of the cost of goods bought. Rebates on sales that are allowed by way of commis- sions, or as a reward for selling certain quantities of commodities, should be carried in a separate account in the ledger and treated in the income tax return as a general expense under " Deductions " and included in " Commissions " in the supplementary statement, item 4 (a) 1, under " Expenses, General." Purchases Merchandise purchased should be charged to a " Purchase Account " in the ledger. As an income tax deduction in the ascertainment of " Gross Income from Operations," there should be added to the purchases all transportation charges paid or incurred thereon. There should be deducted: returns, claims, discounts received and " anticipations " received. A manufacturing corporation employing a cost system that is an integral part of the bookkeeping system, i. e., where such system is comprehended in the general books of account and included in the general ledger trial bal- ance, may state as " Purchases " the cost of manufac- tured goods, as derived from such cost system. Mere cost memoranda, data, or books of account, however, that are not subject to proof of correctness, are not sufficiently reliable records from which to prepare in- come tax returns. It is not necessary that the cost accounts should be kept in the same binder or within the same cover as the general ledger, but, in summary, BOOKKEEPING SUGGESTIONS 91 Freight on Sales Freight on Purchases Inventories the costs should be controlled by general ledger accounts. For further discussion of this subject, see " Manufactur- ing Corporations Operating Cost-systems," page 110. Where a cost-system does not answer the requirements of proof as to accuracy of results the form of return (Form 1031) should be adhered to. Corporations doing a mercantile business (buying and selling raw materials or finished products manufactured by others) as well as a manufacturing business, should conform to the classification contained in the return, unless the separate departments are clearly differentiated in the books of account. Transportation charges on goods sold (freight out) should be kept separate from those on goods purchased (freight in). Freight on goods sold, for income tax pur- poses, is an expense of doing business and should be in- cluded in item 4 (a) under " Deductions," and in the supplementary statement in item 4 (a) 7. Transportation charges on goods bought increases their cost and should be added to the cost of purchases. Separate accounts in the ledger should be kept of freight on sales and freight on purchases, to be known, respectively, as " Freight Out " and " Freight In." Items of expressage and cartage may respectively be charged or credited to these accounts. In case where own trucks are used the appor- tionment may be estimated based upon the cost of stable or auto expenses, labor, etc. Stock on hand should be carried in a separate account in the ledger under the title of " Inventory Account." Where freight and other transportation charges have been added to the purchases, the proportion added thereto should, technically, be included in the inventory. But this would have to be approximated at best, and may, as an expediency, be disregarded except where it is a very material item or where the computation is rendered simple. 92 INCOME TAX LAW AND ACCOUNTING For income tax purposes, inventories should be com- puted at cost and so stated in 3 (a) of supplementary statement of the return. The deduction of depreciation from the cost of commodities dealt in is prohibited. (See "Stock on Hand," page 83.) " No part of the overhead expenses should be added to the inventory." Care should be exercised to see that the amount ot stock on hand reported at the beginning of a tax year is the same amount as that shown as on hand at the close of the preceding year. An increase in the amount at the beginning of a year over that stated at the close of the previous year would result in a decrease in the gross income, which, in the absence of a clerical or technical error, would be prima facie evidence of fraud. Rentals Rents received should be kept in a separate account from rents paid. Receipts of rent, where the corpora- tion owns the rented property, must be reported as in- come, whereas rents paid are deductible as general ex- penses. The amount paid on a leasehold may be prorated over the period of the lease and deducted annually as rent paid during the year. This is also true where a building, reverting to the landlord, is erected on leased land; the annual rate of deduction being the fraction: one, as the numerator, and the number of years of the leasehold, as the denominator, multiplied by the cost of the building and improvements. The cost of such im- provements should be charged to a " Leasehold Account " in the ledger and the amount charged off annually should be stated in the income tax return in item 4 (a) 3, under " Expenses, General " in the supplementary statement. Ordinary rentals paid should also be stated in the supplementary statement under " Expenses, General " in item 4 (a) 3, the total of which appears in the report un- der " Deductions " in item 4 (a). Royalties Royalties received are returnable as income from ren- tals. Where royalties are both paid and received, it is BOOKKEEPING SUGGESTIONS 93 Interest Received Interest Paid advisable to keep a separate account for each in the ledger, designating them " Royalties Received " and " Royalties Paid/' because they are separately reported in the return of net income. Royalties paid are return- able under 4 (b) " Payments in Lieu of Rent." Royal- ties received should be included in item 3 (b) " From Rentals " under " Gross Income." Interest received and interest paid should be respec- tively credited and charged to separate ledger accounts, and each of them should be further subdivided accord- ing to the separation called for by the tax return, as follows : Interest received on bonds or other obligations of the United States, or its possessions, from a State, Munici- pality or other political subdivision, although not subject to the income tax, must be reported as income in 3 (c) of the supplementary statement and should be credited to an account in the ledger entitled " Interest Received on Government Securities." All interest, other than that received on Government bonds or obligations, except " anticipations," should be credited to a general " Interest Received Account," and should be reported in item 3 (c) under " Gross Income " in the return. "Anticipations " interest received for the prepayment of accounts payable should be credited to "Anticipation Account " and for income tax purposes are deductible from the cost of purchases, the same as are discounts received. Interest paid by a corporation should be classified as follows : 1. " Interest paid on indebtedness, wholly secured by collateral, the subject of sale in the ordinary business of the corporation," should be charged to an account en- titled " Interest Paid on Secured Debts " and reported in the return under " Expenses, General," item 4 (a) 5 in the supplementary statement. 94 INCOME TAX LAW AND ACCOUNTING 2. Interest paid on mortgages secured by property which the corporation occupies but does not own and has no equity in, should be charged to " Interest Paid in Lieu of Rent " and stated in the return under " Deduc- tions " in item 4 (b). 3. All interest paid on bonds and other indebtedness should be charged to " Interest Paid Account " and stated in the return in item 6 (a) under " Deductions." The amount of interest deductible under this item is the amount actually paid within the year on an amount of bonded or other indebtedness not in excess of the sum of one of the subdivisions of " A " plus " B " : A. 1. The paid-up capital stock outstanding at the close of the year, or 2. If the capital stock has no par or nominal value, the amount of cash or its equivalent paid or transferred to the corporation as a consid- eration for shares issued and outstanding at the close of the year, or 3. If no capital stock, the entire amount of capi- tal (not including liabilities) employed in the business at the close of the year, plus B. One-half of the interest-bearing indebtedness out- standing at the close of the year. For example, in the case of a corporation having, at the close of the year, a capital stock of $500,000 and bonded and other indebtedness of $200,000, the deduct- ible interest, at 6 per cent, per annum, would not exceed : 6 per cent, on $500,000 $30,000 6 per cent, on 100,000 6,000 Total, 6 per cent, on $600,000 $36,000 BOOKKEEPING SUGGESTIONS 95 Should the actual interest paid during the year exceed the sum of $36,000, in the example cited, the excess would not be deductible and only $36,000 should be entered in item 6 (a) of the report under " Deductions." In the case of subdivision A, 3, having no capital stock, the " capital employed in the business * * * contem- plates the entire capital paid in by the members of the company, including so much of the accumulated sur- plus as is not in excess of the needs of the business, but does not include any borrowed capital or interest- bearing indebtedness." In the supplementary statement under item 6 (a) " In- terest Deductible " should be listed " all forms of in- debtedness upon which interest was paid," stating as to each: 1. Name or kind of obligation (Bonds Payable, Mortgages Payable, Bills Payable, etc.), 2. Amount of principal of each class, 3. Rate of interest on each class, 4. Amount of interest paid on each class of obliga- tions. Irrespective of the amount deducted in the main re- port under " Deductions," the amount stated as " in- terest paid " in the supplementary statement is the total amount paid during the year. The amount deducted cannot exceed the total amount actually paid, but, by the limitation of law hereinbefore stated, may be less. No dividends or so-called interest on any kind of capi- tal stock are deductible ; " guaranteed," cumulative or preferred dividends are no exceptions. Interest Interest on any bonds of a corporation secured by " Debenture mortgage on its real or personal property is deductible Bonds" in a return of net income of the corporation. Where, however, a corporation issues so-called "de- benture bonds " secured by mortgages on real estate made 96 INCOME TAX LAW AND ACCOUNTING by borrowers from the corporation in favor of such corporation, the interest on such bonds is not deductible from the taxable income. In the case of Middlesex Banking Company vs. Robert O. Eaton, Collector (221 Fed., 86), affirmed by the United States Circuit Court of Appeals, it was found upon the trial that the plain- tiff, under its charter had the powers of a safe-deposit company, of a bank of deposit, and of a company to sell securities, but that its principal business was the sale of securities. Judge Ward of the United States Cir- cuit Court of Appeals found that " practically the whole of the business done by the plaintiff during the years in question was the sale of its own obligations, called ' de- benture bonds,' secured by mortgages on property in the South and West, deposited with the Columbia Trust Co. as trustee for the bondholders, and of the obligations of borrowers to the plaintiff, secured by mortgages, which, accompanied by its own interest coupons for a less rate of interest than it receives from the borrowers, it guar- antees as to both principal and interest and sells to pur- chasers. These latter are called ' guaranteed real estate securities.' Both these forms of securities the plaintiff sells throughout the East by means of agents, and its profit in each case is represented by the difference be- tween the rate of interest it receives from its southern and western borrowers and the interest which it pays to the eastern purchasers of the obligations." The plaintiff's theory was that the interest in question was paid upon money deposited with it and as such was deductible; this the Court disposed of in the following language : " Without stopping to analyze the charter powers of the plaintiff and to determine whether it is or is not a bank or banking association and, whether, if so, it has not also other and different powers, we think it perfectly clear that the interest in question is not interest upon money deposited with it, but is interest paid on its own obligations or on the obligations of others guar- BOOKKEEPING SUGGESTIONS 97 anteed by it which it has sold to the investing public. The purchase price is no more money deposited with the plaintiff at interest than is money paid to a railroad com- pany for the purchase of its bonds. The transaction is not a banking transaction at all like the giving of a pass book or a certificate of deposit to a depositor, but a busi- ness of selling securities to investors. Selden vs. Equi- table Trust Co. (94 U. S., 419)." F. A. Cleveland, in his work on " Funds and Their Uses/' says that : " The term debenture bond is the most loosely used of any of the terms descriptive or sug- gestive of financial instruments." The test of deduci- bility of interest on such bonds is whether it is actually an " expense of the business," and to be such it must be paid upon an actual obligation of the company, not merely upon an " evidence of indebtedness." Interest paid as a distribution of profits is not deductible in an income tax return. Dividends Dividends received by a corporation should be credited to " Dividends Received Account " and in the income tax return included in item 3 (d) under " Gross Income." Dividends received out of earnings accrued prior to March 1, 1913, are not taxable to the recipient. Stock dividends constitute taxable income to the amount of their cash value and " such cash value is held to be the proportionate share of the surplus accrued to the paying corporation since March 1, 1913, as is rep- resented by the stock distributed or ordered to be dis- tributed to the receiving corporation." Inasmuch as corporations pay the normal tax (2%) on their net earnings, dividends paid to individual stock- holders out of such net earnings are free from a further normal tax. But that is not so in the case of dividends paid to a corporation stockholder. Such corporate stock- holder is again taxable on its net income, which includes the dividends received. Hence, on dividends paid by one 98 INCOME TAX LAW AND ACCOUNTING Income Sundry Sources corporation to another corporation, the normal tax is paid twice. It is not necessary that the dividends be actually paid either by cash or stock, because " dividends shall be held to mean any distribution made or ordered to be made by a corporation out of its earnings." Therefore, a mere credit on the books of the issuing corporation is sufficient to obligate the recipient to include the amount of such credit applicable to him or it (a corporation) as income in his or its return of net income. All income, other than that derived from trading, rent- als, interest, dividends received, and income from the sale of capital assets, should be credited in the ledger to an account " Income from Sundry Sources " and should be stated in item 3 (e) under " Gross Income." Profits from the sale of capital assets should be included in this item of the return. For treatment of the account in the ledger, and method of computing profit from the sale of capital assets, see page 105. In the supplementary statement, item 3 (e), all income from sources other than those specifically called for in the return, which is subject to tax, should be itemized. Labor, These items are called for in toto in the supplementary CommiSons statement of tne report, item 4 (a) 1, under " Expenses, General." " Labor " and " wages " for the purpose of the income tax return, apply to all wages, direct and in- direct (except where a cost-system is operated, see page 110). All salaries, other than those of officers of the corporation which are stated separately in item 4 (a) 6, should be included in " Labor, Wages and Commissions." Bonus and profit sharing payments to employees other than officers which are not gratuities, but additional pay for services actually rendered, should be included in this deduction. A separate ledger account should be kept to which items of this class will be charged. Separate ledger accounts should be kept for wages and BOOKKEEPING SUGGESTIONS 99 Fuel, Light, Power, etc. Repairs, Ordinary and Incidental commissions, respectively, and each of them should be further subdivided into separate accounts according to requirements of the business. For example, wages paid in connection with production (Productive Wages), office salaries, salaries of salesmen, etc., should be car- ried in separate accounts to facilitate the preparation of intelligible Profit and Loss Accounts and for purposes of comparison of various departmental expenses of dif- ferent periods. Commissions, also, should be kept in accounts, that, by their title, designate whether they are applicable to cost of production, administration or selling expenses. Income from commissions should be credited to a " Commissions Received Account " and included in item 3 (e) under " Gross Income " of the tax return. Where commissions are both received and paid they should always be credited and charged, respectively, to separate ledger accounts that by their title are descriptive of their contents. These items, called for in the supplementary state- ment, item 4 (a) 2, under " Expenses, General," should contain in toto only the cost of supplies and service pur- chased, such as coal, gas, electricity, power, etc., and should not include labor of engineers, firemen, etc., which latter are called for by item 4 (a) 1. Ordinarily the items to be included in line 4 (a) 2 are charged in an account called " Light, Heat and Power." To make easier the preparation of the tax return such accounts should be subdivided, one for labor, and the other for supplies consumed in the production of light, heat and power, as " Light, Heat and Power, Labor " and " Light, Heat and Power, Supplies." For the purpose of the income tax return, it is neces- sary only to keep one general " Repair Account " of materials. For accounting purposes, however, repairs should be subdivided according to requirements, as Re- 100 INCOME TAX LAW AND ACCOUNTING pairs to Machinery and Plant, Repairs to Buildings, etc. To more easily prepare the tax report these accounts again should be divided into Repairs Materials and Supplies, and Repairs Wages, because they are called for separately. The separation of wages and materials only applies where the repairs are made by own em- ployees of the corporation. Where the repairs are made by " outsiders " the total cost of repairs may be charged in item 4 (a) 4. Care should be exercised to differentiate repairs and renewals from improvements and betterments ; the latter are not deductible as expenses. A mere replacement that is not an improvement and does not enhance the material value is chargeable as a repair; the same is true of that which merely maintains efficiency. Salaries of A separate ledger account, to which should be charged Officers a ii salaries of officers, should be kept. The amount of such salaries will be stated in the supplementary state- ment of the return in item 4 (a) 6, under " Expenses, General." A salary is, in the ordinary acceptation of the word, a compensation that is fixed by agreement in advance. Salaries, to be deductible, shall not be based upon stockholdings ; they must be a business expense and not a distribution of profits. A distribution of profits is not deductible as an expense. Where, however, " special payments, often designated as bonuses, are made to officers or employees of corpo- rations, pursuant to a contract, express or implied, as additional compensation for services rendered, which payments, when added to the stipulated salaries, do not exceed a reasonable compensation for the services ren- dered, such payments may be regarded as a part of the wages or hire of the officer or employee, and, as such, may allowably be deducted from gross income as a busi- ness expense." In such case the bonus or additional compensation of an officer should be included in item BOOKKEEPING StJGGESTiQ.N'S lOi 4 (a) 6, " Salaries of Officers." But " this ruling cun- templates that such payments are conditioned upon the services rendered by the employee and not upon the earnings of the corporation. If it should appear that the additional or special payments are dependent upon the earnings of the company, rather than upon the serv- ices rendered, or if such payments are made only occa- sionally, and then, at the option of the corporation, as a sort of thank-offering because of a prosperous year, and not in pursuance of a fixed policy or practice, or any contract, express or implied, it will be held that such pay- ments are gratuities and, as such, are not properly de- ductible from gross income." Voluntary contributions or donations, such as " Christ- mas gifts " are riot deductible. But a payment by an employer to his employee, irrespective of when made, during the holiday or any other season of the year, in consideration of services rendered, as extra compen- sation, is deductible by the payer. In addition to the accounts, the balances of which are separately called for by the return, every mercantile concern has more or less additional expenses for which separate accounts, according to requirements, should be kept, such as: Freight on Sales Insurance Packing Supplies Postage Shipping Supplies Stationery & Printing Stable Expense Telegraph & Telephone Auto Expense Legal Expense Advertising Auditing Expense Traveling Expense General Office Expense In the case of a manufacturing company, that does not operate a cost-system as an integral part of the book- keeping system (see page 110) an intelligible classifica- tion would require such additional accounts as General Factory Expense, Production Supplies, etc. .INCOHE.TAX L AND ACCOUNTING All expenses that are not separately provided for in the return, such as those just mentioned, should be stated in item 4 (a) 7 " Other Expenditures " in the supplementary statement. It is not necessary to state each account separately; they may be combined so as to include them all in five groups. Each group should con- tain items related to each other or coming under the same general head of production, administration or sell- ing expenses. For example, they may be grouped as fol- lows: Packing and Shipping Supplies, Stable and Auto Expense, Advertising and Traveling Expense, Postage, Stationery, Telegraph & Telephone, Legal and Auditing Expense. Items that cannot be classified under a general head may be stated as " Miscellaneous Unclassified Expenses/' but the amount so stated should be comparatively small. Import duties and import taxes should be charged to " Duties Account " in the ledger and included in the return as expense in item 4 (a) under " Deductions " and in the supplementary statement in item 4 (a) 7. These items should not be deducted as taxes. The names of all officers and employees receiving sal- aries of $3,000 or more per anum, shall be reported in the supplementary statement in item 4 (a) 8, under VVMholding ExpenseSj General." The total of this column does not enter into the main report because the salaries here reported are included under " Expenses, General " in item 4 (a) 1 and 4 (a) 6. Salaries paid by capital stock, rentals or by property shall be stated at the cash value thereof. Every corporation shall withhold for the year 1916 1 per cent, of the amount paid to officers and em- ployees, and every year thereafter 2 per cent, on all salaries paid in excess of the amount of exemption to Customs Duties Salaries in Excess of $3,000 BOOKKEEPING SUGGESTIONS 103 Report of Bad which the recipient is entitled, namely, unmarried per- sons $3,000, and married persons or head of family $4,000. A corporation shall not deduct such exemption unless the individual entitled thereto files with it a certificate of exemption in due time. All individuals receiving income in excess of $3,000 per annum must make and file return on Form 1040 in addition to the returns of their employers. In addition to the return of annual net income (Form 1031 ) every corporation, paying salaries of $3,000 or more in the year, must make a return on Form 1042 Revised (Tax Withheld at Source, etc.). This is com- pulsory, and failure to file such additional return in due time subjects the corporation to a fine of from $20 to $1,000. Under the old income tax law fines were im- posed without exception for failure to file return of taxes withheld. Uncollectible accounts receivable should be charged to a separate account that by its title designates what it con- tains, such as Bad Debts, Uncollectible Accounts or Bad Accounts. Bad debts should not be charged to Profit and Loss Account until at the end of the fiscal period, when the books are closed. Rulings direct that accounts shall be deducted only when they have been actually ascertained to be worth- less. Reserves to provide for anticipated bad debts are not deductible. The accounts deducted must be charged off in the books of account during the year for which the return is made, wherein the accounts are deducted. Payments received on accounts after they have been charged off should be credited to Income from Bad Debts Account and stated in the return as income " From other sources " under " Gross Income." The total of such in- come should also be stated in the supplementary state- ment of the return in item 3 (e) designating the same as " Income from Bad Debts." 104 INCOME TAX LAW AND ACCOUNTING In the return of corporations it is not required to state of what the debts charged off consist, when they were created, when they became due, how they were actually ascertained to be worthless, etc., as is required of indi- viduals. But the fact that this is not asked of them does not indicate that corporations are allowed any greater leeway than are individuals. The most prevalent causes that justify the charging off of accounts receivable, are : 1. Bankruptcy of debtor, 2. Assignment by debtor for benefit of creditors, 3. Execution against property returned unsatisfied, 4. Disappearance of debtor leaving no assets, 5. Death of debtor leaving no estate. The test of charging off accounts should not be lim- ited to the reasons stated above. Each case should be determined upon the particular conditions governing it. The language of rulings under the old income tax law would indicate that legal procedure must be exhausted before an account may be charged off. That, no doubt, is true in many cases, but all accounts do not justify the expenditure of money to effect collection. Bankruptcy, as a general rule, is sufficient in itself to warrant the charging off of an account. The average per cent, of dividends paid by the estates of bankrupts to creditors is so small that unless it is apparent that an estate has good assets, in a reasonable proportion to the liabilities, the entire account may be charged off at once. Where dividends are received thereon, such dividends should be stated as income. The question as to when an account is " actually ascer- tained to be worthless " is one that can best be answered by the creditor, and he might better err on the side of safety than to permit the accumulation of uncollectible accounts. BOOKKEEPING SUGGESTIONS 105 Loss by Fire losses usually involve both capital and current assets. It is customary immediately after a fire casualty to proceed to arrive at an inventory based on cost of the destroyed, partly destroyed and damaged merchandise for insurance purposes. When this has been done the value of the destroyed and damaged merchandise, based on such inventory, should be charged to an account in the ledger bearing title of " Fire Loss Account." To this account should also be charged all expenses incurred in the adjustment of loss, including compensation of adjusters, if any, as well as the cost of repairs and re- placement of buildings' occasioned by the fire. The amount recovered from insurance companies should be credited to said account. The debit excess of the Fire Loss Account will then represent the loss sustained by fire which should be included in the income tax return, item 5 (a) under " Deductions," and under the same designation in the supplementary statement. At the end of the fiscal period the balance of Fire Loss Account should be charged to Profit and Loss Account. Sales of The profit or loss on the sales of capital assets is de- Assets' termined in the case of assets acquired subsequent to March 1, 1913, by the difference between the cost and selling price. If the assets sold were acquired prior to March 1, 1913, then the profit or loss is the difference between the fair market value on March 1, 1913, and the selling price. The profit or loss on the sale of capital assets should be credited or charged, -respectively, to " Income on Sales of Capital Assets Account " and " Loss on Sales of Capital Assets." The debit of such accounts will be a transfer of the cost or fair market value, as the case may be, from the asset account in which the subject of sale had previously been carried in the ledger. According to the supplementary statement of the in- come tax return, it would appear that the profit on sales 106 INCOME TAX LAW AND ACCOUNTING of capital assets should be included in " Gross Income From Operations." This is obviously wrong in prin- ciple, and it is suggested that such income be stated in item 3 (e) under " Gross Income " calling for income " From other sources." Losses on sales of capital assets should be included in item 5 (a) under " Deductions." Depreciation This subject has been treated at some length in Chap- ter IV, pages 68 to 85. Suffice it to say here, that any amount deducted in the return of net income for depre- ciation (item 5 (b) in both the report and supplementary statement) must be actually charged off in the ledger, either on the asset account itself or in a negative account, such as, a Reserve for Depreciation. Depreciation is usually charged off by a journal entry, debiting Depreciation Account and crediting Reserve for Depreciation. The Depreciation Account is closed into the Profit and Loss Account and the Reserve Account remains open until the asset that it offsets (writes down), is either sold or otherwise disposed of ; then the difference between the cost and the amount written off in past years, plus proceeds of sale, is charged off as a capital loss or profit, as the case may be. Depletion As in the case of depreciation of property, depletion of mines and oil or gas wells, by reason of exhaustion of the natural product, must be actually charged off in the ledger of the corporation seeking the deduction. Mere memorandum entries thereof are insufficient. The purpose of an allowance for depletion is to return to the corporation the capital invested, or, in case of purchase prior to March 1st, 1913, an amount sufficient to return to the corporation the fair market value of such de- posits as at that date. Depletion should be entered in item 5 (c) of both the return proper and the supple- mentary statement. Ledger It has been indicated by the Commissioner of Internal Depletion of Revenue that in order to render a claim for depletion Property of property deductible from income for tax purposes, BOOKKEEPING SUGGESTIONS 107 it is insufficient to make a mere journal entry thereof; it must be actually charged off in the general ledger, either against the asset account of the property depleted, or to the credit of " Reserve for Depletion" ; further, that such reserve shall be deducted from the asset ac- count in the balance sheet, as well as in the report to the stockholders. The amount deducted for depletion in an income tax return must, in fact, be charged off in such way that it reduces the asset account in the general ledger by the amount deducted in the return of annual net income. Taxes should be charged to an account in the ledger bearing that title. All taxes are deductible except that: 1. Foreign taxes accruing to a foreign corporation are not deductible from income derived upon capital invested in this country. 2. Taxes paid for local benefits are not deductible. 3. Taxes paid by corporations to render their stock or bonds tax-free are not deductible, because such taxes are primarily obligations of their stockholders and bondholders. Foreign taxes paid by a corporation organized under the laws of any State of the United States are deduct- ible, because such corporation pays an income tax on its entire net income irrespective of where such income is derived or where its capital is invested. Journal entries of income tax items may be avoided by providing a separate column in the cash book for income tax deducted at the source. In the books of the recipient of income on which the tax has been withheld, the amount deducted becomes a charge to Tax Deducted at Source Account. Cash Account is debited with the net amount of cash received, the tax deducted is debited in the special column provided therefor, and the credit to the income account is stated at the gross amount, inclusive of both cash received and tax deducted. The 108 INCOME TAX LAW AND ACCOUNTING Treatment of Tax Withheld at Source on Books of Payer of Income Capital Stock income tax deducted may then be posted in totals at the end of each month. Tax Deducted at Source Account becomes a prepaid expense until it has been deducted from the annual return of the recipient. This is appli- cable particularly to individuals, but will also apply to such foreign corporations as are subject to have the in- come tax withheld. A separate column should also be provided in the cash book of the payer of income that is subject to with- holding of tax at the source of payment. This applies to individuals and corporations generally. The net amount of cash paid (obligation, less tax withheld) is credited to Cash Account. The amount of tax with- held is entered in the special column and credited to In- come Tax Withheld Account. The expense chargeable is debited with the total (cash paid plus tax withheld). Having a separate column in the cash book makes it possible to post the items withheld in totals at the end of each month, thereby reducing the number of individual postings. At the same time the Income Tax Withheld Account represents at all times the amount owing to the Government by reason of such deductions. When the tax is paid to the Collector such payment is charged to the Income Tax Withheld, which closes the account. Item 1 of the income tax return calls for the amount of capital stock paid-in and outstanding. This does not include either stock unissued or " treasury stock." If the corporation has no capital stock, then it should state the amount of capital employed in the business, which, ordinarily, is the excess of the assets over liabilities, i. e., invested capital plus surplus. Item 1, in the supplementary statement, calls for the division of capital stock into common and preferred. If the company has no capital stock then the " capital em- ployed in the business" should be stated. (See inter- pretation, page 95.) BOOKKEEPING SUGGESTIONS 109 Interest- Item 2, in the main report, calls for the amount of bearing bonded and other interest-bearing indebtedness outstand- Indebted- . ness ing at the close of the year, exclusive of indebtedness wholly secured by collateral, the subject of sale or hypo- thecation in the ordinary business of the corporation. Item 2, in the supplementary statement, calls for de- tails by classification, rate of interest and amount of principal of all interest bearing indebtedness. It in- cludes all the items of item 2 in the body of the report, and in addition thereto, the total amount owing, etc., on debts, wholly secured by collateral, the subject of sale in the ordinary business of the corporation. Merchandise it w iH be noted that no provision has been made for a merchandise account; instead, separate accounts have been recommended, consisting of Sales, Purchases, Re- turn Sales and Inventory. Return purchases, ordin- arily, may be credited to Purchase Account. A Mer- chandise Account has no place in a modern set of books. Profit and No postings should be made to the Profit and Loss Loss Account Account during the interim of a fiscal period, that is to say, until the books are closed at the end of the year. The practice of charging or crediting expenses or losses and income, respectively, direct to Profit and Loss Account, makes it necessary to analyze the account in order to allocate the items contained therein for pur- poses of the tax return. But apart from this disad- vantage and as a matter of good accounting, Profit and Loss Account should contain no entries until the close of the fiscal period. In the meantime all items of in- come and expense should be credited or charged to ac- counts that by their titles are descriptive of their con- tents. After the books have been closed the balance of Profit and Loss Account should be transferred either to Sur- plus or Impairment of Capital Account, as the case may be. no INCOME TAX LAW AND ACCOUNTING Dividends Declared Reconcilia- tion of Return with Books of Account Manufac- turing Cor- porations Operating Cost- System Dividends declared should be charged to Surplus Ac- count and credited to Dividend Account against which the payments of dividends should be charged. For the purpose of future reference, the net income as shown by the return of net income should be recon- ciled with the result shown by Profit and Loss Account. The difference, where the return is made for the fiscal year of the corporation, will consist of such items of income as are not taxable, readjustment of book values to express appraisal valuations or expenses or losses not by law deductible. Items are not deductible unless they are charged off in the books of account within the year covered by the return. " A manufacturing corporation may include as an element of the cost of manufactured products, the cost of raw material, the cost of labor of the men who actu- ally work on such products, as well as the cost of super- visory, or what may be designated as ' unproductive labor,' such as that of the foremen, inspectors, over- seers, etc., provided ,such expenditures are not separately deducted from gross income in the Return of Annual Net Income. " The overhead charges referred to in Form 1031 should include the salaries of officers, clerk hire, and such other office expenses as do not have to do directly with the manufacture of the product." (T. D., 2152.) This ruling under the old law, and provisions with respect to account keeping of the amended law, makes it possible for manufacturing corporations employing cost-systems, that are embraced in the general books of account and subject to proof as to accuracy, to make their returns on the basis of cost of production, as shown thereby. The form of the return (1031), how- ever, is not well adapted to that kind of report. For example, it calls for items under " Deductions " that BOOKKEEPING SUGGESTIONS 111 ordinarily (according to opinion of the cost accountant) are charged to the cost of production, as rent, fuel, light and power, repairs, payments in lieu of rent, de- preciation, depletion and taxes. Any of these items that are included in the cost of production through the cost- system, should not again be stated as deductions. Items that have been included in the cost of produc- tion that are separately provided for in the report or supplementary statement thereof, should be explained by a notation " included in cost of manufacture." The de- tailed information as to basis of computing depreciation and depletion, and amount of domestic and foreign taxes charged to the period, should be furnished in the sup- plementary statement even though these items, or either of them, were included in the cost of manufactured goods. Where interest on capital is theoretically added to the cost of production, such interest, for income tax pur- poses, must either be deducted from the cost of pro- duction or separately stated as income in the return. It is quite usual to maintain, in connection with a modern cost-system, a " perpetual " or " running " in- ventory. Irrespective of the degree of care with which such inventory may be operated, more or less differences occur in the course of time. This necessitates the taking of physical inventories and the adjustment of the " run- ning " inventory therewith. Physical inventories should be taken and the book inventory reconciled therewith at least once in each fiscal period. 112 CHAPTER VI INFORMATION REQUIRED TO PREPARE RE- TURN OF NET INCOME OF MERCANTILE CORPORATION The following is a list of all items required in order to prepare a return of net income of a mercantile corpora- tion, showing where each item should be entered in the return proper, and in the supplementary statement thereof. Where the books of account are kept upon the " ac- crual basis," the amount accrued or deferred may be included in the return but no accrued expense so deducted shall exceed: 1. The amount due and payable within the year, or 2. An amount actually accrued or incurred for which the business received value within the year. Supple- mentary Item. Return. Statement. 1. Total capital stock issued and out- standing at close of year. In case of partly paid stock, then the amount of instalments paid in at the close of year 1 2. Common stock, paid-up, at close of year 1 3. Preferred stock, paid-up, at close of year 1 4. If the stock has no par value, then the amount of capital employed in the business at the close of the year, exclusive of liabilities and borrowed capital 1 1 MERCANTILE CORPORATION 113 Supple- mentary Item. Return. Statement. 5. Total amount of interest-bearing indebtedness at close of year, exclusive of indebtedness wholly secured by collateral, the subject of sale in ordinary busi- ness of the corporation 2 6. Character of obligation, rate of in- terest and amount of principal at close of year of all interest- bearing indebtedness, for the payment o'f which the corpora- tion or its property is bound, including that wholly secured by collateral 2 7. Stock on hand at close of year. (At cost) 3 (a) 8. Stock on hand at beginning of year. (At cost) 3 (a) INCOME. 9. Sales of Merchandise, less dis- counts allowed, allowances on goods sold and return sales. . . 3 (a) 10. Rentals received, including royal- ties, if any 3 (b) 11. Interest received on government bonds, or any other Govern- ment obligation, including municipal, state and Federal (not taxable) 3 (c) 12. All interest received, other than that on Government securities. 3 (c) 114 INCOME TAX LAW AND ACCOUNTING Supple- mentary Item. Return. Statement. 13. Dividends received out of earn- ings of corporations and limited partnerships, accrued since March 1st, 1913 3 (d) 14. Income received from all other sources. (Itemized) 3 (e) 3 (e) DEDUCTIONS. 15. Purchases, plus transportation charges thereon, less return purchases, discounts and " anti- cipations " received 3(a) 16. All labor, wages and commissions (not including salaries of offi- cers) 4 (a) 4 (a) 1 17. Fuel, light, power, etc 4 (a) 4 (a) 2 18. Rentals paid during the year 4 (a) 4 (a) 3 19. Repairs, ordinary and incidental. ( Not including improvements and betterments) 4 (a) 4 (a) 4 20. Total of salaries paid to officers. . 4 (a) 4 (a) 6 21. Bad debts (uncollectible accounts) actually ascertained to be un- collectible and charged off in the books of account within the year 5 (a) 5 (a) 22. Losses on capital assets computed on basis outlined on page 22.. 5(a) 5(a) 23. All other losses not recovered by insurance or otherwise 5 (a) 5 (a) MERCANTILE CORPORATION 115 Supple- mentary Item. Return. Statement. 24. Depreciation charged off on all depreciated properties, and the following data as to each class of property: (a) Kind of property 5 (b) (b) Its cost 5 (b) (c) Probable life after ac- quirement 5 (b) (d) Amount charged for year covered by return 5 (b) 5 (b) (e) Total amount charged off thereon in previous years 5 (b) NOTE. -In case of buildings, state kind of construction as frame, brick, concrete, etc. 25. Interest paid during the year classified as follows : a. Interest paid on indebtedness wholly secured by collateral, the sub- ject of sale or hypothecation in ordi- nary business of the corporation. (This item is deducted as a general expense) 4 (a) 4 (a) 5 b. Interest paid on mortgages se- cured by property which the corpora- tion occupies but does not own. (To be included in item " Payments in lieu of rent ") 4 (b) c. All other interest paid, including that on bonds, borrowed capital, bank loans and accounts bearing interest. . 6 (a) NOTE. The amount on which interest is deductible shall not exceed the paid-up 116 INCOME TAX LAW AND ACCOUNTING Supple- mentary Item. Return. Statement. capital stock outstanding at the close of the year, or if no capital stock the amount of capital employed in the business, plus one-half of the interest-bearing indebted- ness then outstanding. 26. Also the following data with re- spect to interest paid : (a) Name or kind of obliga- tion. (Bonds payable, bills payable, accounts payable, loans payable, etc.) 6 (a) (b) Amount of principal. . . 6 (a) (c) Rate of interest 6 (a) (d) Amount of interest paid. 6 (a) NOTE. The above detailed information should be given as to each class of inter- est-bearing indebtedness. 27. Taxes paid or accrued on the books of account not in excess of the amount due and payable within the year: Domestic, Federal, State, etc. (Not including local bene- fits) 7 (a) 7 (a) Foreign (of domestic cor- porations only) 7 (b) 7 (b) 28. All other expenditures or expenses not separately called for above, such as: Freight on Sales, Ad- vertising, Traveling Expense, Insurance, Postage, Stationery, Telephone and Telegraph, MERCANTILE CORPORATION 117 Supple- mentary Item. Return. Statement. Legal Expense, General Office Expense, etc., classified into five groups. (See page 101) .. 4 (a) 4 (a) 7 29. Miscellaneous information as fol- lows : Names and addresses of officers and employees receiving $3,000 or more in the year and the amount thereof 4 (a) 8 30. Detailed information as to the sales of capital assets, including original cost of such assets, if acquired since March 1st, 1913 ; fair market value as of March 1st, 1913, if acquired prior to that date ; how such " fair market value " was ascertained ; selling price, and the resulting profit or loss, as the case may be: Profits 3(e) 3 (a) Losses 5 (a) 5 (a) 31. If the return is not made on the basis of actual receipts and dis- bursements, then state how the income was computed 7 (b) The difference between items designated 3 (a) in the order stated in the supplementary statement, being the " Gross Income from Operations " should be entered in the return in item 3 (a) 118 INCOME TAX LAW AND ACCOUNTING Supple- mentary Item. Return. Statement. Where the same designation ap- pears more than one time under " Returns " the aggre- gate amount of all such items should be entered in the report proper. Items called for by the " supplementary statement " should be separately entered. 119 CHAPTER VII PREPARATION OF INCOME TAX RETURNS OF INDIVIDUALS Method of The privilege afforded by the income tax law to cor- Bookkeepmg p Ora ti O ns with respect to the preparation of income tax returns upon a basis other than that of actual receipts and disbursements is also extended to individuals, in the following language: " An individual keeping accounts upon any basis other than that of actual receipts and disbursements, unless such other basis does not clearly reflect his income, may, subject to regulations made by the Commissioner of In- ternal Revenue, with the approval of the Secretary of the Treasury, make his return upon the basis upon which his accounts are kept, in which case the tax shall be com- puted upon his income as so returned." The " accrual method," if it may be so called, is ex- plained on page 88. Separation Source Columns "A" and "B" of the income tax return should, respectively, contain income on which the normal tax has been withheld at the source of payment and in- come on which the normal tax has not been withheld. In column " A " should be entered the gross amount of income on which the tax has been withheld, i. e., inclu- sive of the amount of tax deducted by the withholder. For example, in the case of a salary of $10,000, less the personal exemption of $4,000, the tax withheld for the year 1916 would be 1 per cent, (after January 1, 1917, 2 per cent.) of $6,000, namely, $60, and the recipient of such salary would receive during the year $9,940. But the amounts to be entered in the return are: $6,000 in column " A " and $4,000 in column " B." 120 INCOME TAX LAW AND ACCOUNTING INCOME. Separate or Husband and wife may render separate returns or Returnsof either of them may make the return and include the in- Husband and CO me and deductions of the other as provided by the form of the return. If separate returns are made by husband and wife, each of them shall only deduct, re- spectively, his and her own expenses and deductions. In any case the aggregate personal exemption deducted by both husband and wife, shall not exceed $4,000. Return of Individuals engaged in mercantile or manufacturing Merchant business on their own account, and unincorporated, are not called upon to state in their returns the same amount of detail that is required of corporations. The gross profit from operation of a business will be entered in item 16 under " Gross Income " on page 2 of the return. The following illustrates method of computing gross profit : Net Sales for the year $50,000 00 Stock on Hand (beginning of year) $7,500 00 Add Purchases during the year.... 35,000 00 Total $42,500 00 Deduct Stock on Hand (end of year) 6,500 00 Cost of Goods Sold 36,000 00 Interest Received Gross Profit for the Year (Entered in Item 16). $14,000 00 All expenses of the business, other than interest, taxes, losses arising from fires, storms, or other casualties and from theft, not compensated for by insurance, bad debts and depreciation, will be entered in item 32 on page 3 under " General Deductions." As to what comprises " Net Sales " and " Purchases," see pages 89 and 90, respectively. All interest received by an individual, excepting that on bonds or other obligations of the Government (tax exempt) is returnable for income tax purposes and RETURNS OF INDIVIDUALS 121 should be separated into the three classes prescribed by the return and entered in the respective items, as follows : Interest on promissory notes of individuals and corporations, mortgages of individuals, bank deposits, loans, and from other sources not included in the following classifica- tions, to be entered in item 18 under "Gross Income." Interest upon obligations of domestic corporations, joint- stock companies or associations and insurance com- panies, including bonds, mortgages, deeds of trust, or other similar instruments, to be entered in item 19 under " Gross Income." Interest upon obligations of foreign corporations engaged in business in foreign countries, such as bonds, mortgages, deeds of trust or other similar obligations, issued in foreign countries ; also, dividends received upon the stock of such foreign corporations, to be entered in item 22 under "Gross Income." Salaries, Under the present income tax law it is not required C^missions ^ iat an ^dividual sna ^ report income from any source until the same is actually received. A promissory note, for income tax purposes, has been ruled to be payment and should be treated as a cash receipt. Upon default of payment thereof such note may be deducted when it has been ascertained to be worthless. Income received in property, i. e., the equivalent of cash, should be reported at the cash value thereof. Salaries, wages and commissions from all sources should be entered in item 14 under " Gross Income." All commissions and other compensation received by persons acting in a fiduciary capacity, should be reported in this item. In cases where the administration of an estate covers a period of years, it is suggested that the compensation of the trustee be computed and reported, whether paid or not, for each year, because it has been ruled that where such compensation covering a period of years is paid in one sum, such compensation cannot be prorated over the period of years covered thereby. 122 INCOME TAX LAW AND ACCOUNTING and f Vocatfons T ^ e remar ^ s state d above with respect to requirements of reporting income from salaries, wages and commis- sions, only when actually received, is also true of income from professions and vocations. A lawyer or doctor, for example, is not required to report income until actual payment of a fee has been received. All income from professional or vocational sources should be entered in item 15 under " Gross Income." Business I n addition to gross income from mercantile and man- Commerce u factoring pursuits, there should be included in item 16, under " Gross Income " all profits from the sale of real and personal property, including that derived from sources " not in trade," such as, profits on speculations. For method of determining profit on sales of properties purchased or acquired by the taxpayer prior to March 1, 1913, see page 23. Rents Rentals are not required to be reported until actually received by cash or the equivalent. The total of income from this source should be entered in item 17 under " Gross Income." Income from All income received from guardians, trustees, execu- cianes tors, administrators, receivers and conservators, or other persons acting in a fiduciary capacity, should be included in item 20 under " Gross Income." Dividends received from domestic corporations, through fiduciaries, how- ever, which are not subject to the normal tax, should be entered in item 29. Partnership The share of profit and gains of partners in a part- nership, whether distributed or not, should be reported in item 21, under " Gross Income," exclusive of dividends from domestic corporations which are returnable on line 28, " Dividends received through partnership." Inasmuch as income of partnerships is not subject to withholding at the source the entire share in partnership RETURNS OF INDIVIDUALS 123 profits credited to the partner should be reported in col- umn " B." In cases where the partners by provision of partnership articles are allowed a drawing account in the form of salary, charged in the books of the partnership as an ex- pense of the business, such salary compensation should be reported in item 14 of the return under " Gross In- come " and the normal tax should be withheld thereon and paid by the partnership on amounts in excess of personal exemption. Where the partners draw moneys on account of accru- ing profits, such withdrawals, being included in the part- nership profits (distributed and undistributed) should not again be included in the return of net income. Royalties All income received in the form of royalties from mines, oil wells, patents, franchises or other legalized privileges should be reported in item 23, under "Gross Income." Income from All income not separately provided for in the return lources should be entered in item 24 and the source of each noted therein. It is not necessary to particularize the source except by general classification. Dividends Dividends on stock of domestic corporations, which Received are subject to the normal tax on their income, should be reported on line 27 under " Gross Income." There should be included in this item all distributions of net earnings of such corporations, whether or not there was a formal declaration of dividends by the board of direc- tors ; for example, distribution of earnings by " close cor- porations " that do not observe technical requirements of corporation law with respect to the declaration of divi- dends by board of directors, but distribute profits in- formally as they accrue, should be included therein. 124 INCOME TAX LAW AND ACCOUNTING DEDUCTIONS. Necessary Unless the "' accrual method " of account keeping is Expenses employed by the taxpayer, the amount deducted in item 32 under " General Deductions " should be only the total of expenses actually paid within the year. There shall not be included therein any personal, living or family expenses. In the case of a merchant this item will in- clude the administration and selling expenses of his busi- ness but not the cost of merchandise purchases, which are deductible from sales in the ascertainment of gross profit entered in item 16 under " Gross Income." No partnership expenses are deductible in the return of an individual. In the case of rented property, amounts expended for maintenance and repairs are deductible in this item, but amounts expended for permanent improvements or better- ments are not competent deductions. Interest Paid All interest paid within the year by the taxpayer on his indebtedness is deductible in item 33 under " General Deductions." There is no limitation as to the amount of interest deductible by an individual taxpayer, such as there is in the case of a corporation except, in the case of nonresident alien individuals, see page 30. Taxes Paid All national, foreign, State, county, school and munic- ipal taxes paid within the year, not including assessments for local benefits, such as sewerage, sidewalk, street im- provements, etc., are deductible in item 34 under " Gen- eral Deductions." Taxes paid on the residence of the taxpayer are deductible. Losses All losses sustained during the year incurred in business or trade, or arising from fires, storms, shipwreck or other casualties, and from theft, not compensated by insurance, or otherwise, are deductible in item 35 under " General Deductions." RETURNS OF INDIVIDUALS 125 Loss Not In Trade Bad Debts Where a loss is sustained in the sale of property acquired prior to March 1, 1913, the measure of loss is the difference between the fair market price or value as at March 1, 1913, and the amount realized from such sale. This item should be supplemented with the following information : (a) Of what the loss consisted. (b) When it was actually sustained. (c) How it was determined to be a loss. (d) If sustained by sale of property acquired before March 1, 1913, the fair market price or value as of that date and how such value was determined. Losses sustained during the year in transactions entered into for .profit but not connected with the business or trade of the taxpayer, should be entered in item 36 under " General Deductions." Such losses are only de- ductible up to the amount of profit or income during the year derived from the same class of transactions, which would be included under " Gross Income " in item 16. The amount of profit or income derived from such transactions during the year should be entered under Item 36 and the same information called for with respect to losses incuned in trade in item 35 should be furnished with regard to losses not in trade. Uncollectible accounts actually ascertained to be worth- less, charged off on the books of account of the individual within the year, should be stated in item 37, supple- mented by the following information : (a) Of what the debts consisted. (b) When they were created. (c) When they became due. (d) How they were actually determined to be worthless. (e) Whether or not they have been included in the present or previous return. As to what constitutes worthless accounts receivable for purposes of the income tax return, see page 103. 126 INCOME TAX LAW AND ACCOUNTING To render an item deductible under this title it must be actually charged off within the year. Depreciation A reasonable allowance for exhaustion, wear and tear of property, arising out of its use or employment in busi- ness or trade, should be deducted in item 38 under " Gen- eral Deductions." As to deductibility of depreciation on various classes of properties, see Chapter IV, on Depreciation, page 68. The following information should be given with respect to each class of property on which such deduction is made: (a) Kind of property on which depreciation is taken. (b) Cost of same. (c) What percentage of depreciation is claimed. In case of buildings, state when erected and of what materials constructed. Depletion A reasonable allowance for depletion of oil, gas wells and mines should be deducted in item 39 under " General Deductions." For limitation of deductibility of depletion on oil, gas wells and mines, respectively, see pages 27 and 28. In the case of property acquired prior to March 1, 1913, the depletion allowable shall be at a rate, which, during the estimated life of the property being depleted will return : The cost of the property, if acquired after March 1, 1913, or The fair market value as of March 1, 1913, if acquired before that date. These items should be supplemented with the following information : (a) The cost of property, if purchased after March 1, 1913. (b) The fair market value as of March 1, 1913, if purchased prior to that date. (c) How such value was determined. (d) The basis upon which the amount of depletion claimed was computed. RETURNS OF INDIVIDUALS 127 Illustration For the purpose of illustrating the method of comput- Computing ing the normal and additional tax of an individual, based Normal and on requirements of the law for the year 1916 (only 1 per cent, withheld), the following summary of income and deductions is assumed : Additional Tax Line of Re- turn. Description of Income. (Page 2). A. Income on Which Tax Has Been Paid or Withheld. B. Income on Which Tax Has Not Been Paid or Withheld. 25. Totals (Note. Enter 1 per cent of total amount of Column A on line 9) $80,000 00 $250,000 00 26. Aggregate Totals of Col- umns A and B 330,00000 27. Dividends on stock of corporations, etc., subject to like tax $5,00000 28. Dividends received through partner- ship. (See line 21) 50000 29. Dividends received through fiduci- aries. (See line 20) 1,00000 30. Total Dividends. (Lines 27, 28 and 29.) (Enter on line 4) 6,500 00 31. Total Gross Income (to be entered on line 1) $336,500 00 Deductions (Page 3). 40. Total " General Deductions " (to be entered one line 2) $25,000 00 Summary (Page 1). 1. Gross Income (brought from line 31) $336,500 00 2. General Deductions (brought from line 40) 25,000 00 3. Net Income $311,500 00 4. Dividends brought from line 30.... $6,500 00 5. Personal exemption (single, $3,000; married or head of family, $4,000) 4,000 00 6. Total dividends and personal exemption (Items 4 and 5) $10,500 00 128 INCOME TAX LAW AND ACCOUNTING 7. Amount of Income subject to normal tax 301,000 00 8. Amount of Normal Tax at rate of 2 per cent, on income shown on line 7 6,020 00 9. Credit by amount of normal tax paid or to be paid at source (1 per cent, of amount of in- come shown on line 25, Column A) 300 00 10. Balance of normal tax due $5,220 00 Income. Tax. One per cent, on amount over $20,000 and not exceeding $40,000 $20,000 00 $200 00 Two per cent, on amount over $40,000 and not exceeding $60,000 20,000 00 400 00 Three per cent, on amount over $60,000 and not exceeding $80,000 20,000 00 600 00 Four per cent, on amount over $80,000 and not exceeding $100,000 20,000 00 800 00 Five per cent, on amount over $100,000 and not exceeding $150,000 50,000 00 2,500 00 Six per cent, on amount over $150,000 and not exceeding $200,000 50,000 00 3,000 00 Seven per cent, on amount over $200,000 and not exceeding $250,000 50,000 00 3,500 00 Eight per cent, on amount over $250,000 and not exceeding $300,000 50,000 00 4,000 00 Nine per cent, on amount over $300,000 and not exceeding $500,000 11,500 00 1,035 00 Ten per cent, on amount over $500,000 and not exceeding $1,000,000 Eleven per cent, on amount over $1,000,000 and not exceeding $1,500,000 Twelve per cent, on amount over $1,500,000 and not exceeding $2,000,000 Thirteen per cent, on amount over $2,000,000 11. Total additional tax $16,035 00 12. Balance of normal tax due, as shown on line 10 . 5,220 00 13. Total Tax Due $21,255 00 129 APPENDIX A FEDERAL INCOME TAX LAW ENACTED SEPTEMBER 8, 1916 PART I. ON INDIVIDUALS SEC. 1. (a) That there shall be levied, assessed, collected, and paid annually upon the entire net income received in the preceding calendar year from all sources by every individual, a citizen or resident of the United States, a tax of two per centum upon such income ; and a like tax shall be levied, assessed, collected, and paid annually upon the entire net income received in the preceding calendar year from all sources within the United States by every individual, a non-resident alien, including interest on bonds, notes, or other interest-bearing obligations of residents, corporate or otherwise. (b) In addition to the income tax imposed by subdivision (a) of this section (herein referred to as the normal tax) there shall be levied, assessed, collected, and paid upon the total net income of every individual, or, in the case of a non- resident alien, the total net income received from all sources within the United States, an additional income tax (herein referred to as the additional tax) of one per centum per annum upon the payment by which such total net income exceeds $20,000 and does not exceed $40,000, two per centum per annum upon the amount by which such total net income exceeds $40,000 and does not exceed $60,000, three per centum per annum upon the amount by which such total net income exceeds $60,000 and does not exceed $80,000, four per centum per annum upon the amount by which such total net income exceeds $80,000 and does not exceed $100,000, five per centum per annum upon the amount by which such total net income exceeds $100,000 and does not exceed $150.000, six per centum per annum upon the amount by which such total net income exceeds $150,000 and does not exceed $200,000, seven per centum per annum upon the amount by which such total net income exceeds $200,000 and does not exceed $250,000, eight per centum per annum upon the amount by which such total net income exceeds $250,000 and does not exceed $300,000, nine per centum per annum upon the amount by which such total net income exceeds $300,000 and does not exceed $500,000 ten per centum per annum upon the amount by which such total net income exceeds 130 APPENDIX A Dividends Subject to Additional Tax Calendar Year $500,000, and does not exceed $1,000,000, eleven per centum per annum upon the amount by which such total net income exceeds $1,000,000 and does not exceed $1,500,000, twelve per centum per annum upon the amount by which such total net income exceeds $1,500,000 and does not exceed $2,000,000, and thirteen per centum per annum upon the amount by which such total net income exceeds $2,000,000. For the purpose of the additional tax there shall be included as income the income derived from dividends on the capital stock or from the net earnings of any corporation, joint-stock company or association, or insurance company, except that in the case of non-resident aliens such income derived from sources without the United States shall not be included. All the provisions of this title relating to the normal tax on individuals, so far as they are applicable and are not incon- sistent with this subdivision and section three, shall apply to the imposition, levy, assessment, and collection of the addi- tional tax imposed under this subdivision. (c) The foregoing normal and additional tax rates shall apply to the entire net income, except as hereinafter provided, received by every taxable person in the calendar year nineteen hundred and sixteen and in each calendar year thereafter. Net Income Defined "Dividends" Distributed or Ordered Distributed INCOME DEFINED. SEC. 2. (a) That, subject only to such exemptions and deduc- tions as are hereinafter allowed, the net income of a taxable person shall include gains, profits, and income derived from salaries, wages, or compensation for personal service of what- ever kind and in whatever form paid, or from professions, vocations, businesses, trade, commerce, or sales, or dealings in property, whether real or personal, growing out of the owner- ship or use of or interest in real or personal property, also from interest, rent, dividends, securities, or the transaction of any business carried on for gain or profit, or gains or profits and income derived from any source whatever: Pro- vided, That the term "dividends" as used in this title shall be held to mean any distribution made or ordered to be made by a corporation, joint-stock company, association, or insurance company, out of its earnings or profits accrued since March first, nineteen hundred and thirteen, and payable to its share- holders, whether in cash or in stock of the corporation, joint- stock company, association, or insurance company, which stock FEDERAL INCOME TAX LAW 131 dividend shall be considered income, to the amount of its cash value. Income of (b) Income received by estates of deceased persons during Estates the period of administration or settlement of the estate, shall be subject to the normal and additional tax and taxed to their estates, and also such income of estates or any kind of property held in trust, including such income accumulated in trust for the benefit of unborn or unascertained persons, or persons with contingent interests, and income held for future distribution under the terms of the will or trust shall be likewise taxed, the tax in each instance, except when the income is returned for the purpose of the tax by the beneficiary, to be assessed to the executor, administrator, or trustee, as the case may be: Individual Provided, That where the income is to be distributed annually ar . . or regularly between existing heirs or legatees, or beneficiaries the rate of tax and method of computing the same shall be based in each case 'upon the amount of the individual share to be distributed. Indemnity to Such trustees, executors, administrators, and other fiduciaries Fiduciaries are hereby indemnified against the claims or demands of every beneficiary for all payments of taxes which they shall be required to make under the provisions of this title, and they shall have credit for the amount of such payments against the beneficiary or principal in any accounting which they make as such trustees or other fiduciaries. Basis of (c) For the purpose of ascertaining the gain derived from Determining the sale or other disposition of property, real, personal, or Gam on mixed, acquired before March first, nineteen hundred and Acquired thirteen, the fair market price or value of such property as of Prior to March first, nineteen hundred and thirteen, shall be the basis March 1,1913 f or determining the amount of such gain derived. ADDITIONAL TAX INCLUDES UNDISTRIBUTED PROFITS. Undistributed SEC. 3. For the purpose of the additional tax, the taxable Profits income of any individual shall include the share to which he would be entitled of the gains and profits, if divided or dis- tributed, whether divided or distributed or not, of all cor- porations, joint-stock companies or associations, or insurance companies, however created or organized, formed or fraudu- lently availed of for the purpose of preventing the imposition of such tax through the medium of permitting such gains and profits to accumulate instead of being divided or distributed; 132 APPENDIX A and the fact that any such corporation, joint-stock company or association, or insurance company, is a mere holding company, Accumulation 01 " that the gains and pr fits are P ermitted to accumulate Evidence of be y nd tne reasonable needs of the business, shall be prima Fraud Tax Exempt Income Insurance Gifts Bequests Interest on Obligations of State Compensation of Certain Employees of State Deductions facie evidence of a fraudulent purpose to escape such tax; but the fact that the gains and profits are in any case permitted to accumulate and become surplus shall not be construed as evidence of a purpose to escape the said tax in such case unless the Secretary of the Treasury shall certify that in his opinion such accumulation is unreasonable for the purposes of the business. When requested by the Commissioner of Internal Revenue, or any district collector of internal revenue, such corporation, joint-stock company or association, or insur- ance company shall forward to him a correct statement of such gains and profits and the names and addresses of the individuals or shareholders who would be entitled to the same if divided or distributed. INCOME EXEMPT FROM LAW. SEC. 4. The following income shall be exempt from the pro- visions of this title: The proceeds of life insurance policies paid to individual beneficiaries upon the death of the insured; the amount received by the insured, as a return of premium or premiums paid by him under life insurance, endowment, or annuity contracts, either during the term or at the maturity of the term men- tioned in the contract or upon the surrender of the contract; the value of property acquired by gift, bequest, devise, or descent (but the income from such property shall be included as income) ; interest upon the obligations of a State or any political subdivision thereof or upon the obligations of the United States or its possessions or securities issued under the provisions of the Federal farm loan Act of July seventeenth, nineteen hundred and sixteen ; the compensation of the present President of the United States during the term for which he has been elected, and the judges of the Supreme and inferior courts of the United States now in office, and the compensation of all officers and employees of a State, or any political sub- division thereof, except when such compensation is paid by the United States Government. DEDUCTIONS ALLOWED. SEC. 5. That in computing net income in the case of a citi- zen or resident of the United States (a) For the purpose of the tax there shall be allowed as de- ductions FEDERAL INCOME TAX LAW 133 Necessary Expenses Interest Taxes First The necessary expenses actually paid in carrying on any business or trade, not including personal, living, or family expenses ; Second. All interest paid within the year on his indebtedness ; Third. Taxes paid within the year imposed by the authority of the United States or its Territories, or possessions, or any foreign country, or under the authority of any State, county, school district, or municipality, or other taxing subdivision of any State, not including those assessed against local benefits; Fourth. Losses actually sustained during the year, incurred in his business or trade, or arising from fires, storms, shipwreck, or other casualty, and from theft, when such losses are not compensated for by insurance or otherwise: Provided, That for the purpose of ascertaining the loss sustained from the sale or other disposition of property, real, personal, or mixed, ac- quired before March first, nineteen hundred and thirteen, the fair market price or value of such property as of March first, nineteen hundred and thirteen, shall be the basis for determin- ing the amount of such loss sustained; Fifth. In transactions entered into for profit but not con- nected with his business or trade, the losses actually sustained therein during the year to an amount not exceeding the profits arising therefrom; Sixth. Debts due to the taxpayer actually ascertained to be worthless and charged off within the year; Depreciation Seventh. A reasonable allowance for the exhaustion, wear and tear of property arising out of its use or employment in the business or trade; Depletion Eighth, (a) In the case of oil and gas wells a reasonable allowance for actual reduction in flow and production to be ascertained not by the flush flow, but by the settled production or regular flow; (b) in the case of mines a reasonable allow- ance for depletion thereof not to exceed the market value in the mine of the product thereof, which has been mined and sold dur- ing the year for which the return and computation are made, such reasonable allowance to be made in the case of both (a) and (b) under rules and regulations to be prescribed by the Limitation of Secretary of the Treasury: Provided, That when the allow- Depletion ances authorized in (a) and (b) shall equal the capital origi- nally invested, or in case of purchase made prior to March first, Losses in Trade Loss on Property Acquired Prior to March 1, 1913 Losses not in Trade Bad Debts 134 APPENDIX A not Deductible nineteen hundred and thirteen, the fair market value as of that Improvements date, no further allowance shall be made. No deduction shall be allowed for any amount paid out for new buildings, perma- nent improvements, or betterments, made to increase the value of any property or estate, and no deduction shall be made for any amount of expense of restoring property or making good the exhaustion thereof for which an allowance is or has been made. Normal Tax Credits Dividends Deductions Nonresident Aliens Necessary Expenses Proportion of Interest Taxes CREDITS ALLOWED. (b) For the purpose of the normal tax only, the income embraced in a personal return shall be credited with the amount received as dividends upon the stock or from the net earnings of any corporation, joint-stock company or association, trustee, or insurance company, which is taxable upon its net income as hereinafter provided; (c) A like credit shall be allowed as to the amount of in- come, the normal tax upon which has been paid or withheld for payment at the source of the income under the provisions of this title. NONRESIDENT ALIENS. SEC. 6. That in computing net income in the case of a non- resident alien (a) For the purpose of the tax there shall be allowed as deductions First. The necessary expenses actually paid in carrying on any business or trade conducted by him within the United States, not including personal, living, or family expenses; Second. The proportion of all interest paid within the year by such person on his indebtedness which the gross amount of his income for the year derived from sources within the United States bears to the gross amount of his income for the year derived from all sources within and without the United States, but this deduction shall be allowed only if such person includes in the return required by section eight all the informa- tion necessary for its calculation; Third. Taxes paid within the year imposed by the authority of the United States, or its Territories, or possessions, or under the authority of any State, county, school district, or muni- cipality, or other taxing subdivision of any State, paid within the United States, not including those assessed against local benefits ; FEDERAL INCOME TAX LAW 135 Losses Fourth. Losses actually sustained during the year, incurred in business or trade conducted by him within the United States, and losses of property within the United States arising from fires, storm, shipwreck, or other casualty, and from theft, when such losses are not compensated for by insurance or otherwise: Ascertaining Provided, That for the purpose of ascertaining the amount of Amount of such loss or losses sustained in trade, or speculative transactions not in trade, from the same or any kind of property acquired before March first, nineteen hundred and thirteen, the fair market price or value of such property as of March first, nine- teen hundred and thirteen, shall be the basis for determining the amount of such loss or losses sustained: Losses not in Trade Bad Debts Fifth. In transactions entered into for profit but not con- nected with his business or trade, the losses actually sustained therein during the year to an amount not exceeding the profits arising therefrom in the United States; Sixth. Debts arising in the course of business or trade con- ducted by him within the United States due to the taxpayer actually ascertained to be worthless and charged off within the year; Depreciation Seventh. A reasonable allowance for the exhaustion, wear and tear of property within the United States arising out of its use or employment in the business or trade; (a) in the case of oil and gas wells a reasonable allowance for actual re- duction in flow and production to be ascertained not by the flush flow, but by the settled production or regular flow; (b) in the case of mines a reasonable allowance for depletion thereof not to exceed the market value in the mine of the product thereof, which has been mined and sold during the year for which the return and computation are made, such reasonable allowance to be made in the case of both (a) and (b) under rules and regulations to be prescribed by the Limitation of Secretary of the Treasury: Provided, That when the allow- Depletion ance authorized in (a) and (b) shall equal the capital origin- ally invested, or in case of purchase made prior to March first, nineteen hundred and thirteen, the fair market value as of that Improvements date, no further allowance shall be made. No deduction shall be allowed for any amount paid out for new buildings, perma- nent i m p rovemen t s , or betterments, made to increase the value of any property or estate, and no deduction shall be made for any amount of expense of restoring property or making good the exhaustion thereof for which an allowance is or has been made. Deductible 136 APPENDIX A (b) There shall also be allowed the credits specified by sub- divisions (b) and (c) of section five. PERSONAL EXEMPTION. Individual SEC. 7. (a) That for the purpose of the normal tax only, Exemption there shall be allowed as an exemption in the nature of a de- duction from the amount of the net income of each of said persons, ascertained as provided herein, the sum of $3,000, plus $1,000 additional if the person making the return be a head of a family or a married man with a wife living with him, or plus the sum of $1,000 additional if the person making the return be a married woman with a husband living with her; but in no event shall this additional exemption of $1,000 be deducted by both a husband and a wife : Provided, That only one deduction of $4,000 shall be made from the aggregate in- come of both husband and wife when living together : Provided further, That guardians or trustees shall be allowed to make this personal exemption as to income derived from the property of which such guardian or trustee has charge in favor of each ward or cestui que trust: Provided further, That in no event shall a ward or cestui que trust be allowed a greater personal exemption than $3,000, or, if married, $4,000, as provided in this paragraph, from the amount of net income received from all Estates sources. There shall also be allowed an exemption from the amount of the net income of estates of deceased persons during the period of administration or settlement, and of trust or other estates the income of which is not distributed annually or regu- larly under the provisions of paragraph (b), section two, the sum of $3,000, including such deductions as are allowed under section five. Exemption to (b) A nonresident alien individual may receive the benefit of Nonresident the exemption provided for in this section only by filing or Ward Cestui que Trust Alien Conditional causing to be filed with the collector of internal revenue a true and accurate return of his total income, received from all sources, corporate or otherwise, in the United States, in the manner prescribed by this title ; and in case of his failure to file such return the collector shall collect the tax on such income, and all property belonging to such nonresident alien individual shall be liable to distraint for the tax. RETURNS. Returns of SEC. 8. (a) The tax shall be computed upon the net income, Net Income as thus ascertained, of each person subject thereto, received in each preceding calendar year ending December thirty-first. FEDERAL INCOME TAX LAW 137 When and With Whom to File Return Extension of Time to File Return Return by Agent (b) On or before the first day of March, nineteen hundred and seventeen, and the first day of March in each year there- after, a true and accurate return under oath shall be made by each person of lawful age, except as hereinafter provided, having a net income of $3,000 or over for the taxable year to the collector of internal revenue for the district in which such person has his legal residence or principal place of business, or if there be no legal residence or place of business in the United States, then with the collector of internal revenue at Baltimore, Maryland, in such form as the Commissioner of Internal Revenue, with the approval of the Secretary of the Treasury, shall prescribe, setting forth specifically the gross amount of income from all separate sources, and from the total thereof deducting the aggregate items of allowances herein authorized; Provided, That the Commissioner of Internal Revenue shall have authority to grant a reasonable extension of time, in meritorious cases, for filing returns of income by persons residing or traveling abroad who are required to make and file returns of income and who are unable to file said returns on or before March first of each year : Provided further, That the aforesaid return may be made by an agent when by reason of illness, absence, or nonresidence the person liable for said return is unable to make and render the same, the agent assuming the responsibility of making the return and incurring penalties provided for erroneous, false, or fraudu- lent return. (c) Guardians, trustees, executors, administrators, receivers, conservators, and all persons, corporations, or associations act- ing in any fiduciary capacity, shall make and render a return of the income of the person, trust, or estate for whom or which they act, and be subject to all the provisions of this title which apply to individuals. Such fiduciary shall make oath that he has sufficient knowledge of the affairs of such person, trust, or estate to enable him to make such return and that the same is, to the best of his knowledge and belief, true and correct, and be subject to all the provisions of this title which apply to individuals : Provided, That a return made by one of two or more joint fiduciaries filed in the district where such fiduciary resides, under such regulations as the Secretary of the Treasury may prescribe, shall be a sufficient compliance with the requirements of this paragraph. Withholding (d) All persons, firms, companies, copartnerships, corpora- Tax at Source tions, joint-stock companies, or associations, and insurance companies, except as hereinafter provided, in whatever capacity Returns by Fiduciaries 138 APPENDIX A acting, having the control, receipt, disposal, or payment of fixed or determinable annual or periodical gains, profits, and income of another individual subject to tax, shall in behalf of such person deduct and withhold from the payment an amount equivalent to the normal tax upon the same and make and render a return, as aforesaid, but separate and distinct, of the portion of the income of each person from which the normal tax has been thus withheld, and containing also the name and address of such person or stating that the name and address or the address, as the case may be, are unknown : Provided, That the provision requiring the normal tax of individuals to be deducted and withheld at the source of the income shall not be construed to require the withholding of such tax accord- ing to the two per centum normal tax rate herein prescribed until on and after January first, nineteen hundred and seven- teen, and the law existing at the time of the passage of this Act shall govern the amount withheld or to be withheld at the source until January first, nineteen hundred and seventeen. That in either case mentioned in subdivisions (c) and (d) of this section no return of income not exceeding $3,000 shall be required, except as in this title provided. Partnerships (e) Persons carrying on business in partnership shall be liable for income tax only in their individual capacity, and the share of the profits of the partnership to which any taxable partner would be entitled if the same were divided, whether divided or otherwise, shall be returned for taxation and the tax paid under the provisions of this title : Provided, That from the net distributive interests on which the individual members shall be liable for tax, normal and additional, there shall be excluded their proportionate shares received from interest on the obligations of a State or any political or taxing subdivision thereof, and upon the obligations of the United States and its possessions, and all taxes paid to the United States or to any possession thereof, or to any State, county, or taxing subdivision of a State, and that for the purpose of computing the normal tax there shall be allowed a credit, as provided by section five, subdi- vision (b), for their proportionate share of the profits derived from dividends. And such partnership, when requested by the Commissioner of Internal Revenue, or any district collector, shall render a correct return of the earnings, profits, and income of the partnership, except income exempt under section four of this Act, setting forth the item of the gross income and the deductions and credits allowed by this title, and the names and Interest on State Obligations Excluded Dividends Excluded FEDERAL INCOME TAX LAW 139 Withholding and Paying Tax at Source addresses of the individuals who would be entitled to the net earnings, profits, and income, if distributed. (f) In every return shall be included the income derived from dividends on the capital stock or from the net earnings of any corporation, joint-stock company or association, or insurance company, except that in the case of nonresident aliens such income derived from sources without the United States shall not be included. (g) An individual keeping accounts upon any basis other than that of actual receipts and disbursements, unless such other basis does not clearly reflect his income, may, subject to regu- lations made by the Commissioner of Internal Revenue, with the approval of the Secretary of the Treasury, make his return upon the basis upon which his accounts are kept, in which case the tax shall be computed upon his income as so returned. ASSES'SMENT AND ADMINISTRATION. SEC. 9. (a) That all assessments shall be made by the Com- missioner of Internal Revenue and all persons shall be notified of the amount for which they are respectively liable on or before the first day of June of each successive year, and said amounts shall be paid on or before the fifteenth day of June, except in cases of refusal or neglect to make such return and in cases of erroneous, false, or fraudulent returns, in which cases the Commissioner of Internal Revenue shall, upon the discovery thereof, at any time within three years after said return is due, or has been made, make a return upon infor- mation obtained as provided for in this title or by existing law, or require the necessary corrections to be made, and the assessment made by the Commissioner of Internal Revenue thereon shall be paid by such person or persons immediately upon notification of the amount of such assessment; and to any sum or sums due and unpaid after the fifteenth day of June in any year, and for ten days after notice and demand tTiereof by the collector, there shall be added the sum of five per centum on the amount of tax unpaid, and interest at the rate of one per centum per month upon said tax from the time the same became due, except from the estates of insane, deceased, or insolvent persons, (b) All persons, firms, copartnerships, companies, corpora- tions, joint-stock companies, or associations, and insurance com- panies, in whatever capacity acting, including lessees or mort- gagors of real or personal property, trustees acting in any trust 140 APPENDIX A Exemption Certificate Must be Filed with Payer Penalty False Claim for Exemption Deductions How Obtained capacity, executors, administrators, receivers, conservators, em- ployers, and all officers and employees of the United States having the control, receipt, custody, disposal, or payment of interest, rent, salaries, wages, premiums, annuities, compensa- tion, remuneration, emoluments, or other fixed or determinable annual or periodical gains, profits, and income of another per- son, exceeding $3,000 for any taxable year, other than income derived from dividends on capital stock, or from the net earn- ings of corporations and joint-stock companies or associations, or insurance companies, the income of which is taxable under this title, who are required to make and render a return in behalf of another, as provided herein, to the collector of his, her, or its district, are hereby authorized and required to de- duct and withhold from such annual or periodical gains, profits, and income such sum as will be sufficient to pay the normal tax imposed thereon by this title, and shall pay the amount withheld to the officer of the United States Government author- ized to receive the same; and they are each hereby made per- sonally liable for such tax, and they are each hereby indemnified against every person, corporation, association, or demand what- soever for all payments which they shall make in pursuance and by virtue of this title. In all cases where the income tax of a person is withheld and deducted and paid or to be paid at the source, such person shall not receive the benefit of the personal exemption allowed in section seven of this title except by an application for refund of the tax unless he shall, not less than thirty days prior to the day on which the return of his income is due, file with the person who is required to withhold and pay tax for him a signed notice in writing claiming the benefit of such exemption, and thereupon no tax shall be withheld upon the amount of such exemption : Provided, That if any person for the purpose of obtaining any allowance or reduction by virtue of a claim for such exemption, either for himself or for any other person, knowingly makes any false statement or false or fraudulent representation, he shall be liable to a penalty of not exceeding $300. And where the income tax is paid or to be paid at the source, no person shall be allowed the benefit of any deduction pro- vided for in sections five or six of this title unless he shall, not less than thirty days prior to the day on which the return of his income is due, either (1) file with the person who is required to withhold and pay tax for him a true and correct FEDERAL INCOME TAX LAW 141 Claim for Deduction Maybe Made to Payer Return by Agent Normal Tax Deductible from Coupons, etc. Irrespective of Amount of Income return of his gains, profits, and income from all other sources, and also the deductions asked for, and the showing thus made shall then become a part of the return to be made in his behalf by the person required to withhold and pay the tax, or (2) likewise make application for deductions to the collector of the district in which return is made or to be made for him : Pro- vided, That when any amount allowable as a deduction is known at the time of receipt of fixed annual or periodical income by an individual subject to tax, he may file with the person, firm, or corporation making the payment a certificate, under penalty for false claim, and in such form as shall be prescribed by the Commissioner of Internal Revenue, stating the amount of such deduction and making a claim for an allowance of the same against the amount of tax otherwise required to be deducted and withheld at the source of the income, and such certificate shall likewise become a part of the return to be made in his behalf. If such person is absent from the United States, or is unable owing to serious illness to make the return and application above provided for, the return and application may be made by an agent, he making oath that he has sufficient knowledge of the affairs and property of his principal to enable him to make a full and complete return, and that the return and appli- cation made by him are full and complete. (c) The amount of the normal tax hereinbefore imposed shall be deducted and withheld from fixed or determinable annual or periodical gains, profits, and income derived from interest upon bonds and mortgages, or deeds of trust or other similar obligations of corporations, joint-stock companies, asso- ciations, and insurance companies, whether payable annually or at shorter or longer periods, although such interest does not amount to $3,000, subject to the provisions of this title requiring the tax to be withheld at the source and deducted from annual income and returned and paid to the Government. (d) And likewise the amount of such tax shall be deducted and withheld from coupons, checks, or bills of exchange for or in payment of interest upon bonds of foreign countries and upon foreign mortgages or like obligations (not payable in the United States), and also from coupons, checks, or bills of ex- change for or in payment of any dividends upon the stock or interest upon the obligations of foreign corporations, associa- tions, and insurance companies engaged in business in foreign countries, 142 APPENDIX A Withholding And the tax in such cases shall be withheld, deducted, and returned for and in behalf of any person subject to the tax hereinbefore imposed, although such interest or dividends do not exceed $3,000, by (1) any banker or person who shall sell or otherwise realize coupons, checks, or bills of exchange drawn or made in payment of any such interest or dividends (not payable in the United States), and (2) any person who shall obtain payment (not in the United States), in behalf of another of such dividends and interest by means of coupons, checks, or bills of exchange, and also (3) any dealer in such coupons who shall purchase the same for any such dividends or interest (not payable in the United States), otherwise than from a banker or another dealer in such coupons. (e) Where the tax is withheld at the source, the benefit of the exemption and the deductions allowable under this title may be had by complying with the foregoing provisions of this section. License (f) All persons, firms, or corporations undertaking as a mat- Required by^ ter of business or for profit the collection of foreign payments of such interest or dividends by means of coupons, checks, or bills of exchange shall obtain a license from the Commissioner of Internal Revenue, and shall be subject to such regulations enabling the Government to ascertain and verify the due with- holding and payment of the income tax required to be withheld and paid as the Commissioner of Internal Revenue, with the approval of the Secretary of the Treasury, shall prescribe; and any person who shall knowingly undertake to collect such pay- ments as aforesaid without having obtained a license therefor, or without complying with such regulations, shall be deemed guilty of a misdemeanor and for each offense be fined in a sum not exceeding $5,000, or imprisoned for a term not exceeding one year, or both, in the discretion of the court. Collectors of Foreign Payments General Assessment of Income (g) The tax herein imposed upon gains, profits, and income not falling under the foregoing and not returned and paid by virtue of the foregoing shall be assessed by personal return under rules and regulations to be prescribed by the Commissioner of Internal Revenue and approved by the Secretary of the Treasury. The intent and purpose of this title is that all gains, profits, and income of a taxable class, as defined by this title, shall be charged and assessed with the corresponding tax, normal and additional, prescribed by this title, and said tax shall be paid by the owner of such income, or the proper repre- sentative having the receipt, custody, control, or disposal of the same. For the purpose of this title ownership or liability shall FEDERAL INCOME TAX LAW 143 Income of Corporations, etc., Subject to Tax Rate Dividends Defined Calendar or Fiscal Year be determined as of the year for which a return is required to be rendered. The provisions of this title relating to the deduction and pay- ment of the tax at the source of income shall only apply to the normal tax hereinbefore imposed upon individuals. PART II. ON CORPORATIONS. SEC. 10. That there shall be levied, assessed, collected, and paid annually upon the total net income received in the preceding calendar year from all sources by every corporation, joint-stock company or association, or insurance company, organized in the United States, no matter how created or organized but not including partnerships, a tax of two per centum upon such income ; and a like tax shall be levied, assessed, collected, and paid annually upon the total net income received in the pre- ceding calendar year from all sources within the United States' by every corporation, joint-stock company or association, or insurance company* organized, authorized, or existing under the laws of any foreign country, including interest on bonds, notes, or other interest-bearing obligations of residents, corporate or otherwise, and including the income derived from dividends on capital stock or from net earnings of resident corporations, joint-stock companies or associations, or insurance companies whose net income is taxable under this title : Provided, That the term " dividends " as used in this title shall be held to mean any distribution made or ordered to be made by a corporation, joint-stock company, association, or insurance company, out of its earnings or profits accrued since March first, nineteen hundred and thirteen, and payable to its shareholders, whether in cash or in stock of the corporation, joint-stock company, association, or insurance company, which stock dividend shall be considered income, to the amount of its cash value. The foregoing tax rate shall apply to the total net income received by every taxable corporation, joint-stock company or association, or insurance company in the calendar year nineteen hundred and sixteen and in each year thereafter, except that if it has fixed its own fiscal year under the provisions of existing law, the foregoing rate shall apply to the. proportion of the total net income returned for the fiscal year ending prior to December thirty-first, nineteen hundred and sixteen, which the period between January first, nineteen hundred and sixteen, and the end of such fiscal year bears to the whole of such fiscal year, and the rate fixed in Section II of the Act approved October third, nineteen hundred and thirteen, entitled "An Act 144 APPENDIX A to reduce tariff duties and to provide revenue for the Govern- ment, and for other purposes," shall apply to the remaining portion of the total net income returned for such fiscal year. Ascertaining For the purpose of ascertaining^ the gain derived or loss Profit or Loss sustained from the sale or other disposition by a corporation, joint-stock company or association, or insurance company, of property, real, personal, or mixed, acquired before March first, nineteen hundred and thirteen, the fair market price or value of such property as of March first, nineteen hundred and thir- teen, shall be the basis for determining the amount of such gain derived or loss sustained. CONDITIONAL AND OTHER EXEMPTIONS. Organizations SEC. 11. (a) That there shall not be taxed under this title Not Taxable anv income received by any First. Labor, agricultural, or horticultural organization. Second. Mutual savings bank not having a capital stock repre- sented by shares ; Third. Fraternal beneficiary society, order, or association, operating under the lodge system or for the exclusive benefit of the members of a fraternity itself operating under the lodge system, and providing for the payment of life, sick, accident, or other benefits to the members of such society, order, or association or their dependents; Fourth. Domestic building and loan association and coopera- tive banks without capital stock organized and operated for mutual purposes and without profit ; Fifth. Cemetery company owned and operated exclusively for the benefit of its members; Sixth. Corporation or association organized and operated ex- clusively for religious, charitable, scientific, or educational pur- poses, no part of the net income of which inures to the benefit of any private stockholder or individual ; Seventh. Business league, chamber of commerce, or board of trade, not organized for profit and no part of the net income of which inures to the benefit of any private stockholder or individual : Eighth. Civic league or organization not organized for profit but operated exclusively for the promotion of social welfare; Ninth. Club organized and operated exclusively for pleasure, recreation, and other nonprofitable purposes, no part of the net income of which inures to the benefit of any private stock- holder or member ; Tenth. Farmers' or other mutual hail, cyclone, or fire insur- FEDERAL INCOME TAX LAW 145 ance company, mutual ditch or irrigation company, mutual or cooperative telephone company, or like organization of a purely local character, the income of which consists solely of assess- ments, dues, and fees collected from members for the sole purpose of meeting its expenses; Eleventh. Farmers', fruit growers', or like association, or- ganized and operated as a sales agent for the purpose of marketing the products of its members and turning back to them the proceeds of sales, less the necessary selling expenses, on the basis of the quantity of produce furnished by them; Twelfth. Corporation or association organized for the exclu- sive purpose of holding title to property, collecting income there- from, and turning over the entire amount thereof, less expenses, to an organization which itself is exempt from the tax imposed by this title; or Thirteenth. Federal land banks and national farm-loan asso- ciations as provided in section twenty-six of the Act approved July seventeenth, nineteen hundred and sixteen, entitled "An Act to provide capital for agricultural development, to create standard forms of investment based upon farm mortgage, to equalize rates of interest upon farm loans, to furnish a market for United States bonds, to create Government depositaries and financial agents for the United States, and for other purposes." Fourteenth. Joint stock land banks as to income derived from bonds or debentures of other joint stock land banks or any Federal land bank belonging to such joint stock land bank. (b) There shall not be taxed under this title any income derived from any public utility or from the exercise of any essential governmental function accruing to any State, Terri- tory, or the District of Columbia, or any political subdivision of a State or Territory, nor any income accruing to the govern- ment of the Philippine Islands or Porto Rico, or of any political subdivision of the Philippine Islands or Porto Rico: Provided, That whenever any State, Territory, or the District of Columbia, or any political subdivision of a State or Territory, has, prior to the passage of this title, entered in good faith into a contract with any person or corporation, the object and purpose of which is to acquire, construct, operate, or maintain a public utility, no tax shall be levied under the provisions of this title upon the income derived from the operation of such public utility, so far as the payment thereof will impose a loss or burden upon such State, Territory, or the District of Columbia, or a political subdivision of a State or Territory; but this provision 146 APPENDIX A is not intended to confer upon such person or corporation any financial gain or exemption or to relieve such person or cor- poration from the payment of a tax as provided for in this title upon the part or portion of the said income to which such person or corporation shall be entitled under such contract. DEDUCTIONS. Deductions SEC. 12. (a) In the case of a corporation, joint-stock corn- Allowed to pany or association, or insurance company, organized in the Domestic ^ United States, such net income shall be ascertained by deducting from the gross amount of its income received within the year from all sources Necessary First. All the ordinary and necessary expenses paid within the Expenses year in the maintenance and operation of its business and prop- erties, including rentals or other payments required to be made as a condition to the continued use or possession of property to which the corporation has not taken or is not taking title, or in which it has no equity. Second. All losses actually sustained and charged off within the year and not compensated by insurance or otherwise, includ- ing a reasonable allowance for the exhaustion, wear and tear of property arising out of its use or employment in the business or trade; (a) in the case of oil and gas wells a reasonable allowance for actual reduction in flow and production to be ascertained not by the flush flow, but by the settled production or regular flow ; (b) in the case of mines a reasonable allowance for depletion thereof not to exceed the market value in the mine of the product thereof which has been mined and sold during the year for which the return and computation are made, > such reasonable allowance to be made in the case of both (a) and (b) under rules and regulations to be prescribed by the Limitation Secretary of the Treasury: Provided, That when the allowance of Depletion authorized in (a) and (b) shall equal the capital originally invested, or in case of purchase made prior to March first, nineteen hundred and thirteen, the fair market value as of that date, no further allowance shall be made; and (c) in the case of insurance companies, the net addition, if any, required by law to be made within the year to reserve funds and the sums other than dividends paid within the year on policy and Improvements annuity contracts : Provided, That no deduction shall be allowed for any amount paid out for new buildings, permanent improve- ments, or betterments made to increase the value of any property or estate, and no deduction shall be made for any Losses Depreciation Depletion FEDERAL INCOME TAX LAW 147 amount of expense of restoring property or making good the exhaustion thereof for which an allowance is or has been made: Provided further, That mutual fire and mutual employers' lia- bility and mutual workmen's compensation and mutual casualty insurance companies requiring their members to make premium deposits to provide for losses and expenses shall not return as income any portion of the premium deposits returned to their policyholders, but shall return as taxable income all income received by them from all other sources plus such portions of the premium deposits as are retained by the companies for purposes other than the payment of losses and expenses and reinsurance reserves : Provided further, That mutual marine insurance companies shall include in their return of gross income gross premiums collected and received by them less amounts paid for reinsurance, but shall be entitled to include in deduc- tions from gross income amounts repaid to policyholders on account of premiums previously paid by them and interest paid upon such amounts between the ascertainment thereof and the payment thereof, and life insurance companies shall not include as income in any year such portion of any actual premium received from any individual policyholder as shall have been paid back or credited to such individual policyholder, or treated as an abatement of premium of such individual policyholder, within such year; Third. The amount of interest paid within the year on its indebtedness to an amount of such indebtedness not in excess of the sum of (a) the entire amount of the paid-up capital stock outstanding at the close of the year, or, if no capital stock, the entire amount of capital employed in the business at the close of the year, and (b) one-half of its interest-bearing indebtedness then outstanding: Provided, That for the purpose of this title preferred capital stock shall not be considered in- terest-bearing indebtedness, and interest or dividends paid upon this stock shall not be deductible from gross income : Provided further, That in cases wherein shares of capital stock are issued without par or nominal value, the amount of paid-up capital stock, within the meaning of this section, as represented by such shares, will be the amount of cash, or its equivalent, paid or transferred to the corporation as a consideration for such shares: Provided further, That in the case of indebtedness wholly secured by property collateral, tangible or intangible, the subject of sale or hypothecation in the ordinary business of such corporation, joint-stock company or association as a dealer only in the property constituting such collateral, or in loaning the 148 APPENDIX A Taxes Income of Foreign funds thereby procured, the total interest paid by such corpora- tion, company, or association within the year on any such in- debtedness may be deducted as a part of its expenses of doing business, but interest on such indebtedness shall only be de- ductible on an amount of such indebtedness not in excess of the actual value of such property collateral : Provided further, That in the case of bonds or other indebtedness, which have been issued with a guaranty that the interest payable thereon shall be free from taxation, no deduction for the payment of the tax herein imposed, or any other tax paid pursuant to such guaranty, shall be allowed; and in the case of a bank, banking association, loan or trust company, interest paid within the year on deposits or on moneys received for investment and se- cured by interest-bearing certificates of indebtedness issued by such bank, banking association, loan or trust company; Fourth. Taxes paid within the year imposed by the authority of the United States, or its Territories, or possessions, or any foreign country, or under the authority of any State, county, school district, or municipality, or other taxing subdivision of any State, not including those assessed against local benefits. (b) In the case of a corporation, joint-stock company or association, or insurance company, organized, authorized, or Corporations existing under the laws of any foreign country, such net income shall be ascertained by deducting from the gross amount of its income received within the year from all sources within the United States Deductions First. All the ordinary and necessary expenses actually paid Allowed within the year out of earnings in the maintenance and opera- Foreign ^ t j on O f i ts business and property within the United States, in- corporations c i u( ji n g ren tals or other payments required to be made as a condition to the continued use or possession of property to which the corporation has not taken or is not taking title, or in which it has no equity. Losses Depreciation Depletion Second. All losses actually sustained within the year in business or trade conducted by it within the United States and not compensated by insurance or otherwise, including a rea- sonable allowance for the exhaustion, wear and tear of property arising out of its use or employment in the business or trade; (a) and in the case (a) of oil and gas wells a reasonable allow- ance for actual reduction in flow and production to be ascer- tained not by the flush flow, but by the settled production or regular flow; (b) in the case of mines a reasonable allowance FEDERAL INCOME TAX LAW 149 for depletion thereof not to exceed the market value in the mine of the product thereof which has been mined and sold during the year for which the return and computation are made, such reasonable allowance to be made in the case of both (a) and (b) under rules and regulations to be prescribed by Limitation the Secretary of the Treasury: Provided, That when the allow- of Depletion ance authorized in (a) and (b) shall equal the capital originally invested, or in case of purchase made prior to March first, nine- teen hundred and thirteen, the fair market value as of that date, no further allowance shall be made; and (c) in the case of insurance companies, the net addition, if any, required by law to be made within the year to reserve funds and the sums other than dividends paid within the year on policy and annu- Improvements ity contracts : Provided, That no deduction shall be allowed for any amount paid out for new buildings, permanent improve- ments, or betterments, made to increase the value of any property or estate, and no deduction shall be made for any amount of expense of restoring property or making good the exhaustion thereof for which an allowance is or has been made: Provided, Mutual further, That mutual fire and mutual employers' liability and Companies mutual workmen's compensation and mutual casualty insurance companies requiring their members to make premium deposits to provide for losses and expenses shall not return as income any portion of the premium deposits returned to their policy- holders, but shall return as taxable income all income received by them from all other sources plus such portions of the pre- mium deposits as are retained by the companies for purposes other than the payment of losses and expenses and reinsurance reserves : Provided further, That mutual marine insurance com- panies shall include in their return of gross income gross pre- miums collected and received by them less amounts paid for reinsurance, but shall be entitled to include in deductions from gross income amounts repaid to policyholders on account of premiums previously paid by them, and interest paid upon such amounts between the ascertainment thereof and the payment thereof, and life insurance companies shall not include as in- come in any year such portion of any actual premium received from any individual policyholder as shall have been paid back or credited to such individual policyholder, or treated as an abatement of premium of such individual policyholder, within such year; Interest Third. The amount of interest paid within the year on its indebtedness to an amount of such indebtedness not in excess of the proportion of the sum of (a) the entire amount of the 150 APPENDIX A Interest Deductible Limitation of paid-up capital stock outstanding at the close of the year, or, if no capital stock, the entire amount of the capital employed in the business at the close of the year, and (b) one-half of its interest-bearing indebtedness then outstanding, which the gross amount of its income for the year from business transc- acted and capital invested within the United States bears to the gross amount of its income derived from all sources within and without the United States : Provided, That in the case of bonds or other indebtedness which have been issued with a guaranty that the interest payable thereon shall be free from taxation, no deduction for the payment of the tax herein im- posed or any other tax paid pursuant to such guaranty shall be allowed ; and in case of a bank, banking association, loan or trust company, or branch thereof, interest paid within the year on deposits by or on moneys received for investment from either citizens or residents of the United States and secured by interest-bearing certificates of indebtedness issued by such bank, banking association, loan or trust company, or branch thereof ; Taxes Reserve Insurance Companies not Deductible Tax Year Fiscal Year Fourth. Taxes paid within the year imposed by the authority of the United States, or its Territories, or possessions, or under the authority of any State, county, school district, or munic- ipality, or other taxing subdivision of any State, paid within the United States, not including those assessed against local benefits. (c) In the case of assessment insurance companies, whether domestic or foreign, the actual deposit of sums with State or Territorial officers, pursuant to law, as additions to guarantee or reserve funds shall be treated as being payments required by law to reserve funds. RETURNS. SEC. 13. (a) The tax shall be computed upon the net income, as thus ascertained, received within each preceding calendar year ending December thirty-first: Provided, That any cor- poration, joint-stock company or association, or insurance com- pany, subject to this tax, may designate the last day of any month in the year as the day of the closing of its fiscal year and shall be entitled to have the tax payable by it computed upon the basis of the net income ascertained as herein provided for the year -ending on the day so designated in the year pre- ceding the date of assessment instead of upon the basis of the net income for the calendar year preceding the date of assess- ment; and it shall give notice of the day it has thus designated FEDERAL INCOME TAX LAW 151 as the closing of its fiscal year to the collector of the district in which its principal business office is located at any time not less than thirty days prior to the first day of March of the year in which its return would be filed if made upon the basis of the calendar year; (b) Every corporation, joint-stock company or association, or insurance company, subject to the tax herein imposed, shall, on or before the first day of March, nineteen hundred and seventeen, and the first day of March in each year thereafter, or, if it has designated a fiscal year for the computation of its tax, then within sixty days after the close of such fiscal year ending prior to December thirty-first, nineteen hundred and six- teen, and the close of each such fiscal year thereafter, render a true and accurate return of its annual net income in the man- ner and form to be prescribed by the Commissioner of Internal Revenue, with the approval of the Secretary of the Treasury, and containing such facts, data, and information as are appro- priate and in the opinion of the commissioner necessary to determine the correctness of the net income returned and to carry out the provisions of this title. The return shall be sworn to by the president, vice president, or other principal officer, and by the treasurer or assistant treasurer. The return shall be made to the collector of the district in which is located the principal office of the corporation, company, or association, where are kept its books of account and other data from which the return is prepared, or in the case of a foreign corporation, company, or association, to the collector of the district in which is located its principal place of business in the United States, or if it have no principal place of business, office, or agency in the United States, then to the collector of internal revenue at Baltimore, Maryland. All such returns shall as received be transmitted forthwith by the collector to the Commissioner of Internal Revenue; Receivers, ( c ) * n cases wherein receivers, trustees in bankruptcy, or Trustees, etc., assignees are operating the property or business of corpora- Must Make tions, joint-stock companies or associations, or insurance com- panies, subject to tax imposed by this title, such receivers, trustees, or assignees shall make returns of net income as and for such corporations, joint-stock companies or associations, and insurance companies, in the same manner and form as such organizations are hereinbefore required to make returns, and any income tax due on the basis of such returns made by re- ceivers, trustees, or assignees shall be assessed and collected 152 APPENDIX A Basis of Keeping Accounts Withholding Tax Interest in the same manner as if assessed directly against the organi- zations of whose businesses or properties they have custody and control; (d) A corporation, joint-stock company or association, or insurance company, keeping accounts upon any. basis other than that of actual receipts and disbursements, unless such other basis does not clearly reflect its income, may, subject to regu- lations made by the Commissioner of Internal Revenue, with the approval of the Secretary of the Treasury, make its return upon the basis upon which its accounts are kept, in which case the tax shall be computed upon its income as so returned; (e) All the provisions of this title relating to the tax author- ized and required to be deducted and withheld and paid to the officer of the United States Government authorized to receive the same from the income of nonresident alien indi- viduals from sources within the United States shall be made applicable to incomes derived from interest upon bonds and mortgages or deeds of trust or similar obligations of domestic or other resident corporations, joint-stock companies or asso- Nonresident ciations, and insurance companies by nonresident alien firms, Organizations copartnerships, companies, corporations, joint-stock companies or associations, and insurance companies not engaged in busi- ness or trade within the United States and not having any office or place of business therein ; Dividends (0 Likewise, all the provisions of this title relating to the tax authorized and required to be deducted and withheld and paid to the officer of the United States Government authorized to receive the same from the income of nonresident alien in- dividuals from sources within the United States shall be made applicable to income derived from dividends upon the capital stock or from the net earnings of domestic or other resident corporations, joint-stock companies or associations, and insur- Nonresident ance companies by nonresident alien companies, corporations, Organizations j oint-stock companies or associations, and insurance companies not engaged in business or trade within the United States and not having any office or place of business therein. ASSESSMENT AND ADMINISTRATION. Assessments SEC. 14. (a) All assessments shall be made and the several corporations, joint-stock companies or associations, and insur- ance companies shall be notified of the amount for which they are respectively liable on or before the first day of June of each successive year, and said assessment shall be paid on or FEDERAL INCOME TAX LAW 153 Payment of Tax When Due Penalty Delayed Payment Returns Constitute Public Records Conditions Inspection before the fifteenth day of June; Provided, That every corpora- tion, joint-stock company or association, and insurance company, computing taxes upon the income of the fiscal year which it may designate in the manner hereinbefore provided, shall pay the taxes due under its assessment within one hundred and five days after the date upon which it is required to file its list or return of income for assessment; except in cases of refusal or neglect to make such return, and in cases of erroneous, false, or fraudulent returns, in which cases the Commissioner of Internal Revenue shall, upon the discovery thereof, at any time within three years after said return is due, make a return upon information obtained as provided for in this title or by existing law; and the assessment made by the Commissioner of Internal Revenue thereon shall be paid by such corporation, joint-stock company or association, or insurance company immediately upon notification of the amount of such assessment; and to any sum or sums due and unpaid after the fifteenth day of June in any year, or after one hundred and five days from the date on which the return of income is required to be made by the taxpayer, and after ten days' notice and demand thereof by the collector, there shall be added the sum of five per centum on the amount of tax unpaid and interest at the rate of one per centum per month upon said tax from the time the same becomes due; Provided, That upon the examination of any return of income made pur- suant to this title, the Act of August fifth, nineteen hundred and nine, entitled, "An Act to provide revenue, equalize duties and encourage the industries of the United States, and for other purposes," and the Act of October third, nineteen hundred and thirteen, entitled, " An Act to reduce tariff duties and to provide revenue for the Government, and for other purposes," if it shall appear that amounts of tax have been paid in excess of those properly due, the taxpayer shall be permitted to present a claim for refund thereof notwithstanding the provisions of section thirty-two hundred and twenty-eight of the Revised Statutes; (b) When the assessment shall be made, as provided in this title, the returns, together with any corrections thereof which may have been made by the commissioner, shall be filed in the office of the Commissioner of Internal Revenue and shall con- stitute public records and be open to inspection as such; Pro- O f vidcd, That any and all such returns shall be open to inspection only upon the order of the President, under rules and regula- tions to be prescribed by the Secretary of the Treasury and approved by the President; Provided further, That the proper officers of any State imposing a general income tax may, upon 154 APPENDIX A False Return the request of the governor thereof, have access to said returns or to an abstract thereof, showing the name and income of each such corporation, joint-stock company or association, or insur- ance company, at such times and in such manner as the Secre- tary of the Treasury may prescribe; Penalty ( c ) If an y of the corporations, joint-stock companies or asso- Refusal to ciations, or insurance companies aforesaid shall refuse or neglect to make a return at the time or times hereinbefore specified in each year, or shall render a false or fraudulent return, such corporation, joint-stock company or association, or insurance company shall be liable to a penalty of not exceeding $10,000; Provided, That the Commissioner of Internal Revenue shall have authority, in the case of either corporations or individuals, to grant a reasonable extension of time in meritorious cases, as he may deem proper. (d) That section thirty-two hundred and twenty-five of the Revised Statutes of the United States be, and the same is hereby, amended so as to read as follows : Second " SEC. 3225. When a second assessment is made in case of any Assessment list, statement, or return, which in the opinion of the collector or deputy collector was false or fraudulent, or contained any understatement or undervaluation, no tax collected under such assessment shall be recovered by any suit unless it is proved that the said list, statement, or return was not false nor fraudulent and did not contain any understatement or undervaluation; but this section shall not apply to statements or returns made or to be made in good faith under the laws of the United States, regarding annual depreciation of oil or gas wells and mines." "State" "United States" Defined Disclosing Information Prohibited PART III. GENERAL ADMINISTRATIVE PROVISIONS. SEC. 15. That the word "State" or "United States" when used in this title shall be construed to include any Territory, the District of Columbia, Porto Rico, and the Philippine Islands, when such construction is necessary to carry out its provisions. SEC. 16. That sections thirty-one hundred and sixty-seven, thirty-one hundred and seventy-two, thirty-one hundred and seventy-three, and thirty-one hundred and seventy-six of the Revised Statutes of the United States as amended are hereby amended so as to read as follows: " SEC. 3167. It shall be unlawful for any collector, deputy col- lector, agent, clerk, or other officer or employee of the United States to divulge or to make known in any manner whatever FEDERAL INCOME TAX LAW 155 not provided by law to any person the operations, style of work, or apparatus of any manufacturer or producer visited by him in the discharge of his official duties, or the amount or source of income, profits, losses, expenditures, or any particular thereof, set forth or disclosed in any income return, or to permit any income return or copy thereof or any book containing any abstract or particulars thereof to be seen or examined by any person except as provided by law ; and it shall be unlawful for any person to print or publish in any manner whatever not pro- vided by law any income return or any part thereof or source of income, profits, losses, or expenditures appearing in any in- come return; and any offense against the foregoing provision shall be a misdemeanor and be punished by a fine not exceeding $1,000 or by imprisonment not exceeding one year, or both, at the discretion of the court; and if the offender be an officer or employee of the United States he shall be dismissed from office or discharged from employment. "SEC. 3172. Every. collector shall, from time to time, cause his deputies to proceed through every part of his district and inquire . after and concerning all persons therein who are liable to pay any internal-revenue tax, and all persons owning or having the care and management of any objects liable to pay any tax, and to make a list of such persons and enumerate said objects. Provisions of "SEC. 3173. It shall be the duty of any person, partnership, Administra- firm, association, or corporation, made liable to any duty, special tax, or other tax imposed by law, when not otherwise provided for, (1) in case of a special tax, on or before the thirty-first day of July in each year, (2) in case of income tax on or before the first day of March in each year, or on or before the last day of the sixty-day period next following the closing date of the fiscal year for which it makes a return of its income, and (3) in other cases before the day on which the taxes accrue, to , make a list or return, verified by oath, to the collector or a deputy collector of the district where located, of the articles or objects, including the amount of annual income charged with a duty or tax, the quantity of goods, wares, and merchandise, made or sold and charged with a tax, the several rates and aggregate amount, according to the forms and regulations to be prescribed by the Commissioner of Internal Revenue, with the approval of the Secretary of the Treasury, for which such person, partnership, firm, association, or corporation is liable: Provided, That if any person liable to pay any duty or tax, or owning, possessing, or having the care or management of prop- erty, goods, wares, and merchandise, article or objects liable 156 APPENDIX A to pay any duty, tax, or license, shall fail to make and exhibit a list or return required by law, but shall consent to disclose the particulars of any and all the property, goods, wares, and merchandise, articles, and objects liable to pay any duty or tax, or any business or occupation liable to pay any tax as aforesaid, then, and in that case, it shall be the duty of the collector or deputy collector to make such list or return, which, being distinctly read, consented to, and signed and verified by oath by the person so owning, possessing, or having the care and management as aforesaid, may be received as the list of such person : Provided further, That in case no annual list or return has been rendered by such person to the collector or deputy collector as required by law, and the person shall be absent from his or her residence or place of business at the time the collector or a deputy collector shall call for the annual list or return, it shall be the duty of such collector or deputy col- lector to leave at such place of residence or business, with some one of suitable age and discretion, if such be present, other- wise to deposit in the nearest post office, a note or memorandum addressed to such person, requiring him or her to render to such collector or deputy collector the list or return required by law within ten days from the date of such note or memor- andum, verified by oath. And if any person, on being notified or required as aforesaid, shall refuse or neglect to render such list or return within the time required as aforesaid, or when- ever any person who is required to deliver a monthly or other return of objects subject to tax fails to do so at the time required, or delivers any return which, in the opinion of the collector, is erroneous, false, or fraudulent, or contains any undervaluation or understatement, or refuses to allow any regularly authorized Government officer to examine the books of such person, firm, or corporation, it shall be lawful for the collector to summon such person, or any other person having possession, custody, or care of books of account containing entries relating to the business of such person, or any other person he may deem proper, to appear before him and produce such books at a time and place named in the summons, and to give testimony or answer interrogatories, under oath, re- specting any objects or income liable to tax or the returns thereof. The collector may summon any person residing or found within the State or Territory in which his district lies; and when the person intended to be summoned does not reside and can not be found within such State or Territory, he may enter any collection district where such person may be found FEDERAL INCOME TAX LAW 157 and there make the examination herein authorized. And to this end he may there exercise all the authority which he might lawfully exercise in the district for which he was commissioned ; Provided, That ' person,' as used in this section, shall be con- strued to include any corporation, joint-stock company or asso- ciation, or insurance company when such construction is neces- sary to carry out its provisions. " SEC. 3176. If any person, corporation, company, or associa- jollector tion fails to make and file a return or list at the time prescribed ay Prepare b v j aw> or ma kes, willfully or otherwise, a false or fraudulent return or list, the collector or deputy collector shall make the return or list from his own knowledge and from such informa- tion as he can obtain through testimony or otherwise. Any return or list so made and subscribed by a collector or deputy collector shall be prima facie good and sufficient for all legal purposes. eturn ^ aueer, Lenawee, Livingston, M'acomb, Midland, Monroe, Mtontmorency, Oakland, Ogemaw, Oscoda, Otsego, Presque Isle, Roscomonon, Sag- inaw, Sanilac, Shiawassee, St. Clair, Tuscola, Washtenaw, and Wayne. JAMES J. BRADY, Detroit. Fourth District. Counties of Alger, Allegan, Antrim, Baraga, Barry, Benzie, Berrien, Cass, Charlevoix, Chippewa, Delta, Dickinson, Eaton, Emmet, Gogebic, Grand Traverse, Houghton, Ionia, Iron, Kalamazoo, Kalkaska, Kent, Keweenaw, Lake, Leelanau, Luce, Mack- inac, M,aniste,e Marquette, Mason, Mecosta, Menommee, Mis- saukee, Montcalm, M'trskegon, Newaygo, Oceans, Ontonagon. Osceola, Ottawa, St. Joseph, Schoolcraft, Van Buren, and Wexford. EMANUEL J. DOYLE, Grand Rapids. MINNESOTA. EDWARD J. LYNCH, St. Paul. MISSISSIPPI (See Alabama). The State of Mississippi detached from the District of Louisiana and added to the District of Alabama June 1, 1908. 174 APPENDIX C MISSOUBI, First District. The counties of Adair, Audrian, Bellinger, Boon*, Butler, Callaway, Oape Girardeau, Carter, Clark, Crawford, Deat Dunklm, Franklin, Gasconade, Howard, Iron, Jefferson, Knox] Lewis, Lincoln, Linn, Macon, Madison, Maries, Marion, Mississippi, Montgomery, Monroe, New Madrid, Oregon, Osage, Pemiscot, Perry, Phelps, Pike, Pulaski, Rails. Randolph, Reynolds, Ripley, St. Charles, St. Francois, Ste. Genevieve, St. Louis, Schuyler, Scot- land, Scott, Shannon, Shelby, Stoddard, Warren, Washington, and GEORGE H. M'OORE, St. Louis. Sixth District. The counties of Andrew, Atchison, Barry, Barton, Bates, Benton, Buchanan, Caldwell, Camden, Carroll, Cass Cedar Chanton, Christian, Clay, Clinton, Cole, Cooper, Dade Dallas, Daviess, Dekalb, Douglas, Gentry, Greene, Grundy. Harrison, Henry, Hickory, Holt, Howell, Jackson, Jasper, Johnson, Laclede, Lafayette, Lawrence, Livingston, McDonald, M'ercer, Miller, Moni- teau, Morgan, Newton, Nodaway, Ozark, Pettis, Platte, Polk, Putnam, Ray, St. Olair, Saline, Stone, Sullivan, Taney, Texas, Vernon, Webster, Worth, and Wright. EDGAR M. HARBER, Kansas City c - WHALEY ' Hciena - NEVADA (See First California). NEW HAMPSHIRE (Includes Maine and Vermont), SETH W. JONES, Portsmouth. NEW JERSEY, First District. The counties of Atlantic, Burlington, Cainden, Cape May, Cumberland, Gloucester, Mercer, Monmouth, Ocean, and Salem. SAMUEL IREDELL, Camden. Fifth District. The counties of Bergen, Essex, Hudson, Hunterdon, Middlesex, Morris, Passaie, Somerset, Sussex, Union, and Warren. CHARLES V. DUFFY, Newark. NEW MEXICO (Includes Arizona), LEWIS T. CARPENTER. Phoenix, Arizona. NEW YORK, First District. The counties of Kings, Nassau, Queens. Richmond, and Suffolk. . HENRY P. KEITH, Brooklyn. Second District. The first, second, third, fourth, fifth, sixth, eighth, ninth, and fifteenth wards of New York City; that portion of the fourteenth ward lying west of the center of Mott street; that portion of the sixteenth ward lying south of the center of West Twenty-fourth Street, and Governors Island. JOHN Z. LOWE, Jr., Custom House, New York. Third District. The seventh, tenth, eleventh, twelfth, thirteenth, seventeenth, eighteenth, nineteenth, twentieth, twenty-first, and twenty-second wards of New York City; that part of the four- teenth ward lying east of the center of Mott Street; that part of the sixteenth ward lying north of the center of West Twenty- fourth Street, and Blackwells, Randalls, and Wards Islands. MARK EISNER, 1150 Broadway, New York. Fourteenth District. The counties of Albany, Clinton, Columbia, Dutchess, Essex, Fulton, Greene. Hamilton. Montgomery. Orange, Putnam, Rensselaer, Rockland, Saratoga, Schenectady, Schoharie, Sullivan, Ulster, Warren, Washington, and Westchester, and the twenty- third and twenty-fourth wards of New York City. ROSCOE IRWIN, Albany. Twenty-first District. The counties of Brooine, Cayuga, Chenango, Cortland, Delaware, Franklin, Herkimer, Jefferson, Lewis, Madison, Oneida. Onondaga, Oswego, Otsego, St. Lawrence, Schuyler, Seneca, Tioga, Tompkins, and Wayne. NEIL BREWSTER, Syracuse. Twenty-eighth District. The counties of Allegany. Cattaraugus, Chaii- taqua, Chemung, Erie, Genessee, Livingston, Monroe, Niagara, On- tario, Orleans, Steuben, Wyoming, and Yates. VINCENT H. RIORDAN, Buffalo. COLLECTION DISTRICTS 175 NORTH CAROLINA, Fourth District. The counties of Alamance, Beaufort, Bertie, Bladcn, Brunswick, Camden, Carteret, Caswell, Chatham, Chowan, Columbus, Craven, Cumberland, Currituck, Dare, Duplin, Durham, Edgecombe, Franklin, Gates, Granville, Greene, Halifax, Harnett, Hertford, Hyde, Johnston, Jones, Lenoir, Martin, Montgomery, M)oore, Nash, New Hanover, Northampton, Onslow, Orange, Pamlico, Pasquotank, Pender, Perquimans, Person, Pitt, Richmond, Robeson, Samson, Scotland, Tyrrell, Vance, Wake, Warren, Washington, Wayne, and Wilson. JOSIAH W. BAILEY, Raleigh. Fifth District. The counties of Alexander, Allegany, Anson, Ashe, Buncombe, Burke, Cabarrus, Caldwell, Catawba, Cherokee, Clay, Davidson, Davie, Forsyth, Gaston, Graham, Guilford, Haywood, Henderson, Iredell, Jackson, Lincoln, McDowell, Macon, Madison, Mecklenburg, Mitchell, Polk, Randolph, Rockingham, Rowan, Rutherford, Stanly, Stokes, Surry, Swain, Transylvania, Union, Watauga, Wilkes, Yadkin, and Yancey. ALSTON D. WATTS, Statesville. NORTH AND SOUTH DAKOTA, JAMES COFFEY, Aberdeen, S. Dak. OHIO, First District. The counties of Brown, Butler, Clarke, Olermont, Clinton, Fayette, Greene, Hamilton, Highland, Miami, Montgomery, Preble, and Warren. ANDREW 0. GILLIGAN, Cincinnati. Tenth District. The counties of Allen, Auglaize, Champaign, Craw- ford, Darke, Defiance, Erie, Fulton, Hancock, Hardin, Henry, Huron, Logan, Lucas, M'ercer, Ottawa, Paulding, Putnam, San- dusky, Seneca', Shelby, Van Wert, Williams, Wood, and Wyandot. FRANK B. NILES, Toledo. Eleventh District. The counties of Adams, Athens, Coshocton, Dela- ware, Fairfield, Franklin, Gallia, Guernsey, Hocking, Jackson, Knox, Lawrence, Licking, Madison, Marion, M'eigs, Morgan, Mor- row, Muskingum, Noble, Perry, Pickaway, Pike, Ross, Scito, Union, Vinton, and Washington. BERIAHE. WILLIAMSON, Columbus. Eighteenth District. The counties of Ashland, Ashtabula, Belmont, Carroll, Columbiana, Cuyahoga, Geauga, Harrison, Holmes, Jefferson, Lake, Larain, Mahoning, Medina, Monroe, Portage, Richland, Stark, Summit, Trumbull, Tuscarawas, and Wayne. HARRY H. WEISS, Cleveland. OKLAHOMA, HUBERT L. BOLEN, Oklahoma City. OREGON, MILTON A. MILLER, Portland. PENNSYLVANIA, First District The counties of Berks, Bucks, Chester, Delaware, Le- high, Montgomery, Philadelphia, and Schuylkill. EPHRAIM LEDERER, Philadelphia. Ninth District. The counties of Adams, Bedford, Blair, Cumberland, Dauphin, Franklin, Fulton, Huntington, Juniata, Lancaster, Leba- non, Mifflin, Perry, Snyder, York. BENJAMIN F. DAVIS, Lancaster. Twelfth District. Bradford, Carbon, Center, Clinton, Columbia, Lack- awanna, Luzerne, Lycoming. Monroe, Montour, Northampton, Northumberland, Pike. Potter, Sullivan, Susqnehanna. Tioga, Union. Wayne, Wyoming. (Twelfth District reestablished May 1, 1915.) FRED. C. KIRKENDALL, Scranton. Twenty-third District. The counties of Allegheny, Armstrong, Beaver, Butler, Cambria, Cameron, Clarion, Clearfield, Crawford, Elk, Erie, Fayette, Forest, Greene, Indiana, Jefferson, Lawrence, McKean, Mercer, Somerset, Venango, Warren, Washington and Westmore- land. 0. GREGG LEWELLYN, Pittsburgh. RHODE ISLAND (See Connecticut). POTTTH CAFOUNA, DUNCAN C. HEYWARD, Columbia. ROTTTH DAKOTA (See North and South Dakota). TF.NNESSEE. EDWARD B CRAIG, Nashville. TEXAS, ALEXANDER S. WALKER, Austin. TTTAH (See Montana). VERMONT (See New Hampshire). 176 APPENDIX C VIRGINIA Second District. The counties of Amelia, Appomattox, Brunswick, Buckingham, Caroline, Charles City, Chesterfield, Cumberland, Dinwiddie, Elizabeth City, Essex, Fluvanna, Gloucester, Goochland, umberland, Nottaway, Powhatan, Prince Edward, Prince George, Princess Anne, Richmond, Stafford, Southampton, Spottsylvania, Surry, Sussex, Warwick, Westmoreland, and York. RICHARD C. L. MONCURE, Richmond. Sixth District. The counties of Albemarle, Alexandria, Alleghany, Amherst, Augusta, Bath, Bedford, Bland, Botetourt, Buchanan, Campbell, Carroll, Charlotte, Clarke, Craig, Culpeper, Dickenson, Fairfax, Fauquier, Floyd, Franklin, Frederick, Giles, Grayson, Greene, Halifax, Henry, Highland, Lee, Loudoun, M'adison, Meck- lenburg, Montgomery, Nelson, Orange, Page, Patrick, Pittsylvania, Prince William, Pulaski, Rappahannock, Roanoke, Rockbridge, Rockingham, Russell, Scott, Shenandoah, Smyth, Tazewell, Warren, Washington, Wise, and Wythe. JOHN M. HART, Roanoke. The counties of Accomac and Northampton are in the District of Maryland. WASHINGTON (Includes Alaska), DAVID J. WILLIAMS, Tacoma. WEST VIRGINIA, SAMUEL A. HAYS, Parkersburg. WISCONSIN, First District. Counties of Brown, Calumet, Dodge, Door, Florence, Fond du Lac, Forest, Green Lake, Kenosha, Kewaunee, Manitowoc, Marinette, M'arquette, Milwaukee, Oconto, Outagamie, Ozaukee, Racine, Shawano, Shebpygan, Walworth, Washington, Waukesha, Waupaca, Waushara, Winnebago, and county of Langlade with ex- ception of the eight townships of said county which were formerly in Lincoln County. PAUL A. HEMMY, Milwaukee. Second District. Counties of Adams, Ashland, Barron, Bayfield, Buf- falo, Burnett, Chippewa, Clark, Columbia, Crawford, Dane, Doug- las, Dunn, Eau Claire, Grant, Green, Iowa, Iron, Jackson, Jeffer- son, Juneau, La Crosse, Lafayette, Lincoln, Marathon, Monroe, Oneida, Pepin, Pierce, Polk, Portage, Price, Richland, Rock, Rusk, St. Croix, Sauk, Sawyer, Taylor, Trempealeau, Vernon, Vilas, Washburn, Wood, and the eight townships in the western part of Langlade County which were formerly in Lincoln County. BURT WILLIAMS, Madison. WYOMING (See Colorado). INDEX Page Abatement ; claim for 15 Absence; extension of time because of: Corporation 48, 157 Individual 13, 137 Absence abroad does not absolve from making return... Accident insurance Accident ; reimbursement of expenses of Account : Page Advertising 101 Allowance 89 Auditing expense-. 101 Auto expense 101 Bad debts 103 Commissions 99 Depletion 106 Depreciation 106 Discounts allowed 90 Discounts received 90 Dividends paid 110 Dividends received ... 97 Duties 102 Fire loss 105 Freight on purchases. 91 Freight on sales 91,101 Fuel, light, power, etc. 99 General factory ex- pense 101 General office expense 101 Income from sundry sources 98 Insurance 101 Interest paid 93 Interest received 93 Inventory 91 Labor, wages and commissions 98 Legal expense 101 Light, heat and power 99 12 18 18 Merchandise 109 Negative (note) 70 Packing supplies 101 Perpetual (running) inventory Ill Postage 101 Productive wages 99 Production supplies . . 101 Profit and loss 109 Purchases 90 Rebates 90 Rentals paid 92 Rentals received 92 Repair 99 Return sales 89 Royalties 92 Salaries of officers... 100 Sales (merchandise) . 89 Sales of capital assets 105 Shipping supplies 101 Stable expense 101 Stationery and print- ing 101 Surplus 110 Taxes paid 107 Taxes withheld 107,108 Telegraph and tele- phone 101 Traveling expense 101 178 INDEX Page Account; books of: Best guide to income 87 Corporation's 53 Examination of, by Internal Revenue Officers 14, 87 Individual's 119 Reconciliation of, with return 110 Accounts : Accrual of 88 Basis of keeping, corporations 86 Basis of keeping, individuals 119 Distribution of 88 Prepayment of 88 What justifies charging off 104 Worthless (see "Debts, bad"). Accounts receivable 103 Accrual basis of bookkeeping 88, 112 Accruals : treatment of accruals in return 88 Accrued interest on bonds purchased 29 Accumulation of surplus 132 Act of 1916, Income Tax Law (Sept 8, 1916) 129 Act of 1916, Federal Corporation Capital Stock Tax Law (Sept. 8, 1916) 161 Actors and actresses; depreciation of costumes of 82 " Actually paid " or " paid during the year " 88 Additional tax : Computation, illustration of 127 Dividends included in computing 10, 130 Rates of 10, 129 Undistributed profits subject to 131 Undistributed surplus subject to 16, 130 Additions and betterments (see "Improvements"). Administration of estates, income during 20 Administration of Income Tax Law; provisions of 155 Administrators (see "Fiduciaries"). Agent : Collecting agent of foreign income 32 Insurance agent, commissions of . 21 Liability of, making return 12 Power of attorney, agent under 12 Real estate agent, commissions of 29 Real estate agent, not fiduciary. , . 16 Real estate agent, withholding by 36 Return may be made by 12, 137, 141 INDEX 179 Page Agricultural corporations, exempt 53 Aliens, resident and non-resident 15 Alimony, not deductible 29 Allowance account (deduction from sales) 89 Allowance for depreciation 71 Amended law 9 Amended return 51 Amended statute (Sept. 8, 1916) 129 Amortization of bonds 71 Amortization of discounts on bonds 64 Anderson vs. Forty-two Broadway Co 64 Annual return (see "Returns"). Annuities 17 Appeal, right of : 159 Appendix A, Federal Income Tax Law (Sept. 8, 1916) . . 129 Appendix B, Federal Corporation Capital Stock Tax Law (Sept. 8, 1916,) and regulations 161 .Appendix C, list of collection districts and collectors of United States 172 Apportionment of income of 1916 of designated fiscal year of corporations 50 Appreciation in value of good will 81 Appreciation in value of assets not income 53, 82 Assessments : Capital stock, assessment of, not income 60 Capital stock, assessment of, not deductible by indivi- duals 29 General assessment 142 Local benefits, assessment of 25 Notice of assessment, corporations 47 Notice of assessment, individual 14 Second assessment 50 Assets ; deferred 88 Assets ; computing profit on sales of 22 Assets ; income on sales of 58 Associations ; income of mutual 58 Attorney's fees, when returnable 20 Auto trucks, depreciation of 80 Auxiliaries, depreciation of 78 Bad debts account 103 Bad debts (see "Debts, Bad"). Baldwin Locomotive Works vs. McCoach 82 180 INDEX Bank: Page Depreciation of securities of 82 Interest on deposits in 36 Banking department ; order by State or Federal 82 Bankruptcy of debtor 104 Batteries, depreciation of storage 78 Bequests and gifts, exempt 21, 132 Beneficiaries : Heirs and legatees, income of 12 Income received by 12, 122, 131 Proceeds of accident policy paid to 18 Proceeds of life insurance paid to 132 Return by 12, 20 Undistributed income returnable by fiduciary 11 Betterments (see "Improvements"). Boards of trade, exempt 54 Boilers and engines, depreciation of 76 Bonded indebtedness 94 Bonds : Accrued interest on bonds purchased 29 Amortization of bonds 71 Charging off depreciation on bonds 82 Debenture bonds 95 Income on Government bonds (exempt) 19, 93 Interest on bonds 64 Premium on fidelity bond paid by employee 29 Premium on bonds purchased 65 Redemption of bonds 63 Tax-free covenants in bonds 32 Withholding tax from interest on bonds 31 Bonuses : Subject to withholding of tax 36 Taxable as income of recipient 20 When deductible 66, 100 Book value: Decrease in book value not deductible 82 Increase in book value not income 53, 82 Books of account (see "Accounts, Books of"). Bookkeeping methods : Corporations' 86 Cost-system 90, 110 Individuals' 119 Branches ; foreign 51 INDEX 181 Page Brands : Depreciation of brands 82 Loss on sale of brands 83 Buildings : Buildings erected by tenant 74 Depreciation on buildings, generally. . . 72 Depreciation on dwellings 74 Depreciation on factory buildings 73 Depreciation on farm buildings 75 Determining cost of buildings for depreciation purposes. 72 Dilapidated buildings removed by authority of Govern- ment 28 Improvements and betterments 28 Repairs to buildings 73 Voluntary removal of buildings 28 Business : Individuals having more than one business 26 Losses in business 26 Place of business, filing returns at 13, 46 Cables and wires, depreciation of 78 Calendar year : Corporation return for 46, 143 Individual tax based on 10, 130 Campaign expenses 29 Capital employed in the business, defined Capital employed in business; interest deductible based on. 93 Capital returned to stockholders Capital assets: Appreciation in value of 53, 82 Depreciation of 68 Increase or decrease in book value of 82 Losses on 61, 105 Profits on 22, 23, 58, 105 Sales of 105 Valuation of 23 Capital Stock: Assessment of capital stock not income 60 Capital stock outstanding at close of year 108 Depreciation of stock 82 Dividends on stock (see "Dividends"). Exchange of property for stock Exchange of shares 19 182 INDEX Page Capital Stock: Sale of " rights " to subscribe 19 Sales of stock at premium 60 Stock having no par value 94 Capital Stock Tax Law (Sept. 8, 1916) 161 Capital Stock Tax Law Regulations 163 Cash value of dividends : Dividends declared payable in securities 18 Stock dividends 19 Cemetery companies, exempt 54 Certificates : Claims for deductions 35 Claims for exemption 34, 103, 140 Scrip 33 Charitable organizations, exempt 54 Christmas gifts 101 Citizen residing abroad must make return 12 Civic league or association, exempt 54 Claims : Abatement of assessment 15 Exemption, false representation in claim 34 Excess amounts paid to Government 15 Excess amounts withheld 35, 140, 141 Refund of taxes 15 Specific exemptions 24 Statute of limitation 15 Clergymen ; income of 21 Cleveland, F. A 97 " Close corporations " not exempt 56 Clubs organized for pleasure and recreation, exempt Cohen, Hyman, vs. John Z. Lowe, Jr., Collector 72 Collateral ; interest on debts secured by 64 Collecting agents of foreign income Collection districts ; list of 172 Collection of tax; due date and penalty for delayed payments : Corporations '47, 48 Individuals 14 Collectors of Internal Revenue: List of collectors in United States 172 Returns made by collectors for corporations 46 Returns made by collectors for individuals 13 INDEX 183 Page Commercial paper of corporations ; interest on 33 Commission account 99 Commissions : Executors' 121 Insurance agents' 21 Labor, wages and commissions 98 Real estate agents' 29 Salesmen's 36 When returnable 121 Compensation of trustee 21 Compromise of penalty for failure to make return 13 Conservators (see "Fiduciaries"). Contingent reserves 63 Contracting corporations ; gross income of 57 Co-operative associations (exempt) 54 Co-partnerships (see " Partnerships "). Copyrights ; depreciation of 80 Corporate obligations : Exempt organizations subject to withholding of tax 55 Interest on bonds, mortgages and deeds of trust 31 Limitation of interest deductible 93 Ordinary commercial paper 33 Tax-free covenant 32 Corporations : Additions and betterments 73 Apportionment of income for 1916 50 Assessment of capital stock 60 Bonds issued at discount 64 Books of account 53 Close corporations 56 Cost-system 110 Deductions (see "Deductions in Returns of Corpora- tions")- Dividends received 58 Doubtful as to exemption 56 Exempt organizations 53 Exempt organizations includes foreign of the same classes 56 Foreign income of domestic corporations 46 Foreign branches 51 Gross income of manufacturing corporations 56 Gross income of mercantile corporations 57 Gross income of miscellaneous corporations 57 184 INDEX Page Corporations : Gross income of contracting corporations 57 Gross income of insurance companies 58 Income of domestic corporations 45, 143 Income of foreign corporations 45, 148 Incompletely organized corporations 51 Interstate commerce 53 Net income , 56 Return, false or fraudulent 49 Return, holding companies 51 Return, mercantile corporations 112 Return, prepared by Collector of Internal Revenue 49 Return, refusal or neglect to prepare 49 Return, receivers and trustees 52 Return, specific exemption 46 Return, subsidiary companies 52 Return, when due, where, etc 46, 47, 51, 52, 53, 112 Return, withheld taxes 103 Corporations ; foreign : Deductions allowed 66, 148, 149, 150 Income 45, 148 Where to file return 46 Corporations; non-resident alien: Exemption of withholding tax from income 37 Cost-system : Manufacturing corporation operating 110 " Purchases " according to 90 Reliability of 91 Costumes of actors and actresses, depreciation 82 Cost of manufactures Ill Cost of property acquired prior to March 1, 1913: Corporations 59, 105 Individuals 23 Coupon interest 31, 141 Courts ; jurisdiction of 159 Craven, George M 76, 78 Crop shares ; farmers 39 Customs duties 102 Damages received for injuries sustained 18 Damage suits, test of deductibility of payments of 28 Debenture bonds ; interest on 95 INDEX 185 Page Debts, bad: Bankruptcy * 104 Corporations 62 Deductible 103 Individual 27, 125, 133 Reserve 62 Deceased persons ; income to time of death of Deductions in return of domestic corporations: Allowable .61, 146 Amortization of bonds 64 Bad debts 62 Defalcation, embezzlement 66 Depletion 62, 146 Depreciation 61, 68, 146 Expenses, necessary 61, 146 Improvements (not deductible) 146 Income tax paid 66 Interest 63, 64, 93 Losses 61, 146 Organization expense 65 Premium on bonds 65 Salesmen's expenses 66 Taxes 148 Tax withheld from interest, coupons, etc 31,141 Tax withheld on income in excess of $3,000 per an- num 33, 137, 139 Deductions in returns of foreign corporations : Depreciation 66, 68 Depletion 67 Interest 67 Losses 66 Necessary expenses 66 Improvements (not allowed) 67 Restoring property 67 Taxes 67 Deductions in returns of individuals: Accrual basis of bookkeeping 124 Bad debts 27, 125, 133 Depletion 27, 28, 133 Depreciation 68, 133 Dividends 9, 18, 134 Exemptions (see "Exemptions"). Improvements (not deductible) 25, 28, 134 186 INDEX Page Deductions in returns of individuals: Income tax, paid , 25 Interest 124, 133 Living expenses (not deductible) 25 Losses 124, 133 Necessary expenses 25, 124, 133 Non-resident alien ; deductions of 29, 134, 135 Normal tax withheld 31, 33, 134 Only items applicable to the year deductible 21 Prorating compensation of trustees 21 Tax withheld in excess 35, 140 Taxes 25, 124, 133 Deeds of trust ; interest on 31 Defalcation, when deductible 66 Deferred assets 88 Delay in filing return (see "Failure to file return"). Delayed payment of tax; penalty: Corporation 47 Individual 14 Depletion of natural deposits: Deductible by corporations 62 Deductible by individuals 27, 28, 126, 133 Deductible by non-resident alien 30 Gas and oil wells 27,75 Ledger account of depletion 106 Limitation of depletion 133 Mines 28, 75 Purpose of depletion 106 Depreciation : Account of depreciation 106 Deductible by corporation 61 Deductible by individual 27, 133 Depreciation defined 68 Diminishing value method 68 Entries of depreciation 69 Equal instalment method 68 Excess charge for depreciation is income 71 Fixing upon rates for depreciation 77 Limitation of amount chargeable 71 Methods of computing 68 INDEX 187 Page Depreciation : Property subject to depreciation Page Auto trucks 80 Auxiliaries 78 Belted generators .... 78 Boilers and engines . . 76 Brands (not deduct- ible) 82 Buildings 72 Copyrights 80 Dwellings 74 Farm buildings 75 Furniture and fixtures 74 Good will (not de- ductible) 81 Horses I 81 Inventories (not de- ductible) 83 Investments (not de- ductible) 82 Laundry equipment.. 79 Machinery 75 Miscellaneous equip- ment 78 Purpose of depreciation 77 Rates of depreciation, generally 71, 77 Repairs and replacements 76 Reserve for depreciation 69, 71 Treatment of depreciation in sales of capital assets 22 Dicksee, L. R 75, 76, 79 Disclosing information prohibited 154 Discounts allowed 90 Discounts received 90 Discounts; reserve for: Amortization of discounts on bonds , Discounts on sales of merchandise Dissolved corporations; return of capital of. Distribution of accounts. . Motors 78 Patents 79 Patterns 79 Shafting 78 Shop equipment 78 Stable equipment. ... 81 Steam piping 78 Steam turbines 78 Stocks and bonds (not deductible) 82 Stock on hand (not deductible) 83 Storage batteries 78 Switchboards 78 Theatre costumes 82 Timber lands 75 Tools 78 Trade marks (not de- ductible) 82 Wires and cables . . 78 64 63 19 88 District court, jurisdiction of 159 Diverting reserves prohibited 70 Dividends : Accounts of dividends 97, 110 Credits to partners for proportionate share of dividends. 43 188 INDEX Page Dividends : Dividends, defined 143 Distributed or undistributed 130 Declared out of profits earned prior to March 1, 1913.. 19 Declared payable in. securities 18, 58 Life insurance companies 17 Not subject to normal tax 9,18,134 Received by corporations 58, 139 Received by individuals 123, 139 Received by partnerships 43, 138 Stock dividends 19 Subject to additional tax 130 Doctors ; fees of 20 Donations (See "Gifts"). Due date: Return of corporations 46, 48 Return of individuals 13 Return, when last day falls on Sunday or legal holiday. . 47 Payment of tax by corporations 47, 48 Payment of tax by individual 13, 139 Duty ; customs 102 Duties account 102 Dwellings ; depreciation of 74 Embezzlement ; deduction of 66 Engines and boilers, depreciation of 76 Entertainment by salesmen, when deductible 66 Equipment subject to depreciation: Laundry 79 Miscellaneous 78 Shop 78 Stable 81 Estates : Exemption of estates 25, 136 Income of estates 20, 131 Excess deduction at source 35 Exchange of stock 19 Executors : Commissions 121 Dividends received through executors 122 Returns by executors 11, 137 INDEX 189 Page Exempt corporations and organizations : Classes 53 Doubtful as to exemption 56 Foreign 56 Must withhold at source 55 Exemptions; specific: Claims for 34, 140 Certificate of 34, 103, 140 Corporation (none allowed) 46 Estate 25, 136 False representations in claim 34, 140 Individual (personal) 9, 24, 136 Non-resident, alien 24, 136 Prorating exemption between husband and wife 11 Ward, cesui que trust 25, 136 Expense accounts ; sundry 101 Extension of time: Corporation 48 Individual 13, 137 Failure to file return ; penalties, etc. : Compromises 13 Corporations' 48 Individuals' 13 Failure to pay tax ; penalties, etc. : Corporation 47 Individual 14 False returns; penalties, etc.: Corporations 49 Individuals 14 Family ; head of, exemption 24 Family ; head of, defined 24 Farm: Books of account 41 Buildings 75 Deductions allowed farmer 39 Depreciation of farm property 40 Income 39 Maintained for recreation only 41 Federal Corporation Capital Stock Tax Law and Regula- tions 161, 163 Federal Farm Loan ; interest on, exempt 19, 132 190 INDEX Page Federal Income Tax Law (Sept. 8, 1916) 129 Federal Trade Commission 68, 84 Fees, of lawyers, doctors, etc. ; when returnable 20 Fidelity bond ; premium on 29 Fiduciaries : Agents are not fiduciaries 12 Compensation of 121 Dividends received through 122 Income from , 122 Indemnity to 131 More than one fiduciary 11 Return by 11, 137 Final returns (see "Tentative Returns"). Fire loss ; treatment of account of 105 Fiscal year of corporation: How to adopt fiscal year 47 When return is due under fiscal year 46 Foreign corporations (see "Corporations, Foreign"). Foreign income: Tax withheld from foreign income 31, 142 Foreigners (see "Aliens"). Forms : Application for deduction of tax withheld in excess (1008, Revised, and 1088) 35 Exemption of withholding from income of non-resident alien corporations (1086) 37 Return of corporations (1031, Revised) 46 Return of fiduciaries (1041, Revised) 11 Return of individuals (1040, Revised) 10 Return of insurance companies (1030, Revised) 46 Return of taxes withheld (1042, Revised) 34, 37 Freight on purchase 91 Freight on sales 91, 101 Fuel, light and power 99 Fund ; reserve 70 " Fundamentals of a cost-system for manufacturers " 68 Furniture and fixtures 70, 74 Gas wells: Depletion of 27, 75 Royalties : 123 Generators ; depreciation on belted generators 78 INDEX 191 Page Gifts : Bonuses 66 Christmas gifts 101 Exempt 132 Gratuities, test of deductibility 101 Income from gifts 21 Good will : Depreciation 81 Treatment of account 81 Government bonds ; income from Government obligations not taxable 19 Gratuities (see "Gifts"). Gross income: All sources 57 Business, trade, com'merce 122 Contracting corporations 57 Insurance companies 58 Manufacturing corporations 56, 90 Mercantile corporations 57 Merchant 120 Miscellaneous corporations 57 Guardians : Deduction of exemption of ward or cestui que trust 25 Return by guardians II Head of family, exemption 24 Heat, light and power account 99 Heirs and legatees ; income returnable 12 Holding companies ; returns of 51 Holiday ; when due date falls on 47 Horses ; depreciation of 81 Horticultural organizations (exempt) 53 Household expenses ; not deductible 29 How to adopt fiscal year of corporation 47, 4S Husband and wife : Exemption of, may be prorated 11 Returns by 11, 120 Separate income, computing additional tax 11 Specific exemption 11 Illustration ; computing normal and additional tax 127 Impairment of capital account 109 192 INDEX Page Improvements : Betterments 25, 28, 73 Leased property 73 Local benefits 65 Not deductible 134 Repairs 73 Income : Apportionment of income for 1916 in case of designated fiscal year of corporation 50 Appreciation in value not income 53 Attorney's fees 20 Beneficiaries 131 Qergymen 21 Commissions of insurance agents 21 Corporations, domestic 45, 143 Corporations, foreign 45, 148 Deduction from (see "Deductions"). Estates 20, 131 Exempt from tax 132, 145 Gross income (see "Gross Income"). Heirs and legatees In trade 20 Individuals 16, 130 Installment business 60 Interest (see "Interest"). Money equivalent : Partnerships, general 42 Partnerships, limited 44 Promissory note 20, 21 Public utility 145 Real estate development corporation Rents, when returnable 21 Return (see "Returns"). Sale of stock rights 19 Subject to withholding 31, 33 Sundry sources 98, 123 Incorporation expenses 65 Indebtedness ; interest bearing 109 Indebtedness, bonded ; interest paid on 64 Indemnity to withholding party 37 Information required to prepare return of mercantile cor- poration 1 12 Injuries ; damages received on account of 18 INDEX 193 Page Instalment businesses ; what constitutes sales in 60 Insurance : Accident 18 Account 101 Agents 21 Annuities 17 Dividends 17 Losses not compensated for by insurance 26, 61, 124 Partnership 43 Premiums, fire 29 Premiums, life 29 Proceeds of policy (exempt) 132 Reserves for insurance 29 Insurance companies: Gross income of 58 Mutual ' 58 Reserves 63 Returns of 46 In trade, defined 26 Interest : Accounts 93 Accrued on bonds bought 29 Annuities 17 Bank deposits 36 Bonds 64 Collateral subj ect of sale, etc 64 Commercial paper of corporations 33 Cost of manufactures Ill Coupon 31, 141 Debenture bonds 95 Deductible by individual. 25, 124 Deductible by corporation 63 Government bonds 19, 93 Limitation of interest on indebtedness 93, 147 Preferred stock 64 Received by individuals 120 Scrip certificates 33 Sinking funds 59 Tax-free covenant 32 Withholding at source on interest 31, 33 Internal Revenue Officers may prepare return 14 Internal Revenue Officers may examine books of taxpayer 87 194 INDEX Inventories : Account 91 Depreciation on 83 Overstatement, understatement 83 Investments ; depreciation of 82 Joint fiduciaries 1 1 Journal entries of depreciation 69 Joint stock companies (see "Corporations"). Judgments ; test of deductibility of 28 Jurisdiction of District Court 159 Labor, wages and commissions 98 Land, not subject to depreciation 72 Land ; timber 75 Last day to file return 13, 46 Last day; when last day falls on Sunday or legal holiday. 47 Laundry equipment ; depreciation of 79 Law; Federal Income Tax (Sept. 8, 1916) 129 Lawyers' fees ; when returnable 20 Leased property: Additions to 73 Permanent buildings erected ??.y tenant 74 Leasehold account 92 Legatees ; income of, returnable 12 Liability of withholder of tax 34 License required by collecting agents 32, 142 Life insurance company (see "Insurance"). Limitations ; statute of, when removed 15 Limited partnerships: How created 44 Profits of 44 Returns, etc 44 Living expenses, not deductible 25 Local benefits, not deductible 25, 65 Losses : Bad Debts (see "Debts, bad"). Loss, defined 26 Deductible by corporation, domestic 61 Deductible by corporation, foreign 67 Deductible by individual 26, 124 Deductible by non-resident alien 30 Deductible, limitation as to individuals 26,125 Farms and farmers 40 INDEX 195 Losses: Fluctuation ..... : ..................................... 82 In trade .............................................. 26 Speculations, losses in ................................. 26 Machinery ; depreciation of .............................. 75, 76 Mailing returns in due time ....................... . ...... 47 Manufacturing corporation : Cost-system .......................................... 90, 110 Gross income of ...................................... 56 Market value ; how determined .......................... 23 Married person ; exemption of .......................... 24 Mercantile corporation : Information required to prepare return of ............ 112 Gross income of ....................................... 57 Merchandise : Account ......... I .................................... 109 Allowances ............................... ............ 89 Purchases ............................................ 90 Sales ................................................. 89 Merchant ; return of .................................... 120 Method of bookkeeping : Corporations ......................................... 86, 88 Individuals ........................................... 88, 119 Cost-system .......................................... 90, 110 Method of computing tax, normal and additional ........ 127 Mines ; depletion of ..................................... 62, 75 Miscellaneous corporations ; gross income of ............. 57 Misrepresentation by omission or declaration ............ 86 Money equivalent ; income received in ................... 20 Mortgages : Interest on mortgages of corporations ............ . ..... 31 Interest on mortgages of individuals .................. 121 Motors ; depreciation of ................................. 78 Municipalities ; interest on obligations of ................ 19 Mutual insurance .................. . .................... 58, 147 Mutual Benefit Life Ins. Co. vs. Herold .................. 74 Middlesex Banking Co. vs. Eaton ....................... 96 National guardsmen ; salaries of ........................ 66 Negative account (note) ................................ 70 Net income, defined: Corporations ......................................... 56, 143 Individuals ........................................... 16, 135 196 INDEX Page Non-resident citizen required to make return, etc 12 Non-resident alien : Deductions of 29, 134, 135 Exemption, conditional 14, 24 Return, where filed 13 Withholding from income of 37 Nontaxable income: Corporations 145 Individuals 132 Normal tax 9, 129 Notes ; promissory : Equivalent to cash receipts 20, 21, 121 Interest on 121 Notice of assessment by collector : Corporation Individual 14 Notice to collector: Corporation adopting fiscal year 47 Extension of time 13, 48 Obligations of Government ; interest on 19, 132 Office equipment Officers' salaries 100 Oil wells ; depreciation of 27, 75 Ores; depletion of (see "Mines"). Organization expenses 65 Organizations exempt Paid : " actually paid " or " paid during the year " 88 Partners : Credits on individual returns of 43 Drawing accounts of 123 Life insurance of 43 Returns of 42 Salaries of 123 Partnerships : Dividends received by '. . . . .43, 122, 138 Exclusion of interest on state obligations in return of.. 138 Exclusion of taxes in return of 138 Expenses of 43 Income of 42 Limited partnership, taxable as corporation 43 Not required to make return unless ordered 42, 138 INDEX 197 Page Partnerships : Not subj ect to withholding tax from income 122 Profits, distributed or not 42, 122, 138 Profits, when accrued 42 Partnerships, Limited: Make returns as corporations 43 Profits 44 Patents : Depreciation of 79 Royalties from 123 Patterns ; depreciation of 79 Penalties; delayed payment of tax: Corporations 47 Individual 14 Penalties ; failure to 'file return : Corporations 48 Individual 13 Penalties : False claim for exemption 34, 140 False or fraudulent return 14, 49 Refused or neglected to file return 13, 49 Pensions : Received from United States 21 Paid to retired employees 66 Profit and loss account 109 Purchases account 90 Permanent improvements (see "Improvements"). Personal exemptions 10 Philippine Islands 159 Piping, steam ; depreciation of 78 Place of business, filing returns at: Corporations (domestic and foreign) 46 Individuals 13 Non-resident aliens 14 Subsidiary companies 52 Political campaign expenses 29 Porto Rico 159 Power, fuel, light, etc 99 Power of attorney ; agent acting under 12 Preferred stock; interest on, not deductible 64 198 INDEX Page Premiums : Bonds purchased 65 Fire insurance 29 Life insurance 29 Prepayments : treatment of prepayments in return 88 President of United States; inspection of return subject to order of 50 Price : Fair market price or value 23 Professional fees ; when returnable 20, 122 Profit and loss account 109 Profit : Accumulation of profit of corporation 17 Defined 24 In trade 20 Sales of capital assets, taxable Profit sharing payments subject to withholding of tax 36 Promissory note, income 20, 21 Property acquired prior to March 1, 1913: Computing profit or loss on 23, 59, 131, 144 Property : Restoring property 28 Prorating : Cost of improvements by tenant 73 Exemption, husband and wife 11 Loss on sale of bonds 71 Profit or loss on sale of capital assets 23 Public Utility ; income from 145 Public records : Returns become public records 50 Purchases : Merchandise 90 Freight on purchases 91 Railroad company; damages received from 18 Ranches (see "Farms"). Rates of income tax: Corporation 45, 143 Individual 9, 10, 129 Rates, water 26 Rates of depreciation 71, 72 Real estate agents: Commissions paid to 29 Not required to withhold tax 36 INDEX 199 Page Real estate companies : Accounts of 59 Anderson vs. Forty-two Broadway Co 64 Development corporations 59 Property collateral of 64 Rebates 90 Receipts for taxes paid 15, 157 Receivers (see " Fiduciaries "). Redemption of bonds 64 Refund ; claims for 15 Refusal to file (see "Penalties"). Regulations, Federal Corporation Capital Stock Tax Law. 163 Renewals of office equipment 74 Rent: Account of 92 Crop shares received by farmer k 39 Interest paid in lieu of 94 Real estate agent collecting 36 When returnable 21, 122 Withholding tax on 35 Rental value as income 20 Rents : Paid and received 92 Repairs : Buildings / 73 Incidental 77 Ordinary 99 When deductible 76 Replacements ; test of deductibility 76 Reserves : Bad debts 62 Contingent 63 Depreciation 69, 71 Discounts on sales 63 Diverting reserves 70 Insurance , 29 Insurance companies 63 Secret 63 Separate accounts of reserves 70 Residence : Citizen residing abroad 12 Resident alien 15 Residence, defined 15 Depreciation of dwelling 74 200 INDEX Page Residing in the United States temporarily 15 Return : Defined 10 By agent 12 Publicity of 50 Reconciliation of return with books of account 110 Tentative and amended 51 Verifying by Inspectors of Internal Revenue 87 Returns of corporations: Amended 51 Books of account 53, 86 Contents of return 112 Delayed 48 Extension of time to file 48 Failure to file, penalty 48 False or fraudulent 49 Form of return 46 Holding companies 51 How executed 47, 151 Insurance companies 46 Interstate Commerce 53 Mercantile corporations 112 Refusal to file 49 Suggestion as to preparation of 86 Taxes withheld at source 37 Tentative 51 When due 46 Where filed 46 When Internal Revenue officer will prepare return 49 Returns of individuals : By agent 12, 137, 141 Books of account 119 Delayed 13 Extension of time to file 13, 137 Fiduciaries 11, 137 Form of return Failure to file, penalty Extension of time to file 13, 137 False or fraudulent Liability of agent making return Refusal to file Suggestions as to preparation of When due . 13,137 INDEX 201 Returns of individuals: Page Where filed 13, 137 When Internal Revenue officer will prepare 14 Who is required to make return 10 Returns of exempt organizations : Return of tax withheld 53 Returns of non-resident aliens 14 Returns of general partnerships: Not required unless ordered 41 Returns of limited partnerships : Same as corporations 43 " Rights," sale of 19 Royalties received and paid 92, 123 Salaries : Based on stockholdings 100 Bonuses 20 Commissions 121 Entries of salaries in return 119 Exempt corporations must withhold tax on salaries paid 55 National guardsmen 66 Officers 100 Paid by stock 20 Paid by property 20 When returnable 20, 121 Withholding tax from payments of salary 102 Sales : Capital stock sold at premium 60 Instalment businesses 60 Profit on sales of capital assets 22, 23, 59 Real estate development corporation 59 Reserve for discounts on sales of commodities 63 Freight on sales 91 Sales of capital assets 105 Sales account (merchandise) 89 Salesmen paying traveling expenses; employer should not withhold tax 36 Salvage value of goods returned 60 Scrip certificates ; interest on 33 Second assessments 50 Secured debts ; interest on 64 Securities : Fair market value of 23 Dividends paid by 58 202 INDEX Page Shafting ; depreciation of 78 Shipwrecks ; losses by 124 Sickness: Extension of time to file return on account of, Corporations 48 Individuals 13 Sinking fund ; not deductible 63 Sinking fund ; interest on, is income 59 Source; tax payable at 31, 33, 137 Source ; return of tax withheld at 37 Specific exemptions: Corporations not entitled to 46 Prorated between husband and wife 11 Penalty for false claim of 34 Who is entitled to 24 Stable equipment ; depreciation of 81 State : Defined 154 Compensation of employees of 132 Interest on obligations of 132 Statute of limitations: Claims for refund under old 15 Return may be made by Internal Revenue Officer within three years 14 Steam Piping ; depreciation of 78 Steam turbines ; depreciation of 78 Stock assessment ; payment of, not deductible 29 Stock assessment ; not income to corporation 60 Stock, capital: Called ^for by return 108 Sales of, not income 60 Sales of right to subscribe to 19 Stock: Depreciation of 82 Dividends 19 Exchange of 19 Interest on preferred 64 Salary paid by 20 Stock on hand ; depreciation of 83 Stock on hand ; account of 91 Stockholders' responsibility for undivided surplus 16 Stockholder ; return of capital to 19 Stocks and bonds ; fluctuation in value 82 INDEX 203 Page Subsidiary companies : Income of 52 Returns of 52 Where to file returns of 52 Suggestions ; bookkeeping 86 Summons : Collector has authority to summon any tax- payer or other person in connection with examinations by him 156 Sunday or legal holiday; last filing day falling on 47 Sundry expense accounts 101 Supertax (see "Additional tax"). Surplus : Beyond reasonable needs of corporation 17 Dividends charged to 110 Surplus account 109 Undivided 16 Surtax (see "Additional tax"). Suspense items not deductible 63 Switchboards ; depreciation of 78 " System of accounts of retail merchants " 84 Selden vs. Equitable Trust Co 97 Tax bills : Corporations 47 Individuals 14 Tax-free covenant in bonds, not recognized 32 Tax on corporations : Assessment, notice of 47 Calendar year 45 Fiscal year 47 Claims for abatement and refund 15 .Delayed payment of tax, penalty, etc. . . . 47 Income tax paid, deductible 66 Rate 45, 143 Receipt for taxes paid 15, 157 When due 47,48 Tax on individuals : Assessment of tax 14 Normal 9, 129 Additional tax 10, 129 Calendar year 10, 130 Claims for tax withheld in excess 35, 140 Claims for abatement and refund 15 204 INDEX Tax on individuals: Page Delayed payment of, penalty 14, 139 Income tax, deductible 25 Liability of withholder of tax 34 Real estate agent not required to withhold 36 Rates of 9,10 Tax-free 25 Tax year 10 Who is subject to tax 9 When due 14,139 Tax exempt income , 132 When 50% penalty is added 13 Taxes : Accounts of 107 Accounts of, withheld at source 107, 108 Deductible 25, 36, 124 Entries in return of taxes withheld 119 Taxes paid by tenant 65 Withheld at source over $3,000 33 Withheld at source irrespective of amount paid 31 Computation of normal and additional tax 127 Tenant : Buildings erected by 74 Improvements made by 73 Taxes paid by 65 Tenant required to withhold tax on rent payable to in- dividuals in excess of $3,000 per annum 36 Tentative returns 51 Theatrical costumes ; depreciation of 82 Three year limitation; Collector may make return within. 14,49 Timber lands ; depletion of 62 Tools ; depreciation of 78 Trade : " In trade," defined 26 Income, in trade 20 Losses, in trade 26 Trademarks ; depreciation of 82 Traveling abroad; extension of time 13 Transportation charges 91 Treasury Regulations ; Corporation Capital Stock Tax Law 163 Treasury stock 108 Trucks, auto ; depreciation of 80 Trustees : Compensation of 21 Returns by 11 INDEX 205 Page Trusts (see "Fiduciaries"). Turbines ; depreciation of 78 Undistributed income : Of corporations 16 Of estates 20 Of partnerships 42, 122 Subj ect to additional tax 131 United States vs. The Cleveland, Gin., Chicago & St. L. Ry. 66 United States, defined 154 Verification of returns of corporations 47 Vested interest; agent required to report distributed and undistributed income 12 Voluntary assessment of stockholders 60 Wages, labor and commissions * 98 Water rates deductible in rented property, not on dwelling of taxpayer 26 Wages (see "Salaries"). Ward, cestui que trust; exemption of 25, 136 Withholding corporation ; return of 103 Withholding tax: Commercial paper 33 Commissions paid to salesmen. 36 Exempt organizations required to withhold 55 Income of non-resident alien corporation 37 Indemnity to withholding party 37 Income of partnerships 41 Income from rent 35 Real estate agent not required to withhold 36 Interest on bank balances 36 Return of taxes withheld 37 Taxes withheld in excess of taxpayers' liability for nor- mal taxes 35, 140, 141 Withholding party personally liable for taxes required to be withheld 34 Who is required to withhold taxes 31, 33, 137, 139, 142 Wires and cables ; depreciation of 78 Worthless accounts receivable 103 Worthless stocks and bonds 82 Year, tax: Corporations 45, 47 Individual . 10, 130 THIS BOOK IS DUE ON THE LAST DATE STAMPED BELOW AN INITIAL FINE OF 25 CENTS WILL BE ASSESSED FOR FAILURE TO RETURN THIS BOOK ON THE DATE DUE. THE PENALTY WILL INCREASE TO SO CENTS ON THE FOURTH DAY AND TO $1.OO ON THE SEVENTH DAY OVERDUE. Tm JUH Ic; . .%*> 1955 JUNO 8 199} LD21-100m-7,'33 YC 23476 U.C. BERKELEY LIBRARIES COH43223flb UNIVERSITY OF CALIFORNIA LIBRARY