INCOME and FEDERAL TAX REPORTS BY JOHN A. CONLIN LECTURER ON INCOME TAXES AT NEW YORK UNIVERSITY SCHOOL OF COMMERCE, ACCOUNTS AND FINANCE WITH THE COLLABORATION OF HENRY BRACH, B. C. S. PUBLIC ACCOUNTANT C.' D. EVERSFIELD, B. C. S. INSTRUCTOR IN ACCOUNTING, NEW YORK UNIVERSITY PRIMUS E. GODRIDGE, B. C. S. ASSISTANT TRUST OFFICER, BANKERS TRUST COMPANY INSTRUCTOR IN ACCOUNTING, NEW YORK UNIVERSITY GEORGE HAMILTON, B. C. S. ASST. STAFF SECRETARY, ALEXANDER HAMILTON INSTITUTE INSTRUCTOR IN ACCOUNTING. NEW YORK UNIVERSITY SECOND 1918 EDITION prentice-hAll*, Inc:'* NEW YORK First Edition February 9, 1918 v ill d\ Second Edition February 27, 1918 Copyright, 1918, by PRENTICE -HALL, Inc. AU rights reserved. PREFACE "We are ready to pay our taxes, if only somebody will tell us how." That is the sentiment of every American. To tell them how, is the purpose of this book. I have kept in mind, while writing this book, the fact that the taxpayer will have before him a tax blank to which he will be required to transfer information contained in his books of account. How is that blank to be filled out? Why are the questions asked? Definite, concrete, illus- trative answers to these questions, I am sure, will be welcome. I have assumed all along and I believe my assumption is well-founded that the taxpayers of America are honest; that they are not asking to evade taxes, but that, on the other hand, they are anxious not to make errors that will subject them to unnecessary tax burdens. It is a modern American characteristic to spend lit- tle time in arguing about the expediency or the wisdom of a certain measure, when it appears more important to get some kind of action concerning that measure. I should have had little patience with a publisher who asked me to write an economic treatise on the income tax. I should have had little desire to undertake the arduous labor of compiling this book had I not felt it a patriotic duty to do what I could to bring the people of the country, upon whom the taxes herein described are to fall, in full sympathy with the law and the adminis- tration of the law. The demands of the moment would ill iv PREFACE have led me to a sympathetic treatment of the tax pro- gram of the government, however unjust that program may have seemed to some persons and however just their complaints may have seemed to me. But fortu- nately there is little basis for complaint. While in some cases the tax rate appears to be high, the scheme of tax- ation merely follows the time-honored practice of "ap- portioning public burdens in accordance with the pre- sumed capacity of individuals," and the exigencies of the situation demanded that every individual be required to contribute to his utmost. On the other hand, the reach- ing down of the government to the incomes of those in moderate circumstances, I believe, will bear its reward in habits of thrift and in a growing sense of responsibility to and for the government, and these rewards will more than offset the temporary small sacrifice that the tax laws require. I entered upon the compiling of this work with enthusiasm and took from an already busy life every moment possible to complete the book within time to make it of value to the average business man. I must take this opportunity to thank my collaborators heartily for their assistance not only because it has enabled me to accomplish what otherwise would have been an im- possible task, but because their energy and enthusiasm prevented my own spirit from weakening under the fatigue of unbroken effort. John A. Conlin. New Yobk University, February 5, 1918. TABLE OF CONTENTS CHAPTEB PAGE I. INTRODUCTION 1 II. Administration 17 III. Individual Income Tax Gross Income 32 IV. Individual Income Tax Deductions 99 V. Individual Income Tax Rate of Tax 126 VI. Individual Income Tax Returns and Computation of Tax 138 Vll. Corporation Income Tax Corporations Subject to Tax 165 VIII. Corporation Income Tax Gross Income 180 IX. Corporation Income Tax Deductions 206 X. Corporation Income Tax Rate and Computation of Tax 252 XI. Withholding, Deduction and Information at the Source 258 XII. Fiduciaries 281 XIII. The Income Tax Law 296 XIV. Capital Stock Tax 347 XV. The Capital Stock Tax Law 381 XVI. Federal Estate or Inheritance Tax 385 XVII. The Federal Estate Tax Law 422 XVIII. Munition Manufacturer's Tax 434 XIX. The Munition Manufacturer's Tax Law 451 XX. Occupational Taxes 458 XXI. The Occupational Taxes Law 471 XXII. War Excise Taxes 477 XXIII. The War Excise Taxes Law 488 XXIV. The Tax on Beverages Law 493 XXV. War Stamp Taxes 520 XXVI. The War Stamp Taxes Law 564 XXVII. War Tax on Public Utilities and Insurance 575 XXVIII. The War Tax on Public Utilities and Insurance Law 590 XXIX. War Tax on Admissions and Dues 596 XXX. The War Tax on Admissions and Dues Law 606 XXXI. Collection Districts 609 XXXII. The War Excess Profits Tax Law 625 XXXIII. War Excess Profits Tax 639 Index INCOME AND FEDERAL TAX REPORTS CHAPTER I INTRODUCTION The tax program of 1918 based on precedent. The federal government has been fortunate in being brought into the great European conflict with reasonable notice. We have had time to inquire into the finan- cial expedients of our previous wars. Moreover, we have had the experience of Great Britain and France through three years of extreme stress to guide us. Fi- nally, we have had our difficulties pile up before us gradually, so that our people and our businesses have not been suddenly thrust into a period of heavy tax burdens, but have had time and opportunity gradually to put themselves on a war basis. It is a notable fact that there is practically nothing new in the present tax program. The excess profits tax is a modern expedient, but we borrowed that from Eng- land. The other taxes were used in one form or an- other in the Civil War. Civil War taxes. While most readers will be inter- ested in the 1918 war taxes only to know how they must be met, there will be many who will take a broader in- terest and who will be ready to inquire how those taxes happened to come about. As we have already indicated, for most of the forms of special taxes that are now be- ing levied there is a precedent, in the taxes which were imposed to meet the demands of the Civil War. Con- 1 2 INCOME AND FEDERAL TAX REPORTS gress levied estate taxes, special taxes on liquors, on articles of common use and on luxuries such as car- riages and yachts. There were stamp taxes and income taxes, occupation taxes on financial institutions, and on advertisements. There appears, however, to have been no precedent for the excess profits tax, the tax on ad- missions to places of amusements and no tax on the mail. History of Income Taxes. Of all the taxes enacted dur- ing the Civil War the most interesting was the income tax. The original act of August 5, 1861, levied a tax of 3 per cent on incomes over $800. The exemption was later, September 1, 1862, reduced to $600. Incomes received from obligations of the United States were taxed IY2 per cent. Citizens living abroad were taxed at the rate of 5 per cent. Supertaxes of 5 per cent were levied on incomes in excess of $10,000. The law was several times amended, and finally expired by limita- tion at the end of 1871. It is to be credited with rais- ing $376,290,600.56 for the government, and drew in- come tax from 276,661 persons. In 1894 Congress adopted another income tax, but it was held unconstitutional in the following year on the ground that it was a direct tax, and was not, in pur- suance to the federal constitution, apportioned among the States. Moreover, it was objectionable, since it did not exempt the interest on State and municipal bonds. In 1909 Congress, in spite of this decision, enacted what was in effect an income tax on corporations, but the Su- preme Court validated it by calling it an excise on cor- porations, assessed "with respect to" incomes. In 1913 the doubt about the validity of federal income taxes was ended with the ratification of the Sixteenth Amend- ment to the Federal Constitution, which provides : "The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without appor- 1 Pollock v. Farmers' Loan and Trust Co. (157 U. S. 429; 158 U. S. 601). INTRODUCTION 3 tionment among the several States, and without regard to any census or enumeration." Finally, in 1916, the Supreme Court stated "that taxation on income was in its nature an excise," and therefore valid without the aid of the sixteenth amendment. The Income Tax of 1909. The tax of 1909 was a tax on corporations only, but the word corporations in- cluded joint stock companies or associations organized for profit and having a capital stock, as well as insur- ance companies, organized under the laws of the United States. Foreign corporations were also liable for the tax, which was applied to that part of their net income which was earned within the United States. Charitable institutions were expressly exempted. Net income was found by deducting from gross income (1) operating and maintenance expenses, including rentals and fran- chise payments; (2) losses not compensated by insur- ance, including reasonable depreciation; (3) interest on bonded indebtedness to an amount not exceeding the amount of issued stocks, and interest on deposits, when paid by banks; (4) all taxes of a State or of the United States and all foreign taxes imposed as a condition of carrying on business in foreign countries; and (5) the amount received as dividends from other companies sub- ject to the tax. Reports were due on the first of March covering the income of the previous calendar year, and the tax at the rate of 1 per cent upon the entire net in- come over and above $5,000 was due on June 30. Pen- alties were provided for breaches of the law. The 1909 law is now of historical interest only the present law does not in any way refer to it, as it does to the true Income Tax laws of 1913 and 1916. The Income Tax of 1913. This law was enacted Octo- ber 3, 1913. It was not intended as a temporary meas- ure, but was intended to bring revenues to the govern- ment, which had quite definitely abandoned its almost sole reliance for revenues on import duties. 4 INCOME AND FEDERAL TAX REPORTS The law of 1913, popularly known as the Underwood Tariff Bill, was the first valid income tax law since the Civil War. It applied to individuals as well as to cor- porations. Corporations were taxed upon their entire net income, without the benefit of the exemption of dividends received from another corporation also subject to the tax. Partnerships were to return their income only in case the Internal Eevenue Department required such returns to check up the returns of their several partners. Besides an exemption of $3,000 for single persons and $4,000 for married persons, there were deducted from the gross income to find the taxable net income (1) expenses of carrying on any business, (2) interest paid on personal indebtedness, (3) all State and local taxes paid, (4) losses not compensated by insurance, (5) uncollectible debts charged off, (6) a rea- sonable allowance for depreciation, (7) a credit of divi- dends received from corporations paying the tax, (8) and income upon which the tax had been collected at the source. Interest received from public securities and salaries of State and local officials were specifically exempted. The normal rate was one per cent. Super- taxes were levied on incomes over $20,000. A novel feature of the tax was the English expedient of collec- tion at the source, by which is meant that all persons or corporations paying to individuals income in the form of wages, interest, rent or the like in excess of $3,000 or $4,000 were required to deduct the one per cent tax and pay it over to the collector. The Income Tax of 1916. On September 8, 1916, the law of 1913 was repealed and a new income tax law was enacted. The 1916 law is still in effect, though it has been amended and supplemented by the "War Rev- enue law of October 3, 1917. It is unnecessary at this place to give even a summary of the law of 1916, for it is described at length in the pages that follow; but for the sake of continuing the outline unbroken, we shall INTRODUCTION 5 indicate a few of the changes that were made in the law of 1913. The normal tax was raised from 1 per cent to 2 per cent, and the surtax was increased from a maximum of 6 per cent (on incomes over $500,000) to a maximum of 13 per cent (on incomes over $2,000,000). The other principal change was the extension of the $4,000 exemption from married persons to the "head of a family." Deductions were also allowed for taxes paid in foreign countries and for certain kinds of losses, including thefts, and allowances were made for actual depletion of natural resources; these deductions and allowances had not been recognized under the law of 1913. The Treasury Department extended all its rul- ings under the 1913 act, as far as applicable to the 1916 act. The income tax provisions of the 1917 War Revenue Law. The 1917 War Tax Law was approved October 3, 1917. It amended the 1916 law in certain respects but did not repeal it. It also added new extra taxes on in- come for war purposes. In effect, then, there is now a double tax on income, although it is calculated from a single return. Indeed, from this single return four amounts will have to be calculated: (1) the normal tax of 2 per cent under the 1916 act; (2) the normal tax of 2 per cent under the 1917 act; (3) the supertaxes un- der the 1916 act; and (4) the supertaxes under the 1917 law. The normal tax under the 1917 law is not to be collected at the source, though this provision still re- mains in part as to the normal tax under the 1916 law. Further discussion of the details of the income tax features of the War Revenue Act of 1917 is reserved to the chapters dealing with the individual and corpora- tion income tax reports. Other war taxes in general. The acts of 1909 and 1913 were enacted before the European war broke out. The revenues designed to be raised from them had nothing to do with a preparedness program. But the act of 6 INCOME AND FEDERAL TAX REPORTS 1916 was a step toward preparedness and was intended to yield large revenues. For this reason it raised the normal and supertax rates. But it added other features besides the income tax to the federal taxing system. Indeed, it had been preceded, on October 22, 1914, by a War Kevenue Law, which laid a special tax on bankers, brokers, commercial brokers, commission merchants, custom-house brokers, pawn-brokers, theater, museum and concert halls, circuses and other public exhibitions, bowling alleys and billiard rooms and on tobacco manu- facturers and dealers. This law of 1914 also provided stamp taxes on promissory notes, legal and other in- struments, on perfumery, cosmetics and chewing gum, and on liquors and wines. The law of 1916 made several changes in the act of October 23, 1914, and contained provisions intended to aid certain industries. Among the latter is the increased import duty on dyestuffs. The Estates Tax. One of the most important taxes added to the act of 1916 (the other was the munitions tax) was the so-called Estates Tax. Inheritance taxes were used to finance the Civil War. It was proposed to include another such tax in the tariff law of 1909, but the States felt that the federal government should not take away an established source of State income, and their objections were heeded. By 1916 the needs of the federal government, however, had become so great that little difficulty was found in introducing the estates tax provisions into the law of 1916. They provide for a tax on the transfer of the entire estate, the tax being based on the net estate, calculated by deducting from the gross estate, debts, administrative expenses, losses and the like, and also an exemption of $50,000 for resi- dents of the United States. The tax applies to the es- tate of every decedent whether a resident of the United States or not. Exemption is not, but deductions are al- lowed on the estates of non-residents in proportion to INTRODUCTION 7 the parts of the estates that were situated within the United States, but his provision is conditioned upon receipt of full information by the government. On March 3, 1917, the Estates Tax law was amended. The rates were raised, and they were again raised by the War Tax Act of October 3, 1917. Under the pres- ent scheme the rates of the September 8, 1916, act have been increased by those of the act of March 3, 1917, and these latter are still in effect, but have been added to by the rates imposed by the act of October 3, 1917. The rates in the three acts are as follows: Act of Act of Act of March 3, Oct. 3, Total Rate Estate Sept. 8, 1917, 1917, 1917 Addi- Addi- tional tional Rates Rates % % % % Not exceeding $50,000 1 y* y 2 2 Exceeding $50,000 but not $150,000.. 2 i l 4 " 150,000 * " 250,000.. 3 i^ W* 6 " 250,000 " u 450,000. . 4 2 2 8 " 450,000 " " 1,000,000.. 5 2^ 2^ 10 " 1,000,000 " u 2,000,000.. 6 3 3 12 " 2,000,000 " * 3,000,000.. 7 33^ 3^ 14 3,000,000 " " 4,000,000. . 8 4 4 16 4,000,000 " " 5,000,000.. 9 4^ 4^ 18 " 5,000,000 " " 8,000,000. . 10 5 5 20 " 8,000,000 u " 10,000,000. . 10 5 7 22 " 10,000,000 10 5 10 25 The estates tax as it now stands is to run indefi- nitely, but will probably be repealed after the war. The additional tax of October 3, 1917, is not to be im- posed on the estates of those dying while serving in the military or naval forces of the United States during the present war, or within one year after its close, if death results from injuries or disease contracted in the service. The Munitions Tax. The Munition Manufacturers' Tax was enacted as a part of the War Eevenue Act of September 8, 1916. It followed, in its purposes, the 8 INCOME AND FEDERAL TAX REPORTS somewhat similar taxes of Sweden and Denmark among the neutrals, and of Great Britain, France, Italy and Germany among the combatants. It was originally re- stricted to a period ending one year after the close of the European war. The latest act, that of October 3, 1917, reduced the tax from twelve per cent to ten per cent upon net profits for the year 1917, and provided that the tax should cease on and after January 1, 1918. Capital Stock Tax. In place of the tax of one dollar for each $1,000 of capital employed by banks a tax originating in the law of October 22, 1914 the law of September 8, 1916, imposed a special excise tax of 50 cents per $1,000 of fair value of capital stock upon every domestic corporation, insurance company or asso- ciation having a capital stock represented by shares. The legal reserves of insurance companies are not to be included and an exemption of $99,000 is allowed each company. Foreign corporations transacting business within the United States are also subject to this tax at the rate of 50 cents per $1,000 of capital actually em- ployed in the transaction of business in the United States. A proportion of the exemption of $99,000 is allowed these foreign corporations, measured by the ratio of capital employed within the United States to the total capital invested. Title III of the act allows that munition manufacturers are not to be subject to the provisions of this act and those of the Munitions Tax law, but are to be subject to the tax which pro- vides the greatest revenue to the government. Excess Profits Tax. Of the various laws thus far men- tioned the most important is the Income Tax law. But the most important tax, from the standpoint of yield to the government, is the Excess Profits tax. This tax is expected to raise no less than $1,000,000,000. The Ex- cess Profits tax law was first passed in March, 1917; under the provisions of this act profits in excess of 8 per cent on invested capital were taxed at the rate of INTRODUCTION 9 8 per cent. It will be seen that this act differed radi- cally from its prototype, the English Excess Profits tax, which was indeed a tax on excess profits caused by the war. The War Tax law of October, 1917, made material changes in the Excess Profits tax. As the law now stands the basis of the tax is to be found in the "pre-war" period of 1911-12-13. If the profits of that period amounted to less than 7 per cent of the then invested capital, then 7 per cent of the capital for the taxable year is deducted from the net profits before de- termining the amount of taxable net profits. If the profits of the pre-war period ranged from 7 to 9 per cent, then the actual percentage is used in calculating the proper deduction, but if profits in the pre-war pe- riod exceeded 9 per cent, then 9 per cent is taken as the per cent of allowable untaxed profits. Profits in excess of that rate are taxable. Extra allowances of $3,000 for domestic corporations and of $6,000 for partnerships and individuals are made. Further dis- cussion is reserved for the chapter devoted specially to this tax. On account of the great difficulty that has been ex- perienced in drafting and interpreting the Excess Profits Tax Law, we have added the following descrip- tion of the English method of computing the tax, taken from the London Economist, November 27, 1915: "This tax is, in fact, an additional income tax im- posed on certain trades and businesses, not upon offi- cials, employees, and professional men who are exempt. But any business man or agent who is paid partly by commission is included, except commercial travellers, who are specifically excluded. All salaried persons are excluded, whether their salaries have been stationary or not. Clerks working overtime or persons who have changed one salaried occupation for another with higher remuneration escape taxation. If a small por- tion of the income is received by way of commission, 10 INCOME AND FEDERAL TAX REPORTS as is often the case with company directors or mana- gers, such persons, according to Mr. McKenna (then Chancellor of the Exchequer), do not fall within the scope of the Act, because they do not 'carry on a busi- ness.' . . . "The trades and business liable to the tax include any which are carried on in the United Kingdom or are owned or carried on in any other place by persons ordinarily resident in the United Kingdom. Any busi- ness or trade to which the tax applies is liable to pay to the Exchequer a sum equal to 50 per cent of the amount by which the profits for the 'accounting period' exceed by more than 200 the defined pre-war standard of profits. . . . "It is important to remember that the tax is not a tax upon war profits as such, nor upon high profits earned during war conditions, but upon profits enjoyed during the war period. . . . "The computation of the profits of the 'accounting period' is dealt with in Part 1 of the Fourth Schedule. The profits are not to be calculated by income tax rules, but are to be the actual profits of the* period, and de- ductions will be allowed for interest on borrowed money or for rent or royalties or other payments which are excluded under the Income Tax Acts, because income tax on them is collected at the source. On the other hand, all profits or gains from lands, etc., forming part of the assets of the business, which are excluded under the Income Tax Acts because they are taxed under a separate schedule, must be brought into the excess profits computation. "No deductions for wear and tear or for any expen- diture of a capital nature for renewals are allowed, ex- cept such as may be allowed under the Income Tax Acts, and then only such amounts as appears to the Commissioners of Inland Eevenue to be reasonable and to be properly attributable to the year or account- INTRODUCTION 11 ing period. Here practice is to be based upon income tax principles. . . . "It is provided that without special reasons the sums allowed as remuneration of directors and managers may not exceed the sums allowed in the last pre-war trade year, and no deduction is allowed in respect of any transaction which appears to have artificially re- duced the amount of profits. Any transaction already carried through which would have this effect must be disclosed under pain of severe penalties. In the Bill as originally drafted power was given to the Commission- ers to examine and make copies of books of account, but this was expunged in Committee. "Excess profits are to be determined upon the basis of a pre-war standard, which is defined as the average of any two of the last three pre-war trade years; the two years to be selected by the taxpayer. If this amount is less than 6 per cent upon the capital at the end of the last pre-war year in the case of a company, or 7 per cent in the case of any other business, the standard profit is to be taken as equal to 6 per cent, or 7 per cent, as the case may be, upon that capital, and where a business has changed hands within the last three pre-war years or has been started within that period, the percentage standard is to be adopted. In- creases in the standard percentage, or adjustments in the pre-war profit standard, may be made by the Board of Eeferees at their discretion. Mr. McKenna evi- dently intended the Board to use very wide latitude, for he stated that the 6 per cent allowance upon cap- ital would be ridiculous in the case of rubber plantation companies. "To meet the case of trades or businesses which have been unduly depressed during the past three years, Mr. McKenna introduced an amendment on November 22, 1915, which provides that where it is proved to the satisfaction of the Commissioners that the last three 12 INCOME AND FEDERAL TAX REPORTS pre-war trade years were years of abnormal depres- sion, the average of any four of the last six pre-war trade years may be substituted as the pre-war standard of profits. The last three pre-war trade years may not be considered as years of abnormal depression unless the average profits of those years have been at least 25 per cent lower than the average profits of the preced- ing three years. "The manner of assessing the capital is dealt with in Part 3 of the Fourth Schedule, and it is here that in- terpretation is most difficult. Capital is defined 'so far as it does not consist of money,' as (a) the price at which assets acquired by purchase were purchased, sub- ject to any proper deductions for wear and tear or re- placement, or for unpaid purchase money; (b) debts due to the trade or business, subject to any reduction which has been allowed in respect of those debts for income tax purposes; and (c) the value of other assets at the time when they became assets subject to any deductions for wear and tear or replacement. Any cap- ital the income on which is not taken into account in calculating the profits (i.e., interest on investments in the case of companies other than financial companies), and any borrowed money or debts shall be deducted when arriving at the amount of capital for the purpose of the percentage standard allowance. "The value to be attached to goodwill stands in a very curious position. If a company is assessed upon the pre-war standard basis, goodwill does not enter into the matter at all; but if no pre-war standard is avail- able, the basis of assessment is the percentage standard upon capital. Section 3 of the Fourth Schedule states that where any asset has been paid for otherwise than in cash its cost price shall be the value of the consid- eration at the time the asset was acquired. But where a business has been sold to a company and the consid- eration consisted wholly or mainly of shares, no value INTRODUCTION 13 shall be attached to those shares so far as they are rep- resented by goodwill, or otherwise than by material as- sets. This will apply most inequitably to concerns which adopted the joint-stock principle shortly before the outbreak of war and acquired a really valuable goodwill in exchange for shares. A private banking business, for example, generally has a goodwill more valuable than the nominal capital of the business, and if turned into a joint-stock company the partners gen- erally desire to retain a large interest in the business by accepting the greater part of their purchase price in shares. Under the excess profits proposals the shares issued in respect of goodwill will be inadmis- sible as capital." What the taxes will yield. 1 It was estimated that the war taxes would yield in 1918 about $2,500,000,000, as followS: Millions Incomes, individual and corporate 851.0 Excess profits 1,000.0 Spirits, liquors, wines 193.0 Soft drinks, syrups, etc 13.0 Tobacco, and manufactures thereof 63.4 Freight transportation 77.5 Express transportation 10.8 Passenger transportation 60.0 Pipe lines 4.5 Seats and berths 4.5 Telegraph and telephone messages 7.0 Insurance 5.0 Automobiles 40.0 Musical instruments, etc 3.0 i Later estimates have greatly increased this amount, and now the gov- ernment expects to receive $1,201,000,000 from income taxes before July 1, including $666,000,000 from individuals and $535,000,0ou from corpora- tions. This is more than one-third of the $3,400,000,000 estimated receipts under the War Revenue act passed by Congress at the last session. From excess profits taxes the Government expects to realize about $1,220,000,000 before July 1. 14 INCOME AND FEDERAL TAX REPORTS Millions Motion picture films 3.0 Jewelry 4.5 Sporting goods 1.2 Pleasure boats .5 Perfumes and cosmetics 1.9 Proprietary medicines 3.4 Chewing gum .4 Cameras .7 Admissions 50.0 Club dues 1.5 Stamp taxes, etc 9.0 Estate taxes 5.0 First-class mail matter 70.0 Second-class mail matter 6.0 Munition manufacturers' tax 25.0 2,514.8 Income tax yields of previous years. The following table has been prepared to show the yields to the gov- ernment of the tax on the incomes of individuals: 1913-14 1914-15 1915-16 Rate 000 000 000 per cent Omitted Omitted Omitted Normal tax 1 $12,728 $16,500 $23,966 Additional tax on net in- come of: $20,000 to $50,000. 1 2,935 4,107 6,092 50,000 to 75,000. 2 1,646 2,501 4,071 75,000 to 100,000. 3 1,323 2,103 3,624 100,000 to 250,000. 4 3,836 5,945 10,936 250,000 to 500,000. 5 2,335 3,328 6,394 Exceeding $500,000 6 3,438 6,439 12,648 Settlement in compro- 14 63 183 mise Total 28,254 41,046 67,944 INTRODUCTION 15 In 1917 the collections were as follows: Normal tax of 2 per cent $55,742,230.89 Additional tax on net income of: $20,000 to $200,000 36,363,894.44 200,000 to 250,000 6,241,807.10 250,000 to 300,000 5,196,876.88 300,000 to 500,000 12,969,686.27 500,000 to 1,000,000 14,501,213.51 1,000,000 to 1,500,000 7,531,893.76 1,500,000 to 2,000,000 4,888,040.10 Exceeding $2,000,000 16,145,856.30 Settlements in compromise 15,994.50 Total $167,787,089.39 In comparing the year 1913-14 with the other years it must be remembered that the tax fell on the income not of the entire year but of ten months of the year 1913 only. In 1913 only 357,598 persons made returns. In 1917 this number increased to 437,036. It is estimated that with the decrease in the non-taxable exemption from $3,000 and $4,000 to $1,000 and $2,000 a great many more people will file returns, the aggregate for 1918 being placed at 6,350,000 persons. Summary. In a statement issued October 5, 1917, the Commissioner of Internal Eevenue, Daniel C. Roper, enumerated the persons subject to the new tax laws. The statement gives the following list: All individuals receiving incomes of more than $1,000 or $2,000 a year. All corporations, joint-stock companies and associa- tions. All distillers, rectifiers, wholesalers and retailers, holders of distilled spirits intended for sale or to be used for manufacturing purposes. All dealers in fermented liquors and malt liquors, wines, cordials and liqueurs, domestic and imported. 16 INCOME AND FEDERAL TAX REPORTS All dealers in soft drinks, table waters and carbonic acid gas. All manufacturers of and dealers in cigars, cigarettes, tobacco, snuff and cigarette papers. All carriers of freight, express, or passengers, and all operators of pipe lines. All dealers in life, marine, inland, fire and casualty insurance. All manufacturers and wholesale dealers in motor vehicles of every kind, [certain mechanical] musical instruments, motion picture films, jewelry, boats, sporting goods, perfumes, cosmetics, medicinal preparations, chewing gum and cameras. All proprietors of amusement places, including caba- rets. All persons executing legal documents of any type. All traders on produce or stock exchanges and boards of trade. All importers of merchandise. All manufacturers and importers of playing cards. Duty of persons to file returns and pay the tax. Every citizen and every person resident in the United States is bound to make a return if his income is over $1,000 or $2,000, as the case may be. The duty of citizens was stated by Commissioner Roper as follows: "Upon every citizen rests the responsibility of con- tributing to the utmost of his ability toward the suc- cessful termination of the war. The War Revenue Act represents the judgment of the United States Congress as to what is the proper share for each citizen to con- tribute. This share is based upon the ability of the citizen to contribute. It is the unquestioned duty, therefore, of every true American citizen not only to pay the full tax the law requires of him, but to remove every possible obstacle to the successful administration of the law by the Bureau of Internal Revenue. In the circumstances, it is a high privilege for every citizen to comply strictly with the terms of the law and to make it a part of his duty to see that every other citi- zen does likewise." CHAPTER II ADMINISTRATION Organization of the Internal Revenue Bureau. The ad- ministration of the internal revenue laws is in the hands of the Bureau of Internal Eevenue, a division of the Treasury Department. This bureau, which is now under the direction of Commissioner of Internal Eevenue Daniel C. Roper, is charged with the administration of all internal revenue laws and with the collection of taxes imposed by these laws. The amount of taxes collected by this bureau has increased greatly in the past four years, the increase being due almost entirely to the enactment of the Income Tax law. The new "war taxes" are expected to result in such an increase in the amount of taxes that the bureau has been en- tirely reorganized in anticipation of its great task. An idea of the immensity of this task may be obtained from the fact that the government's estimate of the amount of internal revenue for its fiscal year ending June 30, 1918, is $3,500,000,000 as compared with $750,000,000 collected for the fiscal year ended June 30, 1917. The Commissioner of Internal Revenue is responsible to the financial executive of the country, the Secretary of the Treasury. The Secretary has called to the Com- missioner's assistance two advisory boards, (1) the Legal Advisory Board and (2) the Excess Profits Ad- visory Board. The Legal Advisory Board is composed of a number of the leading lawyers of the United States. This Board will advise the Treasury Department in all legal 17 18 INCOME AND FEDERAL TAX REPORTS matters arising through the enforcement of the vari- ous tax laws. The members of the Excess Profits Advisory Board are: Representative Cordell Hull, a member of the House Committee on Ways and Means; T. S. Adams, economist, of Yale University; Wallace D. Simmons, President, Simmons Hardware Co., of St. Louis and Philadelphia; J. E. Sterret, of Price, Waterhouse & Co., accountants, of New York City; S. E. Bertron, of Bertron, Griscom & Co., bankers, of New York City; E. T. Meredith, of Des Moines, Iowa, editor of Suc- cessful Farming; T. W. McCullough, editor of the Omaha Bee, of Omaha, Nebr. ; Stewart W. Cramer, of the National Association of Cotton Manufacturers, Charlotte, N. C, and Henry Walters, Chairman of the Board of the Atlantic Coast Line and Louisville & Nashville Railways. In announcing the appointment of the Board, Secre- tary McAdoo said: "The Government is fortunate in obtaining as advisors men of such broad vision and experience, who are patriotically interested in seeing that the money so vitally needed for war purposes is collected with the least inconvenience to the public and to business generally." The Internal Revenue Bureau is divided into six di- visions, each division in charge of a deputy commis- sioner or supervisor. The first three divisions take care of the regulations regarding the collection of the various taxes. The In- come, Excess Profits and Munitions taxes are under the supervision of one deputy commissioner. The Tobacco, Distilled Spirits, Capital Stock, and Estate taxes form the second division, the third division covering the Miscellaneous and Sales taxes. The deputy at the head of each division is charged with the duty of making all necessary regulations for the collection of the taxes under his control. The regulations issued by these ADMINISTRATION 19 deputies must have been approved by the Commis- sioner of Internal Revenue. The fourth department has charge of the actual col- lection of the tax. The head of this division has the official title of Supervisor of Collectors' Offices, and is responsible for organization, methods and personnel. The fifth division, under the Chief Revenue Agent, is in charge of the inspection of returns. The work of this department in seeing that the taxes are paid by every one subject to them is discussed in detail later in this chapter. The sixth division covers an entirely new phase of governmental activity. The creation of the Division of Business Cooperation is a recognition of the fact that the taxpayer as well as the government is interested in the methods of collecting the taxes. The work of this division is twofold; it is to act as an educator and also as an adjuster. It is estimated that 7,000,000 more people will file income tax returns for 1917 than did for 1916. It is necessary, therefore, to educate the public as to the requirements of the new law. The Division of Business Cooperation is conducting a na- tional campaign of education, cooperating with Cham- bers of Commerce, Boards of Trades, manufacturers' organizations and other volunteers. The second func- tion of the Division is to act as an adjuster between the tax payer and the government. All complaints and suggestions for improvements in the operation of the law will be handled through this department. How the tax laws are interpreted. In the administra- tion of the internal revenue laws by the Treasury De- partment, the Commissioner of Internal Revenue, with the approval of the Secretary of the Treasury, prepares sets of "Rulings" covering questions of interpretation and administration of the tax law, theretofore enacted by Congress. These rulings are given a number and are then known by that number. The last general com- 20 IX CO ME AND FEDERAL TAX REPORTS pilation of rulings on the Income Tax was issued on January 5, 1914, and is known as Regulations No. 33. From time to time the Commissioner of Internal Eevenue issues formal "Treasury Decisions" (the so- called "T. D.'s"). These have the approval of the Sec- retary of the Treasury and serve the purpose of ex- plaining some feature of the regulations or of the law itself. Besides these formal rulings, the Department, in answer to inquiries made by collectors or by taxpay- ers, usually through the collectors, gives mimeographed rulings or opinions, sometimes referred to as "Letters." These letters refer to matters not important enough to become the subject of a formal decision. The contents of some letters are given to the public and are taken into account in the explanation of various matters in this book. Whenever a rule or regulation is issued it supersedes previous rulings on the same subject. The Department has the power to make these rulings retroactive, since the rulings do not affect the law but merely interpret it. The Department, however, has in several cases re- frained from enforcing its ruling retroactively in cases where property rights would be affected as between dif- ferent persons or groups of persons. Court Decisions. Other decisions which affect the law are the interpretations of the court. If a taxpayer is dissatisfied with the ruling of the department he may bring an action in one of the District Courts, and may appeal from the decision of this court to the United States Supreme Court. The Department ordinarily will be guided by the decision of the final court, but of course may claim that the facts in any given case do not fit exactly the decision in the previous case. The taxpayer in such a case may be compelled to take his case to the court. How the law will be construed. The main purpose of the courts in deciding any case is to discover the true ADMINISTRATION 21 intent of the legislature and then give to the law such an interpretation as will carry out this intent. This does not mean that the court can go outside the law itself, as, for example, to the record of the debate contained in the Congressional Eecord, to inquire into the intent of the legislature. The intent is to be discovered from the use of the words, the general purpose of the act, and from general principles of justice. While the law will not be construed strictly in favor of the taxpayer, as in the case of the laws relating to crimes, the benefit of any doubt as to the true meaning of a clause will be given to the taxpayer. The courts, of course, will rely on their own previous opinions when applicable, and will even give weight to the rulings of the Treas- ury Department, especially ' to those of long standing. The court, however, will always make an independent inquiry into the meaning of the law and will not de- cide in favor of a Treasury Department ruling which seems clearly contrary to the meaning of the law. Taxes in outlying possessions. Under the 1916 law the tax applies to the "United States," which is construed, for the purpose of the Income Tax, to include "the United States, any Territory, the District of Columbia, Porto Eico, and the Philippine Islands." A resident of Porto Rico or the Philippine Islands would pay the taxes in those Territories, the internal revenue officers of which are given power to administer the law. Under the amendments contained in the In- come Tax law of October 3, 1917, however, the several legislatures of those Territories are given the right to amend or repeal the Income Tax law within their own boundaries, and inquiry must be made therefore in the respective territories concerning what action, if any, has been taken by the local legislatures and adminis- trative officers. Residents of the United States, how- ever, part of whose income is derived from investments in those Territories, should include such income in 22 INCOME AND FEDERAL TAX REPORTS their returns and pay their taxes in the district wherein they reside. The collection of the income and excess profits taxes. The actual collection of the taxes is handled by the local collectors of internal revenue. For the purpose of tax collection, the United States is divided into 64 collection districts, each district being in charge of a collector of internal revenue. A list of the districts, with the names and addresses of collectors, will be found in the appendix. Every person, firm or corporation required by law to file a return for any tax should file the return within the required time with the collector of internal revenue for the district in which they reside or have their principal place of business. When a return is filed it is examined to see if it is properly prepared. If there are any gross errors the return may be sent back to be corrected. If a new re- turn is made out, the old return, showing the date of its receipt, should also be returned to the collector to avert the possibility of the assessment of a penalty for failure to file the return on time. The amount of tax is then calculated and the returns are listed for assess- ment on what is known as the monthly list. The list and returns are forwarded to the Commissioner of In- ternal Revenue, who charges the local collector with the total amount of the tax, as shown by the list, which is then returned to the collector. Upon receipt of this list the collector sends each person or organization a bill for the amount of tax assessed (Form 647 or Form 17). The tax must be paid by a date fixed by law or within 10 days after the receipt of the first notice and demand (Form 17). Penalties. The law imposes various penalties for fail- ure to make returns, and for failure to pay the tax. For failure to file a return on time, except in case of sickness or accident, a penalty will be imposed of 50 ADMINISTRATION 23 per cent in addition to the amount of the tax. If a return is voluntarily made, without notice from the col- lector, and it is shown that the failure to file was due to a reasonable cause and not to wilful neglect, the penalty will not be imposed. If a false or fraudulent return is made, a penalty of 100 per cent of the amount of tax will be imposed. This penalty of 100 per cent is always computed upon the amount actually due. In the case of special taxes, the basis on which the 100 per cent penalty is computed may be one or more of the taxable occupations of the taxpayer not disclosed in his false return, or an addi- tional amount for the same occupation not disclosed by the false return. For failure to file the proper returns on or before March 1 of each year an individual or an agent is liable to a specific penalty of from $20 to $1,000, but the 50 per cent penalties for failure to make return will not be assessed against delinquent withholding agents. Any individual or any officer of a corporation required to make or verify any return who makes an intentionally fraudulent return is guilty of a misde- meanor and is subject to a fine not exceeding $2,000 or imprisonment, or both, in the discretion of the court, and must also pay the cost of the proceedings. If any corporation refuses or neglects to file a re- turn in time, or makes a false or fraudulent return, it is liable to a specific penalty of not exceeding $10,000. On any taxes remaining unpaid for 10 days after no- tice and demand by the collector there is added a pen- alty of 5 per cent of the amount of the tax, and inter- est at the rate of 1 per cent a month until it is paid. If a claim for abatement is made the 5 per cent penalty is stayed until the claim is rejected. More than one of these penalties may be incurred in connection with the same return. If all the facts caus- ing the different penalties are known all the penalties 24 INCOME AND FEDERAL TAX REPORTS will be assessed at the same time, but the assessing of only one penalty is no bar to the assessing of another penalty for the same return at a future date. Checking up taxpayers. Section 3172 of the Revised Statutes provides that "every collector shall, from time to time, cause his deputies to proceed through every port of his district and inquire after and concerning all persons who are liable to pay any internal revenue tax, and all persons owning or having the care and man- agement of any objects liable to pay any tax, and to make a list of such persons and enumerate said ob- jects." Various methods are used by the collectors in com- pliance with this provision of the law as it is applied to the Inheritance Income Tax. Under the 1916 law, with exemptions of $3,000 and $4,000, the local collec- tors would make up lists of all purchasers of auto- mobiles, etc., of all persons occupying apartments rent- ing for over $1,000 a year, and other similar lists of people who would seem to be having an income of $3,000. With the exemption reduced to $1,000 and $2,000, the work of the collectors will be more difficult. The new provision, however, regarding information at the source, will undoubtedly furnish a check on almost every person liable to the tax. When a collector has information indicating that any person in his district has neglected to file a return he may send out the following form letter: Sir: This office is in possession of information which indicates that for the taxable period January 1 to December 31, 1917, you were in receipt of aa income subject to the income tax. The records of this office do not show that you have made and filed a return of income for this taxable period. Under the authority of section 3173, Revised Statutes of the United States, as amended and made part of the Income Tax Law, you are re- quested and required to make and file, within ten days after the date of this letter, a return of your income for the period January 1, 1917, to De- ADMINISTRATION 25 cember 31, 1917, inclusive, in accordance with Income Tax Form 1040, two copies of which are herewith enclosed. Should you fail to make and file a return of income within the time herein limited it is made the duty of the Collector "to summon such per- son, or any other person having possession, custody or care of books of account 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 inter- rogatories, under oath, respecting any objects liable to tax or the returns thereof." Paragraph K of the Income Tax Law confers jurisdiction upon the dis- trict courts of the United States for the district within which any person summoned under this section to appear to testify or to produce books shall reside, to compel attendance, production of books, and testimony by appro- priate process. Respectfully, (Signature) Collector. Right of collector to make returns. Where no return is filed or where the return is false or fraudulent the collector has the right to examine the books and rec- ords of the individual or corporation and make up a return from such information as he can secure. Such a return is held prima facie good for the purpose of assessment and for all legal purposes. The United States District Courts are given juris- diction on any suits arising under the Income Tax Law, and have the power to compel the attendance of wit- nesses and the production of books and testimony. Second notice of tax assessment. In the event of fail- ure to pay the tax on or before due date a second no- tice is sent to the taxpayer immediately following the due date. This notice, which is very similar to the first notice, reads as follows: Having failed to make payment of taxes set forth opposite, within the prescribed time of notice and demand on Form 17, there has attached a 5 per cent penalty on said tax and interest at 1 per cent per month from date given below, demand is made for said taxes, penalty, and such inter- est as may accrue before payment. If payment is not made within 10 days from the above date, it will be my duty to collect the same with costs by seizure and sale of property. Date interest began Collector of Internal Revenue. 26 INCOME AND FEDERAL TAX REPORTS Receipts for payment of taxes. In the case of stamp taxes, the placing of the stamp on the document or commodity taxed is sufficient evidence of payment. On all other taxes the collector is required to give an official receipt. This official receipt is the only receipt that will be accepted by the Department as evidence of the payment of the tax. Deputy collectors may sign personal receipts or voucher receipts, but these are merely for the con- venience of the taxpayer, and are not official receipts. Auditing and investigation of return. After the re- turns are checked against the assessment lists at Wash- ington they are turned over to the Chief Revenue Offi- cer for auditing. The returns are checked first for mathematical accuracy, second for compliance with the law, and third for evidence of fraud. Any mathe- matical errors on the return are corrected, and if nec- essary an additional assessment is made. Where the return does not give all the required in- formation or where there is evidence of fraud an ab- stract of the return is made and turned over to the supervisor of the field force of the district in which the return was filed, for investigation. This field force of investigators now numbers about 1,100 men, but it is being rapidly increased, and by the middle of 1918 will no doubt number about 2,500 men. It is impossible to say just what items will cause an investigation of a return. As a general rule, the most frequently investigated items are expenses, losses, bad debts and depreciation. The examining officer has the right to examine the books and records of the person or corporation making the report to determine their ac- curacy. On the basis of his investigation he either reports the original return correct or makes recom- mendation for assessment of additional tax, as dis- closed to be due. The salaries of these inspectors are in no way dependent upon the amount of additional tax ADMINISTRATION 27 assessed as a result of their investigations. The results show that there are very few cases of intentional fraud, and that most incorrect returns are due to a misun- derstanding of the requirements of the Treasury De- partment. "Where a revised return or assessment of tax is made because the former one is held to be false or fraudu- lent the taxpayer cannot question the new assessment unless he proves that the original return was correct. This provision also applies in cases of additional assess- ments made as a result of examinations of the taxpay- ers' books of account which disclose additional tax due. Claims for refund and abatement of taxes. All taxes erroneously or illegally assessed or collected, all pen- alties collected without authority, and all taxes that appear to be unjustly assessed or excessive in amount, or in any manner wrongfully collected, will be re- funded to the taxpayer if they have already been paid, or abated, if payment has not been made. Claims for the refunding of assessed taxes and pen- alties must be made out upon Form 46, prescribed for that purpose. The burden of proof rests upon the claimant. All the facts relied upon in support of the claim should be clearly set forth under oath. The claim should be still further supported by the attach- ment thereto of the receipt or stamp issued in the pay- ment of the tax. Claims can now be made for refund of taxes paid under the act of August 5, 1909, act of October 3, 1913, and act of September 8, 1916, if the question involves a review of the return, notwithstand- ing the two-years' "Statute of Limitations" under the provisions of section 3228 of the Revised Statutes of the United States. Such claims should be filed with the collector of internal revenue in the district wherein the tax was paid for which claim for refund is made. A claim for abatement of tax must be filed on Form 47. The claim must be sustained by the affidavits of 28 INCOME AND FEDERAL TAX REPORTS the party against whom the tax was assessed or of other parties cognizant of the facts, and must be ac- companied by the affidavit of the deputy collector and the collector of the division in which the claim arose. Suit to restrain assessment or collection of taxes. Sec- tion 3224 of the Bevised Statutes provides that "no suit for the purpose of restraining the assessment or collection of any tax shall be maintained in any court." If an assessment is made which the taxpayer be- lieves is excessive he may file a claim for abatement. If that is refused he must pay the tax. He may then enter a claim for a refund, and if that is refused his only recourse is the courts. Suits for recovery of taxes wrongfully collected. No suit will be maintained in any court for the recovery of taxes wrongfully collected unless an appeal has been made to the Commissioner of Internal Eevenue in the manner explained above, and a decision obtained. If, however, the decision is delayed more than six months from the date of the appeal suit may be brought with- out awaiting the decision of the Commissioner. Compromises. The Commissioner of Internal Eev- enue is permitted to compromise any civil or criminal case arising under the internal revenue laws before commencing suit thereon, and also after the instituting of suit by the Government. Secrecy of returns. The law provides that "it shall be unlawful for any collector, deputy collector, agent, clerk or other officer or employee of the United States to divulge or to make known in any manner not pro- vided 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, expen- ditures, or any particular thereof, set forth or dis- closed in any income return, or to permit any income return or copy thereof or any book containing any ab- ADMINISTRATION 29 stract 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 man- ner whatever not provided by law any income return or any part thereof or source of income profits, losses, or expenditures appearing in any income return. An offense against the provision is a misdemeanor and is punishable by a fine not exceeding $1,000 or by impris- onment not exceeding one year, or both, at the discre- tion of the court, and if the offender is an officer or employee of the United States he will be dismissed from office or discharged from employment. Use of returns for public records. The following rules and regulations for the inspection of returns have been made by the Secretary of the Treasury, with the ap- proval of the President, and published as T. D. 2016: 1. The return of every individual and of every corporation, joint stock company or association, and' every insurance company, whether foreign or domestic, shall be open to the inspection of the proper officers and em- ployees of the Treasury Department. Returns of individuals shall not be subject to inspection by any one except the proper officers and employees of the Treasury Department. 2. Where access to any return of any corporation is desired by an offi- cer or employee of any other department of the Government, an application for permission to inspect such return, setting out the reasons therefor, shall be made in writing, signed by the head of the executive department in which such officer or employee is employed, and transmitted to the Secretary of the Treasury. If the return of a corporation is desired to be used in any legal proceedings other than those to which the United States is a party, or to be used in any manner by which any information contained in the re- turn could be made public, the application for permission to inspect such return or to furnish a certified copy thereof shall be referred to the Sec- retary of the Treasury. 3. All returns, whether of persons or of corporations, joint stock com- panies or associations, or insurance companies, may be furnished, upon approval of the Secretary of the Treasury, for use, either in the original or by certified copies thereof, in any legal proceedings before any United States grand jury or in the trial of any cause to which both the United States and the person or corporation or association rendering the return are parties either as plaintiff or defendant, and in the prosecution or de- fense or trial of which action, or proceeding before a grand jury, such re- turn would constitute material evidence, but in any case arising in the col- lection of the income tax, the Commissioner of Internal Revenue may fur- 30 INCOME AND FEDERAL TAX REPORTS nish for use to the proper officer either the original or certified copies of returns without the approval of the Secretary of the Treasury. In all cases where the use of the original return is necessary, it shall be placed in evidence by the Commissioner of Internal Revenue or by some officer of the Bureau of Internal Revenue designated by him for that purpose, and after such original return has been placed in evidence it shall be returned to the files in the office of the Commissioner of Internal Revenue at Washington, D. C. 4. The Secretary of the Treasury, at his discretion, upon application to him made, setting forth what constitutes a proper showing of cause, may permit inspection of the return, of any corporation, by any bona-fide stock- holder in such corporation. The person desiring to inspect such return shall make application, in writing, to the Secretary of the Treasury, set- ting forth the reasons why he should be permitted to make such inspection, and shall attach to his application a certificate signed by the president, or other principal officer, of such corporation, countersigned by the secre- tary, under the corporate seal of the company, that he is a bona-fide stock- holder in said company. (Where this certificate cannot be secured, other evidence will be considered by the Secretary of the Treasury to determine the fact whether or not the applicant is a bona-fide stockholder and, there- fore, entitled to inspect the return made by such company.) Upon re- ceipt of such application the corporation whose return it is desired to inspect shall be notified of the facts and shall be given opportunity to state whether any legitimate reason exists for refusing permission to make such inspection. The privilege of inspecting the return of any corporation is personal to the stockholders, and the permission granted by the Secre- tary to a stockholder to make such inspection cannot be delegated to any other person. 5. The returns of the following corporations shall be open to the inspec- tion of any person upon written application to the Secretary of the Treas- ury, which application shall set forth briefly and succinctly all facts nec- essary to enable the Secretary to act upon the request: (a) The returns of all companies whose stock is listed upon any duly organized and recognized stock exchange within the United States, for the purpose of having its shares dealt in by the public generally. (b) All corporations whose stock is advertised in the press or of- fered to the public by the corporation itself for sale. In case of doubt as to whether any company falls within the classification above, the person desiring to see such return should make application, supported by advertisements, prospectus, or such other evidence as he may deem proper to establish the fact that the stock of such corporation is offered for general public sale. Returns can be inspected only in the office of the Commissioner of Internal Revenue, in Washington, D. C. In no case shall any collec- tor, or any other Internal Revenue officer outside of the Treasury Department in Washington, permit to be inspected any returns or fur- nish any information whatsoever relative to any return or any information secured by him in his official capacity relating to such ADMINISTRATION 31 return, except in answer to a proper subpoena, in a case to which the United States is a party. 6. Returns of individuals shall not be open to the inspection of any per- son other than the proper officers and employees of the Treasury Depart- ment or person rendering the same, and are under no conditions to be made public, except where such publicity shall result through the use of such returns in any legal proceedings in which the United States is a party. 7. Upon request of the governor of a State imposing a general income tax, the proper officer of such State, to be designated by name and official position by the Governor of such State, in his application to the Secretary of the Treasury, may have access to the returns or to abstracts thereof showing the name and income of each corporation, joint stock company or association, or insurance company, at such times and such manner as the Secretary of the Treasury may prescribe. Such application shall be in writing, addressed to the Secretary of the Treasury, and shall show (first) that the State, whose governor makes the request, imposes a general in- come tax; (second) the name and address of each corporation, etc., to which access is desired; (third) why permission to inspect the returns of the corporations, etc., named in the request is desired; and (fourth) what officer or officers are designated to make the desired inspection, giving their names and official designations. Such request must be signed by the gov- ernor of the State and sealed with the seal thereof, and shall be transmitted to the Secretary of the Treasury for his consideration and action thereon. No provision is made in the law for furnishing a copy of any return to any person or corporation, and no copy of any return will be furnished to any other than the person or corporation making the return, or their duly constituted attorney, except as hereinbefore authorized. The provisions herein contained shall be effective on and after the 1st day of September, 1914. W. G. McAdoo, Secretary of the Treasury. Approved : Woodbow Wilson, The White House, July 28, 1914. (T. D. 2016.) CHAPTER III INDIVIDUAL INCOME TAX Income Tax laws now in effect. In February, 1913, the Sixteenth Amendment to the Constitution of the United States became effective. This amendment gave to Con- gress the power "to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States." In October, 1913, the first income tax was repealed and a new law substituted. This law is still in effect. On October 3, 1917, Con- gress passed the so-called War Revenue Law. This act amended the 1916 law in a number of important matters, and among other things imposed an additional "War Income Tax." Income for the calendar year of 1917 is therefore subject to the combined taxes jmposed by the 1916 and the 1917 laws. The exemptions allowed under the "War Income" Act are considerably lower than under the 1916 law, and it is estimated by the Treasury Department that 7,000,000 more people will pay the income tax under the new law than paid under the old law. WHO MUST FILE REPORTS Returns required. Under the law as it is in effect for the year 1917 returns * of net income will be re- quired of: i The word "return" frequently is used in discussion of the income tax. No definition is given since the word has come to have a fairly well defined meaning in connection with the administration of tax laws. A "return"' is simply the sworn, signed statement of a person, which is to be filed or "returned" to the proper tax office that there may be calculated the amount of tax that the person making the return will be obliged to pay. 32 INDIVIDUAL INCOME TAX 33 1. Every individual, a citizen or resident of the United States, having a net income of: (a) $1,000 or over if unmarried, or married but not living with husband or wife. 1 (b) $2,000 or over if married and living with hus- band or wife. 2 If the husband and wife have separate incomes, each may report their in- come separately, or they may report their combined income on one return. In the lat- ter event, the normal 3 tax is computed upon the joint income, but the super-tax is com- puted only upon the separate income of each. If the income of husband and wife to- gether, or of husband, wife and minor chil- dren together, or of parent and minor chil- dren together exceeds $5,000, a separate re- port should be filed for the income of each. Otherwise, it is possible that the super-tax may be imposed on the joint income, whereas, the intention of the law is that the super-taxes be imposed only on the separate incomes. 2. Every non-resident alien having a net income from sources within the United States regard- less of the amount or character of such net in- come. 4 i In so far as the exemption from filing a return is concerned the Treas- ury Department treats a married person not living with husband or wife as if unmarried. The fact that an individual is treated as unmarried for the purpose of filing a return does not prevent such individual from taking advantage of the specific exemption of $2,000. There will undoubtedly be a number of cases where a return will be required but where no tax will be levied. * No return of net income will be required of husband and wife living together during the year 1917 and subsequent years when the separate in- come of either exceeds $1,000 but the combined income does not equal or exceed $2,000. 3 See Chapter on Rate of Tax, p. 126. * From the rulings of the Department it might seem that no returns will be required of non-resident aliens having an income from sources 34 INCOME AND FEDERAL TAX REPORTS No returns, however, are required of foreign gov- ernments receiving income from investments in the United States in stocks, bonds or other do- mestic securities owned by such foreign govern- ments, or from interest on deposits in banks in the United States belonging to foreign govern- ments. 3. Every executor or administrator for: (a) The net income of a decedent from January 1 to the date of his death, provided such in- come was $1,000 or over (or $2,000 or over in case the decedent was married and living with husband or wife at time of death). (b) Net income received by the estate during pe- riod of administration or settlement, the in- come of which is distributed annually to beneficiaries, provided the amount paid to any one beneficiary equals $1,000 or $2,000 according to the marital status of the bene- ficiary, and where more than one beneficiary is shown on the return the lowest exemption would determine the liability for the purpose of making a return. (c) Income of any trust estate not distributed, pro- vided it is $1,000 or over. It should be within the United States of less than $3,000. This mistake is caused by the fact that under the law of September 8, 1916, non-resident aliens were not required to file a return unless their income was $3,000 or over. They were also allowed the specific exemption of $3,000 or $4,000. By the amend- ments of October 3, 1917, the right to the specific exemption was taken away and for the year 1917 non-resident aliens are therefore taxed on their entire taxable net income. It is true that the normal tax of 2 per cent, on all income accruing in the United States to non-resident aliens is to be withheld at the source, but there are any number of circumstances where this withholding is impracticable. To protect itself, the Treasury Depart- ment will require returns of every non-resident alien for his entire taxable income derived from all sources in the United States, corporate or other- wise, regardless of the character or amount of such income. 'INDIVIDUAL INCOME TAX 35 noted, however, that no exemption is allowed to estates of non-resident alien decedents. 4. Fiduciaries acting for minors or other incom- petents, provided the net income is $1,000 or $2,000, according to their marital status. Definition of "every individual." "Every individual" means every person of lawful age, regardless of sex. The income of a dependent child under the age of 18 should be included with that of the head of the family, who is allowed an additional deduction for every child so dependent (see specific exemption, discussed later), unless such income was derived from a separate estate under control of a guardian, trustee or other fiduciary. Income of a minor or incompetent, derived from a sepa- rate estate, must be reported by his legal represen- tative. The status of an individual as to whether such in- dividual must file a return when income equals $1,000 but is not in excess of $2,000 is determined by the status as of the end of the year for which the return is filed. It must be borne in mind that the exemption from filing a return is not on the same basis as the specific exemption allowed from the normal tax. To illustrate: A, who is supporting a crippled brother, has an income of $1,500. As the head of a family (defined on p. 130), he is allowed a specific exemption of $2,000. He must, nevertheless, file a return, because his income is in excess of $1,000 and he does not come within the clas- sification of "married and living with husband or wife." Payment of income taxes to foreign countries does not exempt from tax. Any individual subject to the income tax is not relieved from liability to the tax by reason of the fact that such individual is also subject to the income tax laws of other countries. 36 INCOME AND FEDERAL TAX REPORTS Meaning of "State" and "United States." The 1916 In- come Tax law provides: "That the word "State" or "United States," when used in this title, shall be con- strued to include any territory, the District of Colum- bia, Porto Eico, and the Philippine Islands, when such construction is necessary to carry out its provisions." The act of October 3, 1917, states distinctly that its provisions do not extend to Porto Rico and the Philip- pine Islands. Residents of the Philippine Islands and Porto Rico are therefore subject to the tax only at the rates im- posed by the 1916 law. Citizenship. Citizens born in the United States, even though they have resided abroad for a number of years, will for taxing purposes be considered citizens of the United States, unless they have definitely renounced their citizenship. But under the provisions of an act dated March 2, 1907 (sec. 2), a naturalized citizen raises the presumption of expatriation by his protracted residence abroad. The Treasury Department, however, has held that "an individual's native or naturalized status remains unless changed by affirmative action or forfeited by an overt act." Thus, cases may arise where an individual will be held by the State Department to have expatriated himself by reason of his protracted residence abroad and at the same time will be held by the Treasury Department as subject to the income tax as a citizen of the United States. It will be noted that if a woman marries a foreigner she takes the nationality of her husband. When is an alien "resident" in the United States. "Residence" is held to be "that place where a man has his true, fixed and permanent home and principal es- tablishment and to which, whenever he is absent, he has the intention of returning; and indicates permanency of occupation as distinct from lodging or boarding, or temporary occupation." INDIVIDUAL INCOME TAX 37 Where, for business purposes or otherwise, an alien is permanently located in the United States; has there his principal business establishment and is there per- manently occupied or employed, even though his domi- cile may be without the United States, he will be con- sidered a resident of the United States. But aliens who are physically present in the United States, and only temporarily resident or employed therein (as for a season or other similarly definite term, and with the expectation or intention of leaving the United States upon the termination of employment or accomplishment of the purpose which necessitated their presence in the United States), are not considered "residents" of the United States for income tax pur- poses. Practical effect of distinction between "residents and citi- zens of the United States" and "non-resident aliens." A person who is considered a citizen or resident of the United States is subject to the income tax at the rates provided in both the September 8, 1916, act and the October 3, 1917, act, and must report all income from all sources within or without the United States. Such individuals, however, are allowed the specific exemp- tions of $3,000 or $4,000 as provided in the 1916 law and of $1,000 or $2,000 as provided in the 1917 law. A person who is a non-resident alien is subject to the 2 per cent normal tax of the 1916 law, but not to the 2 per cent normal tax imposed by the 1917 law, but he is subject to the super-tax imposed by both laws. How- ever, he need report only such income as arises from sources within the United States. Such individuals are not entitled to any personal exemption. That is to say, they are taxed on their entire net income arising from sources within the United States. What is net income? In order to determine whether or not an income tax return should be filed, the net in- come must first be ascertained, by deducting from the 38 INCOME AND FEDERAL TAX REPORTS gross income (not including exempt items, which need not be reported), the following items, subject to the regulations of the Treasury Department: 1. Business expenses. 2. Interest paid. 3. Taxes paid. 4. Losses incurred. 5. Bad debts. 6. Depreciation. Summary outline. The scheme of the Individual In- come Tax law and of its administration will possibly be clearer to the reader after he has studied carefully the following outline, which is given partly by way of summary of what has already been said and partly in anticipation of questions yet to be taken up. Individuals : A. Those who file no report. 1. Unmarried, or married but not living with spouse, and having income of less than $1,000. 2. Married and living with spouse but having joint income (of individual and spouse) of less than $2,000. B. Those who file a report. 1. Unmarried, or married but not living with spouse and having income of $1,000 or more. 2. Married and living with spouse and having joint income of $2,000 or more. 3. Non-resident aliens, regardless of amount of income. Items of Income: A. Exempt items those which should not be re- reported. B. Partially exempt items those which must be reported but which may be subject to only a INDIVIDUAL INCOME TAX 39 part or parts of the tax. The total tax pay- able for the year 1917 may really be divided into four parts: (1) the normal tax of the 1916 law; (2) the super-tax of the 1916 law; (3) the normal tax of the 1917 law; (4) the super-tax of the 1917 law. C. Fully taxable items those items which are to be reported and are subject to all the taxes. EXEMPT INCOME NOT REPORTABLE Income exempt from taxation and which may be omitted from the income tax reports. The Income Tax law, sec. 4, exempts the following items of income: 1. (a) The proceeds of life insurance policies paid to individual beneficiaries upon the death of the insured; (b) the amount received by the insured as a return of a premium or of premiums paid by him under life in- surance, endowment, or annuity contracts, either dur- ing the term or at the maturity of the term mentioned in the contract or upon surrender of the contract. 2. The value of property acquired by gift, bequest, devise or descent. But the income from such property must be reported as income. 3. Interest upon the obligation of a State or any po- litical subdivision thereof or upon the obligations of the United States (but in the case of obligations of the United States issued after September 1, 1917, only if and to the extent provided in the act authorizing the issue thereof) or its possessions, or securities issued under the provisions of the Federal Farm Loan act of July 17, 1916. 4. The compensation of the present President of the United States during the term for which he has been elected. 5. The compensation of the judges of the Supreme and inferior courts of the United States in office as of October 3, 1917. 40 INCOME AND FEDERAL TAX REPORTS 6. The compensation of all officers and employees of a State, or any political subdivision thereof, except when such compensation is paid by the United States Government. Proceeds of life insurance policies. When the proceeds of insurance policies are paid to a beneficiary other than the insured these proceeds are entirely exempt. But where the amount returned on a life insurance, endowment or annuity contract is paid to the person making the contract, either upon the maturity or sur- render of the contract, the amount by which the sum received exceeds the sum paid is (according to the ruling of the Treasury Department) income, and should be reported as such. To illustrate: A takes out a twenty-year endowment policy, the premium of which is $40 a year, payable to his wife upon his death if it should occur prior to the termination of the twenty- year period. He received dividends on his policy aver- aging about $2 a year. Should he die before the ex- piration of the twenty-year period, his wife is not re- quired to include the amount received ($1,000) as in- come. If he lives to collect the $1,000 he must return as income the difference between the amount received, $1,000, and the amount paid in, [20 X $38 ($40 $2)], $760, or $240. Annuities. Where annuities are purchased by the an- nuitant for a lump sum the same rule holds. So much of the annuities paid to the annuitant as represents payments made by him on an annuity contract and re- turned to him is not to be included as income of the annuitant. Any increment on the purchase price of an annuity is taxable income. To illustrate : An annuity of $3,500 is purchased for the lump sum of $45,000. The annuitant would not have to include the annuity in his income for the first twelve years of the contract, at the end of which time he would have collected $42,000. In the thirteenth year he would report as income $500 INDIVIDUAL INCOME TAX 41 the difference between the total amount received by him up to that time ($45,500) and the original amount which the annuity had cost him ($45,000). Thereafter he would include the entire annual payment of $3,500 as income. Dividends from life insurance policies. Dividends paid on life insurance policies that have not matured, whether such dividends are drawn in cash by the in- sured or applied to the reduction of the premium due, are not considered items of taxable income under the law, and should be excluded from a return of income. Dividends from paid-up policies, however, are consid- ered income to the recipient, and must be included in the annual return of income as such. Value of property acquired by gift, bequest, devise or descent is exempt. While the value of property ac- quired by gift is not subject to the income tax, all gains, profits, or income derived therefrom are subject to the tax, and if the property so acquired is subse- quently sold at a price greater than the appraised value at the time the property was acquired by gift, if acquired subsequent to March 1, 1913, the gain in value is held to be income and is subject to the tax. If the property was acquired by gift prior to March 1, 1913, and sold thereafter, the gain, if any, is the difference between the market value March 1, 1913, and the sell- ing price. Any increment in the value of the property prior to March 1, 1913, need not be reported and is exempt from tax. Meaning of "Political subdivision of a State." The law exempts from the tax interest on obligations of a State or any political subdivision thereof. The term "po- litical subdivision" includes special assessment districts or divisions of a State created by the proper authority of the State acting within its constitutional powers and under its general laws, for the purpose of carrying out a portion of those functions of the State which by long 42 INCOME AND FEDERAL TAX REPORTS usage and inherent necessities of government have al- ways been regarded as public. This definition is very broad and includes cities, towns, villages, school dis- tricts, road districts, levee districts and other special assessment districts created under the laws'of the State for public purposes, such as the improvement of streets and highways, the provision of sewerage, gas and light, and the reclamation, drainage or irrigation of bodies of land within such special assessment districts, provided such districts are for public use. But where a municipality purchases a public utility subject to a mortgage, the mortgage retains its original character, even though the municipality assumes the mortgage and pays the interest thereon. The indebt- edness secured by such a mortgage is not an obliga- tion of a "political subdivision" of a State, and the in- terest therefrom is not exempt from tax. Exemption of income on bonds of the United States. Interest upon the obligations of the United States or its possessions issued prior to September 1, 1917, is entirely exempt from the tax, and need not be included in the return of income. Interest on any obligations issued subsequent to that date is exempt only if such exemption is provided for in the law authorizing their issue, and then only to the extent authorized. Interest on bonds of the second Liberty Loan, on Treasury Certificates of Indebtedness and on the new War Savings Certificates issued under the act of Sep- tember 24, 1917, should be included in the return to the extent that such interest is on a principal amount of such securities in excess of $5,000. This is because the inter- est is exempt only from the normal tax, and from the super-tax to the extent of the interest on $5,000 par value of the bonds or certificates. Interest on the first Liberty Loan bonds, i.e., the Sy 2 s, is exempt and need not be reported. INDIVIDUAL INCOME TAX 43 Compensation of judges of U. S. Supreme Court and in- ferior courts exempt. The exemption of the compensa- tion of the judges of the Supreme and other courts of the United States (i.e., Federal Courts), applies only to those in office prior to October 4, 1917. The salary of all judges appointed subsequent to that date is subject to income tax. Exemption of State officers and employees. The com- pensation of all employees of a State or of any po- litical subdivision thereof (for definition of political subdivision see p. 41, ante), are exempt. But when State employees are compensated by the United States, such income is taxable. It must be borne in mind that an individual who enters into a contract with a State, or any political subdivision thereof, for the construction of a public highway or other public works, is held not to be an officer or employee of the State or political subdivision thereof. Therefore, the amounts received by him from the State or political subdivision thereof, under the terms of the contract, are not exempt from tax under the provisions of the Federal Income Tax law, and should be included in any return of annual net income which the contractor may be required to render. Of course, it follows that employees of such a contractor are not employees of a State or of any political sub- division thereof. They, too, must include the compen- sation received from the contractor in any return re- quired. Salaries of government officials of Porto Rico, the Philip- pine Islands and the District of Columbia. Income of offi- cials of Porto Rico, the Philippine Islands and the Dis- trict of Columbia or any political subdivision thereof is not exempt from the tax, and must be included in the return filed. 44 INCOME AND FEDERAL TAX REPORTS INCOME TO BE REPORTED Gross income. The gross income of an individual in- cludes all gains, profits and income derived from sala- ries, wages, or compensation for personal service of whatever kind and in whatever form paid; or from professional vocations, business, trade, commerce, or sales; or from dealings in property, whether real or personal, growing out of the ownership or use of or interest in real or personal property; also from inter- est, rent, dividends, securities, or the transaction of any business caried on for gain or profit, or gains or profits and income derived from any source whatever. Non-resident aliens. But the non-resident alien need report only such income as arises from sources within the United States. The phrase "from sources within the United States" is very broad. It includes income from sales of goods to residents within the United States, royalties received on patents used in manufac- turing goods in the United States, and interest on bonds and dividends on stock of domestic corporations owned by non-resident aliens, even though the securities them- selves are physically located and payable outside of the United States. 1 The fact that income is paid in the United States does not necessarily mean that the source of the income is in the United States. Interest on bonds and divi- dends on the stock of a foreign corporation, for exam- ple, even though paid in the United States, is not in- come from sources within the United States, and should not be included in the report filed by the non-resident alien. Income earned prior to March 1, 1913, not taxable. The intention of the Income Tax law is to tax all income earned by individuals subsequent to March 1, 1913. The general practice is to tax the income received in i See also pp. 171, 172. INDIVIDUAL INCOME TAX 45 any year, at the rates in effect at the time the income is reported. Partnership profits, however, are required to be reported when earned, regardless of whether they are distributed or not. (See Partnership Income, page 71 post.) Where the income received is partly earned prior to March 1, 1913, and not received by the person making the return until the year 1917, the bur- den of showing what part of the income was actually earned prior to March 1, 1913, is upon the taxpayer. Income earned in previous years. Where the income which is reported in the year received was earned in a previous year or years, the question arises as to whether the income should be taxed at the rates in effect for the year in which it was earned or those in effect for the year in which it was reported. The an- swer is, that in such a case the individual must pay the tax at the rate in effect at the time the income is re- ported. The taxpayer, to be sure, has the privilege of reporting his income when earned, instead of when re- ceived, but the Department correctly holds that if he does not take advantage of this privilege he must pay the tax at the rates in effect at the time when the in- come is received and reported. Dividends received from corporations are an excep- tion to this rule. The taxpayer does not have any option as to the time of reporting such income. The income is not earned by him until received, though, as a matter of fact, the income represented by the divi- dends may have been earned by the corporation in a previous year. The Department, therefore, holds that dividends are taxable at the rates in effect in the year in which they were earned by the corporation. The burden of showing that the dividends were earned in years previous to that in which they were paid is, of course, upon the taxpayer, and it follows, therefore, that if the individual does not prove that the dividends were earned in previous years, they will be taxed at 46 " INCOME AND FEDERAL TAX REPORTS the rates in effect in the year in which they are re- ported. 1 In the case where an individual has been employed for the past three years at an annual salary of $5,000, but due to the financial condition of the employer he has received only $2,000 each year, and in 1917 he re- ceives all his back salary, plus the regular salary of $5,000, the total amount received in 1917 salary must be then included as income, unless it had been reported in previous years on an accrual basis. Income may be reported either when received or when earned. Section 1 of the Income Tax law of September 8, 1916, as amended, provides that the tax shall be lev- ied, assessed, collected, and paid annually "upon the entire net income received in the preceding calendar year from all sources." However, section 8, paragraph (g), further provides that, "any individual keeping ac- counts 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 Internal Eevenue, and 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." Thus, if an amount of salary earned during the year was not received until some date subsequent to De- cember 31st of that year, it need not be reported for the year in which it was earned, unless the individual has kept his accounts on an accrual basis in which he credited himself with that salary during the year in which it was earned. If the accrual basis of determin- ing income is used one year, it must also be used the following year. For example: A is employed at a salary of $500 a month, payable on the 15th of each month. His salary is raised to $750 a month begin- i See Dividends, p. 78. INDIVIDUAL INCOME TAX 47 ning the 15th of June, 1917. If he reported his 1916 income on the basis of cash received he will report for 1917 an income from salaries of $7,500. But if he re- ports his 1916 income on an accrual basis he will re- port for 1917 an income from salaries of $7,625. Classification of gross income. Gross income may be classified as arising from the following sources (each item is explained in full in the following pages) : 1. Salaries, wages and commissions. 2. Income from professions and vocations. 3. Profits from business, trade, and farm. 4. Profits from sales or dealings in property, whether real or personal. 5. Royalties from mines, oil wells, patents, franchises or other legalized privileges. 6. Rents. 7. Interest on notes, mortgages, bank deposits, other than included in class 8 or 9, below. 8. Interest on bonds, mortgages, or deeds of trust, or other similar obligations of domestic corporations, joint- stock companies or associations, and insurance com- panies. 9. Income of fiduciaries in their trust capacity (ex- cept dividends from domestic corporations and interest on second Liberty Bonds). 10. Partnership gains or profits (excluding dividends and interest on second Liberty Bonds). 11. Interest and dividends upon securities of foreign corporations. 12. Miscellaneous income or income from other sources. 13. Dividends on stocks and interest on second Lib- erty Bonds. (a) Received directly. (b) Received through partnership. (c) Received through fiduciaries. 48 INCOME AND FEDERAL TAX REPORTS SALARIES, WAGES AND COMMISSIONS Salaries, wages and commissions. Our first subdivision of gross income is salaries, wages and commissions and other compensation of the individual during the year. As has been indicated, salaries of officers or employees of the State or of any political subdivision of the State and of certain federal officials are exempt from taxa- tion and need not be included in the report. The compensation may be in cash or its equivalent. The compensation of an individual need not be money; it may take the form of living quarters, light, board, use of special privileges, etc. The value of such extra com- pensation should be calculated or determined and in- cluded in the return as part of the salary or compensa- tion. The Treasury Department has stated that where an individual is provided with living quarters in addi- tion to his salary, the rental value of the living quar- ters is regarded as compensation subject to the income tax. In some cases it is difficult to determine whether or not the granting of special privileges is part of the compensation. Furnishing a salesman with the use of a car for business purposes would not be compensation, even though he is permitted to use the car for per- sonal purposes. The test of whether any particular item is received as compensation and therefore re- turnable in the report is this: "Is the item in lieu of some non-deductible expense, such as ordinary living expenses, that would otherwise be incurred?" If it is in lieu of such non-deductible expense it should be in- cluded as income to the extent of the expense that would otherwise be incurred. For example : A is an em- ployee living in a suburban town. Commutation to his place of business amounts to $100 a year. If A is given a pass over a railroad or is furnished with an automobile to go to and come from his business, he should report INDIVIDUAL INCOME TAX 49 the pass or use of the automobile as income to the ex- tent of $100. Quarters, mileage and expense of government officers and employees. The Treasury Department has issued the following instructions to government officers and em- ployees : "When quarters are furnished of a less number of rooms than the number allowed by law, the money equivalent only of the number of rooms actually as- signed shall be returned as income. When quarters are furnished of a greater number of rooms than the num- ber allowed by law, it is to be assumed that the excess number is assigned for the convenience of the Govern- ment, and the money equivalent only of the number of rooms allowed by law shall be returned as income." Heat and light. Amounts received by, or paid for, an officer for heat and light shall be returned as income. "This includes the money equivalent, as fixed by the Government, of heat and light furnished to an officer occupying public quarters (for residence purposes)." Mileage. The difference between the amount received as mileage and the amount of actual necessary expenses incurred on a journey is to be returned as income. The actual expenses to be deducted by the individual before ascertaining his gain, profit, or income on account of mileage are the expenses for which reimbursement would be made by the government if he had traveled on an actual expense basis instead of on a mileage basis. Reimbursement for actual expenses. Amounts re- ceived from the government to reimburse the individual for subsistence and other items of actual expenses in- curred while absent on business for the government are not required to be reported as income. The difference between the amount received as a per diem allowance and the amount of actual necessary ex- 50 INCOME AND FEDERAL TAX REPORTS penses incurred on a journey must be reported as in- come. Voluntary offerings received by clergymen should be con- sidered as income. Easter offerings, and fees received by clergymen for funerals, masses, marriages, baptisms, etc., are considered income subject to tax under the pro- visions of the Income Tax law, and must be reported. Christmas gifts, however, are not considered income within the meaning of the law and should not be in- cluded in a return. The theory probably is that all in- come except the Christmas gifts are earnings, while the Christmas gifts are in the nature of gratuities. Compensation of the trustee of any estate should be re- turned as income for the year in which received. If the amount due the trustee of any estate as compensation for his services over a period of years is not deter- mined until the trust is terminated, the amount the trustee is allowed should be return in full, as income for the year in which it is paid. It should not be pro- rated over the length of time during which he served as trustee. But if the trustee can show that part of this fee has been definitely earned prior to March 1, 1913, that part of the fee will be exempt from the tax and need not be reported. This rule also applies to administrators and executors of an estate. Expense allowances. Where an individual receives, in addition to his salary or commissions, an allowance for traveling or other expenses, there should be included as income any difference between the allowance and the amount actually paid for these expenses. The entire allowance may be included as income un- der the heading miscellaneous income, and the amount of expenses actually paid may be included in the deduc- tions as necessary expenses, or simply the difference may be reported. Salaries paid by exempt organizations are not exempt from the income tax. Salaries paid by corporations, INDIVIDUAL INCOME TAX 51 which have been held to be exempt from the income tax, are subject to the income tax and should be returned as income by the individuals receiving them. For ex- ample, the salary of an individual employed by a char- itable institution would not be exempt, though he is em- ployed by an exempt organization. Bonuses. If special payment is made to an employee and is a gratuity or voluntary payment, for which no service is rendered, the amount so paid may be con- sidered as a gift and need not be reported as income received. However, any bonus or other item of com- pensation paid to an employee in addition to his regu- lar salary or wages as additional compensation for services actually rendered, as a reward for past en- deavors, or as a stimulus to further zeal and enthu- siasm in the discharge of his duties, is held to consti- tute taxable income, which should be reported under gross income in the employee's report. The circum- stances under which such bonuses will be considered as being for services rendered are discussed more fully under allowable deductions for corporations. Wher- ever the employer may deduct from its income pay- ments such as bonuses to employees, the employee must report the amount so received as income. Whenever the employer is not permitted to make such a deduc- tion, the employee need not report the amount received. Christmas remembrances, anniversary gifts, etc., from an employer to an employee do not constitute such items as are considered taxable income, and need not be reported as income by the employee. Commissions received should be reported as income. Commissions received by salesmen are income and must be reported in the tax return of the salesman. Commissions received on renewal premiums for insur- ance are income when received, and must be reported in the period in which they are received. It follows that a commission retained by a life insurance agent on 52 INCOME AND FEDERAL TAX REPORTS his own life insurance policy is income accruing to the agent, and must be included in his personal return of income. Professional and vocational fees. The services of a professional man are usually of such a nature as to be compensated by fees, or else of such a nature that no portion of the amount becomes due until the service is completed. In such a case the total amount of the compensation should be included in the return for the year in which the compensation is received. However, if the person making the report keeps his books on an accrual basis, he may report his income during the year in which the fee becomes due, even though it is not received until a later year. If subsequently any of these fees should prove uncollectible they may be de- ducted as bad debts in the year in which they are found uncollectible. INCOME FROM BUSINESS, TRADE, OR FARM Income from business, trade, or farm. Our third sub- division of gross income is income received from busi- ness, trade, or farm. If an individual is engaged in business or trade, con- ducted by him as a sole proprietor, or is the owner of a farm, he should report the total amount of cash re- ceived from the sale of merchandise or farm products for the calendar year, regardless of the time of closing of the books of his business. If the individual keeps books upon the "accrual" basis he may report the amount of income "accrued," that is, earned but not yet received, instead of the amount of cash received. As against this he may de- duct expenses incurred but not yet paid. If the income is reported on a cash basis, only the expenses actually paid may be deducted. The individual may not report his income on one basis and his expenses on another. The cash received from the sale of merchandise is, INDIVIDUAL INCOME TAX 53 manifestly, not all profit, as neither the cost of the merchandise sold nor the expenses of the business have been considered. Accountants make a distinction between "gross" profit, which is the profit on the sale of merchandise, and "net" income, which is the profit after deducting the expenses of the business. The method of arriving at gross profit as used by account- ants is illustrated by the following example: Sales $100,000 Inventory at the beginning of the year $30,000 Add purchases 90,000 Total $120,000 Less inventory at end of year $40,000 Cost of goods sold 80,000 Gross profit on sales $20,000 To ascertain the net income of this business, all other expenses, such as rent and labor, would be deducted from the gross profit on sales. A form provided by the Treasury Department for the return of net income of individuals does not make this same distinction between gross profit and net in- come. The form provides for the stating of the total receipts as gross income and for the deduction of the various expenses, such as labor, rent, depreciation, etc. (all of which are covered in detail in a later sec- tion of this book). In the form, merchandise purchased is included among the expenses to be deducted, and no provision is made for stating the inventories at the be- ginning and at the end of the year. The amount of purchases, as may be seen by the illustration used above, does not of necessity represent the cost of the merchandise sold. The cost of merchandise sold is de- 54 INCOME AND FEDERAL TAX REPORTS termined by adding to the purchases the inventory at the beginning of the year and subtracting from the re- sulting figure the inventory at the end of the year. The net result of the transaction is to add to purchases the decrease in the inventory or to subtract from pur- chases the increase in the inventory. In the illustra- tion just used the inventory at the end of the year shows an increase of $10,000. This means that of the $90,000 worth of merchandise purchased $10,000 was not sold. Deducting $10,000 from $90,000 we have the cost of the merchandise sold, or $80,000. In the form provided by the Treasury Department this latter figure should be stated as the merchandise purchased for re- sale, and should be deducted from the income of the business. See also Chapter on "Eeturn and Computa- tion of Tax," pp. 142 and 148. Valuation of inventories. The most usual and by far the most conservative business and accounting practice is to value inventories either at cost or at market, whichever is lower. In past years the attitude of the Treasury Department was not in accord with this prac- tice, the Department insisting that the inventory of goods on hand be valued at cost, without regard to any change in market value. Eecently, however, the posi- tion of the department has been modified so as to per- mit the valuation of inventories either at cost, or at cost or market, whichever is lower. The effect of this de- cision is discussed at length under Corporations in a later chapter. Practical considerations governing inventory valuation. While the new decision gives every merchant the op- tion of deducting from his taxable income any loss he may have sustained due to a decrease in the market value of his merchandise or stock inventory, it is not always advisable for the merchant to exercise this op- tion. It is well to bear in mind that the inventory fig- ure reported at the end of one year must be used as INDIVIDUAL INCOME TAX 55 the inventory figure at the beginning of the following year. It is obvious, therefore, that any deduction from inventory valuations one year will be reflected in the following year's report, showing a corresponding in- crease in the income for the following year. Therefore, it is often better (to save taxes in a sub- sequent year) to value inventories at cost, even when market value is lower. Obviously, this is true when, even if the inventories are valued at cost, no profit will be shown. The loss in inventory value can then be deducted in some subsequent year (when the goods are sold below the cost), and diminish the taxable profits for that year. Moreover, if the profits are small this year, and much larger profits are anticipated the following year, it would probably save super-taxes, or excess profits taxes, in the later year to inventory the goods at cost this year. But if the company cannot afford to pay much in taxes this year, it should inventory its goods at market price (if market price is lower than cost) so as to keep down its taxable profits this year. The effect of val- uing inventories at market price, when that is lower than cost, is to decrease taxable profits for the current year, and practically to increase taxable profits for a future year. From a taxpayer's standpoint it is often advisable to ask himself the following question: "Should I in- ventory my goods at market price, and thus save taxes this year, and take a risk on next year's taxes, or at cost, assuming my profits will be larger or the tax rate will be greater next year?" Inventory at end of fiscal year. If an individual's gross profit from business is determined by an inven- tory taken at the end of a fiscal year other than the calendar year he must estimate his profits for part of the year so as to comply with the Department's regu- 56 INCOME AND FEDERAL TAX REPORTS lations requiring him to report his gross income for the calendar year. To illustrate: A takes inventory and closes his books November 30. In making his re- turn for the 10 taxable months of 1913, 1 he took nine- twelfths of his income for the fiscal year December 1, 1912, to November 30, 1913, and then estimated the profits for the remaining month (i.e., December, 1913) of the calendar year. The next year he took the dif- ference between the income for the full fiscal year and the estimated income for the month of December, 1913, and then added a new estimated figure for December, 1914. This method would be followed each year. In deter- mining his gross income for the calendar year 1917, A would take his gross income for the fiscal year ending November 30, 1917, deduct the amount estimated in pre- paring the return, as the gross income for the month of December, 1916, and add to the resulting figure the estimated profit for the month of December, 1917. Unless a perpetual inventory has been kept it will be necessary to estimate the gross income for the period between the close of the fiscal year and the close of the calendar year. The only reasonable method is to assume that the percentage of gross profit on sales for the period in question is the same as that actually determined for the preceding fiscal year. Business need not be lawful. The law of 1913 levied a tax on the gains from any lawful business. But the law of 1916 levies a tax on the gains from "business, trade, etc.," and the law does not specifically mention "lawful" businesses or trades. This would indicate that even though the business is of an unlawful nature the gains or profits should be reported. Income from partnership. Income from partnership interest in a business should not be reported under i The income tax law of October 3, 1913, levied a tax on the income of individuals for the 10 months only, from March 1, 1913, to December 31, 1913, because the sixteenth amendment did rot become effective until February 28, 1913. INDIVIDUAL INCOME TAX 57 this caption, inasmuch as it is reported under a separate caption. (See "Partnership Income," p. 71.) Other income. Income derived from the sale of or from dealings in property should be reported under this caption. If part of the business income is derived from interest, rents, royalties or dividends, such items should be shown under their respective captions. Partially completed contracts. If an individual enters into a contract in 1917 which will not be completed until 1918, and he is unable to determine what amount of gain or profit he will derive from the contract until its completion, any payments received thereon during 1917 need not be included as income for that year. Neither will the expenses incurred up to that time be included as a deduction. When the contract is com- pleted in 1918, the net gain or profit derived therefrom should be reported in the return for that year. Appreciation of book value of capital assets is not in- come. Any appreciation in the value of assets due to reappraisal or adjustment and so recorded on the books of the individual or corporation is not income until such appreciation, as a result of a completed and closed transaction, has been converted into cash or its equiva- lent. Until any appreciation taken up on the books has been so realized, it will not be considered income. Hence, in the preparation of returns and in the ex- amination of books for the purpose of verifying the same, mere book entries of appreciation in the value of capital assets will be disregarded. But in the event of the sale of the assets, the increase in whose value was previously taken up on the books, the profit or in- come to be reported (i.e., the taxable income) as a re- sult of the sale will be determined upon the basis of the difference between the cost and the selling price of the assets; that is to say, in the case of a sale, book values will be ignored except as such book values rep- resent the actual cost of the properties. For example, 58 INCOME AND FEDERAL TAX REPORTS an individual has a building which cost $100,000. Dur- ing the year 1916 an entry was made raising the value to $200,000, thereby creating a book profit of $100,000. This profit should not be included in income for the year 1916. During 1917 the property was actually sold for $175,000. The books of the individual for 1917 show a loss of $25,000. For the purpose of the income tax he must disregard his book figures and go back to the original cost. The measure of profit is the differ- ence between the original cost and the selling price, or $75,000, which should be reported as income for 1917. If the building was purchased prior to March 1, 1913, the measure of profit is the increase in fair market value above the fair market value as of March 1, 1913. Non-resident aliens method of determining profits from business in the United States. A non-resident alien, as has been explained hereinbefore, is required to report only such income as arises from sources within the United States. If the business from which the non- resident alien derives profit is conducted entirely within the United States, there is no question but that the en- tire profits from the business should be included as income from within the United States. The phrase "from sources within the United States" is very broad and would include the income from busi- nesses which maintain a selling office in the United States or which even send a salesman here. In such cases the profit on the orders taken in the United States must be reported. Where a separate record of the cost of the goods has not been kept, the only fair method is to presume that the same percentage of profit is made on business done in the United States as is made on the total business transacted. If the foreign individual does a total business of $1,000,000, of which $100,000 is in the United States, if the total cost of doing this business is $800,000, the profit to be reported as from the United States is the same per cent of the business INDIVIDUAL INCOME TAX 59 done in the United States as the total profit is of the total business. In this case the total profit is $200,000, or 20 per cent. The profit from sources within the United States would be 20 per cent of $100,000, or $20,000. If this method is used the special expenses incurred in the United States cannot be deducted, as they have already been included in determining the profit of the entire business. PROFIT FROM SALE OF LAND, BUILDINGS AND OTHER PROPERTY Profit from sale of real estate is subject to tax. For in- come tax purposes, where there has been an actual sale and transfer, profit will be considered as realized even though payment is to be made in installments; it is held that notes for deferred payments, secured by the title of the property, and bearing interest, are worth in cash, presumably, their face value. Therefore, the en- tire profits realized by individuals from the sale of real estate or other property will be taxable except where the property in connection with which the profit is ob- tained was acquired prior to March 1, 1913, and in that case the profit will be the difference between the sell- ing price and the fair market value of the property as of March 1, 1913. But where lots are sold on a monthly installment basis, and title remains in the seller until the last payment is made, and where a fixed amount is received each month in payment of the total purchase price, the monthly installment received must be consid- ered part profit and part cost. For example, let it be supposed that A sells 10 lots for $400 each, receiving $100 down and $5 a month on each lot. Let it be sup- posed, further, that the cost of each lot, including cost of improvements, sewers, walks, etc., was $300, and that the cost of the 10 lots sold was $3,000. One-fourth of the sale price, therefore, is profit. It would be nec- essary to consider three-fourths of every dollar re- 60 INCOME AND FEDERAL TAX REPORTS ceived in payment as cost and to consider one-fourth as profit. Thus, if $2,400 had been received on account of the sale price of these lots, the profit to be returned would be $600. Appreciation and depreciation of good-will. Good-will, for income tax purpose, is capable neither of apprecia- tion nor of depreciation, and should be eliminated from any calculations of income. A book entry setting a value upon the good-will and thereby creating a surplus should be ignored in the preparation of the income tax report. Therefore, any stock dividend declared out of surplus which consists merely of an increased value placed on the good-will of a corporation is not being paid from earnings of the corporation and would not be income to the recipient. But, if an individual sells his good-will or stock dividend, the sum received for it would be shown in the increased price he receives for his assets and would be included as income, as being a profit on the sale of the assets. How to ascertain profits on stock transactions. When stock is purchased for a price lower than the market price at the time of reporting yearly income, such in- crease should not be considered as profit, inasmuch as it is only an appreciated value on the books of the re- porting individual and is not an established profit due to a completed transaction. Thus, if stock is purchased on March 10th at 90 and is retained by the purchaser, and, on the December 31st following, the stock is sell- ing in the open market at 95, the 5-point market in- crease will be disregarded and not reported as income. On the other hand, if stock is purchased at 90 and is actually sold during the year for 95, the 5-point gain must be reported as income. Of course, in the first case, if the stock is sold in some subsequent year at 95, the 5-point gain must be reported in the year of the sale of the stock. When various parcels of stock of the same issue are INDIVIDUAL INCOME TAX 61 bought and sold at different dates, the shares sold, whenever possible, should be identified by the number of the certificates covering them. When stock is sold, and its identity cannot be determined, it should be charged against the stock first purchased and remaining unsold. Thus, on March 20th A buys 100 shares of Southern Pacific stock at 83. This stock is represented by certificate No. 1037. On April 10th, A buys 100 more shares of the same company at 89. These shares are represented by certificate No. 2419. On June 10th A sells certificate No. 2419, representing 100 shares of Southern Pacific, at 90. In this case A reports a profit from the transaction of $100. But if A did not have a record of the numbers of the certificates representing the shares he would have to report a profit of $700, for the profit would then have to be charged against the stock first purchased. Exchange of securities through reorganization. The Treasury Department has held that no profit or loss will be taken into consideration for the purpose of the income tax unless it has been realized as a result of a closed and completed transaction. A closed and com- pleted transaction is defined as one in which an asset is disposed of for cash or for assets other than cash at a fixed or determined value at the time the transaction is consummated. Where an individual holds the securities of a cor- poration and as a result of a reorganization he ex- changes his securities for the securities of the new cor- poration, the question arises as to whether such an ex- change is a closed and completed transaction under the above definition. If it is held to be a completed trans- action, what is the measure of the profit or loss to be reported? The attitude of the Department formerly was that such transactions were merely an exchange in kind and that no profit or loss could be determined until the new securities were actually sold. The meas- \ 62 INCOME AND FEDERAL TAX REPORTS ure of profit or loss would then be the difference be- tween the price realized for the new securities and the cost (or, where the stocks were purchased prior to March 1, 1913, the value at that date) of the original securities. However, it was later held that, for income tax pur- poses, where securities in one company were exchanged for securities in a reorganized company, the transaction would be treated as a sale of the original securities, and the profit or loss would be the difference between the value of the old stock March 1, 1913 (or date of pur- chase subsequent to that date), and the value at which the same stock was given in exchange for the new stock. In the particular case before the Commissioner the stock of the New York Title Insurance Company was exchanged for stock of the New York Title and Mort- gage Company at $50 per share; that is, for each $100 par value of stock in the old Title Insurance Company there was given $50 par value of stock in the new Title and Mortgage Company. The assets were placed upon the books of the new company at approximately the same figure as that at which they were carried by the old company, thereby creating a surplus upon the books of the new company, and a portion of such surplus was then marked off by reason of the depreciation in mar- ket value of the old stock below the book value. The Commissioner held that this constituted a closed trans- action and that the stockholders of the old New York Title Insurance Company could deduct as a loss the difference between the cost price of the stock (the mar- ket price March 1, 1913, if the stock was purchased prior to that date) and $50 per share, to the extent that such losses, however, did not exceed gains from other similar transactions during the same year. This position, which has been since modified, offered a loophole for fraud. To illustrate: Company A, with assets of $100,000 and a capital stock of $100,000 INDIVIDUAL INCOME TAX 63 (1,000 shares), sells its assets to company B for the en- tire capital stock (500 shares, par $100) of company B, which it distributes to its own stockholders. Stockhold- ers of company A receive only $50 of new capital stock for each $100 of the old stock. Under the ruling just cited the stockholders would be allowed to deduct as a loss, subject to the limitations on losses hereinafter de- scribed, the difference between the cost of the stock and $50. Actually no loss has been incurred. Company B has exactly the same assets that company A had. Each stockholder has the same proportionate share of these assets as before the reorganization. Completed transaction defined. In August, 1917, the Treasury Department took the position that in the sale or disposition of capital assets a closed and completed transaction is held to be one in which an asset is dis- posed of for cash or for assets other than cash at a fixed or determined value, that is, for cash or its equivalent in value at the time the transaction is con- summated. If the assets are exchanged for other assets of a like character, and no account is taken of compen- satory value, it will be held that such a transaction constitutes merely a change in the form of assets, and the investment will be considered a continuing one, no profit or loss to be taken into account until the assets are disposed of for cash or its equivalent. This attitude appears to be sounder than the one taken in the second case cited and will no doubt be maintained by the Department. Sale of rights to subscribe to stock. Income received from the sale of rights to subscribe to new stock in a corporation in which a person is a stockholder must be included in his report. If the rights are not sold, but are permitted to lapse or are used to acquire stock of the company, it would seem that they in no way affect the income of the reporting individual. At least 64 INCOME AND FEDERAL TAX REPORTS that seems at present to be the attitude of the Treas- ury Department. Profits on sale of securities. When stock was pur- chased prior to March 1, 1913, the method of determin- ing the gain to be reported from a subsequent sale is to take the difference between the selling price and the average market for that stock on March 1, 1913. How to determine fair market price of stock as of March 1, 1913, when subsequently sold. The fair market price or value as of March 1, 1913, is held to be as of the entire day of March 1, 1913, and in case of a variation between "opening and closing price" the fair value would be determined by taking the average price for the day. This is conditioned, however, upon the show- ing by the taxpayer that the "Exchange" quotation represented the fair market price or value of the stock, as it is this "fair market price or value" which is to control, in whatever manner that fact may be ascer- tained. Computing profits on sales of securities left by decedent. If securities are sold by the beneficiary at a price greater than the appraised value placed upon them in the settlement of the estate, the gain in value is in- come of the beneficiary subject to tax, and such gain must be included in the report of the beneficiary. If securities belonging to an estate are sold prior to the settlement of the estate by the administrators or trustees at a price greater than their appraised value as of the date of the decedent's death, the amount of gain derived from the transaction is considered income accruing to the estate and subject to income tax, and should be included in the return filed by the adminis- trator. Profits from sale of property acquired by gift are subject to tax. As previously stated, all profits derived from the sale of property acquired by gift are subject to the tax. This profit is the difference between the selling INDIVIDUAL INCOME TAX 65 price and the appraised or fair value of the property at the time of receiving the gift, or its fair value as of March 1, 1913, if the gift was received before that date. It must be remembered that the gift itself is not con- sidered income when it is received by the donee, nor is it deductible from the income of the donor. Profits derived from sale or exchange of farm products. All income derived from the sale or exchange of farm products, whether produced on the farm or purchased and resold by a farmer, is income for the year in which the products were actually marketed and sold. A farmer is not required to report as income the value of the farm produce which he raises and which is consumed by himself and family; and any. expense incurred in producing such products so consumed can- not be claimed as an expense of this business. If a farmer exchanges his produce for merchandise, grocer- ies, etc., or in any manner disposes of his produce in other ways than by selling it, he should include as in- come the regular price placed upon the goods so ex- changed for the produce, or if no exchange price has been agreed upon, then the fair market value of the goods received in exchange for his produce. Rents received in crop shares are income in the year during which the crop shares are reduced to money or a money equivalent. For example, if A, the land owner, has the right to one-third of the crop, the other two-thirds going to the party who supplies the seed, implements and labor, the owner, A, would not report his share of the crop till he had sold it or consumed it. The exemption from the tax of farm products con- sumed applies only to those products raised by a farmer and consumed by himself and his family; it does not apply to farm products acquired as crop shares or through barter. The above rulings apply only to those who cultivate or manage farms for gain or profit. A person cultivating or 66 INCOME AND FEDERAL TAX REPORTS operating a farm for recreation or pleasure, on a basis other than one in accordance with the recognized prin- ciples of commercial farming, the result of which oper- ations is a continual loss from year to year, is not re- garded as a farmer. In such cases, if the expenses in- curred in connection with the farm are in excess of the receipts therefrom, the entire receipts from sale of products should be ignored in rendering a return of income; and the expenses incurred, being regarded as personal expenses, will not constitute allowable deduc- tions in the return of income derived from other sources. RENTS Rent may be returnable as income for year in which re- ceived. Eent is the gain or profit which accrues to the owner of a piece of property from the tenant for the use of that property. In a case where rent is not paid during the year for which it applies, the landlord may include in his return of annual net income only the rents actually paid to him within the year. For ex- ample, the rent paid on January 5, 1918, for the months of November and December, 1917, may be reported as income for the year 1918, or, if the landlord so de- sires, he may report the rent as of the date when it actually became due and payable, provided he keeps his books of accounts on the accrual basis and not upon the cash basis, as hereinbefore explained. (See p. 46.) Where property is handled through an agent, who remits to the owner the net proceeds after paying taxes and expense, the owner should report the total amount of rents collected by the agent, and under expenses take credit for the expenses paid by the agent. Board, lodging, crops and other consideration received in lieu of cash for rent is income. If an owner of a piece of property rents it and receives as rent his board or lodging or a share of the crops raised on the property, the value of the board or lodging or share of the crops INDIVIDUAL INCOME TAX 67 is considered income and therefore should be included in the return of net income. If the tenant works prop- erty on shares, the landlord should report the money received from the sale of the crops in the year in which they are sold. Tenants' improvements are income to the owner of the property. Where a tenant under the provisions of a lease erects a building or makes an improvement which reverts to the owner, it must be reported as income by the owner of the property at the expiration of the lease. The amount of gain or profit is the difference between the cost of the building or improvement and a reason- able allowance for the exhaustion, wear and tear of the property. INTEREST Interest is returnable as income in the year received. Interest on notes, ordinary mortgages, and corporate and other obligations should be entered on the annual return for the year in which such payments were re- ceived, unless books have been kept on an accrual basis. Interest which accrued prior to March 1, 1913, but which is paid in the current year is not taxable. Interest on bonds of the second Liberty Loan and on War Saving Certificates in excess of $5,000 par value should also be reported. This interest is exempt from the normal tax and also from the super-tax, but from the latter only to the extent of the interest on $5,000 par value of bonds or certificates. Interest on the Sy 2 per cent Liberty Bonds is not to be reported as income, since these bonds are not subject to any income tax. Interest on bank deposits must be returned as income. Interest paid, or accrued and unpaid, must be included in the annual income return of the person entitled to receive such interest, whether on open account or on a certificate of deposit. G8 INCOME AND FEDERAL TAX REPORTS Interest accrued on bonds at time of purchase and sale. Interest accrued on bonds at time of purchase and sale should be reported by the vendor and not by the vendee. Where the purchaser of bonds pays, in addi- tion to the price of the bonds, the amount of accrued interest, he should include in his return only such in- terest as has been earned after the purchase. In such a case the vendor considers as income the interest which has accrued on the bonds up to the time of their sale. For example, A owns one $1,000 X 6 per cent bond, interest payable January 1 and July 1. On April 1, A sells the X bond to B for $1,000 plus ac- crued interest, i.e., $1,030. In that case A must report as income the $30 interest accrued on the bond up to April 1, when it was sold to B. B will receive an in- terest check of $60 on July 1. Only $30 of this need be reported, for only $30 interest was earned on the bond after B purchased it, i.e., between April 1 and July 1. Bonds purchased at a premium. When a 6 per cent bond which has 10 years to run to maturity is pur- chased at 119 (i.e., for $1,190), the real income from the bond is not $60. Some business men might con- sider only the fact that they receive $60 each year as interest and lose sight of the fact that at the end of the 10 years they will receive only $1,000 for the bond which cost $1,190. This means a loss of $190. Insur- ance companies and other concerns which own a large number of bonds would distribute this loss over the life of the bond so that their interest account would show an annual income on this bond of $41 instead of $60.* To protect himself, the individual investor should follow the example of these concerns. If he were to report the income as $60 each year, he would have to i For the scientific method of "amortization," as this process is called. see Sprague's "Investment Accounting." INDIVIDUAL INCOME TAX 69 deduct as a loss at the end of the tenth year the dif- ference between $1,190 and $1,000, or $190. This loss would then be regarded by the Treasury Department as a "loss incurred in transaction other than from busi- ness," and subject to the limitations imposed by the Department on the deduction of such losses. Bonds purchased at a discount. When bonds are pur- chased at a discount, the real income of the holder of the bond is more than the bond interest rate. For ex- ample, a 10-year, 6 per cent $1,000 bond, bought at $800, gives the purchaser not only an income of $50 a year, but also a profit of $200 at the end of 10 years, representing the difference between what the purchaser pays for the bond, $800, and what he receives from the corporation at the end of 10 years, $1,000, which is the par value of the bond. This profit of $200 may be ap- portioned over the life of the bond and an equal part of the profit reported as income during each of the ten years, or the entire $200 profit may be reported at the end of ten years. Under the first method, the holder of the bond would report each year an income of $70, representing $50, the interest received from the cor- poration, plus $20, one-tenth of the $200 discount. 1 Under the second method the holder of the bond would report an income of $50 each year for 9 years, and an income of $250 in the tenth year. It must be remembered, however, that if the premium is written off over the life of the bond the discount on bonds must also be treated in the same manner. If the individual were to write off the premium on his bonds and not accumulate the discount his records would not reflect his true income and would not be ac- 3 If the scientific method of figuring the amortization of the discount were used, the holder of the bond would report an annual income of only $65.90, i.e., $50 plus $15.90. for $15.90 laid aside during each of the ten years and earning 5 per cent interest (the interest rate of the bond) would amount to $200 at the end of 10 years. 70 INCOME AND FEDERAL TAX REPORTS cepted by the Department because of the inconsistency of his accounting methods. Interest on bonds received by legatee. The ruling that accrued interest must be apportioned between a buyer and a seller of a bond in proportion to the length of the interest period during which each was the owner of the bond does not apply to the interest on bonds received by a legatee. The legatee is required to re- turn as income the full amount of interest received by him on a bond, notwithstanding the fact that a part of the first coupon, payable after he received it, has been added to the bond and included in the gross estate of the decedent, thereby becoming taxable under the Estate Tax law. Interest on certain public obligations taxable. Where a municipality purchases a public utility subject to a mort- gage, the income from which is taxable, the mortgage retains its original character even though the municipal- ity assumes the mortgage indebtedness and pays the interest on it. The interest on such obligations, accord- ingly, is taxable income. Interest from bonds of exempt organizations should be considered as income subject to tax. The fact that a corporation, joint-stock company or association is exempt from the income tax does not exempt the inter- est on its obligations from the tax when received by an individual or corporation subject to the tax. Fiduciaries. Income received from fiduciaries includes all income received from guardians, trustees, executors, administrators, receivers, conservators, or other persons acting in a fiduciary capacity. Such part of the income received from fiduciaries as represents dividends from domestic corporations should not be included under the heading of "interest," but should be shown separately under the heading of "divi- dends received through fiduciaries." This separation is necessary in order that the amount of such dividends INDIVIDUAL INCOME TAX 71 may be deducted in computing the normal tax. In or- der to do this the beneficiary should obtain from the fiduciary a report of the income and expenditures of the estate so that he may determine how much of his share is from dividends or from non-taxable sources. Such part of the beneficiary's income as is from non- taxable sources should be omitted from his return entirely. PARTNERSHIP INCOME Partnership gains and profits. No return is required of partnerships as such. Each member of a partner- ship should report, as an individual, his share of the net profits of the partnership. Limited partnerships are held to be corporations, for the purpose of the income tax, and in their or- ganized capacity are subject to the income tax as cor- porations. The individual members of the limited part- nership should report their share of the profits in the same manner as that in which they report dividends on stock of corporations. The same rule also applies to members of a joint-stock company. When income from partnership accrues. The Income Tax law of September 8, 1916, section 8, subdivision (e), provides that "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 en- titled if the same were divided, whether divided or oth- erwise, shall be returned for taxation and the tax paid under the provisions of this title." The income from a partnership accrues to the indi- vidual partner at the time his distributable interest is determined and reduced to possession. The member of a partnership should include in his return his interest in the partnership profits ascertained at the end of the business year falling within the calendar year for 72 INCOME AND FEDERAL TAX REPORTS which his return is rendered. Such share of profits should not be again included in the return when it is actually paid to the partner. To illustrate: A is a member of a partnership whose fiscal year ends Jan- uary 31. His share of the profits of the partnership for the fiscal year ending January 31, 1917, should be included in his report of income for the year 1917, and any moneys actually received by him in 1918 from the earnings of the partnership for the fiscal year ending January 31, 1917, will, therefore, not be reported by him as income for the year 1918. Partnership profits taxed at rates in effect in year in which they were earned. Section 8, paragraph (e), of the Income Tax law, as amended October 3, 1917, pro- vides that: "A partnership shall have the same privi- lege of fixing and making returns upon the basis of its own fiscal t year as is accorded to corporations under this title. If a fiscal year ends during 1916 or a subse- quent calendar year for which there is a rate of tax different from the rate for the preceding calendar year, then (1) the rate for such preceding calendar year shall apply to an amount of each partner's share of such partnership profits equal to the proportion which the part of such fiscal year falling within the calendar year bears to the full fiscal year, and (2) the rate for the calendar year during which such fiscal year ends shall apply to the remainder." In the illus- tration in the preceding paragraph eleven-twelfths of A's share of the profits of the partnership which he reported for 1917 is subject to the tax at the rates in effect for the calendar year 1916. The remaining one- twelfth is taxable at the rates in effect for 1917. The section of the law quoted above was not in the Income Tax law. of September 8, 1916, but is included i A fiscal year of a business concern is its twelve months' business period, which may or may not coincide with the calendar year. In the Income Tax law the use of the term "fiscal year" implies that the year in question does not coincide with the calendar year. INDIVIDUAL INCOME TAX 73 in the amendment of October 3, 1917. The Department had therefore taxed all partnership profits included in the 1916 returns at the rates in effect for the cal- endar year 1916. This new section of the law, how- ever, is retroactive to 1916, and therefore affects the 1916 returns. Individuals who included in their 1916 returns profits from a partnership for a fiscal year part of which fiscal year fell within the calendar year 1915, it appears, are entitled to a refund of the difference between the tax as assessed under the 1916 rates and the amount which should have been assessed under the 1915 rates, on such proportion of the profits from the partnership as should have been taxed only at the 1915 rates. To refer to the previous illustration, A in his report of income for the calendar year 1916, which he filed on or before March 1, 1917, included his share of the partnership profits for the fiscal year ended Jan- uary 31, 1916. His income was taxed at the rates fixed for the calendar year 1916. According to the amended provisions of the law he should have been taxed at the 1915 rates on eleven-twelfths of his income from the partnership. He should make application for a refund for the difference between what he was assessed and what he should have been assessed. 1 Non-taxable income of partnership to be omitted from returns of partners. Any non-taxable items of income, such as interest on State, municipal or government bonds, including Liberty Bonds of the first issue, or the bonds into which they are converted, but excepting interest on second Liberty Bonds, 2 should be deducted i The method of obtaining a refund is discussed on p. 27. 2 Interest on bonds of the second liberty loan is not entirely free from the income tax. It is free from the normal tax, but is free from the super- tax only to the extent of the interest on $5,000 par value of the bonds. No tax is levied upon a partnership as an entity, the tax being upon the members of the partnership. Each partner will report his share of the net profits of the partnership, including the interest on the Liberty Bonds of the second issue in excess of the interest on more than $5,000 par value of such bonds. The interest on the principal, $5,000 or less of Liberty 4s, 74 INCOME AND FEDERAL TAX REPORTS by each of the individual partners from his share of the partnership profits. Such income is exempt from tax even though the bonds are deposited as collateral to secure loans the interest on which is deducted as a business expense by the partnership. Dividends should be shown separately. Each partner should show his share of dividends received by the part- nership under a separate caption, i.e., "Dividends Re- ceived from Partnership." If he includes such divi- dends under partnership profits he will not be allowed to deduct them in computing the normal tax. Returns may be required of partnerships. Though part- nerships are not taxable as such, the Commissioner of Internal Eevenue has power to require any partner- ship to file a report of its net profits, with a statement of its members, their names and addresses, and their respective interests in the net profits earned. Determining net profits of a partnership. The net profits to be reported by an individual partner should be his share of the net profits of the partnership as shown by its books, less the deductions allowed an individual in a similar business. The amount of losses which may be deducted by a partnership is subject to the same restrictions as that placed upon individuals. Therefore, in determining the net profit of a partnership that does not own a mem- bership in a stock exchange, or if dealing in securi- ties is not a part of its regular business, losses actually sustained in stock transactions entered into for profit is not taxable and need not be reported. The member of a partnership which owns Liberty Bonds will be regarded as an individual owner of an amount of bonds proportionate to his interest in the partnership. Thus if the partnership, composed of three equal part- ners, owns $6,000 of Liberty Bonds, each member is regarded as owning $2,000 of the bonds, and the interest is not reportable or taxable. If, how- ever, such a member himself owns additional Liberty Bonds, not included in the partnership assets, in an amount sufficient to make his individual and partnership holdings together as much as $5,000 or more, he must report and pay taxes on interest on bonds which he holds in excess of the principal amount of $5,000. INDIVIDUAL INCOME TAX 75 may be deducted in an amount not exceeding the profits derived from similar transactions entered into for profit. If a partnership, however, is engaged in the busi- ness of purchasing and selling securities, or if it owns a membership in a stock exchange, the full amount of losses sustained on such transactions may be deducted. 1 INTEREST ON BONDS AND DIVIDENDS ON STOCK ISSUED IN FOREIGN COUNTRffiS Interest on bonds and dividends on stock issued in for- eign countries. Interest on bonds, deeds of trust, notes and other similar interest-bearing obligations issued in foreign countries must be reported in full by citizens and resident aliens, but need not be reported by non- resident aliens, even though the securities on which the interest is paid are physically present in the United States. Dividends on stock of foreign corporations, joint- stock companies or associations or insurance companies which are engaged in business in foreign countries should also be reported as income. Where the entire net income of a foreign corpora- tion is from sources within the United States, the divi- dends on the stock of such a corporation are treated in like manner as are the dividends on stock of a domes- tic corporation and may be deducted in computing the normal tax. Such dividends, in order to be deductible, should therefore be included under the caption "divi- dends received from domestic corporations." If only part of the net income of the corporation is from sources within the United States, the dividends on the stock of the corporation will be treated as if the corporation were entirely engaged in business abroad and will, therefore, not be allowed as a deduc- tion in computing the normal tax. Foreign income not remitted to United States. Where the interest on bonds or dividends on the stock of a for- i See Chapter on Deductions, p. 120. 76 INCOME AND FEDERAL TAX REPORTS eign corporation owned by a resident American citizen is credited to his account abroad but not remitted to the United States he should return the income at the rate of exchange prevailing at the time it was credited to him. On the other hand, if the income is neither credited to him abroad, nor received by him here, the resident American citizen need not report the income, which he could obtain if he wished to, unless he keeps his books on an accrual basis. This would apply, for example, in the case of a resident American citizen owning some foreign corporation or Government coupon bonds, the interest on which is payable only on surrender of the coupon. If the American citizen did not clip his cou- pon and send it abroad for payment, and if it were not paid during 1917, he would not be compelled to report the value of the -coupon as income, until he collected it. SPECIAL SOURCES OF INCOME Royalties from mines, oil wells, patents, franchises and other legalized privileges are returnable as income. In the case of mines operated by a lessee on a royalty basis, the lessor, in disposing of his ores or natural de- posits, is receiving back part of his capital due to the depletion of the mine. The lessor should report the total royalty received as income, and deduct a proper amount representing the actual depletion of the prop- erty. 1 Amount received from sale of royalty and patent rights is returnable as income after deducting cost. In the sale of a patent or of royalties, where all rights and title to the patent are surrendered, the amount received for such a sale, less the aggregate amounts expended in perfecting the invention and obtaining the patent, is income. If only the right to manufacture and sell under a patent is sold, the total amount of the price i The question of depletion of mines and oil wells is considered in the chapter on Corporation Deductions, p. 233. INDIVIDUAL INCOME TAX 77 received for the right is income. The owner of the pat- ent will, however, be allowed to deduct a reasonable allowance for the depreciation of the patent. 1 Pensions. Pensions received from any private source or from the United States Government must also be reported as income subject to taxation. But pensions received by an employee of a State or any political subdivision of a State, for services rendered to the State or its political subdivision, are exempt and need not be reported. Damages recovered. Damages recovered through law- suits or settlements, less the lawyers' fees and all ex- penses incurred incident to the suit or claim, must be reported as income. In the case of a recovery of dam- ages for personal injuries, for example, lawyers' fees, doctors' bills, medical bills, the cost of medicines, and all other expenses incurred should be deducted from the amount of the judgment collected, and only the net amount should be reported. Accident insurance and employees' accident compensa- tion. Money received by a person from accident in- surance, less all insurance premiums paid for the in- surance and less all expenses incurred as a result of the accident, should also be reported as taxable income. The expenses which may be deducted, in. addition to insurance premiums, are mentioned in the preceding paragraph. Only the net amount should be reported as income. The same rules apply to money received by a person from his employer or an insurance company under State or Federal accident compensation laws. It must be borne in mind that the proceeds of acci- dent insurance policies or the accident compensation paid upon the death of the person insured to the bene- ficiaries will be treated the same as the proceeds of life insurance policies, heretofore discussed. i See chapter on Corporation Deductions, p. 230. 78 INCOME AND FEDERAL TAX REPORTS Income from bad debts charged off in a previous period. If payments are received on account of debts charged off as bad debts in previous years they must be in- cluded as income during the current year. This is the ruling, even though such bad debt was charged off prior to March 1, 1913. Alimony. The Treasury Department has held that alimony is income and must be reported as such (T. D. 2090). A recent decision in the Supreme Court (Gould vs. Gould, decided November 19, 1917) holds that ali- mony in the hands of the recipient is not subject to the income tax, nor is it a deductible item of expense of the payor. DIVIDENDS Dividends. Under this heading should be included dividends received from domestic corporations, joint- stock companies or associations and insurance companies and from foreign corporations whose entire net income is derived from sources within the United States. The dividends should be classified according to their source into: 1. Dividends received directly from corporations. 2. Dividends received through fiduciaries. 3. Dividends received through partnerships. Dividends are exempt from the normal tax, and are therefore subject only to the super-taxes. Individuals having an income of less than $5,000 are not taxed on income received in the form of dividends. The reason for exempting dividends from the normal tax is that the income represented by the dividends has been taxed when earned by the corporation, and therefore should not be taxed again when distributed to the stock- holder. All dividends received, unless specifically ex- empt from all income taxes (see following pages) must be included in the return. In calculating the normal tax, the amount of dividends should be deducted. 1 i See the chapter on Eeturns and Computation of Tax, p. 158. INDIVIDUAL INCOME TAX 79 It is important that any dividends included as in- come as received through fiduciaries or through a partnership be shown on the report as dividends, in order that such amount may be deducted in computing the normal tax. Income received from private banks considered as divi- dend. In the case of private banks which have the form of corporations and which are held to be associations within the meaning of the Federal Income Tax Law, the income which the members of the association receive from the bank because of their investments will be considered dividends. Taxes paid by bank for owners of bank stock consid- ered a dividend. Taxes assessed against the stock- holders of a bank and paid by the bank in their behalf are considered an additional dividend to the amount of the taxes paid and should be included in the returns of the individual stockholders. Dividends from paid-up policies considered income. Dividends from paid-up insurance policies are con- sidered income to the recipient, and must be included in the annual return of income. They are considered the same for the purpose of the tax as dividends or net earnings from corporations. Record owner of stock is not to include dividend in return if stock is owned by another. The record owner of stock is not required to include in the income tax return any amount of dividends received on stock that actually belongs to another. But if a question should be raised as to why dividends on stock recorded in the name of an individual, firm or corporation are not included in the record owner's income tax return, such owner will be required to show conclusively that the actual ownership of the stock rested with another. Profits of limited partnerships considered dividends. The profits of limited partnerships, which make returns in the same manner as corporations make returns, 80 INCOME AND FEDERAL TAX REPORTS will be treated as dividends of corporations and must be reported in the returns of individual members in the same manner as are dividends upon the stock of corporations. That is to say, members of a limited partnership report only so much of the profits as they receive (like stockholders of a corporation), and not their undistributed share of the profits (like part- ners in a general partnership). Dividends declared from reserves. Where a corpora- tion declares a dividend out of surplus created by crediting reserves which were previously set aside to meet depreciation and depletion of property, such divi- dends constitute income to the stockholders and must be reported as income if the reserves were accumu- lated subsequent to March 1, 1913. But if the re- serves were created prior to March 1, 1913, the divi- dends need not be included as income. In the latter case, if the stock on which the dividends were paid is sold, in calculating the profit on the sale of the stock the dividends must be subtracted from the original pur- chase price, and the difference subtracted from the sell- ing price of the stock. In calculating the loss, if any, on the sale of the stock, the selling price is subtracted from the cost minus the dividends mentioned. Dividends paid from surplus created by revaluation of assets are not income. As any surplus created by a book appreciation of assets is not income to the corporation, so the dividends paid from such surplus are not income in the hands of the stockholders. The same rule holds true as to dividends paid from a surplus created by setting up a good-will account upon the books of the corporation. If such dividend is paid in cash and the stock on which the dividends were paid is subsequently sold, the amount of these dividends must be considered in determining the profit or loss from the sale. The amount of these dividends should be deducted from INDIVIDUAL INCOME TAX 81 the cost, if the stock was purchased subsequent to March 1, 1913, or from the fair value March 1, 1913, if it was purchased prior to that date. The difference between the resulting figure and the selling price will be the amount of profit or loss on the transaction. To illustrate: A owns 100 shares of stock which he purchased in 1916 at $90 a share. In March, 1917, he received a dividend of $5 a share, the dividend being paid out of a surplus created by revaluing the plant of the corporation. In October he sells the stock at $100 a share. He would not be required to report the dividend as' income, 1 but would be required to include a profit on the sale of the stock of $1,500, arrived at as follows: Cost of 100 shares at $90 $9,000 Dividend of $5 a share 500 Net cost $8,500 Selling price of 100 shares 10,000 Profit $1,500 If the dividend is paid in stock, instead of in cash, and some or all of the stock is subsequently sold, the situation is quite complicated. To use the figures of the illustration above: A at the beginning had 100 shares which cost him $9,000. He receives 5 shares as a stock dividend, the dividend being paid out of a surplus created by re- valuing the plant of the corporation, or by setting up a good-will account. He now has 105 shares. What is the cost per share? The Treasury Department re- quires that the 100 shares and the 5 shares be consid- ered as separate lots, the method used when different lots of the same stock are purchased, and that the 100 i He should, however, attach a statement to his return stating the amount of the dividend, and the reason for not including it as income. 82 INCOME AND FEDERAL TAX REPORTS shares cost be regarded as $90 a share, and the 5 shares nothing. If we sold the 5 shares, we would have to report the entire sales price as income. The sounder practice would seem to be to consider the entire 105 shares as one lot which cost $9,000, or $85.71 a share. It then would not make any difference how many shares are sold; the profit or loss would be the differ- ence between $85.71 per share and the selling price. Dividends need not be paid in cash. The Income Tax Law, section 31(a) states: "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 ac- crued since March first, nineteen hundred and thirteen, and payable to its shareholders, whether in cash or in stock of the corporation, joint stock company, associa- tion, or insurance company, which stock dividend shall be considered income, to the amount of the earnings or profits so distributed." Scrip dividends. Scrip dividends 2 are to be treated as cash dividends to the face value of the scrip. The transaction is held to be a payment in cash of the divi- dend and an investment of the cash in the scrip. Dividends paid in bonds issued under Act of Congress approved April 24, 1917. The fact that a dividend was paid in Liberty Bonds of either the first or second issue does not make the dividend exempt from tax. Dividends from surplus earned prior to March 1, 1913, not taxable. The law as stated above specifically ex- empts from the tax any earnings or profits accrued prior to March 1, 1913. This provision first appeared in the Income Tax law of September 8, 1916. Prior to that time dividends were taxable as income when received, i See discussion on stock dividends later in this chapter, pp. 87-98. 2 Scrip dividends are dividends paid in the form of promissory notes in- stead of in cash. INDIVIDUAL INCOME TAX 83 regardless of whether or not the profits from which they were paid were earned or accrued prior to March 1, 1913. This old ruling was attacked but was upheld in the recent decision in the case of Gulf Oil Corporation v. C. G. Lewellyn, Collector, decided in the United States Circuit Court of Appeal, Third Circuit. There is no doubt that under the present law any dividends received from earnings accrued prior to March 1, 1913, are not taxable. There is some question as to the method of determining from what particular earnings a dividend is paid. Prior to August 6, 1917, a corporation could declare a dividend and state that it was paid out of surplus or undivided profits accumulated prior to March 1, 1913. Such a statement would be accepted as cause for ex- empting such dividends provided that there was a sur- plus on March 1, 1913, out of which this dividend could have been declared. The 50 per cent dividend of the American Eadiator Company may be used as an ex- ample : This dividend was declared February 1, 1917, payable March 15, 1917. At the time of declaration it was stated that the dividend was paid out of surplus acquired prior to March 1, 1913. The surplus account, of the company follows : Left in Year Ended Net Income Dividends Surplus Total Surplus Jan. 31, 1910.. $971,600 $610,000 $361,600 $4,526,650 Jan. 31, 1911.. 1,772,517 779,000 993,517 5,520,167 Jan. 31, 1912.. 1,312,052 825,000 487,052 6,007,220 Jan. 31, 1913.. 1,696,193 1,476,900 219,293 6,226,513 Jan. 31, 1914.. 2,081,267 1,603,590 477,677 6,704,190 Jan. 31, 1915.. 2,289,075 1,865,680 423,395 7,127,586 Jan. 31, 1916.. 2,364,593 1,519,336 845,257 7,972,843 Jan. 31, 1917.. 2,604,068 1,579,696 1,084,372 9,057,215 Common capital stock outstanding Jan. 31, 1917 8,185,600 50 per cent dividend March 15, 1917 4,092,800 84 INCOME AND FEDERAL TAX REPORTS On January 31, 1913, this corporation had a surplus of $6,226,513, which was still available on Feb. 1, 1917, and which was enough to cover the dividend declared. Stockholders of the American Radiator Company should therefore omit this 50 per cent dividend from their re- turn. They should, however, attach a statement that the dividend is omitted because it was paid out of sur- plus acquired prior to March 1, 1913. If this dividend had been distributed on or after Au- gust 6, 1917, the dividend would be treated as being de- clared from the most recently accumulated surplus or undivided profits (Income Tax Law, Sec. 31, b.) In other words, the dividend would have to exhaust first the surplus created in 1917, next the surplus created in 1916, and so on. The dividend, instead of being paid out of the surplus created prior to March 1, 1913, would be treated as follows: S Paid out of 1917 earnings $1,084,372 Paid out of 1916 earnings 845,257 Paid out of 1915 earnings 423,395 Paid out of 1914 earnings 477,677 Paid out of earnings prior to March 1, 1913 1,262,099 $4,092,800 The holder of 20 shares of the common stock would receive $1,000 as a dividend. Of this $1,000, 30 8/10 / 12621 \ per cent I tnnnn T -308 1 or $308, would be excluded V 40928 ./ from his return as earned prior to March 1, 1913. Dividends taxable at rates in effect for year when profits were earned. In the example cited in the previous para- graph the $692 calculated to have been earned after March 1, 1913, would for tax purposes, be apportioned as follows: INDIVIDUAL INCOME TAX 85 From 1917 earnings $265.00 From 1916 earnings 206.50 From 1913 to 1915 earnings . 230.50 Total $692.00 and taxed at the rates in effect for the respective years (Income Tax Law, Sec. 31, b.) That is, $265 would be taxed at the rates in effect for 1917, $206.50 at the rate in effect for 1916, and $230.50 at the rate in effect for 1913 to 1915, inclusive. This represents the first recognition by Congress and the Treasury Department of the fact that a divi- dend declared in one year may represent the earnings of a previous year, and should be taxed at the rate for the year in which it was earned. Prior to 1917, income from dividends was taxed at the rates in effect when reported. It will be noticed that the fiscal year of the American Eadiator Company ends January 31. The income of the fiscal year ending January 31, 1917, is treated as being entirely earned in 1917. The Treasury Depart- ment has always held that no income accrues to the corporation until the close of the fiscal year unless the books are actually closed at an intervening period. If the American Radiator Company had closed its books on July 31, 1916, the net income for that half year would of course be treated as earned in 1916. It must be remembered that the date when the earn- ings, out of which the dividend was paid, were accumu- lated by the company declaring the dividend, and not the date when such earnings were accumulated by a subsidiary, is the deciding date in determining the rates at which the dividend should be taxed,. To illustrate: Company A receives a dividend on January 10, 1917, from its subsidiary, Company B. The earnings repre- sented by this dividend were earned by Company B in 86 INCOME AND FEDERAL TAX REPORTS 1916. On March 10, 1917, Company A paid a dividend to its stockholders, the dividend being paid out of the earnings received from corporation B. The stock- holders of Company A must pay the tax at the rates in effect for 1917, because the earnings out of which the dividend was paid were not received by Company A until 1917. 1917 dividends are held to be paid out from the most recently accumulated surplus. The law states that any dividend declared in 1917 and future years will be treated as being paid out of the most recently accumu- lated surplus or undivided profits. This provision does not apply to any dividends which are stated as being paid out of surplus acquired prior to March 1, 1913, distributed prior to August 6, 1917. To illustrate: The Bethlehem Steel Corporation on Feb. 15, 1917, declared a dividend of 200 per cent, which amounted to $30,000,000. Surplus Account of the Bethlehem Steel Corporation Year Earnings Dividends Carried to Surplus Total Surplus 1916 . ...$43,593,968 $5,502,160 $38,091,808 $69,370,198 1915 . .. 17,762,813 1,043,560 16,719,253 31,278,390 1914 . .. 5,590,020 745,400 4,844,620 14,559,137 1913 . .. 1,941,963 745,400 1,196,563 9,714,517 1912 .. . . 1,209,287 1,209,287 8,517,954 1911 . . . 2,038,979 2,038,979 7,308,667 No statement was made that the dividends were paid out of surplus accrued prior to March 1, 1913, either in whole or in part. Consequently, the dividends will be treated as paid out of the most recent earnings, i.e., the 1916 earnings, and they will be taxable at the 1916 rates. The directors could have declared $8,517,954 of the dividend paid out of surplus accumulated prior to March 1, 1913. The remainder of the dividend, $21,- INDIVIDUAL INCOME TAX 87 482,046, could then have been treated as having been paid out of the 1916 earnings. The directors could not claim that the $21,482,046 was paid out of 1915 earn- ings. SUMMARY OF RULES APPLICABLE TO 1917 DIVIDENDS Dividends distributed prior to August 6, 1917, may be declared as out of surplus created prior to March 1, 1913. If not specifically declared as out of such sur- plus they will be treated as being paid out of the most recently accumulated surplus. Dividends distributed subsequent to August 5, 1917, are considered as being paid out of the most recently accumulated surplus, regardless of the statement ac- companying the dividend. Stock dividends are income to amount of profits dis- tributed. The Income Tax Law, section 31, a, referring to stock dividends, reads in part : "Which stock dividend shall be considered income to the amount of the earn- ings or profits so distributed." In T. D. 2090, explain- ing the law, the Department said: "Stock dividends included in a return of income should be accounted for at the valuation placed upon the stock by the corpora- tion when said stock dividends were issued." The valu- ation placed on the shares by the corporation can be found by dividing the amount of surplus distributed as a dividend by the number of shares distributed in pay- ment of the dividend. To illustrate: a corporation dis- tributes 500 shares of common stock in payment of a dividend declared from a surplus amounting to $50,000. The value at which the shares should be included in the return is $100 per share. The practical effect of this provision is to treat a stock dividend as income to the extent of the par value of the stock received. The author cannot recollect any case in which stock was distributed as a dividend at any other figure than its par value. 88 INCOME AND FEDERAL TAX REPORTS The taxing of stock dividends at their full par value often results in a double taxation and a consequent in- justice to the last purchaser of the stock. To turn to the case of Bethlehem Steel Company: Bethlehem Steel Common, (now class A, common) in 1914 could be bought at $40 a share. A person buying 100 shares in 1914 at 40 and selling them in January, 1917, at 415, would be taxed on the profit of $37,500. This would be no more than fair as he had actually made that profit on the transaction. Turning to the man who bought the stock at 415 in February, we find that he received a 200 per cent stock dividend in a new class B common stock on which he would be taxed on its par value, $20,000. This taxes the holder on income which his capital never earned, as he made no profit by the receipt of the dividend. After receiving the dividend he holds 100 shares of class A common and 200 shares of class B common, the average market value of which for the month of March, 1917, was as follows: 100 shares class A at 135 $13,500 200 shares class B at 125 25,000 $38,500 Original cost of 100 shares A 41,500 Market Loss $ 3,000 Should the holder of these shares sell them subsequently for less than $61,500 (i.e. $41,500 + $20,000) he would be allowed to deduct the difference as a loss, subject to the restrictions on losses, see chapter on Deductions. Stock dividends held not taxable under 1913 law. The entire question of the taxability of stock dividends has been reopened by the decision of the United States Su- preme Court in Toivne vs. Eisner, decided January 7, 1918, which holds that a stock dividend declared January INDIVIDUAL INCOME TAX 89 2, 1914, should not have been regarded as income under the provisions of the law of October 3, 1913. The decision, written by Justice Holmes, follows: Henry R. Towne Plaintiff in Error, vs. Mark Eisner, Collector of United States Revenue for the Third Dis- trict of the State of New York. In error to the District Court of the United States for the Southern District of New York. Argued December 12, 1917. Decided January 7, 1918. Charles E. Hughes George Welwood Murray Charles P. Howland Louis H. Porter, Counsel for Plaintiff in Error. John W. Davis, Solicitor General Counsel for the United States. Mr. Justice Holmes delivered the opinion of the Court. This is a suit to recover the amount of a tax paid under duress in respect of a stock dividend alleged by the Government to be income. A demurrer to the declaration was sustained by the District Court and judgment was entered for the defendant. 242 Fed. Rep. 702. The facts alleged are that the corporation voted on December 17, 1913, to transfer $1,500,000 surplus, being profits earned before January 1, 1913, to its capital account, and to issue fifteen thousand shares of stock representing the same to its stockholders of record on December 26; that the dis- tribution took place on January 2, 1914, and that the plaintiff received as his due proportion four thousand and one hundred and seventy-four and a half shares. The defendant compelled the plaintiff to pay an income tax upon his stock as equivalent to $417,450 income in cash. The District Court held that the stock was income within the meaning of the Income Tax Act of October 3, 1913, c. 16, Section II; A, sub- division 1 and 2; and B. 38 Stat. 114, 166, 167. It also held that the Act so constructed was constitutional, whereas the declaration set up that so far as the Act purported to confer power to make this levy it was unconstitutional and void. The Government in the first place moved to dismiss the case for want of jurisdiction, on the ground that the only question here is the construction of the statute, not its constitutionality. It argues that if such a stock dividend is not income within the meaning of the con- stitution, it is not income within the intent of the statute, and hence that the meaning of the Sixteenth amendment is not an immediate issue, and is important only as throwing light on the construction of the Act. But it is not necessarily true that income means the same thing in the Constitution and the Act. A word is not a crystal, transparent 90 INCOME AND FEDERAL TAX REPORTS and unchanged; it is the skin of a living thought and may vary greatly in color and content according to the circumstances and the time in which it is used. Lamar vs. United States, 240 U. S. 60, 65. Whatever the meaning of the Constitution, the Government had applied its force to the plaintiff, on the assertion that the statute authorized it to do so, be- fore the suit was brought, and the Court below has sanctioned its course. The plaintiff says that the statute as it is construed and administered is unconstitutional. He is not to be defeated by the reply that the Gov- ernment does not adhere to the construction by virtue of which alone it has taken and keeps the plaintiff's money, if this Court should think that the construction would make the Act unconstitutional. While it keeps the money it opens the question whether the Act construed as it has construed it can be maintained. The motion to dismiss is overruled. Billings vs. United States, 232 U. S. 261, 267. B. Altman-Company vs. United States, 224 U. S. 583, 596, 597. The case being properly here, however, the construction of the Act is open, as well as its constitutionality if construed as the Government has construed it by its conduct. Billings vs. United States ubi supra. Not- withstanding the thoughtful discussion that the case received below we can not doubt that the dividend was capital as well for the purposes of the Income Tax Law as for distribution between tenant for life and remainderman. What was said by this Court upon the latter question is equally true for the former. "A stock dividend really takes nothing from the property of the corporation, and adds nothing to the interest of the shareholders. Its property is not diminished and their interests are not increased. . . . The proportional interest of each shareholder remains the same. The only change is in the evidence which represents that interest, the new shares and the original shares together represent- ing the same proportional interest that the original shares represented before the issue of the new ones." Gibbons vs. Mahon, 136 U. S. 549, 559, 560. In short, the corporation is no poorer and the stockholder is no richer than they were before. Logan County vs. United States, 169 U. S. 255, 261. If the plaintiff gained any small advantage by the change it certainly was not an advantage of $417,450, the sum upon which he was taxed. It is alleged and admitted that he received no more in the way of dividends and that his old and new certificates together are worth only what the old ones were worth before. If the sum had been carried from surplus to capital account without a corresponding issue of stock certificates, which there was nothing in the nature of things to prevent, we do not suppose that any one would contend that the plaintiff had received an accession to his income. Presumably his certificate would have the same value as before. Again if certificates for $1,000 par were split up in ten certificates, each for $100, we presume that no one would call the new certificates income. What has happened is that the plaintiff's old certificates have been split up in effect and have diminished in value to the extent of the value of the new. Judgment reversed. Mr. Justice McKenna concurs in the resujt. INDIVIDUAL INCOME TAX 91 Effect of "Towne vs. Eisner" decision on stock dividends paid in 1913, 1914 and 1915. The court in Towne vs. Eisner, decided that under the provisions of the In- come Tax law of October 3, 1913, stock dividends could not be taxed as income. All taxes collected on such dividends in 1913, 1914 and 1915 were wrongfully as- sessed and collected. All persons who paid an income tax on stock dividends in 1913, 1914 and 1915 are no doubt entitled to a refund and should file a claim for the same with the collector for the district in which the return, on which the tax was wrongfully assessed, was filed. 1 Treasury Department holds stock dividends taxable un- der the 1916 and 1917 laws. The only Income Tax law considered by the court was the October 3, 1913, law. But the wording of the decision is such that it may be inferred that the taxing of stock dividends is unconsti- tutional. Inasmuch as this part of the opinion was not necessary to the decision it is merely dictum and its weight is questionable. The Treasury Department maintains that the decis- ion does not change the right to tax stock dividends paid in 1916 and 1917. The basis of their argument is that the law of September 8, 1916, contains a provision (section 31, a) which specifically taxes stock dividends. This position of the department is shown in the follow- ing letter: "Treasury Department, "Office of Commissioner of Internal Revenue, "Washington, D. C, January 10, 1918. "To Collectors of Internal Revenue, and Internal Revenue Agents: "Please note carefully the statement below with reference to the effect of the decision of the Supreme Court of January 7, 1918, in the case of Towne vs. Eisner and see that it is given general publicity. "Daniel C. Roper, "Commissioner. i As yet the Treasury Department has issued no statement as to whether this particular case will apply to tax imposed upon stock divi- dends paid in 1913, 1914 or 1915 from profits earned by the corporation subsequent to March 1, 1913. 92 INCOME AND FEDERAL TAX REPORTS "Misapprehension exists as to the effect of the decision of the Supreme Court in the case of Towne vs. Eisner, handed down January 7, 1918. In this opinion it was held that under the Act of October 3, 1913, a stock dividend declared by a corporation January 2, 1914, was not properly regarded as income. It does not necessarily follow, however, that no stock dividends are to be held taxable under the provisions of the Acts of September 8, 1916, and October 3, 1917. "The Act of October 3, 1913, which was the only Act before the Court in the case, contained no provision expressly providing for treating stock dividends as income, and the decision of the Court was to the effect that the Act was not to be construed as taxing such dividends. The Court did not decide that such dividends cannot be income within the meaning of the Sixteenth Amendment, but expressly recognized that the word "income" may have a different meaning in the Statute from the meaning in the Constitution. "The Act of September 8, 1916, contains an express provision taxing stock dividends declared and paid out of earnings accrued since March 1, 1913. In the absence of a decision as to the legal effect of these ex- press provisions contained in the latter Acts, the Bureau of Internal Revenue naturally will continue to be governed by the express provisions of the later Acts in reference to stock dividends." Opinions opposed to Treasury Department's holding. While the holding of the Department, it seems, is tech- nically correct, the weight of the opinion outside of the Department is that the decision affects all the income tax laws and that the Supreme Court will so decide if a test case is brought before it. The arguments supporting this position are brought out in the following editorial from the New York Times. "Trifling With the Court" "The Commissioner of Internal Revenue says that income taxes will be collected upon stock dividends, the opinion of the Supreme Court under the law of 1913 to the contrary notwithstanding. The Collector relies upon the declaration of the law of 1916 that " 'Dividends shall be held to mean any distribution made or ordered to be made . . . payable to share- holders, whether in cash or stock . . . which said stock dividend shall be considered income to the amount of the earnings or profits so distributed.* i New York Times, January 12, 1918. INDIVIDUAL INCOME TAX 93 "No doubt Congress can tax either property or in- come, but it cannot tax both by simply declaring that one is the other, when the Supreme Court says that they are different. It is true that the court's decision arose under the statute of 1913, which contains no such provision as the one quoted above. But the court's decision was on principle, not on the words of the statute, and the principle is applicable to both statutes. The court decided that income must be something which is separated from the principal, as crops are severed from land, or dividends paid in cash are separated from the resources of the company. A share dividend sepa- rates nothing from the property of the corporation. In the words of the court: " 'A stock dividend really takes nothing from the property of the corporation, and adds nothing to the interest of the shareholders. Its property is not dimin- ished and their interests are not increased. . . . The proportional interest of each shareholder remains the same. The only change is in the evidence which repre- sents the interest, the new shares and the old shares together representing the same proportional interest that the original shares represented before the issue of the new ones.' "The definition of the later law may suffice to control the discretion of the tax collectors, but it will not per- suade the court that income is principal, or that prin- cipal is income, because they are so defined by a statute. If either can be taxed under the name of the other, then it can be taxed under both names, with the result of double taxation and deprivation of property without due process of law. The statute will signify as little to the court as the court's decision signifies to the tax authorities. If anything is collected under this defini- tion, it will be repaid, unless the court shall change its mind regarding the constitutional argument. The lower 94 INCOME AND FEDERAL TAX REPORTS court decided that stock dividends were taxable as in- come under the 1913 statute, and the Supreme Court overruled it. The lower court also decided that the 1913 statute was constitutional with that construction regarding the taxability of stock dividends as income. Before the Supreme Court the Government would have abandoned the argument for the constitutionality of the 1913 statute as thus construed, but was not allowed to do so. The Supreme Court said that while the Treas- ury kept the tax money it was to be held to the position it took originally as to the constitutionality of the stat- ute as thus construed. "When the tax officers go into the Supreme Court with the 1916 statute they are sure to be met with the argu- ment of Mr. Hughes, supported by the decision which already is against them. The statute upon which they rely is to blame, not the tax collectors. Least of all are the taxpayers to blame for disputing the statute. The statute is obnoxious to most of the canons of taxation. In the instant case the attempt was to collect a tax upon $417,450, which the court said Mr. Towne did not re- ceive. His dividends were not increased, his property was not increased, and yet he was to be taxed upon a half million of printed paper. There is $100,000,000 of such paper now claimed to be taxable, although the tax is brand new. The result of maintaining the constitu- tionality of the statute would be to overturn settled principles of law and finance." This attitude is substantially the same as that taken by Archibald E. "Watson, former Corporation Counsel of New York, in an interview reprinted below. "Sees Stock Dividend Free From Taxation" 1 "Archibald E. Watson, former Corporation Counsel, a member of the law firm of Barber, Watson & Gib- boney, said yesterday that the recent income tax decis- iNew York Times, January 13, 1918. INDIVIDUAL INCOME TAX 95 ion of the United States Supreme Court in the case of Towne vs. Eisner would precede in authority any order of any Federal department. Mr. Watson was asked to comment on the decision and on the bulletin of the Treasury Department instructing Internal Revenue Col- lectors to continue to assess and collect income taxes upon stock dividends, because his firm, as amicus curiae, submitted a brief when the case was in the Federal Dis- trict Court. "Mr. Watson said that the Commissioner of Internal Revenue apparently regarded the Supreme Court de- cision as inconclusive. He based this statement on the instructions to Collectors of Internal Revenue to treat as income all stock dividends declared and paid out of earnings accrued since March 1, 1913. "Collector Edwards, in a recent statement, called at- tention to the opinion of the United States Supreme Court that a stock dividend declared by a corporation Jan. 2, 1914, under the act of Oct. 3, 1913, was not properly regarded as income. He thought, however, that it did not necessarily follow that no stock dividends were to be held taxable under the provisions of the acts of Sept. 8, 1916, and Oct. 3, 1917. He recalled that the act of 1913 was the only one before the court, and that it contained no provisions expressly providing for treating stock dividends as income." Opinion of the Court "Mr. Watson declared that the opinion of the Su- preme Court was both a 'decision upon particular facts and an enunciation of principles,' and that a fair deduc- tion of the language of the court was 'that a stock divi- dend based upon earnings' was not taxable. " 'The first income tax law,' said Mr. Watson, 'which was passed Oct. 3, 1913, was made retroactive to March 1st of that year, the constitutional amendment authoriz- ing a direct tax on incomes not having become effective 96 INCOME AND FEDERAL TAX REPORTS until Feb. 28, 1913. Of course, the decision of the United States Supreme Court is conclusive and final as to everything actually decided or necessarily involved in the decision. " 'The bulletin issued by the Treasury Department claims that in the case of Towne vs. Eisner the Su- preme Court only held that under the law of Oct. 3, 1913, a stock dividend declared in January, 1914, was not properly regarded as income. But Towne vs. Eis- ner was both a decision upon particular facts and an enunciation of principles. Limited to its special cir- cumstances, it is not of wide interest, because of the comparatively few persons in like situation. But as a declaration of fundamentals it is sure to have important consequences. " 'Though the case does not expressly so hold, a fair deduction from its language is that a stock dividend, based upon surplus earnings, which have in good faith been carried into capital, is not taxable as income under the Sixteenth Amendment to the Constitution; that is to say, a further constitutional change would be required to authorize such u tax. In this connection Mr. Justice Holmes reaffirms the doctrine of the Gibbons case, de- cided in 1890, (136 U. S. 549), which did not, however, involve the taxation of stock dividends, quoting the following : " 'A stock dividend really takes nothing from the property of the corporation, and adds nothing to the interest of the shareholders. Its property is not dimin- ished and their interests are not increased. . . . The proportional interest of each shareholder remains the same. The only change is in the evidence which rep- resents that interest, the new shares and the original shares together representing the same proportional in- terest that the original shares represented before the issue of the new ones.' INDIVIDUAL INCOME TAX 97 " 'Justice Holmes' opinion concludes with the sen- tence : " 'What has happened is that the plaintiff's old cer- tificates have been split up in effect and have diminished in value to the extent of the value of the new. " 'A tax upon the certificates, therefore, would be a tax on capital and not upon income, and as such not au- thorized by the Sixteenth Amendment. " 'Under the present income tax law, as amended, stock dividends are declared to be subject to tax as income in the hands of the stockholder, but only at the income tax rates in force at the time the profits so dis- tributed were earned. Under the reasoning of the opin- ion in the Towne vs. Eisner case, however, such divi- dends would not be taxable at all, because, in effect, only a splitting up of the stockholder's old certificates, or a change in the evidence representing the stockhold- er's interest. May Hypothecate Stock " 'It may be anticipated, therefore, that stock divi- dends in preference to cash dividends will be more popular than ever during the coming year. The re- cipient of a stock dividend may hypothecate the stock as security for a loan without being taxed upon the amount so borrowed, and would even be allowed as a deduction interest paid upon such a loan, under the provisions of the law as it stands: "Of course, if the recipient of a stock dividend should sell the stock so received, together with the original stock held by him, any profit thus realized over and above the original cost of the stock, in respect of which the stock dividend was declared, would probably be taxed as income. But short of this there would ap- pear to be considerable advantage in dividend distribu tions of stock in preference to cash by corporations. " 'It is true, as pointed out in the recent bulletin of 98 INCOME AND FEDERAL TAX REPORTS the Treasury Department, the act of October 3, 1913, does not contain an express provision for the taxing of stock dividends. Later acts, that is, the act of Septem- ber 8, 1916, and of October 3, 1917, do contain such provisions. The act of October 3, 1913, purports, how- ever, to tax dividends, without distinguishing between cash dividends and dividends paid in stock, and the Treasury Department ruled that stock dividends con- stituted taxable income to the same extent as cash. If the Commissioner of Internal Eevenue is in doubt about the matter, the sooner a test case is brought the better for all concerned. But there can be little doubt that the principle enunciated by the Supreme Court in the case of Towne vs. Eisner will be held to prevent the taxation of stock dividends, whether under the in- come tax law of October, 1913, or later enactments.' " The position of the taxpayer. Until the matter of the taxability of stock dividends under the 1916 and 1917 laws is finally passed on by the courts, the individual taxpayer will be compelled to conform with the require- ments of the Treasury Department. Those taxpayers who have received in 1917 stock dividends representing earnings of corporations earned subsequent to March 1, 1913, should include such amounts in their returns of income, and attach to such return of income a statement fully setting forth the facts. Such returns should be filed under protest, until such time as it is seen what will be the decision of the court with reference to the acts of 1916 and 1917. In case the position of the Department is not upheld by the Court, the taxpayer will then be able to obtain a refund of any such taxes paid under protest. Income on building and loan shares. It is held that amount credited to shareholders of building and loan associations, when title to such credit passes to the shareholder at the time of the credit, has a taxable status for the normal and additional tax as for the year of the credit. Where the amount of such accumulations does not become available to the shareholder until the maturity of a share the amount of a share in excess of the aggregate amount paid in by the shareholder is income to be accounted for as for the year of the maturity of the share for both the normal and additional tax. CHAPTER IV INDIVIDUAL INCOME TAX DEDUCTIONS FROM GROSS INCOME Deductions from gross income. The income tax is based upon the net income of the individual making the return. After computing his gross income the in- dividual will calculate the deductions allowed him by law and by subtracting these deductions from his gross income will arrive at his net income. Deductions allowed in computing net income of citizens and residents of the United States, The Income Tax law ? sec. 5, provides, that in computing net income in the case of a citizen or resident of the United States " ( a ) For the purpose of the tax there shall be allowed as deductions : "First The necessary expenses actually paid in carrying on any busi- ness, or trade, not including personal, living or family expenses. "Second All interest paid within the year on his indebtedness except on indebtedness incurred for the purchase of obligations or securities the interest upon which is exempt from taxation as income under this title. "Third Taxes paid within the year imposed by the authority of the United States (except income and excess profits taxes) or of its Territories, or possessions, or any foreign country, or by 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 cas- ualty, and from theft, when such losses are not compensated for by insur- ance or otherwise: "Provided, that for the purpose of ascertaining the loss sustained from the sale or other disposition 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 loss sustained. 99 100 INCOME AND FEDERAL TAX REPORTS "Fifth In transactions 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. "Sixth Debts due to the taxpayer actually ascertained to be worthless and charged off within the year. "Seventh A reasonable allowance for the exhaustion, wear and tear of property arising out of its use or employment in the business or trade. "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 allowance for depletion not ex- ceeding the market value in the mine, of the product mined and sold during the year for which the return is made. "Ninth Contributions or gifts actually made within the year to cor- porations or associations organized and operated exclusively for religious, charitable, scientific, or educational purposes, or to societies for the pre- vention of cruelty to children or animals, no part of the net income of which inures to the benefit of any private stockholder or individual, to an amount not in excess of fifteen per centum of the taxpayer's taxable net income as computed without the benefit of this paragraph. Such contribu- tions or gifts shall be allowable as deductions only if verified under rules and regulations prescribed by the Commissioner of Internal Eevenue, with the approval of the Secretary of the Treasury." Deductions allowed in computing net income of non-resi- dent aliens. As to non-resident aliens the law allows the following deductions: "First The necessary expenses actually paid in carrying on any business or trade conducted by him within the United States, not including per- sonal, living or family expenses. "Second The proportion of all interest paid within the year by such person on his indebtedness (except on indebtedness incurred for the pur- chase of obligations or securities the interest upon which is exempt from taxation as income under this title) 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 infor- mation necessary for its calculation. "Third Taxes paid within the year imposed by the authority of the United States (except income and excess profits taxes), or of its Territories, or possessions, or by the authority of any State, county, school district, or municipality, or other taxing subdivision of any State, paid within the United States, not including those assessed against local benefits. "Fourth Losses actually sustained during the year, incurred in busi- ness or trade conducted by him within the United States, and losses of property within the United States arising from fires, storms, shipwreck, INDIVIDUAL INCOME TAX- 101 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 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, nineteen hundred and thirteen, shall be the basis for de- termining the amount of such loss or losses sustained. "Fifth. In transactions 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 in the United States. "Sixth. Debts arising in the course of business or trade conducted by him within the United States due to the taxpayer actually ascertained to be worthless and charged off within the year. "Seventh. A reasonable allowance for the exhaustion, wear and tear of property within the United States arising out of its use or employ- ment in the business or trade. "Eighth. (a) In the case of oil and gas wells a reasonable allowance for actual reductions 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 com- putation are made. "Provided, That when the allowance authorized in caption "Eight" (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 for depletion shall be made. "No deduction shall be allowed for an amount paid out for new buildings, permanent 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 restor- ing property or making good the exhaustion thereof for which an allow- ance is or has been made." The deductions allowed to non-resident aliens it is seen are practically the same as those allowed to citi- zens and residents of the United States with the ex- ception that the deductions of non-resident aliens are limited to items arising within the United States, and this is for the reason that non-resident aliens need report only such income as arises from sources within the United States. Any special distinctions between residents and non-resident aliens are considered under the various headings. 102 IXOOUB AND FEDERAL TAX REPORTS Necessary business expenses actually paid allowed as a deduction from income. The taxpayer may first deduct from gross income all items of business expense that have actually been paid within the calendar year and that have been incurred in the carrying on of an indi- vidual business. Family or living expense cannot be deducted. If an individual keeps his books on an accrual basis in which he charges expenses when they are incurred (instead of when they are paid) he may deduct the business expenses that have been incurred during the year, instead of the amount actually paid during the year. But if an individual reports his expenses as in- curred he must also report his income as earned. Otherwise his records would come under the heading of "records which do not clearly reflect his income," and would not be acceptable as a basis from which to make his return. Expenses of a partnership should not be included, as they are taken into consideration in arriving at the figure "Net Income from Partnership," which net fig- ure is reported on the income side of the return. 1 All expenses incurred in earning taxable income are de- ductible. Expenses incurred in earning income which is exempt are not allowable deductions. But expenses incurred in the earnings of taxable income are deduc- tible. Deductible expenses therefore include all amounts paid by a farmer for labor in preparing his land for a crop and the cultivation, harvesting, and marketing of the crop; the cost of the seed and fertilizer used; the amounts expended for labor in caring for live stock; the cost of the feed, the cost of stock purchased for the purpose of resale (it should be understood, that if such cost is claimed as a deduction, the entire proceeds received upon a sale of the stock is to be returned as income) ; the amounts actually paid in mak- i See pages 71, 74. 72V DIVIDUAL INCOME TAX 103 ing repairs to farm buildings (but not to the dwelling house of the individual) ; repairs to fences, farm ma- chinery, etc. The cost of materials for immediate use, of farm tools which are used in the course of a year, and the amount of rent paid for a farm itself may also be deducted. A merchant may deduct as expenses the amounts paid for advertising, hire of clerks and other employees, the cost of light, heat, water, telephone, etc., used in or at his place of business, all freight bills, the cost of operating delivery wagons, trucks and the repairs to the same. If the individual employs a minor son or daughter to assist him in his business and to whom he pays a salary or wages for such assistance, such amount paid is not a proper deduction as an expense. If, however, the son or daughter has attained his or her majority the amount of compensation paid for such services may be claimed. Amounts expended by a business man in entertain- ing out-of-town customers or prospective customers are a proper expense, provided the sole purpose of the business man in making such expenditures is to culti- vate the good will of his customers and secure an in- crease in trade. Such expenditures may be looked upon in the same light as sums paid in advertising the business or as other selling expenses. The individual engaged in a business and keeping accurate records will have to be able to determine most of the deductible expenses of his business. Some im- portant questions will arise as to whether or not cer- tain items are allowable as deductions. These questions are taken up in detail under Corporation Deductions, in a later chapter. It is the salaried or professional man whose deductible expenses are fully treated here. Persona], family and living expenses are not deductible. Personal, family or living expenses are, by provision 104 INCOME AND FEDERAL TAX REPORTS of the law, not deductible. Alimony has been definitely held as a non-deductible personal expense of the person paying it. All payments which represent savings invest- ments, such as building and loan payments, pension fund payments, life insurance premiums, etc., are not deduc- tible. Clothing as a general rule is considered as a personal expense. Actors and actresses, however, are allowed to deduct the cost of stage costumes if of use only during the current year. Wages paid domestic servants, etc., not deductible. The wages of domestic and other servants, such as maids, valets and chauffeurs of pleasure cars are considered personal expenses and are not deductible. Rent of living quarters. Bent of living quarters may not be deducted. If an individual owns his own home he is not required to include in his income the rental value of the property. On the other hand, he is not allowed to deduct the cost of maintenance of the prop- erty, other than taxes, and interest on bonds or notes secured by a mortgage on the property. Where a building is occupied by both a tenant and the landlord, the expenses of maintenance should be separated as between the tenant's and the owner's por- tion of the building. The expenses applicable to the tenant's portion of the building are an allowable deduc- tion. Where the expenses are not directly applicable to either portion of the building they should be pro- rated on the basis of the rental values of the respec- tive portions. Where a person uses his residence both as a home and as an office, as is very common among physicians and dentists, he may deduct as a necessary expense of his business the rental value of such rooms as he uses solely as an office, provided he pays rent. Automobiles used for business. The cost of upkeep of an automobile used for business purposes is an allowable deduction. INDIVIDUAL INCOME TAX 105 This deduction is allowable even though the machine may be occasionally used for pleasure. The fact that a physician occasionally takes his family out for a pleasure trip does not affect the fact that the upkeep of the car is a necessary expense of his profession. But the total upkeep should not be charged as a busi- ness expense. Only that proportion of the expenses which the business trip mileage bears to the total mileage, including business and pleasure, should be deducted. Membership dues. Membership dues in a club or other society are not deductible if the organization is for social purposes. Membership dues in a trade or technical associa- tion, such as Trade Union, Chambers of Commerce, Medical Societies, etc., are deductible as necessary ex- penses. Technical magazines and books. The same rule applies to magazines. The cost of general magazines and news- papers is considered as a personal expense. The cost of technical and trade magazines is a deductible ex- pense. As to books, the original cost of either class of books is not a deductible expense. The depreciation on tech- nical books is an allowable deduction under the head- ing "depreciation." The premium on a fidelity bond is an allowable deduc- tion. If an employee is required to furnish bond and pay the premium on such bond, as a necessary incident of his employment, the premium on the bond will constitute an allowable deduction in computing net in- come. Traveling expenses. The general rule is that expenses incurred in traveling from place to place in the prose- cution of business may be deducted. A salesman work- ing on a commission basis may deduct railroad fares, carfare, etc. He may deduct the cost of lodging, but 106 INCOME AND FEDERAL TAX REPORTS not the cost of his meals, the distinction being that he presumably maintains a home, and that the cost of lodging is an added expense made necessary to earn his income. Commutation to and from work not a deduction. A person engaged in business in New York, for exam- ple, and residing in the suburbs is not allowed to de- duct the commutation or the fare to and from his busi- ness. This expense is a part of the living expenses. The landlord's expenses in connection with rented prop- erty are deductible. Deduction may be claimed on ac- count of any expense incurred in the maintenance or use of property for rental purposes, including amounts paid for repairs, insurance, fuel, light and water, and janitor and elevator service. A reasonable allow- ance may also be deducted for depreciation of the property. This deduction is provided for under a sepa- rate heading. 1 Commissions paid to real estate agents. Commissions paid to real estate agents for the collection of rents and the management of property is a legitimate busi- ness expense, and may be deducted. But commissions paid for the purchase of property are not deductible expenses. Such commissions should be added to the cost of the property, and commissions paid for the sale of property should be deducted from the selling price in ascertaining the gain or loss on the sale. Insurance premiums. Premiums paid for fire insur- ance on a building which is rented or leased to secure an income may be deducted. If the building or property is occupied by the owner as a dwelling, such insurance charges are not allowable deductions. 2 Insurance on furniture in an individual's home is a personal expense, but insurance on office furniture i See page 122. 2 If part of the building is rented, or is used by the owner for business purposes, apply the rules found on page 104. INDIVIDUAL INCOME TAX 107 would be a business expense. The cost of all fire, burglary, plate glass, sprinkler leakage and other forms of insurance on any property used in the business of the individual is a business expense. This also includes insurance on the live stock of a farmer, or on a truck- man's horses. Life insurance premiums are not deductible. Life in- surance premiums paid are not an allowable deduction. The amount of premiums paid may, however, be de- ductible from the proceeds of the policy. 1 This applies to insurance upon the life of an employee, payable to the employer, and to insurance upon the life of a part- ner payable to the partnership, as well as insurance upon the life of an individual. Liability insurance. Amounts paid by individuals in business as insurance against a liability which if ac- tually incurred would be deductible as an expense of business, are permitted as a deduction. Assessments paid on stock of a corporation are not de- ductible expenses. Assessments paid by a stockholder on stock he holds in a corporation or other business association are not allowed as a deduction in the indi- vidual's return. Such assessments are considered an investment of capital and not an expense. This is held true, whether the assessment is legally levied by the corporation or is simply a voluntary payment of the stockholders to make good a deficit. The amount of the assessment may be added to the cost of the stock in determining the profit or loss from its sale. Deductions from income allowed to farmers. The farmer may deduct from gross income the legitimate expenses incident to the production of farm products. Deduction may be claimed in the return of income 1 The rulings of the Department up to September, 1916, permitted the deduction of insurance upon the lives of employees, payable to employers, and upon the lives of partners, payable to the partnership. Premiums which were deducted as an expense of business under these rulings may not be deducted again from the proceeds of policy. 108 INCOME AND FEDERAL TAX REPORTS for the tax year in which the right to such deductions arises, although the products to which such expenses are incident may not have been sold or exchanged for money, or a money equivalent, during the year for which the return is rendered. However, when farm products are held for favorable market prices, no de- duction on account of shrinkage in weight or physical value, or losses by reason of such shrinkage or deteri- oration in storage is allowed, as the reduction in value is reflected in the sales price received. The cost of live-stock purchased for resale is an al- lowable deduction under the item of expense, but money expended for stock for breeding purposes is re- garded as capital invested, and the amounts so ex- pended do not constitute allowable deductions except where stock after being purchased dies from disease or injury or is condemned by the public authorities. In such a case the farmer may deduct as an expense the actual purchase price of such stock, less any depre- ciation which he may have previously claimed, or less any insurance which he may have collected. 1 Loss not to be deducted if farm is for pleasure. A per- son cultivating or operating a farm for recreation or pleasure, on a basis other than the recognized principles of commercial farming, the result of which operations is a continual loss from year to year, is not regarded as a farmer. In such cases, if the expenses incurred in connection with the farm are in excess of the re- ceipts therefrom the entire receipts from sale of prod- ucts may be ignored in rendering a return of income; and the expenses incurred being regarded as personal expenses will not constitute allowable deductions in the return of income derived from other sources. 2 i The farmer is allowed, as an expense of business, the premium so paid for insurance. 2 However, if the farm is operated at a profit and not a loss, the entire receipts should be included as income, and the expense of such farm would constitute a proper deduction. INDIVIDUAL INCOME TAX 109 Interest. Under this caption should be included all interest paid (or accrued, if books are kept on the ac- crual basis), during the year on any indebtedness, ex- cept that incurred in the purchase of securities the in- terest on which is exempt from the income tax. The interest on bonds of the second Liberty Loan, which includes both the first conversion 4s, and the second 4s, is exempt from the surtax only to the ex- tent of the interest on $5,000 par value of the bonds. The interest on indebtedness incurred in the purchase of second Liberty Loan Bonds should not be deducted under this section, but it is deductible x in computing the super-tax. (T. D. 2541.) The interest will also be an allowable deduction in computing the income sub- ject to the Excess Profits tax. It will be noticed that an individual holding an amount up to $5,000 of second Liberty Loan Bonds will be allowed as deductions in computing the surtax and Excess Profits tax the inter- est on the bonds and interest on loans made to purchase them. Interest paid to purchase stock of corporations which pay dividends may be allowed as an item of expense in the individual's report, although the dividends them- selves are not subject to normal tax in the hands of the individual, they only bearing super-tax. However, the corporation before distributing dividends is as- sessed a normal tax upon its net income, and from the balance the dividends are paid, and it therefore follows that the interest paid by an individual on indebtedness incurred to purchase stock of a corporation is a proper deduction in his income tax report. The amount of interest that may be deducted by a non-resident alien is limited by Sec. 6, subdivision 2, of the Income Tax law to: "The proportion of all interest paid within the year by such person on his indebted- ness which the gross amount of his income for the i See Rate of Tax Deductions from Super-Tax. HO INCOME AND FEDERAL TAX REPORTS 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 all the information neces- sary for its calculation." For example, a non-resident alien has a total income of $100,000, $10,000 of which is from sources within the United States, and he pays out $1,000 in in- terest. He will be allowed as a deduction 1/10 (j^^) of $1,000, or $100. He will be allowed this deduction only if he includes in his return a statement of his total income from all sources and also the total amount of interest paid. Taxes. The individual may deduct all taxes paid with the exception of income and excess profits taxes lev- ied by the United States and assessments levied for local benefits. Assessments levied for local benefits are held to include all taxes paid pursuant to assessments levied by special districts, such as irrigation, reclamation, drainage districts, etc., for sidewalks in cities, street extension, grading, paving, etc. While the individual may not deduct as an expense any excess profits taxes paid, his net income as re- ported to the Government will be credited with the amount of any excess profits tax imposed by act of Congress and assessed for the same calendar year or fiscal year upon the taxpayer. In the case of a part- nership, each member will be credited with his propor- tionate share of the excess profits tax imposed upon the partnership. The reason for this distinction between deduction and credit is clear. The excess profits tax is based upon the net income and therefore cannot be deducted in comput- ing the net income. The law does not intend a double taxation and accordingly allows a credit for the amount of excess profits tax in imposing the Income Tax. INDIVIDUAL INCOME TAX HI It is to be noted that the act of September 8, 1916, as amended October 3, 1917, distinctly specified that in- come taxes are not to be included as a deduction. That means that as the amendments are retroactive to Janu- ary 1, 1917, but to that date only, that income taxes actually paid during 1917 for the earnings of 1916 are not to be deducted in the return of income for 1917. The amendment in question applies only to the business man or individual who keeps his books of accounts on the cash receipt basis. Section 8, subdivision (g) of the act of September 8, 1916, allows for the rendering of reports by an in- dividual on a basis other than "cash" unless such basis does not truly reflect the true earnings for the taxable period. Therefore it follows that those individuals who kept their books of accounts on the "accrual" basis for the year 1916 and included as part of the taxes due, the 1916 income tax, although it was not paid until later in 1917, were allowed as a de- duction the income taxes for the year 1916 paid during 1917. Of course this does not apply to 1917 or subsequent income taxes. Inheritance tax not deductible. Inheritance taxes are charges against the corpus or capital of the estate and are not deductible either by the estate or by a bene- ficiary. This applies to State inheritance taxes as well as to the Federal Estate Tax. Taxes on property used as a residence may be deducted. The fact that the property on which the tax is assessed is used as a residence does not prevent the deduction of the tax. In this respect the man who owns his home has an advantage over the one who pays rent. The owner is not required to report as income the rented value of the property, yet he may deduct as ex- penses the taxes paid on such property and any interest 112 INCOME AND FEDERAL TAX REPORTS paid on mortgages outstanding against the value of the property. The rent payer, on the other hand, cannot deduct as an expense the rent paid for the residence he occupies. Taxes paid by bank on stock held by individual. Taxes assessed against the stockholders of a bank and paid by the bank in behalf of the stockholders do not constitute an allowable deduction from the gross income of the bank, but do constitute an allowable deduction as taxes paid in the return of the individual. Of course the in- dividual must also report as income from dividends the amount of the taxes paid by the bank in his behalf. If the stock is owned by one stockholder at the time the tax is levied and by another at the time it is paid de- duction may be made by the holder of the stock at the time that the taxes were paid. To illustrate, A owns a number of shares of stock which he holds at the time the taxes are assessed against the stockholders of a bank. A sells to B prior to the payment of the tax by the bank. B, holding the stock at the time the taxes were paid by the bank, would be allowed the deduction. However, taxes assessed while the stock was in A's hand, which became due and pay- able prior to date of sale to B, may be deducted by A. As has been already pointed out, taxes paid by a bank for the stockholder should be considered an additional dividend by the stockholder, and included in the return of income of the one allowed the deduction. Customs duties may be deducted. Customs duties paid during the year are allowable if they are paid on mer- chandise imported for business purposes. The duty would then be considered part of the cost price of the merchandise. If, however, the duty was paid on per- sonal belongings or merchandise to be used for purposes other than for business, such duty would be allowed as a deduction, because it is an item of taxes. INDIVIDUAL INCOME TAX 113 Contributions to charitable organizations. Contributions to charitable and other similar organizations may be deducted only to the extent of 15 per cent of the tax- able net income of an individual as computed without deducting the amount of such gifts. An individual having a net income of $100,000 could deduct such gifts or contributions to the extent of $15,000. This provis- ion is a new feature in the law; the 1916 act as origi- nally enacted specifically stated that gifts of any sort were not deductible. The change is undoubtedly due to the enormous amounts contributed to the Red Cross and other war charitable organizations. Deductible con- tributions include contributions made to the Red Cross, Y. M. C. A., Knights of Columbus War Fund, for the furtherance of any religious activities, including the construction of a new church, and to the associated charities of one's home city. Contributions made to- ward the support of a needy family cannot be included, as contributions made to individuals do not constitute allowable deductions, which deductions are limited to contributions made to organizations or associations. Of course, the association need not be a duly incorpo- rated organization. A non-resident alien is not allowed to deduct gifts or contributions made to charitable organizations, etc., neither are any corporations either domestic or foreign. BUSINESS LOSSES Necessity for distinguishing "business" losses. Under the Income Tax law, as in effect for the years 1913 to 1915, inclusive, no deductions were allowed except for losses incurred in business, but all profits from sources outside the business were included as income. As amended in 1916, the law permits the deduction of losses outside of business but this deduction is limited to the amount of profits derived from similar sources during the year. It is therefore important to know just what the Treasury 114 INCOME AND FEDERAL TAX REPORTS Department's definition of business is, and what losses it will consider as "losses incurred in business or trade." Definition of "business" and "trade." Business has been defined by the Treasury Department as "That which oc- cupies and engages the time, attention and labor of any one for the purpose of livelihood, profit, or improve- ment; that which is his personal concern or interest; employment, regular occupation, but it is not necessary that it should be his sole occupation or employment." The Department further states that: "The term 'in trade,' as used in the law, is held to mean the trade or trades in which the person making the return is engaged; that is, in which he has invested money otherwise than for the purpose of being employed in isolated transactions, and to which he devotes at least a part of his time and attention. A person may engage in more than one trade and may deduct losses incurred in all of them, provided, that in each trade the above requirements are met. As to losses on stocks, grains, cotton, etc., if these are incurred by a person engaged in a trade to which the buying or selling of stocks, etc., are inci- dent as a part of the business, as by a member of a stock, grain, or cotton exchange, such losses may be deducted. "A person can be engaged in more than one business but it must be clearly shown in such cases that he is actually a dealer or trader or manu- facturer, or whatever the occupation may be, and is actually engaged in one or more lines of recognized business before losses can be claimed with respect to either or more than one line of business." An individual may deduct as a loss of business, his share of the loss of any partnership of which he is a member. 1 If, however, he owns an interest in a cor- poration he is not allowed to deduct the decrease in the value of stock holdings unless the loss is determined by a sale of the stock and even then his loss is treated as a loss in a stock transaction and not as a loss in business. 2 i In determining the partners' distributable profits or losses of a part- nership that does not own a membership in a stock exchange, or if dealing in securities does not form part of its regular business, losses actually sustained in stock transactions entered into for profit may be deducted in an amount not exceeding the profits derived from similar transactions entered into for profit. Of course if a partnership is engaged in the busi- ness of purchasing and selling securities, or owns a membership in a stock exchange, the full amount of losses sustained on such transactions may be deducted. 1 The fact that the individual cannot dispose of the asset will not alter the above rule. If an individual holds some worthless mining stock he INDIVIDUAL INCOME TAX 115 But if he is a dealer in securities he may deduct losses on stock, even before the stock is sold. As far as transactions in stocks, etc., are concerned, the Department has not insisted that the individual or partnership be a member of the exchange in order that the transactions may constitute a business, but it has held that he or the partnership must have the standing of a recognized dealer in securities or in commodities. It is important to remember that, for the purpose of ascertaining whether a person is a dealer in securities, etc., the individual and the partnership of which he is a member are treated as separate entities. The mere fact that an individual is a member of a partnership engaged in dealing in securities, does not permit the individual to deduct losses resulting from stock transactions on his own account unless he, individually, is a recognized "dealer." To each return there should be attached a statement of each loss containing the following information: a. What the loss consisted of. b. When it was actually sustained. c. How it was determined to be a loss. d. If sustained by loss of property acquired prior to March 1, 1913, the fair market price or value as of that date and how such value was determined. Losses by theft. Losses of any assets by theft, not en- tirely compensated for by insurance or otherwise, are a proper deduction. This includes losses of personal jew- elry, pleasure or business automobiles and securities. If, however, the theft represents a loss of merchandise or the stock in trade of the individual, and the indi- vidual computes his income on the basis of an annual inventory, then the amount of loss cannot be claimed, inasmuch as such loss will be reflected in the reduced inventory at the time inventory is taken at the end of must actually sell the stock before he is allowed to deduct the loss and then be subject to the limitations of the taxing act. 116 INCOME AND FEDERAL TAX REPORTS the year. In the latter case, if the loss has been cov- ered by insurance, the insured should report the insur- ance collected as income. But if he has not previously deducted the premiums in each year as they were paid, he need report as income only the difference between the amount collected and the total insurance premiums paid. The loss offsetting the insurance collected will be shown either in the reduced gross sales or in the reduced inventory at the end of the period. Losses by fire or the elements. Losses by fire of any asset of the individual, including even his own residence or a pleasure automobile, and not compensated for by insurance or otherwise are a proper deduction. Losses of crops, either growing or harvested, or of fruit trees or rose bushes of a grower through frost, fire, etc., are not deductible as an expense. This is for the reason that the actual cost of harvesting or pro- ducing that which has been destroyed is allowed as an expense of business in the year in which the ex- penses were incurred, and to permit the deduction of the value of the crops lost, in addition to the deduction of the expense of creating that value, would result in a double deduction, manifestly unfair to the govern- ment. If the loss has been covered by insurance, the insured should report the insurance collected as income. If he has not previously deducted the premiums in each year as they were paid, he need report as income only the difference between the amount collected and the total insurance premiums paid. Losses through accidents. Amounts paid by an em- ployer for an accident an employee sustains are deduc- tible expenses. Likewise, amounts paid to persons who are injured in the operation of the plant or equipment of a business are deductible. Thus, if an automobile is operated for business and runs over a person, the amount paid to such a person is a deductible expense. INDIVIDUAL INCOME TAX 117 But if the automobile were operated for pleasure, the amounts paid for an injury resulting from an accident cannot be deducted even though they represent amounts paid through judgments rendered. LOSSES OTHER THAN FROM BUSINESS Losses other than business losses. The allowance of losses resulting from transactions not connected with the individual's trade or business is subject to two re- strictions. 1. The loss must be the result of a transaction entered into for profit. 2. The loss may be deducted only if there is at least an equal amount of income from transactions entered into for profit, and not connected with the individual's trade or business. Losses sustained through fire, storm, shipwreck, or by theft are not included under this heading. Such losses, not compensated for by insurance, may be deducted without any limitation. The loss must be the result of a transaction entered into for profit. To be deductible, such losses must arise from transactions actually entered into for profit and not for any other purpose. If a transaction is entered into merely for pleasure and not for profit, losses, if in- curred, could not be deducted. The loss may be deducted only as an offset against profits from similar transactions. The amount that may be de- ducted as losses other than from business is limited to the amount of profit during the year from similar trans- actions. 1 This limitation does not mean that a loss on one stock transaction may be offset only by the profit on another stock transaction. It does, however, mean 1 To come within the definition of a "similar transaction" the profit must have been realized in the same manner as that in which the loss was sustained, i.e., if the loss was sustained due to purchase and sale of an asset, then the profit to offset such loss must have been realized through a purchase and a sale. 118 INCOME AND FEDERAL TAX REPORTS that a loss on a stock transaction cannot be offset against any income, but against the profit from another transac- tion entered into for profit outside of the trade or busi- ness of the individual. A loss on a stock transaction cannot be offset against income from rent, interest on bonds, dividends on stocks, or similar items. Such items do not come under the classification of "transac- tions entered into for profit but not connected with the trade or business of the individual." But the loss on a stock transaction can be deducted from the profit on a cotton or grain market operation, or from the profit on a sale of real estate, or from the profit on a foreign exchange speculation. A is engaged in the manufacturing business. In 1914 he invested $20,000 in real estate, but as a result of local conditions the rental return decreased to such an extent that in 1917 he sold this property for $14,000, thereby incurring a loss of $6,000. Inasmuch as he had no income from a similar transaction entered into for profit, and as the real estate business was not his recognized line of business, A would not be allowed to charge off in 1917 the loss of $6,000 so sustained. Losses due to destruction of building. Losses due to the voluntary removal or destruction of buildings made nec- essary by improvements to the property, as when an old building is destroyed and a new building erected, are a charge to the cost of the new building. In no case may such "losses" be charged as a loss in deter- mining net income. The amount which may be added to the cost of the new building is the difference be- tween the cost of the building removed and the amount of the depreciation reserve already provided for depre- ciation of the old building. The individual therefore does not receive any credit against his net income on account of such a loss unless the new building is sold. In the case of a sale of the new building, the loss or profit on the transaction will be the difference between INDIVIDUAL INCOME TAX 119 the selling price of the new building on the one hand, and the cost of the new building plus the value of the old building at the time it was destroyed, on the other hand. Of course, in calculating the depreciation on the new building, the owner may use as the basis of depreciation calculations the construction cost of the new building plus the value of the old building at the time it was destroyed. The following will illustrate exactly what may be done in the above cases. A constructs a building orig- inally costing $300,000, and having an estimated life of 30 years. At the end of 20 years he tears down the old building, on which he has already deducted $200 r 000 depreciation, and erects a new building at an addi- tional cost of $900,000, with an estimated life of 40 years. The apparent loss sustained in the destruction of the old building ($100,000) may not be deducted as a loss. This loss of $100,000 is charged to the cost of the new building, and the following year A may deduct depreciation on a valuation of the new building of $1,- 000,000. He may therefore deduct $25,000 depreciation each year. If A later sells the new building for $1,400,000 his profit is $400,000, not $500,000. If A sells the new building for $900,000, his loss is $100,000. Losses sustained by the destruction of unsafe or insanitary buildings ordered destroyed by the authori- ties of a municipality cannot be claimed as a deduction, either as a loss or as depreciation. But losses due to the destruction of a building by fire or the elements are properly deductible, to the extent that they were not covered by insurance. This is true, even though the building is not used for business pur- poses. And the amount of loss sustained in this case is not limited to "the gains from similar transactions." 120 INCOME AND FEDERAL TAX REPORTS Losses on stock transactions. The method of determin- ing losses on stock transactions is as follows: A stock- holder's investment is in the stock of a corporation. If he disposed of his stock for more than its fair market value on March 1, 1913, or its cost if acquired since that date, the profit realized must be returned as in- come; if he disposes of it at a loss, the loss sustained is deductible from gross income within the limits of the taxing act. In computing the profit or loss sustained there must be taken into account dividends paid from reserves accumulated prior to March 1, 1913, which were not returned as income for the year in which re- ceived. Losses on stock transactions may be deducted in full by an individual: 1. If he is a member of a stock exchange. 2. A licensed or recognized broker engaged in buying and selling securities for others. 3. If the buying and selling of securities form a part of his regular business or trade. 1 BAD DEBTS Bad debts deductible. The taxpayer is allowed to de- duct only such debts as are actually ascertained to be worthless and charged off within the year. An indi- vidual is not allowed to deduct an estimated amount to cover losses that may be charged off in the future, such as "reserves for bad debts." But amounts paid as premiums for credit insurance are deductible. Debts which arise from items of income (i.e., ac- counts receivable from sales, etc.) and which later prove to be worthless, will not be allowed as a deduction, unless the income which they represent is included in the return, or has been included in a return of a previ- ous year. Thus an individual would not be allowed to i See also the treatment of this subject under Corporation Deductions in a later chapter, p. 219. See also p. 60. INDIVIDUAL INCOME TAX 121 deduct as a bad debt unpaid salary, unless he had kept his books in such manner as to include the salary as income when it was earned. Debts due and payable prior to March 1, 1913, and not ascertained to be worthless prior to that date, are proper deductions in the year when they are actually ascertained to be worthless, and are charged off as uncollectible. Where the debtor is an individual, or partnership, the Treasury Department does not require the creditor to secure a judgment against the debtor and proceed upon the judgment, before allowing him to deduct the debt. It does, however, require him to show, beyond a reasonable doubt (taking into consideration the time the debt has run and the financial conditioning of the debtor), that the debt is worthless and uncollectible. Where the debtor is a corporation possessed of assets no deduction can be claimed until the corporation's affairs are finally closed and its receiver in bankruptcy discharged. Where a creditor makes a compromise agreement or common law settlement with the debtor and accepts a part of the debt as full payment releasing the debtor from payment of the balance, he may deduct the unpaid portion as a bad debt. The same rule applies if the creditor accepts a composition settlement in bankruptcy. But if A claimed that B owed him $1,000, and B con- tested the claim, but agreed to pay $500 to settle it, A could not deduct the balance which he contended was due him. This case differs from the preceding one in that there is a contest as to the amount of the indebt- edness. If the debtor corporation has no assets whatsoever and it is definitely known that nothing whatsoever can be collected from the debtor itself or any person con- nected with it, a creditor need not go to the expense of instituting bankruptcy proceedings in order to es~ 122 INCOME AND FEDERAL TAX REPORTS tablish his right to claim the worthless debt as a deduc- tion. Should an individual endorse a note and later be obligated to make good the payment of the instrument by reason of the insolvency of the maker, he may charge off the amount involved as a bad debt after he has actually paid it, unless at the time of his endorse- ment, he was aware the maker was insolvent. Bad debts arising from transactions not connected with business. Any bad debt is deductible; it is not neces- sary that it should be one which has arisen out of trans- actions connected with the individual's trade or business. Thus, a personal loan which proves uncollectible is a proper deduction. The purchase price of a bond or note purchased for investment (and not for speculative purposes) which proves to be worthless, is deductible. There is absolutely no limitation imposed on the amount of bad debts which may be deducted. Losses sustained incident to foreclosure of a mortgage. A loss sustained by a mortgagee in the foreclosure of a mortgage is deductible, providing the debt represented by the bond or note of the mortgagor is uncollectible. DEPRECIATION Depreciation deductible. The amount that may be de- ducted under this heading is limited to a reasonable allowance for the exhaustion, and wear and tear of property, arising out of its use or employment in busi- ness or trade. This deduction is permitted even though the property has not actually been used, as when a plant remains idle, because of adverse business or other conditions. In such a case the amount of depreciation allowed will usually be less than if it had been in oper- ation. The fact that the property may have been ac- quired by gift does not prevent a reasonable allowance for depreciation from being deducted, providing, of course, that the property is used for business purposes. INDIVIDUAL INCOME TAX 123 But no depreciation is allowed on a building occupied as a residence by the owner. If the building is also partly rented to one or more tenants, a proportionate part of the depreciation may be deducted. 1 Where in the course of years, the owner of property has claimed its full cost as depreciation in his income tax returns, no further claim for depreciation will be allowable. Kepairs, however, will nevertheless be al- lowable. The methods of determining the amount of deprecia- tion that may be deducted each year are fully discussed in the Chapter on Corporate Income Tax, Depreciation. Depreciation on personal items. Depreciation is not allowable on items used for personal pleasure or con- venience, such as pleasure automobiles, etc. Deprecia- tion is allowed only when the property itself is used for the purpose of producing income. It will also be allowed when property is vacant and the owner intends to use it for business purposes. If the article is used for both business and pleasure, depreciation may be deducted in proportion to the amount of business use the article received. Depreciation in land values. Depreciation in the value of land is not allowable as a deduction, nor must appre- ciation in the value of the land be reported as income, until the land is sold. And this is true even when de- preciation is deducted on the building standing on the land. Depletion. The question of depletion of oil wells, mines, etc., is discussed under "Corporate Income Tax," which see also for a complete discussion of other forms of depletion. See p. 233. No deductions allowed for improvements, etc. No deduc- tion is allowed for payments for new buildings, per- manent improvements, or for betterments made to in- crease the value of the property. The distinction be- i See page 104. 124 INCOME AND FEDERAL TAX REPORTS tween an improvement and a repair is very often a fine one. 1 The distinction is brought out in the following three citations: (1) The most commonly accepted is that in so far as the transaction results in an addition of substantial and permanent character which increases the value of the plant, such increase is a capital expense and should be charged to the construction account. (Mackintosh vs. Flint Pere Marquette Ry. 34. Fed. Rep. 60). Or, as it is clearly expressed in Hubbard vs. Weare: "Money paid out should not be reckoned as an asset. If paid for property that is on hand, the property is an asset. If expended in a way that has enhanced the value of the general assets it is included in its valua- tion. If so expended as to have brought no property, and no enhancement of that on hand, then it is a loss, and should not be counted as an asset." (79 la. 678.) (2) A more extreme view is that expressed, for in- stance, by T. F. Woodlock: "An addition which does not increase revenue or diminish expenditure is not a proper capital charge according to the best modern practice in railroads. That which simply tends to hold business and not to increase business is a proper charge against operating expenses.'' 2 (3) At the other extreme is the view, presented in the decision by Lord Kyllachy in Cox vs. Edinburgh and District Tramways Company, him. (6 S. L. T. 63) (1898) that where an improvement is made in the plant, even though it be in the nature of the substitution of a new plant for old, the entire cost of the new plant, and not merely the excess in value of the new over the old, may be charged to construction account. Of these three views the first is not only the most generally accepted but seems to comport best with i See also Chapter on Corporation Deductions for further treatment of repairs and renewals and depreciation, pp. 221-233. 2 Engineering Magazine, Vol. xi, p. 241. INDIVIDUAL INCOME TAX 125 accounting principles. It has furthermore been author- itatively adopted for railway accounting by the Inter- state Commerce Commission. The second view, while praised for its conservatism seems to imply that there must be a constant rate of normal interest or profits, a condition denied by economic history. If a general decline in profits occurs, an improvement which, in a given enterprise, prevents the fall and maintains the old rate of profits is clearly a source of additional value, and would be capitalized in the money market. The third view is rarely justified by accountants. 1 i Hatfield, Modern Accounting. CHAPTER V INDIVIDUAL INCOME TAX RATE OF TAX On whom imposed. Citizens and residents of the United States, including the territories of Alaska and Hawaii and the District of Columbia, are subject to two distinct taxes on their income for the calendar year of 1917. The original Income Tax law, as amended September 8, 1916, remains in force, subject to some modifications caused by the act of October 3, 1917. This act, under Title I, imposed an additional tax on the net income of every individual, a citizen or resident of the United States. Non-resident aliens are not subject to the normal tax imposed by the 1917 law, but they are subject to the super-taxes imposed by that law. They are not allowed to deduct the specific exemption allowed under the 1916 law. Citizens of the Philippines and Porto Rico are con- sidered citizens of the United States under the 1916 law, but they are specifically exempt from the provisions of the 1917 law. The liability of the different classes of individuals to the various taxes is clearly shown by the following table : Normal Normal Super-tax Super -tax Class tax 1916 tax 1917 1916 1917 Citizens and residents of the United States Yes Yes Yes Yes Non-resident alien individuals .... Yes * No Yes Yes Residents of Porto Rico and the Philippines Yes No Yes No i Non-resident aliens are not now allowed the specific exemption of $3,000 or $4,000. 126 INDIVIDUAL INCOME TAX 127 Rates under 1916 law. The 1916 law levies a normal or base tax at the rate of 2 per cent on the net income of every citizen or resident of the United States and every non-resident alien, and in addition levies sur- taxes as follows: On net income in excess of $20,000 and not over $40,000 1% On net income in excess of 40,000 and not over 60,000 2 On net income in excess of 60,000 and not over 80,000 3 On net income in excess of 80,000 and not over 100,000 4 On net income in excess of 100,000 and not over 150,000 5 On net income in excess of 150,000 and not over 200,000 6 On net income in excess of 200,000 and not over 250,000 7 On net income in excess of 250,000 and not over 300,000 8 On n<^t income in excess of 300,00J and not over 500,000 9 On net income in excess of 500,000 and not over 1,000,000 10 On net income in excess of 1,000,000 and not over 1,500,000 11 On net income in excess of 1,500,000 and not over 2,000,000 12 On net income in excess of 2,000,000 13 Deductions from net income allowed for normal tax un- der 1916 law. 1. Specific exemptions of $3,000 or $4,000. For the purpose of the normal tax only, every individ- ual (except non-resident aliens) is allowed to deduct from his income the sum of $3,000 as an exemption. Thus, if a man's income is $5,000, he may deduct $3,000, and the 2 per cent tax will be imposed on only $2,000. If the person making the return is the head of a family, or a married man with a wife living with him, or a married woman with a husband living with her, he or she is allowed an exemption of $4,000. For defini- nition of head of family see next section. If the husband and wife are living together, only one deduction of $4,000 may be made from their aggregate income. The income of husband and wife need be combined only for the normal tax. 1 Surtaxes will be levied on the separate incomes. i The parent is held to be the natural guardian of the minor child. In- come received by a minor child from sources other than the parent should be included by the parent in his return of income. The fact that such 128 INCOME AND FEDERAL TAX REPORTS If husband and wife are living apart, each is entitled to an exemption of $3,000. If the person making the return is married or is the head of a family, he is allowed, in addition to the ex- emption of $4,000, $200 for each dependent child who is under 18 years of age or else incapable of self-sup- port because of mental or physical defect. This $200 additional exemption is not allowed for other de- pendents. The single or married status of a person claiming the specific exemption is determined as of the close of the year for which the return is made. Guardians or trustees are allowed to make this per- sonal exemption of $3,000 or $4,000 from the income derived from the property of which they have charge, in favor of each ward or cestui que trust (beneficiary). An exemption of $3,000 is allowed from the net in- come of a decedent's estate during its administration or settlement, even though the period be less than one year, and from a trust or other estate the income of which is not distributed annually or regularly. Where a person dies during the year, his executor, in filing the return of decedent's income, may claim the full specific exemption of $3,000 or $4,000, as the case may be, according to the marital status of such person at the time of his death. 2. Dividends. To arrive at the net income on which the normal tax will be applied, dividends received from domestic corporations should also be deducted. The income is not appropriated by the parent is immaterial, as it will be held, in the absence of a showing of fact to the contrary, that such income was subject to appropriation by the parent and that the child receives the same as a gift from the parent. When the income is from a separate estate and the parent has been appointed guardian and the facts are such that the income so received is to be held for the use of the child, it should not be included in the return of income for the parent, but should be accounted for otherwise for the purpose of the Income Tax in the manner and form called for by the facts of the particular case. See Chapter on Fiduciaries, p. 288. INDIVIDUAL INCOME TAX 129 amount deducted should include only dividends from domestic corporations, joint-stock companies, Massa- chusetts trusts, associations and insurance companies, dividends from foreign corporations whose entire net income is from sources within the United States, and also profits from limited partnerships. The income of all these organizations is subject to the Corporation Income Tax when earned. To tax their income again when distributed would be a form of double taxation. Dividends and profits from organizations which are sub- ject to the income tax are exempt from the normal tax of both laws. They are, however, subject to the sur- taxes imposed by both laws, provided they were paid out of 1917 surplus or undivided profits. If the divi- dends were paid out of surplus or undivided profits ac- cumulated in 1916 l they are, by the provisions of the law (sec. 31), subject to the super-taxes at the rates in ef- fect for the year 1916. This means that they are not subject to the super- tax imposed by the 1917 law. Divi- dends paid from surplus acquired in the years 1913 to 1915 inclusive are subject to the super-taxes in effect for that period. 2 The super-taxes for the period from 1913 to 1915 are the same as those for 1916 until the net income exceeds $40,000. Above that amount, the rates in the 1916 law are a trifle higher. Individ- uals with an income in excess of $40,000 who have re- ceived dividends paid out of surplus earned in the years 1913, 1914 and 1915 are entitled to take credit on the returns for the amount by which the surtax on i In the case of profits distributed out of the most recent earnings of a corporation which closes its books as of June 30, 1917, so much of the dividend as represented the distribution of earnings for the period Janu- ary 1 to January 30, 1917, inclusive, would be subject, in the hands of the stockholders receiving same, to the graduated additional taxes imposed by the aet of September 8, 1916, as amended, and the act of October 3, 1917, and so much of it as represented a distribution of profit or surplus accumulated in 1916 would be subject to additional tax at the 1916 rate. 2 For the method of determining out of which year's surplus the divi- dend was paid, see pp. 78-88. 130 INCOME AND FEDERAL TAX REPORTS such dividends as figured under the 1916 law exceeds the amount as figured under the 1913 law. (See Com- putation of Tax, next chapter.) 3. Interest on bonds of the second Liberty Loan, i.e., first and second 4s. Interest on bonds of the first Lib- erty Loan is entirely exempt from the tax and should not appear in the return. Head of family. For the purpose of the personal ex- emption, the head of a family is held to be any per- son who actually supports and maintains one or more individuals who are closely connected with him by blood relationship, relationship by marriage or adoption, and whose right to exercise family control and provide for these dependent individuals is based upon some moral or legal obligations. For example, the oldest son of a family supporting a widowed mother and several minor children would come within this class. In some cases there may be two members of a family, each of whom is the "head of a family." For example, A and B are brothers supporting a mother and a grandmother. A and B may each claim to be the head of a family, as each is supporting one dependent. Each may therefore claim an exemption of $4,000. Deductions from net income allowed for super-tax com- putation. 1. Interest received on bonds of the second Liberty Loan is deductible from the net income for the purpose of the super-tax only to the extent that such in- terest is from a principal of $5,000 or less. The maximum deduction in any one year would therefore be $200.* 2. Interest paid on obligations incurred in the pur- chase of bonds of the second Liberty Loan, either first or second 4s, is deductible for the purpose of the super- tax. 2 Interest paid on obligations incurred in the pur- i For the year 1917 the maximum deduction will be $25. The bonds bear interest from November 15, 1917. A person selling them December 31, 1917, would get iy 2 month's interest. 2 The amount of interest deductible is that proportion of total interest payments which the excess over $5,000 is to the total amount of such bonds purchased. See Chapter on Returns, Form 1040, Division E, p. 149. INDIVIDUAL INCOME TAX 131 chase of bonds of the first Liberty Loan, i.e., the 3y 2 s, is not deductible. But if, while the obligation was still in force, the 3y 2 per cent bonds were converted into the 4 per cent bonds, the interest on the loan from the date of conversion may be deducted. Rates under 1917 law. The law of October 3, 1917, levies an additional normal tax of 2 per cent on the net income of every individual, a citizen or resident of the United States. Non-resident aliens, and citizens of Porto Eico and the Philippines are not subject to the normal taxes imposed by this law. The 1917 law imposes additional surtaxes on all in- dividuals, including non-resident aliens, and excluding citizens of Porto Rico and the Philippines, as follows: Total surtax On net income and not Supertax imposed including 1916 in excess of over bv 1917 act 1 and 1917 rates 1 $5,000 $7,500 1% 1% 7,500 10,000 2 2 10,000 12,500 3 3 12,500 15,000 4 . 4 15,000 20,000 5 5 20,000 40,000 7 8 40,000 60,000 10 12 60,000 80,000 14 17 80,000 100,000 18 22 100,000 150,000 22 27 150,000 200,000 25 31 200,000 250,000 30 37 250,000 300,000 34 42 300,000 500,000 37 46 500,000 750,000 40 50 750,000 1,000,000 45 55 1,000,000 1,500,000 50 61 1,500,000 2,000,000 50 62 2,000,000 50 63 Deductions from net income allowed for 1917 normal tax. -The deductions for the normal tax allowed under the i The Excess Profits tax rates are not included in this table. 132 INCOME AND FEDERAL TAX REPORTS 1916 law are allowed under the 1917 law, with the ex- ceptions that: 1. The personal exemption is reduced to $1,000 for individuals other than married persons or heads of families. 2. The personal exemption for married individuals or heads of families is reduced to $2,000 plus an extra allowance of $200 for each dependent child. 3. Personal exemption on income of decedent prior to his death is reduced to $1,000 or $2,000, according to his marital status at the time of his death. 4. Deduction allowed to estates pending settlement and on undistributed income of trust estates is reduced to $1,000. Another difference between the 1916 and 1917 laws, as far as deductions are concerned, is that the latter permits the deduction of such part of the income from partnerships distributable during the year as is tax- able, according to the provisions of section 8, paragraph (e) of the law, at the rates in effect for the year 1916. This section provides that a partnership may establish a fiscal year and that the income of the partnership in that case shall be prorated, as between 1916 and 1917, on the basis of the number of months of their fiscal year falling within the calendar year. To illus- trate: The partnership of A and B for the fiscal year ending June 30, 1917, earned $100,000, of which A was entitled to $60,000 and B to $40,000. Of this $100,000, six-twelfths (the number of months falling in 1917), or $50,000, is taxable at the rates in effect for the year 1917, that is, the rates in effect for the year 1916 plus the 1917 rates; the balance of $50,000 is taxable only at the 1916 rates. A will report his $60,000 as income from partnership, and in calculating his tax will deduct one-half or $30,000, from his net income, and pay the taxes in effect for the year 1917 only on the remaining $30,000. This $30,000 deducted is sub- ject to tax only at the 1916 rates. INDIVIDUAL INCOME TAX 133 RATES OF TAX BASED ON A PERSONAL EXEMPTION OF $4,000 AND $2,000 UNDER THE 1916 AND 1917 LAWS RESPEC- TIVELY* Income Nor- Nor- Total Super- Super- Total mal, mal, Nor- tax, tax, Super- 1916 1917 mal 1916 1917 tax 2% 2% 2 4 2% 2 4 2 2 4 'l% i% 2 2 4 2 2 2 2 4 3 3 2 2 4 4 4 2 2 4 5 5 2 2 4 'i% 7 8 2 2 4 2 10 12 2 2 4 3 14 17 2 2 4 4 18 22 2 2 4 5 22 27 2 2 4 6 25 31 2 2 4 7 30 37 2 2 4 8 34 42 2 2 4 9 37 46 2 2 4 10 40 50 2 2 4 10 45 55 2 2 4 11 50 61 2 2 4 12 50 62 2 2 4 13 50 63 Total Tax $1,000 to 2,000 to 3,000 to 4,000 to 5,000 to 7,500 to 10,000 to 12,500 to 15,000 to 20,000 to 40,000 to 60,000 to 80,000 to 100,000 to 150,000 to $2,000. 3,000. 4,000. 5,000. 7,500. 10,000. 12,500. 15,000. 20,000. 40,000. 60,000. 80,000. 100,000. 150,000. 200,000. 200,000 to 250,000. 250,000 to 300,000. 300,000 to 500,000. 500,000 to 750,000. 750,000 to 1,000,000. 1,000,000 to 1,-500,000. 1,500,000 to 2,000,000. 2,000,000 and over. . . . 2% 4 4 5 6 7 8 9 12 16 21 26 31 35 41 46 50 54 59 65 66 67 * The rates of tax for individuals who are unmarried and have no de- pendents are exactly the same as shown above, except that the 1916 normal tax begins at $3,000, and the 1917 normal tax begins at $1,000. The total tax rates on such persons are as follows: $1,000 to $3,000, 2%; $3,000 to $5,000, 4%; $5,000 to $7,500 and above this, the rates are the same as shown in the last column in the table. 134 INCOME AND FEDERAL TAX REP0RT8 INCOME BASED ON A PERSONAL EXEMPTION OF $4,000 AND (1) (2) (3) (4) (5) Taxable 1916 1916 1916 1917 1917 Income Normal Tax Supertax Total Tax Normal Tax Supertax $1,000 2,000 .... 3,000 "26 .... 4,000 40 5,000 "20 "26 60 6,000 40 40 80 10 7,000 60 60 100 20 8,000 80 80 120 35 9,000 100 100 140 55 10,000 120 120 160 75 12,500 170 170 210 150 15,000 220 220 260 250 20,000 320 320 360 500 25,000 420 ' ' 50 470 460 850 30,000 520 100 620 560 1,200 40,000 720 200 920 760 1.900 50,000 920 400 1,320 960 2,900 60,000 1,120 600 1,720 1,160 3,900 75,000 1,420 1,050 2,470 1,460 6,000 80,000 1,520 1,200 2,720 1,560 6,700 100,000 1,920 2,000 3,920 1,960 10,300 125,000 2,420 3,350 5,670 2,460 15,800 150,000 2,920 4,500 7,420 2,960 21,300 200,000 3,920 7,500 11,420 3,960 33,800 250.000 4,920 11,000 15,920 4,960 48,800 300,000 5,920 15,000 20,920 5,960 65,800 400,000 7,920 24,000 31,920 7,960 102,800 500,000 9,920 33,000 42,920 9,960 139,800 600,000 11,920 43,000 54,920 11,960 179,800 750,000 14,920 58,000 72,920 14,960 239,800 1,000,000 19,920 83,000 102,920 19,960 352,300 1,500,000 29,920 138,000 167,920 29,960 602,300 2,000,000 39,920 198,000 237,920 39,960 852,300 Column 1 is the amount of the normal tax imposed by the law of Sept. 8, 1916. Allowance is made for a personal exemption of $4,000. Column 2 is the amount of the supertax imposed by the law of Sept. 8, 1916. Column 3 is the amount of total tax, both normal and supertax, imposed by the Law of Sept. 8, 1916. Allowance is made for a personal exemption of $4,000. Column 4 is the amount of normal tax imposed by the law of Oct. 3, 1917. Allowance is made for a personal exemption of $2,000. Column 5 is the amount of supertax imposed by the law of Oct. 3, 1917. Column 6 is the amount of the total tax imposed by the law of Oct. 3, 1917. Allowance is made for a personal exemption of $2,000. Column 7 is the total tax imposed by both laws and is the amount of tax that will be paid by citizens and residents of the United States who are mar- INDIVIDUAL INCOME TAX 135 TAX CHART $2,000 UNDER THE 1916 AND 1917 LAWS RESPECTIVELY (6) (7) (8) (9) (10) 1917 Total Tax 1916 Tax 1917 Tax Total Tax , Taxable Total Tax for 1917 Actual % Actual % Actual % Income of Income of Income of Income $1,000 2,000 "20 ' ' 20 .67 .67 3,000 40 40 1.00 1.00 4,000 60 80 .40 1.20 1.60 5,000 90 130 .67 1.50 2.17 6,000 120 180 .86 1.71 2.57 7,000 155 235 1.00 1.94 2.94 8,000 195 295 1.11 2.16 3.27 9,000 235 355 1.20 2.35 3.55 10,000 360 530 1.36 2.88 4.24 12,500 510 730 1.47 3.40 4.87 15,000 860 1,180 1.60 4.30 5.90 20,000 1,310 1,780 1.88 5.24 7.12 25,000 1,760 2,380 2.07 5.87 7.94 30,000 2,660 3,580 2.30 6.65 8.95 40,000 3,860 5,180 2.64 7.72 10.36 50,000 5,060 6,780 2.87 8.43 11.30 60,000 7,460 9,930 3.29 9.95 13.24 75,000 8,260 10,980 3.40 10.32 13.72 80,000 12,260 16,180 3.92 12.26 16.18 100,000 18,260 23,930 4.54 14.61 19.15 125,000 24,260 31,680 4.95 16.17 21.12 150,000 37,760 49,180 5.71 18.88 24.59 200,000 53,760 69,680 6.37 21.50 27.87 250,000 71,760 92,680 6.97 23.92 30.89 300,000 110,760 142,680 7.98 27.69 35.67 400,000 149,760 192,680 8.58 29.95 38.53 500,000 191,760 246,680 9.15 31.96 41.11 600,000 254,760 327,680 9.72 33.97 43.69 750,000 372,260 475,180 10.29 37.23 47.52 1,000,000 632,260 800,180 11.19 42.15 52.34 1,500,000 892,260 1,130,180 11.90 44.61 56.51 2,000,000 ried or have dependents, for the calendar year 1917. The taxpayer may sub- tract from these taxes, $4 for each dependent under 18 years of age, or incap- able of self-support due to mental or physical disability, if the tax is $40 or less. If the tax is above $40, he may subtract an additional $4 for each such dependent from the amount of the tax above $40. Column 8 is the actual per cent of income taken by the tax under the 1916 law. Column 9 is the actual per cent of income taken by the tax under the 1917 law. Column 10 is the actual per cent of income taken by the total tax for the year 1917. 136 INCOME AND FEDERAL TAX REPORTS EFFECT OF TOTAL TAX ON Taxable Income 3M's 4's 43^'s 5's $2,000 3,000 4,000 5,000 6,000 7,000 8,000 9,000 10,000 12,500 15,000 20,000 25,000 30,000 40,000 50,000 60,000 75,000 80,000 100,000 125,000 150,000 200,000 250,000 300,000 400,000 500,000 600,000 750,000 1,000,000 1,500,000 2,000,000 3.50 3.477 3.465 3.444 3.424 3.410 3.397 3.386 3.376 3.352 3.33 3.294 3.251 3.222 3.177 3.137 3.105 3.026 3.019 2.933 2.830 2.761 2.639 2.525 2.419 2.252 2.151 2.061 1.971 1.837 1.833 1.523 4.00 3.973 3.960 3.936 3.913 3.897 3.882 3.869 3.858 3.831 3.806 3.764 3.715 3.683 3.642 3.586 3.548 3.470 3.451 3.353 3.235 3.155 3.016 2.885 2.765 2.572 2.458 2.356 2.253 2.099 1.866 1.739 4.50 4.470 4.455 4.428 4.402 4.384 4.368 4.353 4.341 4.310 4.282 4.234 4.179 4.143 4.097 4.034 3.992 3.904 3.882 3.772 3.639 3.550 3.393 3.246 3.111 2.895 2.766 2.650 2.534 2.362 2.099 1.957 5.00 4.966 4.95 4.92 4.891 4.871 4.853 4.836 4.823 4.788 4.757 4.705 4.644 4.603 4.552 4.482 4.435 4.338 4.314 4.191 4.043 3.944 3.770 3.606 3.457 3.216 3.073 2.944 2.816 2.624 2.333 2.175 INDIVIDUAL INCOME TAX 137 YIELD OF TAXABLE BONDS 5M's 6's 6K's 7's Yield of Liberty 4's % Taxable Income 5.50 6.00 6.50 7.00 4.00 $2,000 5.463 5.959 6.457 6.953 4.00 3,000 5.445 5.940 6.435 6.93 4.00 4,000 5.412 5.904 6.396 6.888 4.00 5,000 5.380 5.869 6.359 6.848 3.993 6,000 5.359 5.846 6.333 6.820 3.988 7,000 5.338 5.824 6.309 6.794 3.982 8,000 5.320 5.804 6.287 6.771 3.975 9,000 5.305 5.787 6.269 6.752 3.97 10,000 5.267 5.746 6.224 6.703 3.952 12,500 5.233 5.708 6.184 6.659 3.933 15,000 5.175 5.646 6.116 6.587 3.9 20,000 5.108 5.573 6.037 6.502 3.856 25,000 5.064 5.524 5.984 6.445 3.827 30,000 5.008 5.463 5.918 6.374 3.79 40,000 4.931 5.397 5.827 6.275 3.736 50,000 4.872 5.322 5.766 6.208 3.7 60,000 4,772 5.206 5.639 6.073 3.624 75,000 4.745 5.177 5.608 6.039 3.605 80,000 4.610 5.029 5.449 5.867 3.508 100,000 4.447 4.852 5.256 5.660 3.39 1 125,000 4.338 4.733 5.127 5.522 3.31 150,000 4.146 4.524 4.902 5.278 3.174 200,000 3.967 4.328 4.688 5.049 3.043 250,000 3.803 4.148 4.494 4.840 2.922 300,000 3.538 3.860 4.181 4.503 2.732 400,000 3.381 3.688 3.995 4.303 2.617 500,000 3.237 3.532 3.826 4.120 2.515 600,000 3.098 3.379 3.661 3.942 2.412 750,000 2.886 3.149 3.411 3.674 2.259 1,000,000 2.566 2.799 3.032 3.25 2.026 1,500,000 2.392 2.609 2.827 3.044 1.9 2,000,000 CHAPTER VI INDIVIDUAL INCOME TAX RETURNS AND COMPUTATION OF TAX RETURNS Filing of returns. Every individual required by law to file a return must file a return of his or her net in- come for the calendar year on or before March 1 of the following year. The time for filing the return for 1917, however, has been extended to April 1, 1918. The return must be made out and sworn to in person by the individual from whom the return is due, unless he is unable to do so by reason of minority, sickness, absence, or insanity. In such cases the return should be made by the individual's guardian or agent. As is explained in a later chapter on "Fiduciaries," fiduciaries need report only the income of the persons, trusts, or estates for whom they act as fiduciaries, un- less they are legally authorized to act for the bene- ficiaries as agents or attorneys. In fact, a fiduciary is under no obligation to make out the personal return for the beneficiary unless the beneficiary is a non-resident alien or incompetent. The liability of the fiduciary to make a return applies only with respect to such income as accrues and is payable through himself, and not to the income of the beneficiary derived from other sources. Extensions of time for filing returns. The collector of the district may, in cases of sickness or absence, grant an extension of time, not exceeding 30 days from the time the return would otherwise be due. 138 INDIVIDUAL INCOME TAX 139 The Co mmi ssioner of Internal Bevemie has authority to grant a further extension of time for any adequate reason. Under this provision of the law an extension of time has been granted for the filing of returns for the year 1916 and subsequent years to non-resident alien individuals and corporations and to American citizens residing abroad. These individuals will be given, by the provisions of T. D. 2581, until 90 days after the proclamation of the President of the United States announcing the end of the war with Germany. This extension applies only in those cases where the delay was caused by war conditions. In all such cases there must be attached to the return, when made, an affidavit stating the cause or causes of delay in filing returns of income within the time required by law. If this affidavit shows that the failure to file the return in time was excusable, no penalty will be incurred. In cases where a complete return cannot be filed within the time prescribed by law or within the exten- sion period, a tentative return should be filed within the time in order to avoid any penalty which would otherwise be incurred (see page 22). Following this tentative return, a true and accurate return should be filed just as soon as the data to be incorporated in the complete return are available. Where return is to be filed. The return should be filed with the collector of internal revenue for the district 1 in which the individual has his legal residence or place of business. If the individual has no legal residence or place of business in the United States the return must be filed with the collector of internal revenue at Baltimore, Md. A fiduciary should file a return with the collector of internal revenue for the district in which he resides. The location of an individual's legal residence may be subject to dispute. As far as the income tax is con- i See Collection Districts, p. 609. 140 INCOME AND FEDERAL TAX REPORTS cerned, it makes no difference in what district the re- turn is filed, except that for administrative purposes the Department prefers that it be filed in the district in which the individual resides. The filing of a return in a certain district would be an admission on the part of the individual that his legal residence was within that district, which admis- sion might be important as far as State inheritance and personal property taxes are concerned. Form of return. The return must be made out on the form furnished by the collector of internal revenue, and must be signed and sworn to before an officer author- ized by law to administer oaths. The forms of returns provided for the use of indi- viduals are Form 1040 A, to be used by individuals hav- ing a net income not in excess of $3,000, and Form 1040, to be used by individuals having a net income in excess of $3,000. The information required on each of the forms is discussed in the preceding chapters; the preparation and execution of the form is discussed on the following pages. FORM 1040 A When Form 1040 A is to be used. This form is de- signed to be used by individuals whose income is sub- ject only to the 2 per cent tax imposed by the War Eevenue Act of October 3, 1917. The maximum amount of income for which this form may be used in various cases is as follows : Income not exceeding Single not head of family $3,000 Married or head of family 4,000 Married or head of family, which includes one dependent child 4,200 two dependent children 4,400 three dependent children 4,600 four dependent children 4,800 five or more dependent children 5,000 INDIVIDUAL INCOME TAX 141 In order to determine whether or not a return should be filed, or whether or not this form may be used, the amount of net income should be calculated on page 3 and totaled on line H of the Form. This amount is then forwarded to page 4 and to it is added (a) the amount of dividends received and (b) the amount of interest on tax-free covenant bonds. 1 Interest on bonds of the second Liberty Loan, War Savings certificates and Treasury certificates of in- debtedness, are subject to the super-tax on the interest from bonds and certificates in excess of a total of $5,000 par value. The amount of such interest on the amount of bonds and certificates held by one individual in ex- cess of $5,000 should also be added in arriving at this total income. The officials in making up this form have apparently overlooked the possibility that a person with such an income, as shown on line 13, of less than $5,000 may be the owner of more than $5,000 worth of bonds of the second Liberty Loan and certificates mentioned above. From the resulting figure of total income there should be deducted the amount of contributions. 2 The amount deducted is limited to 15 per cent of the total income shown on the line above. The resulting figure is the total net income. If this figure is in excess of the amount stated as a maximum on the preceding page, the large form, 1040, should be used. No individual whose net income for the calendar year has been less than $1,000 need file a return, 3 and no re- turn is required of man or wife, or both, living to- gether, if their combined net income is less than $2,000, including income of minor children. Any other citizen or resident will not be required to file a return if his total net income is less than $1,000. i See Chapter on Withholding, etc., at the Source, p. 266. 2 See page 113. 3 This refers to a return of taxable income, and not to the report of in- formation at the source. See "Information at the Source," pp. 277-280. 142 INCOME AND FEDERAL TAX REPORTS The preparation of Form 1040 A. Page 3 of the form should be filled out first. This form does not have the separation of total income and total deductions provided in the old forms. Instead, income is divided into five subdivisions, and certain deductions are allowed directly against a certain class of income. In addition, a sec- tion is provided for general deductions, not applicable to any specific class of income. Section A includes income from salaries, wages, com- missions, bonuses and pensions. These items are dis- cussed on pp. 48 to 52. Division B includes income from business, farm, or profession. This section requires the gross receipts from the sale of farm products, merchandise, or business or profes- sional services to be reported. (See pp. 52-59.) The deductions against these receipts are: 1. Labor. Salary paid by the person making the re- turn to himself or members of his dependent family should not be deducted here unless it is included as in- come in Section A. But the salary paid a member of the family (other than wife) may be deducted here and not be included as income elsewhere in the return, if such person is 21 years of age or over and not actually a dependent. In such case that person should file a personal return of net income in excess of $1,000 or $2,000, as the case may be. 2. Materials and supplies. The instruction as to in- ventories is, that increases in inventories should be added to the gross receipts, and decreases in inven- tories should be added to the amount of expenses. On pages 52-56 it is pointed out that the proper method is to deduct the inventory increase or add the inventory decrease to the purchases of materials. The result in either case is the same. 3. Eent. The deduction of rent in cases where a building is used both for business and as a dwelling INDIVIDUAL INCOME TAX 143 and other questions arising under "Rent" are discussed on page 104. 4. Merchandise or live stock bought for sale. The comment as to inventories of materials and supplies ap- plies to merchandise also. The instructions do not state whether inventories should be valued at cost or market value. This question is still open, and a dis- cussion of it will be found on pages 54 and 55. 5. Wear and tear and repairs. This includes not only the amount paid out for repairs but also an allow- ance for depreciation. For a full discussion, see pp. 122-124. 6. Losses by fire, storm, other casualties, or theft. Losses from bad debts should apparently be included under "Other expenses." 7. Other expenses. In the instructions this is called: "Other expenses and losses." Losses from bad debts should be included under this heading. Losses on bad debts arising from transactions not connected with the individual's business should be deducted under Division G-, as a general deduction. Items 1 to 7 should be totaled and deducted from the amount of gross receipts reported. This will give the net income from business, farm or profession. In order to support the item of wear, tear and re- pairs, a statement is required of the cost of the business or farm property; of the construction of the build- ings; and the cost of the business equipment. Division C. Profit from sale of land, buildings, and other property, real or personal. As to each item of property sold there is required a statement of 1. The kind of property, that is, "farm," "apartment house," "dwelling," "mine," etc. 2. The year in which the property was acquired. 3. The sale price of the property. 4. The cost of the property, or the fair market value, as of March 1, 1913, if it was acquired prior to 144 INCOME AND FEDERAL TAX REPORTS March 1, 1913. Depreciation or depletion previously deducted from income must be deducted from the cost Other factors affecting the profit are discussed in the chapter on Individual Income, pp. 59-66. Division D. Income from rents and royalties (pp. 66-67 and 76-77). The form requires as to each piece of property a statement of: 1. The kind of property, including its construction. 2. The cost of the building. This should be only the cost of the property on which an allowance for depre- ciation is claimed. 3. The cash or equivalent received as rent or royalty. 4. The amount of wear, tear and repairs. In the case of oil and gas wells, 'mines, etc., a reasonable allowance may be deducted for depletion. See chapter on Corporation Income, Deductions. 5. Other expenses and losses. The amount received as rent or royalty (3), less the sum of the wear, tear and repairs (4), and expenses (5), will be the net income from rents and royalties. Division E. Other income. All income not reported under the previous headings must be reported here with the exception of: 1. Dividends received from corporations which are themselves subject to the income tax. (See p. 78.) 2. Interest received on bonds on which the issuing corporation has agreed to pay the tax. (See chapter on Withholding, Deduction and Information at the Source.) 3. Interest received on bonds of the United States or its possessions, or any State or any political sub- division of a State. (See pp. 41 and 42.) 4. Interest on federal farm loans. (See p. 39.) 5. Proceeds of life insurance policies paid by the in- sured and premiums returned by life insurance com- panies. (See p. 40.) 6. Principal only of gifts and legacies. (See p. 41.) INDIVIDUAL INCOME TAX 145 The first two items would be subject to the super- tax if the income were in excess of $5,000, and therefore must be shown on page 4 of the return to make sure that the net income would not exceed $5,000 if these were included. The income from partnership, excluding any income from items 1, 3, 4, 5, 6 listed above, should also be in- cluded. (See pp. 56 and 71 to 75.) Interest on tax- free covenant bonds received through a partnership must be included as income. No withholding is au- thorized against partnerships and therefore the issuing corporation cannot pay the tax at the source, in accord- ance with its contract. (See chapter on "Withhold- ing, Deduction, and Information at the Source.") The instructions do not mention the fact that where a partnership determines its profits on the basis of a fis- cal year the individual partners are taxed on their shares of the profits at the rates in effect for the re- spective years in which such profits were earned. In- dividuals who received income from a partnership clos- ing its books as of a fiscal year should apportion such income between 1916 and 1917, as explained in the chap- ter on Income from Partnerships (pp. 72 to 73). The entire amount should be reported under Column 1 as "Cash received"; the amount determined as earned in 1916 under Column 2 as expenses paid, and the differ- ence will be the amount taxable as income for 1917. Income on which the tax has not been paid, received from fiduciaries, excluding any income from items 1 to 6 listed on the preceding page should also be reported. (See Chapter on Fiduciaries.) The net income as shown under headings A to E in- clusive should be totaled, giving the total net income. If a loss is reported under Division B, D, or E it may be shown as a general deduction under Division Gr. If a loss is shown under Division C, it will be allowed as a deduction only if the transactions out of which the 146 INCOME AND FEDERAL TAX REPORTS loss resulted were connected with the individual's busi- ness. (See p. 113, Deductions.) If this deduction is claimed a statement must be attached to the return ex- plaining how the transactions were connected with the individual business. Division G. General deductions. Under "Interest paid," all interest payments should be deducted, except interest paid on obligations incurred in the purchase of tax-exempt securities, including Liberty Bonds of the first and second loan. Taxes (see p. 110), losses on personal loans and on other bad debts that are not connected with the indi- vidual's business (see p. 120) may also be deducted. Charitable contributions made should not be included in this section. F. The net income will be the difference between the total net income and the general deductions. From this figure may be deducted contributions made to relig- ious, charitable and educational organizations to an amount not in excess of 15 per cent of the total net income (including dividends and interest from tax-free bonds), as previously explained. (See p. 113, Deduc- tions.) From this "balance of net income," as it is called on the form, is to be deducted the personal exemption al- lowed by the law, which is explained in the preceding chapter on Rate of Tax. The resulting figure is the income subject to the 2 per cent tax imposed by the act of October 3, 1917. The tax due will be 2 per cent of this figure. Additional information required. In addition to the statement of his net income, the taxpayer must also state whether or not he filed a return for 1916, and if so, what address he gave and to what collector's office he sent the return. He must also support his claim for personal exemption by stating his status as of Decem- ber 31, 1917- He must also state whether or not a INDIVIDUAL INCOME TAX 147 separate return was made by his wife, or dependent child, and if so, the name under which such return was filed. He must also give any other address which he furnished to any person, firm or corporation from whom he received $800 or more income during 1917. The return must be signed by the taxpayer or his agent and properly sworn to. If signed by an agent, the reason why the return is made by the agent must be given. Special provision has been made for the verification of returns of individuals in the naval and military forces of the United States. The verification of the re- turn by any officers authorized to administer oaths for military or naval justice will be accepted by the Treas- ury Department. FORM 1040 The preparation of Form 1040. Form 1040 is to be used by individuals having a net income in excess of $3,000, although as previously stated, Form 1040 A may, under certain conditions, be used by individuals having a net income in excess of $3,000, but not in excess of $5,000. The taxpayer is required to report his net income under one or more of the headings shown in the return. Net income is grouped into eight divisions, a short discussion of the items to be reported under heading follows : Division A. Income from salaries, wages, commis sions, bonuses, directors' fees, pensions and from pro- fessions (see pp. 48-52). Income resulting from the employment of other than nominal capital should not be reported under this heading but should be shown under Division B. A definition of nominal capital will be found in the Chapter on Excess Profits Tax. The income reported under this heading is subject also to a tax of 8 per cent on the amount in excess of $6,000 148 INCOME AND FEDERAL TAX REPORTS under the War Excess Profits Tax. The amount of this tax (Excess Profits) will be credited against the net income before computing the income tax. The income to be reported should be that income as is explained under "Salaries, Wages, Commissions, etc." A discus- sion of the various items which constitute allowable deductions against this income will be found in the chapter on "Individual Income Tax Deductions Neces- sary Expenses." The nature of the deductions should be described briefly in the space provided on the form. Salary or commission or other income amounting to $800 or more received from one person, firm or cor- poration should be reported separately, together with the name of the person, firm or corporation paying- same. Division B. Income from business, including farm- ing (see pp. 52-59). The form provides a clear method of showing the net income from business. A profit and loss statement taken from the books of the individual may be attached to the return and the net income shown by the statement entered as net income from business. Merchandise and securities may be inventoried either at cost or at cost or market, whichever is lower. A discussion of the advisability of inventorying mer- chandise at market price will be found on pages 54 and 55. Division C. Profits from sale of real estate, bonds and other securities (see pp. 59-66). In determining the cost of real estate sold such incidental expenses of purchasing the property as have not been deducted in previous returns may be added to the original cost, as may also the amount of taxes assessed against the prop- erty for local benefits. The amount of depreciation deducted from income on previous returns should be added to the sales price. If such transactions show a net loss, the loss will not INDIVIDUAL INCOME TAX 149 be permitted as a deduction unless the transactions were connected with the individual's regular business. A discussion of the meaning of "regular business" will be found in the chapter on "Individual Income Tax Deductions." Division D. Income from rents and royalties. The amount received as rents (see pp. 66-67) or royalties (see pp. 76-77) should be reported here. The allow- able deductions include repairs, depreciation, interest, taxes, and other expenses. See Chapter on "Individual Income Tax Deductions." Division E. Interest on bonds and other obligations of the United States issued after September 1, 1917. There should be reported only the interest received on the amount of bonds of the second Liberty Loan, War Savings Certificates and Treasury Certificates of In- debtedness held by one individual in excess of a total of $5,000 of par value. From this there may be de- ducted that portion of the interest paid on indebted- ness incurred in the purchase of such bonds or certifi- cates as the amount of such obligations held in excess of $5,000 is to the total amount held. To illustrate: A purchased $10,000 worth of Liberty 4's on November 15, 1917. In order to purchase them he borrowed $10,000 from his bank at 5 per cent. He sold his bonds Decem- ber 31, 1917, at par and accrued interest and with the proceeds took up his loan at the bank. He would re- port as follows: 1. Amount of bonds. . $10,000.00 2. Amount of interest received on amount in excess of $5,000 25.00 3. Indebtedness incurred for the purchase of bonds or certificates 10,000.00 4. Interest paid on proportionate part of indebtedness (total interest paid $62.50), one-half of $62.50 31.25 5. Excess of interest paid 6.25 150 INCOME AND FEDERAL TAX REPORTS This excess of interest paid should be included among other deductions in Division J of the form, which will exclude such excess from the super-tax. This excess interest paid is not a proper deduction from the normal tax and therefore must be added to the amount of income, subject to the normal tax, as provided on line 24. Where the amount of interest received exceeds the amount of interest paid the excess amount received is included as income, but inasmuch as the interest on these bonds is subject only to the super-tax, the excess amount received must be deducted on line 19 from the amount of income subject to the normal tax. Division F. Dividends on stock of corporations or- ganized or operating in the United States and subject to the income tax. To be included in this division the dividends must be on stocks of corporations which are subject to the income tax on their entire net income. As hereinbefore explained, dividends on stocks of for- eign corporations transacting part of their business in the United States and therefore subject to tax on part of their net income should be included under "Other Income." Dividends, as previously explained (see pp. 82-88), are taxed at the rates in effect for the years in which the surplus out of which they are paid was accumu- lated. Dividends should therefore be separated accord- ing to the year accumulated. The amount accumulated prior to 1913 need not be shown. The amounts in the years 1913, 1915, 1916, 1917 should be shown separately on the form, but only the amount accumulated in 1917 is included in the income subject to the taxes in effect for 1917. The tax on the amount accumulated in the previous years must be made separately and the amount of tax entered on line 37. The method used in this cal- culation is illustrated in the paragraphs on Computation of Tax, p. 155. INDIVIDUAL INCOME TAX 151 Division G. Interest on tax-free covenant bonds on which one normal tax of 2 per cent was withheld at the source, Interest on bonds containing a tax-free cove- nant and on which no exemption has been claimed should be reported here. If exemption has been claimed and no tax paid at the source the interest should be re- ported under "Other Income," Division H. Division H. Other income. All forms of income, with the exception of tax-exempt income, which have not been included elsewhere, should be reported under this heading. Income from partnerships should be included,, except that part of the profits which was originally derived from the following sources, which should be excluded: 1. Interest on obligations of the United States issued since September 1, 1917. This should be shown in Di- vision E to the extent provided under that heading. 2. Dividends on stocks. This should be entered in Division F. 3. Interest on tax-exempt securities. These need not be shown on the return at all. Where the fiscal year of the partnership differs from the calendar year the income should be apportioned as between 1916 and 1917. That portion which is deter- mined to be earned in 1917 should be extended in the net income column. The portion which is applied to 1916 should be entered in the deduction column. The calculation of the tax upon this amount at the rates in effect for 1916 is to be made separately and the amount of the tax is to be added to the total tax due. See p. 72. Income from fiduciaries should be entered here, ex- cepting income from the three sources above, and also excepting interest on tax-free covenant bonds on which no exemption has been claimed. This interest should be included in Division G. Division I. Total net income from all sources. The 152 INCOME AND FEDERAL TAX REPORTS total of divisions A to H inclusive will give the total net income from all sources. From this may be de- ducted the "general deductions." Division J. General deductions. Under this heading will be included interest on personal indebtedness, taxes paid on dwelling, the excess interest paid as reported under Division E, the loss, if any, reported under B, D or H, and the loss, if any, provided under Division C, if such transactions formed part of the individual's business. Division K. Total net income. This is the differ- ence between I and J. Division L provides for the deduction from K of the amount of excess profit taxes, if any, for 1917. The resulting figure is M. Division N. Contributions to charitable organiza- tions. Provides for the deduction from M of contribu- tions to an amount not in excess of 15 per cent of item M (see Individual Income Tax Deductions). These contributions must be listed. The final figure M minus N is the net income (Item 0) on which the income tax, normal tax and super-tax, is to be calculated. In the instructions on Form 1040, Revised, contri- butions cannot be over 15 per cent of item M. Item M, it appears, includes all income received with the ex- ception of dividends received in 1917 paid out of cor- porations' accumulated profits earned in 1913, 1914, 1915 and 1916. Inasmuch as the income which may be reported under these four years is not added to the total in computing the amount to be extended on line M of page 4, the statement with reference to the total deductions on page 4 of Form 1040, that the contribu- tions cannot exceed 15 per cent of item M, seems erroneous. It appears that the intent of Congress was to allow 15 per cent of the total taxable income of an individual and which should also include the divi- dends received in 1917 from corporations' accumulated INDIVIDUAL INCOME TAX 153 profit earned in years prior to 1917. By following strictly the instructions on Form 1040, it appears that an individual will not be allowed full deductions of contributions which should be allowed them. Before computing the normal tax there should be de- ducted, as provided for by lines 19, 20, and 21 and 22, those items which are exempt from the normal tax, as follows : 1. Excess of interest received over interest paid on obligations incurred to purchase obligations of the United States issued since September 1, 1917 (Item E), 2. Dividends (Item F) paid out of 1917 earnings, and 3. The personal exemption (explained in Chapter on "Rate of Tax"). To the remaining balance (line 23) there must be added any items which are subject to the normal tax but not to the super- tax. The only item in this class is : 1. Excess of interest paid on indebtedness incurred for purchase, over interest received, on obligations of United States issued since September 1, 1917 (line 24), as shown under Division E. The resulting amount (line 25) is subject to the 2 per cent normal tax imposed by the act of October 3, 1917. Deducting $2,000 (line 26), which is the differ- ence between the personal exemptions allowed by the 1916 and 1917 laws, we have the income subject to the 2 per cent tax imposed by the act of September 8, 1916 (line 27). Calculation of super-tax. The super-tax or surtax will be calculated on Item O, "Net income on which income tax is to be calculated," according to the table on page 154. To compute the amount of surtax due on any amount of net income in excess of $5,000, first find in Column A the largest sum which is less than the amount of total net income reported on the return, Item O, then find in Column E the corresponding amount of total surtax. 154 INCOME AND FEDERAL TAX REPORTS Amount Sub- Amount of ject to Surtax Rate Amount of Total Sur- Net Income at Rate shown Surtax at tax on Each in Column C Each Rate Amount A B C D E $5,000 $000 o% $00 $00 7,500 2,500 1 25 25 10,000 2,500 2 50 75 12,500 2,500 3 75 150 15,000 2,500 4 100 250 20,000 5,000 5 250 500 40,000 20,000 8 1,000 2,100 60,000 20,000 12 2,400 4,500 80,000 20,000 17 2,400 7,900 100,000 20,000 22 4,400 12,300 150,000 50,000 27 13,500 25,800 200,000 50,000 31 15,500 41,300 250,000 50,000 37 18,500 59,800 300,000 50,000 42 21,000 80,800 500,000 200,000 46 92,000 172,800 750,000 250,000 50 125,000 297,800 1,000,000 250,000 55 137,500 435,300 1,500,000 500,000 61 305,000 740,300 2,000,000 500.000 62 310,000 1,050,300 Over 2,000,000 63 To this amount add an amount computed as follows: Subtract from the net income (Item O) the sum first found in Column A and multiply the remainder by the rate shown on the next line below in Column C. The sum of these two amounts is the total surtax due. Calculation of total tax. Having calculated the amount of surtax, the amount of the total tax due will be ar- rived as follows: 1. Normal tax of 2 per cent on amount shown on line 25; plus 2. Normal tax of 2 per cent on amount shown on line 27; giving INDIVIDUAL INCOME TAX 155 3. Total normal tax (line 30) 4. Less tax withheld on tax-free covenant bonds (2 per cent on net total of item G) ; leaving 5. Balance of normal tax due; plus 6. Surtax, plus 7. Excess profits tax of 8 per cent on amount of in- come in excess of $6,000 shown under Division A. 8. Excess profits tax on income from business with invested capital as computed on excess profits tax re- turn (Form 1001) ; giving 9. Total tax. 10. Additional or surtax on account of dividends ac- cumulated in 1913, 1914, 1915, or 1916, and partnership profits earned in 1916. 11. Total tax due. COMPUTATION OF INCOME TAX ON INDIVIDUALS Example illustrating method. The following example illustrates the method of computing the tax where cer- tain items of income are taxable at rates other than those in effect for 1917: A, a married person, a citizen of the United States, has the following income: From partnership of A, B & Co $100,000 Interest on bonds 5,000 Stock dividend of 100 per cent on 1,000 shares (par value $100 per share) of the X, Y , Z Cor

*1 P Jijj 5 2 4 s a.2 go. o v V H Ha m s .S "3 S k - a o g^5-2fiT3-d -ass p < & 5 OS b "0 efl 8 "8 || Jo* o 0.2 .a c c o o I Sfllsl * V > OD rt g d. S o 272 INCOME AND FEDERAL TAX REPORTS Treasury Decision 2452 follows: When a non-resident alien record owner of stock of domestic or resident corporations is an organization subject to withholding at the source of dividend payments, as provided by section 13(f) of the act of September 8, 1916, but is not the actual owner of the stock, such record owner may adapt income tax certificate Form 1087, to disclose actual ownership and to claim exemptions from withholding by striking out the words "to be filed with representative in the United States of such Foreign Principal" in the caption and the words "in the United States" in the body of the form and executing the certificate as the representative of the actual owner, as provided in the space for signature. Thus modified, certificates Form 1087 may be filed, under the penalties prescribed for misrepresentation, with debtor corporations or their with- holding agents in the United States and may be accepted by them as evidence that the record owner is not liable for income tax on the divi- dends to be paid and hence is not subject to having tax withheld. If the record owner does not exercise his right to disclose actual owner- ship for the purpose of claiming exemption from having tax withheld at the source, debtor corporations and their withholding agents in the United States will be held liable on their stock records of ownership for the tax required to be withheld by section 13(f) of the act of September 8, 1916. In the absence of a disclosure of actual ownership filed with debtor corporations or their withholding agents on certificate Form 1087, the normal tax required to be withheld in accordance with stock records of ownership can only be released to a record owner not liable for tax, upon a proper showing to the Commissioner of Internal Revenue of record and actual ownership, the names and post-office addresses of debtor corpora- tions and withholding agents, and the amounts withheld. As a record owner is held to be "the proper representative having the receipt, custody, control or disposal" (Sec. 9(g), act of September 8, 1916) of income of the actual owner, this showing should be made by means of a return by or in behalf of the actual owner when the actual owner is liable for a return under the provisions of law. When a return is not required to be filed by or in behalf of the actual owners, the showing may be made upon the certification of the record owner. Upon the showing thus made, either by certification or return, as the circumstances may require, the Commissioner of Internal Revenue will make such assessments and issue such instructions to debtors and with- holding agents as will insure the proper collection of tax in accordance with the respective actual tax liabilities. The law does not provide any method for withholding the tax on dividends paid in stock of the corporation. The safest procedure for the issuing corporation to fol- low would be to require the foreign stockholder to de~ "with holding;' etc., at source 273 posit an amount of money sufficient to cover the tax required to be withheld, before turning over the cer- tificates for the new shares. Withholding on miscellaneous incomes. The withholding of the tax on miscellaneous income should be at the rates of 2 per cent on income accruing to non-resident alien individuals and 6 per cent to non-resident alien corporations. This would include any royalties, disposition of profits (other than dividends), interest on bank deposits, com- missions, or any other income that was actually deter- minable. It would also include that income paid by a fiduciary or executor of an estate where the beneficiary was a non-resident alien. Claims for deduction allowed non-residents. No claims for the specific exemptions of $3,000 or $4,000 allowed under the 1916 law will be allowed non-resident claims, as these exemptions have been eliminated in the amended law. (Section 7, subdivision (b).) The non- resident alien may, however, file with the withholding agent a claim for the benefit of known deductions allow- able on or before Feb. 1. Refund to non-residents for excess taxes withheld at the source. In cases of excess taxes withheld at the source from non-resident aliens such non-resident aliens should file with the collector of internal revenue at Baltimore, Md., on or before March 1, a true and accu- rate return of total income from sources within the United States and attach to such return a complete state- ment clearly setting forth the names and addresses of the withholding agents, and the districts wherein their withholding reports were filed, so that proper adjustment may be made in order that correct assessment may be made against the withholding agent, and the difference then refunded by such withholding agent to the non- resident alien. If such report cannot be filed within 274 INCOME AND FEDERAL TAX REPORTS 8J 2 O a O U. , i V oj a I 111 5 g-3-3 o P-^ 1 a 3 a X O H ia """2 23* la O t- O o a o D 5 iS .SB -3 03 -a gup (J* u O o J^n-. CO M P SB 2 C 'S fl 03 F I* a o >-. C o 0> o qj S is * i 9 Ed5 p-d at *o J3.S-S fit "WITHHOLDING," ETC., AT SOURCE 275 that time, and the total tax is withheld and paid by the withholding agent, the non-resident alien should make claim for refund on Form 46, and attach to such form a copy of his true and actual return of net income. A State, county, municipality or any other political subdivision of a State is not required to withhold any amount of income tax from interest which it may pay upon its own obligations, even though such interest is paid to non-resident alien individuals or to foreign cor- porations. Reports required of withholding corporations. Debtor corporations withholding any amount of income tax from interest on "tax-free" obligations paid to citizens or residents of the United States, are required to report such payments, on the prescribed form (Form 1012), to the collectors for their districts within twenty days after the close of the month during which the tax was with- held. This ruling is also applicable to any payments of interest made on corporate obligations, whether "tax-free" or not, made to non-resident alien individuals, foreign corporations, joint stock companies, etc., having no office or place of business in the United States. A return of the amount of tax withheld from pay- ments of fixed and determinable gains, profits or income made to non-resident alien individuals, other than in- terest on corporate obligations, by individuals, citizens or residents of the United States, domestic or resident corporations, joint stock companies, etc., is not required until after the close of the year during which the tax was withheld, but such returns are not to be filed later than March 1 of the next succeeding year on forms 1042 and 1098. The amount of tax assessed against such withholding returns as are rendered is to be paid by the withholding agent to the collector of internal revenue for the district, after receipt from the collector of a notice of the amount assessed and demand therefor. 276 INCOME AND FEDERAL TAX REPORTS Release of tax heretofore, but not now, required to be with- held. Section 1212 of the act of October 3, 1917, provides that any amount heretofore withheld by any withhold- ing agent, as required by Title I of the act of Septem- ber 8, 1916, on account of the tax imposed upon the income of any individual, a citizen or resident of the United States, for the calendar year of 1917, except that withheld from interest paid on bonds containing a "tax-free" or "no-deduction" clause, shall be released and paid over to such individual. Therefore, any amount of normal tax withheld during the year 1917 from income paid to a citizen or resident of the United States, including income withheld on sal- ary paid to officers and employees of a corporation or firm, except interest on bonds and mortgages or deeds of trust, or other similar obligations of corporations, joint stock companies, etc., containing a so-called "tax- free" or "no-deduction" clause, may now be released and paid over to such individual, and no return or pay- ment of such tax will be required from the withholding agent. In a case where a bank or other collection agency detached the ownership certificate which accompanied an interest coupon and substituted its own certificate, Form 1059, which did not disclose the name and ad- dress of the bond owner, it is held that where substi- tute certificate, Form 1059, has been used in connection with coupons from bonds which do not contain a "tax- free" or "no deduction" clause, the withholding agent shall request the bank or collection agency to disclose the name and address of the owner of the bond, as shown by the original certificate, and it shall be the duty of the bank or collection agency to make such dis- closure to the withholding agent. If the owner of the bond is a citizen or resident of the United States, the withholding agent shall refund the amount of tax de- ducted, as provided by law, and if a non-resident alien, "WITHHOLDING," ETC., AT SOURCE 277 no refundment shall be made, but the withholding agent shall make return thereof on or before March first, and on or before the time fixed by law for the payment of the tax shall pay the amount withheld to the Auditor of the United States Government authorized to receive the same. (T. D. 2635.) In lieu of withholding at the source on salaries and other fixed and determined annual income paid to in- dividuals, the law now provides for an elaborate system of information at the source. INFORMATION AT THE SOURCE Returns of information. Section 26 of the act of Sep- tember 8, 1916, as amended, provides that every corpora- tion, joint-stock company or association or insurance eompany subject to the Federal Income Tax on its own income, shall, when required by the Commissioner of Internal Revenue, render a correct return on form 1096, duly verified under oath, of its payments of dividends, whether made in cash or its equivalent or in stock, which return shall give the names and addresses of the stockholders, the number of shares owned by each, the aggregate amount of dividends received by each, and the tax years and the applicable amounts in which such dividends were earned. 1 Section 27 provides that every person, corporation, partnership or association, doing business as a broker on any exchange or board of trade or other similar place of business shall, when required by the Commis- sioner of Internal Eevenue, render a correct return on form 1096, duly verified under oath, showing the names and addresses of customers for whom any busi- ness has been transacted, with such details as to profits, losses or other information which the Commis- sioner of Internal Revenue may require to enable him to i For the present the commissioner will not require this information. (Letter dated February 14, 1918.) 278 INCOME AND FEDERAL TAX REPORTS determine whether all income tax due on profits or gains of such customers has been paid. 1 Section 28 provides that all persons, corporations, partnerships, associations and insurance companies, making a payment to any person, corporation, partner- ship, association or insurance company, of interest, rent, salaries, wages, premiums, or other items of fixed and determinable gains, profits and income (other than dividends on stocks or gains or profits derived from transactions on any exchange or board of trade, or other similar place of business) of $800 or more during any calendar year, shall render a true and accurate return on forms 1096 and 1099 covering the payments made, which return shall disclose the names and addresses of the recipients of such payments and the aggregate amount paid to each during the calendar year. This report must show the name of the recipient of the income, the address, and the total income paid dur- ing the year. A return is not required to be filed where an indi- vidual is paid merely at a rate equal to or in excess of $800 a year, if the entire amount actually paid to him within the year did not equal or exceed $800. It does not matter, for the purpose of the tax, in what form an individual is paid, whether his income is fixed or not, whether he receives wages or is paid on a piece-work basis; if his total income from a single payor during the year equalled $800, such payor must file a return. A return of information at the source is required, moreover, if the cash compensation paid, plus any commissions, living expenses, or other allowances, in the aggregate amount exceeds $800 for the tax year. This requirement also attaches to fiduciaries paying any beneficiary to an estate income of $800 or more during the year (see chapter on Fiduciaries). i For the present the commissioner will not require this information. (Letter dated February 14, 1918.) "WITHHOLDING," ETC., AT SOURCE 279 Keturns of information will also be required, regard- less of amounts paid, in the case of payments of inter- est upon bonds and mortgages or deeds of trust or other similar obligations of corporations, joint-stock companies, associations and insurance companies and, also, in the case of collections of items (not payable in the United States) of interest upon the bonds of foreign countries and interest upon bonds and dividends from the stock of foreign corporations, from all persons, corporations, partnerships or associations which undertake as a mat- ter of business or profit the collection of foreign pay- ments of interest or dividends by means of coupons, checks or bills of exchange on forms 1096 and 1099. Such certificates or forms are not required to be filed nor such information given by the paying bank regard- ing the payment of interest on either the 3y 2 per cent or the 4 per cent Liberty Bonds when interest coupons are presented for collection. Payment to agent. When an agent receives, in behalf of his principal, a payment falling within the pro- vision of the law for information at the source, the agent is required by law to furnish the name and address of the principal upon receipt of a demand therefor from the payor. If the agent refuses to comply with this demand he becomes liable for a penalty of not less than $20 nor more than $1,000. License for collecting foreign income. Under the pro- visions of section 9 of the act of September 8, 1916, as amended, no person, corporation, partnership or associ- ation can undertake as a matter of business or for profit the collection of foreign payments of interest or dividends by means of coupons, checks or bills of ex- change without first obtaining a license from the Com- missioner of Internal Revenue, and whoever knowingly undertakes to collect such payments, as aforesaid, with- out having obtained a license therefor, or without com- plying with prescribed regulations, shall be deemed 280 INCOME AND FEDERAL TAX REPORTS 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. Those who had obtained such a license under the act of October 3, 1913, or under the Act of September 8, 1916, are not required to take out a new license, as it is held that such licenses previously obtained under either of those acts fully meet this requirement. The time for filing returns for information at the source has been extended for 1917 reports until April 1, 1918. CHAPTER XII FIDUCIARIES WHO ARE FIDUCIARIES "Fiduciaries" defined. For the purpose of the In- come Tax law, the term "fiduciaries" includes "guard- ians, trustees, executors, administrators, receivers, con- servators and all persons, corporations, or associations, acting in any fiduciary capacity." A fiduciary capacity is that in which a person holds the legal title to an estate in which another person, known as the bene- ficiary, has the beneficial interest. The beneficiary, as well as the fiduciary, may be either an individual or a corporation or other organization. Where the fidu- ciary is a corporation, it is for all intents and purposes to regard itself as an individual fiduciary, that is, there are no separate forms for corporate and individual fidu- ciaries. Classes of fiduciaries. The following paragraphs give brief definitions of the classes of fiduciaries, within the meaning of the term as used in the Income Tax law. Guardian. A legal guardian (in whom is vested legal title to an estate for the benefit of a minor, whether or not he is the parent of the minor child) is a fiduciary, but a natural guardian, as such, is not. The guardian of an insane or otherwise incompetent person comes under the first classification. Trustee. A trustee is a person who holds the legal title to an estate, and as such has the right to control it, though the beneficial interest belongs to another person. Trustees of individuals in bankruptcy are fiduciaries; those of corporations are not, that is, the trustees or 281 282 INCOME AND FEDERAL TAX REPORTS receivers of corporations in bankruptcy report on the forms used for corporations and can know how to fill out their returns if they look upon themselves as agents for the corporation. Executor. An executor is one who gets title to the personal estate of a decedent by virtue of an appoint- ment in the latter's will and a confirmation of that ap- pointment by the proper judicial officer, such as a sur- rogate or judge of a probate or orphans' court. After an executor has converted an estate into money, ascer- tained its exact amount, paid debts and specified legacies he may continue to hold some of the property under a direction contained in the will as trustee for named beneficiaries. ' Administrator. An administrator is one who gets title to the personal estate of a decedent by virtue of an appointment by a court charged with the administra- tion of the estate. Thus executors are appointed in a will and administrators are appointed where there is no will, or where the will makes no nomination or where the person named in the will fails to qualify. Receiver. A receiver is an impartial person ap- pointed by a court of equity to hold property, pending the termination of litigation with respect to the prop- erty. The receiver is "the right arm of the court" and his holding of the property in effect puts the control of the property in the hands of the court itself. The re- ceiver for an individual is classed as a fiduciary but the receiver for a corporation, joint-stock company, as- sociation or insurance company is not. The receivers for such organizations report their income on the cor- porate forms. Conservator. Conservators are persons designated by law to hold property pending its ultimate disposition by virtue of some provision of the law. They are ordinarily charged with no active duties respecting the estate beyond doing what is necessary to conserve it. FIDUCIARIES 283 Agent not a fiduciary. Since a fiduciary must be one who holds legal title for the benefit of a cestui que trust, an agent acting only under a power of attorney is not a fiduciary, within the meaning of the Income Tax law, whatever may be his authority as to manage- ment and distribution of the estate or income of his principal. Receivers, trustees in bankruptcy and assignees of cor- porations etc., are not fiduciaries. A receiver, trustee in bankruptcy, or assignee of a corporation, joint-stock company or association or insurance company, as we have seen, is not a fiduciary, but an agent, and is re- quired to render regular returns of corporate income in the same manner and form as would the officers of the corporation were they themselves operating its business. Receivers, etc., for individuals are fiduciaries. The fore- going paragraph applies only to corporations and other organizations as specified therein, and not to individ- uals. Eeceivers, trustees and assignees of individuals are fiduciaries, for the purpose of the tax. Who are beneficiaries. Any person entitled to an in- terest in the estate held by a fiduciary is said to be a beneficiary. Thus legatees, heirs, wards, creditors of bankrupt individuals are all looked upon as beneficiaries and even the estate itself is to be regarded a beneficiary in respect to income received during the year and un- distributed. WHAT REPORTS MUST BE FILED BY FIDUCIARIES Fiduciaries act for and are subject to provisions apply- ing to individuals. In general, fiduciaries are required to "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." They must file (1) reports of information at the source and (2) reports of taxable 284 INCOME AND FEDERAL TAX REPORTS income on Forms 1040 or 1041, as explained in the following sections. Report of information at the source. If the income paid by a fiduciary to a beneficiary amounts during a calendar year to $800 or more, he must file a return of information at the source at such time and in such manner as may be prescribed by the Commissioner of Internal Eevenue, with the approval of the Secretary of the Treasury. This report is not a report of income received by the fiduciary, but a report of money paid over to the bene- ficiary and is a counterpart of the report required of any person who pays money in excess of or equal to $800 to another when the money paid is considered in- come by the latter. See preceding chapter on "With- holding," etc., at the Source." No report required if only corpus of estate is distributed. Income paid to beneficiaries must be reported under the conditions mentioned above, but if the amounts paid to the beneficiary are a distribution of only the prin- cipal or corpus of the estate, no report is required. Report when income from estate is distributed annually. In the case of estates the income of which is distrib- uted annually, if the amount paid during the calendar year to any one beneficiary is in excess of the specific exemption allowed to that beneficiary, $1,000 or $2,000 as the case may be, the fiduciary is required to file a return on Form 1041, that is, if there is among the beneficiaries one or more receiving an amount in excess of the specific exemption, so that the income tax would apply, the return must be filed on Form 1041, and on this return must be shown not only the amounts paid to the taxable beneficiary, but also all amounts paid to all other beneficiaries. Fiduciary to pay tax on income of decedent earned prior to his death. If the net income of a decedent from Jan- uary 1, of the year during which he died to the date FIDUCIARIES 285 of his death equalled or exceeded, in the case of an unmarried person, $1,000, and in the case of a married person, $2,000, the fiduciary should file a return on Form 1040 on behalf of such decedent, and pay the tax indicated to be due by such return, and if the income of the decedent's estate for the remainder of the calendar year equals or exceeds $1,000 and the estate is not settled and distributed by December 31st of that year, the fiduciary will be required to file a return (Form 1040) on behalf of the estate, and pay the taxes indi- cated thereon to be due. Taxes to be paid by fiduciary on income of minors, in- sane persons and non-resident alien beneficiaries. The fidu- ciary, as we have seen, is required by law to make out the returns for minors, insane persons and non-resident alien beneficiaries for whom he acts. The law also re- quires the fiduciary in such cases to pay the taxes, both normal and additional. An exception exists in the case where a minor becomes of age during the calendar year for which the income is being reported. In such cases the fiduciary makes a report for the period during which he acted, and the minor also makes a report which in- cludes also the income received through the fiduciary. Report of income of trust estate. Whenever the income of a trust estate (that is, an estate which receives its own income, as when the income, instead of being dis- tributed to beneficiaries, is held in trust or put back or added to the corpus of the estate) equals or exceeds $1,000, (the specific exemption allowed to estates) the fiduciary must file a return of income on Form 1040, and pay all the taxes and supertaxes due thereon. In cases where part of the income is retained by the estate and the balance distributed to beneficiaries, the return is not required unless (1) the amount paid to a beneficiary or (2) the amount retained by the estate, equals or exceeds the specific exemption allowed respec- tively to the beneficiary or to the estate. If the amount 286 INCOME AND FEDERAL TAX REPORTS paid to any beneficiary equals or exceeds the specific exemption allowed him ($1,000 or $2,000 depending upon his status) the fiduciary must file a return on Form 1041, showing (1) the amounts paid to the bene- ficiary; (2) amounts paid to any other beneficiaries who may have received any sums whatsoever; (3) the amounts retained by the estate. If the income retained by the estate equals or exceeds $1,000, the fiduciary must file also a return on Form 1040, for the estate itself; that is, both returns are required when both the estate and any one or more of the beneficiaries are taxable. Report of income of estate during period of settlement. In the case of estates during period of administration or settlement, Form 1040 should be filed, and normal and supertaxes paid, if the net income during the calen- dar year equals or exceeds $1,000; the income, after the tax has been paid by the fiduciary, becomes part of the corpus of the estate, and when such income is later paid over to the beneficiaries of the estate it will be free from taxation in their hands. If, however, the beneficiary knows what share he is entitled to, and reports such income himself, the fidu- ciary need not report it on Form 1040 but should report it on Form 1041. In such cases the estate is not taxed, but the amount of tax is based upon the individual's income, and when the income is later transferred to the beneficiary it is tax-exempt since it has already borne its share of the tax. Beneficiaries not entitled to inspect fiduciary's return. The beneficiaries of an estate are not entitled to the privilege of inspecting the returns filed by a fiduciary covering the estate in which they are interested, since the fiduciary is not subject to the control of the bene- ficiaries. Fiduciary should render statement giving essential infor- mation to beneficiary. However, a fiduciary distributing FIDUCIARIES 287 annually income of an estate to a beneficiary should render to such beneficiary a statement apprising the beneficiary of the sources of the income so distributed, disclosing just what part of the amount distributed was received from dividends on stock of corporations which had already borne the income tax, what amount represents income already tax-paid at the source, and what income was not tax-paid at the source, in order that the beneficiary may be in a position properly to account for such income under the proper captions in his own personal return of income, on Form 1040. If any part of the income distributed to the bene- ficiary is tax-exempt, such as income from public secur- ities, property coming to the estate by gift, bequest, de- vise or descent, or if any portion of the corpus of the estate is distributed to the beneficiary, he should be in- formed of the fact by the fiduciary, in order that the beneficiary may omit such items from his tax return. Report of income of decedent prior to his death. If, dur- ing the year of a decedent's death, and prior to that event, his net income equalled or exceeded the exemp- tions allowed ($1,000 or $2,000, as the case might have been) the fiduciary must file a personal return on Form 1040, executed for and in behalf of the decedent as his agent; he must file also another return upon the same form (1040) for and in behalf of the estate, if it remains in process of administration and its net income from the date of the decedent's death until the end of the tax- able year (December 31) equals or exceeds $1,000. Reports of ancillary administrators. An ancillary ad- ministrator is held to be merely the agent of the domi- ciliary administrator, and should transmit to his prin- cipal all information as to income received by him as such agent, in order that the domiciliary administrator may make a report covering the entire income of the estate. Reports for foreign beneficiaries. When there is only one beneficiary and he is a non-resident alien, the fidu- 288 INCOME AND FEDERAL TAX REPORTS ciary practically takes the place of the beneficiary and makes out the return for him on Form 1040. The fiduciary executes the report as the agent of the alien and reports the income of the estate as the income of the alien. Where there are two or more beneficiaries the fiduciary must file one return for the estate (Form 1041) and a separate return for each non-resident alien beneficiary (Form 1040). The fiduciary is required to account for and pay both the normal taxes and super- taxes shown thereon to be due. Reports for minors and insane persons. The fiduciary who acts for a single minor or insane beneficiary makes out a return for such minor or beneficiary on the form provided for individuals; he is not required to make out a return as fiduciary for the estate. Where, how- ever, the fiduciary under one estate has more than one ward, he should file the fiduciary return on Form 1041, and a separate return on Form 1040 for each ward, if unmarried, whose income is at least $1,000, and if mar- ried, is at least $2,000. Fiduciaries are treated as the agents of wards and insane persons and are required to pay for their wards both normal and additional taxes out of the income in their control. The fiduciary, in fil- ing returns for wards or other beneficiaries, should claim for and in behalf of the ward or beneficiary the specific exemptions to which the ward or beneficiary is entitled. When a minor becomes of age, the fiduciary is re- quired to render a return on Form 1041 stating such facts and showing the income for the period from the beginning of the year to the day when the minor be- comes of age, and the quondam minor makes his sep- arate return and includes all money received by him during the year from the guardian. Reports where there are several trustees. Where there is more than one trustee, one only need file the report. This is usually done by the person having direct charge of the estate. The fiduciary executing the report must FIDUCIARIES 289 make oath that he has sufficient knowledge of the affairs of such person, trust, or estate to enable him to make the return. WHERE AND WHEN TO FILE RETURN Where report is filed. The fiduciary, or the one of several fiduciaries, executing a return should file the return in the collection district where he resides or has his place of business. The residence of the beneficiaries is immaterial in determining this question. When returns must be filed. All returns required of fiduciaries must be filed on or before March 1, 1918, un- less an extension of 30 days time is granted by the col- lector of internal revenue. Corporate trustees are gov- erned by the same rules as apply to individuals and must report for the calendar year. Failure to file a return within the time prescribed subjects the fiduciary to the same penalties as are imposed upon an individual, excepting the penalty of the 50 per cent additional to the tax. The tax is due and payable on or before June 15, and for failure to remit the tax within that time or within 10 days after notice and demand (Form 17) a 5 per cent penalty will be added, together with interest at the rate of 1 per cent per month. CONTENTS OF REPORTS OF FIDUCIARY Gross income. Gross income consists of the income received by a fiduciary for the benefit of the estate. It will be remembered of course that the report is really being made by the fiduciary for the estate and every- thing included in the report for any estate is treated as though it were the sole income or outgo of the fidu- ciary as a fiduciary. In other words, the fiduciary should not confuse with the estate he is reporting, any income from transactions that pertain only to his own personal business or to that of other estates he may 290 INCOME AND FEDERAL TAX REPORTS represent. Where one person creates several separate estates with a single trustee, the trustee must make out separate returns for each of the several estates, even if the beneficiaries of the several estates are the same per- sons. The gross income of an estate to be reported by fidu- ciaries is similar to that required to be reported by an individual, and will include all income derived from business, trade or sales; dealings in property, whether real or personal, which the estate may control or be interested in; rents received; and all interest received, whether from notes, mortgages or bank balances, and all interest from corporate obligations of domestic cor- porations. Interest received on obligations of foreign corporations should be separately reported, together with dividends on stock paid by foreign corporations having no place of business in the United States. Distributive net interest in partnerships in which the estate may share should be reported under a separate caption, and income from royalties or any other miscel- laneous income received should also be separately re- ported. , All dividends received by the estate from domestic corporations, or which have been received through other estates or through a partnership distribution of divi- dends on stock of domestic corporations held by the partnership should be grouped and shown separately, for the reason that such income has already borne its tax burden. Interest on bonds or obligations of the United States (issued prior to September 1, 1917), or any of its pos- sessions or of any State or political subdivision of a State, need not be reported. Interest on Liberty S^'s need not be reported, but interest on a total in excess of $5,000 par value of Liberty 4's, Treasury Certificates of Indebtedness and War Saving Certificates, must for the purpose of the FIDUCIARIES 291 income tax be shown in the report when such a report is required to be filed. Property received by the estate by way of gift, be- quest or devise need not be reported, but income earned from such property must be reported. Deductions from gross income in report filed by fiduciary. Certain expenses may be incurred in the earning of income by an estate. These are allowable deductions from gross income, as are similar expenses incurred by individuals in the earning of their incomes. These ex- penses include such business expenses as wages, salaries, repairs and rentals. Amounts paid for permanent improvements or better- ments are capital expenses, and are not deductible. Expenses of the administration of an estate, such as court costs, attorneys' fees, etc., are chargeable against the corpus of the estate before distribution to the beneficiaries, and therefore reduce the estate while it is still in the administrators' hands, hence they are not deductible from gross income in the income tax re- port. With regard to executors' and administrators' com- missions, it should be definitely ascertained by a fidu- ciary whether under State laws, under the terms of a will, or by the decree of a court, the commissions in question are deductible from the corpus of the estate, or from the income accruing to the beneficiaries of the estate. If the commissions are properly deductible from the corpus of the estate, they should not be de- ducted from gross income in the fiduciary's report. If, on the other hand, the commissions are to be deducted from the income of the estate distributable among the beneficiaries, the amount should be charged as a legiti- mate and necessary expense, properly deductible from the gross income of the estate. Besides necessary expenses, there may be deducted from gross income all interest paid within the year, 292 INCOME AND FEDERAL TAX REPORTS except on indebtedness incurred in purchasing securities which are also deductible, excepting state inheritance and Federal Estate taxes, these being properly charge- able against the corpus of the estate. Losses sustained during the year are allowable de- ductions if similar losses sustained by an individual would be deductible. (See Chapter on Individual In- come Tax, Deductions.) Debts past due and actually ascertained to be worth- less and which did not become due until after the dece- dent's death, may be charged off if the amounts which they represent were included as income in a previous year's return of the fiduciary. Debts due the decedent cannot be charged off under this caption, for the reason that those bad debts reduce the corpus of the estate. The only allowable bad debts deductible are those which the fiduciary included as in- come in the present or previous years. Such bad debts would be those which became due after the death of the decedent and which represent amounts which have been included by the fiduciary as income in previous or the current year's income tax returns; or debts which are represented by investments or loans made by the fiduciary after the creation of the estate or trust. A reasonable amount for depreciation and depletion is allowable as a deduction from gross income. (See the discussion under Corporation Income Tax, Deduc- tions, pp. 221-243.) In the case of an estate the income of which is dis- tributable annually to the beneficiaries or, in the case of a "trust" estate, where the terms of the will or trust or the decree of a court of competent jurisdiction pro- vide for keeping the corpus of the estate intact, and when physical property forming a part of the corpus of the estate has suffered depreciation through its use or employment in business, a reasonable allowance for depreciation will be permitted, provided that a de- FIDUCIARIES 293 preciation reserve representing the amount of such a deduction is set aside out of profits earned by the estate since the creation of the estate. Such depreciation al- lowance will not be deductible if no depreciation reserve is provided for out of profits, and the entire income is being paid annually to the beneficiaries. Where fiduciaries include as a deduction an amount for depreciation, they should file with their return either (1) a copy of the provisions of the will, trust or decree requiring such depreciation deduction where any such provisions exist, or (2) a statement showing that actual depreciation occurs, that the amount thereof is that stated and that the funds or assets retained as a reserve against depreciation have been or will be preserved and applied as such, and not distributed to beneficiaries. The purpose of these requirements is to prevent fidu- ciaries from including depreciation deductions in the returns they file for the estate when, actually, there is no depreciation reserve maintained, but the amounts claimed as a depreciation are in fact distributed to the beneficiaries. WHO PAYS THE TAX Withholding at the source against and by fiduciaries. In respect to income due fiduciaries, income is treated the same as that due individuals. Fiduciaries who are citizens or who reside or have a place of residence here get their income for their estates without deduc- tion at the source. Foreign non-resident fiduciaries must submit to the deduction of the income at the source and persons paying such income to them are liable for the tax in the same way as they are liable for the taxes on incomes due non-resident alien individuals. The same rule applies to the income due from a fiduciary to a beneficiary. The former is not bound to make any deduction for the tax except in the case of non-resident alien individual beneficiaries. 294 INCOME AND FEDERAL TAX REPORTS When the beneficiary reports and pays the tax. Where the beneficiary is neither a minor, nor an insane per- son nor a non-resident alien, he makes his own report and includes in it the income received from the fiduciary or credited to him by the fiduciary. In such case, of course, the beneficiary pays the tax himself. When the fiduciary pays the tax. The fiduciary, as we have seen, pays the tax and makes the return where his beneficiary is a minor or an insane person. He also pays the tax, normal and super, and makes a separate return for the income coming to the estate that is not credited to any definite beneficiary or that is accumu- lated in trust for the benefit of unborn or unascertained persons, or persons with contingent interests. Where income is accumulated for future distribution and is not credited to any beneficiary and is not reported by the beneficiary, it is to be treated as income coming into the hands of the fiduciary, to be reported by him. The taxes, normal and additional, are in such cases paid by the fiduciary, and the remaining income in such cases is looked upon thereafter as a part of the corpus of the estate not subject to taxation as income when it is trans- ferred subsequently to the beneficiary. Fiduciary to pay tax during period of settlement of the estate. Taxes, normal and additional, are paid by the fiduciary on behalf of the estate on income received by estates of deceased persons, during the period of ad- ministration or settlement of the estate. But where the income is to be distributed annually or regularly and where the share of a beneficiary can be determined and is credited to such beneficiary, if the beneficiary keeps his books on an accrual basis he may report the in- come and pay the tax on his share in the same manner as though he had actually received it. Thus, if a legacy of $100,000 in bonds is left to A and the estate is quite certainly solvent, A may report the interest accruing on the bonds though the interest may be collected and FIDUCIARIES 295 retained by the fiduciary and credited to the account of A. In such a case A would add the credited income to his own income and pay the normal taxes as well as the additional taxes which such an aggregate income would require. A, of course, would follow this procedure where his aggregate net income is less than the aggregate income of the estate, since under such circumstances the tax rate would be lower on the income if credited to A and re- ported by him than if kept in the estate and reported by it. "Income of estate or any kind of property held in trust, including such income accumulated in trust for the benefit of unborn or unascertained persons, or per- sons with contingent interests and income held for fu- ture distribution under the terms of the will or trust" will be taxed as though it were the income of an in- dividual and paid by the fiduciary. But where the in- come is to be distributed annually or regularly the amount of the tax is fixed with reference to each bene- ficiary's share, and paid by the beneficiary. CHAPTER XIII THE INCOME TAX LAW, AFFECT- ING INDIVIDUALS AND CORPORATIONS TITLE I OF THE ACT OF SEPTEMBER 8, 1916 (39 STATS. AT LARGE 771); AS AMENDED BY THE ACT OF MARCH 3, 1917 (39 STATS. AT LARGE 1000), AND AS FURTHER AMENDED BY TITLE XII OF THE ACT OF OCTOBER 3, 1917 (PUBLIC No. 50 65th CONGRESS) TITLE I. INCOME TAX PART I. ON INDIVIDUALS Individual normal tax rate. 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 resi- dent of the United States, a tax of two per centum upon such income ; and a like tax shall be levied, assessed, col- lected, and paid annually upon the entire net income re- ceived in the preceding calendar year from all sources within the United States by every individual, a non-resi- dent alien, including interest on bonds, notes, or other interest-bearing obligations of residents, corporate or otherwise. Individual additional tax rate. (b) In addition to the income tax imposed by subdivision (a) of this section (herein referred to as the normal tax) there shall be 296 THE INCOME TAX LAW 297 levied, assessed, collected, and paid upon the total net income of every individual, or, in the case of a non-resi- dent alien, the total net income received from all sources within the United States, an additional income tax (here- in referred to as the additional tax) of one per centum per annum upon the amount by which such total net in- come 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 ex- ceed $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 an- num upon the amount by which such total net income exceeds $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 cor- 298 INCOME AND FEDERAL TAX REPORTS poration, joint-stock company or association, or insur- ance 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 inconsistent with this subdivision and section three, shall apply to the imposition, levy, assessment, and col- lection of the additional tax imposed under this sub- division. (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 calen- dar year nineteen hundred and sixteen and in each calen- dar year thereafter. Individual income denned. Sec. 2. (a) That, subject only to such exemptions and deductions as are herein- after allowed, the net income of a taxable person shall include gains, profits, and income derived from salaries, wages, or compensation for personal service of whatever kind and in whatever form paid, or from professions, vocations, business, trade, commerce, or sales, or deal- ings in property, whether real or personal, growing out of the ownership 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. (b) 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, and also such income of estates or any kind of property held in trust, including such income accumulated in trust for the benefit of un- born or unascertained persons, or persons with contin- gent interests, and income held for future distribution under the terms of the will or trust shall be likewise THE INCOME TAX LAW 299 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 : Provided, That where the income is to be distributed annually 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. Such trustees, executors, administrators, and other 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 pro- visions of this title, and they shall have credit for the amount of such payments against the beneficiary or prin- cipal in any accounting which they make as such trustees or other fiduciaries. (c) For the purpose of ascertaining the gain derived from the sale or other disposition of property, real, per- sonal, 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 thirteen, shall be the basis for determining the amount of such gain derived. Additional tax includes undistributed profits. Sec. 3. For the purpose of the additional tax, the taxable in- come of any individual shall include the share to which he would be entitled of the gains and profits, if divided or distributed, whether divided or distributed or not, of all corporations, joint-stock companies or associations, or insurance companies, however created or organized, formed or fraudulently availed of for the purpose of preventing the imposition of such tax through the me- dium of permitting such gains and profits to accumulate instead of being divided or distributed ; and the fact that any such corporation, joint-stock company or association, or insurance company, is a mere holding company, or 300 INCOME AND FEDERAL TAX REPORTS that the gains and profits are permitted to accumulate beyond the reasonable needs of the business, shall be prima 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 accumula- tion is unreasonable for the purposes of the business. When requested by the Commissioner of Internal Reve- nue, or any district collector of internal revenue, such corporation, joint-stock company or association, or in- surance 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. Income exempt from law. Sec. 4. The following income shall be exempt from the provisions of this title : The proceeds of life insurance policies paid to indi- vidual beneficiaries upon the death of the insured; thp amount received by the insured, as a return of premium or premiums paid by him under life insurance, endow- ment, or annuity contracts, either during the term or at the maturity of the term mentioned in the contract or upon surrender of the contract; the value of property acquired by gift, bequest, devise, or descent (but the in- come 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 (but, in the case of obligations of the United States issued after September first, nineteen hundred and seventeen, only if and to the extent provided in the Act authorizing the issue thereof) or its possessions or se- curities issued under the provisions of the Federal Farm Loan Act of July seventeenth, nineteen hundred and six- teen; the compensation of the present President of the United States during the term for which he has been THE INCOME TAX LAW 301 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 subdivision thereof, except when such compensation is paid by the United States Government. Deductions allowed. Sec. 5. That in computing net in- come in the case of a citizen or resident of the United States (a) For the purpose of the tax there shall be allowed as deductions First. The necessary expenses actually paid in carry- ing on any business or trade, not including personal, liv- ing, or family expenses ; Second. All interest paid within the year on his in- debtedness except on indebtedness incurred for the pur- chase of obligations or securities the interest upon which is exempt from taxation as income under this title; Third. Taxes paid within the year imposed by the authority of the United States (except income and excess profits taxes) or of its Territories, or possessions, or any foreign country, or by 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, in- curred 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 ascertain- ing the loss sustained from the sale or other disposition of property, real, personal, or mixed, acquired before March first, nineteen hundred and thirteen, the fair mar- ket price or value of such property as of March first, nineteen hundred and thirteen, shall be the basis for de- termining the amount of such loss sustained ; Fifth. In transactions entered into for profit but not connected with his business or trade, the losses actually 302 INCOME AND FEDERAL TAX REPORTS sustained therein during the year to an amount not ex- ceeding the profits arising therefrom ; Sixth. Debts due to the taxpayer actually ascertained to be worthless and charged off within the year ; Seventh. A reasonable allowance for the exhaustion, wear and tear of property arising out of its use or em- ployment in the business or trade ; Eighth, (a) In the case of oil and gas wells a reason- able allowance for actual reduction in flow and produc- tion 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 Secretary of the Treasury : Provided, That when the allowance authorized in (a) and {b) 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 shall be made. No deductions shall be allowed for any amount paid out for new buildings, permanent improvements, or better- ments, 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 ex- haustion thereof for which an allowance is or has been made; Ninth. Contributions or gifts actually made within the year to corporations or associations organized and operated exclusively for religious, charitable, scientific, or educational purposes, or to societies for the preven- tion of cruelty to children or animals, no part of the net income of which inures to the benefit of any private stockholder or individual, to an amount not in excess THE INCOME TAX LAW 303 of fifteen per centum of the taxpayer's taxable net in- come as computed without the benefit of this paragraph. Such contributions or gifts shall be allowable as deduc- tions only if verified under rules and regulations pre- scribed by the Commissioner of Internal Revenue, with the approval of the Secretary of the Treasury. 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 herein- after provided; (c) A like credit shall be allowed as to the amount of income, the normal tax upon which has been paid or with- held for payment at the source of the income under the provisions of this title. Non-resident aliens deductions and credits allowed. 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 carry- ing 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 (except on in- debtedness incurred for the purchase of obligations or securities the interest upon which is exempt from taxa- tion as income under this title) which the gros3 amount of his income for the year derived from sources within the United States bears to the gross amount of his in- come for the year derived from all sources within and without the United States, but this deduction shal] be allowed only if such person includes in the return re- 304 1NVOME AND FEDERAL TAX REPORTS quired by section eight all the information necessary for its calculation ; Third. Taxes paid within the year imposed by the au- thority of the United States (except income and excess profits taxes), or of its Territories, or possessions, or by the authority of any State, county, school district, or municipality, or other taxing subdivision of any State, paid within the United States, not including those as- sessed against local benefits ; Fourth. Losses actually sustained during the year, in- curred in business or trade conducted by him within the United States, and losses of property within the United States arising from fires, storms, shipwreck, or other casualty, and from theft, when such losses are not com- pensated for by insurance or otherwise : Provided, That for the purpose of ascertaining the amount of such loss or losses sustained in trade, or specu- lative 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, nineteen hundred and thirteen, shall be the basis for determining the amount of such loss or losses sustained; Fifth. In transactions entered into for profit but not connected with his business or trade, the losses actually sustained therein during the year to an amount not ex- ceeding the profit arising therefrom in the United States ; Sixth. Debts arising in the course of business or trade conducted by him within the United States due to the taxpayer actually ascertained to be worthless and charged off within the year; Seventh. A reasonable allowance for the exhaustion, wear and tear of property within the United States aris- ing out of its use or employment in the business or trade ; (a) In the case of oil and gas wells a reasonable al- lowance for actual reduction in flow and production to be ascertained not by the flush flow, but by the settled TEE INCOME TAX LAW 305 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 Sec- retary of the Treasury : Provided, That when the allowance authorized in (a) and (b) shall equal the capital originally invested, or in case of purchase made prior to March first, nineteen hun- dred and thirteen, the fair market value as of that date, no further allowance shall be made. No deduction shall be allowed for any amount paid out for new buildings, permanent improvements, or betterments, made to in- crease the value of any property or estate, and no de- duction 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. (b) There shall also be allowed the credits specified by subdivisions {b) and (c) of section five. (c) A nonresident alien individual shall receive the benefit of the deductions and credits provided for in this section only by filing or causing to be filed with the col- lector 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. Personal exemption. Sec. 7. That for the purpose of the normal tax only, there shall be allowed as an exemp- tion in the nature of a deduction from the amount of the net income of each citizen or resident of the United States, ascertained as provided herein, the sum of $3,000, plus $1,000 additional if the person making the return 306 INCOME AND FEDERAL TAX REPORTS 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 ad- ditional exemption of $1,000 be deducted by both a hus- band and a wife: Provided, That only one deduction of $4,000 shall be made from the aggregate income of both husband and wife when living together: Provided further, That if the person making the return is the head of a family there shall be an additional exemption of $200 for each child dependent upon such person, if under eighteen years of age, or if incapable of self-support be- cause mentally or physically defective, but this provision shall operate only in the case of one parent in the same family: Provided further, That guardians or trustees shall be allowed to make this personal exemption as to in- come 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 exemp- tion than as provided in this section, from the amount; of net income received from all sources. There shall also be allowed an exemption from the amount of the net income of estates of deceased citizens or residents of the United States during the period of administration or settlement, and of trust or other estates of citizens or residents of the United States the income of which is not distributed annually or regularly under the provision of subdivision (b) of section two, the sum of $3,000, including such deductions as are allowed under section five. Individual returns Sec. 8. (a) The tax shall be com- puted upon the net income, as thus ascertained, of each person subject thereto, received in each preceding cal- endar year ending December thirty-first. (b) On or before the first day of March, nineteen hun- dred and seventeen, and the first day of March in each THE INCOME TAX LAW 307 year thereafter, 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 Eevenue, 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 non-residence 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 penal- ties provided for erroneous, false, or fraudulent return. Returns of trustees and other fiduciaries. (c) Guardians, trustees, executors, administrators, receivers, conserva- tors, 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 pro- visions 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 sub- 308 INCOME AND FEDERAL TAX REPORTS ject to all the provisions of this title which apply to in- dividuals : 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 : Provided further, That no return of income not exceed- ing $3,000 shall be required except as in this title other- wise provided. Returns of individual partners. (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 di- vided 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, nor- mal and additional, there shall be excluded their propor- tionate 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 (if and to the extent that it is provided in the Act authorizing the issue of such obligations of the United States that they are exempt from taxation), and its possessions, and that for the purpose of computing the normal tax there shall be allowed a credit, as provided by section five, sub- division (b), for their proportionate share of the profits derived from dividends. Such partnership, when re- quested by the Commissioner of Internal Eevenue or any district collector, shall render a correct return of the earnings, profits, and income of the partnership, ex- cept income exempt under section four of this Act, set- ting forth the items of the gross income and the deduc- tions and credits allowed by this title, and the names and addresses of the individuals who would be entitled to THE INCOME TAX LAW 309 the net earnings, profits, and income, if distributed. A partnership shall have the same privilege of fixing and making returns upon the basis of its own fiscal year as is accorded to corporations under this title. If a fiscal year ends during nineteen hundred and sixteen or a sub- sequent calendar year for which there is a rate of tax different from the rate for the preceding calendar year, then (1) the rate for such preceding calendar year shall apply to an amount of each partner's share of such part- nership profits equal to the proportion which the part of such fiscal year falling within such calendar year bears to the full fiscal year, and (2) the rate for the calendar year during which such fiscal year ends shall apply to the remainder. (/) In every return shall be included the income de- rived from dividends on the capital stock or from the net earnings of any corporation, joint-stock company or as- sociation, 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. (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 in- come, may, subject to regulations made by the Commis- sioner 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. Assessment and administration. Sec. 9. (a) That all as- sessments shall be made by the Commissioner of Internal Eevenue 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 310 INCOME AND FEDERAL TAX REPORTS 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 information obtained as pro- vided 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 de- mand 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 became due, except from the estates of insane, deceased, Or insolvent per- sons. Withholding of tax at the source. (b) All persons, cor- porations, partnerships, associations, and insurance com- panies, in whatever capacity acting, including lessees or mortgagors of real or personal property, trustees acting in any trust capacity, executors, administrators, receiv- ers, conservators, employers, and all officers and em- ployees of the United States, having the control, receipt, custody, disposal, or payment of interest, rent, salaries, wages, premiums, annuities, compensation, remunera- tion, emoluments, or other fixed or determinable annual or periodical gains, profits, and income of any nonresi- dent alien individual, other than income derived from dividends on capital stock, or from the net earnings of a corporation, joint-stock company or association, or in- surance company, which is taxable upon its net income as provided in this title, are hereby authorized and required to deduct 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 make return thereof on or before March first of each year and, on or before the time fixed by law for THE IXCOME TAX LAW 311 the payment of the tax, shall pay the amount withheld to the officer of the United States Government authorized to receive the same; and they are each hereby made personally liable for such tax, and they are each hereby indemnified against every person, corporation, partner- ship, association, or insurance company, or demand whatsoever for all payments which they shall make in pursuance and by virtue of this title. (c) The amount of the normal tax hereinbefore im- posed shall also be deducted and withheld from fixed or determinable annual or periodical gains, profits and in- come derived from interest upon bonds and mortgages, or deeds of trust or other similar obligations of corpora- tions, joint-stock companies, associations, and insurance companies (if such bonds, mortgages, or other obligations contain a contract or provision by which the obligee agrees to pay any portion of the tax imposed by this title upon the obligee or to reimburse the obligee for any portion of the tax or to pay the interest without deduc- tion for any tax which the obligor may be required or permitted to pay thereon or to retain therefrom under any law of the United States) whether payable annually or at shorter or longer periods and whether such interest is payable to a nonresident alien individual or to an in- dividual citizen or resident of the United States, subject to the provisions of the foregoing subdivision (b) of. this section requiring the tax to be withheld at the source and deducted from annual income and returned and paid to the Government, unless the person entitled to receive such interest shall file with the withholding agent, on or before February first, a signed notice in writing claiming the benefit of an exemption under section seven of this title. License required to collect foreign payments. (/) All per- sons, corporations, partnerships, or associations, under- taking as a matter of business or for profit the collec- tion of foreign payments of interest or dividends by 312 INCOME AND FEDERAL TAX REPORTS means of coupons, checks, or bills of exchange shall ob- tain a license from the Commissioner of Internal Reve- nue, and shall be subject to such regulations enabling the Government to obtain the information required under this title, as the Commissioner of Internal Revenue, with the approval of the Secretary of the Treasury, shall pre- scribe ; and whoever knowingly undertakes to collect such payments 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 im- prisoned for a term not exceeding one year, or both, in the discretion of the court. Intent and purpose of tax. (g) The tax herein im- posed upon gains, profits, and incomes not falling under the foregoing and not returned and paid by virtue of the foregoing or as otherwise provided by law shall be assessed by personal return under rules and regulations to be prescribed by the Commissioner of Internal Rev- enue 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 correspond- ing tax, normal and additional, prescribed by this title, and said tax shall be paid by the owner of such income, or the proper representative having the receipt, custody, control, or disposal of the same. For the purpose of this ownership or liability shall be determined as of the year for which a return is required to be ^rendered. The provisions of this section, except subdivision (c), relating to the deduction and payment of the tax at the souree of income shall only apply to the normal tax here- inbefore imposed upon non-resident alien individuals. PART II. ON CORPORATIONS. Rate of tax on corporations. Sec. 10. (a) That there shall be levied, assessed, collected, and paid annually TEE INCOME TAX LAW 313 upon the total net income received in the preceding calen- dar year from all sources by every corporation, joint- stock company or association, or insurance company, or- ganized 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 preceding calendar year from all sources within the United States by every cor- poration, joint-stock company or association, or insur- ance company, organized, authorized, or existing under the laws of any foreign country, including interest on bonds, notes, or other interest-bearing obligations of resi- dents, corporate or otherwise, and including the income derived from dividends on capital stock or from net earn- ings of resident corporations, joint-stock companies or associations, or insurance companies, whose net income is taxable under this title. The foregoing tax rate shall apply to the total net in- come 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 six- teen, 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 thir- teen, entitled "An Act to reduce tariff duties and to pro- vided revenue for the Government, and for other pur- poses," shall apply to the remaining portion of the total net income returned for such fiscal year. For the purpose of ascertaining the gain derived or loss sustained, from the sale or other disposition by a 314 INCOME AND FEDERAL TAX REPORTS corporation, joint-stock company, or association, or in- surance company, of property, real, personal, or mixed, acquired before March first, nineteen hundred and thir- teen, the fair market price or value of such property as of March first, nineteen hundred and thirteen, shall be the basis for determining tire amount of such gain de- rived or loss sustained. Rate of tax on undistributed income. (b) In addition to the income tax imposed by subdivision (a) of this sec- tion there shall be levied, assessed, collected, and paid annually an additional tax of ten per centum upon the amount, remaining undistributed six months after the end of each calendar or fiscal year, of the total net income of every corporation, joint-stock company or association, or insurance company > received during the year, as deter- mined for the purposes of the tax imposed by such sub- division (a), but not including the amount of any income taxes paid by it within the year imposed by the authority of the United States. The tax imposed by this subdivision shall not apply to that portion of such undistributed net income which is actually invested and employed in the business or is re- tained for employment in the reasonable requirements of the business or is invested in obligations of the United States issued after September first, nineteen hundred and seventeen : Provided, That if the Secretary of the Treas- ury ascertains and finds that any portion of such amount so retained at any time for employment in the business is not so employed or is not reasonably required in the busi- ness a tax of fifteen per centum shall be levied, assessed, collected," and paid thereon. The foregoing tax rates shall apply to the undistrib- uted net income received by every taxable corporation, joint-stock company or association, or insurance com- pany in the calendar year nineteen hundred and seventeen and in each year thereafter, except that if it has fixed its own fiscal year under the provisions of existing law, the THE INCOME TAX LA^Y 315 foregoing rates shall apply to the proportion of the tax- able undistributed net income returned for the fiscal year ending prior to December thirty-first, nineteen hundred and seventeen, which the period between January first, nineteen hundred and seventeen, and the end of such fiscal year bears to the whole of such fiscal year. Conditional and other exemptions. Sec. 11. (a) That there shall not be taxed under this title any income re- ceived by any First. Labor, agricultural, or horticultural organiza- tion; Second. Mutual savings bank not having a capital stock represented by shares ; Third. Fraternal beneficiary society, order, or associ- ation, operating under the lodge system or for the exclus- ive 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 co-operative banks without capital stock organized and operated for mutual purposes and without profit; Fifth. Cemetery company owned and operated exclus ively 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 stockholder or indi- vidual ; 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 316 INCOME AND FEDERAL TAX REPORTS pleasure, recreation, and other non-profitable purposes, 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 company, mutual or co-operative telephone company, or like or- ganization of a purely local character, the income of which consists solely of assessments, dues and fees col- lected from members for the sole purpose of meeting its expenses ; Eleventh. Farmers', fruit growers', or like association, organized 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 exclusive purpose of holding title to property, collecting income therefrom, 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 associations as provided in section twenty-six of the Act approved July seventeenth, nineteen hundred and sixteen, entitled "An Act to provide capital for agricul- tural development, to create standard forms of invest- ment based upon farm mortgage, to equalize rates of in- terest upon farm loans, to furnish a market for United States bonds, to create Government depositaries and fi- nancial agents for the United States, and for other pur- poses." Fourteenth. Joint-stock land banks as to income de- rived 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 in- come derived from any public utility or from the exercise THE INCOME TAX LAW 317 of any essential governmental function accruing to any State, Territory, or the District of Columbia, or any po- litical subdivision of a State or Territory, nor any income accruing to the government of the Philippine Islands or Porto Eico, or of any political subdivision of the Philip- pine Islands or Porto Eico: 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 ac- quire, 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 Terri- tory; but this provision is not intended to confer upon such person or corporation any financial gain or exemp- tion or to relieve such person or corporation 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 allowed to corporations organized in United States. Sec. 12. (a) In the case of a corporation, joint- stock company or association, or insurance company, or- ganized in the United States, such net income shall be as- certained by deducting from the gross amount of its in- come received within the year from all sources First. All the ordinary and necessary expenses paid within the year in the maintenance and operation of its business and properties, including rentals or other pay- ments 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 318 INCOME AND FEDERAL TAX REPORTS within the year and not compensated by insurance or otherwise, including a reasonable allowance for the ex- haustion, 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 allow- ance for actual reduction in flow and production to be as- certained not by the flush flow but by the settled produc- tion or regular flow ; (b) in the case of mines a reasonable allowance for de- pletion 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 Secretary of the Treasury: Provided, That when the allowance 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 addi- tion, 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 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 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 em- ployers' liability 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 TEE INCOME TAX LAW 319 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 com- panies 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 deductions from gross income amounts repaid to policy holders on account of premiums previously paid by them and interest paid upon such amounts between the ascer- tainment thereof and the payment thereof, and life in- surance 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 (except on indebtedness incurred for the purchase of obligations or securities the interest upon which is exempt from taxation as income under this title) 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 interest-bearing in- debtedness, and interest or dividends paid upon this stock shall not be deductible from gross income : Provided further, That in cases wherein shares of capi- tal 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 320 INCOME AND FEDERAL TAX REPORTS 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 in- tangible, the subject of sale or hypothecation in the or- dinary business of such corporation, joint-stock company or association as a dealer only in the property constitut- ing such collateral, or in loaning the funds thereby pro- cured, the total interest paid by such corporation, com- pany, or association within the year on any such indebt- edness may be deducted as a part of its expenses of do- ing business, but interest on such indebtedness shall only be deductible 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 in- debtedness, 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 is- sued by such bank, banking association, loan or trust com- pany shall be deducted; Fourth. Taxes paid within the year imposed by the authority of the United States (except income and excess profits taxes), or of its Territories, or possessions, or any foreign country, or by the authority of any State, county, school district, or municipality, or other taxing subdi- vision of any State, not including those assessed against local benefits. Deductions allowed to foreign corporations. (b) In the case of a corporation, joint-stock company or association, or insurance company, organized, authorized, or existing under the laws of any foreign country, such net income shall be ascertained by deducting from the gross amount THE INCOME TAX LAW 321 of its income received within the year from all sources within the United States First. All the ordinary and necessary expenses ac- tually paid within the year out of earnings in the main- tenance and operation of its business and property within the United States, including rentals or other payments re- quired 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 within the year in business or trade conducted by it within the United States and not compensated by insurance or otherwise, including a reasonable 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 of oil and gas wells a reasonable al- lowance 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 de- pletion 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 Secretary of the Treasury: Provided. That when the allowance authorized in (a) and (b) shall equal the capital originally invested, or in case of pur- chase made prior to March first, nineteen hundred and thirteen, the fair market value as of that date, no fur- ther 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 re- serve funds and the sums other than dividends paid within the year on policy and annuity contracts : Provided, That no deduction shall be allowed for any amount paid out for new buildings, permanent improvements, or better- 322 INCOME AND FEDERAL TAX REPORTS ments, 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 ex- haustion thereof for which an allowance is or has been made : Provided further, That mutual fire and mutual em- ployers' liability 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 pre- mium deposits as are retained by the companies for pur- poses other than the payment of losses and expenses and reinsurance reserves : Provided further, That mutual ma- rine 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 en- titled to include in deductions from gross income amounts repaid to policyholders on account of premiums previ- ously 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 policy- holder, or treated as an abatement of such individual policyholder, within such year ; Third. The amount of interest paid within the year on its indebtedness (except on indebtedness incurred for the purchase of obligations or securities the interest upon which is exempt from taxation as income under this title) to an amount of such indebtedness not in excess of the proportion 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 the capital employed in the business at the close of the year, and (b) THE IX COME TAX LAW 323 one-half of its interest-bearing indebtedness then out- standing, 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 : Provided, That in the case of bonds or other in- debtedness 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 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 invest- ment from either citizens or residents of the United States and secured by interest-bearing certificates of indebted- ness issued by such bank, banking association, loan or trust company, or branch thereof; Fourth. Taxes paid within the year imposed by the authority of the United States (except income and excess profits taxes), or of its Territories, or possessions, or by the authority of any State, county, school district, or mu- nicipality, or other taxing subdivision of any State, paid within the United States, not including those assessed against local benefits. Guarantee or reserve funds of assessment insurance com- panies. (c) In the case of assessment insurance compan- ies, 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. Corporation returns. Sec. 13. (a) The tax shall be computed upon the net income, as thus ascertained, re- ceived within each preceding calendar year ending De- cember thirty-first: Provided, That any corporation, joint-stock company or association, or insurance com- pany, subject to this tax, may designate the last day of 324 INCOME AND FEDERAL TAX REPORTS 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 ascer- tained as herein provided for the year ending on the day so designated in the year preceding the date of assess- ment instead of upon the basis of the net income for the calendar year preceding the date of assessment; and it shall give notice of the day it has thus designated 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 associ- ation, or insurance company, subject to the tax herein im- posed, 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 sixteen, and the close of each such fiscal year thereafter, render a true and ac- curate return of its annual net income in the manner and form to be prescribed by the Commissioner of Internal Eevenue, with the approval of the Secretary of the Treas- ury, and containing such facts, data, and information as are appropriate 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 ac- count and other data from which the return is prepared, or in the case of a foreign corporation, company, or as- THE INCOME TAX LAW 325 sociation, to the collector of the district in which is lo- cated 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 in- ternal revenue at Baltimore, Maryland. All such returns shall as received be transmitted forth- with by the collector to the Commissioner of Internal Eevenue ; (c) In case wherein receivers, trustees in bankruptcy, or assignees are operating the property or business of corporations, joint-stock companies or associations, or in- surance companies, 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 receivers, trustees, or assignees shall be assessed and collected in the same manner as if assessed directly against the or- ganizations 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, 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; Withholding of tax at the source. (e) 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 non-resident alien individuals from sources within the United States shall be made applicable 326 INCOME AND FEDERAL TAX REPORTS to the tax imposed by subdivision (a) of section ten upon 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 as- sociations, and insurance companies by non-resident alien firms, co-partnerships, companies, corporations, joint- stock companies or associations, and insurance compan- ies, not engaged in business or trade within the United States and not having any office or place of business therein ; (/) Likewise, all the provisions of this title relating to the tax authorized and required to be deducted and with- held and paid to the officer of the United States Govern- ment authorized to receive the same from the income of non-resident alien individuals 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 insurance compan- ies by non-resident alien companies, corporations, joint- 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. Sec. 14. (a) All assess- ments shall be made and the several corporations, joint- stock companies or associations, and insurance compan- ies shall be notified of the amount for which they are re- spectively liable on or before the first day of June of each successive year, and said assessment shall be paid on or before the fifteenth day of June : Provided, That every corporation, 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 re- THE INCOME TAX L.UY 327 fusal or neglect to make such return, and in cases of er- roneous, false, or fraudulent returns, in which cases the Commissioner of Internal Eevenue shall, upon the dis- covery 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 Eeve- nue thereon shall be paid by such corporation, joint-stock company or association, or insurance company immedi- ately upon notification of the amount of such assessment ; and to any sum or sums due and unpaid after the fif- teenth 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 in- come made pursuant 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 ap- pear 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 constitute public records and be open to inspection as such: Provided, That any and all such 328 INCOME AND FEDERAL TAX REPORTS returns shall be open to inspection only upon the order of the President, under rules and regulations to be pre- scribed by the Secretary of the Treasury and approved by the President : Provided further, That the proper offi- cers of any State imposing a general income tax may, upon 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 insurance company, at such times and in such manner as the Secretary of the Treasury may prescribe; (c) If any of the corporations, joint-stock companies or associations, or insurance companies aforesaid shall re- fuse 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 com- pany or association, or insurance company shall be liable to a penalty of not exceeding $10,000 : Provided, That the Commissioner of Internal Eevenue 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 Eevised Statutes of the United States be, and the same is hereby, amended so as to read as follows : "Sec. 3225. 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." THE INCOME TAX LAW 329 PART III. GENERAL ADMINISTRATIVE PROVISIONS Meaning of "States and United States." Sec. 15. That the word "State" or "United States" when used in this title shall be construed to include any Territory, the Dis- trict of Columbia, Porto Rico, and the Philippine Islands, when such construction is necessary to carry out its pro- visions. General 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 collector, agent, clerk, or other officer or employee of the United States to divulge or to make known in any manner whatever not provided by law to any person the operations, style of work, or apparatus of any manufac- turer 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 in- come 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 un- lawful for any person to print or publish in any manner whatever not provided by law any income return or any part thereof or source of income, profits, losses, or ex- penditures appearing in any income return; and any of- fense against the foregoing provision shall be a misde- meanor 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. 330 INCOME AND FEDERAL TAX REPORTS 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 manage- ment of any objects liable to pay any tax, and to make a list of such persons and enumerate said objects." "Sec. 3173. It shall be the duty of any person, partner- ship, 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 be- fore the day on which the taxes accrue, to make a list or return, verified by oath, to the collector or a deputy 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 aggre- gate amount, according to the forms and regulations pre- scribed by the Commissioner of Internal Revenue, with the approval of the Secretary of the Treasury, for which such person, partnership, firm, association, or corpora- tion is liable: Provided, That if any person liable to pay any duty oi tax, or owning, possessing, or having the care or manage- ment of property, goods, wares, and merchandise, articles or objects liable 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 ob- jects liable to pay any duty or tax, or any business or oc- cupation 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 dis- THE IX COME TAX LAW 331 tinctly 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 dep- uty 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 col- lector or deputy collector to leave at such place of resi- dence or business, with some one of suitable age and dis- cretion, if such be present, otherwise to deposit in the nearest post office, a note or memorandum addressed to such person, requiring him or her to render to such col- lector 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 re- quired as aforesaid, or whenever any person who is re- quired 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 col- lector, 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 testi- mony or answer interrogatories, under oath, respecting any objects or income liable to tax or the returns thereof. The collector may summon any person residing or found 332 INCOME AND FEDERAL TAX REPORTS 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 Terri- tory, he may enter any collection district where such person may be found and there make the examination herein authorized. And to this end he may there exer- cise all the authority which he might lawfully exercise in the district for which he was commissioned: Pro- vided, That "person," as used in this section, shall be construed to include any corporation, joint-stock com- pany or association, or insurance company when such construction is necessary to carry out its provisions." "Sec. 3176. If any person, corporation, company, or association fails to make and file a return or list at the time prescribed by law, or makes, wilfully 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 information 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 pur- poses. "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. "The Commissioner of Internal Revenue shall assess all taxes, other than stamp taxes, as to which returns or lists are so made by a collector or deputy collector. In case of any failure to make and file a return or list within the time prescribed by law or by the collector, the Commissioner of Internal Revenue shall add to the tax fifty per centum of its amount except that, when a return is voluntarily and without notice from 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 wilful neglect, no such addition shall be made to the tax. In case a THE INCOME TAX LAW 333 false or fraudulent return or list is wilfully made, the Commissioner of Internal Revenue shall add to the tax one hundred per centum of its amount. "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." Sec. 17. That it shall be the duty of every collector of internal revenue, to whom any payment of any taxes is made under the provisions of this title, to give to the per- son making such payment a full written or printed re- ceipt, expressing the amount paid and the particular ac- count for which such payment was made ; and whenever such payment is made such collector shall, if required, give a separate receipt for each tax paid by any debtor, on account of payments made to or to be made by him to separate creditors in such form that such debtor can con- veniently produce the same separately to his several creditors in satisfaction of their respective demands to the amounts specified in such receipts ; and such receipts shall be sufficient evidence in favor of such debtor to justify him in withholding the amount therein expressed from his next payment to his creditor ; but such creditor may, upon giving to his debtor a full written receipt, acknowledging the payment to him of whatever sum may be actually paid, and accepting the amount of tax paid as aforesaid (specifying the same) as a further satisfaction of the debt to that amount, require the surrender to him of such collector's receipts. Sec. 18. That any person, corporation, partnership, as- sociation, or insurance company, liable to pay the tax, to make a return or to supply information required under this title, who refuses or neglects to pay such tax, to make such return or to supply such information at the time or times herein specified in each year, shall be liable, except as otherwise specially provided in this title, to a penalty 334 INCOME AND FEDERAL TAX REPORTS of not less than $20 nor more than $1,000. Any individual or any officer of any corporation, part- nership, association, or insurance company, required by law to make, render, sign, or verify any return or to sup- ply any information, who makes any false or fraudulent return or statement with intent to defeat or evade the as- sessment 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 ; Pro- vided, That where any tax heretofore due and payable has been duly paid by the taxpayer, it shall not be re-col- lected from any withholding agent required to retain it at its source, nor shall any penalty be imposed or col- lected in such cases from the taxpayer, or such withhold- ing agent whose duty it was to retain it, for failure to re- turn or pay the same, unless such failure Was fraudulent and for the purpose of evading payment. Sec. 19. The collector or deputy collector shall require every return to be verified by the oath of the party rend- ering it. If the collector or deputy collector have reason to believe that the amount of any income returned is understated, he shall give due notice to the person making the return to show cause why the amount of the return should not be increased, and upon proof of the amount understated may increase the same accordingly. Such person may furnish sworn testimony to prove any rele- vant facts, and, if dissatisfied with the decision of the collector, may appeal to the Commissioner of In- ternal Revenue for his decision under such rules of pro cedure as may be prescribed by regulation. Sec. 20. That jurisdiction is hereby conferred upon the district courts of the United States for the district within which any person summoned under this title to appear to testify or to produce books shall reside, to compel such attendance, production of books, and testimony by ap- propriate process. THE INCOME TAX LAW 335 Sec. 21. That the preparation and publication of sta- tistics reasonably available with respect to the operation of the income tax law and containing classifications of tax- payers and of income, the amounts allowed as deductions and exemptions, and any other facts deemed pertinent and valuable, shall be made annually by the Commis- sioner of Internal Revenue with the approval of the Sec- retary of the Treasury. Sec. 22. That all administrative, special, and general provisions of law, including the laws in relation to the as- sessment, remission, collection, and refund of internal revenue taxes not heretofore specifically repealed and not inconsistent with the provisions of this title, are hereby extended and made applicable to all the provisions of this title and to the tax herein imposed. Sec. 23. That the provisions of this title shall extend to Porto Rico and the Philippine Islands: Provided, That the administration of the law and the collection of the taxes imposed in Porto Rico and the Philippine Islands shall be by the appropriate internal-revenue officers of those governments, and all revenues collected in Porto Rico and the Philippine Islands thereunder shall accrue intact to the general governments thereof, respectively: Provided further, That the jurisdiction in this title con- ferred upon the district courts of the United States shall, so far as the Philippine Islands are concerned, be vested in the courts of the first instance of said islands: And provided further, That nothing in this title shall be held to exclude from the computation of the net income the compensation paid any official by the governments of the District of Columbia, Porto Rico, and the Philippine Islands, or the political subdivisions thereof. Sec. 24. That Section II of the Act approved October third, nineteen hundred and thirteen, entitled "An Act to reduce tariff duties and to provide revenue for the Gov- ernment, and for other purposes," is hereby repealed, ex- cept as herein otherwise provided, and except that it 336 INCOME AND FEDERAL TAX REPORTS shall remain in force for the assessment and collection of all taxes which have accrued thereunder, and for the im- position and collection of all penalties or forfeitures which have accrued or may accrue in relation to any of such taxes, and except that the unexpended balance of any appropriation heretofore made and now available for the administration of such section or any provision thereof shall be available for the administration of this title or the corresponding provision thereof. Sec. 25. That income on which has been assessed the tax imposed by Section II of the Act entitled "An Act to reduce tariff duties and to provide revenue for the Gov- ernment, and for other purposes," approved October third, nineteen hundred and thirteen, shall not be consid- ered as income within the meaning of this title : Provided, That this section shall not conflict with that portion of section ten, of this title, under which a taxpayer has fixed its own fiscal year. Information to be furnished at the source. Sec. 26. Every corporation, joint-stock company or association, or insur- ance company subject to the tax herein imposed, when required by the Commissioner of Internal Eevenue, shall render a correct return, duly verified under oath, of its payments of dividends, whether made in cash or its equivalent or in stock, including the names and addresses of stockholders and the number of shares owned by each, and the tax years and the applicable amounts in which such dividends were earned, in such form and manner as may be prescribed by the Commissioner of Internal Eevenue, with the approval of the Secretary of the Treasury. Sec. 27. That every person, corporation, partnership, or association, doing business as a broker on any exchange or board of trade or other similar place of business shall, when required by the Commissioner of Internal Revenue, render a correct return duly verified under oath, under such rules and regulations as the Commissioner of Ic- THE IK COMB TAX LAW 337 ternal Revenue, with the approval of the Secretary of the Treasury, may prescribe, showing the names of customers for whom such person, corporation, partnership, or asso- ciation has transacted any business, with such details as to the profits, losses, or other information which the com- missioner may require, as to each of such customers, as will enable the Commissioner of Internal Revenue to de- termine whether all income tax due on profits or gains of such customers has been paid. Sec. 28. That all persons, corporations, partnerships, associations, and insurance companies, in whatever ca- pacity acting, including lessees or mortgagors of real or personal property, trustees acting in any trust capacity, executors, administrators, receivers, conservators, and employers, making payment to another person, corpora- tion, partnership, association, or insurance company, of interest, rent, salaries, wages, premiums, annuities, com- pensation, remuneration, emoluments, or other fixed or determinable gains, profits, and income (other than pay- ments described in sections twenty-six and twenty-seven), of $800 or more in any taxable year, or, in the case of such payments made by the United States, the officers or employees of the United States having information as to such payments and required to make returns in regard thereto by the regulations hereinafter provided for, are hereby authorized to render a true and accurate return to the Commissioner of Internal Revenue, under such rules and regulations and in such form and manner as may be prescribed by him, with the approval of the Sec- retary of the Treasury, setting forth the amount of such gains, profits, and incomes, and the name and address of the recipient of such payment: Provided, That such re- turns shall be required, regardless of amounts, in the case of payments of interest upon bonds and mortgages or deeds of trust or other similar obligations of corpora- tions, joint-stock companies, associations, and insurance companies, and in the case of collections of items (not 338 INCOME AND FEDERAL TAX REPORTS payable in the United States) of interest upon the bonds of foreign countries and interest from the bonds and divi- dends from the stock of foreign corporations by persons, corporations, partnerships, or associations, 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. When necessary to make effective the provisions of this section the name and address of the recipient of income shall be furnished upon demand of the person, corpora- tion, partnership, association, or insurance company pay- ing the income. The provisions of this section shall apply to the calen- dar year nineteen hundred and seventeen and each calen- dar year thereafter, but shall not apply to the payment of interest on obligations of the United States. Deduction of war excess profits tax. Sec. 29. That in as- sessing income tax the net income embraced in the return shall also be credited with the amount of any excess profits tax imposed by Act of Congress and assessed for the same calendar or fiscal year upon the taxpayer, and, in the case of a member of a partnership, with his pro- portionate share of such excess profits tax imposed upon the partnership. Exemption of income of foreign governments. Sec. 30. That nothing in section II of the Act approved October third, nineteen hundred and thirteen, entitled "An Act to reduce tariff duties and to provide revenue for the Gov- ernment, and for other purposes," or in this title, shall be construed as taxing the income of foreign govern- ments received from investments in the United States in stocks, bonds, or other domestic securities, owned by such foreign governments, or from interest on deposits in banks in the United States of moneys belonging to for- eign governments. Meaning of "dividends" and taxation of dividends. Sec. 51. (a) That the term "dividends" as used in this title THE INCOME TAX LAW 339 shall be held to mean any distribution made or ordered to be made by a corporation, joint-stock company, associa- tion, 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 con- sidered income, to the amount of the earnings or profits so distributed. (b) Any distribution made to the shareholders or members of a corporation, joint-stock company, or asso- ciation, or insurance company, in the year nineteen hundred and seventeen, or subsequent tax years, shall be deemed to have been made from the most recently accumulated undivided profits or surplus, and shall con- stitute a part of the annual income of the distributee for the year in which received, and shall be taxed to the distributee at the rates prescribed by law for the years in which such profits or surplus were accumulated by the corporation, joint-stock company, association, or insurance company, but nothing herein shall be con- strued as taxing any earnings or profits accrued prior to March first, nineteen hundred and thirteen, but such earnings or profits may be distributed in stock dividends or otherwise, exempt from the tax, after the distribution of earnings and profits accrued since March first, nine- teen hundred and thirteen, has been made. This subdivision shall not apply to any distribution made prior to August sixth, nineteen hundred and seventeen, out of earnings or profits accrued prior to March first, nineteen hundred and thirteen. Premiums on "business" life insurance not deductible. Sec. 32. That premiums paid on life insurance policies covering the lives of officers, employees, or those finan- cially interested in any trade or business conducted by an individual, partnership, corporation, joint-stock com- pany or association, or insurance company, shall not 340 INCOME AND FEDERAL TAX REPORTS be deducted in computing the net income of such indi- vidual, corporation, joint-stock company or association, or insurance company, or in computing the profits of such partnership for the purposes of subdivision (e) of section eight. Refund of tax withheld at the source in 1907. Sec. 1212 [of Title XII. "Income Tax Amendments" of Act of October 3, 1917]. That any amount heretofore withheld by any withholding agent as required by Title I of such Act of September eighth, nineteen hundred and sixteen, on account of the tax imposed upon the income of any individual, a citizen or resident of the United States, for the calendar year nineteen hundred and seventeen, except in the cases covered by subdivision (c) of sec- tion nine of such Act, as amended by this Act, shall be released and paid over to such individual, and the entire tax upon the income of such individual for such year shall be assessed and collected in the manner prescribed by such Act as amended by this Act. Act of September 8, 1916, in effect September 9, 1916. Effective date of Act as amended, October 4, 1917. CHAPTER XIII (Continued) THE WAR INCOME TAX AFFECT ING INDIVIDUALS AND COPORATIONS TITLE I OF THE ACT OF OCTOBER 3, 1917 (PUBLIC No. 50 65th Congress) TITLE I WAR INCOME TAX Individual normal war tax rate. Sec. 1. That in addi tion to the normal tax imposed by subdivision (a) of section one of the Act entitled "An Act to increase the revenue, and for other purposes," approved September eighth, nineteen hundred and sixteen, there shall be levied, assessed, collected, and paid a like normal tax of two per centum upon the income of every individual, a citizen or resident of the United States, received in the calendar year nineteen hundred and seventeen and every calendar year thereafter. Individual additional war tax rate. Sec. 2. That in addition to the additional tax imposed by subdivision (b) of section one of such Act of September eighth, nineteen hundred and sixteen, there shall be levied, assessed, collected, and paid a like additional tax upon the income of every individual received in the calendar year nineteen hundred and seventeen and every calendar year thereafter, as follows: One per centum per annum upon the amount by which the total net income exceeds $5,000 and does not exceed $7,500; 341 342 INCOME AND FEDERAL TAX REPORTS Two per centum per annum upon the amount by which the total net income exceeds $7,500 and does not exceed $10,000; Three per centum per annum upon the amount by which the total net income exceeds $10,000 and does not exceed $12,500; Four per centum per annum upon the amount by which the total net income exceeds $12,500 and does not exceed $15,000; Five per centum per annum upon the amount by which the total net income exceeds $15,000 and does not ex- ceed $20,000; Seven per centum per annum upon the amount by which the total net income exceeds $20,000 and does not exceed $40,000; Ten per centum per annum upon the amount by which the total net income exceeds $40,000 and does not exceed $60,000; Fourteen per centum per annum upon the amount by which the total net income exceeds $60,000 and does not exceed $80,000; Eighteen per centum per annum upon the amount by which the total net income exceeds $80,000 and does not exceed $100,000; Twenty-two per centum per annum upon the amount by which the total net income exceeds $100,000 and does not exceed $150,000; Twenty-five per centum per annum upon the amount by which the total net income exceeds $150,000 and does not exceed $200,000; Thirty per centum per annum upon the amount by which the total net income exceeds $200,000 and does not exceed $250,000; Thirty-four per centum per annum upon the amount by which the total net income exceeds $250,000 and does not exceed $300,000; Thirty-seven per centum per annum upon the amount THE WAR INCOME TAX 343 by which the total net income exceeds $300,000 and does not exceed $500,000; Forty per centum per annum upon the amount by which the total net income exceeds $500,000 and does not exceed $750,000; Forty-five per centum per annum upon the amount by which the total net income exceeds $750,000 and does not exceed $1,000,000; Fifty per centum per annum upon the amount by which the total net income exceeds $1,000,000. Specific exemptions from normal war tax. Sec. 3. That the taxes imposed by sections one and two of this Act shall be computed, levied, assessed, collected, and paid upon the same basis and in the same manner as the sim- ilar taxes imposed by section one of such Act of Sep- tember eighth, nineteen hundred and sixteen, except that in the case of the tax imposed by section one of this Act (a) the exemptions of $3,000 and $4,000 provided in section seven of such Act of September eighth, nineteen hundred and sixteen, as amended by this Act, shall be, respectively, $1,000 and $2,000, and (b) the returns required under subdivisions (b) and (c) of section eight of such Act, as amended by this Act, shall be required in the case of net incomes of $1,000 or over, in the case of unmarried persons, and $2,000 or over in the case of married persons, instead of $3,000 or over, as therein provided, and (c) the provisions of subdivision (c) of section nine of such Act, as amended by this Act, requiring the nor- mal tax of individuals on income derived from interest to be deducted and withheld at the source of the income shall not apply to the new two per centum normal tax prescribed in section one of this Act until on and after January first, nineteen hundred and eighteen, and there- after only one two per centum normal tax shall be 344 INCOME AND FEDERAL TAX REPORTS deducted and withheld at the source under the provi- sions of such subdivision (c), and any further normal tax for which the recipient of such income is liable under this Act or such Act of September eighth, nineteen hun- dred and sixteen, as amended by this Act, shall be paid by such recipient. Corporation war income tax. Sec. 4. That in addition to the tax imposed by subdivision (a) of section ten of such Act of September eighth, nineteen hundred and sixteen, as amended by this Act, there shall be levied, assessed, collected, and paid a like tax of four per centum upon the income received in the calendar year nineteen hundred and seventeen and every calendar year thereafter, by every corporation, joint-stock company or association, or insurance company, subject to the tax imposed by that subdivision of that section, except that if it has fixed its own fiscal year, the tax imposed by this section for the fiscal year ending during the calen- dar year nineteen hundred and seventeen shall be levied^ assessed, collected, and paid only on that proportion of its income for such fiscal year which the period between January first, nineteen hundred and seventeen, and the end of such fiscal year bears to the whole of such fiscal year. The tax imposed by this section shall be computed, levied, assessed, collected, and paid upon the same in- comes and in the same manner as the tax imposed by subdivision (a) of section ten of such Act of September eighth, nineteen hundred and sixteen, as amended by this Act, except that for the purpose of the tax imposed by this section the income embraced in a return of a corporation, joint-stock company or association, or in- surance company, shall be credited with the amount received as dividends upon the stock or from the net earnings of any other corporation, joint-stock company or association, or insurance company, which is taxable upon its net income as provided in this title. THE WAR INCOME TAX 345 Porto Rico and the Philippine Islands not affected. Sec. 5. That the provisions of this title shall not extend to Porto Rico or the Philippine Islands, and the Porto Rican or Philippine Legislature shall have power by- due enactment to amend, alter, modify, or repeal the income tax laws in force in Porto Rico or the Philippine Islands, respectively. In effect October 4, 1917. TITLE X. ADMINISTRATIVE PROVISIONS OF THE ACT OF OCTOBER 3, 1917 (Public No. 50 65th Congress) [Effective October 4, 1917] Prepayment of taxes. Sec. 1009 [of Title X. Admin- istrative Provisions of the Revenue Act of October 3, 1917]. That the Secretary of the Treasury, under rules and regulations prescribed by him, shall permit tax- payers liable to income and excess profits taxes to make payments in advance in installments or in whole of an amount not in excess of the estimated taxes which will be due from them, and upon determination of the taxes actually due any amount paid in excess shall be re- funded as taxes erroneously collected: Provided, That when payment is made in installments at least one-fourth of such estimated tax shall be paid before the expiration of thirty days after the close of the taxable year, at least an additional one-fourth within two months after the close of the taxable year, at least an additional one-fourth within four months after the close of the taxable year, and the remainder of the tax due on or before the time now fixed by law for such payment: Provided further, That the Secretary of the Treas- ury, under rules and regulations prescribed by him, may allow credit against such taxes so paid in advance of 346 INCOME AND FEDERAL TAX REPORTS an amount not exceeding three per centum per annum calculated upon the amount so paid from the date of such payment to the date now fixed by law for such payment; but no such credit shall be allowed on pay- ments in excess of taxes determined to be due, nor on payments made after the expiration of four and one- half months after the close of the taxable year. All penalties provided by existing law for failure to pay tax when due are hereby made applicable to any failure to pay the tax at the time or times required in this section. Payment of tax with Treasury certificates and uncertified checks. Sec. 1010. That under rules and regulations prescribed by the Secretary of the Treasury, Collectors of Internal Eevenue may receive, at par and accrued interest, certificates of indebtedness issued under sec- tion six of the Act entitled "An Act to authorize an issue of bonds to meet expenditures for the national security and defense, and, for the purpose of assisting in the prosecution of the war, to extend credit to for- eign governments, and for other purposes," approved April twenty-fourth, nineteen hundred and seventeen, and any subsequent Act or Acts, and uncertified checks in payment of income and excess profits taxes, during such time and under such regulations as the Commis- sioner of Internal Eevenue, with the approval of the Secretary of the Treasury, shall prescribe; but if a check so received is not paid by the bank on which it is drawn the person by whom such check has been ten- dered shall remain liable for the payment of the tax and for all legal penalties and additions the same as if such check had not been tendered. CHAPTER XIV CAPITAL STOCK TAX History of capital stock tax. The law of September 8, 1916, under Title IV., Section 407, imposes an excise 1 tax on every domestic corporation the fair value of whose total outstanding capital stock exceeds $99,000 and on every foreign corporation engaged in business in this country. This excise tax, or as it is frequently called, the capital stock tax, was substituted for the special tax on bankers imposed under the Emergency Revenue Law of October 22, 1914. The distinction between the two is that the old law was a tax on every person, firm, or cor- poration engaged in banking, while the new law taxes every corporation, whether engaged in banking or any other business. This tax is an excise tax on the privilege of doing business, and is similar to the occupational taxes im- posed on individuals except that, instead of being a flat tax, the amount of the tax is measured by the average value of the stock during the preceding year. Being a privilege or occupational tax, it is payable in advance annually in July, which is the beginning of the Government's fiscal year. This law went into effect January 1, 1917, and the first tax collected was for the privilege of doing busi- ness for the half year from January 1, 1917, to June 30, 1917. The second tax was collected in July, 1917, and was for the privilege of doing business for the en- i "Excise" is defined to be an inland imposition, sometimes upon the con- sumption of the commodity and sometimes upon retail sale, sometimes upon the manufacturer and sometimes upon the vendor. (22 Cyc. 1598.) 347 348 INCOME AND FEDERAL TAX REPORTS suing taxable year ending June 30, 1918. The tax is therefore payable every July for the privilege of doing business for the taxable year ending the following June 30th. Capital Stock Tax independent of other taxes. The Capital Stock Tax has no connection with the Income Tax, the War Excess Profits Tax, or with State capital stock taxes. It is an entirely separate and distinct tax. Keports for this tax are required to be made out on a separate form and filed at a different time from that of the filing of returns for any other tax. Deduction of Munitions Tax. The amount of tax paid under Section 301 of Title III of the act of September 8, 1916 (Munitions Manufacturer's Tax) since the filing of the last previous report may be deducted in comput- ing the Capital Stock Tax. 1 What United States corporations are subject to tax. Every corporation, joint stock company or association, or insurance company, organized in the United States for profit, and having a capital stock represented by shares the fair value of which is in excess of $99,000, which was engaged in business during the preceding fis- cal year, is subject to this tax unless specially exempted by the Act. While the tax does not accrue except in cases where the valuation of the capital stock exceeds $99,000, a re- turn must be filed in the case of a corporation the mar- ket value of whose capital stock outstanding is $75,000 or more. Foreign corporations subject to tax. Every corpora- tion, joint stock company or association, or insurance company organized for profit under the laws of any foreign country and engaged in business in the United i Credit cannot be had on capital stock tax return for 1917 for muni- tions tax paid in 1917, but as to whether such credit can be had against subsequent capital stock tax returns, in cases where the munitions tax is in excess of the capital stock tax paid, is a question not yet passed on by the Department, but which will be if it should arise. CAPITAL STOCK TAX 349 States is subject to the tax on the value of the capital actually invested in the transaction of business in the United States. If the corporation makes a return show- ing the total amount of capital invested in the transac- tion of business both abroad and in this country it may deduct from the value of the capital invested in the United States such proportion of $99,000 as the amount invested in the United States bears to the total amount invested in the United States and elsewhere. To illustrate, a foreign corporation has $100,000 actu- ally invested in the United States. Its total capital invested (including that invested in the United States) is $1,000,000. It will be allowed as a deduction 10$ (100,000 -f- 1,000,000) of $99,000, or $9,900. Corporations need not have been in business during the entire preceding year. It is not necessary that the cor- poration, to be liable, must have been engaged in busi- ness during the entire year ended June 30th. It is suffi- cient that the corporation was engaged in business at some time during the year. The length of time it was engaged in business has no bearing upon the amount of the tax to be paid. Inactive corporations need not pay tax. Corporations which were engaged in business at some time during the preceding fiscal year but which were not engaged in business at the time a return was due (i. e., July 1st to 30th, inclusive), are not required to file a return, but should they subsequently resume business they must file a return in the month in which they resume business. Returns required of United States corporations. Eegu- lation Number 38, of the Treasury Department, pro- vides that: "Every corporation, joint stock company or association, or insurance company organized in the United States for profit and having a capital stock is- sued and outstanding of the market value of $75,000 or over and not exempt by the act, shall make a return on Form 707 irrespective of the par value of its capital 350 INCOME AND FEDERAL TAX REPORTS stock, unless such corporation, joint stock company or association, or insurance company was not engaged in business during the preceding taxable year." The phrase "of the market value of $75,000" as used in this decision should be held as meaning "of the fair value of $75,000." The tax is based upon the "fair value" of the stock. While the Treasury Department recognizes that the market value is the fair value where the market value can be obtained, it also provides a method of determining the fair value in cases where there is no basis from which to obtain the market value. Returns will therefore be required of all corporations the fair value of whose stock is $75,000 or more, re- gardless of whether or not a market value has been established. Returns required of every foreign corporation. "Every corporation, joint stock company or association or in- surance company, organized for profit under the laws of any foreign country and engaged in business in the United States, shall make return on Form 708 irrespec- tive of the amount of capital employed either at home or in this country in the transaction of its business." (T. D. Reg. 38.) * Returns required from holding companies. The filing of returns by its subsidiary companies does not relieve a holding company from its liability to the tax or from filing its own return. Corporations exempt. Section 407 of this Act exempts from the Capital Stock Tax all corporations which are exempt from the Income Tax under the provisions of section 11, Title I. For a list of such exempt classes of corporations, joint stock companies or associations, and insurance companies, see Chapter VII. Although labor, agricultural or horticultural associa- tions are exempt under the section referred to, this ex- emption does not include corporations engaged in general farming, raising cattle, or agricultural business for profit. CAPITAL STOCK TAX 351 Mutual companies exempt. Inasmuch as the basis of the tax is the fair value of the stock of a corporation, mutual insurance companies and other associations not having capital represented by shares will also be ex- empt from the tax because of the absence of a basis for the computation of the tax. Massachusetts, or Common Law Trusts, exempt. Massa- chusetts trusts, the so-called Common Law trusts, were held to be exempt from the Corporation Tax of 1909, under the decision in the case of Eliot vs. Freeman et al. (220 U. S. 178). In T. D. 2418, the Treasury De- partment stated that the ruling would be held to cover the Capital Stock Tax. The court stated as follows: "The two cases under consideration embrace trusts which do not derive any benefit from and are not organized under the statutory laws of Massachusetts. Joint stock companies of the statutory character are not known to the laws of that Commonwealth. These trusts do not have perpetual succession but end with lives in being and 20 years thereafter. "Entertaining the view that it was the intention of Congress to embrace within the Corporation Tax statutes only such corporations and joint stock asso- ciations as are organized under some statute or derive from that source some quality or benefit not existing at the common law, we are of the opinion that the real estate trusts involved in these two cases are not within the terms of the Act." Domestic Building and Loan Associations organized and operated for mutual purposes and without profit are exempt. The words "no part of the net income of which inures to the benefit of any private stockholder or individual" does not apply to domestic building and loan associa- tions operated for the mutual benefit of members. See Herold, Collector, vs. Park View B. & L. Ass'n. (210 Fed. 577). 352 INCOME AND FEDERAL TAX REPORTS Corporations in the hands of receivers exempt. Cor- porations which were in the hands of receivers at the due time of filing returns would not be required to make a return unless the receivership terminated before the close of the taxable period. If the operation of the corporation were then re- sumed under corporate management, a return on Form 707 must be filed during the month in which operation was resumed. The tax would be computed propor- tionately from the first day of the month in which it resumes business to the end of the fiscal year. Corporations operating under their corporate man- agement but which were in the hands of receivers dur- ing the preceding fiscal year (July 1, 1916, to June 30, 1917), would not be required to file return during July, 1917, for the period ending June 30, 1918. Corporations not engaged in business during preceding taxable year are exempt. The last part of Section 407, Title IV, reads: "This tax shall not be imposed upon any corporation, joint stock company or association, or insurance company not engaged in business during the preceding taxable year." When is a corporation not engaged in business. The tax is an excise tax imposed on corporations. It is not imposed on the franchise of the corporation irrespec- tive of its use in business, nor upon the property of the corporation, but it is imposed on the doing of cor- porate business and for the privilege of doing business. The simple fact of holding a franchise does not make a corporation liable to the tax. It is necessary that a corporation do certain acts so that it may be held as engaged in business. The question of what degree of activity is necessary in order that a corporation be so held has been somewhat complicated by the varying views of the several court decisions rendered. The Corporation Tax Law of 1909 levied a tax upon the net income of corporations "engaged in business." CAPITAL STOCK TAX 353 Quite naturally the question arose as to the meaning of the term "engaged in business." A number of cases were decided in the Supreme Court and in the District courts defining the term. Treasury Decision 2418, of December 15, 1916, re- lating to this point, is as follows: "The following decisions, made in cases arising un- der the corporation tax act of August 5, 1909, will be followed where they are final or have been acquiesced in by the Department in similar questions arising un- der the special excise tax imposed by section 407, Title IV, Act of September 8, 1916." Next followed the decisions in a number of Supreme Court cases, and also a list of a number of cases de- cided in the lower courts, ending with the statement: "Corporations which are not 'engaged in business' or 'transacting business' as construed under the language of the courts in the above decisions are not subject to the special excise tax imposed under section 407 of the act of September 8, 1916." Among the cases cited was the case of United States vs. Nippissing Mines Company (206 Fed. 431), in which it was held that a corporation owning the stock of a number of subsidiary companies receiving dividends on the stocks and distributing said dividends to its own stockholders was not engaged in business. When the first returns were due, in January, 1917, a number of corporations claimed exemption under this decision, and in answer to these claims the Treasury Department, in T. D. 2429, of January 4, 1917, stated as follows: "In reply you are advised that this office has never acquiesced in the decision of the court in the case of United States vs. Nippissing Mines Company, and the question of whether a corporation organized for the purpose of acquiring and holding all the capital stock of subsidiaries, and actually engaged in holding such stock, voting thereon, receiving dividends when paid by 354 INCOME AND FEDERAL TAX REPORTS the subsidiaries, keeping books, and paying out money to its own shareholders, is now doing business within the meaning of the Corporation Tax Act of August 5, 1909, is now pending in the Circuit Court of Appeals for the Southern District of New York. "This office is of the opinion, therefore, that a 'hold- ing company' organized in the United States for the purpose of acquiring and holding capital stock of sub- sidiary companies and actually engaged in holding such stock, voting thereon, and distributing money among its own shareholders, is engaged in business within the meaning of the Act of September 8, 1916, and is sub- ject to the special tax imposed under section 407. A ruling to this effect will be published in the weekly edi- tion of Treasury Decisions, and will be followed by the Department until the Supreme Court decides to the contrary." On January 15, 1917, the Supreme Court issued its decision in the case of Baumbach vs. Sargent Realty Company. (T. D. 2436. Dated January 19, 1917. In part only.) ( Decision. ) Corporation Excise Tax Law of 1909. SUPREME COURT OF THE UNITED STATES. Fred Von Baumbach, Collector of Internal ' Revenue, Petitioner, vs. Sargent Land Company. Writs of Certiorari to the United States Circuit Court of Appeals for the Eighth Circuit. Same, vs. Sutton Land Company. Same, vs. Kearsarge Land Company. [January 15, 1917.] Mr. Justice Day delivered the opinion of the Court. CAPITAL STOCK TAX 355 STATEMENT OF FACTS. These three cases were argued and submitted together and involve practically the same facts. Suits were brought by the corporations named in the United States District Court for the District of Minnesota against the Collector of Internal Revenue, to recover certain taxes, paid under protest, assessed under the Corporation Tax Law of 1909 (36 Stat. 11, 112), for the years 1909, 1910 and 1911. The judgments in the District Court were for the respondents (207 Fed. 423) which judgments were affirmed in the Circuit Court of Appeals (219 Fed. 31). In 1890, John S. Pillsbury, George A. Pillsbury and Charles A. Pills- bury, doing business together as John S. Pillsbury & Company, were the owners of large tracts of lands in northern Minnesota, which nad been acquired for the timber and from which the timber had been cut, being valuable after such severance of the timber for the mineral deposits con- tained therein. In the year named, the Pillsburys entered into an arrange- ment with John M. Longyear and Russell M. Bennett, authorizing the latter two to explore the lands for iron deposits. In 1892, Longyear and Bennett having discovered valuable deposits of iron ore, a half interest in something over ten thousand acres of the lands was conveyed to them, the lands thereafter being owned by the Pillsburys, John, George and Charles, each an undivided sixth, and John M. Longyear and Russell M. Bennett each an undivided fourth. In the year 1901, the Pillsburys having died, these corporations were formed under the laws of Minnesota. In 1906, the ownership of these leased lands was vested in the three corpora- tions named as respondents in the proceedings. As originally organized, the nature of the business was stated to be "the buying, owning, exploring and developing, leasing, improving, selling and dealing in lands, tenements and hereditaments, and the doing of all things incidental to the things above specified." In December, 1909, the articles of incorporation were amended to read as follows: "The general purpose of the corporation is to unite in one ownership the undivided, fractional interest of its various stockholders in lands, tenements and hereditaments, and to own such property, and, for the convenience of its stockholders, to receive and dis- tribute to them the proceeds of any disposition of such property, at such times, in such amounts, and in such manner as the Board of Directors may determine." All of the mining leases, hereinafter mentioned, with the exception of a contract with the Van Buren Mining Company, were executed before the organization of the corporations. Each of these instruments provided that the owners of the property demised to the lessees, exclusively, all the lands covered by the descriptions for the purpose of exploring for, mining and removing the merchantable iron ore which might be found therein for and during the period named, usually fifty years. The lessees were given ex- clusive right to occupy and control, the demised premises and to erect all necessary buildings, structures and improvements thereon. Right was reserved to the lessors to enter for the purpose of measuring the amount 356 INCOME AND FEDERAL TAX REPORTS of ore mined and removed and making observations of the operations in the mines. The lessees agreed to pay, in most cases, twenty-five cents per ton for all ore mined and removed, and to make such payments monthly for ore mined and shipped during the preceding month. The lessees agreed to mine and ship a specified quantity of ore in each year, and, in default of this, to pay the lessors for the minimum amount specified, and take credit therefor and apply such sums upon ore mined and shipped thereafter in excess of such minimum. The lessees were to pay the taxes and to keep the property free from encumbrances and liens. Right was reserved to terminate the contract upon the failure of the lessees to comply with the terms thereof. The form of the leases is shown in Exhibits 15 and 16, which were not in the printed record, owing to their length, but copies of which, pursuant to stipulation, have been sent to this court. An examination of Exhibit 16 shows that the lessees had the right to terminate and surrender the lease by giving the lessors, or those having their estate in the premises, sixty days' written notice, and executing sufficient conveyances releasing all interest and right of the lessees in the premises with any improvements thereon, and surrendering the same in good order and condition, etc., and that thereupon all liability of the lessees to taxes subsequently assessed on the demised premises or for rent thereof thereafter to accrue, or royalty on ores therefrom except on account of ores removed, should cease and determine; the lessees to be liable for all ores removed from the premises not theretofore paid for, and to pay for the premises rent or royalty for the year in which termination should be made, or the portion thereof which should have expired, at the rate of $12,500.00 per annum. Since their organization the corporations have disposed of certain lands and have also disposed of the stumpage on some timber lands. Cer- tain parcels were rented and leased, and a village was allowed to use part of the land for schoolhouse purposes, as well as another part for a public park. To insure the proper carrying on of the mining operations, the com- panies employed another corporation, engaged in engineering and inspec- tion of ore properties, to provide supervision and inspection of the work upon the respondents' properties, for which the inspecting company was paid from month to month, as statements were rendered. The companies were assessed upon their gross income, being the entire receipts of the companies from .royalties on the leases collected in the years 1909, 1910, and 1911, and some sums received from the sales of lots, lands and stumpage, from which expenses and taxes were deducted, but no deduction was made upon account of the depletion of the ore in the properties, or on account of such sales. The brief for the respondents states that these cases present for con- sideration four questions, which are: "1. Are the respondents corporations organized for profit? "2. Were the respondents carrying on or doing business during the years 1909, 1910, 1911? "3. Were moneys received by the respondents during those years in CAPITAL STOCK TAX 357 payment for iron ore, under the contracts covering their mineral lands, gross income, or did they represent, in whole or in part, the conversion of the investment of the corporations from ore into money? "4. If such moneys were gross income, are the respondents entitled to make any deduction therefrom on account of the depletion of their capi- tal investment?" 1. The Companies Webe Obganized fob Pbofit. 2. They Webe Cabbying on ob Doing Business within the Meaning of the Act of 1909. As to the second question: Were the respondents carrying on busi- ness, within the meaning of the Corporation Tax Act? This question was dealt with by this court in the first of the Corporation Tax Cases, Flint v. Stone Tracy Company, 220 U. S. 107. As the tax was there held to be assessed upon the privilege of doing business in a corporate capacity, it became necessary to inquire what it was to do business, and this court adopted with approval the definition, judicially approved in other cases, which included within the comprehensive term "business" that which oc- cupies the time, attention and labor of men for the purpose of a livelihood or profit." In that case a number of realty and mining companies were dealt with, and the Park Realty Company, organized to deal in real estate, and engaged at the time in the management and leasing of a certain hotel, was held to be engaged in business. It was also held that the Clark Iron Company, organized under the laws of Minnesota, and owning and leasing ore lands for the purpose of carrying on mining operations, and receiving a royalty depending upon the quantity of ore mined, was engaged in business. At the same time, and decided with the main corporation tax case, this court held, in the case of Zonne v. Minneapolis Syndicate, 220 U. S. 187, that a corporation which owned a piece of real estate which had been leased for 130 years, at an annual rental of $61,000, and which had amended its articles of incorporation so as to limit its purposes to holding the title to the property mentioned, and, for the convenience of its stock- holders, to receiving and distributing from time to time the rentals that accrued under the lease and the proceeds of any disposition of the land, was not engaged in doing business within the meaning of the act, by reason of the fact that the corporation had practically gone out of business and had disqualified itself from any activity in respect thereto. The act next came before this court in the case of McCoach, Col- lector, v. Minehill Railway Company, 228 U. S. 295, in which it was held, distinguishing the case of the Park Realty Company, supra, and applying the case of Zonne v. Minneapolis Syndicate supra, to the facts before the court, that a corporation which had leased all its property to another, and was doing only what was necessary to receive and distribute 358 INCOME AND FEDERAL TAX REPORTS the income therefrom among stockholders, was not doing business within the meaning of the act. In United States v. Emery, 237 U. S. 28, this court held that a corporation which merely kept up its organization, distributing rent received from a single lessee, was not doing business within the meaning of the act. It is evident, from what this court has said in dealing with the former cases, that the decision in each instance must depend upon the particular facts before the court. The fair test to be derived from a con- sideration of all of them is between a corporation which has reduced its activities to the owning and holding of property and the distribution of its avails and doing only the acts necessary to continue that status, and one which is still active and is maintaining its organization for the pur- pose of continued efforts in the pursuit of profit and gain and such activi- ties as are essential to those purposes. From the facts clearly established in these cases, we think these cor- porations were doing business, within the meaning of the act. They were organized for the purposes stated, and their activities included something more than the mere holding of property and the distribution of the receipts thereof. As was found by the District Court, the evidence shows that these three companies sold, during each of the years named, quantities of real estate, and the same were not small. They sold stumpage from some of the properties which had been burned over, leased certain properties in the village of Hibbing, and granted leases to squatters. One of the com- panies made explorations and incurred expenses in the matter of test pits. They employed another company to see that the mining operations were properly carried on, and that the lessees lived up to the engagements of their contracts. "All these things indicate," said the learned district judge, "the doing of and engaging in business. It [the corporation] was doing the business of handling a large property, selling lots, and seeing that the lessees lived up to their contracts. If that is not engaging in business, I do not know what is." We agree that it certainly was doing business, and, as the Corporation Tax Act requires no particular amount of business in order to bring a company within its terms, we think these activities brought the corporations in question within that line of decisions in this court which have held such corporations were doing business in a corporate capacity within the meaning of the law. 3. The Royalties Received from Lessees were Income. 4. No Allowance Could be Claimed Under the Corporation Tax Act or 1909 for Depletion of Natural Resources. Judgments reversed. CAPITAL STOCK TAX 359 In this decision the court states: "It is evident from what this court has said in dealing with the former cases, that the decision in each instance must depend upon the particular facts before the court. The fair test to be derived from all of them is between a cor- poration which has reduced its activities to the owning and holding of property and the distribution of its avails and doing only the acts necessary to contiaue that status, and one which is still active and is main- taining its organization for the purpose of continued efforts in the pursuit of profit and gain and such activi- ties as are essential to those purposes. From the facts clearly established in these cases, we think these cor- porations were doing business within the meaning of the Act." This decision, published as T. D. 2436, laid down the general rule but did not cover any of the cases relat- ing specifically to holding companies. In March, 1917, the United States District Court, Southern District of New York, upheld the decision in United States vs. Nippissing Mines Company in deciding the case of The Butterick Company vs. United States (206 Fed. 431). The court said: "The Government contends that the direction of the management of the subsidiary com- panies by the holding company was a doing of business which subjected the holding company to an excise tax. This direction was accomplished only by the control of the subsidiary companies through stock ownership. Of course, proxies had to be issued to vote at the meetings of the operating companies, and the directors of the latter were chosen by the owners of the stock. No holding company can exist without a corporate activity involved in the exercise of such control through its stock ownership in the operating company, but such corporate activity is not, under the authority of the United States vs. Nippissing Mines Company (206 Fed. 431), the exercise of a franchise which is subject to an 360 INCOME AND FEDERAL TAX REPORTS excise tax. The endorsement by the Butterick Com- pany of the notes of its subsidiary company was the only fact which is to be added to the facts before the court in the case of United States vs. Nippissing Mines Company, supra, which was decided by the Circuit Court of this circuit, but this is not sufficient to differ- entiate that case from the action by the Butterick Com- pany here under consideration." The decision in the above case is not a Supreme Court decision, and therefore does not affect the De- partment's ruling that holding companies are tax- able. In the cases of real estate companies and other com- panies that have leased their entire property for a period of years, the rule laid down in Baumbach vs. Sargent Realty Company, as stated above, forms the best basis for deciding whether or not such a company is taxable. With reference to a real estate corporation that was holding real estate for enhancement in value, mak- ing no sales whatever during the fiscal year July 1, 1916, to June 30, 1917, the Treasury Department ruled : "The fact that this corporation is holding its prop- erty until it can obtain a fair price for it would indi- cate that the company is engaged in business for profit. As the corporation is performing some of the functions for which it is incorporated, it will, of course, be re- quired to file a return of capital stock on Form 707 and pay the special excise tax for the period July 1, 1917, to June 30, 1918, and file that report during July, 1917. When is a foreign corporation engaged in business in the United States? The question of just what activities are necessary in order that a foreign corporation may be held as doing business in the United States has been CAPITAL STOCK TAX 361 passed on in decisions under the corporation tax law of August 5, 1909. These decisions are reviewed in the case of Laurenlide Company, Limited, vs. Durey, Col- lector of Internal Revenue (231 Fed. 223). The court states "doing business within the state" or "doing or transacting business in the United States" do not include the doing of a single act or the making of single contract, but do include a "continued series of acts by an agent or agents continuously within the state or the United States, as the case may be." From this decision it will be seen that any corpora- tion maintaining an agency or having a resident agent in the United States will be held as doing business in the United States. The tax, though, is based upon capital invested in the United States, and there are any number of firms doing a large volume of business with- out having any capital in the United States. Take the case of a foreign steamship company plying between England and the United States. The steam- ships, if registered in a foreign port, cannot properly be considered as "capital actually invested in the trans- action of business in the United States." The value of the steamships, therefore, should not be included as capital invested in the transaction of business in the United States on Form 708, although a return of cap- ital stock should be filed irrespective of the amount of capital employed either abroad or in this country, in- asmuch as this company was engaged in business in the United States. A leasehold interest in a dock in this country, however, may properly be considered as an asset of a foreign corporation and part of its capital invested in the United States. The basis of the tax, and methods of valuation. The Capital Stock Tax is an excise tax, payable in advance, for the privilege of doing business for a fiscal year. The amount of the tax is computed upon the average 362 INCOME AND FEDERAL TAX REPORTS fair value of the capital stock of the company for the preceding fiscal year at the rate of fifty cents ($.50) for each full $1,000.00 of such fair value. The fair value of the capital stock of a corporation can be only an estimate. The Treasury Department, therefore, furnishes three methods of estimating the fair value of the capital stock of United States cor- porations. These methods are to be used in different cases to which they may be applicable or appropriate: Case I, where the stock is listed on an exchange; Case II, where the stock is not listed on an exchange but where sales of the stock have been made during the preceding fiscal year; Case III, where the stock is not listed on any exchange and where no sales have been made or where sales have been made and the price is unknown. Case I. Where the stock is listed on an exchange. If the stock is listed on any exchange its fair value will be determined by adding the quoted highest bid price for the stock on the last day of each month during the preceding fiscal year (or if no bid price was quoted on the last day of each month then the latest day in the month on which a bid was quoted) and dividing by 12, the result being the average bid price per share for that year. A corporation, if it prefers, may average the fair value throughout the entire fiscal year by showing on a statement attached to the back of the return the high- est price bid for the stock on each day throughout the year. Where the stock is subject to great fluctuations and the highest bid prices on the last day of each month do not indicate the fair value of the stock, the corpora- tion should calculate the average bid price as in- structed above and attach to the return a statement showing why the figures under the case do not indi- cate a fair value of the stock. This statement will be CAPITAL STOCK TAX 363 taken into consideration when the assessment of the tax is made. Case II. Where the stock is not listed on an exchange but where sales have been made. If the stock is not listed on any exchange, but sales thereof have actually been made, and the price paid for the stock is known to the officer making the return, or can be dis- covered by him, the average price at which sales were made during the preceding fiscal year shall be the determining factor in ascertaining the fair value per share. The "average price at which sales were made" should be used, and not the average selling price per share. Thus if 10 shares were sold at $100 and 1,000 shares were sold at $70, the "average price" at which sales 100 + 70 were made would be $85 I = 85 I , which is (100 + 70 \ the correct figure to use. The "average selling price" / 10 X 100 + 1,000 X 70 in such a case would be $70.29 I \ 1,010 = 70.29 1 , but this price will not be accepted as an average fair value. Corporations protesting against this method of computing the value of stock may file a statement with the return setting forth the facts in de- tail and requesting the local collector to bring the mat- ter to the attention of the Commissioner of Internal Eevenue. Where the number of sales is small and the circum- stances attending the sales are such that they do not indicate the fair value, the same procedure should be followed as suggested in Case I. The average price at which sales are made should be calculated and a state- ment attached to the report showing why it does not represent the fair value. INCOME AND FEDERAL TAX REPORTS Case III. If the stock is not listed on an exchange or if no sales have been made. If Case I and Case II cannot be applied, i. e., if the stock is not listed on any ex- change, and no actual sales have been made during the preceding fiscal year, or if the price at which sales have been made is not known to the officer making the return, the fair average value of the capital stock shall be estimated, and the surplus and undivided profits for the preceding fiscal year will be taken into considera- tion as required by the statute, as well as the nature of the business, its earning capacity and average divi- dends paid or profits earned during the preceding five years. (Reg. 38.) The book value of a stock includes the total par value of the stock, the surplus, and the undivided profits. Thus, if a corporation has 10,000 shares, par $100 per share, a surplus of $500,000, and undivided profit of $50,000, the book value of its stock would be $1,550,000, unless for any reason the book value is fic- titious because in some way the assets have been over- estimated in the books of the corporation. The real value of a stock is determined by its earn- ing capacity. A reasonable return per share will make a stock worth par. As the return increases the real value of the stock increases proportionately. If a re- turn of 10% will make a stock worth par, a return of 20% will make its real worth twice par. If the par is $100, the real value per share is then $200. If the re- turn is 5%, then the real value of the stock is $50. Just what rate of return is required to make a stock worth par depends upon the nature and hazards of the busi- ness of the corporation. The Treasury Department has issued a statement of the rate of return on different classes of corporations which in its opinion is required to make their stock worth par. CAPITAL STOCK TAX 365 Class of Corporation Per Cent. Banking: States west of Mississippi River 8 States east of Mississippi River 6 Mining 10 Mercantile 10 Industrial 10 Oil-producing companies 15 Oil-refining companies 10 Public utilities 8 The stock of a manufacturing corporation earning 20% would be worth $200 a share. Multiplied by the number of shares outstanding, this would give the total fair value of the capital stock. The earning capacity should be taken from the aver- age profits per share for the last five years. The net income each year need not be taken from the income tax returns of that year. There are cases where the corporation has income which is not taxable under the income tax law or where the corporation has actually incurred expenses which are not deductible in the cal- culation of the income tax. For instance, that income which is derived from investments in bonds or securi- ties of a State, municipality, or of the United States, that is not taxable under the income tax laws, should be included in the total net income entered on the re- turn under Case III, inasmuch as this income was a great influence at times, so far as the valuation of a particular stock is concerned. In the same way, interest actually paid during the year is not at all times allowed as an expense of opera- tion of a corporation, due to the limitations as to the maximum that may be charged as an expense. (See Chapter IX.) Nevertheless, the total interest paid dur- ing the year should be included as an expense when de- termining net income for capital stock valuation. In such cases the corporation should use the figures actu- 366 INCOME AND FEDERAL TAX REPORTS ally shown on its books and which reflect its true earn- ing capacity. The net income each year should be divided by the number of shares outstanding 1 each year, the result being the earnings per share. If the par value of the shares is $100, the dollars earned per share is equiva- lent to the per cent earned per share. If the shares are more or less than $100 par, the per cent earned must then be calculated by dividing the earnings per share by the par value of the share. To determine the average per cent earned, add the per cents earned per share in each of the five years and divide by 5. The rate thus determined should be capitalized at the fair rate of return so as to give the fair value per share, as indicated below. Average Per Cent. Fair Value per Share (par $100.00) Earned At 6% At 8% At 10% At 15% At 20% 6 100 75 60 40 30 7 116 87 70 46 35 8 133 100 80 53 40 9 150 113 90 60 45 10 167 125 100 67 50 11 184 137 110 74 55 12 200 150 120 81 60 13 216 163 130 87 65 14 233 175 140 94 70 15 250 188 150 100 75 16 267 200 160 107 80 17 284 213 170 113 85 18 300 225 180 120 90 19 316 237 190 126 95 20 333 250 200 133 100 21 350 263 210 139 105 22 367 275 220 146 110 23 384 288 230 153 115 24 400 300 240 160 120 i Capital stock which has been issued by a corporation is regarded as being outstanding, even though it is afterwards acquired by the company for value, and carried on the books as treasury stock. CAPITAL STOCK TAX 367 Fair value of total capital stock. The fair value of the total capital stock is found by multiplying the fair value per share by the number of shares outstanding at the date of making the return unless the number of shares outstanding has changed during the fiscal year. Increases or decreases in capital stock during fiscal year. Where the capital stock has been increased or de- creased the case will be governed by the ruling laid down in T. D. 2503, which reads as follows: "If a corporation has increased or decreased its cap- ital stock during the fiscal year, a statement should be attached to the back of the return setting forth the number of shares of stock outstanding each month, with the average fair value of the stock for that month, computed under one of the three cases." The method of applying these instructions under va- rious circumstances is as follows: Proposition I. Books of the corporation on Dec. 31, 1916 show: Capital Stock, 1,000 shares, par $100. Total. $100,000 Surplus 100,000 Total Book Value $200,000 On January 1, 1917, a stock dividend of 100% is declared. The average earnings are $20 per share, or $20,000 per year. Methods of determining fair value under the three cases mentioned above are as follows: INCOME AND FEDERAL TAX REPORTS Case I No of Highest Year Month Shares Outstanding Average Bid Price for Month Fair Value 1916 July 1,000 $210 $210,000 August 1,000 205 205,000 September 1,000 200 200,000 October 1,000 195 195,000 November 1,000 190 190,000 December 1,000 200 200,000 1917 January 2,000 105 210,000 February 2,000 100 200,000 March 2,000 90 180,000 April 2,000 110 220,000 May 2,000 95 190,000 June 2,000 100 200,000 $2,400,000 $2,400,000-^12 = $200,000, average fair value. Case II The same procedure is followed as in Case I, except that "Highest Sales Price During Month" is taken in- stead of "Highest Average Bid Price for Month." Case III The average earnings of $20 per share would give an estimated fair value per share (if the corporation is an industrial or mining company) of $200 per share. The question that arises is, "By what number of shares should this fair value per share be multiplied in order to arrive at the average fair value of the capital stock?" The face of the return (Form 707) calls for the number of shares outstanding at the time of filing the return, in this case 2,000 shares; the instructions on the reverse of the form are that the average number of shares out- standing should be used, in this case 1,500 shares. Neither of the methods would give a true value. The increased number of shares merely represent a trans- CAPITAL STOCK TAX 369 fer from the surplus to the par value of the capital stock outstanding. The amount of capital invested is the same and there should be no increase in the total fair value of the stock. The method suggested by the Department when this specific case was put before them was to calculate the average earnings of the shares outstanding June 30, 1917, which would give an average earning per share of $10, and a fair value per share of $100, and then to multiply by the number of shares outstanding on June 30, 1917, or 2,000 shares. This would give a total fair value of $200,000. This method suggested by the Gov- ernment has the merit of basing the entire problem on the number of shares that are actually outstanding at the time of making the return. Proposition II. On December 31, 1916, a corpora- tion has outstanding 1,000 shares, par $100, total $100,- 000. On January 1, 1917, another 1,000 shares are is- sued for cash at par. The average rate of earnings is $10 per share, or $10,000 per year. Case I ; No. of Highest Fair Value Year Month Shares Quoted Outstanding Bid Price 1916 July 1,000 $99 $99,000 August 1,000 101 101,000 September 1,000 103 103,000 October 1,000 102 102,000 November 1,000 98 98,000 December 1,000 101 101,000 1917 January 2,000 97 194,000 February 2,000 100 200,000 March 2,000 99 198,000 April 2,000 101 202,000 May 2,000 100 200,000 June 2,000 99 198,000 $1,796,000 $1,796,000 -=- 12 = $149,666, average fair value. 370 INCOME AND FEDERAL TAX REPORTS Case II No. of Highest Fair Value Year Month Shares Sale Price Outstanding Each Month 1916 July 1,000 $101 $101,000 August 1,000 101 101,000 September 1,000 101 101,000 October 1,000 99 99,000 November 1,000 100 100,000 December 1,000 100 100,000 1917 January- 2,000 102 204,000 February 2,000 102 204,000 March 2,000 102 204,000 April 2,000 98 196,000 May 2,000 98 196,000 June 2,000 98 196,000 $1,802,000 $1,802,000 -f- 12 = $150,166, average fair value. If there was no sale during the month, the last month's price should be used. Case III The average rate of earnings of $10 would give a fair value per share of $100. This should be multiplied by the average number of shares outstanding during the year, or 1,500 shares, giving an average fair value of $150,000, due to the fact that the additional number of shares issued by the corporation were sold for cash and the capital stock of the corporation was increased to that extent. Proposition HI. Corporation books on December 31, 1916, show: Capital Stock (1,000 shares at $100) $100,000 Surplus 100,000 $200,000 CAPITAL STOCK TAX 371 On January 1, 1917, 1,000 additional shares were is- sued and paid for at par. The earnings average $20 per share, or $20,000 per year. Case I No. of Highest Fair Value Year Month Shares Quoted Outstanding Bid Price 1916 July 1,000 $200 $200,000 August 1,000 205 205,000 September 1,000 210 210,000 October 1,000 200 200,000 November 1,000 195 195,000 December 1,000 190 190,000 1917 January 2,000 150 300,000 February 2,000 155 310,000 March 2,000 145 290,000 April 2,000 150 300,000 May 2,000 160 320,000 June 2,000 140 280,000 $3,000,000 $3,000,000 -f- 12 = $250,000, average fair value. Case II No. of Highest Fair Value Year Month Shares Quoted Outstanding Bid Price 1916 July 1,000 $200 $200,000 August 1,000 200 200,000 September 1,000 195 195,000 October 1,000 195 195,000 November 1,000 205 205,000 December 1,000 205 205,000 1917 January 2,000 155 310,000 February 2,000 155 310,000 March 2,000 155 310,000 April 2,000 145 290,000 May 2,000 145 290,000 June 2,000 145 290,000 $3,000,000 $3,000,000 -=- 12 = $250,000, average fair value. 372 INCOME AND FEDERAL TAX REPORTS If no sale has been made during the month, the fig- ures of the previous month should be used. Case III The average earnings are $20 a share, which would give a fair value of $200 per share. If this were mul- tiplied by the average number of shares outstanding, 1,500 shares, it would give a fair value of $300,000. This is not the average fair value of the total capital stock, which was figured under Cases I and II to be $250,000. The doubling of the number of shares did not mean the doubling of the amount of capital. The Gapital December 31, 1916, was $200,000 (capital stock, $100,000; surplus, $100,000). On January 1, 1917, an additional $100,000 was added, bringing the capital up to $300,000. This would make the average capital $250,000. In a case similar to this a statement should be attached to the back of the return setting forth the number of shares of stock outstanding each month, with the average fair value of the stock for that month, as worked out in Cases I and II. Bate of earnings if calculated on the basis of capital. If the earnings are calculated on the basis of the cap- ital (i. e., par value of issued stock plus the surplus or undivided profits), instead of the number of shares, we can arrive at a fair value of the invested capital. If after determining this fair value of the invested capital the amount of capital is increased or decreased, the value of the invested capital is increased or decreased proportionately. Increases or decreases in capital stock are ignored except as the result of an increase or de- crease in the amount of invested capital. In all cases this method would give the figure required by the law, namely, "the average fair value of the capital stock for the preceding fiscal year." Turning back to the cases given in the foregoing para- graphs, the method would work out as follows: CAPITAL STOCK TAX 373 In Proposition I the capital of $200,000 has an earn- ing power of $20,000 per year. The corporation being an industrial company, the fair value of the capital is $200,000.! The issuing of $100,000 par value of capital stock to distribute the 100% stock dividend neither increased nor decreased the amount of capital invested. The fair value of the capital remains at $200,000. In Proposition II the capital was $100,000 and the earnings were $10,000 per year. This gives the fair value of the capital as $100,000. On January 1, 1917, 1,000 shares are issued for cash at par. This transac- tion adds $100,000 to the capital, an increase of 100%. The fair value of the capital is increased proportion- ately, becoming $200,000. The tax, however, is based on the average fair value during the year. The fair value for the six months from July 1, 1916, to Dec. 31, 1916, was $100,000; from Jan. 1, 1917, to June 30, 1917, it was $200,000. The average fair value is therefore $150,000. In Proposition III the capital and the earning power are the same as in Proposition I, the fair value of the capital being $200,000. On January 1, 1917, 1,000 shares are sold at par. This transaction adds $100,000 to the capital, an increase of 50%. The fair value of the cap- ital is increased proportionately, becoming $300,000. The average fair value of the capital is therefore $250,- 000 ($200,000 for the first six months and $300,000 for the second six months). Cases where earning power will not be considered. Cor- porations that have no regular earnings, such as com- panies organized for the purpose of developing and sell- ing timber land, mining property, and other real prop- i To the average business man it may seem a paradox to say there is such a thing as a fair value of capital. To him a dollar is worth a dollar. But the fact remains that from the investment point of view a dollar may be worth more than a dollar. The dollar that earns 20 cents a year is worth twice as much as the dollar that earns only 10 cents. 374 INCOME AND FEDERAL TAX REPORTS erty (including real estate), and corporations that have earned no profits in the past five years or have only been engaged in business one or two years, cannot well estimate the value of the stock from their earning ca- pacity. They are permitted to estimate the fair value of the stock from the book value, and should attach a detailed balance sheet as of the close of the fiscal year to the back of the return. Fictitious book values. If the book value is fictitious, and is the result of overestimating the assets, this fact should be fully explained, either on the return or in a statement attached to the return. Value of stock of subsidiaries. Where a holding com- pany owns all the stock of several subsidiaries, which stock is not listed on any exchange or has not been sold in the last fiscal year, it has been held that the fair value of the stock of such subsidiary companies may be estimated from the market value of the total capital stock of the holding company (the parent corpora- tion). The fair value of the total capital stock of the parent company is generally computed under Cases I or II, and therefore this amount may be divided among the subsidiaries in proportion to the total amount of net profits earned by the subsidiaries plus the amount of net profits earned by the parent company from actual operations and investments or holdings of stock in other companies. Preferred and common stock under Case III. Where there is more than one class of stock there is no pro- vision under Case III for arriving at the fair value per share of each class separately, and therefore the earn- ings should be based on the total number of shares out- standing, giving an average fair value per share irre- spective of the class of stock. This fair value will be multiplied by the total number of shares outstanding, in order to arrive at the total fair value. CAPITAL STOCK TAX 375 Basis of tax for foreign corporations. Foreign corpora- tions are taxed on the basis of the average amount of capital actually invested in the transaction of business in the United States during the preceding fiscal year, with the provision that deposits or reserve funds main- tained or held in the United States by insurance com- panies under the requirements of law or contract for the protection of or payment to or apportionment among policyholders shall be deducted. Any surplus or undivided profits invested in United States bonds or other securities which have no connec- tion whatever with the actual business of the corpora- tion transacted in this country will not be considered as capital invested in the United States for the purpose of the tax. Bank balances carried in the United States should be considered as capital in the United States if they are treated as such upon the books of the company. The corporation may state on its return the amount of capital invested outside of the United States and deduct such proportion of $99,000 as the capital in- vested in the United States bears to the total capital both here and abroad. Foreign insurance companies may state the amount of "surplus to policyholders" as shown by the conven- tional form of report to State insurance departments, for the fiscal year ended December 31st. In this case the only deduction allowed is the amount of deposits actually required by States in which the company is transacting business. Rate and computation of tax for United States corpora- tions. The tax is at the rate of 50 cents on each full one thousand dollars of fair value of the capital stock in excess of ninety-nine thousand dollars. When an inactive corporation resumes business the tax will be computed proportionately from the first day of the month in which it resumes business to the end of 376 INCOME AND FEDERAL TAX REPORTS the fiscal year. A corporation resuming business in August would be taxed at the rate of 45.83 cents instead of 50 cents per thousand dollars. Domestic insurance corporations are not permitted to deduct reserves and deposits maintained or held in the United States for the protection of, or payment to, or apportionment among policyholders, as such reserves and deposits are reflected in the fair value of the stock as computed under Cases I, II and III. The amount actually paid for munitions tax during the preceding fiscal year should be deducted from the amount of the tax. No deductions are allowed United States corporations for capital invested in foreign countries. Rate and computation of the tax for foreign corporations. The tax is at the rate of 50 cents on each full one thousand dollars of capital invested in the transaction of business in the United States. The amount of cap- ital invested in the United States is subject to two de- ductions: (1) the allowable proportion of $99,000; (2) the amount of reserves and deposits maintained or held in the United States by insurance companies as required by law or contract. The amount actually paid for munitions tax during the preceding fiscal year should be deducted from the amount of the tax. Returns due annually in July. All corporations re- quired to file returns should file them annually in July, with the Collector of Internal Revenue for the district in which the principal place of business of the corpora- tion is located. Returns may be made by Collector. If any corporation fails to make a return at the time prescribed by law, or makes a false or fraudulent return, the collector or deputy collector shall make the return or list from his own knowledge and from such information as he can obtain through testimony or otherwise. Any return or CAPITAL STOCK TAX 377 list so made and subscribed by a collector or deputy collector shall be prima facie good and sufficient for all legal purposes. Forms are supplied by the Government, but failure to re- ceive forms does not relieve from penalty. Forms will be sent to all taxable corporations known to the collectors, but failure to receive a blank form does not relieve a corporation from the penalties prescribed for failure to make returns within the time required. Extension of time. If the failure to file a return or list is due to sickness or absence of an officer required to sign the return, the collector may allow an extension of not more than thirty days from July 31 in which to file the return. Form of return for domestic corporations. Domestic corporations are required to make returns upon Form 707, and foreign corporations upon Form 708. Form 707 requires the following information: 1. Kind of business. 2. Par value of common stock. 3. Par value of preferred stock. 4. Total value of capital stock. 5. Amount of surplus. 6. Amount of undivided profits. The figures given in answer to questions 5 and 6 should be as of the date of the return, but if these figures cannot be obtained, those of the end of the last calendar or fiscal year of the corporation may be used. 7. Average fair value per share, to be computed as indicated in any of the three cases. Under Case III the "average dividends per share paid during preceding five years" is required. This is only for the information of the office of the collector of in- ternal revenue in a case where a corporation shows an earning capacity but does not state any surplus or un- divided profits. 378 INCOME AND FEDERAL TAX REPORTS 8. Number of shares of common stock outstand- ing June 30, multiplied by average value per share as arrived at under No. 7, giving total fair value of common stock. 9. Number of shares of preferred stock outstand- ing June 30, multiplied by average value per share as arrived at under No. 7, giving total fair value of preferred stock. 10. Fair value of total capital stock for preceding fiscal year ended June 30, the sum of 8 and 9. 11. Deduction allowed by law $99,000. 12. Amount of fair value of stock over $99,000. 13. Tax at rate of 50 cents per year for each full $1,000. 14. Deduction of amount of munitions tax paid. 15. Amount of tax due. This return must be signed and sworn to by two offi- cers of the corporation before an officer authorized to administer oaths, and the seal of the attesting officer, if he is required to have a seal, must be impressed on the return. Form of return for foreign corporations. Form 708, for foreign corporations, requires the following informa- tion: 1. Kind of business. 2. Capital invested in the United States. (This should be the average amount invested dur- ing the year.) 3. Capital invested in foreign countries. The law does not require this to be the average cap- ital invested. The figure used may be either that of June 30th or of the end of the fiscal year of the corporation. 4. Total capital invested by the corporation both in the United States and elsewhere the sum of 2 and 3. CAPITAL STOCK TAX 379 5. Amount of capital invested in the United States (brought down from Item 2 above), and percentage of total capital invested in the United States. 6. Deductions allowed by law. (1) Reserves and deposits of insurance com- pany. (2) Proportion of $99,000. 7. Amount of capital on which tax should be com- puted. 8. Tax at rate of 50 cents per year. 9. Deduction of munitions tax paid. 10. Amount of tax due. This return must be signed and verified by the agent or attorney, or other principal officer in charge of the United States branch of the foreign corporation, and must be sworn to before an officer authorized to admin- ister oaths, and the seal of the attesting officer, if he is required to have a seal, must be impressed on the re- turn. Tax payable when notice of assessment has been given. The tax may be paid at the time of filing or at any time subsequent, but no penalty will be attached until assessment is made and ten days' notice given and de- mand made on the official form (Form 17) for the tax. Payment may be made in cash or by certified check. Receipts need not be displayed. The corporation will receive a receipt as evidence of the payment of the tax, but will not be required to display same as if it were a special stamp tax. Penalty for failure to file return. In case of failure to make and file a return within the time prescribed by law, there shall be added to the tax 50% of its amount, and the corporation shall be liable to a fine of not more than $500. Subsequent voluntary returns. Should a return be filed voluntarily after the time required by the law, without 380 INCOME AND FEDERAL TAX REPORTS notice from the collector, no 50% penalty will attach if it is shown that the failure to file the return was due to a reasonable cause and not to wilful neglect. Penalty for false or fraudulent return. In case a false or fraudulent return or list is wilfully made, the Com- missioner of Internal Eevenue shall add to the tax one hundred per centum of its amount. Penalty for failure to pay tax when due. Upon failure to pay the tax assessed within ten days after notice and demand, a penalty of 5 per cent of the tax unpaid and interest at the rate of 1 per cent per month until paid shall be added to the amount of such tax. Specific penalty for failure to pay tax. Section 408, Title IV, of the Act of September 8, 1916, provides that every person who carries on any business or occupation for which special taxes are imposed by this title, with- out having paid the special tax therein provided, shall, besides being liable to the payment of such special tax, be deemed guilty of a misdemeanor, and upon conviction thereof shall pay a fine of not more than $500 or be imprisoned not more than six months, or both, in the discretion of the court. CHAPTER XV CAPITAL STOCK TAX LAW BEING TITLE IV OF "AN ACT TO INCREASE THE REVENUE AND FOR OTHER PURPOSES," APPROVED SEPTEMBER 8, 1916 (PUBLIC NO. 271 64th CONGRESS) IN EFFECT SEPTEMBER 9, 1916. Excise tax on domestic and foreign corporations. Sec. 407. That on and after January firstj nineteen hundred and seventeen, special taxes shall be, and hereby are, imposed annually, as follows, that is to say: Every corporation, joint-stock company or association, now or hereafter organized in the United States for profit and having a capital stock represented by shares, and every insurance company, now or hereafter organized under the laws of the United States, or any State or Terri- tory of the United States, shall pay annually a spe- cial excise tax with respect to the carrying on or doing business by such corporation, joint-stock company or association, or insurance company, equivalent to fifty cents for each $1,000 of the fair value of its cap- ital stock and in estimating the value of capital stock the surplus and undivided profits shall be included: Provided, That in the case of insurance companies such deposits and reserve funds as they are required by law or contract to maintain or hold for the protection of or payment to or apportionment among policyholders shall not be included. The amount of such annual tax shall in all cases be computed on the basis of the fair aver- 381 382 INCOME AND FEDERAL TAX REPORTS age value of the capital stock for the preceding year: provided, That for the purpose of this tax an exemption of $99,000 shall be allowed from the capital stock as de- fined in this paragraph of each corporation, joint-stock company or association or insurance company. And provided further, That a corporation, joint-stock com- pany or association, or insurance company, actually paying the tax imposed by section three hundred and one of Title III [Munition Manufacturer's Tax] of this Act shall be entitled to a credit as against the tax im- posed by this paragraph equal to the amount of the tax so actually paid: And provided further, That this tax shall not be imposed upon any corporation, joint-stock company or association, or insurance company not en- gaged in business during the preceding taxable year, or which is exempt under the provisions of section eleven, Title I, of this Act. Every corporation, joint-stock company or associa- tion, or insurance company, now or hereafter organized for profit under the laws of any foreign country and engaged in business in the United States, shall pay an- nually a special excise tax with respect to the carrying on or doing business in the United States by such cor- poration, joint-stock company or association, or insur- ance company, equivalent to 50 cents for each $1,000 of the capital actually invested in the transaction of its business in the United States: Provided, That in the case of insurance companies such deposits or reserve funds as they are required by law or contract to main- tain or hold in the United States for the protection of or payment to or apportionment among policyholders shall not be included. The amount of such annual tax shall in all cases be computed on the basis of the aver- age amount of capital so invested during the preceding year: Provided, That for the purpose of this tax an exemption from the amount of capital so invested shall be allowed equal to such proportion of $99,000 as the CAPITAL STOCK TAX LAW 383 amount so invested bears to the total amount invested in the transaction of business in the United States or elsewhere: Provided further, That this exemption shall be allowed only if such corporation, joint-stock company, or association, or insurance company makes return to the Commissioner of Internal Revenue, under regulations prescribed by him, with the approval of the Secretary of the Treasury, of the amount of capital in- vested in the transaction of business outside the United States: And pro\ided further, That a corporation, joint-stock company or association, or insurance com- pany, actually paying the tax imposed by section 301 of Title III [Munition Manufacturer's Tax] of this act, shall be entitled to a credit as against the tax imposed by this paragraph equal to the amount of the tax so ac- tually paid: And provided further, That this tax shall not be imposed upon any corporation, joint-stock com- pany or association, or insurance company not engaged in business during the preceding taxable year, or which is exempt under the provisions of section eleven, Title I, of this act. Penalties for evasion of tax. Every person who car- ries on any business or occupation for which special taxes are imposed by this title, without having paid the special tax therein provided, shall, besides being liable to the payment of such special tax, be deemed guilty of a misdemeanor, and upon conviction thereof shall pay a fine of not more than $500, or be imprisoned not more than six months, or both, in the discretion of the court. Administrative provisions. Sec. 409. That all ad ministrative or special provisions of law, including the law relating to the assessment of taxes, so far as ap- plicable, are hereby extended to and made a part of this title, and every person, firm, company, corpora- tion, or association liable to any tax imposed by this title, shall keep such records and render, under oath. 384 INCOME AND FEDERAL TAX REPORTS such statements and returns, and shall comply with such regulations as the Commissioner of Internal Revenue, with the approval of the Secretary of the Treasury, may from time to time prescribe. Approved by the President, September 8, 1916. CHAPTER XVI FEDERAL INHERITANCE OR ESTATE TAX INTRODUCTION Origin of inheritance taxes. A little less than a decade ago inheritance taxes were practically unknown in the United States. They are, however, of ancient origin. Historians tell us that over two thousand years ago they were imposed by the Romans, where, perhaps, the idea had been introduced from Egypt, while in the Middle Ages it seems they existed as an incident of feudal ten- ures. Today practically every civilized nation has adopted some system of inheritance taxation, while in the United States all but five States * have enacted such laws. Inheritance taxes in the United States. As a means of contributing to the income of the Federal Government, inheritance taxes are not new. The first tax of this nature was imposed by the Stamp Act of July 6, 1797, which was repealed five years later. The War Rev- enue Act of July 1, 1862, included an inheritance tax, which remained in force until July 14, 1870. Although the income tax provisions of the Revenue Act of August 27, 1894, embraced inheritances, the scheme failed, when the law was declared unconstitutional. The next in- heritance tax law passed by Congress was the War Revenue Act of June 13, 1898, which, so far as the in- heritance feature is concerned, was repealed April 12, i Ala., Fla., Miss., N. Mex., and S. Car. 385 386 INCOME AND FEDERAL TAX REPORTS 1902. Finally, on September 8, 1916, the national leg- islature passed an "Act to Increase the Eevenue and for Other Purposes," imposing an "estate" tax on the property of resident and non-resident decedents alike, which has twice been amended for the purpose of in- creasing the rates. Earlier laws were emergency measures. Prior to Sep- tember 8, 1916, inheritance taxes were adopted by the Federal Government as an emergency measure, as was done subsequent to the Eevolutionary War and during the Civil and the Spanish-American Wars, while it seems to have been taken for granted that, in normal times at least, this method of raising money should be left to the States. The new law, however, was passed at a time when we were at peace and enjoying unusual prosperity. Does it herald the era when all inheritance taxation will be reserved exclusively to the Federal Government, while the States merely will participate in the proceeds? The Act of September 8, 1916. Unlike most inheritance tax laws, the Act of September 8, 1916, imposes a tax on the entire net estate, instead of on each distributive share. The law also requires the executor, under cer- tain conditions, to file a notice with the Collector of Internal Revenue within thirty days after qualifying or coming into possession of property of the decedent, and to file a return and to pay the tax on or before one year after the death of the decedent. In some instances, donees, beneficiaries, heirs, trustees, fiduciaries, trans- fer and paying agents and registrars must file the no- tice, make the return and pay the tax. A penalty of $500 is imposed where the notice or the return is not filed on time, and for making any false statement a fine of $5,000, with perhaps imprisonment. As mentioned above, the original "estate" tax law passed September 8, 1916, has been amended twice for the purpose of increasing the rates. The rates pro- FEDERAL INHERITANCE OR ESTATE TAX 387 vided in the original act apply to the net estate of every decedent dying on and after September 9, 1916, to and including March 2, 1917. The rates provided in the first amendment apply to the net estate of every de- cedent dying on and after March 3, 1917, to and includ- ing October 3, 1917. The rates provided in the second amendment apply to the net estate of every decedent dying on and after October 4, 1917 (except where the decedent died while serving in the military or naval forces of the United States, during the continuance of the war in which the United States is now engaged, or if decedent died from injuries, or disease, while in the service, within one year after the termination of the war). The administration of the law is governed by regula- tions and decisions issued by the Treasury Department. In the succeeding paragraphs there have been defined the duties of executors, administrators and others, as required by the law, regulations and treasury decisions issued to date of publication of this book. DEFINITIONS OF TERMS Several terms are used in the law and regulations, which, in addition to their common import, have been assigned special meanings. It is thought best, there- fore, to define their exact meaning under the law. Collector. This term means the collector of inter- nal revenue of the district in which the decedent maintained his legal residence at the time of his death. If the decedent resided outside of the United States, then the term "collector" means the collector of the district in which is located the decedent's property. If a non-resident decedent leaves property in more than one district, then the term means the collector at Bal- timore, Maryland. The Act does not distinguish between citizens and 388 INCOME AND FEDERAL TAX REPORTS aliens, but does distinguish between residents and non- residents of the United States at the time of their death. If a citizen of the United States has main- tained his principal domicile abroad prior to his death, his estate is taxable as that of a non-resident. Executor. This term includes an executor, or admin- istrator, of the estate of a decedent. If there is no executor or administrator, the term nevertheless in- cludes any person having or coming into possession of property of the decedent. Exemption. This term means the $50,000 specific exemption permitted to be deducted from the gross es- tate in determining the amount of the net estate of a resident decedent, whether citizen or alien of the United States. (See "Net Estate.") (Law Sec. 203; Reg. Art. 20.) Gross Estate. This term includes all property, both real and personal, tangible or intangible, wherever sit- uated at the time of a resident decedent's death ; and all property situated in the United States at the time of a non-resident decedent's death. It also includes any transfer, either in trust or otherwise, of property, ex- cept for a fair consideration in money or money's worth, effected by a taxable decedent at any time dur- ing his life but in contemplation of death, regardless of whether the transfer was fully effected or the instru- ment of transfer executed before or after the passage of the taxing act of September 8, 1916. It has been held that the language of the Act is so specific that it was clearly the intent of Congress "to include not only such transfers, including gifts and sales not bona fide, made by instrument dated after i The term United States means only the States, the Territories of Alaska and Hawaii and the District of Columbia. The tax is not imposed in Porto Rico, the Philippine or Virgin Islands, but the property in the United States of deceased residents of these islands is taxable as the property of non-residents. FEDERAL INHERITANCE OR ESTATE TAX 389 September 8, 1916, or when the actual transfer took place after that date, but transfers of any kind made in contemplation of death at any time whatsoever prior to September 8, 1916. It is believed also that there is no question of the power of Congress to enact such revenue legislation. The test of the tax liability is not in such cases the date of the instrument making the transfer, or the date of the actual transfer, but the date of the death of the decedent." The term includes the interest of the decedent in any property held jointly by the decedent and any other person, or deposited in banks or otherwise. It does not include the interest which a decedent had in property devised to him for life only, with the remainder vested in another. But a vested remainder in property, sub- ject to a life tenancy, should be included in gross es- tate. This is for the reason that the estate tax is based upon the actual value of the interest of the decedent at the time of death. The value of the vested remain- der is computed by reference to mortality tables. In computing the value of the gross estate no pro- vision is made for the deduction of the widow's dower or husband's curtesy. Gross estate also includes accrued interest on securi- ties, and accrued dividends on preferred stock, if fixed and certain, to the day of death, and all other divi- dends that were declared prior to the day of death. Income of the estate and appreciation of values after death are excluded. All insurance, not payable directly to a beneficiary named in the policy, is included, also any accrued divi- dends. All property over which decedent exercised his power of appointment is also included. Stock in a domestic corporation and held by a non- resident decedent is a part of the gross estate, and is deemed property within the United States, even though 390 INCOME AND FEDERAL TAX REPORTS actually situated outside the United States at the time of decedent's death. Gross estate does not include any bonds of domestic corporations owned by a non-resident physically located outside the United States at the time of his death. However, a tax is imposed upon the value of bonds, both foreign and domestic, owned by a non-resident decedent which bonds were physically situate in the United States, Hawaii or Alaska at the time of the owner's death, and the value of such bonds must be in- cluded as a portion of his gross estate. Bonds, both foreign or domestic, owned by a resident decedent are taxable regardless of where such bonds are situated at the time of the owner's death. The value of United States and other "tax exempt" bonds owned by the decedent is a part of the gross estate. One-half of the value of so-called "community prop- erty" * should be included in the gross estate of the decedent husband or wife. If the survivor's interest be that merely of dower or curtesy, then the whole value of the "community property" is to be included in the gross estate of the decedent. Household goods and other miscellaneous personalty of like nature used by husband and wife in the mar- riage relation are presumed to be the property of the husband and must be included in his gross estate. If the widow claims any part as her separate property she must furnish evidence showing that such articles were (1) owned by her prior to marriage; or (2) pur- chased out of her separate funds; or (3) acquired by gift or inheritance to her direct. i In Texas, and in a few other States, all property earned or acquired by purchase or by gift (with one or two exceptions) by a husband or wife during the period of their marriage, is termed "community property." Such property is owned jointly by the husband and wife, and upon the death of either, the title thereto vests absolutely in the survivor. A similar condition exists in Pennsylvania, respecting real property, in cases where the convevance is made to both the husband and wife. FEDERAL INHERITANCE OR ESTATE TAX 391 The value of loans evidenced by promissory notes is to be included in the gross estate, even though by will the decedent provides that the notes shall be cancelled. The gross value of mortgaged property must be shown in the gross estate, and the amount of the mort- gage treated as a deduction. Thus, if a decedent's es- tate consists exclusively of real property valued at $75,000, against which there is a mortgage of $40,000, the gross estate must be reported at $75,000, even though the equity of the decedent is but $35,000. Net Estate. "Net estate" means that portion of the gross estate remaining after deductions for the follow- ing have been made: (a) Resident's Estate: (1) Funeral expenses; administration expenses, in- cluding the executor's and attorney's fees and miscel- laneous expenses, but excluding all State inheritance taxes; claims against the estate, including mortgages and debts of the decedent; losses arising from fires, storms, shipwreck, or other casualty, and from theft during administration and not compensated for by in- surance or otherwise; support during settlement of the estate of those actually dependent upon the decedent; and such other charges, if any, as are allowed by the local laws under which the estate is being administered. (2) A specific exemption of $50,000. (b) Non-Resident's Estate: Such a proportion of the items specified in section (a), subdivision 1, above, as the proportion of de- cedent's property located within the United States bears to the total amount of decedent's property wherever situated, provided the executor includes in the return required to be filed the value at the time of his death of that part of the gross estate of the non-resident not situated in the United States. The specific exemption of $50,000, or any portion 392 INCOME AND FEDERAL TAX REPORTS thereof, allowed to a resident decedent's estate is not allowed a non-resident decedent's estate. It should be noted that no claim for deduction will be allowed unless the amount claimed has been actually expended, and is within the statutory limitation, if any, of the local jurisdiction. Amounts paid for the support of dependents will not be allowed as a deduction unless all and each of the following conditions exist: 1. There must be an actual expenditure of money not merely its equivalent; 2. The persons for whose support the money is ex- pended must be actually dependent upon the deceased if they have independent means, the claim will not be allowed. 3. The amount actually expended must not exceed the limit set by the local laws under which the estate is being administered. Losses sustained through sale of assets at less than the inventory value are not allowed as a deduction. In the schedule of assets of a certain estate the stocks and bonds owned by the decedent at time of death were inventoried at $388,000, and during the ad- ministration of the estate all were sold to raise the nec- essary cash to pay pecuniary legacies and taxes. The amount realized from the sale was $361,000, so that there was a determined loss to the corpus of the es- tate of $27,000, arising from the necessity of adminis- tration. It was stated that the executor had used his best judgment in making sales, but due to the state of the security market it was impossible to realize on even the most gilt-edged securities without taking some loss from quotations on the market at the date of the de- cedent's death. Under these circumstances it was argued this loss to the estate should be included among the deductions from the gross estate allowed in com- FEDERAL INHERITANCE OR ESTATE TAX 393 puting the tax; also, that inasmuch as the purpose of making these sales was to provide for the payment of pecuniary legacies and of the State and Federal taxes, the loss so sustained should be allowed either under "Administration expenses" or "Determined losses dur- ing administration." The Treasury Department held: "The value of securities as of the date of decedent's death should be returned as a portion of his gross es- tate. Any subsequent depreciation or appreciation is not considered for Federal Estate Tax purposes. Losses occurring during administration which are deductible are set out in Section 203 (l) 1 of the Act of September 8, 1916, and losses other than those specifically enumer- ated are not deductible." Prior to September 10, 1917, the Treasury Depart- ment (T. D. 2395) held that amounts paid to States on account of inheritance, succession or legacy taxes were a lawful deduction, but T. D. 2524 revoked this ruling, so that State inheritance taxes are not now deductible. This ruling also applies to non-resident decedents' es- tates. The Federal estate tax is not determined, does not attach and cannot be assessed or paid until the net estate upon which it is based has been exactly estab- lished. The estate tax, therefore, cannot be deducted from the gross estate to determine the taxable net estate. Non-resident decedent. The term "non-resident de- cedent" includes aliens and citizens of the United States residing outside of the United States at the time of their death. For example, the estate of a citizen of the United States who had prior to his death main- tained his principal residence in London, would be taxed as that of a non-resident. Residents of the Phil- ippine Islands and Porto Rico are taxed as non-resi- dents upon any property in the United States. i Such losses are those arising from fires, storms, shipwrecks or other casualty, and theft, when not compensated for, by insurance or otherwise. 394 INCOME AND FEDERAL TAX REPORTS Notice. (Also termed "Thirty-day Notice," Forms 704, 705 and 714.) "Notice" means the written notice required to be filed with the collector within thirty days after letters testamentary or of administration are granted, or within thirty days after coming into pos- session of property of the decedent, except where pos- session of the property was obtained prior to decedent's death, in which case the notice must be filed within thirty days after decedent's death. Executors and ad- ministrators are required to file Form 704; transfer agents and registrars, Form 714, and all others must file Form 705. Person. "Person" includes partnerships, corpora- tions and associations. Resident decedent. This term includes citizens and aliens residing at the time of their death in the United States. Return. "Eeturn" (Form 706) means the statement re- quired to be executed by the executors and filed with the collector within one year after the decedent's death, setting forth in detail the amount of the gross estate, the deductions allowed, the amount of the net estate and the tax payable thereon. This return is required in the case of resident decedents where the gross estate exceeds $60,000, or where the net estate exceeds the specific exemption of $50,000. A return is required for every non-resident decedent's estate regardless of the size of the estate. United States. The term "United States" includes all the States, the territories of Alaska and Hawaii, and the District of Columbia. It does not include the Phil- ippine Islands, the Virgin Islands or Porto Rico. DUTIES OF EXECUTORS AND ADMINISTRATORS Thirty-day Notice Form 704. Every executor or ad- ministrator, within thirty days after qualifying as such, FEDERAL INHERITANCE OR ESTATE TAX 395 or after coming into possession of any property of the decedent, whichever event first occurs, shall give writ- ten notice thereof on Form 704 to the collector of in- ternal revenue in whose district was decedent's domicile at the time of death; and in the case of a non-resident, with the collector of the district in which the property is located. If the non-resident's property is located in more than one district, the notice must be filed with the collector at Baltimore, Md. However, if the decedent was a resident of the United States, and the gross estate does not exceed $60,000 or the net estate does not exceed $50,000, then such notice is not required to be filed. 1 (See back of Form 704.) But, where the gross estate exceeds $60,- 000, even though the net estate may be less than $50,000, such notice must be filed. 2 (Beg. Art. 32.) Ancillary executors or administrators of non-resident decedents' estates are required to file Form 704 within the time specified above, regardless of the size of the decedent's estate. The estate of a non-resident decedent is liable for the tax upon that portion of the estate physically situated within the United States, and, in addition, upon the value of the stock of domestic cor- porations owned by the decedent at the time of his death, whether or not such stock be physically located in the United States. Bonds of domestic corporations owned by non-resident decedents and physically located outside of the United States are not deemed "property within the United States." The filing of the notice should not be delayed in order to secure exact information concerning the value of the gross or net estate. Approximate figures may be given. i For example, if the gross estate amounts to $58,000, and the net estate to $48,000, the notice will not be required. But, even though the gross estate is only $58,000, if the net estate is over $50,000 (that is, in excess of the specific exemption), the notice must be filed. 2 Thus, if the gross estate is $65,000 and the net estate $45,000, the notice must be filed. 396 INCOME AND FEDERAL TAX REPORTS Return Form 706. It is the duty of every executor or administrator to file, within one year after the de- cedent's death, a return on Form 706, where the gross estate of a resident decedent exceeds $60,000 or the net estate exceeds $50,000. If, at the expiration of the year, it is impossible for the executor to show upon the return complete and accurate data of the gross es- tate and deductions, he should file a tentative return, and inform the collector of the cause for delay. The collector will, in his discretion, extend the time for filing the final return. A return is required of the estate of every non-resi- dent owning property physically located within the United States, or owning stocks of domestic corpora- tions regardless of their physical situs. Payment of tax. The tax is due and payable one year after the decedent's death, and should be paid by the executor or administrator. A discount at the rate of 5 per cent per annum is allowed for prior payment. If the tax is not paid within 90 days after it is due inter- est is added at the rate of 10 per cent or 6 per cent per annum, as the case may be, calculated from the day of decedent's death to the date of payment, and the tax becomes a lien on the gross estate for ten years. (See Payment of Tax; Penalties.) It is important for the executor to keep in mind that Section 208 of the law expressly provides that, so far as it is practicable and unless otherwise directed by the will of the decedent, the tax must be paid out of the estate before its distribution. This brings up the ques- tion in a testate's estate whether the tax shall be shared proportionately by all the legatees, or borne entirely by the residuary legatee. Where the testator expressly di- rects that all inheritance taxes be paid out of the resid- uary estate, the will, of course, governs. But, where the will is silent, whether or not the tax is to be borne by the residuary legatee depends upon the laws of the FEDERAL INHERITANCE OR ESTATE TAX 397 State where the estate is administered. If the laws of the State make no provision for the apportionment of the tax, the executor should petition the surrogate, or the judge of the probate court, for an order expressly directing the apportionment of the tax, rather than as- sume that it should be borne by the residuary estate. In the case of an estate of a decedent who died without making a will, this question will not be encountered; the residuary estate, after being charged with the amount of the tax, will be distributed among the heirs and next of kin according to law. DUTIES OF BENEFICIARIES, HEIRS, DONEES, TRUSTEES AND FIDUCIARIES Where the estate of a decedent is represented by a duly appointed executor or administrator, no obligation to file the thirty-day notice (Form 705), or the return (Form 706) or to pay the tax is imposed upon a bene- ficiary, 1 heir, donee, trustee or fiduciary. It is only in cases where a taxable estate has no duly appointed rep- resentative, or where property of the decedent passes directly to the beneficiary without coming under the control of the executor, that the beneficiary, or his guardian, trustee or fiduciary must file the notice and return and pay the tax. In this respect the Solicitor of Internal Revenue has given his opinion, as follows : "The said law defines the term 'executor' as mean- ing 'the executor or administrator of the decedent, or, if there is no executor or administrator, any person who takes possession of any property of the decedent,' " and further states: "Manifestly the purpose of the law is to secure such information and returns as will enable the Government i Wherever the term "beneficiary" is used in this chapter, it includes heirs, donees, trustees, fiduciaries, and all other persons holding property of a decedent. 398 INCOME AND FEDERAL TAX REPORTS to properly execute the law and collect such taxes as may be thereby imposed. "In view of this uniform interpretation as to the re- quirement of notice and returns in all matters of rev- enue taxation, as well as the specific language of the law, I am of the opinion that you are justified in the preparation of regulations requiring persons who come into the possession of the property of a decedent, or any part thereof, prior to the appointment of executors or administrators, to give due and proper notice to the Collector of that fact. When executors or administra- tors are appointed they, of course, supersede all other persons in the control of the property, whether such persons are in possession or not, and the duty of giving notice and making returns for the entire estate imme- diately devolves upon such executors or administrators." It is the intention of the Treasury Department to give a broad construction to the expression "any per- son who takes possession of any property of the de- cedent" contained in Section 200, and to impose upon such persons the duties and obligations of executors, where none has been duly appointed. The law contemplates also that the notice should be filed by all persons who shall have received, within two years prior to the death of the decedent, any material part of decedent's property either as a gift in contem- plation of death, or by a transfer intended to take legal effect at or after decedent's death, or by a so-called sale which was not a bona fide sale for a fair consideration in money or money's worth. With the notice to the col- lector, the donee or transferee may file such evidence as may be desired to establish whether the gift or trans- fer was in contemplation of, or intended to take effect at, the donor's or transferror's death, or whether the sale was bona fide. Thirty-day Notice Form 705. Where the estate is not represented by a duly appointed executor or adminis- FEDERAL INHERITANCE OR ESTATE TAX 399 trator, Form 705 must be filed within 30 days after the death of the decedent, or within 30 days after coming into possession of property of decedent, by the follow- ing persons: A. In the case of estates of resident decedents. (1) By the surviving husband or wife, as the case may be, for one-half the value at the decedent's death, of com- munity property owned by the decedent and the sur- vivor. (2) By the first taker after the decedent of any of decedent's real property where this passes, in accord- ance with local law, directly to the heirs of the decedent. (3) By donees who have received within two years prior to the decedent's death any gift of material value from the decedent, or who have received at any time whatever gifts made by decedent in contemplation of, or intended to take legal effect at, death. (4) By trustees holding property conveyed during his lifetime by the decedent in contemplation of death (or with the intent to provide for others than the de- cedent at or after decedent's death), regardless of the date of the instrument making the conveyance, or the date of possession by the trustee, or the date of vesting of the right of survivors to possession or enjoyment at or after decedent's death. (5) By fiduciaries holding property of any kind jointly or in entirety for the decedent and another or others. (6) By any other person holding or taking any prop- erty upon decedent's death which will not pass through the executor or administrator. The notice should be filed with the collector for the district in which the decedent maintained his principal residence. B. Estates of non-resident decedents. All persons who at any time have received property from a non- 400 INCOME AND FEDERAL TAX REPORTS resident decedent as a gift in contemplation of death, and all persons, including beneficiaries, heirs, trustees and fiduciaries, who hold any property of a non-resi- dent decedent physically located within the United States, shall file the notice (Form 705) with the col- lector, regardless of the amount of the property. The notice must be filed within 30 days from the decedent's death with the collector of the district in which the property is located. If the property is located in more than one district, the notice must be filed with the col- lector at Baltimore, Md. If information of a non-resi- dent decedent's death is not received in time to enable the beneficiary to file the notice within the thirty-day period, no penalty for failure to file such notice will be imposed if the notice is filed within 30 days from the time information of decedent's death was received. Return Form 706. Keturns must be made as follows: A. Resident decedent's estate. In the case of estates having no executors or administrators, or where any part of the gross estate passes direct to a beneficiary, the law places upon the separate beneficiaries the pre- cise duties with regard to filing of the return and pay- ment of the tax that are otherwise imposed on execu- tors. Where the property is held for the beneficiary by guardians, trustees, or fiduciaries, the return may be filed by such representatives. Each beneficiary making return for any part of the estate is required to give full information regarding the estate, and the collector will compile a final and com- plete return from the several returns, if any, made by the beneficiaries and assess the tax accordingly. B. Non-resident decedent's estate. If the foreign executor has failed to file the return within one year from the date of decedent's death, the collector shall re- quire the return to be made by a beneficiary. No de- ductions whatever may be taken upon such returns unless it is proved that all the non-resident's property FEDERAL INHERITANCE OR ESTATE TAX 401 is located within the United States and is included in the gross estate on the return. Under no circumstances may a beneficiary release to a foreign executor or administrator or foreign bene- ficiary of a non-resident decedent's estate any of de- cedent's property, until (1) The amount of tax has been paid; or (2) Ancillary letters have been taken out in the United States; or (3) Provision has been made by the estate for the satisfaction of the tax lien resting upon decedent's property in this country. When ancillary letters have been taken out, or pro- vision made for the payment of the tax, the beneficiary should immediately notify the collector of such fact. A penalty will be imposed for failure to comply with these requirements. Payment of tax. Payment of the tax by the bene- ficiary is required only where he has filed a return, or released property of a non-resident decedent's estate to a foreign executor, administrator or beneficiary and withheld the amount of tax due. It is very important for trustees to note that they are personally liable for the amount of any tax due and unpaid upon the value of decedent's interest in any property in their hands which had been transferred to them in trust at any time by the decedent, if such trans- fer was made by the decedent in contemplation of death. Such property, to the extent of decedent's interest therein, is subject to a lien for the amount of the tax. DUTIES OF BANKING INSTITUTIONS AND SAFE DEPOSIT COMPANIES Thirty-day notice Form 705. The thirty-day notice provisions apply as follows to the two classes of es- tates : 402 INCOME AND FEDERAL TAX REPORTS A. Resident decedent's estate. Where the property of a resident decedent's estate is taken in charge by a duly appointed executor or administrator there is no obligation upon a bank or safe deposit company to file the notice or to see that the executor files the notice, and the bank or safe deposit company may safely re- lease all funds and other property unto the executor or administrator. But, if the property held by the bank or safe deposit company is a joint account, or any other property which would not pass through the executor's hands, the primary duty of filing the notice is upon the bank or safe deposit company. If the bank or safe deposit company, however, depends upon the executor to file the notice for property, which does not come into his charge, it does so at its own risk. Unless the bank or safe deposit company is satisfied that the gross es- tate of the decedent is less than $60,000 or the net es- tate is less than $50,000, it should file the notice for its own protection and thus relieve itself from all liability. B. Non-resident decedent's estates. Where ancillary letters are taken out in the United States, and the prop- erty of a non-resident decedent in the possession of a bank or safe deposit company is taken in charge by the ancillary executor or administrator, there is no obliga- tion upon a bank or safe deposit company to file the notice, and the property may safely be released to the ancillary representative. But if no such representative has qualified within thirty days after the death of a non-resident decedent or notice thereof, then the bank or safe deposit company should promptly file the notice (Form 705) with the collector, regardless of the amount of the property held, and retain such property in its custody. Return Form 706. No return is required from a bank or safe deposit company where the property of the decedent has been delivered to a duly appointed execu- tor or administrator, or where ancillary letters are FEDERAL INHERITANCE OR ESTATE TAX 403 taken out in the United States, to an ancillary execu- tor or administrator. Where a bank or safe deposit company holds prop- erty of a resident decedent in a joint account, the col- lector will look either to the executor or to the succeed- ing owner, depending upon the circumstances in the particular case, for making the return. In the case of a non-resident decedent, if the foreign executor has failed to file the return within one year from the date of decedent's death, the collector shall re- quire return to be made by the bank or safe deposit company. No deductions whatever may be taken upon such return unless there is a showing that all the non- resident's property is located in the United States, and is included in the gross estate on the return. Under no circumstances may a bank or safe deposit company release to a foreign executor or administrator or to a foreign beneficiary of the non-resident decedent any property within the United States at the time of decedent's death until either (1) The tax due has been paid; or (2) Ancillary letters have been taken out in the United States; or (3) Provision has been made for the satisfaction of the tax lien resting upon decedent's property in the United States. When ancillary letters have been granted, or pro- vision made for the payment of the tax, full and com- plete notice thereof shall immediately be given to the collector. A penalty will be imposed for failure to com- ply with these requirements. Payment of tax. Payment of the tax by a bank or safe deposit company is only required where it has filed a return, or where it has released property of a non- resident decedent's estate to a foreign executor, admin- istrator or beneficiary and withheld the amount of the tax due. 404 INCOME AND FEDERAL TAX REPORTS DUTIES OF AGENTS OR REPRESENTATIVES OF NON-RESIDENT DECEDENTS Conditions of release to foreign administrator. Under no circumstances may the local agent, representative, etc., release to a foreign administrator or executor or a foreign beneficiary of the decedent any property within the United States at the time of the decedent's death until either (1) the tax due has been paid, or (2) ancil- lary letters have been taken out in the United States, or (3) the retaining by the local representative of a sum sufficient to guarantee the payment of the entire tax that would be due. When ancillary letters have been taken out, or provision made for the payment of the tax, the local agent shall immediately inform the collector fully as to the facts (T. D. 2454). The duties of agents or representatives of non-resi- dent decedent's estates, with regard to the filing of the notice and the return, and the payment of the tax, are the same as those of banking institutions and safe de- posit companies with respect to the estate of non-resi- dent decedents. These duties are described in pages 401-403 of this chapter. With relation to non-resident decedents, the thirty- day notice (Eeturn Form 706) and tax payment are required of representatives in this country where no executor acts within the required time. An inquiry was made as to the liability, under Section 205, of rep- resentatives in this country of a non-resident decedent leaving property in the hands of representatives, and where, so far as the representatives knew, no execu- tor had been appointed. Section 205 requires that the executor, within thirty days after qualifying as such, or after taking possession of any property of a decedent, whichever event first occurs, shall give notice to the Collector of Internal Revenue, and that later the ex- ecutor shall file return of the estate. Section 207 re- FEDERAL INHERITANCE OR ESTATE TAX 405 quires that the executor shall pay the tax to the collec- tor or his deputy. In Section 200 the term "executor" is denned as meaning either the executor or adminis- trator, or if there is none, any person who takes pos- session of any property of the deceased. In this certain case it was argued that the represen- tatives in this country of the non-resident decedent do not "take possession" of decedent's property, and that, since the representatives are neither administrators nor beneficiaries, they cannot be required to file the thirty-day notice, or return, or make payment of the tax. From that view the Treasury Department dissented, for although there is no change of agent or representa- tive, there was immediately upon the non-resident's death a complete change in the character of the agency. Prior to the death, the local representatives held the property in charge for the non-resident, but imme- diately the death occurred they held it subject to the order of executors or administrators, and for the bene- ficiaries legally entitled thereto. At the moment of death there was, on the part of the local representa- tives, an actual legal taking of possession for succeed- ing owners, a change in the conditions of possession so complete that no actuality would be added by the sub- stitution of other agents. It is clear, therefore, that such representatives are responsible for the filing of the thirty-day notice, and can be saved from that responsibility only if, prior to the expiration of thirty days from the death of the non- resident, the required notice (Form 704) has been filed by the executors or administrators. Further weight is given to this contention by a con- sideration of the evident intent of Congress in its definition of the term "executor" (see Section 200 of Law). This definition was given with the sole purpose of providing effective means for the ascertainment and 406 INCOME AND FEDERAL TAX REPORTS collection of the tax due in every case where the com- plete facts might not be known to the executor or where the executor might be in a position successfully to evade his responsibilities under the Act. The object on the part of Congress in causing "any person who takes possession of any property of the de- cedent" to share equally with executors and adminis- trators the liability to render notice and return and to pay the tax, was that there should not be, under any circumstances of transmission, a failure of the admin- istrative power to secure a full disclosure of the facts and a complete satisfaction of the tax. Congress must have foreseen, in enacting the final paragraph of Sec- tion 202, 1 that without such an administrative require- ment as this the tax due, because of stock owned by a non-resident in domestic corporations, could be success- fully evaded. The definition of "executor" in Section 200 was made intentionally so broad that no property subject to the tax could escape taxation through any uncertainty as to the person liable for giving accurate information with regard thereto. In the case of a non-resident de- cedent, the appointment of a foreign executor or ad- ministrator will not relieve a person in control of property in the United States from these duties, unless and until he has made return and tendered payment of tax. DUTIES OF CORPORATIONS AND THEIR TRANSFER AGENTS, REGISTERS OF BONDS AND PAYING AGENTS Duties of corporate agents denned. The following is an extract from Treasury Decision 2490, defining the du- ties of corporate transfer agents, registers of bonds and paying agents, and of corporations performing these duties themselves: "(1) Where the transfer of stock or bonds or payment of dividends or interest theretofore the legal property of a decedent, whether a resident i Section 202, subdivision (c). FEDERAL INHERITANCE OR ESTATE TAX 407 or a non-resident, is made to or upon the order of an executor or administra- tor acting under letters granted in the United States, Hawaii, or Alaska, the corporate agent or officer will not be required to file the thirty-day notice, make return, or pay tax. "(2) The thirty-day notice (Form 714) is required to be filed whenever a corporation, its transfer agent, register, or paying agent is called upon to make a transfer of stocks or bonds, or to pay interest or dividends to any person succeeding in right thereto [of] a stockholder or bondholder who, since September 8, 1916, has died domiciled outside the United States, Hawaii, or Alaska, unless such successor in interest is an executor or ad- ministrator of the non-resident decedent acting under letters granted within the United States, Hawaii, or Alaska. "(3) This notice (Form 714) must be filed for dividends declared prior to the day of death and for interest payable after death to the extent of the portion accrued to the day of death. "(4) If this notice (Form 714) be filed as required either within thirty days from death or immediately upon receipt of the order for transfer or payment, the transfer or payment need not be postponed. The collector, immediately upon receipt of the notice, will communicate with the foreign executor or succeeding party in interest, advising [him] of the require- ments of the estate taxing act and furnishing blank Forms 706 for the making of the return. If, within the legal period, the tax is not paid, proceedings will be instituted under Section 208 of the taxing act for the sale of property and the satisfaction of the tax. "(5) This regulation is promulgated in view of present international conditions, and is subject to revocation should it be demonstrated that the accommodation herein made to corporations and their agents result in insecurity of the revenue.* This regulation is not to be construed in any degree as modifying the interpretation hitherto given by the department of the term "executor" as used in Section 200 of the act of September 8, 1916."2 It should be noted that where the notice on Form 714 has been filed and stock formerly owned by a non-resi- dent decedent has been transferred, that the lien for the tax can be enforced under provisions of Section 208 of the law whenever necessary to protect the Govern- i That is to say, the Treasury Department reserves the right to hold up the transfer until either (1) the tax due has been paid, or (2) ancillary letters have been taken out in the United States, or (3) provision has been made for the satisfaction of the tax lien resting upon the non-resident decedent's property in the United States. 2 In other words, the Treasury Department reserves the right, where necessary, to impose the duties and obligations of executors upon cor- porations and their transfer agents, registrars and paying agents, of filing the return and paying the tax. 408 INCOME AND FEDERAL TAX REPORTS ment, regardless of the possession of the stock by suc- ceeding owners. Purchasers who acquire stock for- merly registered in the name of a non-resident decedent may therefore find a lien for the amount of tax attached to their property if the stock was purchased from a person other than an ancillary executor or administra- tor. The purchaser may protect himself by insisting that the sellor first deposit with the collector such a sum as will fully satisfy the amount of tax, and, upon presentation of the collector's receipt, he may safely pay the purchase price of the stock. RETURNS General rules. Under the various sections of this chapter defining the duties of representatives of a de- cedent's estate it has been stated under what conditions a return (Form 706) is required. In this section will be given the general rules, regulations and instructions regarding the contents of the return and the manner of filing. Section 205 of the law provides that an executor shall file a return under oath, in duplicate, at such times and in such manner as may be required by the Commis- sioner of Internal Eevenue. As the tax is due and pay- able one year after the decedent's death, the Treasury Department requires the return to be filed on or before that date. A return is required of the estate of every resident decedent whose gross estate exceeds in value $60,000, or whose net estate has any value in excess of the specific exemption of $50,000. 1 A return is required of the estate of every non- resident decedent owning property in the United States, including stocks of domestic corporations, even though the certificates were physically located outside i For example: Gross estate $58,000, deductions $4,000, specific exemp- tion $50,000, net estate $4,000. In this estate a return should be filed. FEDERAL INHERITANCE OR ESTATE TAX 409 of the United States at the time of decedent's death. A return is also required if the decedent has at any- time transferred any property in contemplation of death. 1 Tentative and final returns. The logical time for filing the return is coincident with the final settlement of the estate (where this occurs before the expiration of one year from decedent's death), as at that time the values of the gross estate and items of deductions may be ac- curately determined. Where the administration of the estate is unduly delayed and it is desired to take ad- vantage of the discount allowed for prior payment of the tax, a tentative return will be accepted, provided reasonably accurate information is given of the gross estate, and of all items of deductions that have been actually determined (i. e., exclusive of estimated items). Where a tentative return has been filed within the year, a final return must, nevertheless, be made at the expi- ration of the year. If, at the expiration of the year, it is impossible to make the final return, the collector may, upon application, grant an extension not exceeding ninety days. If, at the expiration of ninety days, the cause for delay still exists and is unavoidable, the col- lector may extend the time for filing until the reason- able ground for delay has been removed. (T. D. 2637.) Distribution or sale of personal effects. As the Treas- ury Department desires to verify the accuracy of all returns, executors or other representatives of estates liable to tax are directed not to sell, dispose or dis- tribute any article of furniture, jewelry, works of art i Thus, if a non-resident decedent had assigned property to a resi- dent trustee, under a trust agreement, providing for the payment of the income thereon to him (the decedent) for life, and after his death, the property to revert to his estate, or be otherwise disposed of, a return should be made by the executor or representative of the decedent's estate. If the return is not made this duty devolves upon the resident trustee, who must also pay the tax. 410 INCOME AND FEDERAL TAX REPORTS and other personal effects until the value thereof has been verified by a government agent. Arrangement may be made with the collector to have this done promptly. Where to file. If the decedent maintained more than one residence, his principal residence (actual domicile) determines the internal revenue district in which the return must be filed and tax paid. If decedent was a non-resident and his sole property within the United States, Hawaii or Alaska was stocks or bonds of an American corporation, his return should be filed with the collector in whose district the head office of the corporation is located, unless the estate has a representative in the United States having the stocks or bonds in charge, in which case the return may be filed with the collector in whose district the represen- tative has his office. Description of real property. In describing realty it may not be necessary to recite the whole description on the deed, but sufficient data should be given in each case to permit an immediate and exact location by a Government officer. For example: "W. V25 se c - 2, tp. 20, Madison, 111." j or, "House and lot, 125, So. Main St., Auburn, N. Y." Accrued income. If accrued income has been reduced to cash prior to death and is included in "cash in bank" or otherwise accounted for on the return, it should not be set up in the income column. Gifts in contemplation of death. Under Item 2 there must be shown every gift or transfer of material value made or efifected by decedent within two years prior to day of death. With the return may be submitted such evidence as the estate elects to submit showing whether the gift or transfer was made in contemplation of death, and the question of taxability will be ruled upon by the Commissioner before the assessment against the estate is confirmed. Every gift or transfer made in con- FEDERAL INHERITANCE OR ESTATE TAX 41 1 templation of or intended to take effect at death must be returned, regardless of the date when made or effected. Valuation of stocks and bonds. The highest selling price of stocks and bonds on the day of death fixes the value to be returned ; or if no sale, then the highest bid price. If the stocks or bonds are not listed on the mar- ket, the executor may set up, from the best evidence he possesses, a value that he deems the true value as of the day of decedent's death. The Treasury Department has held that "the actual value of the real and personal estate of decedents on the date of death should be reported upon Form 706. The market value of securities as of the date of death is, of course, the proper value to be returned. If de- cedent died on Sunday or a legal holiday, the market value of the securities on the day preceding his death should be returned. In the absence of a sale on the date of death or day preceding, the highest bid price for the security in question is accepted as the market value. This, of course, refers to securities listed on a stock exchange or dealt in on the Curb. If the security whose market value is sought is not listed on a stock exchange or dealt in on the Curb, the fair market value may be computed from actual sales made during the year preceding the date of death. Sales to employees, sales for the purpose of qualifying directors or other officers, sales pursuant or subject to an agreement re- stricting the re-sale or free action of the purchaser and sales not made within one year preceding the date of death are not of a character that would justify their use in computing the value of corporate stock to the exclusion of any other evidence. If the stock is not listed on an exchange, and no record of any bona-fide sales has been made during the year preceding the date of decedent's death, the value of the stock should be computed upon the basis of the net profits of the cor- poration earned during the preceding five years. 412 INCOME AND FEDERAL TAX REPORTS "It has been found, upon examination of the returns of net income of a large number of different classes of corporations listed on an exchange, that they earn ap- proximately the following rates in order to make their stock worth par: Per cent Banking States west of the Mississippi River 8 States east of the Mississippi River 6 Mercantile 10 Mining 10 Industrial 10 Oil-producing companies 15 Oil-refining companies 10 Public utilities and railroads 8 "The value of corporate stock of corporations which have no regular earnings, such as companies organized for the purpose of developing and selling timber land, mining property and other real property, and corpora- tions which have earned no profits in the past five years, or have only been engaged in business one or two years, is not always determined from the earning capacity of the corporation. Therefore, the book value of such corporations is good evidence of the fair market value." Community property. 1 If the bulk of the estate is community property held in legal partnership by de- cedent and spouse, its value should not be shown under Item 4, but decedent's legal share should be returned under the several items, realty, stocks and bonds, and the like; otherwise the jointly owned property should be exactly described under Item 4. Deductions. No item of deductions can be taken in excess of an amount actually expended, or, if expended, in excess of the limit, if any, set upon such expenditure by the local laws under which the estate is being ad- ministered. i For the meaning of this term see footnote, page 390. FEDERAL INHERITANCE OR ESTATE TAX 413 Mortgages. Mortgages resting on decedent's property should be shown under "Deductions," and the full value of the mortgaged realty should be shown under Item 1 of "Gross estate." A similar rule must be applied with regard to hypothecated personalty. Losses. It should be noted that deductible losses are strictly limited to those arising from fires, storms, ship- wreck, or other casualty, and theft, when not compen- sated for, by insurance or otherwise. Losses sustained through sale or other disposition of property at less than the inventory value thereof at the date of de- cedent's death will not be allowed. Non-resident's estate. A non-resident's estate will show under items of the "Gross estate" only the gross es- tate within the United States, but will show under "Deductions" the entire legal deductions wherever in- curred. It will then show in the space subjoined to "Recapitulation" the whole gross estate wherever sit- uated and compute in accordance with Article XXIII of Regulations No. 37, revised May, 1917, the allowable share of total deductions. Discount allowed for payment of tax within one year. In order to compute the 5 per cent, per annum discount on estate tax paid within one year after the death of decedent, determine, first, the date when the payment will actually be placed in the collector's hands, then count the actual number of days from this day to and including the day when the tax is due. For example: Date of death, March 3, 1917, payment made Sept. 12, 1917; there would be 18 days remaining in September, October 31, November 30, December 31, January 31, February 28, and three days in March, 1918, the due date, making a total of 172 days for which discount is allowable. The discount on $1 for 172 days at 5 per cent is $0.0235616 (see table, page 415) ; multiply the gross tax by this amount, and the amount of discount will be the result. 414 INCOME AND FEDERAL TAX REPORTS (Extracts from T. D. 2497) Instructions, with Tables, Relating to the Computation of the 5 Per Centum Discount to be Allowed on Estate Tax When Paid Before One Year After the Death of Decedent. Treasury Department, Office of Commissioner of Internal Bevenue, Washington, D. C, June 4, 1917. To Collectors of Internal Eevenue: Numerous inquiries have been addressed to the bu- reau relative to the method of computing the 5 per cent, discount allowable on estate taxes where said taxes are paid in less than one year after the death of the decedent, as to accepting partial payments of estate taxes based on tentative returns. Tables showing the discount on $1 from 1 to 364 days have, therefore, been prepared and are hereto ap- pended. Collectors and others concerned in computing the discount should use these tables exclusively. Care should be taken to determine the number of days re- maining in the month during which payment is made and count forward actual days until due date. For ex- ample: Date of death, March 4, 1917, payment made September 13, 1917; there would be 17 days remaining in September, October 31, November 30, December 31, January 31, February 28, and four days in March, the due date, making a total of 172 days for which dis- count is allowable. Now, in computing the discount, find in the table the discount on $1 for 172 days and multiply the gross tax by this. The result will be the discount allowable, which, deducted from the full gross tax, will give the amount of tax on the date payment is made. Executors in computing discount will use as the date of payment the date when said payment will actually be placed in the collector's hands, as the statute fixes FEDERAL INHERITANCE OR ESTATE TAX 415 that as the date of payment regardless of the date of remittance or mailing. Frequently, executors will file a return and request the collector to advise them of the amount of tax due, less discount. In such cases, the collector should com- pute the discount to some future date, advising the executor of the amount necessary to satisfy the tax on the date named, making it clear that the computation is based on the presumption that the money will be in his (the collector's) hands on that date. Again, executors file a tentative return and ask per- mission to make a partial payment of the tax due, usu- ally specifying a certain amount, provided the discount on this amount is allowed. The department sees no objection to collectors ac- cepting such partial payments. Care should be taken, however, to compute the present worth of such pay- ments in order to determine how much of the tax is discharged. The computation in such case should be filed with the tentative return in order that when a complete or final return is filed the balance of the tax due can readily be determined. The present worth may readily be found by use of the table as follows: From $1 deduct the amount of discount on $1 from date of payment to due date. Divide the amount of tax paid by this remainder, and the quotient will be the present worth of the amount of tax liability discharged. For example, a partial payment of $300,000 is ten- dered 278 days before due date. By the table 5 per cent, discount on $1 for 278 days is found to be $0.0380821; $1 less $0.0380821 leaves $0.9619179; $300,- 000 divided by $0.9619179 equals $311,876.82, the pres- ent worth or the amount of tax liability discharged by the partial payment. David A. Gates, Acting Commissioner of Internal Revenue. 416 INCOME AND FEDERAL TAX REPORTS 5 PER CENT DISCOUNT ON $1, 1 DAY TO 364 DAYS Days Discount Days Discount Days Discount Days Discount 1 $0.0001369 50 $0.0068493 99 $0.0135616 148 $0.0202739 2 .0002739 51 .0069863 100 .01369S6 149 .0204109 3 .0004109 52 .0071232 101 .0138356 150 .0205479 4 .0005479 53 .0072602 102 .0139726 151 .0206849 5 .0006849 54 .0073972 103 .0141095 152 .0208219 6 .0008219 55 .0075342 104 .0142465 153 .0209589 7 .0009589 56 .0076712 105 .0143835 154 .0210958 8 .0010958 57 .0078082 106 .0145205 155 .0212328 9 .0012328 58 .0079452 107 .0146575 156 .0213698 10 .0013698 59 .0080821 108 .0147945 157 .0215068 11 .0015068 60 .0082191 109 .0149315 158 .0216438 12 .0016438 61 .0083561 110 .0150684 159 .0217808 13 .0017808 62 .0084931 111 .0152054 160 .0219178 14 .0019178 63 .0086301 112 .0153424 161 .0220547 15 .0020547 64 .0087671 113 .0154794 162 .0221917 16 .0021917 65 .0089041 114 .0156164 163 .0223287 17 .0023287 66 .0090410 115 .0157534 164 .0224657 18 .0024657 67 .0091780 116 .0158904 165 .0226027 19 .0026027 68 .0093150 117 .0160273 166 .0227397 20 .0027397 69 .0094520 118 .0161643 167 .0228767 21 .0028767 70 .0095890 119 .0163013 168 .0230136 22 .0030136 71 .0097260 120 .0164383 169 .0231506 23 .0031506 72 .0098630 121 .0165753 170 .0232876 24 .0032876 73 .0100000 122 .0167123 171 .0234246 25 .0034246 74 .0101369 123 .0168493 172 .0235616 26 .0035616 75 .0102739 124 .0169863 173 .0236986 27 .0036986 76 .0104109 125 .0171232 174 .0238356 28 .0038356 77 .0105479 126 .0172602 175 .0239726 29 .0039726 78 .0106849 127 .0173972 176 .0241095 30 .0041095 79 .0108219 128 .0175342 177 .0242465 31 .0042465 80 .0109589 129 .0176712 178 .0243835 32 .0043835 81 .0110958 130 .0178082 179 .0245205 33 .0045205 82 .0112328 131 .0179452 180 .0246575 34 .0046575 83 .0113698 132 .0180821 181 .0247945 35 .0047945 84 .0115068 133 .0182191 182 .0249315 36 .0049315 85 .0116438 134 .0183561 183 .0250684 37 .0050684 86 .0117808 135 .0184931 184 .0252054 38 .0052054 87 .0119178 136 .0186301 185 .0253424 39 .0053424 88 .0120547 137 .0187671 186 .0254794 40 .0054794 89 .0121917 138 .0189041 187 .0256164 41 .0056164 90 .0123287 139 .0190410 188 .0257534 42 .0057534 91 .0124657 140 .0191780 189 .0258904 43 .0058904 92 .0126027 141 .0193150 190 .0260273 44 .0060273 93 .0127397 142 .0194520 191 .0261643 45 .0061643 94 .0128767 143 .0195890 192 .0263013 46 .0063013 95 .0130136 144 .0197260 193 .0264383 47 .0064383 96 .0131506 145 .0198630 194 .0265753 48 .0065753 97 .0132876 146 .0200000 195 .0267123 49 .0067123 98 .0134246 147 .0201369 196 .0268493 FEDERAL INHERITANCE OR ESTATE TAX 417 5 PER CENT DISCOUNT ON $1, 1 DAY TO 364 DAYS Continued Days Discount Days Discount Days Discount Days Discount 197 S0.0269863 239 $0.0327397 281 $0.0384931 323 $0.0442465 198 .0271232 240 .0328767 282 .0386301 324 .0443835 199 .0272602 241 .0330136 283 .0387671 325 .0445205 200 .0273972 242 .0331506 284 .0389041 326 .0446575 201 .0275342 243 .0332876 285 .0390410 327 .0447945 202 .0276712 244 .0334246 286 .0391780 328 .0449315 203 .0278082 245 .0335616 287 .0393150 329 .0450684 204 .0279452 246 .0336986 288 .0394520 330 .0452054 205 .0280821 247 .0338356 289 .0395890 331 .0453424 206 .0282191 248 .0339726 290 .0397260 332 .0454794 207 .0283561 249 .0341095 291 .0398630 333 .0456164 208 .0284931 250 .0342465 292 .0400000 334 .0457534 209 .0286301 251 .0343835 293 .0401369 335 .0458904 210 .0287671 252 .0345205 294 .0402739 336 .0460273 211 .0289041 253 .0346575 295 .0404109 337 .0461643 212 .0290410 254 .0347945 296 .0405479 338 .0463013 213 .0291780 255 .0349315 297 .0406849 339 .0464383 214 .0293150 256 .0350684 298 .0408219 340 .0465753 215 .0294520 257 .0352054 299 .0409589 341 .0467123 216 .0295890 258 .0353424 300 .0410958 342 .0468493 217 .0297260 259 .0354794 301 .0412328 343 .0469863 218 .0298630 260 .0356164 302 .0413698 344 .0471232 219 .0300000 261 .0357534 303 .0415068 345 .0472602 220 .0301369 262 .0358904 304 .0416438 346 .0473972 221 .0302739 263 .0360273 305 .0417808 347 .0475342 222 .0304109 264 .0361643 306 .0419178 348 .0476712 223 .0305479 265 .0363013 307 .0420547 349 .0478082 224 .0306849 266 .0364383 308 .0421917 350 .0479452 225 .0308219 267 .0365753 309 .0423287 351 .0480821 226 .0309589 268 .0367123 310 .0424657 352 .0482191 227 .0310958 269 .0368493 311 .0426027 353 .0483561 228 .0312328 270 .0369863 312 .0427397 354 .0484931 229 .0313698 271 .0371232 313 .0428767 355 .0486301 230 .0315068 272 .0372602 314 .0430136 356 .0487671 231 .0316438 273 .0373972 315 .0431506 357 .0489041 232 .0317808 274 .0375342 316 .0432876 358 .0490410 233 .0319178 275 .0376712 317 .0434246 359 .0491780 234 .0320547 276 .0378082 318 .0435616 360 .0493150 235 .0321917 277 .0379452 319 .0436986 361 .0494520 236 .0323287 278 .0380821 320 .0438356 362 .0495890 237 .0324657 279 .0382191 321 .0439726 363 .0497260 238 .0326027 280 .0383561 322 .0441095 364 .0498630 Affidavit. In the affidavit show whether the return submitted is tentative or final, by crossing out the in- applicable word. 418 INCOME AND FEDERAL TAX REPORTS When return and payment of tax is due. The return and tax payment must be in the collector's hands before the year from the day of death has expired. Signature. The return should be signed and sworn to by all the executors. RATES OF TAX How tax rate is determined. The application of the rates given below depends upon the date of decedent's death. The rates specified in the original act, passed September 8, 1916, are computed upon the net estate of every decedent dying on and after September 9, 1916, to and including March 2, 1917; the rates pro- vided in the Amendment of March 3, 1917, apply to the net estate of every decedent dying on and after March 3, 1917, to and including October 3, 1917; and the rates provided in the Amendment of October 3, 1917, apply to the net estate of every decedent dying on and after October 4, 1917 (T. D. 2535). Exemptions. The Amendment of October 3, 1917, ex- empts from the additional tax imposed by Title 9 therein, the transfer of the net estate of any decedent dying while serving in the military or naval forces of the United States during the present war. If death results from injuries received or disease contracted in such service, within one year after the termination of the war, the same exemption applies. The effect of this exemption results in subjecting the net estates of mili- tary and naval decedents to rates imposed in the act of March 3, 1917. FEDERAL INHERITANCE OR ESTATE TAX 419 RATE OF TAXATION UPON NET ESTATES Date of Death Sept. 9, Mar. 3, On 1916, to 1917, to and Mar. 2, Oct. 3, After 1917, 1917, Oct. 4, Inclusive Inclusive 1917 Net estate Net estate Net estate Net estate Net estate Net estate Net estate Net estate Net estate Net estate Net estate Net estate not exceeding $50,000 150,000 250,000 450,000 1,000,000 2,000,000 3,000,000 4,000,000 5,000,000 8,000,000 exceeding $50,000 @ 150,000 @ 250,000 @ 450,000 @ 1,000,000 @ 2,000,000 @ 3,000,000 @ 4,000,000 @ 5,000,000 @ 8,000,000 @ 10,000,000 @ 10,000,000 @ 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% 10% 10% m% 3% 4^% 6% 73^% 9% 10K% 12% 133^% 15% 15% 15% 2% 4% 6% 8% 10% 12% 14% 16% 18% 20% fg 25% PAYMENT OF TAX Conditions relating to tax payment. The amount of the tax is based on the return (Form 706). The tax is due and payable one year after the decedent's death. If the tax is not paid within ninety days thereafter, in- terest is added at the rate of 10 per cent, per annum from the time of decedent's death, unless, because of claims against the estate, necessary litigation or other unavoidable delay, the collector finds that the tax can- not be determined, in which case interest is added at the rate of 6 per cent, per annum from the time of decedent's death nntil the cause for delay is removed, and thereafter at the rate of 10 per cent, per annum. Procedure in collection when no return has been filed. If, at the expiration of ninety days after one year from decedent's death, no complete and final return has been made, the collector will require a return to be made in such manner that the tax shown to be due thereon will satisfy, in the collector's opinion, all the tax the estate will be required by law to pay. If the amount of tax 420 INCOME AND FEDERAL TAX REPORTS paid exceeds the amount of tax as finally determined, the Commissioner will refund the excess. If the amount paid is less than the amount finally determined, the Commissioner will notify the executor of the amount of such excess, and interest will be added from the time of notification to the date of payment at the rate of 10 per cent per annum. Discount for prepayment. If the tax is paid before it is due (one year after decedent's death) a discount may be deducted at the rate of 5 per cent, per annum calcu- lated from the time the payment is made (i. e., when actually received by the collector) to the date when the tax is due. Advance payment of tax in an estimated lump amount will not be accepted. The initial tax payment must be based upon a return (either tentative or final) (see "re- turns," page 408 of this chapter), showing reasonably complete and accurate figures for every item of gross estate and deductions. Suit for collection of tax. As stated above, the tax is due one year after decedent's death, and if not paid within ninety days thereafter interest will be added from the day of decedent's death. If, however, the tax is not paid within 60 days after it is due, the collector shall, unless there is reasonable cause for further de- lay, bring suit for collection, and, upon decree, sell the property and satisfy the tax and expenses. Tax is a lien upon estate. The tax shown to be due upon a final return is a lien for ten years, or until sooner paid, upon the entire gross estate, except such part as is used for the payment of charges and expenses of administration. The lien follows the property into the hands of distributees and bona fide purchasers for value. If, after the tax has been paid upon a return and accepted by the commissioner as final, it later ap- pears that an additional tax is due, the lien for the additional tax rests upon the property in the hands of FEDERAL INHERITANCE OR ESTATE TAX 421 decedent's executors or beneficiaries, and does not rest upon any part of decedent's property which may have been sold to a bona fide purchaser. A lien for the amount of the tax rests also upon the value of testator's interest in any property transferred by him in trust at any time to a trustee in contempla- tion of death. PENALTIES Penalty for neglect. Any executor, administrator, beneficiary, heir, donee, transferee, trustee, fiduciary, banking institution, safe deposit company, paying agent, transfer agent, register, or other agent or representa- tive of a decedent's estate who shall fail to file the no- tice (Forms 704, 705 and 714, as the case may be), or the return (Form 706), when required, shall be liable to a fine not to exceed $500, to be recovered, with costs of suit, in a civil action in the name of the United States. A similar penalty is likewise imposed upon anyone refusing to exhibit any record, file or paper containing or supposed to contain information concern- ing a decedent's estate upon the request of the commis- sioner, or his duly authorized agent. Penalty for fraud. Anyone knowingly making a false statement in any notice or return required to be filed shall be liable to a penalty of not exceeding $5,000, or imprisonment not exceeding one year, or both, in the discretion of the court. CHAPTER XVII ESTATE TAX LAW BEING TITLE II OF "AN ACT TO INCREASE THE REVENUE AND FOR OTHER PURPOSES," AP- PROVED SEPTEMBER 8, 1916 (PUBLIC No. 271 64th CONGRESS) IN EFFECT SEPTEMBER 9, 1916 TITLE II. ESTATE TAX. Definition. Sec. 200. That when used in this title The term "person" includes partnerships, corpora- tions, and associations; The term "United States" means only the States, the Territories of Alaska and Hawaii, and the District of Columbia ; The term "executor" means the executor or admin- istrator of the decedent, or, if there is no executor or administrator, any person who takes possession of any property of the decedent; and The term "collector" means the collector of internal revenue of the district in which was the domicile of the decedent at the time of his death, or, if there was no such domicile in the United States, then the collector of the district in which is situated the part of the grost estate of the decedent in the United States, or, if such part of the gross estate is situated in more than one district, then the collector of internal revenue at Balti- more, Maryland. 422 ESTATE TAX LAW 423 Rate of tax. Sec. 201. That a tax (hereinafter in this title referred to as the tax), equal to the following percentages of the value of the net estate, to be deter- mined as provided in section two hundred and three, is hereby imposed upon the transfer of the net estate of every decedent dying after the passage of this Act, whether a resident or non-resident of the United States : One per centum of the amount of such net estate not in excess of $50,000; Two per centum of the amount by which such net estate exceeds $50,000 and does not exceed $150,000; Three per centum of the amount by which such net estate exceeds $150,000 and does not exceed $250,000; Four per centum of the amount by which such net estate exceeds $250,000 and does not exceed $450,000; Five per centum of the amount by which such net estate exceeds $450,000 and does not exceed $1,000,000; Six per centum of the amount by which such net estate exceeds $1,000,000 and does not exceed $2,000,000 ; Seven per centum of the amount by which such net estate exceeds $2,000,000 and does not exceed $3,000,000 ; Eight per centum of the amount by which such net estate exceeds $3,000,000 and does not exceed $4,000,000 ; Nine per centum of the amount by which such net estate exceeds $4,000,000 and does not exceed $5,000,000 ; and Ten per centum of the amount by which such net estate exceeds $5,000,000. Valuation of gross estate. Sec. 202. That the value of the gross estate of the decedent shall be determined by including the value at the time of his death of all prop- erty, real or personal, tangible or intangible, wherever situated : (a) To the extent of the interest therein of the de- cedent at the time of his death which after his death is subject to the payment of the charges against his 424 INCOME AND FEDERAL TAX REPORTS estate and the expenses of its administration and is subject to distribution as part of his estate. Transfers of property made in contemplation of death. (b) To the extent of any interest therein of which the decedent has at any time made a transfer, or with re- spect to which he has created a trust, in contemplation of or intended to take effect in possession or enjoyment at or after his death, except in case of a bona fide sale for a fair consideration in money or money's worth. Any transfer of a material part of his property in the na- ture of a final disposition or distribution thereof, made by the decedent within two years prior to his death without such a consideration, shall, unless shown to the contrary, be deemed to have been made in contempla- tion of death within the meaning of this title; and Joint interests held by decedent and others. (c) To the extent of the interest therein held jointly or as tenants in the entirety by the decedent and any other person, or deposited in banks or other institutions in their joint names and payable to either or the survivor; except such part thereof as may be shown to have origi- nally belonged to such other person and never to have belonged to the decedent. Disposition of stock in domestic corporations owned by decedent. For the purpose of this title stock in a domestic corporation owned and held by a non-resident decedent shall be deemed property within the United States, and any property of which the decedent has made a transfer or with respect to which he has created a trust, within the meaning of subdivision (b) of this section, shall be deemed to be situated in the United States, if so situated either at the time of the transfer or the creation of the trust, or at the time of the dece- dent's death. Valuation of net estate. Sec. 203. That for the pur- pose of the tax the value of the net estate shall be determined ESTATE TAX LAW 425 (a) In the case of a resident, by deducting from the value of the gross estate (1) Such amounts for funeral expenses, administra- tion expenses, claims against the estate, unpaid mort- gages, losses incurred during the settlement of the estate arising from fires, storms, shipwreck, or other casualty, and from theft, when such losses are not compensated for by insurance or otherwise, support during the settlement of the estate of those dependent upon the decedent, and such other charges against the estate, as are allowed by the laws of the jurisdiction, whether within or without the United States, under which the estate is being administered; and (2) An exemption of $50,000; (b) In the case of a non-resident, by deducting from the value of that part of his gross estate which at the time of his death is situated in the United States that proportion of the deductions specified in paragraph (1) of subdivision (a) of this section which the value of such part bears to the value of his entire gross estate, wherever situated. But no deductions shall be allowed in the case of a non-resident unless the executor includes in the return required to be filed under section two hundred and five the value at the time of his death of that part of the gross estate of the non-resident not situated in the United States. Date tax becomes due. Sec. 204. That the tax shall be due one year after the decedent's death. If the tax is paid before it is due a discount at the rate of five per centum per annum, calculated from the time pay- ment is made to the date when the tax is due, shall be deducted. If the tax is not paid within ninety days after it is due interest at the rate of ten per centum per annum from the time of the decedent's death shall be added as part of the tax, unless because of claims against the estate, necessary litigation, or other un- avoidable delay the collector finds that the tax can not 426 INCOME AND FEDERAL TAX REPORTS be determined, in which case the interest shall be at the rate of six per centum per annum from the time of the decedent's death until the cause of such delay is removed, and thereafter at the rate of ten per centum per annum. Litigation to defeat the payment of the tax shall not be deemed necessary litigation. Executor to qualify and file return. Sec. 205. That the executor, within thirty days after qualifying as such, or after coming into possession of any property of the decedent, whichever event first occurs, shall give written notice thereof to the collector. The executor shall also, at such times and in such manner as may be required by the regulations made under this title, file with the collector a return under oath in duplicate, setting forth (a) the value of the gross estate of the decedent at the time of his death, or, in case of a non-resident, of that part of his gross estate situated in the United States; (b) the deductions allowed under section two hundred and three; (c) the value of the net estate of the decedent as defined in section two hundred and three; and (d) the tax paid or pay- able thereon; or such part of such information as may at the time be ascertainable and such supplemental data as may be necessary to establish the correct tax. Return shall be made in all cases of estates subject to the tax or where the gross estate at the death of the decedent exceeds $60,000, and in the case of the estate of every non-resident any part of whose gross estate is situated in the United States. If the executor is unable to make a complete return as to any part of the gross estate of the decedent, he shall include in his return a description of such part and the name of every person holding a legal or beneficial interest therein, and upon notice from the collector such person shall in like manner make a return as to such part of the gross estate. The Commissioner of Internal Revenue shall make all assessments of the tax under the author- ESTATE TAX LAW 427 ity of existing administrative special and general pro- visions of law relating to the assessment and collection of taxes. Cases in which collector shall make return. Sec. 206. That if no administration is granted upon the estate of a decedent, or if no return is filed as provided in section two hundred and five, or if a return contains a false or incorrect statement of a material fact, the collector or deputy collector shall make a return and the Commissioner of Internal Kevenue shall assess the tax thereon. Procedure in tax payment. Sec. 207. That the execu- tor shall pay the tax to the collector or deputy collec- tor. If for any reason the amount of the tax can not be determined, the payment of a sum of money suffi- cient, in the opinion of the collector, to discharge the tax shall be deemed payment in full of the tax, except as in this section otherwise provided. If the amount so paid exceeds the amount of the tax as finally deter- mined, the Commissioner of Internal Revenue shall refund such excess to the executor. If the amount of the tax as finally determined exceeds the amount so paid the commissioner shall notify the executor of the amount of such excess. From the time of such notification to the time of the final payment of such excess part of the tax, interest shall be added thereto at the rate of ten per centum per annum, and the amount of such excess shall be a lien upon the entire gross estate, except such part thereof as may have been sold to a bona fide purchaser for a fair consid- eration in money or money's worth. The collector shall grant to the person paying the tax duplicate receipts, either of which shall be sufficient evidence of such payment, and shall entitle the execu tor to be credited and allowed the amount thereof by any court having jurisdiction to audit or settle his accounts. 428 INCOME AND FEDERAL TAX REPORTS Collection by sale of property in case of default. Sec. 208. That if the tax herein imposed is not paid within sixty days after it is due, the collector shall, unless there is reasonable cause for further delay, com- mence appropriate proceedings in any court of the United States, in the name of the United States, to subject the property of the decedent to be sold under the judgment or decree of the court. Prom the proceeds of such sale the amount of the tax. together with the costs and expenses of every descrip- tion to be allowed by the court, shall be first paid, and the balance shall be deposited according to the order of the court, to be paid under its direction to the person entitled thereto. If the tax or any part thereof is paid by, or collected out of that part of the estate passing to or in the possession of, any person other than the execu- tor in his capacity as such, such person shall be en- titled to reimbursement out of any part of the estate still undistributed or by a just and equitable contribu- tion by the persons whose interest in the estate of the decedent would have been reduced if the tax had been paid before the distribution of the estate or whose in- terest is subject to equal or prior liability for the pay- ment of taxes, debts, or other charges against the estate, it being the purpose and intent of this title that so far as is practicable and unless otherwise directed by the will of the decedent the tax shall be paid out of the estate before its distribution. Tax is a lien against decedent's gross estate. Sec. 209. That unless the tax is sooner paid in full, it shall be a lien for ten years upon the gross estate of the decedent, except that such part of the gross estate as is used for the payment of charges against the estate and expenses of its administration, allowed by any court having juris- diction thereof, shall be divested of such lien. If the decedent makes a transfer of, or creates a trust with respect to, any property in contemplation of or in- ESTATE TAX I, AW 429 tended to take effect in possession or enjoyment at or after his death (except in the case of a bona fide sale for a fair consideration in money or money's worth) and if the tax in respect thereto is not paid when due, the transferee or trustee shall be personally liable for such tax, and such property, to the extent of the decedent's interest therein at the time of such transfer, shall be subject to a like lien equal to the amount of such tax. Any part of such property sold by such transferee or trustee to a bona fide purchaser for a fair consideration in money or money's worth shall be divested of the lien and a like lien shall then attach to all the property of such transferee or trustee, except any part sold to a bona fide purchaser for a fair consideration in money or money's worth. Penalties for false statement and for withholding infor- mation. Sec. 210. That whoever knowingly makes any false statement in any notice or return required to be filed by this title shall be liable to a penalty of not ex- ceeding $5,000, or imprisonment not exceeding one year, or both, in the discretion of the court. Whoever fails to comply with any duty imposed upon him by section two hundred and five, or, having in his possession or control any record, file, or paper, contain- ing or supposed to contain any information concerning the estate of the decedent, fails to exhibit the same upon request to the Commissioner of Internal Eevenue or any collector or law officer of the United States, or his duly authorized deputy or agent, who desires to examine the same in the performance of his duties under this title, shall be liable to a penalty of not exceeding $500, to be recovered, with costs of suit, in a civil action in the name of the United States. Administration of law. Sec. 211. That all administra- tive, special, and general provisions of law, including the laws in relation to the assessment and collection of taxes, not heretofore specifically repealed are hereby 430 INCOME AND FEDERAL TAX REPORTS made to apply to this title so far as applicable and not inconsistent with its provisions. Sec. 212. That the Commissioner of Internal Reve- nue, with the approval of the Secretary of the Treas- ury, shall make such regulations, and prescribe and re- quire the use of such books and forms, as he may deem necessary to carry out the provisions of this title. TITLE IX. Invalidating clause. Sec. 900. That if any clause, sentence, paragraph, or part of this Act shall for any reason be adjudged by any court of competent jurisdic- tion to be invalid, such judgment shall not affect, im- pair, or invalidate the remainder of said Act, but shall be confined in its operation to the clause, sentence, para- graph, or part thereof directly involved in the contro versy in which such judgment shall have been rendered. When Act takes effect conflicting Acts repealed. Sec. 902. That unless otherwise herein specially provided this Act shall take effect on the day following its pas- sage, and all provisions of any Act or Acts inconsistent with the provisions of this Act, are hereby repealed. Approved by the President, September 8, 1916. TITLE IX. WAR ESTATE TAX. 1 Rate of tax upon transfer of decedent's estate. Sec. 900 [of the general revenue Act of which this Title is a part]. That in addition to the tax imposed by section two hundred and one of the Act entitled "An Act to in- crease the revenue, and for other purposes," approved September eighth, nineteen hundred and sixteen, as amended. i War Estate Tax. Being Title IX of "An Act to Provide Revenue to Defray War Expenses and for other Purposes," Approved October 3, 1917. (Public No. 50 65th Congress.) In effect October 4, 1917, unless other- wise specially provided. ESTATE TAX LAW 431 (a) A tax equal to the following percentages of its value is hereby imposed upon the transfer of each net estate of every decedent dying after the passage of this Act, the transfer of which is taxable under such section (the value of such net estate to be determined as pro- vided in Title II of such Act of September eighth, nine- teen hundred and sixteen) : One-half of one per centum of the amount of such net estate not in excess of $50,000; One per centum of the amount by which such net estate exceeds $50,000 and does not exceed $150,000; One and one-half per centum of the amount by which such net estate exceeds $150,000 and does not exceed $250,000; Two per centum of the amount by which such net estate exceeds $250,000 and does not exceed $450,000; Two and one-hali per centum of the amount by which such net estate exceeds $450,000 and does not exceed $1,000,000; Three per centum of the amount by which such net estate exceeds $1,000,000 and does not exceed $2,000,000 ; Three and one-half per centum of the amount by which such net estate exceeds $2,000,000 and does not exceed $3,000,000; Four per centum of the amount by which such net estate exceeds $3,000,000 and does not exceed $4,000,000 ; Four and one-half per centum of the amount by which such net estate exceeds $4,000,000 and does not exceed $5,000,000; Five per centum of the amount by which such net estate exceeds $5,000,000 and does not exceed $8,000,000 ; Seven per centum of the amount by which such net estate exceeds $8,000,000 and does not exceed $10,000,- 000; and Ten per centum of the amount by which such net estate exceeds $10,000,000. 432 INCOME AND FEDERAL TAX REPORTS Estate of soldiers and marines exempt. Sec. 901. That the tax imposed by this title shall not apply to the transfer of the net estate of any decedent dying while serving in the military or naval forces of the United States, during the continuance of the war in which the United States is now engaged, or if death results from injuries received or disease contracted in such service, within one year after the termination of such war. For the purposes of this section the termination of the war shall be evidenced by the proclamation of the President. Approved by the President, October 3, 1917. Taxability of United States Bonds, Treasury Certificates of Indebtedness and War Saving Certificates Issued Under Authority of Act of September 24, 1917. TITLE III. ESTATE TAX. 1 Sec. 300 [of the general revenue Act of which this Title is a part]. That section two hundred and one, Title II, of the Act entitled "An Act to increase the rev- enue, and for other purposes," approved September eighth, nineteen hundred and sixteen, be, and the same is hereby, amended to read as follows: "Sec. 201. That a tax (hereinafter in this title re- ferred to as the tax), equal to the following percentages of the value of the net estate, to be determined as pro- vided in section two hundred and three, is hereby im- posed upon the transfer of the net estate of every de- cedent dying after the passage of this Act, whether a resident or non-resident of the United States : "One and one-half per centum of the amount of such net estate not in excess of $50,000 ; i Amendment Number I. Being Title III of "An Act to Provide Increased Revenue to Defray the Expenses of the Increased Appropriations for the Army and Navy and the Extensions of Fortifications, and for Other Pur- poses," Approved March 3, 1917. (Public No. 377 64th Congress.) In effect March 3, 1917. ESTATE TAX LAW 433 "Three per centum of the amount by which such net estate exceeds $50,000 and does not exceed $150,000; "Four and one-half per centum of the amount by which such net estate exceeds $150,000 and does not ex- ceed $250,000; "Six per centum of the amount by which such net estate exceeds $250,000 and does not exceed $450,000; "Seven and one-half per centum of the amount by which such net estate exceeds $450,000 and does not ex- ceed $1,000,000; "Nine per centum of the amount by which such net estate exceeds $1,000,000 and does not exceed $2,000,000 ; "Ten and one-half per centum of the amount by which such net estate exceeds $2,000,000 and does not exceed $3,000,000; "Twelve per centum of the amount by which such net estate exceeds $3,000,000 and does not exceed $4,000,000 ; "Thirteen and one-half per centum of the amount by which such net estate exceeds $4,000,000 and does not exceed $5,000,000; and "Fifteen per centum of the amount by which such net estate exceeds $5,000,000." Sec. 301. That the tax on the transfer of the net estate of decedents dying between September eighth, nineteen hundred and sixteen, and the passage of this Act shall be computed at the rates originally prescribed in the Act approved September eighth, nineteen hundred and sixteen. Approved by the President, March 3, 1917. CHAPTER XVU1 MUNITION MANUFACTURER'S TAX Origin of Munition Manufacturer's Tax. The Munition Manufacturer's Tax is Title III of "An Act to In- crease the Revenue and for Other Purposes," ap- proved September 8, 1916. Its original purpose was to place an excise tax on the profits derived from the manufacture and sale of certain munitions and muni- tions parts manufactured in the United States and sold to foreign governments. A ruling has been made, however, that the tax applies also to profits from the manufacture and sale of munitions sold to the United States or to any other purchaser for other than industrial purposes. Time during which law is effective. The law became effective September 9, 1916, but was retroactive to January 1, 1916, the first taxable year being the twelve months ended December 31, 1916. It was provided (section 301, subdivision [2]) that the tax should cease to be of effect one year after the termination of the present European war, but this provision was changed by an amendment inserted in the Act of October 3, 1917, which specifies January 1, 1918, as the date upon which the tax shall terminate. Manufacturer pays the tax. The tax is to be paid by every person manufacturing within the United States any of the articles enumerated in section 301, "per- son" including, under Title III, partnerships, corpora- tions and associations, and "United States" meaning only the States, the Territories of Alaska and Hawaii and the District of Columbia. It is to be noted that 434 MUNITION MANUFACTURER'S TAX 435 the tax is only upon the manufacturer or his agent and not upon dealers or brokers unless they are agents of the manufacturer, since the tax on any article is payable only once. In the case of a business which ceases during a cal- endar year, the tax will be assessed against the per- son who owned or carried on the business at the time it ceased, or against his agent, if he had an agent, carrying on the business. In either case the person against whom the tax is assessed will be held liable for its payment and to any penalties that may attach to his failure to comply with the provisions of the law. Assemblage of parts is construed as manufacture. The Commissioner of Internal Revenue, in a letter dated January 18, 1917, holds that a manufacturer of muni- tions, under the Munitions Tax Law, includes one who collects the parts, whether complete or partially com- plete, and, by assembling such parts, constructs a fin- ished and completed article ready for use, and that the net profits from the sale by him of the munitions so manufactured will be subject to the tax imposed by this title. Basis of the tax. The basis of the tax is the entire net profits actually received and accrued from the sale or disposition of such articles manufactured within the United States from January 1, 1916, to January 1, 1918. Profits received subsequently on contracts com- pleted before January 1, 1916, are not included. In the ease of contracts only partially performed at that date, the tax attaches upon all the profits resulting from such contract received after January 1, 1916. Rate of tax. The rate of tax under the original Act was 12y 2 per cent, which rate applied in 1916. The rate for the tax collectible on profits returned in 1917, however, is 10 per cent, as provided in the amendment of October 3, 1917. The changes in the law, reducing the rate and pro- 436 INCOME AND FEDERAL TAX REPORTS viding for the termination of the tax January 1, 1918, were made as a result of (1) the new conditions due to the participation of the United States in the war and (2) the imposition of the War Excess Profits Tax. Computation of Tax. From the foregoing general summary it will be seen that the tax is a given per- centage of net profits derived from the manufacture and sale of certain articles during a specified period of time. The problem of computing the tax due in any specific case, accordingly, resolves itself into a deter- mination of (1) what articles are taxable; (2) what deductions may be allowed from gross income received from the manufacture and sale of those articles in order to ascertain the taxable net profits and (3) what rate of tax applies during the period in which they were produced and sold, together with a determina- tion of the actual time at which a contract has been completed and the profits therefrom accordingly (1) exempt, (2) subject to 12y 2 per cent tax (3) 10 per cent tax, or again exempt, due to the expiration of the taxable period, which ends January 1, 1918. These separate phases of the problem of computing the actual amount of tax payable will be considered in the following pages of this chapter. Articles the net profit derived from the manufacture and sale of which is taxable. The articles enumerated in section 301, the net profit derived from the manu- facture and sale or disposition of which is taxable, will hereafter, for convenience, be referred to as "tax- able articles," and "exempt" will mean that the manu- facturer of such articles will not be held liable for the tax. In the following sections, the above referred to "taxable articles" will be defined where necessary and such information given concerning them as will enable the manufacturer of the same or a similar article to determine whether or not he is liable for the payment of a munition manufacturer's tax. MUNITION MANUFACTURER'S TAX 437 Eeferences given herein, as "Art. 14" below, are to articles of Treasury Department Kegulations 39. Exemption of articles made for industrial purposes. Articles enumerated in (a) and (b) of Section 301, and otherwise taxable, are exempt if used for an indus- trial purpose. Articles sold to the general trade, for sporting purposes, commercial purposes, or other pur- poses not strictly industrial, are not exempt. "Used for industrial purposes" means "used in connection with or in the promotion of some industry." (Art. 14.) Definition of "part." "Parts" of taxable articles are also taxable under Section 301. A part so taxable is any article relatively complete within itself and de- signed or manufactured for the special purpose of being used as a component part of a completed muni- tion, and which, by reason of some peculiar charac- teristic, loses its identity as a commercial commodity, and which, without further treatment, cannot be used for any purpose other than that for which it was designed. A stock or commercial commodity, purchasable in the general trade or in the open market, if adapted for use in the manufacture of a munition, is not a "part" within the meaning of Section 301, and will be treated as raw material, provided that such com- modities ordinarily classed as commercial are "parts" within the meaning of the law if manufactured specially for and sold to a manufacturer to be by him incorpo- rated in and made an essential part of any munitions enumerated in section 301. (Art. 13.) The opinion has been given by the Commissioner of Internal Eevenue that the mere ordering of parts from the manufacturer for use in making munitions does not constitute those parts so ordered taxable, unless they are ordered specifically for and manufactured pursuant to certain specifications given by the munitions manu- facturer. 438 INCOME AND FEDERAL TAX REPORTS Repairs not taxable. Manufacturers who make repairs on munitions either for the United States Government or as regular commercial work will not be subject to the munitions tax, provided the repairs are bona fide repairs and do not involve the manufacture and sale of a completed part of a munition. Expense in such repairs for labor, material, etc., must be eliminated as a deduction in the return, since the profit is not con- sidered income for the purpose of the tax. Explosives. Gunpowder and other explosives are tax- able, excepting blasting powder and dynamite used for industrial (not commercial or sporting) purposes. Cartridges. Cartridges, loaded and unloaded, caps or primers, are included, except those used for industrial (not commercial or sporting) purposes. Projectiles. Projectiles include any and all missiles to be projected from a gun, cannon, mortar or other firearm, and will include bullets, balls, shot and other missiles. (Art. 2.) All projectiles are taxable. Shells or torpedoes. Shells or torpedoes include any receptacle and charge combined. (Art. 2.) All are taxable. Firearms. Firearms of any kind and appendages, including small arms, cannon, machine guns, rifles, and bayonets, are included, with no exceptions what- ever. Appendages. Appendages include those adjuncts or accessories appended to firearms not a part of them, but which facilitate their use, such as straps, belts, scabbards, shields, holsters or other appurtenances com- mon to such firearms. (Art. 2.) Profits derived from original manufacture and sale of "appendages" are, of course, taxable. If a manufacturer purchases such appendages and sells them in connection with a firearm which he him- self manufactures, as a complete unit, e. g., pistol and holster, the entire profit he makes is taxable. If, how- MUNITION MANUFACTURER'S TAX 439 ever, he sells the purchased appendage as a separate unit, not in connection with any firearm, he is consid- ered a dealer, and the profit he may make on the sale of the appendage is not taxable. The cost of purchased appendages or other equip- ment sold with the completed munition is a proper deduction in ascertaining net profits. Appendages only partially manufactured will be con- sidered as raw material to the manufacturer who pur- chases them; the cost is deductible and the profits made upon completion and sale, either with a firearm or separately from it, are taxable. Electric motor boats. Electric motor boats are those boats, regardless of size or character of construction, which are propelled by electric power. All such boats are included under the munitions tax, no matter for what purpose they may be used. Submarines. Submarine or submersible vessels in- clude all craft, no matter how propelled, manufac- tured for the purpose of being at will submerged be- neath the surface of the water. All are taxable. Motors and generators manufactured specifically for application in submarines are "parts" within the mean- ing of the law, and the profits derived by the manufac- turer upon their sale and disposition are taxable. Motors and generators which are not constructed by the manufacturer specifically for and according to specifications furnished by the submarine builder, but are merely sold by him from stock upon receipt of an order from the builder, do not come within the definition of munitions "parts," and the manufacturer in such a case is not liable to the munitions tax. Aeroplanes are not "munitions." Although aeroplanes have become identified with the machinery by means of which war is conducted, almost to the exclusion of any other purpose, they are not included as munitions under the law, and are therefore not taxable, since 440 INCOME AND FEDERAL TAX REPORTS the tax applies only to profits resulting from the manu- facture and sale of the articles specifically mentioned. Ascertainment of net or taxable income. As has been made clear in the foregoing pages, the tax attaches only to net income derived from the manufacture and sale of the articles classed as munitions and enumer- ated and described hereinbefore. In order to ascertain the income which is so taxable, it is necessary to find the gross income received or accrued from the manu- facture and sale of munitions, and to subtract from the amount of this gross income the various amounts which are allowed as deductions. The remainder will be the net taxable income. First we must see what is comprised in the term "gross income" for the pur- poses of the Munitions Tax Law. Gross income denned. The gross income contemplated by Title III, and to be reported in the return for the purpose of the munitions tax, is the gross amount re- ceived by, or accrued to a taxable person during the calendar year, from the sale or disposition of articles named in section 301, Title III, of the Act of Septem- ber 8, 1916, with the exemptions previously noted (ex- plosives, etc., used for industrial purposes and con- tracts performed prior to January 1, 1916). It must be noted with regard to the paragraph in Art. 10, Eeg. 39, which reads as follows: "If, how- ever, the contracts were not fully performed prior to January 1, 1916, any profits resulting from that part of the contracts performed subsequent to January 1, 1916, must be returned for the purpose of this tax," that while this seems to imply that only receipts from the parts of such contracts fulfilled subsequent to Jan- uary 1, 1916, are taxable, and that deferred payments received for such portions of such contracts as had been completed prior to January 1, 1916, are exempt, such an interpretation is not intended, and it is now held that any and all receipts resulting from such MUNITION MANUFACTURER'S TAX 441 partly completed contracts, if received after January 1, 1916, are taxable. The paragraph in question wrongly interpreted the clause of section 301, which clause provides for the exemption of payments re- ceived only from contracts which the manufacturer had fulfilled in toto, for his part, but for which he had not yet received the money which was due him. "In so far as the paragraph in Article II, Regula- tions 39, implies that any profits which accrued in de- liveries made in 1915 under contracts not fully per- formed prior to January 1, 1916, and which profits were received subsequent to that date, should not be returned as taxable income when received, it is erro- neous, and is hereby annulled. "The tax being imposed upon net profits received or accrued, the revised ruling as hereinbefore set out, contemplates that all net profits received subsequent to January 1, 1916, on contracts not then fully per- formed must be returned as taxable profits of the year in which received, regardless of when they may have been earned or accrued. "Hence net profits received subsequent to January 1, 1916, on deliveries made under contracts which were but partially performed at that date, constitute taxable income of the year in which received, and cannot law- fully be excluded therefrom." (T. D. 2458.) In this connection also it must be remembered that sales the receipts from which are to be counted as gross income must have been made at a fair market price; that is, the articles must not have been sold at less than the market price for the benefit of an individual or for any other purpose. In case a sale has been so made at less than a fair market price the amount of the proceeds of such sale for the purpose of the tax will be considered as being the amount that would have been received if the articles had been sold at a fair market price. 442 INCOME AND FEDERAL TAX REPORTS Deductions allowed from gross income. In order to as- certain the net income, from the gross income as above denned the following deductions will be made: (a) cost of raw materials ; (b) running or general expenses ; (c) part cost of new buildings, machinery and equip- ment; (d) interest; (e) taxes; (f) losses; (g) depreci- ation; (h) amortization. These will be denned in the following paragraphs, it being borne in mind that each is to be thought of as included under the title of this paragraph deductions allowed from gross income. Cost of raw materials. It will be remembered that munitions under section 301 are (a) completed articles and (b) parts, which have been denned hereinbefore. Raw materials, used in the manufacture of parts, are held to be any crude or elemental products or sub- stances necessary to the manufacture of such parts, and which, without the application of skill or science cannot become component parts or elements in the finished article or unit. As applied to the manufac- ture of a completed munition, raw materials will in- clude not only such crude products and elemental sub- stances, but all essential finished or unfinished parts as well. The cost of raw material authorized as a deduction, is the cost of raw materials as here de- fined, which materials are actually used in the manu- facture of munitions. Care must be taken to exclude from deduction for cost of raw materials the cost of such raw materials as are used, for example, in an- other department of the business, which is not de- voted to the making of munitions. In other words, the only deduction to be made from gross income on ac- count of the cost of raw materials is the cost of such materials as are actually used in the manufacture of the articles, the profit on the sale or disposition of which is subject to the munition manufacturer's tax. It is not permitted to charge an increase over the actual manufacturing or purchase cost of raw materials MUNITION MANUFACTURER'S TAX 443 because of the fact that at some time during the proc- ess of manufacture the market price of such material was such that it could have been disposed of at a profit. The Department holds that the fact that the manufacturer in such a case preferred not to sell the raw materials, but to continue the process of manufac- turing it into a completed munition, in the hope of receiving the equivalent of such increased price in the ultimate selling price of his product, is evidence that his profit, which he then neglected to take, is reflected in the selling price of the completed munition, and that no deduction, therefore, is allowable except for actual cost, whether of manufacture or of purchase. The foregoing paragraph is of particular interest to concerns operating several plants, as fixing the basis of price at which the munitions plant shall purchase raw material from another plant operated by the same concern. The raw material must be sold or trans- ferred at actual cost. Running or general expenses. Running or general ex- penses are deductible, to the extent that such expenses are incurred and paid during the year in the manu- facture of articles the profits from the sale of which are included in the gross amount of income returned. Such expenses will include expenditures for rent, re- pairs and maintenance, heat, light, power, insurance, management, salaries and wages, as well as commissions and bonuses paid for the securing of contracts. Where another business is carried on in connection with the manufacture of munitions, and the expenses of munition manufacture cannot be segregated from the expenses of the other branches of the business, the expenses deductible are "such a portion of the entire expenses as the gross income received or accrued from the manufacture and sale or disposition of war muni- tions or parts thereof, is a portion of the entire gross income received or accrued from such entire manufac- 444 INCOME AND FEDERAL TAX REPORTS turing business." For example, entire expense is $600,- 000; gross income from munitions is $300,000; entire gross income is $900,000. In such a case the deductible expense would be one third of $600,000. This is held by the Department to be a more accurate method of apportionment of expense than if "net profits" were taken as a basis. Since income received, as explained above, from contracts completed prior to January 1, 1916, is ex- empt, no allowance is permitted to be made for ex- penses incident to such contracts. Commissions and bonuses paid for securing muni- tions contracts are an allowable deduction under "ex- penses" in case they have been paid for securing con- tracts the receipts from which are subject to the tax. Such commissions and bonuses, however, should be spread over the life of the contract in a pro rata pro- portion and deducted from the gross income of each year until the contracts are fully performed. Cost of buildings, machinery and equipment. The cost of new buildings, machinery and equipment installed for the manufacture of munitions will be charged to capital account to be taken care of through the depre- ciation or amortization accounts, which are explained hereafter. Interest. The amount deductible from gross income on account of interest is the amount of interest actually paid during the year on debts or loans contracted to meet the needs of the business of manufacturing munitions, and the proceeds of which were actually used for that purpose. This deduction must not in- clude any interest paid on debts or loans the proceeds of which were used to meet the needs of any other business in which the manufacturer may have been engaged. This deduction can be taken only from the gross income of the year in which the interest was actually paid. MUNITION MANUFACTURER'S TAX 445 As to interest paid in advance, that is prior to 1916, such interest is not deductible if the money upon which the interest paid was used in the furtherance of contracts; but in the event that the money was used in the construction of buildings or purchase of equip- ment, the interest paid in advance for the use of such money may be added to the cost of buildings and equipment. In such a case the interest is as essen- tially a part of the cost of the buildings as is the principal so applied, and the entire amount, principal and interest, is subject to the depreciation and amor- tization charges explained hereafter. Taxes. The taxes deductible are those taxes of all kinds which were actually paid during the year in which the gross income was received or accrued and which were imposed with respect to the property used in the manufacture of munitions. In cases where other businesses are conducted in connection with the making of munitions and the taxes cannot be segregated, the apportionment is made in the same manner as is that of running expenses under similar circumstances, as described hereinbefore. The War Excess Profits tax is not deductible in ascer- taining net munition income for the purpose of measur- ing the munitions tax. The Treasury Department ruling on this point is as follows : The Munition Manufacturer's tax, Title III, section 301, of the Act of September 8, 1916, is an excise tax and not an income tax. It is measured by the net income ascertained as provided by section 302, Title III, Act of September 8, 1916. Paragraph (d) of said section 302 provides for de- duction from "Gross income received or accrued from the sale or disposition" of the product of munitions business "(d) taxes of all kinds paid during the taxable year with respect to the business or property relating to the manufacture." The net income by which the War Excess Profits tax is to be measured is the net income determined for income tax purposes, but without the de- duction of income or excess profits tax paid within the year. The tax upon this income is in addition to and has no taxable relation to any other tax. The net income subject to income tax is the difference between gross 446 INCOME AND FEDERAL TAX REPORTS income as defined by the Income Tax law and the several deductions pro- vided by that Act. The deductions provided must not include "income or excess profits tax." Section 29, Act of September 8, 1916, as amended by the Act of October 3, 1917, permits this net income, for the purpose of assessment of income tax, to be reduced by the amount of war excess profits tax assessed for the same calendar or fiscal year. To be deductible for the purpose of munitions tax, a tax must have been paid within the taxable year "with respect to," that is, concerning or be- cause of the business of munitions manufacture, or to have been paid on "property relating to the manufacture," that is, a tax on property having a special reference to the manufacture of munitions. The War Excess Profits tax is not levied in respect of any business or on any property used in or relating to manufacture, but (in the language of section 201, Act of October 3, 1917) is "in addition to the taxes under existing law and under this Act." It is therefore not deductible under paragraph (d), section 302, Title III, Act of September 8, 1916, in ascer- taining net income from munitions manufacture for the purpose of measur- ing the excise charge on the business of munitions manufacture. With regard to the capital stock tax and its relation to the munitions tax, the Act provides that the Capital Stock Tax returns shall be made in July and Muni- tions Tax returns on or before March 1, upon which basis the tax is paid. It therefore follows that if the munitions tax is paid prior to the time the Capital Stock Tax return is prepared and filed in July, the amount of the munitions tax paid in 1917 can be used as a credit against the capital stock tax to be paid for the fiscal year ending June 30, 1918. As to whether the munitions tax paid when in ex- cess of the capital stock tax paid can be used as a credit in subsequent capital stock tax returns is a question that has not yet been passed on by the De- partment, but which will be, in case it becomes perti- nent to a return. Losses. The losses deductible are those actually sus- tained and charged off during the year for which the return is made, and which were sustained on account of, or in connection with, the business of the manufac- ture and sale or disposition of munitions or parts thereof, and will include losses from fire, flood, storm, accident or other casualty not compensated by insur- MUNITION MANUFACTURER'S TAX 447 ance or otherwise. The casualty losses allowable are those only which relate to the business of munitions manufacturing. Losses sustained in connection with collateral invest* ments or in connection with any other business, the profits from which are not taxable, cannot be deducted from the gross income as contemplated by the Act. A manufacturer engaged in the business of making munitions, and also of supplying raw materials to other munition manufacturers, may not deduct losses incurred in the latter unless such materials are classed as munitions under the definitions set forth herein- before, and as such are taxable. Depreciation. Depreciation is a lowering in value or worth, due to age, use or other causes. The deduction authorized on account of depreciation relates to the loss due to use, wear and tear of physical property, owned and used by a manufacturer, but which is not specifically designed or installed for the purpose of manufacturing munitions or parts thereof, and which, without material alteration and change, may be used in connection with any other business in which the per- son is or may be thereafter engaged. The annual deduction on this account will be a rea- sonable allowance determined upon the basis of the cost and probable number of years constituting the life of the property. Where the same building, machinery or other prop- erty is used also for other purposes than the manu- facture of munitions, the amount deductible from gross income on account of depreciation will be apportioned in accordance with the rule for apportionment of run- ning expenses, as set forth hereinbefore. Amortization. A special amortization deduction is allowable in the case of buildings and machinery consti- tuting plants constructed especially for the manufac- ture of munitions, and which will have no substantial 448 INCOME AND FEDERAL TAX REPORTS value to the manufacturer, except for salvage, when the contracts executed or to be executed for the manufacture of munitions have been fully performed. This allow- ance is to be determined either (1) by estimating the number of years the property is to be used in the manufacture of munitions, and dividing the cost of the property, less estimated salvage value, by this number; the quotient thus obtained will be the amount of the allowed annual deduction until the cost of the property has been extinguished; or (2) the amortiza- tion allowance may be determined on a basis of the quantity of munitions manufactured under contracts in connection with the fulfillment of which the buildings, machinery, or equipment were specially constructed or installed. The amortization deduction should be set up on the books as soon as possible, but since in practically all cases, the Department holds, it cannot be definitely determined until the end of the year, when the net profits have been determined, it will be permissible, in order to get credit in the return, to set up the amor- tization charge as soon as it is ascertained, in any event not later than as of December 31st of the year for which the return is made. Amortization is to be distinguished from deprecia- tion, which is explained in the preceding section. The amounts of all the foregoing allowable deductions, then, when subtracted from the amount of the gross income, leave as a remainder the amount of net income, or profits upon which the tax is payable, at the rate of 12y 2 per cent for the calendar year 1916 and of 10 per cent for the calendar year 1917. Instructions for making the return are to be found in the following sections: Return, assessment and payment of tax. Every person liable for the tax is required to make a return of an- nual net profits or income in the manner and form prescribed in Form 1089. MUNITION MANUFACTURER'S TAX 449 This return, properly subscribed and sworn to before an officer qualified to administer an oath, and stamped with the seal of such officer, if he is required to have a seal, must be filed with the Collector of Internal Revenue of the District in which such person has his principal office or place of business, on or before March 1st next following the year in which the return is made or in which the net profits were received or accrued. If the business is carried on by an individual the return must be signed and sworn to by him; if by a partnership, then by two members of the firm; if by a corporation or association, then by two of the prin- cipal officers of such organization. As soon as practicable after the filing of the return, the Commissioner of Internal Eevenue will assess the tax and notify the taxable person of the amount of the tax, which must then be paid to the Collector with whom the return was filed, on or before 30 days from the date of such notice. If return is not made, or is incorrect. In case no re- turn is made, or if it is desired to verify the informa- tion presented in a return which has been made, the Commissioner of Internal Revenue or his agent is au- thorized to examine the books of the person subject to the tax or whom the Commissioner may believe is subject to the tax, in order that the amount of taxable profits may be determined and the tax assessed and collected. Penalties. The penalty for delinquency in tax pay- ment, if return has been made and tax assessed, is 5 per cent of the amount of the tax and interest at the rate of 1 per cent a month from time tax became due until it is paid. Failure to make return as required subjects the de- linquent to a fine of not more than $10,000 or impris- onment not exceeding one year, or both, and to an 450 INCOME AND FEDERAL TAX REPORTS assessment of 50 per cent additional tax. It is pro- vided, however, that in case of sickness or absence of persons required to make or verify the return, the collector may upon application grant an extension of not exceeding 30 days from March 1st, also that if the return is not made within the required time, but is afterward filed voluntarily and without notice from the Collector, and it is shown that the failure to file the return within the time was due to a reasonable cause and not to wilful neglect, the 50 per cent addition may not be made to the tax. CHAPTER XIX MUNITION MANUFACTURER'S TAX LAW BEING TITLE III OF "AN ACT TO INCREASE THE REVENUE AND FOR OTHER PURPOSES," AP- PROVED SEPTEMBER 8, 1916 (PUBLIC NO. 271. 64th CONGRESS). IN EFFECT SEPTEMBER 9, 1916 TITLE III. MUNITION MANUFACTURER'S TAX. Definitions. Sec. 300 [of the general revenue Act of which this Title is a part]. That when used in this title The term "person" includes partnerships, corpora- tions, and associations; The term "taxable year" means the twelve months ending December thirty-first. The first taxable year shall be the twelve months ending December thirty-first, nineteen hundred and sixteen; and The term "United States" means only the States, the Territories of Alaska and Hawaii, and the District of Columbia. Articles subject to tax and rate of tax (see pp. 436- 439). Sec. 301. (1) That every person manufacturing (a) gun-powder and other explosives, excepting blast- ing powder and dynamite used for industrial purposes; (b) cartridges, loaded and unloaded, caps or primers, exclusive of those used for industrial purposes; (c) projectiles, shells, or torpedoes of any kind, including 451 452 INCOME AND FEDERAL TAX REPORTS shrapnel, loaded or unloaded, or fuses, or complete rounds of ammunition- (d) firearms of any kind and appendages, including small arms, cannon, machine guns, rifles, and bayonets; (e) electric motor boats, sub- marine or submersible vessels or boats; or (/) any part of any of the articles mentioned in (b), (c), (d), or (e) ; shall pay for each taxable year, in addition to the income tax imposed by Title I, an excise tax of twelve and one-half per centum upon the entire net profits ac- tually received or accrued for said year from the sale or disposition of such article manufactured within the United States: Provided, however, That no person shall pay such tax upon net profits received during the year nineteen hundred and sixteen derived from the sale and delivery of the articles enumerated in this section under contracts executed and fully performed by such person prior to January first, nineteen hundred and sixteen. Termination of tax after war (see page 457, post). (2) This section shall cease to be of effect at the end of one year after the termination of the present European war, which shall be evidenced by the proclamation of the President of the United States declaring such war to have ended. Allowable deductions. Sec. 302. That in computing net profits under the provisions of this title, for the purpose of the tax there shall be allowed as deductions from the gross amount received or accrued for the tax- able year from the sale or disposition of such articles manufactured within the United States, the following items : (a) The cost of raw materials entering into the manufacture ; (b) Running expenses, including rentals, cost of re- pairs and maintenance, heat, power, insurance, manage- ment, salaries, and wages; (c) Interest paid within the taxable year on debts MUNITION MANUFACTURER'S TAX LAW 453 or loans contracted to meet the needs of the business, and the proceeds of which have been actually used to meet such needs; (d) Taxes of all kinds paid during the taxable year with respect to the business or property relating to the manufacture ; (e) Losses actually sustained within the taxable year in connection with the business of manufacturing such articles, including losses from fire, flood, storm, or other casualty, and not compensated for by insurance or otherwise; and (/) A reasonable allowance according to the condi- tions peculiar to each concern, for amortization of the values of buildings and machinery, account being taken of the exceptional depreciation of special plants. Effect of selling articles at less than fair market price. Sec. 303. If any person manufactures any article specified in section three hundred and one, during any taxable year or part thereof, whether under any agree- ment, arrangement, or understanding, or otherwise, sells or disposes of any such article at less than the fair mar- ket price obtainable therefor, either (a) in such manner as directly or indirectly to benefit such person or any person directly or indirectly interested in the business of such person, or (b) with intent to cause such benefit, the gross amount received or accrued for such year or part thereof from the sale or disposition of such article shall be taken to be the amount which would have been received or accrued from the sale or disposition of such article if sold at the fair market price. Making and filing of returns. Sec. 304. On or be- fore the first day of March, nineteen hundred and sev- enteen, and the first day of March in each year there- after, a true and accurate return under oath shall be made by each person manufacturing articles specified in section three hundred and one to the collector of in- ternal revenue for the district in which such person has 454 INCOME AND FEDERAL TAX REPORTS his principal office or place of business, in such form as the Commissioner of Internal Revenue, with the ap- proval of the Secretary of the Treasury, shall prescribe, setting forth specifically the gross amount of income received or accrued from the sale or disposition of the articles specified in section three hundred and one, and from the total thereof deducting the aggregate items of allowance authorized in section three hundred and two, and such other particulars as to the gross receipts and items of allowance as the Commissioner of Internal Revenue, with the approval of the Secretary of the Treasury, may require. Payment of tax. Sec. 305. All such returns shall be transmitted forthwith by the collector to the Com- missioner of Internal Revenue, who shall, as soon as practicable, assess the tax found due and notify the person making such return of the amount of tax for which such person is liable, and such person shall pay the tax to the collector on or before thirty days from the date of such notice. Procedure when no return or incorrect return is filed. Sec. 306. If the Secretary of the Treasury or the Commissioner of Internal Revenue shall have reason to be dissatisfied with the return as made, or if no return is made, the commissioner is authorized to make an in- vestigation and to determine the amount of net profits and may assess the proper tax accordingly. He shall notify the person making, or who should have made, such return and shall proceed to collect tax in the same manner as provided in this title, unless the person so notified shall file a written request for a hearing with the commissioner within thirty days after the date of such notice; and on such hearing the burden of estab- lishing to the satisfaction of the commissioner that the gross amount received or accrued or the amount of net profits, as determined by the commissioner, is incorrect, shall devolve upon such person. MUNITION MANUFACTURER'S TAX LAW 455 Temporary owners, agents and others. Sec. 307. The tax may be assessed on any person for the time being owning or carrying on the business, or on any person acting as agent for that person in carrying on the busi- ness, or where a business has ceased, on the person who owned or carried on the business, or acted as agent in carrying on the business immediately before the time at which the business ceased. Examination of books. Sec. 308. For the purpose of carrying out the provisions of this title the Commis- sioner of Internal Revenue is authorized, personally or by his agent, to examine the books, accounts, and rec- ords of any person subject to this tax. Disclosure or inspection of returns prohibited. Sec. 309. No person employed by the United States shall communicate, or allow to be communicated to any per- son not legally entitled thereto, any information ob- tained under provisions of this title, or allow any such person to inspect or have access to any return furnished under the provisions of this title. Penalties for false returns. Sec. 310. Whoever vio- lates any of the provisions of this title or the regula- tions made thereunder, or who knowingly makes false statements in any return, or refuses to give such infor mation as may be called for, is guilty of a misdemeanor, and upon conviction shall, in addition to paying any tax to which he is liable, be fined not more than $10,000, or imprisoned not exceeding one year, or both, in the dis- cretion of the court. Administrative provisions. Sec. 311. All administra- tive, special, and general provisions of law, relating to the assessment and collection of taxes not specifically repealed, are hereby made to apply to this title so far as applicable and not inconsistent with its provisions. Regulations. Sec. 312. The Commissioner of In- ternal Revenue, with the approval of the Secretary of the Treasury, shall make all necessary regulations for 456 INCOME AND FEDERAL TAX REPORTS carrying out the provisions of this title, and may re- quire any person subject to such provisions to furnish him with further information whenever in his judgment the same is necessary to collect the tax provided for here. TITLE IX. Invalidity of one clause not to affect other clauses. Sec. 900. That if any clause, sentence, paragraph, or part of this Act shall for any reason be adjudged by any court of competent jurisdiction to be invalid, such judgment shall not affect, impair, or invalidate the re- mainder of said Act, but shall be confined in its opera- tion to the clause, sentence, paragraph, or part thereof directly involved in the controversy in which such judg- ment shall have been rendered. Effective on day following passage of Act. Sec. 902. That unless otherwise herein specially provided this Act shall take effect on the day following its passage, and all provisions of any Act or Acts inconsistent with the provisions of this Act, are hereby repealed. Approved by the President, September 8, 1916. AMENDMENT TO MUNITION MANUFACTURER'S TAX LAW. Contained in Title II of "An Act to Provide Revenue to De- fray War Expenses, and for Other Purposes," Approved October 3, 1917. (Public No. 50 65th Congress.) In effect October 4, 1917. Rate of tax reduced. Sec. 214 * * * Subdivi- sion (1) of section three hundred and one of such Act of September eight, nineteen hundred and sixteen, i3 hereby amended so that the rate of tax for the taxable year nineteen hundred and seventeen shall be ten per centum instead of twelve and one-half per centum, as therein provided. MUNITION MANUFACTURER'S TAX LAW 457 Act ineffective after January 1, 1918. Subdivision (2) of such section is hereby amended to read as follows: "(2) This section shall cease to be of effect on and and after January first, nineteen hundred and eigh- teen." Approved by the President, October 3, 1917. CHAPTER XX SPECIAL TAXES ON OCCUPATIONS History. These special taxes on occupations are part of the miscellaneous taxes included in Title IV of "An Act to Increase the Revenue and for Other Purposes," approved on September 8, 1916. They are based largely on the Acts of June 13, 1898, and October 22, 1914. In general, Title IV repeals the Emergency Revenue Act of October 22, 1914, except the sections relating to certain occupations and to tobacco manufacturers. The enforcement of these sections was extended to January 1, 1917. Accordingly, the tax on the old basis remained in force for the period up to and including December 31, 1916. The present tax, which is an annual one, became ef- fective on the first of January, 1917. Inasmuch as the taxable year extends from July first to June thirtieth of the year following, the first assessment was made to in- clude the first six months of 1917. Thereafter the tax- able period is one year, extending from the first of July. Accordingly, the tax payment made on July 1, 1917, gives permission to do business up to July 1, 1918. Who pays the tax. Every person, firm or corpora- tion doing business in the United States and engaged in any of the nine "occupations" listed below is sub- ject to this tax: (1) Brokers executing purchases and sales of stocks and bonds, money, commercial paper, etc. (2) Pawnbrokers. (3) Ship brokers. 458 SPECIAL TAXES ON OCCUPATIONS 459 (4) Custom-house brokers. (5) Proprietors of theaters, museums and concert halls. (6) Proprietors of circuses. (7) Proprietors or agents of all other public exhibi- tions or shows. (8) Proprietors of bowling alleys and billiard rooms. (9) Tobacco manufacturers. Brokers. The annual tax payable by brokers is $30. For the purpose of this tax a broker is considered to be any person, partnership or corporation whose busi- ness it is to execute for others purchases or sales of stocks, bonds, exchange, bullion, coined money, bank notes, promissory notes or other securities. In determining liability for this tax it is important to find out whether or not orders are being executed for others. There is no liability where a person ne- gotiates purchases or sales solely for himself. Accord- ing to the terms of a court decision: "It is only when making sales and purchases is his business, his trade, his profession, his means of getting his living or mak- ing his fortune, that he becomes a broker within the meaning of the statute." (Warren v. Shook, 91 U. S., 704.) The following cases, chosen from the Treasury de- cisions based upon the provisions of the old law, illus- trate the general scope of this section of the present law. Inasmuch as this "special tax on occupations" is practically identical with the War Revenue Acts of June 13, 1898, and Oct. 22, 1914, it is assumed that Treasury Department rulings relating to the latter Act will apply in the administration of this Act. Loan and mortgage companies are not liable for loaning money on notes or bonds secured by a mort- gage or trust deed on real estate. However, if they purchase notes, bonds or other securities they become liable as brokers. 460 INCOME AND FEDERAL TAX REPORTS A mining syndicate or other association issuing cer- tificates of stock in a company organized by it is not required to pay a special tax as a broker as a result of those transactions. However, a manager or other person employed to sell the certificates on commission is a broker and is required to pay the tax. Express companies engaged in the business of buy- ing or selling foreign money or bills of exchange are subject to the tax. On the other hand, an express or railway agent doing business for his principals only is not considered a broker and therefore is not taxable. The business of selling land on commission, taking applications for farm loans and writing insurance is not the business of a broker and therefore the tax is not imposed. Each branch office of a broker is subject to the tax. For the purpose of this tax a branch office is consid- ered to be one where the employee in charge not only receives and transmits orders with the money to the main office, but also receives from the main office moneys for disbursement to customers, or keeps ac- counts with customers, or does other business with re- lation to the transactions of brokers at such branch offices. A case in point to illustrate the application of this regulation will serve to make the ruling clear: A cor- poration, a dealer in investment securities, selling se- curities that it owns itself, has branch offices under the control of managers, who in turn employ a number of agents as salesmen. Both the managers and the sales- men are employed under a contract that requires them to devote their whole time to the sale of the securities of the house in question. Class A of these branch offices both purchases and sells securities under author- ity of the main office. Class B of the offices confines itself to the sale of securities. Are either or both of these classes subject to the brokers' tax? In this in- SPECIAL TAXES ON OCCUPATIONS 461 stance the Treasury Department decided that all branch offices in both classes A and B were subject to the tax. Pawnbrokers. The annual tax payable by pawnbrok- ers is $50. According to the provisions of this Act, the pawnbroker's business is one which receives, by way of pledge, pawn or exchange, any goods, wares, merchandise or any kind of personal property as se- curity for the repayment of money loaned. Although up to this time there have been but few Treasury decisions on special phases of this new law, there are available those applying to the old law which is similar in almost every respect. It is safe to as- sume, therefore, that the former rulings will apply with equal force to this law. The following are of impor- tance : A person is not required to pay a special tax as a pawnbroker for rare or occasional acts which cannot be regarded as his business or occupation. The tax is not required to be paid for making loans when the chattels are not taken or received by way of pledge, pawn or exchange. A person using no tickets in his business, but mak- ing a pretense of buying articles which are brought to him, which he holds with a verbal agreement, that the articles can be bought back again by the person sell- ing them upon the payment of a specified bonus, is liable to the tax as a pawnbroker. Ship brokers. The amount of annual tax payable by ship brokers is $20. Under this classification is in- cluded every person, partnership or corporation whose business it is as a broker to negotiate freights and other business for the owners of vessels, or for the shippers or consignors or the consignees of freight carried by vessels. These provisions of the law are specific and require no further discussion. 462 INCOME AND FEDERAL TAX REPORTS Custom-house brokers. For custom-house brokers the annual tax is $10. Agents for others, whose business it is to arrange entries and other custom-house papers, or transact at any port of entry, business relating to imports and exports of goods, wares or merchandise, are considered to be custom-house brokers. If the complete business of a custom-house broker is transacted by or through offices at different ports in one district, a separate and distinct tax of $10 must be paid for each of the offices. A tax stamp taken out by a person in his own name as a custom-house broker is sufficient to cover the busi- ness done by him in his own name, at the place of business stated therein, whether the business is done by him on his own account or as an agent for other persons. An agent for others, whose business it is to enter and clear vessels at the custom-house, cannot be relieved from payment of the tax on custom-house brokers, even though he may in addition have paid a tax as ship broker. Proprietors of theaters, museums and concert halls. The annual tax payable by proprietors of theaters, museums and concert halls is graded according to the following scale, based upon the seating capacity: A seating capacity of not more than 250. . $25 A seating capacity of more than 250 and not over 500 50 A seating capacity of more than 500 and not over 800 75 A seating capacity of more than 800 100 In cities, towns or villages having a population of 5,000 or less, the amount of tax payable by proprietors will be in each case one-half of the amount indicated in the above summary. Every edifice used for the purpose of dramatic, oper- atic or other performances for which a charge for ad- SPECIAL TAXES ON OCCUPATIONS 463 mission is made is subject to the tax. Armories or halls used only occasionally for concerts or theatrical performances are not required to pay the tax. Moving picture shows are taxable as theaters on the same basis as that above mentioned. Airdomes in which are given open-air operatic or dramatic or other representations, plays or moving pic- ture shows, are taxable according to the seating capac- ity, as are theaters, museums, etc. An exception is made, however, in those cases where the airdome is operated in conjunction with a theater for which the tax has been paid. Provided the seating capacity of the airdome does not exceed that of the theater, and that performances are not given simultaneously in the airdome and in the theater, only one tax is payable. The tax paid for the theater will be considered to cover also the performances given in the airdome. Where the proprietor of a theater operates an air- dome at another location, he may, upon closing his theater, transfer to the airdome the tax stamp orig- inally issued for the theater. It is understood, of course, that in such a case the seating capacity of the airdome may not exceed that of the theater. Similarly, the tax stamp may be transferred from an airdome to a theater operated by the same proprietor. In cases where the tax is paid for a theater of a cer- tain capacity and subsequently its capacity is increased, the tax is payable at the highest rate. However, re- demption of the former tax stamp may be made for its unexpired term. The owners or agents of theatrical troupes, traveling around the country and giving performances in halls or auditoriums for which the tax has not been paid by the owners or lessees, are required to pay the special tax on occupations. They may have the tax stamps trans- ferred from place to place, within the State only, upon application to the Collector of Internal Kevenue. 464 INCOME AND FEDERAL TAX REPORTS Proprietors of circuses. The annual tax payable by proprietors of circuses is $100. This tax is payable in every State or Territory or in the District of Colum- bia, in which an exhibition is given. When a circus is exhibiting in any State, say in the month of July, the special tax of $100 is required to be paid for the year beginning July first. If in the following month the cir- cus goes into another State, the tax at the rate of $100 for the year is to be reckoned from the first of August to the first of July following, and a separate tax stamp must be taken out for that State, and so on. For each additional attraction, side show and the like, for which a separate charge for admission is made, there is a special tax liability at the rate of $10 per annum. This tax is payable according to the terms of that section of the Act taxing "proprietors or agents of all other public exhibitions or shows." For the purposes of this Act, a circus is understood to be an exhibition of "feats of horsemanship, or acro- batic sports or theatrical performances not otherwise provided for" in the other eight classes of "occupa- tions" mentioned in the Act. Variety shows, whether given at summer resorts or elsewhere, which include "acrobatic sports," come within the definition of a circus. They are taxable accordingly. In some cases there is a fine distinction between ex- hibitions classified as circuses, taxable at the rate of $100 per annum, and those coming under the classifica- tion of "other public exhibitions or shows," taxable at the rate of $10 per annum. The Treasury Department has given a ruling to the effect that "a show under can- vas exhibiting, among other things, acrobatic and ath- letic exercises, but not feats of horsemanship and hav- ing no menagerie, is not subject to special tax as a cir- cus if the acrobatic exercises are so few and simple as to make it unreasonable to hold that they constitute the show a circus." It is a show coming under the cap- SPECIAL TAXES ON OCCUPATIONS 465 tion of "all other public exhibitions or shows," consid- ered in the following section of this chapter. Proprietors or agents of all other public exhibitions or shows. The amount of annual tax payable for exhibi- tions coming under this classification is $10. All forms of exhibitions, etc., not specially provided for in the preceding sections of the Act are taxable under the pro- visions of this paragraph. An exception is made of "Chautauquas, lecture lyceums, agricultural or indus- trial fairs, or exhibitions held under the auspices of re- ligious or charitable associations." These are not tax- able. As with other forms of exhibitions and shows, the tax is payable for each State in which the perform- ance or show is given. In a case brought before the District Court of the United States by the Redpath Lyceum Bureau, the claim of tax exemption was made. The Act provides that the tax shall not apply to "Chautauquas, lecture lyceums, agricultural or industrial fairs or exhibitions under the auspices of religious or charitable associations." It was on the strength of this provision that the Redpath Com- pany claimed tax exemption. The decision of the court was to the effect that the company was not a lecture lyceum within the meaning of the Act, that the entertainments were not given un- der the auspices of churches and that consequently the company would be required to pay the tax. For wagon shows, dog and pony shows, and other similar exhibitions that do not come under the heading of circuses, the annual tax of $10 is payable. Traveling carnival companies, if charging one gen- eral admission to the grounds, are required to pay the tax at the rate of $10 per annum. Also, for each sepa- rate attraction for which a separate admission is charged, an additional tax at the rate of $10 per annum is required to be paid. The show of a medicine vender is taxable under this 466 INCOME AND FEDERAL TAX REPORTS section of the Act at the rate of $10 per annum. Such a show will generally include athletic, humorous and comic performances, and also an exhibition of rope- walking and trapeze performances, the object of which is to attract a crowd. Agricultural associations are required to pay a spe- cial tax at the rate of $10 for exhibitions which include horse racing. Exhibitions and shows given on fair grounds, but not under management of the fair association, are taxable. Concert gardens where no admission fee is charged, but where beer and other drinks are sold, and shows or stage entertainments are given, come under this clas- sification and are taxable accordingly. A lecturer using a stereopticon to illustrate his lec- ture, and charging an admission fee, is liable to the spe- cial tax. Exemptions. The following are examples of shows and entertainments not taxable, according to former Treasury Department rulings: The tax is not required to be paid by proprietors of restaurants or cafes for employing bands of music or orchestras during meal hours for the benefit of their patrons. The provision is made, however, that there shall be no admission charge and that no performance or exhibition shall be given in connection therewith. Amateur theatrical exhibitions, given either in pri- vate houses or in licensed public halls, for payment of expenses incurred in giving the show and not for pecuniary profit, are not subject to the tax. Amateur clubs or local organizations giving exhibi- tions, even though they charge an admission price, are not required to pay the tax if the proceeds are not for the pecuniary profit of the clubs or associations but are devoted to some charitable object and the payment of expenses. The tax is not required for bands of music playing SPECIAL TAXES ON OCCUPATIONS 467 in saloons to which no price of admission is charged and where persons visiting such places are not under any obligation to buy. Other entertainments not taxable are: merry-go- rounds, fortune telling, football, baseball, etc., bands in city parks, university exhibitions, and the like. Proprietors of bowling alleys and billiard rooms. Every building or place where bowls are thrown or where games of billiards or pool are played, except private houses, is regarded as a bowling alley or a billiard room. The tax is $5 per annum for each alley or table. A recent opinion of the Treasury Department is to the effect that the tax is applicable to pool or billiard tables and bowling alleys in clubs, fraternity houses, lodge halls, charitable institutions, Y. M. C. A. build- ings, hotels, boarding-houses, etc. These are not con- sidered as coming under the classification of "private homes," and consequently are taxable. Concerning pool tables, etc., maintained for the use of officers and employees of State and municipal govern- ments, a fine point of distinction arises. In the event of the tax falling upon the individuals, group of indi- viduals, association or the like, the tax is payable. How- ever, the tax is not applicable if the assessment would have the effect of levying upon the public treasury. The latter is true because of the fact that the Federal Government does not have the right to tax "the sover- eign instrumentalities of a State government necessary to the exercise of its governmental functions." Post exchanges operated under the complete control of the Secretary of the Navy as governmental agencies are not taxable. Tobacco manufacturers. Every person, firm or cor- poration engaged in the manufacture and sale of tobacco is subject to this tax. In all cases the tax is computed on the basis of the annual sales during the preceding fiscal year. 468 INCOME AND FEDERAL TAX REPORTS Herewith is summarized the basis of the annual tax, based upon the volume of business transacted during the year preceding: Manufacturers of tobacco: Annual sales not exceeding 50,000 pounds $3 Annual sales over 50,000 pounds but not exceed- ing 100,000 pounds 6 Annual sales over 100,000 pounds but not exceed- ing 200,000 pounds 12 Annual sales exceeding 200,000 pounds are tax- able at the rate of 8 cents for each 1,000 pounds or fraction thereof. Manufacturers of cigars: Annual sales not exceeding 50,000 cigars 2 Annual sales over 50,000 cigars but not exceed- ing 100,000 cigars 3 Annual sales over 100,000 cigars but not exceed- ing 200,000 cigars 6 Annual sales over 200,000 cigars but not exceed- ing 400,000 cigars 12 Annual sales exceeding 400,000 cigars are taxable at the rate of 5 cents for each 1,000 cigars or fraction of 1,000. Manufacturers of cigarettes: Annual sales of cigarettes and "little cigars," not weighing more than three pounds per 1,000, are taxable at the rate of 3 cents for each 10,000 cigarettes or fraction of 10,000. In all cases where a person, firm or corporation manufactures more than one of these classes of articles, the tax is payable on each class on the basis as indi- cated above, based on annual sales. Each manufacturer is required to pay tax at the ap- propriate rate for each factory operated under his ex- clusive ownership or control. Where more than one factory or branch is operated SPECIAL TAXES ON OCCUPATIONS 469 by the same manufacturer, each tax should be paid to the collector of the district where the factory or place of business is located. The tax stamp showing tax pay- ment should be posted at each factory or place of business. In making a tax return the manufacturer should file a sworn statement covering each factory or branch, showing total sales during the preceding fiscal year. This return should state the factory number, district and State, as to the factory operated, and also the out- put of the factory. The amount of the tax is computed in all cases on the basis of sales made during the preceding fiscal year. Total sales made during that period is the basis, re- gardless of whether business was conducted during the whole year or only part of the year. Dealers or manufacturers who were not engaged in business during the preceding fiscal year must pay the tax and secure the stamps before commencing business. The amount of the tax will be based on the dealer's or manufacturer's estimate of the probable amount of his business during the year. When the limit of sales al- lowed by the tax already paid is reached, the law re- quires that additional tax be paid. At all times the liability to tax on the basis of sales should be covered. Below is given a synopsis of Treasury Decisions made under the Act of June 13, 1898. Although these may not be considered to be binding under the present Act, they will without doubt be given weight in consid- ering similar questions. A manufacturer of tobacco or cigars cannot sell at retail at the place of manufacture. Manufacturers cannot pack goods of another factory with goods made at their own factory. A farmer or grower of tobacco has the right to sell tobacco of his own growth and raising to any person and in any quantity that may be desired, provided its 470 INCOME AND FEDERAL TAX REPORTS condition has not been changed in any manner; this, however, is a personal privilege, and cannot be dele- gated by him to another person. The farmer cannot employ another person to travel from place to place to sell and deliver tobacco to consumers. He has not the right to place the tobacco in the hands of another per- son, to be sold for him to consumers. However, he may place it in the hands of a qualified dealer in leaf tobacco, to be sold on commission to other qualified dealers, or to manufacturers of tobacco or cigars, or to persons who buy leaf tobacco in packages for export. A tax stamp issued to one person cannot be trans- ferred to or made use of by another. The one excep- tion to the rule is in the event of the death of the tax- payer. Filing of returns. The annual tax return is required to be filed by every person, firm, company, corporation or association subject to the tax. The return is to be made under oath and filed with the Collector of Inter- nal Kevenue of the district in which the business it sit- uated. Payment of the tax in the form of cash, cer- tified check or money order, accompanied by the re- turn, should be made before the month of July of each succeeding year. Newly organized businesses should file the report and pay the tax before beginning operations. Penalties. The law provides that "every person who carries on any business or occupation for which special taxes are imposed by this title, without having paid the special tax therein provided, shall, besides being liable to the payment of such special tax, plus a penalty of 50 per cent, be deemed guilty of a misdemeanor, and upon conviction thereof shall pay a fine of not more than $500, or be imprisoned for not more than six months, or both, in the discretion of the court." Special tax stamps are required to be posted con- spicuously at the place of business. CHAPTER XXI OCCUPATIONAL TAXES LAW BEING TITLE IV, OF "AN ACT TO INCREASE THE REVENUE AND FOR OTHER PURPOSES." AP- PROVED SEPT. 8, 1916 (PUBLIC No. 271 64th CONGRESS) IN EFFECT SEPTEMBER 9, 1916 TITLE IV. MISCELLANEOUS TAXES Tax on brokers. Sec. 407. That on and after January first, nineteen hundred and seventeen, special taxes shall be, and hereby are, imposed annually, as follows, that is to say: First. [The first subdivision related to bankers, and went out of effect January 1, 1917.] Second. Brokers shall pay $30. Every person, firm, or company whose business it is to negotiate purchaes or sales of stocks, bonds, exchange, bullion, coined money, bank notes, promissory notes, or other secur- ities, for others, shall be regarded as a broker. Tax on Pawnbrokers. Third. Pawnbrokers shall pay $50. Every person, firm, or company whose business or occupation it is to take or receive, by way of pledge, pawn, or exchange, any goods, wares, or merchandise, or any kind of personal property whatever, as security for the repayment of money loaned thereon, shall be deemed a pawnbroker. Tax on ship brokers. Fourth. Ship brokers shall pay $20. Every person, firm, or company whose business it 471 472 INCOME AND FEDERAL TAX REPORTS is as a broker to negotiate freights and other business for the owners of vessels, or for the shippers or con- signors or consignees of freight carried by vessels, shall be regarded as a ship broker under this section. Tax on customhouse brokers. Fifth. Customhouse brokers shall pay $10. Every person, firm, or company whose occupation it is, as the agent of others, to arrange entries and other customhouse papers, or transact busi- ness at any port of entry relating to the importation or exportation of goods, wares, or merchandise, shall be re- garded as a customhouse broker. Tax on proprietors of theaters, etc. Sixth. Proprietors of theaters, museums, and concert halls, where a charge for admission is made, having a seating capacity of not more than two hundred and fifty, shall pay $25 ; having a seating capacity of more than two hundred and fifty and not exceeding five hundred, shall pay $50; having a seating capacity exceeding five hundred and not ex- ceeding eight hundred, shall pay $75; having a seating capacity of more than eight hundred, shall pay $100. Every edifice used for the purpose of dramatic or oper- atic or other representations, plays, or performances, for admission to which entrance money is received, not including halls or armories rented or used occasionally for concerts or theatrical representations, shall be re- garded as a theater: Provided, That in cities, towns, or villages of five thousand inhabitants or less the amount of such payment shall be one-half of that above stated. Provided further, That whenever any such edi- fice is under lease at the passage of this Act, the tax shall be paid by the lessee, unless otherwise stipulated between the parties to said lease. Tax on proprietors of circuses. Seventh. The proprie- tor or proprietors of circuses shall pay $100. Every building, space, tent, or area where feats of horseman- ship or acrobatic sports or theatrical performances not otherwise provided for in this section are exhibited shall OCCUPATIONAL TAXES LAW 473 be regarded as a circus : Provided, That no special tax paid in one State, Territory, or the District of Columbia shall exempt exhibitions from the tax in another State, Territory, or the District of Columbia, and but one special tax shall be imposed for exhibitions within any one State, Territory, or District. Tax on proprietors of other shows for money. Eighth. Proprietors or agents of all other public exhibitions or shows for money not enumerated in this section shall pay $10: Provided, That a special tax paid in one State, Territory, or the District of Columbia shall not exempt exhibitions from the tax in another State, Terri- tory, or the District of Columbia, and but one special tax shall be required for exhibitions within any one State, Territory, or the District of Columbia: Provided further, That this paragraph shall not apply to Chau- tauquas, lecture lyceums, agricultural or industrial fairs, or exhibitions held under the auspices of religious or charitable associations: Provided further, That an ag- gregation of entertainments, known as a street fair, shall not pay a larger tax than $100 in any State, Terri- tory, or in the District of Columbia. Tax on proprietors of bowling alleys and billiard rooms. Ninth. Proprietors of bowling alleys and billiard rooms shall pay $5 for each alley or table. Every build- ing or place where bowls are thrown or where games of billiards or pool are played except in private homes shall be regarded as a bowling alley or a billiard room, respectively. Taxes on tobacco manufacturers. Sec. 408. That on and after January first, nineteen hundred and seventeen, special taxes on tobacco, cigar and cigarette manufac- turers shall be, and hereby are, imposed annually as follows, the amount of such annual taxes to be com- puted in all cases on the basis of the annual sales for the preceding fiscal year : 474 INCOME AND FEDERAL TAX REPORTS Manufacturers of tobacco whose annual sales do not exceed fifty thousand pounds shall each pay $3; Manufacturers of tobacco whose annual sales exceed fifty thousand and do not exceed one hundred thousand pounds shall each pay $6; Manufacturers of tobacco whose annual sales exceed one hundred thousand and do not exceed two hundred thousand pounds shall each pay $12; Manufacturers of tobacco whose annual sales exceed two hundred thousand pounds shall each pay at the rate of 8 cents per thousand pounds, or fraction thereof; Manufacturers of cigars whose annual sales do not exceed fifty thousand cigars shall each pay $2; Manufacturers of cigars whose annual sales exceed fifty thousand and do not exceed one hundred thousand cigars shall each pay $3; Manufacturers of cigars whose annual sales exceed one hundred thousand and do not exceed two hundred thousand cigars shall each pay $6; Manufacturers of cigars whose annual sales exceed two hundred thousand and do not exceed four hundred thousand cigars shall each pay $12 ; Manufacturers of cigars whose annual sales exceed four hundred thousand cigars shall each pay at the rate of 5 cents per thousand cigars, or fraction thereof; Manufacturers of cigarettes, including small cigars weighing not more than three pounds per thousand, shall each pay at the rate of 3 cents for every ten thou- sand cigarettes, or fraction thereof. In arriving at the amount of special tax, to be paid under this section and in the levy and collection of such tax, each person, firm, or corporation engaged in the manufacture of more than one of the classes of articles specified in this section shall be considered and deemed a manufacturer of each class separately. Penalties. Every person who carries on any business or occupation for which special taxes are imposed by OCCUPATIONAL TAXES LAW 475 this title, without having paid the special tax therein provided, shall besides being liable to the payment of such special tax, be deemed guilty of a misdemeanor, and upon conviction thereof shall pay a fine of not more than $500, or be imprisoned not more than six months, or both, in the discretion of the court. Administrative provisions. Sec. 409. That all admin- istrative or special provisions of law, including the law relating to the assessment of taxes, so far as applicable, are hereby extended to and made a part of this title, and every person, firm, company, corporation, or asso- ciation liable to any tax imposed by this title, shall keep such records and render, under oath, such statements and returns, and shall comply with such regulations as the Commissioner of Internal Revenue, with the ap- proval of the Secretary of the Treasury, may from time to time prescribe. Act of October 22, 1914, repealed in part. Sec. 410. That the Act approved October twenty-second, nineteen hundred and fourteen, entitled "An Act to increase the internal revenue, and for other purposes," and the joint resolution approved December seventeenth, nineteen hundred and fifteen, entitled "Joint resolution extending the provisions of the Act entitled 'An Act to increase the internal revenue, and for other purposes,' approved October twenty-second, nineteen hundred and fourteen, to December thirty-first, nineteen hundred and sixteen," are hereby repealed, except sections three and four of such Act as so extended, which sections shall remain in force till January first, nineteen hundred and seventeen, and except that the provisions of the said Act shall re- main in force for the assessment and collection of all special taxes imposed by sections three and four there- of, or by such sections as extended by said joint reso- lution, for any year or part thereof ending prior to January first, nineteen hundred and seventeen, and of all other taxes imposed by such Act, or by such Act as 476 INCOME AND FEDERAL TAX REPORTS so extended, accrued prior to the taking effect of this title, and for the imposition and collection of all pen- alties or forfeitures which have accrued or may accrue in relation to any of such taxes. Approved by the President, September 8, 1916. CHAPTER XXII WAR EXCISE TAXES Excise taxes on sales. War excise taxes on tobacco products, beverages and certain other commodities are imposed by the Act of October 3, 1917, the date of their passage being construed by the Treasury Department as meaning October 4, 1917, the date upon which the Act became effective. Such taxes as these have been a favorite means of obtaining revenue during the finan- cial stress attendant upon the several war crises in the history of the United States. The articles upon which they have been imposed have been usually what may, in a sense, be termed "luxuries"; that is, not indis- pensable, in the last analysis, yet for which the public would be willing to pay a price which included the tax rather than forego them. Such taxes were first levied by the Act of March 3, 1791. Prior to the Civil War they were regarded as an emergency measure, but since then excise taxes upon tobacco products and beverages have become a regular part of the taxation system of the country. Naturally, as emergency measures, excise taxes were designed primarily for the purpose of obtain- ing revenue. The Act of October 3, 1917, levied heavy additional taxes on manufacturers and importers of tobacco prod- ucts and beverages, and also extended this method of taxation to a number of articles which may be classed as luxuries. A detailed list of the articles will be found in the text of the law. A summary, with the amount of the tax in each case, is as follows: 477 478 INCOME AND FEDERAL TAX REPORTS Under section 600 : motor vehicles, mechanical musical instruments, including records for player pianos and phonographs; jewelry, real or imitation; cameras and process cameras; sporting goods, such as tennis rack- ets, golf clubs, baseball bats, baseballs, footballs, billiard and pool tables, and balls, but with the excep- tion of children's toys and games: a tax at the time of sale amounting to 3 per cent of the selling price. Toilet preparations; proprietary or "patent" medi- cines; chewing gum: 2 per cent of selling price. Moving picture films, not exposed: one-fourth of 1 cent for each linear foot; exposed, that is, ready for projection or exhibition: one-half of 1 cent per linear foot. These taxes are imposed when the film is first sold or leased, and are payable, like other excise taxes, only once. Under section 603: yachts and boats of the kinds enumerated below, with the exception of those used ex- clusively in trade or in national defence, and also with the exception of those built according to plans and specifications approved by the Navy Department: Yachts; pleasure boats; power boats; motor boats with fixed engines and sailing boats of over five tons: length not over fifty feet, fifty cents for each foot; length over fifty feet and not over one hundred feet, $1 for each foot; length over one hundred feet, $2 for each foot; motor boats of not over five net tons, with fixed engines, $5. The length which is to govern in de- termining the measurements is "over-all" length. Floor taxes. Upon the foregoing, with the exception of moving-picture films and boats, a floor tax is imposed, designed to tax the stocks of these commodities in the hands of wholesalers or jobbers at the time of the pas- sage of the Act. This floor tax is an amount equiva- lent to one-half the amount of the tax upon the sale of the respective classes of articles, that is, one-half of 3 per cent upon the one class and one-half of 2 per cent WAti EXCISE TAXES 479 upon the other, based on the price paid for the articles by the wholesaler or jobber when he purchased them. Those liable to this floor tax are any person or corpo- ration other than (1) a retailer who is not also a whole- saler or (2) the manufacturer, producer or importer. A retailer who is not also a wholesaler is defined as being one who does not make it a substantial part of his business to sell to other dealers, and who does not seek or solicit such business for profit, although he may occasionally sell goods to other retailers at less than the retail price. Dealers in automobiles who sell both to users and sub-agents for resale are wholesalers and liable to floor tax. Section 602, which imposes this floor tax, provides that "nothing in this section shall be construed to im- pose a tax upon articles sold and delivered prior to May 9, 1917, where the title is reserved in the vendor as security for the payment of the purchase money." Shipments in transit on October 4, 1917, charged to a jobber's account, but shipped direct to the retailer, are not subject to the floor tax, if invoice was mailed to the consignee prior to October 4, in which case the goods belonged to the consignee, and not to the jobber. Goods shipped and invoiced prior to October 4, if shipped to a wholesaler, are liable to the floor tax. If, however, the title is reserved by the manufacturer he is subject to the manufacturer's sales tax and the whole- saler is relieved of the floor tax. In the case of retail and wholesale stocks kept by the same establishment, the retail stock is not subject to the floor tax, provided that the retail and wholesale departments are kept separate, so far as bookkeeping and stockkeeping are concerned. The floor tax returns were to be made, as provided in section 1002, within thirty days of the passage of the Act. The date of payment, but not that of the filing of the return, may be extended, by the filing of 480 INCOME AND FEDERAL TAX REPORTS a satisfactory bond, to a date not later than seven months from the passage of the Act. For form of bond for the extending of payment of certain taxes, see Form 723, of the Treasury Department. Liberty bonds or certificates of deposit on purchase of Liberty bonds are acceptable as security for the payment of floor taxes. Excise tax on sales by whom paid. The excise tax on sales is to be paid by the manufacturer, producer or importer, no exception being made in the case of goods exported. Where a contract made with a dealer, for sale or lease, prior to May 9, 1917, precludes the adding of the whole amount of tax to the contract price, the vendee or lessee must pay the excess to the vendor at the time the sale or lease is consummated, but the actual payment of the tax must be made by the vendor. The term "dealer" includes a vendee who purchases an article with intent to use it in the manufacture or production of another article intended for sale. "Manufacturer" is construed to mean the latest manufacturer; that is, the one who completes an article ready for use by the consumer. Bottlers of drugs or other goods received in bulk are held to be manu- facturers. Where a manufacturer consigns his entire product to a retailer, retaining ownership in the same until sold by the retailer, he must make monthly returns, and to do this he must secure returns from the retailer of the goods sold. Returns excise tax on sales. Those subject to the excise tax on sales must make returns monthly in duplicate, on or before the close of the month follow- ing that for which the return is made, and pay the tax to the collector of internal revenue for the district in which is located the principal place of business. They should enter on the return the net quantity of WAR EXCISE TAXES 481 sales during the month, determined by deducting from the gross quantity of sales during such month, trade discounts and any quantity sold during any previous month on which the tax was paid and which has been returned or for which credit has been allowed for any other reason. Itinerant manufacturers must report sales and pay the tax in the district in which the sale is made. The word "sold" is construed to mean that a con- tract of sale has been entered into between vendor and vendee under the terms of which the article which is the subject of the contract became the property of the vendee. A transfer by a manufacturing corporation to a sell- ing corporation is a sale, and in such a case the price at which taxable goods shall be sold to the selling cor poration must not be less than that charged to inde- pendent distributors under similar conditions. Goods delivered subject to buyer's approval are not to be reported until sale is completed. Motor vehicles. No tax under this Act is upon the user or purchaser of motor vehicles but only upon the manufacturer, producer or importer. There are no exemptions for cars or motor trucks used for business purposes; all are taxable. Motor vehicles manufactured abroad by companies completely controlled or managed in the United States are taxable. There is no drawback on exported auto- mobiles. Automobiles and motorcycles sold to the United States for the use of the army, including those sold by the manufacturer to the United States Government on contract at contract prices, are taxable. A chassis is held to be an automobile. An automobile body is not taxable when sold alone; when sold with a chassis the tax rests upon the com- pleted article. A motor wheel sold alone is not tax- able, but when sold in connection with a bicycle, 482 INCOME AND FEDERAL TAX REPORTS velocipede or other vehicle, the tax attaches to the completed article. The "Smith-Flyer," for example, a self-propelled vehicle, is taxed as an automobile. A usable automobile, assembled from new or second- hand parts, is taxable, but used or second-hand auto- mobiles are not taxable. Motorcycle side cars are not taxable unless sold with the motorcycle, in which case the tax attaches to the completed article. Where a chassis is sold to a consumer or other person or concern not subject to the tax, the sale is taxable, but if sale is made to one who is subject to tax, the tax will be paid by the manufacturer of the completed machine. Attachments or accessories are taxable if sold with the machine, otherwise they are not taxable. Mechanical musical instruments. The mechanical mu- sical instruments enumerated, together with the records used in connection therewith, are taxable at the 3 per cent rate. It is held that accessories for player pianos, phonographs, etc., other than records, are not taxable unless sold with the instrument, in which case the tax attaches to the price for which the instrument and its accessories is sold. Player pianos have been held not to be taxable. The tax on piano players applies to the player device if sold as a separate instrument or as a separate feature. Where a player is sold as incorporated in a piano, the tax is upon the price of the player as a separate device, if such price can be separately determined; otherwise, the tax is upon the entire instrument, including piano. 1 Toy talking machines or phonographs are taxable. Dictaphones and dictagraphs, used for commercial purposes, are not taxable. iThe recent decision (January 2, 1918) holding that player pianos are not taxable except when sold as a unit with player device, the price of which can not be segregated, is expected to save the piano trade $1,000,000 a year. WAR EXCISE TAXES 483 Moving picture films. The amount of the tax on mov- ing picture films is given above. The tax is not on the manufacture of the film itself, but only upon its sale or lease, so that no floor tax applies. A distributor of films, pure and simple, is not subject to this tax. A laboratory doing the mechanical work of produc- ing a positive print, and charging the owner for labor and materials, and having itself no ownership in the films, will not be regarded as the manufacturer and is not liable to the tax if it does not sell or lease the film. Such a laboratory, however, should keep a record of such films for the information of revenue officers. Blank films are taxable only when sold by a manu- facturer or importer. Printed or hand-lettered titles or subtitles used in connection with a picture are held to be a part of the film and should be included in the length of the film when tax is computed. If these projections are in the shape of slides or announce- ments, however, no tax attaches. Returns are to be made on or before the last day of each month, covering the sales or leases made dur- ing the preceding month. For films not exposed the return will show the number of linear feet sold dur- ing the month; for films containing a picture ready for projection the returns will show the number of linear feet sold or leased during the month. The rates of tax are y an d V2 of 1 cent per foot respec- tively, and are payable only once, when the film is first sold or leased. Jewelry. The tax on jewelry, 3 per cent of selling price, is to be computed by manufacturers upon the price they make to wholesalers and retailers, less trade discounts. As to what is classed as jewelry, all articles so classed .by the Board of Custom Appraisers are in- cluded. All precious stones, real or imitation, whether cut 484 INCOME AND FEDERAL TAX REPORTS or uncut, which are set and ready to wear in condition sold are classifiable as jewelry and are subject to the tax. Precious stones cut but not set are taxable if sold by the importer, or if cutting is done in the United States, when sold by the manufacturer or dealer for whom the cutting was done. Matched pearls sold to a customer are taxable, but not if sold to dealers for further manufacture or completion. This applies also to loose, drilled pearls. All watches not used solely for utility purposes are classed as jewelry, also watches worn externally for ornament, and all other watches ornamented with jewels, or other ornamentation than engraving or en- gine turning. The following when made of precious or imitation metals to be carried on the person are taxable as jewelry : Dorean (powder) boxes; vanity boxes; stamp boxes; match boxes; cigarette cases; cigar cases; eyeglass cases; eyeglass chains; eyeglass holders; lorgnettes; lorgnons; card cases; vinaigrettes; handkerchief hold- ers; garters; suspenders; emblem charms; emblem pins ; emblem buttons ; mesh bags ; memorandum books ; lip salve cases; eyebrow pencils; cigar cutters; com- passes; key chains; key rings and other like articles. Other articles specifically classed as jewelry are: (a) a string of rose beads, {b) pencil- and penholders manufactured of precious or imitation precious metals, (c) souvenir pins for use and sold at summer resorts, (d) knitting needles, protectors, yarn holders, etc., if mounted or decorated in any way with precious or imitation precious metals, (e) slides and swivels used in connection with a ribbon chain, (/) lapel flag pins. It is held that the following shall not be considered as jewelry: (a) silver tableware, (b) eyeglass frames, (c) plain opera and field glasses, (d) clocks, (e) foun- tain pens, (/) rosaries, (g) American Red Cross but- WAR EXCISE TAXES 485 tons, (h) metal bag frames for attachment to silk bags, (t) repairs on jewelry, (j) military and naval insignia, (k) plain hair combs made of rubber, shell, or cellu- loid, absolutely unadorned. Sporting goods, etc. The tax of 3 per cent is im- posed only upon such sporting goods as are specifically mentioned in the Act. Bamboo fishing poles, skee ball and box-ball alleys, flinch and rook cards, or any other games played by both adults and children are taxable. Wooden racks used as receptacles for poker chips and playing cards, toy tennis rackets, tackle and other fishing rod appurtenances, are not taxable. Toilet articles and perfumes. Toilet articles, such as soaps and perfumes, are taxable at the rate of 2 per cent of the price for which they are sold by the manu- facturer, producer or importer. Among such taxable articles are shaving soap, toilet soap, Ivory and Pear's soaps, petroleum jellies for toilet purposes, and chipped soap in barrels or kegs for export. All soaps adver- tised or held out to be suitable for soilet purposes or for application to the body or any part of the body as a cleansing agent are included. All hair tonics are specifically taxed. Raw materials, such as rose oil, etc., to be manu- factured into perfumes, etc., are not taxable. Neither are floor oils, floor wax, kitchen soap powders and other articles used exclusively for household and not for toilet purposes. Containers of perfumes, etc., if billed and shipped separately are not taxable, but if sold together with the perfume the tax attaches upon the combined price of container and perfume. Medicinal preparations, etc. The taxability of a medic- inal substance or preparation is determined by the way it is prepared or marketed. Where taxable, the 486 INCOME AND FEDERAL TAX REPORTS rate is 2 per cent of the selling price. Preparations intended for beasts are taxable if the same would be taxable when used by man. A medicinal preparation is taxable if sold under any trade mark or trade name; it is held to be a medicinal preparation if recom- mended as a cure or remedy for any sickness or dis- ease, and is taxable. This applies even if recom- mended only to physicians, as it is a recommendation intended to reach the public through the physician. If, however, it is recommended only for purposes other than medicinal, as for its food value, the tax does not attach. Insecticides, for example, are not taxable. Licorice, when put up in any form suitable for medicinal purposes and sold under a trademark, is taxable, even though not recommended as a medicinal preparation. A retail dealer, manufacturing a patent medicine by a private formula, must pay the tax, even though he sells the product only in his retail store. Where medicinal preparations are sold under labels which do not indicate that the formula is published, they will be construed to be prepared under secret formulas, unless an affidavit or other evidence is offered to show that the formula is not a secret. Chewing gum. On all chewing gum or substitutes therefor sold by manufacturer, producer or importer, there is a tax of 2 per cent of the price for which it is sold. Cameras. Cameras are taxable at the rate of 3 per cent. Process cameras are not taxable. Returns. The returns for the taxes described above are to be made in duplicate on or before the end of each month, showing the net sales for the preceding month, the amount of which is ascertained by deduct- ing from the gross sales any trade discounts or other credits, such as credits for goods returned which had been sold in a previous month and tax thereon paid. WAR EXCISE TAXES 487 Penalties. Penalty for failure to make return is a fine of not more than $1,000 or imprisonment for not more than one year, or both. Penalty for failure to pay the tax, the return having been duly made, is 5 per cent of the amount of the tax plus interest at 1 per cent a month until tax is paid. Yachts, etc. The tax on pleasure boats, with the exception of those exempt, applies to all boats enu- merated in section 603, whether in use or commission or not, if they are in fit condition for use. The tax is payable yearly in advance, the first tax period begin- ning October, 1917, and ending June 30, 1918. The tax will be paid on or before July 1 of each year following for succeeding fiscal years. In the case of the purchase of a new boat during the fiscal year, the tax is computed by multiplying one-twelfth of the annual tax by the number of months, including the month of purchase, remaining prior to July 1 following. Tax returns are made on Form 732. The tax re- ceipt (Form 725) must be kept on board when the boat is in use and shown upon demand to any Internal Revenue or Navigation officer. The "user" of a boat is held to mean any person who purchases a vessel for his own use as distin- guished from one who buys as a dealer. Instructions for computing tonnage and over-all length will be found on Form 732. The penalties provided for failure to make return and pay the tax are a fine of not more than $1,000 or imprisonment for not more than one year, or both. If the return has been made but payment of tax de- layed, the penalty is 5 per cent of the amount of the tax and interest at 1 per cent per month. CHAPTER XXIII WAR EXCISE TAXES LAW BEING TITLE VI OF "AN ACT TO PROVIDE REVENUE TO DEFRAY WAR EXPENSES, AND FOR OTHER PURPOSES," APPROVED OCTOBER 3, 1917. (PUBLIC No. 50 65th CONGRESS.) IN EF- FECT OCTOBER 4, 1917, UNLESS OTHERWISE SPECIALLY PROVIDED. TITLE VI. WAR EXCISE TAXES Tax on sale or lease by manufacturer, producer, or im- porter. Sec. 600 [of the general revenue Act of which this Title is a part]. That there shall be levied, assessed, collected, and paid Motor-driven vehicles. {a) Upon all automobiles, automobile trucks, automobile wagons, and motorcycles, sold by the manufacturer, producer, or importer, a tax equivalent to three per centum of the price for which so sold; and Mechanical musical instruments and records. (b) Upon all piano players, graphophones, phonographs, talking machines, and records used in connection with any musical instrument, piano player, graphophone, phono- graph, or talking machine, sold by the manufacturer, producer, or importer, a tax equivalent to three per centum of the price for which so sold; and Moving-picture films. (c) Upon all moving-picture films (which have not been exposed) sold by the manu- 488 WAR EXCISE TAXES LAW 489 facturer or importer, a tax equivalent to one-fourth of 1 cent per linear foot; and (d) Upon all positive moving-picture films (contain- ing a picture ready for projection) sold or leased by the manufacturer, producer or importer, a tax equiva- lent to one-half of 1 cent per linear foot; and Jewelry real or imitation. (e) Upon any article com- monly or commercially known as jewelry, whether real or imitation, sold by the manufacturer, producer, or importer thereof, a tax equivalent to three per centum of the price for which so sold; and Sporting goods. (/) Upon all tennis rackets, golf clubs, baseball bats, lacrosse sticks, balls of all kinds, including baseballs, foot balls, tennis, golf, lacrosse, billiard and pool balls, fishing rods and reels, billiard and pool tables, chess and checker boards and pieces, dice, games and parts of games, except playing cards and children's toys and games, sold by the manufac- turer, producer, or importer, a tax equivalent to three per centum of the price for which so sold; and Toilet preparations. (g) Upon all perfumes, essences, extracts, toilet waters, cosmetics, petroleum jellies, hair oils, pomades, hair dressings, hair restoratives, hair dyes, tooth and mouth washes, dentifrices, tooth pastes, aro- matic cachous, toilet soaps and powders, or any sim- ilar substance, article, or preparation by whatsoever name known or distinguished, upon all of the above which are used or applied or intended to be used or applied for toilet purposes, and which are sold by the manufacturer, importer, or producer, a tax equivalent to two per centum of the price for which so sold; and Patent Medicines. (h) Upon all pills, tablets, pow- ders, tinctures, troches or lozenges, sirups, medicinal cordials or bitters, anodynes, tonics, plasters, liniments, salves, ointments, pastes, drops, waters (except those taxed under section three hundred and thirteen of this Act), essences, spirits, oils, and all medicinal prepara- 490 INCOME AND FEDERAL TAX REPORTS tions, compounds, or compositions whatsoever, the manufacturer or producer of which claims to have any private formula, secret, or occult art for making or preparing the same, or has or claims to have any ex- clusive right or title to the making or preparing the same, or which are prepared, uttered, vended, or ex- posed for sale under any letters patent, or trade-mark, or which, if prepared by any formula, published or un- published, are held out or recommended to the public by the makers, venders, or proprietors thereof as proprie- tary medicines or medicinal proprietary articles or prep- arations, or as remedies or specifics for any disease, dis- eases, or affection whatever affecting the human or animal body, and which are sold by the manufacturer, producer, or importer, a tax equivalent to two per cen- tum of the price for which so sold; and Chewing gum. (i) Upon all chewing gum or substi- tute therefor sold by the manufacturer, producer, or im- porter, a tax equivalent to two per centum of the price for which so sold; and Cameras. (j) Upon all cameras sold by the manufac- turer, producer, or importer, a tax equivalent to three per centum of the price for which so sold. Monthly returns. Sec. 601. That each manufacturer, producer, or importer of any of the articles enumerated in section six hundred shall make monthly returns un- der oath in duplicate and pay the taxes imposed on such articles by this title to the collector of internal revenue for the district in which is located the principal place of business. Such returns shall contain such informa- tion and be made at such times and in such manner as the Commissioner of Internal Eevenue, with the ap- proval of the Secretary of the Treasury, may by regu- lations prescribe. Floor tax on wholesaler's stocks. Sec. 602. That upon all articles enumerated in subdivisions (a), (b), (e), (/)> (ff)i W> (*)> or (i) of section six hundred, which 1*1 WAR EXCISE TAXES LAW 491 on the day this Act is passed are held and intended for sale by any person, corporation, partnership, or associa- tion, other than (1) a retailer who is not also a whole- saler, or (2) the manufacturer, producer, or importer thereof, there shall be levied, assessed, collected, and paid, a tax equivalent to one-half the tax imposed by each such subdivision upon the sale of the article there- in enumerated. This tax shall be paid by the person, corporation, partnership, or association so holding such articles. Administration of floor tax. The taxes imposed by this section shall be assessed, collected, and paid in the same manner as provided in section ten hundred and two in the case of additional taxes upon articles upon which the tax imposed by existing law has been paid. Exemption. Nothing in this section shall be construed to impose a tax upon articles sold and delivered prior to May ninth, nineteen hundred and seventeen, where the title is reserved in the vendor as security for the pay- ment of the purchase money. Yachts, boats, etc. Sec. 603. That on the day this Act takes effect, and thereafter on July first in each year, and also at the time of the original purchase of a new boat by a user, if on any other date than July first, there shall be levied, assessed, collected, and paid, upon the use of yachts, pleasure boats, power boats, and sail- ing boats, of over five net tons, and motor boats with fixed engines, not used exclusively for trade or national defense, or not built according to plans and specifica- tions approved by the Navy Department, an excise tax to be based on each yacht or boat, at rates as follows: Yachts, pleasure boats, power boats, motor boats with fixed engines, and sailing boats, of over five net tons, length not over fifty feet, 50 cents for each foot, length over fifty feet and not over one hundred feet, $1 for each foot, length over one hundred feet, $2 for each foot; 4Q2 INCOME AND FEDERAL TAX REPORTS motor boats of not over five net tons with fixed en- gines, $5. Computation of tax. In determining the length of such yachts, pleasure boats, power boats, motor boats with fixed engines, and sailing boats, the measurement of over-all length shall govern. In the case of a tax imposed at the time of the orig- inal purchase of a new boat on any other date than July first, the amount to be paid shall be the same num- ber of twelfths of the amount of the tax as the number of calendar months, including the month of sale, remain- ing prior to the following July first. Approved by the President, October 3, 1917. CHAPTER XXIV TAX ON BEVERAGES LAW BEING TITLE IV OF "AN ACT TO INCREASE THE REVENUE AND FOR OTHER PURPOSES," AP- PROVED SEPTEMBER 8, 1916. (PUBLIC No. 271 4th CONGRESS.) IN EFFECT SEPTEMBER 9, 1916. TITLE IV. MISCELLANEOUS TAXES. Taxable fermented liquors Basis of tax. Sec. 400 [of the general revenue Act of which this Title is a part]. That there shall be levied, collected, and paid a tax of $1.50 on all beer, lager beer, ale, porter, and other similar fermented liquor, brewed or manufactured and sold, or stored in warehouse, or removed for consumption or sale, within the United States, by whatever name such liquors may be called, for every barrel containing not more than thirty-one gallons ; and at a like rate for any other quantity or for the fractional parts of a barrel authorized and defined by law. And section thirty-three hundred and thirty-nine of the Revised Statutes is here- by amended accordingly. Wine defined. Sec. 401. That natural wine within the meaning of this Act shall be deemed to be the product made from the normal alcoholic fermentation of the juice of sound, ripe grapes, without addition or abstrac- tion, except such as may occur in the usual cellar treat- ment of clarifying and aging : Provided, however, That the product made from the juice of sound, ripe grapes 493 494 INCOME AND FEDERAL TAX REPORTS by complete fermentation of the must under proper cel- lar treatment and corrected by the addition (under the supervision of a gauger or storekeeper-gauger in the ca- pacity of gauger) of a solution of water and pure cane, beet, or dextrose sugar (containing, respectively, not less than ninety-five per centum of actual sugar, calcu- lated on a dry basis) to the must or to the wine, to cor : rect natural deficiencies, when such addition shall not increase the volume of the resultant product more thao thirty-five per centum, and the resultant product does not contain less than five parts per thousand of acid before fermentation and not more than thirteen per centum of alcohol after complete fermentation, shall be deemed to be wine within the meaning of this Act, and may be labeled, transported, and sold as "wine," quali- fied by the name of the locality where produced, and may be further qualified by the name of its own particu- lar type or variety: And provided further, That wine as defined in this section may be sweetened with cane sugar or beet sugar or pure condensed grape must and fortified under the provisions of this Act, and wines so sweetened or fortified shall be considered sweet wine within the meaning of this Act. Rates of tax and methods of payment. Sec. 402. (a) That upon all still wines, including vermuth, and upon all artificial or imitation wines or compound sold as wine hereafter produced in or imported into the United States, and upon ail like wines which on the date this section takes effect shall be in the possession or under the control of the producer, holder, dealer, or compoun- der there shall be levied, collected, and paid taxes at rates as follows: On wines containing not more than fourteen per cen- tum of absolute alcohol, 4 cents per wine gallon, the per centum of alcohol taxable under this section to be reck oned by volume and not by weight. On wines containing more than fourteen per cen- TAX ON BEVERAGES LAW 495 turn and not exceeding twenty-one per centum of abso- lute alcohol, 10 cents per wine gallon. On wines containing more than twenty-one per cen- tum and not exceeding twenty-four per centum of abso- lute alcohol, 25 cents per wine gallon. All such wines containing more than twenty-four per centum of absolute alcohol by volume shall be classed as distilled spirits and shall pay tax accordingly : Provided, That on all unsold still wines in the actual possession of the producer at the time this title takes effect, upon which the tax imposed by the Act approved October twenty-second, nineteen hundred and fourteen, entitled "An Act to increase the internal revenue and for other purposes," and the joint resolution approved December seventeenth, nineteen hundred and fifteen, entitled "Joint resolution extending the provisions of the Act entitled 'An Act to increase the internal revenue, and for other purposes,' approved October twenty-second, nineteen hundred and fourteen, to December thirty-first, nineteen hundred and sixteen," has been assessed, the tax so assessed shall be abated, or, if paid, refunded un- der such regulations as the Commissioner of Internal Revenue, with the approval of the Secretary of th^ Treasury, may prescribe. (b) That the taxes imposed by this section shall be paid by stamp on removal of the wines from the cus- tomhouse, winery, or other bonded place of storage for consumption or sale, and every person hereafter pro- ducing, or having in his possession or under his control when this section takes effect, any wines subject to the tax imposed in this section shall file such notice, de- scribing the premises on which such wines are produced or stored ; shall execute a bond in such form ; shall make- such inventories under oath; and shall, prior to sale or removal for consumption, affix to each cask or vessel containing such wine such marks, labels, or stamps as the Commissioner of Internal Revenue, with the ap- 496 INCOME AND FEDERAL TAX REPORTS proval of the Secretary of the Treasury, may from time to time prescribe; and the premises described in such notice shall, for the purpose of this section, be regarded as bonded premises. But the provisions of this sub- division of this section, except as to payment of tax and the affixing of the required stamps or labels, shall not apply to wines held by retail dealers, as denned in sec- tion thirty-two hundred and forty-four of the Eevised Statutes of the United States, nor, subject to regulations prescribed by the Commissioner of Internal Eevenue, with the approval of the Secretary of the Treasury, shall the tax imposed by this section apply to wines pro- duced for the family use of the producer thereof and not sold or otherwise removed from the place of manu- facture and not exceeding in any case two hundred gal- lons per year. The Commissioner of Internal Revenue is hereby authorized to have prepared and issue such stamps denoting payment of the tax imposed by this sec- tion as he may deem requisite and necessary; and until such stamps are provided the taxes imposed by this sec- tion shall be assessed and collected as other taxes are assessed and collected, and all provisions of law relating to assessment and collection of taxes, so far as ap- plicable, are hereby extended to the taxes imposed by this section. (c) That under such regulations and official super- vision and upon the giving of such notices, entries bonds, and other security as the Commissioner of In ternal Revenue, with the approval of the Secretary of the Treasury, may prescribe, any producer of wines de- fined under the provisions of this section or section four hundred and one of this Act, may withdraw from any fruit distillery or special bonded warehouse grape brandy, or wine spirits, for the fortification of such wines on the premises where actually made: Provided, That there shall be levied and assessed against the pro- ducer of such wines a tax of 10 cents per proof gallon TAX ON BEVERAGES LAW 497 of grape brandy or wine spirits so nsed by him in the fortification of such wines during the preceding month, which assessment shall be paid by him within six months from the date of notice thereof : Provided further, That nothing herein contained shall be construed as exempt- ing any wines, cordials, liqueurs, or similar compounds from the payment of any tax provided for in this section. That sections forty-two, forty-three, and forty-five of the Act of October first, eighteen hundred and ninety, as amended by section sixty-eight of the Act of August twenty-seventh, eighteen hundred and ninety-four, are further amended to read as follows: Amendment relating to wine spirits. "Sec. 42. That any producer of pure sweet wines may use in the prep- aration of such sweet wines, under such regulations and after the filing of such notices and bonds, together with the keeping of such records and the rendition of such reports as to materials and products as the Commis- sioner of Internal Kevenue, with the approval of the Secretary of the Treasury, may prescribe, wine spirits produced by any duly authorized distiller, and the Com- missioner of Internal Eevenue, in determining the lia- bility of any distiller of wine spirits to assessment un- der section thirty-three hundred and nine of the Eevised Statutes, is authorized to allow such distiller credit in his computations for the wine spirits withdrawn to be used in fortifying sweet wines under this Act. Wine spirits denned and use regulated. "Sec. 43. That the wine spirits mentioned in section forty-two herein mentioned is the product resulting from the distillation of fermented grape juice, to which water may have been added prior to, during, or after fermentation, for the sole purpose of facilitating the fermentation and eco- nomical distillation thereof, and shall be held to include the product from grapes or their residues commonly known as grape brandy, and shall include commercial grape brandy which may have been colored with burnt 498 INCOME AND FEDERAL TAX REPORTS sugar or caramel; and the pure sweet wine which may be fortified with wine spirits under the provisions of this Act is fermented or partially fermented grape juice only, with the usual cellar treatment, and shall contain no other substance whatever introduced before, at the time of or after fermentation, except as herein expressly provided: Provided, That the addition of pure boiled or condensed grape must or pure crystal- lized cane or beet sugar, or pure dextrose sugar con- taining, respectively, not less than ninety-five per centum of actual sugar, calculated on a dry basis, or water, or any or all of them, to the pure grape juice before fermentation, or to the fermented product of such grape juice, or to both, prior to the fortification herein provided for, either for the purpose of perfect- ing sweet wines according to commercial standards or for mechanical purposes, shall not be excluded by the definition of pure sweet wine aforesaid: Provided, however, That the cane or beet sugar, or pure dextrose sugar added for sweetening purposes shall not be in excess of eieven per centum of the weight of the wine to be fortified: And, Provided further, That the addi- tion of water herein authorized shall be under sucb regulations as the Commissioner of Internal Kevenue, with the approval of the Secretary of the Treasury, may from time to time prescribe: Provided, however, That records kept in accordance with such regulations as to the percentage of saccharine, acid, alcoholic, and added water content of the wine offered for fortifica- tion shall be open to inspection by any official of the Department of Agriculture thereto duly authorized by the Secretary of Agriculture; but in no case shall such wines to which water has been added be eligible for fortification under the provisions of this Act, where the same, after fermentation and before fortification, have an alcoholic strength of less than five per centum of their volume. TAX ON BEVERAGES LAW 499 Withdrawal of wine spirits from bond. "Sec. 45. That under such regulations and official supervision, and upon the execution of such entries and the giving of such bonds, bills of lading, and other security as the Commissioner of Internal Eevenue, with the approval of the Secretary of the Treasury, shall prescribe, any producer of pure sweet wines as denned by this Act may withdraw wine spirits from any special bonded warehouse in original packages or from any registered distillery in any quantity not less than eighty wine gallons, and may use so much of the same as may be required by him under such regulations, and after the filing of such notices and bonds and the keeping of such records and the rendition of such reports as to materials and products and the disposition of the same as the Commissioner of Internal Revenue, with the approval of the Secretary of the Treasury, shall pre- scribe, in fortifying the pure sweet wines made by him, and for no other purpose, in accordance with the fore- going limitations and provisions ; and the Commissioner of Internal Revenue, with the approval of the Secre- tary of the Treasury, is authorized whenever he shall deem it to be necessary for the prevention of violations of this law to prescribe that wine spirits withdrawn under this section shall not be used to fortify wines except at a certain distance prescribed by him from any distillery, rectifying house, winery, or other establish- ment used for producing or storing distilled spirits, or for making or storing wines other than wines which are so fortified, and that in the building in which such fortification of wines is practiced no wines or spirits other than those permitted by this regulation shall be stored in any room or part of the building in which fortification of wines is practiced. The use of wine spirits for the fortification of sweet wines under this Act shall be under the immediate supervision of an officer of internal revenue, who shall make returns 500 INCOME AND FEDERAL TAX REPORTS describing the kinds and quantities of wine so fortified, and shall affix such stamps and seals to the packages containing such wines as may be prescribed by the Commissioner of Internal Revenue, with the approval of the Secretary of the Treasury; and the Commis- sioner of Internal Bevenue, with the approval of the Secretary of the Treasury, shall provide by regulations the time within which wines so fortified with the wine spirits so withdrawn may be subject to inspection, and for final accounting for the use of such wine spirits and for rewarehousing or for payment of the tax on any portion of such wine spirits which remain not used in fortifying pure sweet wines." (d) That under such regulations and upon the execu- tion of such notices, entries, bonds, and other security as the Commissioner of Internal Eevenue, with the approval of the Secretary of the Treasury, may pre- scribe, domestic wines subject to the tax imposed by this section may be removed from the winery where produced, free of tax, for storage on other bonded premises or from said premises to other bonded prem- ises: Provided, That not more than one such addi- tional removal shall be allowed, or for exportation from the United States or for use as distilling material at any regularly registered distillery: Provided, how- ever, That the distiller using any such wine as material shall, subject to the provisions of section thirty-three hundred and nine of the Revised Statutes of the United States, as amended, be held to pay the tax on the product of such wines as will include both the alcoholic strength therein produced by fermentation and that obtained from the brandy or wine spirits added to such wines at the time of fortification. (e) That upon all domestic and imported sparkling wines, liqueurs, cordials, and similar compounds re- maining in the hands of dealers when this section takes effect, or thereafter removed from the place of manu- TAX ON BEVERAGES LAW 501 facture or storage for sale or consumption, there shall be levied and paid, by stamp, taxes as follows : On each bottle or other container of champagne or sparkling wine, 3 cents on each one-half pint or fraction thereof. On each bottle or other container of artificially car- bonated wine, V/ 2 cents on each one-half pint or fraction thereof. On each bottle or other container of liqueurs, cor- dials, or similar compounds, by whatever name sold or offered for sale, containing sweet wine, fortified with grape brandy under the provisions of paragraph (c) of this section, \y 2 cents on each one-half pint or fraction thereof. The taxes imposed by this section shall not apply to wines, liqueurs, or cordials on which the tax imposed by the Act approved October twenty-second, nineteen hundred and fourteen, entitled "An Act to increase the internal revenue, and for other purposes," and the joint resolution approved December seventeenth, nine- teen hundred and fifteen, entitled "Joint resolution extending the provisions of the Act entitled 'An Act to increase the internal revenue, and for other purposes,' approved October twenty-second, nineteen hundred and fourteen, to December thirty-first, nineteen hundred and sixteen," has been paid by stamp. The Commissioner of Internal Eevenue, with the approval of the Secretary of the Treasury, is hereby authorized to have prepared suitable revenue stamps denoting the payment of the taxes imposed by this section; and all provisions of law relating to internal- revenue stamps, so far as applicable, are hereby extended to the taxes imposed by this section: Pro- vided, That the collection of the tax herein prescribed on imported still wines, including vermouth, and spark- ling wines, including champagne, and on imported liqueurs, cordials, and similar compounds, may be made 502 INCOME AND FEDERAL TAX REPORTS within the discretion of the Commissioner of Internal Revenue, with the approval of the Secretary of the Treasury, by assessment instead of by stamps. (/) That any person who shall evade or attempt to evade the tax imposed by this section, or any require- ment of this section or regulation issued pursuant thereof, or who shall, otherwise than provided in this section, recover or attempt to recover any spirits from domestic or imported wine, or who shall rectify, mix, or compound with distilled spirits any domestic wines, other than in the manufacture of liqueurs, cordials, or similar compounds taxable under the provisions of this section, shall, on conviction, be punished for each such offense by a fine of not exceeding $5,000, or imprison- ment for not more than five years, or both, and all wines, spirits, liqueurs, cordials, or similar compounds as to which such violation occurs shall be forfeited to the United States. But the provision of this sub- division of this section and the provision of section thirty-two hundred and forty-four of the Revised Statutes of the United States, as amended, relating to rectification, or other internal-revenue laws of the United States, shall not be held to apply to or prohibit the mixing or blending of wines subject to tax under the provisions of this section with each other or with other wines for the sole purpose of perfecting such wines according to commercial standards: Provided, That nothing herein contained shall be construed as prohibiting the use of tax-paid grain or other ethyl alcohol in the fortification of sweet wines as defined in section fifty- three [401?] of this Act. (g) That the Commissioner of Internal Revenue, by regulations to be approved by the Secretary of the Treasury, may require the use at each fruit distillery of such spirit meters, and such locks and seals to be affixed to fermenters, tanks, or other vessels and to such pipe connections as may in his judgment be TAX ON BEVERAGES LAW 503 necessary or expedient; and the said commissioner is hereby authorized to assign to any such distillery and to each winery where wines are to be fortified such number of gaugers or storekeeper-gaugers in the capac- ity of gaugers as may be necessary for the proper supervision of the manufacture of brandy or the mak- ing or fortifying of wines subject to tax imposed by this section; and the compensation of such officers shall not exceed $5 per diem while so assigned, together with their actual and necessary traveling expenses, and also a reasonable allowance for their board bills, to be fixed by the Commissioner of Internal Revenue, with the approval of the Secretary of the Treasury, but not to exceed $2.50 per diem for said board bills. (h) That the Commissioner of Internal Revenue, with the approval of the Secretary of the Treasury, is hereby authorized to make such allowances for unavoidable loss of wines while on storage or during cellar treatment as in his judgment may be just and proper, and to prepare all necessary regulations for carrying into effect the provisions of this section. (i) That the second paragraph of section thirty- two hundred and sixty-four, Revised Statutes of the United States of America, as amended by section five of the Act of March first, eighteen hundred and seventy-nine, and as further amended by the Act of Congress approved June twenty-second, nineteen hundred and ten, be amended so as to read as follows: "In all surveys forty-five gallons of mash or beer brewed or fermented from grain shall represent not less than one bushel of grain, and seven gallons of mash or beer brewed or fermented from molasses shall represent not less than one gallon of molasses, except in distilleries operated on the sour-mash principle, in which distilleries sixty gallons of beer brewed or fer- mented from grain shall represent not less than one bushel of grain, and except that in distilleries where 504 INCOME AND FEDERAL TAX REPORTS the filtration-aeration process is used, with the ap- proval of the Commissioner of Internal Revenue; that is, where the mash after it leaves the mash tub is passed through a filtering machine before it is run into the fermenting tub, and only the filtered liquor passes into the fermenting tub, there shall hereafter be no limitation upon the number of gallons of water which may be used in the process of mashing or filtration for fermentation; but the Commissioner of Internal Revenue, with the approval of the Secretary of the Treasury, in order to protect the revenue, shall be authorized to prescribe by regulation, to be made by him, such character of survey as he may find suitable for distilleries using such filtration-aeration process. The provisions hereof relating to filtration-aeration process shall apply only to sweet-mash distilleries." Spirits removed for export. Sec. 403. That under such regulations as the Commissioner of Internal Revenue, with the approval of the Secretary of the Treasury, may prescribe, alcohol or other distilled spirits of a proof strength of not less than one hundred and eighty degrees intended for export free of tax may be drawn from receiving cisterns at any distillery, or from storage tanks in any distillery warehouse, for transfer to tanks or tank cars for export from the United States, and all provisions of existing law relat- ing to the exportation of distilled spirits not inconsistent herewith shall apply to spirits removed for export under the provisions of this Act. Amendment exempting certain distillers. Sec. 404. That section thirty-two hundred and fifty-five of the Revised Statutes as amended by Act of June third, eighteen hundred and ninety-six, and as further amended by Act of March second, nineteen hundred and eleven, be further amended so as to read as follows : "Sec. 3255. The Commissioner of Internal Revenue, TAX ON BEVERAGES LAW 505 with the approval of the Secretary of the Treasury, may exempt distillers of brandy made exclusively from apples, peaches, grapes, pears, pineapples, oranges, apricots, berries, plums, pawpaws, persimmons, prunes, figs, or cherries from any provision of this title relat- ing to the manufacture of spirits, except as to the tax thereon, when in his judgment it may seem expedient to do so: Provided, That where, in manufacture of wine, artificial sweetening has been used the wine or the fruit pomace residuum may be used in the distilla- tion of brandy, as [and?] such use shall not prevent the CommissioDer of Internal Eevenue, with the approval of the Secretary of the Treasury, from exempting such distiller from any provision of this title relating to the manufacture of spirits, except as to the tax thereon, when in his judgment it may seem expedient to do so: And, Provided further, That the distillers mentioned in this section may add to not less than five hundred gallons (or ten barrels) of grape cheese not more than five hundred gallons of a sugar solution made from cane, beet, starch, or corn sugar, ninety-five per centum pure, such solution to have a saccharine strength of not to exceed ten per centum, and may ferment the resultant mixture on a winery or distillery premises, and such fermented product shall be regarded as distilling material." Gin bottled in bond for export. Sec. 405. That dis- tilled spirits known commercially as gin of not less than eighty per centum proof may at any time within eight years after entry in bond at any distillery be bottled in bond at such distillery for export without the payment of tax, under such rules and regulations as the Commissioner of Internal Eevenue, with the approval of the Secretary of the Treasury, may prescribe. Amendment Penalties for removal of fermented liquor tax unpaid. Sec. 406. That section thirty-three hun- 506 INCOME AND FEDERAL TAX REPORTS dred and fifty-four of the Eevised Statutes of the United States as amended by the Act approved June eighteenth, eighteen hundred and ninety, be, and is hereby, amended to read as follows: "Sec. 3354. Every person who withdraws any fer- mented liquor from any hogshead, barrel, keg, or other vessel upon which the proper stamp has not been affixed for the purpose of bottling the same, or who carries on or attempts to carry on the business of bottling fermented liquor in any brewery or other place in which fermented liquor is made, or upon any premises having communication with such brewery, or any ware- house, shall be liable to a fine of $500, and the property used in such bottling or business shall be liable to for- feiture: Provided, however, That this section shall not be construed to prevent the withdrawal and trans- fer of unfermented, partially fermented, or fermented liquors from any of the vats in any brewery by way of a pipe line or other conduit to another building or place for the sole purpose of bottling the same, such pipe line or conduit to be constructed and operated in such manner and with such cisterns, vats, tanks, valves, cocks, faucets, and gauges, or other utensils or appar- atus, either on the premises of the brewery or the bot- tling house and with such changes of or additions thereto, and such locks, seals, or other fastenings, and under such rules and regulations as shall be from time to time prescribed by the Commissioner of Internal Ee venue, subject to the approval of the Secretary of the Treasury, and all locks and seals prescribed shall be provided by the Commissioner of Internal Revenue at the expense of the United States. Provided further, That the tax imposed in section thirty-three hundred and thirty-nine of the Revised Statutes of the United States shall be paid on all fermented liquor removed from a brewery to a bottling house by means of a pipe or conduit, at the time of such removal, by the TAX ON BEVERAGES LAW 507 cancellation and defacement, by the collector of the district or his deputy, in the presence of the brewer, of the number of stamps denoting the tax on the fer- mented liquor thus removed. The stamps thus canceled and defaced shall be disposed of and accounted for in the manner directed by the Commissioner of Internal Eevenue, with the approval of the Secretary of the Treasury. And any violation of the rules and regula- tions hereafter prescribed by the Commissioner of Internal Revenue, with the approval of the Secretary of the Treasury, in pursuance of these provisions, shall be subject to the penalties above provided by this section. Every owner, agent, or superintendent of any brewery or bottling house who removes, or connives at the removal of, any fermented liquor through a pipe line or conduit, without payment of the tax thereon, or who attempts in any manner to defraud the revenue as above, shall forfeit all the liquors made by and for him, and all the vessels, utensils, and apparatus used in making the same." Sec. 407. [Occupational taxes, including excise tax on corportions. See page 471.] Sec. 408. [Special tax on tobacco manufacturers. See page 473.] Administration. Sec. 409. That all administrative or special provisions of law, including the law relating to the assessment of taxes, so far as applicable, are hereby extended to and made a part of this title, and every person, firm, company, corporation, or associa- tion liable to any tax imposed by this title, shall keep such records and render, under oath, such statements and returns, and shall comply with such regulations as the Commissioner of Internal Revenue, with the approval of the Secretary of the Treasury, may from time to time prescribe. Act of October 22, 1914, repealed in part. Sec. 410. That the Act approved October twenty-second, nine- 508 INCOME AND FEDERAL TAX REPORTS teen hundred and fourteen, entitled, "An Act to in- crease the internal revenue, and for other purposes," and the joint resolution approved December seven- teenth, nineteen hundred and fifteen, entitled "Joint resolution extending the provisions of the Act entitled 'An Act to increase the internal revenue, and for other purposes,' approved October twenty-second, nineteen hundred and fourteen, to December thirty-first, nine- teen hundred and sixteen," are hereby repealed, except sections three and four of such Act as so extended, which sections shall remain in force till January first, nineteen hundred and seventeen, and except that the provisions of the said Act shall remain in force for the assessment and collection of all special taxes imposed by sections three and four thereof, or by such sections as extended by said joint resolution, for any year or part thereof ending prior to January first, nineteen hundred and seventeen, and of all other taxes imposed by such Act, or by such Act as so extended, accrued prior to the taking effect of this title, and for the imposition and collection of all penalties or forfeit- ures which have accrued or may accrue in relation to any of such taxes. Redemption of unused stamps. Sec. 411. That the Commissioner of Internal Eevenue, subject to regula- tion prescribed by the Secretary of the Treasury, may make allowance for or redeem stamps, issued, under authority of the Act approved October twenty-second, nineteen hundred and fourteen, entitled "An Act to increase the internal revenue, and for other purposes," and the joint resolution approved December seven- teenth, nineteen hundred and fifteen, entitled "Joint resolution extending the provisions of the Act entitled 'An Act to increase the internal revenue, and for other purposes,' approved October twenty-second, nineteen hundred and fourteen, to December thirty-first, nine- teen hundred and sixteen," to denote the payment of TAX ON BEVERAGES LAW 509 internal revenue tax, and which have not been used, if presented within two years after the purchase of such stamps. Act effective on day following passage. Sec. 412. That the provisions of this title shall take effect on the day following the passage of this Act, except where other- wise in this title provided. Sec. 413. [Leaves of absence for internal revenue officers.] Invalidating Clause. Sec. 900 [of the general revenue Act of which the above Title IV is a part]. That if any clause, sen- tence, paragraph, or part of this Act shall for any reason be adjudged by any court of competent juris- diction to be invalid, such judgment shall not affect, impair, or invalidate the remainder of said Act, but shall be confined in its operation to the clause, sentence, paragraph, or part thereof directly involved in the controversy in which such judgment shall have been rendered. Sec. 902. That unless otherwise herein specially provided this Act shall take effect on the day following its passage, and all provisions of any Act or Acts incon- sistent with the provisions of this Act, are hereby repealed. Approved by the President, September 8, 1916. TITLE III. WAR TAX ON BEVERAGES 1 Additional tax on distilled spirits. Sec. 300 [of the general revenue Act of which this Title is a part]. That on and after the passage of this Act there shall be levied and collected on all distilled spirits in bond i War Tax on Beverages. Being Title III of "An Act to Provide Revenue to Defray War Expenses, and for Other Purposes." Approved October 3, 1917. (Public No. 50 65th Congress.) In effect October 4, 1917, unless otherwise specially provided. 510 INCOME AND FEDERAL TAX REPORTS at that time or that have been or that may be then or thereafter produced in or imported into the United States, except such distilled spirits as are subject to the tax provided in section three hundred and three, in addition to the tax now imposed by law, a tax of $1.10 (or, if withdrawn for beverage purposes or for use in the manufacture or production of any article used or intended for use as a beverage, a tax of $2.10) on each proof gallon, or wine gallon when below proof, and a proportionate tax at a like rate on all fractional parts of such proof or wine gallon, to be paid by the distiller or importer when withdrawn and collected under the provisions of existing law. Additional tax on imported perfumes containing distilled spirits. That in addition to the tax under existing law there shall be levied and collected upon all perfumes hereafter imported into the United States containing distilled spirits, a tax of $1.10 per wine gallon, and a proportionate tax at a like rate on all fractional parts of such wine gallon. Such tax shall be collected by the collector of customs and deposited as internal- revenue collections, under such rules and regulations as the Commissioner of Internal Revenue, with the ap- proval of the Secretary of the Treasury may prescribe. Importing of distilled spirits for beverage purposes pro- hibited. Sec. 301. That no distilled spirits produced after the passage of this Act shall be imported into the United States from any foreign country, or from the West Indian Islands recently acquired from Denmark (unless produced from products the growth of such islands, and not then into any State or Territory or Dis- trict of the United States in which the manufacture or sale of intoxicating liquor is prohibited), or from Porto Rico, or the Philippine Islands. Under such rules, regulations, and bonds as the Secretary of the Treasury may prescribe, the provisions of this section shall not apply to distilled spirits imported for other than (1) TAX ON BEVERAGES LAW 511 beverage purposes or (2) use in the manufacture or production of any article used or intended for use as a beverage. Removal of spirits from registered distilleries. Sec. 302. That at registered distilleries producing alcohol, or other high-proof spirits, packages may be filled with such spirits reduced to not less than one hundred proof from the receiving cisterns and tax paid without being entered into bonded warehouse. Such spirits may also be transferred from the receiving cisterns at such dis- tilleries, by means of pipe lines, direct to storage tanks in the bonded warehouse and may be warehoused in such storage tanks. Such spirits may be also trans- ferred in tanks or tank cars to general bonded ware- houses for storage therein, either in storage tanks in such warehouses or in the tanks in which they were transferred. Such spirits may also be transferred after tax payment from receiving cisterns or ware- house storage tanks to tanks or tank cars and may be transported in such tanks or tank cars to the premises of rectifiers of spirits. The Commissioner of Internal Eevenue, with the approval of the Secretary of the Treasury, is hereby empowered to prescribe all neces- sary regulations relating to the drawing off, trans- ferring, gauging, storing and transporting of such spirits ; the records to be kept and returns to be made ; the size and kind of packages and tanks to be used; the marking, branding, numbering and stamping of such packages and tanks; the kinds of stamps, if any, to be used ; and the time and manner of paying the tax ; the kind of bond and the penal sum of same. The tax prescribed by law must be paid before such spirits are removed from the distillery premises, or from general bonded warehouse in the case of spirits transferred thereto, except as otherwise provided by law. Warehouse regulations. Under such regulations as the Commissioner of Internal Revenue, with the approval 512 INCOME AND FEDERAL TAX REPORTS of the Secretary of the Treasury, may prescribe, dis- tilled spirits may hereafter be drawn from receiving cisterns and deposited in distillery warehouses without having affixed to the packages containing the same dis- tillery warehouse stamps, and such packages, when so deposited in warehouse, may be withdrawn therefrom on the original gauge where the same have remained in such warehouse for a period not exceeding thirty days from the date of deposit. Exemptions relating to ethyl and denatured alcohol. Under such regulations as the Commissioner of In- ternal Eevenue, with the approval of the Secretary of the Treasury, may prescribe, the manufacture, ware- housing, withdrawal, and shipment, under the provisions of existing law, of ethyl alcohol for other than (1) bev- erage purposes or (2) use in the manufacture or produc- tion of any article used or intended for use as a beverage and denatured alcohol, may be exempted from the pro- visions of section thirty-two hundred and eighty-three, Eevised Statutes of the United States. Regulations in manufacture of ethyl alcohol. Under such regulations as the Commissioner of Internal Eevenue, with the approval of the Secretary of the Treasury, may prescribe, manufacturers of ethyl alcohol for other than beverage purposes may be granted permission under the provisions of section thirty-two hundred and eighty-five, Eevised Statutes of the United States, to fill fermenting tubs in a sweet-mash distillery not oftener than once in forty-eight hours. Floor tax imposed upon stocks of distilled spirits. Sec. 303. That upon all distilled spirits produced in or imported into the United States upon which the tax now imposed by law has been paid, and which, on the day this Act is passed, are held by a retailer in a quantity in excess of fifty gallons in the aggregate, or by any other person, corporation, partnership, or association in any quantity, and which are intended for TAX ON BEVERAGES LAW 513 sale, there shall be levied, assessed, collected, and paid a tax of $1.10 (or, if intended for sale for beverage purposes or for use in the manufacture or production of any article used or intended for use as a beverage, a tax of $2.10) on each proof gallon, and a propor- tionate tax at a like rate on all fractional parts of such proof gallon: Provided, That the tax on such distilled spirits in the custody of a court of bankruptcy in insolvency proceedings on June first, nineteen hundred and seventeen, shall be paid by the person to whom the court delivers such distilled spirits at the time of such delivery, to the extent that the amount thus de- livered exceeds the fifty gallons hereinbefore provided. War tax on rectified distilled spirits and wines. Sec. 304. That in addition to the tax now imposed or im- posed by this Act on distilled spirits there shall be levied, assessed, collected, and paid a tax of 15 cents on each proof gallon and a proportionate tax at a like rate on all fractional parts of such proof gallon on all distilled spirits or wines hereafter rectified, purified, or refined in such manner, and on all mixtures here- after produced in such manner, that the person so rectifying, purifying, refining, or mixing the same is a rectifier within the meaning of section thirty-two hundred and forty-four, Revised Statutes, as amended, and on all such articles in the possession of the recti- fier on the day this Act is passed: Provided, That this tax shall not apply to gin pro- duced by the redistillation of a pure spirit over juniper berries and other aromatics. Dilution prohibited. When the process of rectifica- tion is completed and the tax prescribed by this section has been paid, it shall be unlawful for the rectifier or any other dealer to reduce in proof or increase in volume such spirits or wine by the addition of water or other substance; nothing herein contained shall, however, prevent a rectifier from using again in the 514 INCOME AND FEDERAL TAX REPORTS process of rectification spirits already rectified and upon which the tax has theretofore been paid. Exemptions from war tax. The tax imposed by this section shall not attach to cordials or liqueurs on which a tax is imposed and paid under the Act entitled "An Act to increase the revenue, and for other purposes," approved September eighth, nineteen hundred and six- teen, nor to the mixing and blending of wines, where such blending is for the sole purpose of perfecting such wines according to commercial standards, nor to blends made exclusively of two or more pure straight whiskies aged in wood for a period not less than four years and without the addition of coloring or flavoring matter or any other substance than pure water and if not reduced below ninety proof: Provided, That such blended whiskies shall be exempt from tax under this section only when compounded under the imme- diate supervision of a revenue officer, in such tanks and under such conditions and supervision as the Com- missioner of Internal Kevenue, with the approval of the Secretary of the Treasury, may prescribe. Distilled spirits subject to uniform regulations. All distilled spirits taxable under this section shall be sub- ject to uniform regulations concerning the use thereof in the manufacture, blending, compounding, mixing, marking, branding, and sale of whiskey and rectified spirits, and no discrimination whatsoever shall be made by reason of a difference in the character of the mate- rial from which same may have been produced. Rectifier subject to regulations of Commissioner of Internal Revenue. The business of a rectifier of spirits shall be carried on, and the tax on rectified spirits shall be paid, under such rules, regulations, and bonds as may be prescribed by the Commissioner of Internal .Revenue, with the approval of the Secretary of the Treasury. TAX ON BEVERAGES LAW 515 Penalties. Any person violating any of the provis- ions of this section shall be deemed to be guilty of a misdemeanor and, upon conviction, shall be fined not more than $1,000 or imprisoned not more than two years. He shall, in addition, be liable to double the tax evaded together with the tax, to be collected by assessment or on any bond given. Stamp regulations. Sec, 305. That hereafter col- lectors of internal revenue shall not furnish wholesale liquor dealer's stamps in lieu of and in exchange for stamps for rectified spirits unless the package covered by stamp for rectified spirits is to be broken into smaller packages. The Commissioner of Internal Eevenue, with the approval of the Secretary of the Treasury, is author- ized to discontinue the use of the following stamps whenever in his judgment the interests of the Govern- ment will be subserved thereby : Distillery warehouse, special bonded warehouse, special bonded rewarehouse, general bonded warehouse, general bonded retransfer, transfer brandy, export tobacco, export cigars, export oleomargarine and export fermented liquor stamps. Commissioner may require installation of revenue-pro- tecting apparatus. Sec. 306. That the Commissioner of Internal Eevenue, with the approval of the Secre- tary of the Treasury, is hereby authorized to require at distilleries, breweries, rectifying houses, and wherever else in his judgment such action may be deemed advisable, the installation of meters, tanks, pipes, or any other apparatus for the purpose of pro- tecting the revenue, and such meters, tanks, and pipes and all necessary labor incident thereto shall be at the expense of the person, corporation, partnership, or association on whose premises the installation is re- quired. Any such person, corporation, partnership, or association refusing or neglecting to install such 516 INCOME AND FEDERAL TAX REPORTS apparatus when so required by the commissioner shall not be permitted to conduct business on such premises. War tax on beer, ale, porter, etc. Sec. 307. That on and after the passage of this Act there shall be levied and collected on all beer, lager beer, ale, porter, and other similar fermented liquor, containing one-half per centum or more of alcohol, brewed or manufactured and sold, or stored in warehouse, or removed for con- sumption or sale, within the United States, by whatever name such liquors may be called, in addition to the tax now imposed by law, a tax of $1.50 for every barrel containing not more than thirty-one gallons, and at a like rate for any other quantity or for the fractional parts of a barrel authorized and denned by law. Removal from brewery to distillery. Sec. 308. That from and after the passage of this Act taxable fer- mented liquors may be conveyed without payment of tax from the brewery premises where produced to a contiguous industrial distillery of either class estab- lished under the Act of October third, nineteen hundred and thirteen, to be used as distilling material, and the residue from such distillation, containing less than one-half of one per centum of alcohol by volume, which is to be used in making beverages, may be manipulated by cooling, flavoring, carbonating, settling, and filter- ing on the distillery premises or elsewhere. The removal of the taxable fermented liquor from the brewery to the distillery and the operation of the distillery and removal of the residue therefrom shall be under the supervision of such officer or officers as the Commissioner of Internal Revenue shall deem proper, and the Commissioner of Internal Revenue, with the approval of the Secretary of the Treasury, is hereby authorized to make such regulations from time to time as may be necessary to give force and effect to this section and to safeguard the revenue. TAX ON BEVERAGES LAW 517 Tax doubled on still wines, champagnes, etc. Sec. 309. That upon all still wines, including vermuth, and upon all champagne and other sparkling wines, liqueurs, cordials, artificial or imitation wines or compounds sold as wine, produced in or imported into the United States, and hereafter removed from the custom-house, place of manufacture, or from bonded premises for sale or consumption, there shall be levied and collected, in addition to the tax now imposed by law upon such articles, a tax equal to such tax, to be levied, collected, and paid under the provisions of existing law. Floor tax on excess stocks of still wines, etc. Sec. 310. That upon all articles specified in section three hundred and nine upon which the tax now imposed by law has been paid and which are on the day this Act is passed held in excess of twenty-five gallons in the aggregate of such articles add intended for sale, there shall be levied, collected, and paid a tax equal to the tax imposed by such section. Withdrawal of grape brandy or wine spirits. Sec. 311. That upon all grape brandy or wine spirits with- drawn by a producer of wines from any fruit distillery or special bonded warehouse under subdivision (c) of section four hundred and two of the Act entitled "An Act to increase the revenue, and for other purposes," approved September eighth, nineteen hundred and six- teen, there shall be levied, assessed, collected, and paid in addition to the tax therein imposed, a tax equal to double such tax, to be assessed, collected, and paid under the provisions of existing law. Floor tax on sweet wines as fortified. Sec. 312. That upon all sweet wines held for sale by the producer thereof upon the day this Act is passed there shall be levied, assessed, collected, and paid an additional tax equivalent to 10 cents per proof gallon upon the grape brandy or wine spirits used in the fortification of such wine, and an additional tax of 20 cents per proof 518 INCOME AND FEDERAL TAX REPORTS gallon shall be levied, assessed, collected, and paid upon all grape brandy or wine spirits withdrawn by a producer of sweet wines for the purpose of fortifying such wines and not so used prior to the passage of this Act. Sirups and extracts in manufacture of soft drinks. Sec. 313. That there shall be levied, assessed, collected, and paid (a) Upon all prepared sirups or extracts (intended for use in the manufacture or production of beverages, commonly known as soft drinks, by soda fountains, bottling establishments, and other similar places) sold by the manufacturer, producer, or importer thereof, if so sold for not more than $1.30 per gallon, a tax of 5 cents per gallon; if so sold for more than $1.30 and not more than $2 per gallon, a tax of 8 cents per gallon; if so sold for more than $2 and not more than $3 per gallon, a tax of 10 cents per gallon; if so sold for more than $3 and not more than $4 per gallon, a tax of 15 cents per gallon; and if so sold for more than $4 per gallon, a tax of 20 cents per gallon; and Soft drinks. (b) Upon all unfermented grape juice, soft drinks or artificial mineral waters (not carbon- ated), and fermented liquors containing less than one- half per centum of alcohol, sold by the manufacturer, producer, or importer thereof, in bottles or other closed containers, and upon all ginger ale, root beer, sarsapar- illa, pop, and other carbonated waters or beverages, manufactured and sold by the manufacturer, producer, or importer of the carbonic acid gas used in carbonat- ing the same, a tax of 1 cent per gallon; and Natural mineral or table waters. (c) Upon all natural mineral waters or table waters, sold by the producer, bottler, or importer thereof, in bottles or other closed containers, at over 10 cents per gallon, a tax of 1 cent per gallon. TAX ON BEVERAGES LAW 519 Monthly returns by manufacturer, bottler, importer, etc., of sirups, soft drinks, and natural mineral waters. Sec. 314. That each such manufacturer, producer, bottler, or im- porter shall make monthly returns under oath to the col- lector of internal revenue for the district in which is lo- cated the principal place of business, containing such in- formation necessary for the assessment of the tax, and at such times and in such manner, as the Commissioner of Internal Revenue, with the approval of the Secretary of the Treasury, may by regulation prescribe. Carbonic Acid Gas. Sec. 315. That upon all carbonic acid gas in drums or other containers (intended for use in the manufacture or production of carbonated water or other drinks) sold by the manufacturer, pro- ducer, or importer thereof, there shall be levied, assessed, collected, and paid a tax of 5 cents per pound. Such tax shall be paid by the purchaser to the vendor thereof and shall be collected, returned, and paid to the United States by such vendor in the same manner as provided in section five hundred and three. Approved by the President, October 3, 1917. CHAPTER XXV WAR STAMP TAXES What is taxed. Bonds of indebtedness, debentures or certificates of indebtedness; bonds of indemnity and surety; capital stock issues; capital stock sales and transfers; produce sales on exchanges or boards of trade; drafts or checks payable otherwise than at sight or on demand; promissory notes; conveyances; deeds; instruments conveying lands, tenements or other realty; entry of goods at customhouse, entry for withdrawal of goods from customs bonded warehouses; passage tickets to foreign ports except in Canada or Mexico; voting proxies; powers of attorney; and parcels post packages are subject to a stamp tax on and after De- cember 1, 1917, under Title VIII of the Act of October 3, 1917. Playing cards are also subjected to an additional tax, effective on and after Oct. 4, 1917. The rate of tax and method of payment in each case will be given in following sections of this chapter, each class of document or article subject to tax being treated in a separate section. Who pays the tax. In the case of documents requiring the tax stamp affixed, the tax is intended to be paid by the person 1 who makes or issues the instrument, but the penalty provided is equally upon the person who accepts a taxable instrument upon which the tax stamps have not been duly affixed. In the case of parcel post packages, the tax is paid i "Person" includes "corporation," "partnership," and association. 520 WAR STAMP TAXES 521 by the sender of the package, and without the payment of the tax the package will not be transported. In the case of playing cards the tax is to be paid by the manufacturer or importer. Exemptions. The tax does not attach to any bond, note or other instrument issued by the United States or by any foreign government, or by any State, Territory or the District of Columbia or local subdivision thereof, or municipal or other corporation exercising the taxing power, when issued in the exercise of a strictly govern- mental, taxing or municipal function. Bonds given by officials of a State, township, county or village, for the faithful performance of duties, and any bonds given to the same political subdivisions cov- ering contracts for governmental purposes or the pro- tection of the State, township, county, village or munici- pality, in any respect, are held to be free from Federal taxation on the broad ground that the sovereign States and subdivisions thereof are constitutionally free from taxation by the Federal Government. This ruling does not apply to bonds otherwise taxable given to the Fed- eral Government for any purpose. Government officers and employees should be careful not to pay the tax, as they can not be reimbursed by the Department of Commerce for such payments inadver- tently made. Exemption is provided also for stocks and bonds is- sued by cooperative building and loan associations which are organized and operated exclusively for the benefit of their members and make loans only to their shareholders. Stocks and bonds issued by mutual ditch or irrigating companies are also exempt. Checks and drafts payable at sight or on demand are not taxed. This exemption does not apply, however, to promissory notes. Bank notes intended for circulation are exempt. 522 INCOME AND FEDERAL TAX REPORTS Bonds of indebtedness. Tax is imposed on bonds of in- debtedness as follows : "Bonds, debentures or certificates of indebtedness issued on and after the first day of De- cember, nineteen hundred and seventeen, by any person, corporation, partnership or association, on each $100 of face value or fraction thereof, 5 cents: Provided, that every renewal of the foregoing shall be taxed as a new issue: Provided, further, that when a bond conditioned for the repayment or payment of money is given in a penal sum greater than the debt secured, the tax shall be based upon the amount secured." A bond is a written promise, under seal, to pay a speci- fied sum of money at a fixed time in the future, and, in the case of corporate or municipal issues, is usually one of a series of similar bonds all carrying interest at a fixed rate. Each bond contains certain provisons as to the time, place and manner of these payments, and usu- ally refers to the mortgage, if any, made to insure their fulfillment or to the law, if any, authorizing the issue. While bonds may be issued by individuals, partner- ships and associations, as well as by corporations, their use is largely confined to corporations (and government or municipal bodies), since the length of time usually in- volved makes the bonds of an individual, in the judg- ment of the market, an uncertain investment. The tax on bonds is only upon issue or renewal on and after December 1, 1917. Subsequent sale or transfer of the bond is not taxable. "Issue" means the first delivery of the instrument, complete in form, to the person who takes it as a holder. "Eenewal," strictly speaking, refers to a new issue supplanting the old, in which some change is made in the agreement, as to time of payment, rate of interest, security or other matters. It is to be presumed that ex- tended bonds will be classed as renewed, for the purpose of the tax. Extended or continued bonds may be, for example, either (1) a new issue with extended date of WAR STAMP TAXES 523 maturity given to the holders of outstanding bonds in exchange for the old ones, in a reorganization or read- justment of a corporation, or (2) the same bonds may be retained and coupons issued for an additional interest period. Bonds are then "stamped." A literal construction of the clause in regard to re- newal of bonds, etc., "Provided further, that every re- newal of the foregoing shall be taxed as a new issue," would impose the renewal tax only upon the "foregoing," which word refers, literally, to "bonds, debentures or certificates of indebtedness issued on and after Decem- ber 1, 1917." Under such a construction, renewals of bonds which were first issued prior to that date would not be taxable, but it is held that the intent of the law was to tax all renewals of bonds, regardless of when the bonds were first issued. In the case of organization or reorganization of a cor- poration, "temporary bonds" may be issued, pending the issue of the regular bonds. Such interim or tem- porary bonds are really a substitute for the permanent bond, and contain the essential recitals. They would be taxable, and if the tax were duly paid, might be sold or transferred or exchanged for the regular bonds, either by the original owner or by a new owner, without additional tax, since the tax does not attach to sale or transfer of a bond, and it would therefore not attach to the sale or transfer of a substitute for the bond. Temporary receipts would be classed with temporary bonds and be subject to the same conditions. A tem- porary receipt, strictly speaking, is a formal acknowl- edgment by a banking house, trust company or the issu- ing corporation of the payment for a bond not yet pre- pared for delivery and the promise to deliver the bond, when prepared, on surrender of the receipt at the proper offices. The distinction ordinarily made between a tem- porary receipt and a temporary bond is that the latter 524 INCOME AND FEDERAL TAX REPORTS is not merely an acknowledgment of value received, but is a substitute for the regular bond. Certificates of deposit of money issued by banks and trust companies are not taxable, whether they are time certificates or whether they contain a certain clause re- serving the right of requiring thirty days' notice for payment. Certificates of deposit issued by a depositary upon receiving bonds or other securities deposited under a reorganization agreement would, generally speaking, be taxable if designed to serve as a substitute for a taxable security. There is no tax upon a contract or agreement by a corporation to issue stock. Debentures. -Although in England the term "deben- ture" implies a charge upon property of the issuing cor- poration, the word is used in the United States to desig- nate a bond without specific security, which rests merely upon the general credit of the company. This is not true of debentures of a financial company, however, which are by law required to be secured. Debentures are classed with bonds for the purpose of the tax, which at- taches, as in the case of bonds, only upon issue or re- newal, and not upon subsequent sale or transfer. Certificates of indebtedness. Certificates of indebted- ness, as contemplated by the tax, are formally executed corporate promises to pay a fixed sum of money in the future. If such certificates are issued under seal and have a far-distant date of maturity they would be classed with bonds. Short term promises to pay, not under seal, would be classed as promissory notes. Trust certificates, stock trust certificates and stock inter- est certificates. The foregoing should be classed with bonds where there is an obligation cited to pay princi- pal, interest or both. Indemnity and surety bonds. The tax on bonds for in- demnifying any person or concern as surety, and on bonds for the due performance of contracts, when no WAR STAMP TAXES 525 premium or fee is paid for the issuance of the bond, is 50 cents for each bond. If a premium is charged for the execution of the bond, the tax is based on the amount of the premium and is at the rate of 1 cent for each $1 or fractional part there- of of the premium charged. The rate and amount of premium charged should be stated on the bond, so that correctness of tax may be verified. Policies of reinsur- ance are exempt. Bonds required in legal proceedings are not taxable. Capital stock original issue. Stock certificates, evi- dencing the stockholder's ownership interest in the issu- ing association, company or corporation, are taxable, like bonds, at the time of issue or renewal, and in addition, are taxable upon sale or transfer. In the case of capital stock with face value, issued upon organization or upon reorganization of any non-exempt association, company or corporation on or after December 1, 1917, a tax is imposed of 5 cents for each $100 or fraction thereof of face value. In the case of stock without face, or par, value, the tax is 5 cents for each share, provided, that if the actual market value of such stock exceeds $100 per share the tax will be 5 cents for each $100 or fraction thereof of the total actual value. For example, in the case of stock with face value, the basis of the tax would be the total face value of the shares issued, regardless of the face value of the indi- vidual shares, which might be $5, $50 or $100, without affecting the amount of the tax. In the case of non-par shares, however, if the actual value is less than $100 per share, the tax is 5 cents upon each individual share. In all cases of issue of capital stock, the stamps de- noting the payment of the tax must be attached to the stock books and not to the certificates themselves. Where there are no stubs or stock books, but loose cer- tificates are issued, the stamps must be affixed to the books of record in which the issues are recorded. INCOME AND FEDERAL TAX REPORTS Ad interim stock certificates. Issues of interim certifi- cates, that is, certificates entitling the holder thereof to receive stock when, as and if issued, pending stock issue of corporations organized or reorganized on or after December 1, 1917, are subject to a tax of 5 cents on each $100 of face value or fraction thereof. Subsequent ex- change of such interim for regular stock certificates will not be subject to tax, but if meanwhile the interim cer- tificate is sold or transferred a sale or transfer tax must be paid. There is no stamp tax upon articles of incor- poration, applications for the issuance of corporate charters, contracts for the performance of services, or upon contracts or agreements by a corporation to issue stock. Capital stock sales, transfers, or agreements to sell. A tax of 2 cents on each $100 of face value or fraction thereof, or in the case of stock without par value, 2 cents on each share, or if value exceeds $100 per share, 2 cents upon each $100 of actual value, or fraction thereof, is imposed upon all sales, or agreements to sell, or memo- randa of sales or deliveries of, or transfer of legal title to shares of certificates of stock in any association, com- pany or corporation, whether made upon or shown by the books of the company, or by assignment in blank, or by any delivery, paper, agreement, memorandum or other evidence of transfer or sale, whether entitling the holder in any manner to the benefit of such stock or not. In computing the tax on such sales or transfers of stock, the basis is the total face, or par, value of all the shares involved in a single transaction, even though the shares are represented by several different certificates. The amount of the tax would be the same upon a trans- fer of ten $50 shares as it would be upon that of five $100 shares, that is 10 cents, or 2 cents for each $100 of face value or fraction thereof. It must be noted, however, that in the case of stock without face, or par, value, the tax upon sale or transfer WAR STAMP TAXES 527 is 2 cents for each share, unless the actual value of each share exceeds $100, in which case the tax is the same as upon shares with face value 2 cents for each $100 or fraction thereof involved in the total transaction. The valuation of non-par stock is to be determined by the actual, sale, or market value. The tax upon transfer or sale of stock must be paid regardless of whether the transfer is made before or after the issuance of the original certificate. Where a corporation organized under the laws of Canada or any other foreign country issues stock in the United States on and after December 1, 1917, such stock is subject to tax. The tax is not imposed upon the deposit of stock cer- tificates as collateral security for money loaned thereon nor upon an agreement relating to such deposit, unless the stock is actually sold, nor is the tax imposed upon deliveries or transfers to a broker for sale, nor upon the delivery or transfer of stock purchased by a broker, to his customer. Such deliveries or transfers, however, must be accompanied by a certificate setting forth the facts. Of course, at the time a broker sells the stock he has received from his customer, a tax must be paid. This may be paid by the broker, who later charges his customer with the amount of the tax. Where stock is transferred on the books of the com- pany, the stamps must be placed upon the books. Where transfer is merely by delivery of the certificate, the stamp must be placed upon the certificate itself. In case of agreement to sell, as well as in the case of transfer by assignment in blank, the seller must make and deliver to the buyer a memorandum or bill of sale or agreement to sell, to which the stamps must be affixed, and such bill or agreement must show the date thereof, the name of the seller, the amount of the sale and the matter or thing to which it refers. Where title passed in the transfer of stock prior to 528 INCOME AND FEDERAL TAX REPORTS December 1, 1917, no tax accrues, even though the actual physical transfer of the stock certificates was not made to the transferee or on the books of the corporation until after that date. In cases where A owns a certificate of 100 shares of stock and transfers 50 shares of this stock to B, and there are two certificates of 50 shares each issued in lieu of the 100-share certificate, 50 shares going to A and 50 shares going to B, the tax is imposed only upon the transfer of the 50 shares to B, there being no tax on A's transfer to himself. The procedure in the collection of stamp taxes on sales and transfers of shares of stock and like securities is given in detail in Part I of Eegulations 40, reprinted herewith, explanatory subject-captions being inserted for the convenience of the reader. TREASURY DEPARTMENT REGULATIONS No. 40 PART I Regulations Promulgated by the Commissioner of Internal Revenue, with the Approval of the Secretary of the Treasury, for Collection of Stamp Taxes on Sales and Transfers of Shares of Stock and Like Securities Definitions Sales and transfers. Article 1. That for the purpose of these regulations, the term "sales or transfers" shall be held to include all sales, agreements to sell, memo- randa of sales, and all deliveries or transfers of legal title, except as otherwise specifically provided in these regulations. Person. That the word "person" or "every person" or similar term whenever used in these regulations shall WAR STAMP TAXES 529 include the plural as well as the singular, and shall be taken to refer to individuals, partnerships, associations, and corporations, except where it is plain from the con- text that a different meaning is intended. Exchange. That wherever the word "exchange" is used in these regulations, except as otherwise specifically indicated, it shall be deemed and taken to include each and every agent or agency, auction place or other meet- ing place at which stocks are publicly bought, sold, bid for, offered, or exchanged, either between the members or patrons of such exchange, or as between members and nonmembers, patrons and the public, and it shall include all incorporated and unincorporated associations of individuals, partnerships, and corporations engaged in the business of publicly selling, buying, or exchanging shares of stock or interests therein. Shares of stock. The term "share or shares of stock," when used in these regulations, except as otherwise therein specifically defined, shall be held and taken to mean and include the shares and certificates for shares of stock representing interests in corporations, and in incorporated and unincorporated associations, as well as voting trust certificates for shares, and certificates for shares or interests in shares, "if, as, and when issued," and for "rights" therein. Clearing house. The terms "clearing house," "clear- ing house corporation," and "clearing house associa- tion," shall be held and taken to mean and include each and every incorporated and unincorporated association of individuals, partnerships, and corporations wholly or partly engaged in the business of clearing, settling, or adjusting transactions in the purchase, sale, receipt, or delivery of shares of stock, whether or not the same be a part or department of an exchange or an independent body. Responsibility for compliance with tax provisions. The act, omission, or failure of any official, agent, or 530 INCOME AND FEDERAL TAX REPORTS other person acting for or employed by any association, partnership, or corporation within the scope of his em- ployment or office, shall, in every case, also be deemed the act, omission, or failure of such association, part- nership, or corporation, as well as that of the person or persons. Registration Who must register. Art. 2. Every person, partner- ship, corporation, exchange, or clearing house engaged in whole or in part in negotiating, making, or recording sales, agreements to sell, deliveries or transfers of shares or certificates for shares of stock, or in conducting or transacting a stock-brokerage business, or in the clear- ing, settling, or adjusting of any of the transactions re- ferred to in section 807, subdivision 4, of the act, or who shall be engaged in the business of accepting or procur- ing the transmission of orders for the sale or purchase or transfers of stock to be made or executed at or under the rules or customs of an exchange in the continental United States, shall, Time of registration. On the first day of December, 1917 and if not on that date engaged in business, then within ten days after engaging in business, and on the first day of July annually thereafter Place of registry. File in the office of the collector of internal revenue of the district in which each place of business of such person, partnership, corporation, ex- change, or clearing house is located, or with such other internal-revenue officer as may be hereafter designated, Contents of registration statement. A statement, under oath, setting forth the full name or names of such per- son or persons, and of all the members of such partner- ship conducting or transacting the business, with the post-office address or addresses of such person or per- sons, or partnership, unless the person so certifying be a corporation, exchange, or clearing house, in which WAR STAMP TAXES 531 event it shall set forth its principal office or place of business, with the names and addresses of its chief offi- cer, its secretary, accompanied by a list of its members and their addresses, and if incorporated, when and where incorporated, and if not incorporated, under what agreement or authority it is conducting such business or agency. Such statement shall also specifically set forth the character of the business to be conducted, Signatures required. And shall be executed and duly acknowledged by the person or persons so conducting or intending to conduct said business, or by the president or secretary of the corporation or exchange or clearing house. Constitution and by-laws. Each exchange or clearing house shall also file with said collector or other desig- nated internal-revenue officer a copy of its constitution, charter, agreement of association, by-laws, rules and regulations, and of all amendments thereto, as the same may from time to time be adopted, New members. And the names and addresses of new members as from time to time admitted to membership. Licenses. The said statement shall further contain information as to whether the person executing the same has been licensed under any State laws or under any other provision of Federal law ; and if so, the dates and places at which any such licenses were issued. Official form supplied by collector. Such statements shall be made upon forms to be furnished upon applica- tion to the collector of internal revenue. Record of Registration Kept by Collector Records preserved by collector. Art. 3. Every col- lector or other designated internal-revenue officer shall file and preserve each statement of registration made to him in accordance with these regulations, Certificate of registry issued by collector. And shall issue to such person, partnership, exchange, clearing 532 INCOME AND FEDERAL TAX REPORTS house, or corporation a certificate of registry, showing the date of issue, the name of the person or persons, or exchange, clearing house, or corporation, conducting the business, the nature of the business for which the license is granted, and the date of expiration of said registry, which certificate shall be signed by the collector or other designated internal-revenue officer, Certificate to be posted in place of business. And shall be posted in some prominent place in the office of said person, partnership, exchange, clearing house, or corpo- ration during the period for which issued. If such busi- ness is conducted at more than one place, a certificate shall be so posted in each such place of business. Rate of Taxation Tax on transfer of stock with face value. Art. 4. In the case of shares or certificates of stock having a face (or par) value, the amount of the tax shall be based upon the total face value of the shares involved in any sale or agreement to sell or memorandum of sale, delivery, or transfer, and shall be at the rate of 2 cents for each $100 of such total face value or fraction thereof, whether such aggregate face value is greater or less than $100. Thus where the total face value of the shares or certifi- cates of stock, agreement to sell, or memorandum of sale involved in any such transaction is less than $100, the amount of such tax shall be 2 cents ; where the total face value exceeds $100 but is $200 or less, the amount of such tax shall be 4 cents; Non-par stock. And where such shares of stock are without face (or par) value, the tax shall be 2 cents on the transfer or sale or agreement to sell on each share, unless the actual value thereof is in excess of $100 per share, in which case the tax shall be 2 cents on each $100 of actual value or fraction thereof. WAR STAMP TAXES 533 Transactions Not Taxable No tax on deposit of stock as collateral. Art. 5. No tax is imposed upon an agreement evidencing a deposit of stock certificates as collateral security for money loaned thereon, which stock certificates are not actually sold or intended to be sold nor as to which there is no change of ownership or interest nor upon such stock cer- tificates so deposited. No tax on transfer to or by a broker. Nor upon de- liveries or transfer to a broker for sale, nor upon deliv- eries or transfers by a broker to a customer for whom and upon whose order he has purchased the same, Certificate to be signed by broker. Provided such deliv- eries or transfers shall be accompanied in each case by a certificate setting forth the facts, such certificates to be substantially in the following form: (a) (In the case of a transfer to a broker) "We hereby certify that we have no ownership, or in- terest, in * * * shares of the stock above transferred, the transfer by the owner to us being merely for the pur- pose of sale." (b) (In the case of a transfer by a broker) "We hereby certify that the transfer of * * * of the within shares to the names indicated by the star is made solely to complete the purchase made by us for our cus- tomer, and we have no ownership or interest therein." No broker who has filed a certificate under the fore- going clause (a) of this ruling shall file a certificate under the foregoing clause (b) with reference to the transfer of any shares of stock covered by the certifi- cate filed by him under clause (a). No tax on clearing house adjustments. Nor upon transfers or deliveries to a clearing house for the sole purpose of clearing or adjusting accounts between mem- bers, where no beneficial interest is vested in said clear- ing house or clearing association and there has been no change of title or interest: Provided, 534 INCOME AND FEDERAL TAX REPORTS Transactions of members to be reported to clearing house. The exchange shall by appropriate by-laws or regulations require from its members that all transac- tions of such members in shares of stock be promptly reported to such clearing house to the end that the stamp taxes thereon may be collected and that no other clear- ances or settlements or trading in balances shall be per- mitted. All transactions, actual or otherwise, except as in the act are exempt, shall be subject to the tax. Administrative provision. No provision, by-law, rule, or custom of any exchange, or similar institution, incon- sistent with any requirement or provision of the act or any regulations thereunder, nor any collateral or addi- tional agreement or understanding, either verbal or writ- ten, respecting the subject matter of such sales or trans- fers, or the settlement or fulfillment thereof, which is in- consistent or in conflict with any requirement of said act or of these regulations, shall exempt any person from the payment of the tax provided for under said act. Delivery of Memorandum of Sales Each taxable transaction must include memorandum. Art. 6. Every person who makes sales, or agreements to sell, or memoranda of sales or deliveries of, or trans- fers of the legal or beneficial title to shares of stock, at, in or on any exchange or similar place of business, and every person who makes any agreement to sell stock or makes a transfer of stock by delivery of the certificate therefor assigned in blank, shall as a part of every such transaction, promptly make and deliver to the buyer a bill, or memorandum of sale, or agreement to sell, Signatures. Duly signed by the principal or his agent, Contents. Which shall show the date of the transaction evidenced by it, the names of the seller and buyer, the shares of stock to which it relates, the number of shares and the price per share of said stock, WAR STAMP TAXES 535 Each memorandum to be numbered. And shall bear a number upon the face thereof. Separate number for each memorandum. No more than one such bill or memorandum made by the seller on any given day shall bear the same number: Provided, how- ever, One stamped memorandum for each transaction, That no single transaction of a purchase or sale that is made upon an exchange by one member for another member shall require to be evidenced by more than one stamped memorandum of sale or agreement to sell. Affixing and Cancellation of Stamps Transfer by assignment in blank. Art. 7. In case the transfer is effected by delivery of the certificate of stock assigned in blank the stamp shall be affixed to the bill, memorandum, or agreement to sell. Transfer by delivery of certificate. In case the change of ownership is by transfer of the certificate of stock, the stamp shall be affixed to the certificate, and in no event shall any company or registrar or transfer agent accept or transfer any shares of stock or certifi- cates therefor unless stamps for all transfer tax required to be affixed to the certificate are attached thereto prop- erly canceled. Transfer on company's books. In case the evidence of the transfer is shown only by the books of the com- pany the stamp shall be placed upon the books. Agreement. In all other cases the payment shall be evidenced by affixing the stamp upon the memorandum or agreement of sale to be delivered by the seller to the buyer. Method of cancellation. The person using or affixing a stamp shall write or stamp thereon, in ink, his initials and the day, month, and year on which the same shall be used or affixed, or shall by cutting or cancelling said stamp with a machine or punch affixing his initials and 536 INCOME AND FEDERAL TAX REPORTS date as aforesaid, so deface the stamp as to render it unfit for reuse. In addition to the foregoing, stamps of the value of 10 cents or more shall have three parallel incisions made by some sharp instrument lengthwise through the stamp after the same has been attached to the bill, memorandum, or other evidence of sale or trans- fer of stock, provided this will not be required where stamps are canceled by perforation. The cancellation by either method should not so deface the stamp as to prevent its denomination and genuineness from being readily determined. Records of Sales or Transfers of Stock Transactions to be recorded. Art. 8. All persons who are wholly or partly engaged in the business of buying, selling, or transferring shares of stock, whether at pub- lic or private sale, or whether or not they are members of an exchange, including persons engaged in transac- tions known as "matched," or "on-order," or "pass- outs," or by any other name or term at, on, or in any exchange or similar place, whether or not such trans- actions are cleared, adjusted, or settled through a clear- ing house or directly between seller and buyer, or other- wise, Contents of record. Shall keep a record showing (a) The date of the transaction. (b) The name of the seller or transferror. (c) The name of the purchaser or transferee. (d) If the order was executed on an exchange, the name of the person who executed the order. (e) Whether the transaction is a purchase or sale. (f) The name of the corporation the stock of which is the subject of the sale and the number of shares thereof. (g) Whether the stock was listed on an exchange, (h) Whether the stock was cleared through a clearing house. WAR STAMP TAXES 537 (i) The face or par value of the stock. (j) The price of the stock if there is no face or par value, (k) Whether the shares were borrowed or loaned. (1) Whether the transaction was "matched," "on- order," a "pass-out," or a "scratched sale," or any other kind of sale or purchase, (m) The amount of tax paid. (n) The identifying number of the bill or memoran- dum of sale, as required by article 6 of these regulations, (o) The origin of the order, whether domestic (refer- ring to the Continental United States), or for- eign (referring to other countries). Records to be in book form and kept two years. Per- sons using such forms may incorporate therein addi- tional columns that would be of use to them, such col- umns to be placed after the columns containing the infor- mation herein required, so as not to interfere with the columns and headings hereby prescribed. These records must be in book form, and all entries therein must be legibly written in ink and the records kept for a period of at least two years. Such record forms will not be supplied by the department. Prescribed form of record. The form of record re- quired shall be as follows: Returns by Persons Making Sales Who makes return. Art. 9. All persons who are wholly or partly engaged in the business of buying, sell- ing, or transferring shares of stock at, in, or on an ex- change, whether or not such sales, purchases, or trans- fers shall be made, cleared, settled, or adjusted through a clearing house ; shall Time and place of filing return. On or before the fif- teenth day of each month, and at any other time or times -that may be designated by the Commissioner of Internal 538 INCOME AND FEDERAL TAX REPORTS Revenue, render under oath a true return of all such sales and purchases to said commissioner for the pre- ceding month or for any other period designated by the commissioner, Contents of return. Containing in detail the following data and information: (a) The month for which the return is made. (b) The name and address of the person, partner- ship, corporation, or association making the re- turn. (c) The number of shares of stock sold and pur- chased on such exchange and cleared by its clearing agency or association. (d) The number of shares of stock sold and pur- chased on such exchange that were not cleared by its clearing agency or association. (e) In respect of shares having a face (or par) value: (1) The aggregate face value of all shares, not including any fraction of less than $100 of face value involved in any transaction. (2) The number of fractions of less than $100 of face value involved in all transactions. (f) In respect of shares having no face (or par) value : (1) As to such shares of an actual value in ex- cess of $100 per share (A) The aggregate actual value of all shares, not including any frac- tion of less than $100 involved in any transaction. (B) The number of fractions of less than $100 involved in all trans- actions in such shares. (2) As to such shares of an actual value of $100 or less per share (A) The total number of such shares. WAR STAMP TAXES 539 (g) As to shares purchased, the same information and detail required for shares sold, transferred, and delivered required under (e) and (f) for shares sold, transferred, or delivered, (h) The number of shares of stock borrowed, (i) The number of shares of stock loaned, (j) The number of shares of loaned stock returned, (k) The number of shares of borrowed stock returned. (1) The amount of tax paid. (m) The amount in dollars of stamps purchased dur- ing the month, (n) The amount in dollars of stamps on hand on the last day of the month for which return is being made. Forms furnished. Such returns shall be made upon forms furnished upon application by the internal reve- nue collector or other designated officer. Commissioner may require returns for any trans- actions. The Commissioner of Internal Eevenue may, from time to time, require any person wholly or partly engaged in the business of buying, selling, or transfer- ring shares of stock, whether at public or private sale, and whether or not such sale shall be made on an ex- change or cleared, settled, or adjusted through a clear- ing house to render under oath returns of all such trans- actions upon forms prescribed by him. Returns by Clearing Houses Clearing house to file return. Art. 10. Every clear- ing house or committee or body through or by which clearing is done shall, Time of filing. On or before the fifteenth day of each month, and at any other time designated by the Com- missioner of Internal Eevenue, render in writing under oath to the Commissioner of Internal Eevenue a return for the preceding month, or for any other period that may be designated by the Commissioner, 540 INCOME AND FEDERAL TAX REPORTS Contents of return. Of all facts in their possession relating to any and all such transactions, and showing in detail: (a) The month for which return is made; (b) The name and address of the clearing house or similar business, agency, or institution making the return; and (c) The number of shares of stock directed to be re- ceived and the number of shares of stock di- rected to be delivered and cleared, settled, or adjusted for each member during the month or period for which the return is made. Forms. Such return shall be made upon the forms to be furnished upon application by the collector of internal revenue or other designated officer. Member's daily written report to clearing house deemed to be the taxable memorandum. If any person who negotiates sales or transfers of stock on a stock exchange, shall appoint in writing the clearing house for such exchange upon which such sale or transfers are made, if any, his agent for the purposes hereinafter in- dicated, such clearing house being approved by the Com- missioner of Internal Revenue, and shall make a written return, statement or sheet, to such clearing house con- taining a full disclosure on each business day of all such transactions, both such as are clearable and non-clear- able, of the preceding day in shares of stock that are listed or permitted to be dealt in by such member on such exchange, also which if any of such stocks are loaned or borrowed, then in that event such return, statement, or sheet delivered to the clearing house shall be deemed to be the bill, or memorandum of sale, or agreement to sell, required under section 807, subdivi- sion 4, of the act approved October 3, 1917, Clearing house may affix and cancel stamps as member's agent. And such clearing house is hereby authorized to WAR STAMP TAXES 541 affix to such return, statement, or sheet the amount of stamps required for each sale or agreement to sell or memorandum of sale for delivery or transfer of such stock indicated thereon, and to cancel the stamp so af- fixed. The affixing and cancellation of such stamps by the clearing house shall be held to be that of the person making such sale or agreement to sell, or memorandum of sale, for delivery or transfer of such stock. Contents of member's memorandum report to clearing house. The returns, statements, or sheets made to the clearing house shall in respect of each sale show the date thereof, the name of the seller, the name of the buyer, the amount of the sale, and the name of the stock, cer- tificates, voting shares, or other things traded in, but a return for more than one sale may be upon the same return, statement, or sheet, Transactions must be fully disclosed. And no settle- ment of differences or other dealings between members shall be permitted that will interfere with the full dis- closure of the whole transaction. Tax paid sheets to be kept two years. Said clearing house shall preserve the returns, statements, or sheets so made and stamped for at least two years. Monthly return to be made by seller to Commissioner of Internal Revenue. But such return, statement, or sheet to the clearing house shall not relieve the person from making the monthly return required by these regu- lations. Clearing house must keep records of transfers of cus- tomers' accounts. Wherever any clearing house associa- tion or similar body carries upon its sheets or records information or reports of transactions showing the transfer by one of its members of an account of a cus- tomer without change of ownership of the securities of the customer, there shall be kept by the members of such clearing house or body concerned in such transaction, a record showing the particulars of such transaction. 542 INCOME AND FEDERAL TAX REPORTS Substitute Returns Agents In default of return, internal revenue officer may in- spect books and make return. Art. 11. If any person or clearing house required to make any return by law, or the regulations thereunder, shall fail or refuse to make such return within the time prescribed, such return may be made by an internal revenue officer, upon inspection of the books and papers of the person or clearing house required to make such returns; but the making of such return by an internal revenue officer shall not relieve the person or clearing house in default from any penalty in- curred by reason of the failure to make such return. Authority of commissioner or agent. Any officer des- ignated by the Commissioner of Internal Eevenue shall have authority to examine the books, papers, and records kept pursuant to these regulations and may require the production of any other books, records, papers, or state- ments of account, necessary to determine any liability to the tax imposed by the act, or to the observance of the provisions of the regulations made in accordance therewith. Sale of Stamps Who may sell stamps. Art. 12. No person other than a collector of internal revenue, or duly authorized dep- uty collector of internal revenue, an Assistant Treas- urer, or other United States designated depositary shall sell or expose for sale, give away, traffic in, trade, bar- ter, lend, borrow, or exchange any stamp, issued pursu- ant to these regulations. No person shall buy or receive any such stamps or have the same in his possession or under his control, unless such stamps have been pur- chased directly from the collector of internal revenue, Assistant Treasurer, or other United States designated depositary, in the district in which the stamps are to be used. WAR STAMP TAXES 543 Requisitions for stamps. All requisitions for stamps to be used under these regulations shall be made in writ- ing, in ink, on a form prescribed by the Commissioner of Internal Eevenue, to the collector of internal revenue, or to an Assistant Treasurer, or other designated de- positary, in the internal-revenue district in which the stamps are to be used, giving the date thereof, the num- ber and denomination of stamps applied for, and the name and address of the purchaser, and shall be signed in ink by the person receiving the stamps. Record of requisitions to be kept by collector. The collector of internal revenue to whom such requests are made shall keep a record thereof, and shall keep the requisitions separate and apart from all other requisi- tions for stamps, and preserve them in his office for a period of two years. Any Assistant Treasurer or desig- nated depositary of the United States receiving requi- sitions for such stamps shall keep a record of each such requisition and at the end of each month shall file such requisitions with his monthly report to the collector of internal revenue of the district in which said Assistant Treasurer or other designated depositary is located. Kinds of stamps. The stamps to be used under these regulations shall be of such kind and color as are pre- scribed by the Commissioner of Internal Eevenue. Note Administrative provisions. For the provisions as to fines and penalties applying particularly to violations or attempted evasions of the act or of these regulations, reference is made to sections 802, 803, 807, subdivisions 4 and 5, and 1004 of the "Act to provide revenue to de- fray war expenses and for other purposes," approved October 3, 1917. The provisions of the internal-revenue laws of the United States, so far as applicable, including sections 3173, 3174 and 3175, of the Eevised Statutes, as amended, apply to said act. 544 INCOME AND FEDERAL TAX REPORTS Sales of products or merchandise on exchange for future delivery. A tax of 2 cents for each $100 in value is im- posed upon all sales of produce or merchandise on ex- changes or boards of trade for future delivery. Cash sales, for immediate or prompt delivery of products or merchandise actually intended to be delivered, are not subject to the tax. Agreements to sell, including so- called transferred or "scratch sales," are likewise tax- able, substantially as provided in the case of agree- ments, etc., relating to the sale of stock, as enumerated hereinbefore. It is provided that sellers of commodities who have duly paid the tax may transfer their contracts to a clear- ing house for the adjustment and balancing of the ac- counts of the members of the clearing house association on their several contracts and that such transfer will not be taxable, provided, however, that the transfer in- vests no beneficial interest in the clearing house asso- ciation. The following are the Treasury Department Kegula- tions relating to the stamp tax upon sales of products or merchandise on exchanges for future delivery. TREASURY DEPARTMENT REGULATIONS No. 40 PART II Regulations Promulgated by the Commissioner of Internal Revenue, with the Approval of the Secretary of the Treasury, for the Collection of Stamp Taxes Upon Sales of Products or Merchandise on Exchanges for Future Delivery Definitions Sale. Art. 1. That for the purposes of these regula- tions the term "sale" or "contract of sale" shall be held to include all sales, or agreements of sale, or agreements to sell, including so-called transfers or "scratched sales." WAR STAMP TAXES 545 Person. The word "person" or "every person," or similar term, whenever used in these regulations, shall include the plural as well as the singular, and shall be taken to refer to individuals, partnerships, associations, and corporations, except where it is plain from the con- text that a different meaning is intended. Exchange. The word "exchange" as used in these regulations, except as otherwise specifically indicated in the regulations, shall be deemed and taken to include each and every agent or agency, auction place, or other meeting place at which produce or merchandise for fu- ture delivery is publicly bought, sold, bid for, offered, or exchanged, or contracts for such future delivery are made, either between the members or patrons of such exchange, or as between members and nonmembers, patrons, and the public, and it shall include all incor- porated and unincorporated associations of individuals, partnerships, and corporations engaged in the business of publicly selling, buying, or exchanging products or merchandise for future delivery. Clearing house. The term "clearing house" shall be held to mean each and every clearing-house corporation, clearing-house association, or incorporated and unincor- porated association, carried on for the purpose of clear- ing, settling, and adjusting transactions in purchasing, selling, receiving, or delivering products or merchandise, whether such clearing house be a part or department of an exchange or an independent body. Responsibility for compliance with tax provisions. The act, omission, or failure of any official, agent, or other person acting or employed by any person, asso- ciation, partnership, or corporation, within the scope of his employment or office, shall in every case also be deemed the act, omission, or failure of such person, asso- ciation, partnership, or corporation. 546 INCOME AND FEDERAL TAX REPORTS Registration Who must register. Art. 2. Every person engaged in whole or in part in making contracts of sale of any prod- uct or merchandise or commodity at, on, or in, or under the rules or customs of any exchange for future deliv- ery, or engaged in the business of accepting or procur- ing the transmission of such contracts of sale, to be exe- cuted on any exchange, and every exchange and every clearing house shall, Time of registration. On the first day of December, 1917, and if not on that date engaged in business, then within ten days after engaging in business, and on the first day of July annually thereafter file Place of registration. In the office of the collector of in- ternal revenue of the district in which each place of business of such person, exchange, or clearing house is located, or with such other internal-revenue officer as may be hereafter designated, Contents of Statement. A statement under oath setting forth the full name of such person, if an individual, and if a partnership the full names of all the members of such partnership, with the post-office address of the in- dividual or partnership; and if the person filing such statement be a corporation or association it shall set forth its principal office or place of business with the names and addresses of its chief officer and its secretary, accompanied by a list of its members and their ad- dresses, and if incorporated, when and where incorpo- rated, and if unincorporated, under what agreement or authority it is conducting business, together with a copy of such agreement. Signatures required. Statements filed in behalf of any corporation, association, exchange, or clearing house shall be executed and duly acknowledged by the presi- dent or secretary thereof. Information required of exchange or clearing house. WAR STAMP TAXES 547 Every statement filed by an exchange or clearing house shall specifically set forth the character of the business conducted or intended to be conducted. Each exchange and clearing house shall also file with the said collector or other designated internal-revenue officer a copy of its constitution, charter, agreement of association, by-laws, and regulations, and all amendments thereto, as the same may from time to time be adopted, and the names and addresses of new members as from time to time admit- ted to membership. Forms. The statements required by these regulations shall be made upon forms to be prescribed by the Com- missioner of Internal Eevenue. Records and Certificates Records kept by collector. Art. 3. Every collector of internal revenue or other designated internal-revenue officer shall file and preserve each statement or registra- tion made to him in accordance with these regulations, Certificate issued by collector. And shall issue to the person making such statement a certificate of registry showing the date of issue, the name of the person, the nature of the business for which the certificate is granted, and the date of the expiration of the registra- tion, which certificate shall be signed by the collector or other designated internal-revenue officer, Certificate to be posted in place of business. And shall at all times during the period for which it is issued be posted in some prominent place in the office of the per- son receiving it. If the business of such person is con- ducted at more than one place, a certificate shall be so posted in each such place of business. Transactions Not Taxable Cash sales for prompt delivery exempt. Art. 4. No tax is imposed on cash sales of products or merchandise for immediate or prompt delivery which in good faith 548 INCOME AND FEDERAL TAX REPORTS are actually intended to be delivered. All sales at an exchange for future delivery are subject to the payment of the tax. "Delivery" defined. For the purpose of these regu- lations "immediate or prompt delivery" shall mean de- livery at once or as soon as practicable, and in any event within twenty days of the date of the sale or agreement. Every sale or agreement not evidenced by a memoran- dum or contract expressly requiring immediate or prompt delivery within the above definition shall be deemed to be for future delivery. In all cases in which the commissioner is not satisfied from the evidence sub- mitted to him that the transaction was in good faith in- tended to be followed by immediate or prompt delivery, within the above definition, the seller shall be required to pay the tax as on a sale for future delivery. Transfer to clearing house. Sellers of products, mer- chandise, or commodities having paid the tax provided by law may transfer such contracts to a clearing-house association, and such transfer shall not be deemed to be a sale, or agreement of sale, or agreement to sell, within the provisions of the act, provided that such transfer does not vest any beneficial interest in the clearing house association and is made for the sole purpose of enabling such clearing-house association to adjust and balance the accounts of the members of said clearing-house asso- ciation on their several contracts. Administrative provisions. No provision, by-law, rule, or custom of any exchange, board of trade, or simi- lar institution or place of business which is inconsistent or in conflict with any requirement or provision of the "Act to provide revenue to defray war expenses, and for other purposes," approved October 3, 1917, or any regu- lations thereunder, nor any collateral, or additional agreement or understanding, either verbal or written, respecting the subject matter of such contract or the set- tlement or fulfillment thereof, which is inconsistent or. WAR STAMP TAXES 549 in conflict with any requirement of said act or the regu- lations thereunder promulgated by the Commissioner of Internal Eevenue, with the approval of the Secretary of the Treasury, shall exempt any person from the pay- ment of the tax provided for under section 807, subdi- vision 5, of said act. Memoranda of Sales Memorandum to be delivered by seller to buyer. Art. 5. Every person who makes sales or contracts of sale of any product, merchandise, or commodity at, on, or in any exchange for future delivery, shall, except as herein otherwise expressly provided, deliver to the buyer a bill, memorandum, agreement, or other evidence of such sale or agreement of sale, Contents of memorandum. Which shall show the date thereof, the name of the seller, the name of the pur- chaser, the product, merchandise, or commodity, the quantity thereof to which it refers, the price, the aggre- gate amount of the sale, and the amount of the tax to be paid, Tax stamps to be affixed. To which bill, memorandum, agreement, or other evidence of sale there shall be affixed a lawful stamp or stamps in value equal to the amount of tax on such sale. One stamped memorandum for each sale. No single sale or contract of sale that is made upon an exchange by one member for another shall require to be evidenced by more than one such stamped memorandum. Memorandum may be delivered to clearing house. If any person making contracts of sale for future delivery of any products or merchandise at, in, or on any ex- change shall in writing appoint the clearing house for the exchange upon which such sales are made his agent for the purposes hereinafter indicated, such clearing house being approved by the Commissioner of Internal Eevenue, and shall make a written return or sheet of 550 INCOME AND FEDERAL TAX REPORTS each such sale to such clearing house in accordance with these regulations, the return or sheet of the person to the clearing house shall be deemed to be the bill, memo- randum, or agreement of sale required to be delivered by the seller to the buyer, Clearing house may pay tax. And the clearing house is hereby authorized to affix to such return or sheet the amount of stamps required for each contract of sale in- dicated thereon, and to cancel the stamps so affixed; the affixing and cancellation of such stamps by the clearing house to be held to be that of the person making such contracts of sale. Contents of return to clearing house. The return or sheet of sales so made to the clearing house shall in re- spect of each sale set forth the date, the name of the seller, the name of the purchaser, the amount of the sale, and the matter or things to which it refers, but a return for more than one sale may be made upon the same paper or sheet. Clearing house must preserve records for two years. The clearing house shall preserve for a term of not less than two years each return or sheet made to it by any person under the foregoing regulations. Clearing house report to Commissioner. Every clear- ing house so acting shall include in the monthly return to the Commissioner a statement of the amounts of stamps so affixed and canceled for each person. Monthly returns required of seller. The making of such return by the clearing house shall not relieve the person making such sales from making the monthly return of his transactions required by these regulations. Method of stamp cancellation. The person using or affixing stamps shall write or stamp thereon in ink his initials and the day, month, and year on which the same shall be used or affixed, or shall, by cutting and canceling the stamp with a machine or punch affix his initials and date as aforesaid, so deface the stamp as to render it WAR STAMP TAXES 551 unfit for reuse. In addition to the foregoing, stamps of the value of 10 cents or more shall have three parallel incisions made by some sharp instrument lengthwise through the stamp after the same has been attached to the document : Provided, This will not be required where stamps are canceled by perforation. The cancellation by either method should not so deface -the stamp as to prevent its denomination and genuineness from being readily determined. Records by Sellers and Buyers Who must keep records, and of what. Art. 6. All per- sons who make sales or contracts of sales, including so- called "transferred or scratch sales," "pass-outs," "pair- offs," or "matched trades," and all other forms of sale of any product or merchandise at, on, in, or under the rules, or customs of any exchange for future delivery shall keep a record showing: (a) Date when contract was made. (b) Name and address of the other party to the con- tract. (c) Name of person executing the contract. (d) Whether the transaction is a purchase or sale. (e) Quantity of product, merchandise, or commodity involved; whether in tons, pounds, bales, bush- els, bags, mats, barrels, gallons, or other unit of measure or weight, as the case may be. (f) Name of product, merchandise, or commodity, in- cluding (if not a basis grade contract) grade, type, sample, or description. (g) Name of customer. (h) Whether the contract is a "basis grade" contract. (i) Time specified in contract for delivery. (j) Specified price per ton, pound, mat, bale, bag, bushel, barrel, gallon, or other unit of measure or weight, as the case may be. (k) Gross amount of sale or purchase. 552 INCOME AND FEDERAL TAX REPORTS (1) Amount of tax paid. (m) Whether the order for sale or purchase was of domestic (meaning the continental United States) or foreign origin (meaning from coun- tries other than the continental United States). (n) Date of delivery or settlement. (o) Method of fulfillment or settlement. Form of record. Persons who use such forms may in- corporate additional columns which would be of use to them, such columns to be placed in such positions as not to interfere with the columns and headings prescribed. Such record forms will not be supplied by the depart- ment. The records required by these regulations shall be legibly written in ink and kept separate in books, and contracts of sale for future delivery of two or more dis- tinct products or merchandise shall be kept separate. Records preserved by seller. Any person who executes or makes such contracts of sale shall preserve the trad- ing cards, memoranda, or slips of each transaction, Records preserved by purchaser. And the purchaser shall preserve the bill, memorandum, or evidence of sale to which the stamps are affixed, for the period of two years. Official form of record. The form of the record re- quired by these regulations shall be as follows: Records to be Kept by Clearing Houses Clearing house records. Art. 7. All persons who act in the capacity of a clearing house or clearing associa- tion shall keep a record showing: (a) Name of person for whom each contract is cleared. (b) Date when contract was made. (c) Whether the transaction is a purchase or sale. (d) Quantity of product, merchandise, or commodity involved, whether in tons, pounds, bales, bush- WAR STAMP TAXES 553 els, bags, mats, barrels, gallons, or other unit of measure or weight, as the case may be. (e) Name of product, merchandise, or commodity, in- cluding (if not a basis-grade contract) grade, type, sample, or description. (f) Whether the contract is a basis-grade contract. (g) Time specified in contract for delivery, (h) Date of settlement. (i) Method of settlement. Separate records for each product. Records of sales for future delivery of two or more distinct products or merchandise must be kept separate. Returns by Members of Exchanges Returns required. Art. 8. All persons who make con- tracts of sale of any commodity, product, or merchan- dise, at, on, or in any exchange, board of trade, or other similar place of business, for future delivery, whether such contracts shall be cleared and adjusted through a clearing house, or clearing association, or directly be- tween the seller and buyer, or otherwise, shall Time of return. On or before the fifteenth day of each month, and at any other time required by the Commis- sioner of Internal Revenue, make return, in writing, to the Commissioner of Internal Revenue, or some officer designated by him, for the preceding month or any other period, verified before some officer authorized to admin- ister oaths, showing: Contents of return. (a) The number of contracts of sale and purchase of each product, merchandise, or commodity brought forward from the preced- ing month. (b) The number of contracts of sale and purchase of each product, merchandise, or commodity dur- ing the current month. (c) The month in which the products, merchandise, or commodity is to be delivered. 554 INCOME AND FEDERAL TAX REPORTS (d) The method of settlement of each contract, i. e., whether by "actual delivery," "notice," "ring," "direct," "transfer," or "scratch sale," "pair off," or "matched," "pass out," "set off," "give up," through a clearing house or clearing asso- ciation, or otherwise. (e) The gross amount of the contracts of sale. (f) The tax paid thereon. (g) The number of contracts both of purchase and sale left open at the end of the month, (h) The amount of stamps on hand from preceding month, (i) The amount of stamps purchased during month, (j) The amount of stamps used during month, (k) Balance of stamps on hand at end of month. (1) The origin of the order of the contracts, whether domestic or foreign. Form of return. Such returns shall be made upon forms to be furnished, upon application, by the collector of internal revenue, or other designated officer of the district in which the exchange, board of trade, or other similar place is located. Returns by Clearing Houses Returns required. Art. 9. Every clearing house, or clearing association, shall, Time of return. On or before the 15th day of each month, and at any other time required, render in writ- ing, under oath, a return, for the preceding month or for any other period designated, to the Commissioner of Internal Eevenue of all facts in their possession show- ing: Contents of return. (a) The number of contracts "long" and "short" for each member brought forward from the preceding month. (b) The number of contracts bought or sold by each member of the association. WAR STAMP TAXES 555 (c) The number of tons, pounds, bales, bushels, bags, mats, barrels, or gallons, or other units of weight or measure involved in such contracts, as the case may be. (d) The month in which such product, merchandise, or commodity is to be delivered. (e) The method of settlement of said contracts i. e., whether by "set-off," "notice," or "delivery," or by any other method. (f ) The number of open contracts "long" and "short" for each member carried to the following month. Form of return. Such returns shall be made upon forms to be furnished, upon application, by the collector of internal revenue of the district, or other designated officer, in which the clearing house or clearing associa- tion is situated. Failure to Make Returns Agents In default of return, same may be made by internal revenue officer. Art. 10. If any person, or clearing house, or clearing association, required to make returns by this act, or the regulations thereunder, shall fail, or refuse to make any return within the time pre- scribed in these regulations, or designated by the Com- missioner of Internal Revenue, then the same shall be made by an internal-revenue officer, upon inspection of the books and papers of the person, or clearing house, or clearing association, so required; Penalty attaches to such default. But the making of said return by an internal-revenue officer shall not re- lieve the person in default from any penalty incurred by reason of his failure to make such return. Authority of internal-revenue officer. Any officer des- ignated by the Commissioner of Internal Revenue shall have authority to examine the books, papers, and rec- ords kept pursuant to these regulations, and may require 556 INCOME AND FEDERAL TAX REPORTS the production of any other books, records, papers, or statements of account, necessary to determine any lia- bility to the tax imposed by this act, or the observance of the provisions of the regulations made in accordance therewith. Sale of Stamps Who may sell stamps. Art. 11. No persons other than a collector of internal revenue, or duly authorized deputy collector of internal revenue, assistant treasurer, or des- ignated depositary of the United States, in the district in which is located an exchange, shall sell or expose for sale, traffic in, trade, barter, or exchange any stamp re- quired by law or by these regulations to be used for the payment of taxes upon sales or contracts of sale of any product or merchandise for future delivery. Requisitions for stamps. All requisitions for such stamps shall be made in writing on a form prescribed by the Commissioner of Internal Eevenue to the collector of internal revenue, an assistant treasurer, or designated depositary in the internal revenue district in which the stamps are to be used, giving the date thereof, the number and denomination of stamps applied for, and the name and address of the purchaser, and shall be signed in ink by the person receiving the stamps. Records of requisitions. If the requisition for such stamps shall be made to any assistant treasurer or des- ignated depositary of the United States, such assistant treasurer or designated depositary shall keep a record thereof, and at the end of each month shall file such requisitions with his monthly report with the collector of internal revenue of the district in which said assistant treasurer or designated depositary is located. The col- lector of internal revenue shall keep the requisitions for such stamps made to him and those filed by such assist- ant treasurer or designated depositary separate and apart from all other requisitions for stamps and pre- serve them in his office for a period of two years. WAR STAMP TAXES 557 Kind of stamps authorized. The stamps shall be of a color and design prescribed by the Commissioner of In- ternal Revenue. Note Fines and penalties enforcement. For the provi- sions as to fines and penalties applying particularly to violations or attempted evasions of the act or of these regulations reference is made to sections 802, 803, 807, subdivision 5, and 1004 of the "Act to provide revenue to defray war expenses, and for other purposes," ap- proved October 3, 1917. The provisions of the internal- revenue laws of the United States, so far as applicable, including sections 3173, 3174, 3175, of the Revised Stat- utes, as amended, apply to said act. Time drafts, post-dated checks and promissory notes. Drafts or checks payable otherwise than at sight or on demand, promissory notes (except bank notes issued for circulation), and each renewal of the same, are taxable as follows: for a sum not exceeding $100 or fractional part thereof, 2 cents, and for each additional $100 or fractional part thereof, 2 cents. A renewal, for the pur- pose of the tax, is any written agreement permitting an extension of the time of payment, whether a new note is made or not. A promissory note is a written promise to pay a speci- fied sum of money on demand or at a specified future time. The chief distinction between promissory notes and bonds, for the purpose of the tax, is that bonds are issued under seal, whereas notes are not. Ordinary checks are not taxable. Checks dated ahead, however, are payable neither at sight or on demand and must therefore have stamp affixed. Drafts drawn in foreign countries and payable in the United States are not subject to the tax. Drafts drawn in the United States and payable in for- 558 INCOME AND FEDERAL TAX REPORTS eign countries are subject to the tax, if payable other- wise than on sight or on demand. Drafts payable on "arrival of goods" and "at sight or on demand after arrival of goods," are subject to the tax. Policy loan and premium extension agreements are not promissory notes within the meaning of the law and are not subject to the stamp tax. Conveyance of real estate. A tax of 50 cents for each $500 in value or fraction thereof is imposed upon all conveyances of lands, tenements or other realty, when the value, exclusive of liens thereon, is $100 or more. No tax is imposed on any instrument or writing given to secure a debt. Leases of real estate are not taxable ; neither are contracts for the sale of real estate, making provision for future delivery by deed. On an instrument conveying real estate there should be attached a tax stamp of the face value corresponding with the amount representing the vendor's equity con- veyed. Where an exchange of equal equities in real estate is made between two persons a stamp should be attached to each of the two deeds, corresponding with the amount of each equity exchanged. In determining the amount of incumbrance upon real estate being trans- ferred, no consideration is to be given to new incum- brances placed upon same at the time of, or after, the sale. Only incumbrances which rest o.n the property be- fore the sale and which are not removed by the sale are to be taken into consideration. A deed issued to cover a gift of property to the Gov- ernment, wherein the consideration named is "desire to promote public welfare and $1," or "$1 and other valu- able considerations," is not taxable. Custom-house entry. Entry of any goods, wares or merchandise at any custom-house, either for consump- tion or warehousing, is taxable as follows : not exceeding $100 in value, 25 cents; exceeding $100 and not exceed- ing $500 in value, 50 cents ; exceeding $500 in value, $1. WAR STAMP TAXE8 559 Entry for customs withdrawal. The tax on an entry for the withdrawal of any goods or merchandise from cus- toms bonded warehouse is 50 cents. Passage tickets. Passage tickets one way or round trip, for each passenger, sold or issued in the United States for passage by any vessel to a port or place not in the United States, Canada, or Mexico, are taxed as follows: if costing not exceeding $30, $1; costing more ^ > than $30 and not exceeding $60, $3; costing more than $60, $5. There is no tax on such tickets costing $10 or less. It will be noted that the stamp tax covers foreign passage tickets only. Passage tickets beween points in the United States are taxed under the Public Utilities tax. Voting proxies. Proxies for voting at any election for officers, or meeting for the transaction of business, of any incorporated company or association, except reli- gious, educational, charitable, fraternal, or literary soci- eties, or public cemeteries, are taxed at the rate of 10 cents for each proxy. Power of attorney. Powers of attorney granting au- thority to do or perform some act for or in behalf of the grantor, which authority is not otherwise vested in the grantee, are taxed 25 cents each. There is no tax upon the power of attorney contained in a transfer by assignment, absolute or as collateral se- curity, of an interest in a contract of insurance, if the power of attorney grants authority to do or perform only such acts for or in behalf of the assignor as are otherwise vested in the assignee. But no stamps are required on any papers necessary to be used for the collection of claims from the United States or from any State for pensions, back pay, bounty, or for property lost in the military or naval service, or upon powers of attorney required in bankruptcy cases. Playing cards. A tax of five cents per pack is imposed, in addition to the tax previously imposed and which still 560 INCOME AND FEDERAL TAX REPORTS remains in effect, on playing cards manufactured or im- ported, and sold, or removed for sale after the passage of the Act. This additional stamp tax on playing cards became effective October 4, 1917, making the total tax 7 cents per pack. This tax does not apply to such cards tax-paid prior to October 4 at the two-cent rate under the Act of Aug. 28, 1894, in the hands of jobbers and retail dealers, un- less the packs have been broken and cards repacked, in which event the dealer would be subject to the manufac- turer's tax. Under authority of sections 1001 and 1006, providing for the collection of taxes of this class under regula- tions prescribed by the Commissioner of Internal Keve- nue and for the use of stamps on hand at the passage of the Act, the following regulations are promulgated by the Treasury Department: "Every manufacturer and importer of playing cards will render to the collector of the district wherein the factory is located, a sworn inventory in duplicate on or before October 31, 1917, showing separately the num- ber of stamped and unstamped packs on hand at the beginning of business October 4th, and likewise the number of attached and unattached stamps at the rate of two cents. These inventories may be rendered on Form 215, modified to suit the nature of the article, or in typewritten form. "On October 31, or within ten days thereafter, a re- turn under oath in duplicate must be rendered, covering the period October 4 to 31 inclusive, showing the num- ber of packs of cards manufactured or imported, the number withdrawn tax-paid, the name and address of each person, firm or corporation to whom such cards may be consigned or sold, the number and total value at the rate of two cents of stamps affixed, and the addi- tional tax of five cents per pack due thereon. "This return will be rendered for each subsequent WAR STAMP TAXES 561 month on the last day thereof, or on or before the tenth day of the succeeding month, until the supply of stamps at the old rate on hand is exhausted. "Forms for rendering these returns may be obtained upon application to the collector of the district ; or manu- facturers or importers, if they so desire, may make up such monthly return upon the typewriter, provided, it conforms in detail with that prescribed. "Collectors will carefully verify these inventories and returns and enter for assessment the additional tax at 5 cents shown due from manufacturers or importers until the stock of stamps, at the rate of two cents, held by the tax payer is exhausted. Thereafter every manu- facturer and importer will be required to render such return for each month during continuance in business, but the additional tax will not be noted thereon, as all stamps purchased from the collector on and after Octo- ber 4 will be sold and accounted for at the new rate. "On and after October 4 the collectors selling stamps on hand of the rate of two cents will overprint same, require payment and account therefor at the rate of seven cents per pack." Parcel post packages. Parcel post packages on which the postage amounts to 25 cents or more are taxed at the rate of 1 cent for each 25 cents or fractional part thereof charged for transportation. The tax is based on transportation charges alone, so that C. 0. D. or in- surance charges are not to be reckoned in computing the tax. The stamp must be affixed by the sender and can- celed by him before the package is mailed, care being taken not to cancel the postage stamps. The stamps for tax payment must be revenue stamps and not extra postage stamps. Packages upon which the tax has not been so paid will not be transported. The tax must be paid on parcel post packages mailed from one point in the United States to another, but pack- 562 IX COME AND FEDERAL TAX REPORTS ages sent to foreign countries, including Porto Rico, are not taxable. For tax on express packages, see page 581. Redemption of unused stamps. Claim for allowance for or redemption of unused stamps may be made by the bona fide owner thereof or by his agent, who must set forth under oath, on Form 46, the facts relied on in sup- port of his claim. The claim should be supported by the certificate of the deputy collector who personally has in- vestigated the statements made by the claimant, and by the certificate of the collector for whom the stamps were purchased, giving such information as the Commissioner of Internal Revenue may desire. Upon allowance of the claim by the Commissioner the claim will be certified by him to the Auditor for the Treasury Department, who, in the absence of fraud or miscalculation, will certify the amount allowed to the Division of Bookkeeping and Warrants. Redemption of stamps affixed to documents or articles. In cases where stamps have been affixed to documents or articles not requiring them and canceled, or where, by error, stamps of greater value than necessary have been used, the procedure is substantially the same as in the case above. The stamps should be returned with the claim and where practicable, accompanied by the in- struments to which the stamps have been attached, or certified copies thereof. If the instrument cannot be sent the collector may instruct his deputy to visit claim- ant's place of business, examine the instrument and can- cel the stamps by writing across them the words "claim for refund filed." Method of payment. Adhesive stamps for the payment of these taxes may be purchased from collectors of the various districts and at post offices and banks designated as United States depositaries. Stamps have so far been issued in various denominations up to $2, but it is in- WAR STAMP TAXES 563 tended later to issue denominations as high as $1,000, for Stock Exchange transactions. Stamps denoting the amount of the tax must be affixed and canceled by writing or stamping upon them the initials of the person or concern using or affixing them, together with the date when so affixed. Stamps of the value of 10 cents or more should also be mutilated by making three parallel incisions lengthwise with a sharp instrument; proper perforations are permissible in lieu of the incisions. Original documents only need to be stamped; copies should merely bear a statement to the effect that stamps are attached to the original. Penalties. The penalties provided for not complying with the stamp provisions are as follows: "That whoever makes, signs, issues, or accepts, or causes to be made, signed, issued, or accepted, any in- strument, document, or paper of any kind or description whatever, without the full amount of tax thereon being duly paid; consigns or ships, or causes to be consigned or shipped, by parcel post, any parcel, package, or ar- ticle without the full amount of tax being duly paid; makes use of any adhesive stamp to denote any tax im- posed by law without canceling or obliterating such stamp as prescribed, is guilty of a misdemeanor, and upon conviction thereof shall pay a fine of not less than $100 for each offence." It will be noted that the foregoing penalties apply equally to the maker and to the acceptor of any docu- ment upon which the tax has not been paid. The penalty for fraudulent use of stamps, which in- cludes the fraudulent removal of stamps from documents, etc., the use of previously canceled stamps or having in possession renovated stamps previously used, is a fine of not over $1,000 or imprisonment for not more than five years, together with forfeiture to the United States of the article upon which the stamp was used. CHAPTER XXVI WAR STAMP TAXES LAW BEING TITLE VIII OF "AN ACT TO PROVIDE REVENUE TO DEFRAY WAR EXPENSES, AND FOR OTHER PURPOSES," APPROVED OCTOBER 3, 1917. (PUBLIC No. 50 65th CONGRESS.) IN EF- FECT OCTOBER 4, 1917, UNLESS OTHERWISE SPECIALLY PROVIDED TITLE VIII. WAR STAMP TAXES Effective Dec. 1, 1917 Stamp taxes on bonds, certificates of stock, and other documents. Sec. 800 [of the general revenue Act of which this Title is a part]. That on and after the first day of December, nineteen hundred and seventeen, there shall be levied, collected, and paid, for and in respect of the several bonds, debentures, or certificates of stock and of indebtedness, and other documents, instruments, matters, and things mentioned and described in Schedule A of this title, or for or in respect of the vellum, parch- ment, or paper upon which such instruments, matters, or things, or any of them, are written or printed, by any person, corporation, partnership, or association who makes, signs, issues, sells, removes, consigns, or ships the same, or for whose use or benefit the same are made, signed, issued, sold, removed, consigned, or shipped, the several taxes specified in such schedule. No tax on bonds or other instruments of U. S., State, Municipal, or Foreign Governments. Sec. 801. That there 564 WAR STAMP TAXES LAW 565 shall not be taxed under this title any bond, note, or other instrument, issued by the United States, or by any foreign Government, or by any State, Territory, or the District of Columbia, or local subdivision thereof, or municipal or other corporation exercising the taxing power, when issued in the exercise of a strictly govern- mental, taxing, or municipal function; or stocks and bonds issued by co-operative building and loan associa- tions which are organized and operated exclusively for the benefit of their members and make loans only to their shareholders, or by mutual ditch or irrigating com- panies. Penalty for failure to pay tax, affix or cancel stamps. Sec. 802. That whoever (a) Makes, signs, issues, or accepts, or causes to be made, signed, issued, or accepted, any instrument, docu- ment or paper of any kind or description whatsoever without the full amount of tax thereon being duly paid. (b) Consigns or ships, or causes to be consigned or shipped, by parcel post any parcel, package, or article without the full amount of tax being duly paid: (c) Manufactures or imports and sells, or offers for sale, or causes to be manufactured or imported and sold, or offered for sale, any playing cards, package, or other article without the full amount of tax being duly paid; (d) Makes use of an adhesive stamp to denote any tax imposed by this title without cancelling or obliterat- ing such stamp as prescribed in section eight hundred and four; Is guilty of a misdemeanor and upon conviction there- of shall pay a fine of not more than $100 for each of- fense. Penalty for fraudulently using stamps. Sec. 803. That whoever (a) Fraudulently cuts, tears, or removes from any vellum, parchment, paper, instrument, writing, package, or article, upon which any tax is imposed by this title, 566 INCOME AND FEDERAL TAX REPORTS any adhesive stamp or the impression of any stamp, die, plate, or other article provided, made, or used in pursu- ance of this title; (b) Fraudulently uses, joins, fixes, or places to, with, or upon any vellum, parchment, paper, instrument, writ- ing, package, or article, upon which any tax is imposed by this title, (1) any adhesive stamp, or the impression of any stamp, die, plate, or other article, which has been cut, torn, or removed from any other vellum, parchment, paper, instrument writing, package, or article, upon which any tax is imposed by this title; or (2) any ad- hesive stamp or the impression of any stamp, die, plate, or other article of insufficient value; or (3) any forged or counterfeit stamp, or the impression of any forged or counterfeited stamp, die, plate, or other article; (c) Willfully removes, or alters the cancellation, or defacing marks of, or otherwise prepares, any adhesive stamp, with intent to use, or cause the same to be used, after it has been already used, or knowingly or willfully buys, sells, offers for sale or gives away, any such washed or restored stamp to any person for use, or knowingly uses the same; (d) Knowingly and without lawful excuse (the burden of proof of such excuse being on the accused) has in possession any washed, restored, or altered stamp, which has been removed from any vellum, parchment, paper, instrument, writing, package, or article, is guilty of a misdemeanor, and upon conviction shall be punished by a fine of not more than $1,000, or by imprisonment for not more than five years, or both, in the discretion of the court, and any such reused, canceled, or counterfeit stamp and the vellum, parchment, document, paper, package, or article upon which it is placed or impressed shall be forfeited to the United States. Method of cancelling stamps. Sec. 804. That whenever an adhesive stamp is used for denoting any tax imposed by this title, except as hereinafter provided, the person WAR STAMP TAXES LAW 567 corporation, partnership, or association, using or affix- ing the same shall write or stamp or cause to be written or stamped thereupon the initials of his or its name and the date upon which the same is attached or used, so that the same may not again be used: Provided, That the Commissioner of Internal Revenue may prescribe such other method for the cancellation of such stamps as he may deem expedient. Methods of preparing, distributing and affixing stamps. Sec. 805. (a) That the Commissioner of Internal Rev- enue shall cause to be prepared and distributed for the payment of the taxes prescribed in this title suitable stamps denoting the tax on the document, articles, or thing to which the same may be affixed, and shall pre- scribe such method for the affixing of said stamps in substitution for or in addition to the method provided in this title, as he may deem expedient. (b) The Commissioner of Internal Revenue, with the approval of the Secretary of the Treasury, is authorized to procure any of the stamps provided for in this title by contract whenever such stamps can not be speedily prepared by the Bureau of Engraving and Printing ; but this authority shall expire on the first day of January, nineteen hundred and eighteen, except as to imprinted stamps furnished under contract, authorized by the Com- missioner of Internal Revenue. (c) All internal-revenue laws relating to the assess- ment and collection of taxes are hereby extended to and made a part of this title, so far as applicable, for the purpose of collecting stamp taxes omitted through mis- take or fraud from any instrument, document, paper, writing, parcel, package, or article named herein. Sale of stamps by Post-offices. Sec. 806. That the Com- missioner of Internal Revenue shall furnish to the Post- master General without prepayment a suitable quantity of adhesive stamps to be distributed to and kept on sale by the various postmasters in the United States. The 568 INCOME AND FEDERAL TAX REPORTS Postmaster General may require each such postmaster to give additional or increased bond as postmaster for the value of the stamps so furnished, and each such postmaster shall deposit the receipts from the sale of such stamps to the credit of and render accounts to the Postmaster General at such times and in such form as he may by regulations prescribe. The Postmaster Gen- eral shall at least once monthly transfer all collections from this source to the Treasury as internal-revenue collections. Sale of stamps by United States depositaries. Sec. 807. That the collectors of the several districts shall furnish without prepayment to any assistant treasurer or desig- nated depositary of the United States located in their respective collection districts a suitable quantity of ad- hesive stamps for sale. In such cases the collector may require a bond, with sufficient sureties, to an amount equal to the value of the adhesive stamps so furnished, conditioned for the faithful return, whenever so required of all quantities or amounts undisposed of, and for the payment monthly of all quantities or amounts sold or not remaining on hand. The Secretary of the Treasury may from time to time make such regulations as he may find necessary to insure the safe-keeping or prevent the illegal use of all such adhesive stamps. SCHEDULE A. STAMP TAXES. Tax on bonds, debentures and certificates of indebtedness. 1. Bonds of indebtedness: Bonds, debentures, or certificates of indebtedness issued on and after the first day of December, nineteen hundred and seventeen, by any person, corporation, partnership, or association, on each $100 of face value or fraction thereof, 5 cents: Provided, That every renewal of the foregoing shall be taxed as a new issue; Provided further, That when a bond conditioned for the repayment or payment of WAR 8TAMP TAXES LAW 569 money is given in a penal sum greater than the debt secured, the tax shall be based upon the amount secured. Tax on surety bonds. 2. Bonds, indemnity and surety : Bonds for indemnifying any person, corporation, part- nership, or corporation who shall have become bound or engaged as surety, and all bonds for the due execution or performance of any contract, obligation, or require- ment, or the duties of any office or position, and to ac- count for money received by virtue thereof, and all other bonds of any description, except such as may be required in legal proceedings, not otherwise provided for in this schedule, 50 cents: Provided, That where a premium is charged for the execution of such bonds the tax shall be paid at the rate of one per centum on each dollar or fractional part thereof of the premium charged : Provided further, That policies of reinsurance shall be exempt from the tax imposed by this subdivision. Tax on original issues of capital stock 3. Capital stock, issue: On each original issue, whether on organization or reorganization, of certificates of stock by any associa- tion, company, or corporation, on each $100 of face value or fraction thereof, 5 cents : Provided, That where capital stock is issued without face value, the tax shall be 5 cents per share, unless the actual value is in excess of $100 per share, in which case the tax shall be 5 cents on each $100 of actual value or fraction thereof. The stamps representing the tax imposed by this sub- division shall be attached to the stock books and not to the certificates issued. Tax on sales or transfers of stock. 4. Capital stock, sales or transfers : On all sales, or agreements to sell, or memoranda of sales or deliveries of, or transfers of legal title to shares or certificates of stock in any asso- ciation, company, or corporation, whether made upon or shown by the books of the association, company, or corporation, or by any assignment in blank, or by any delivery, or by any paper or agreement or memorandum 570 INCOME AND FEDERAL TAX REPORTS or other evidence of transfer or sale, whether entitling the holder in any manner to the benefit of such stock or not, on each $100 of face value or fraction thereof, 2 cents, and where such shares of stock are without par value, the tax shall be 2 cents on the transfer or sale or agreement to sell on each share, unless the actual value thereof is in excess of $100 per share, in which case the tax shall be 2 cents on each $100 of actual value or frac- tion thereof: Provided, That it is not intended by this title to impose a tax upon an agreement evidencing a deposit of stock certificates as collateral security for money loaned thereon, which stock certificates are not actually sold, nor upon such stock certificates so de- posited: Provided further, That the tax shall not be imposed upon deliveries or transfers to a broker for sale, nor upon deliveries or transfers by a broker to a customer for whom and upon whose order he has pur- chased same, but such deliveries or transfers shall be accompanied by a certificate setting forth the facts: Provided further, That in case of sale where the evi- dence of transfer is shown only by the books of the com- pany the stamp shall be placed upon such books; and where the change of ownership is by transfer of the certificate the stamp shall be placed upon the certificate ; and in cases of an agreement to sell or where the trans- fer is by delivery of the certificate assigned in blank there shall be made and delivered by the seller to the buyer a bill or memorandum of such sale, to which the stamp shall be aifixed ; and every bill or memorandum of sale or agreement to sell before mentioned shall show the date thereof, the name of the seller, the amount of the sale, and the matter or thing to which it refers. Any person or persons liable to pay the tax as herein provided, or anyone who acts in the matter as agent or broker for such person or persons who shall make any such sale, or who shall in pursuance of any such sale deliver any stock or evidence of the sale of any stock WAR STAMP TAXES LAW 571 or bill or memorandum thereof, as herein required, without having the proper stamps affixed thereto with intent to evade the foregoing provisions shall be deemed guilty of a misdemeanor, and upon conviction thereof shall pay a fine of not exceeding $1,000, or be im- prisoned not more than six months, or both, at the dis- cretion of the court. Tax on sales of produce on exchanges. 5. Produce, sales of, on exchange: Upon each sale, agreement of sale, or agreement to sell, including so-called transferred or scratch sales, any products or merchandise at any ex- change, or board of trade, or other similar place, for future delivery, for each $100 in value of the merchan- dise covered by said sale or agreement of sale or agree- ment to sell, 2 cents, and for each additional $100 or fractional part thereof in excess of $100, 2 cents: Pro- vided, That on eveiy sale or agreement of sale or agree- ment to sell as aforesaid there shall be made and deliv- ered by the seller to the buyer a bill, memorandum, agreement, or other evidence of such sale, agreement of sale, or agreement to sell, to which there shall be affixed a lawful stamp or stamps in value equal to the amount of the tax on such sale : Provided further, That sellers of commodities described herein, having paid the tax provided by this subdivision, may transfer such con- tracts to a clearing house corporation or association, and such transfer shall not be deemed to be a sale, or agreement of sale, or an agreement to sell within the provisions of this Act, provided that such transfer shall not vest any beneficial interest in such clearing house association but shall be made for the sole purpose of enabling such clearing house association to adjust and balance the accounts of the members of said clearing house association on their several contracts. And every such bill, memorandum, or other evidence of sale or agreement to sell shall show the date thereof, the name of the seller, the amount of the sale, and the matter or 572 INCOME AND FEDERAL TAX REPORTS thing to which it refers; and any person or persons liable to pay the tax as herein provided, or anyone who acts in the matter as agent or broker for such person or persons, who shall make any such sale or agreement of sale, or agreement to sell, or who shall, in pursuance of any such sale, agreement of sale, or agreement to sell, deliver any such products or merchandise without a bill, memorandum, or other evidence thereof as herein required, or who shall deliver such bill, memorandum, or other evidence of sale, or agreement to sell, without having the proper stamps affixed thereto, with intent to evade the foregoing provisions, shall be deemed guilty of a misdemeanor, and upon conviction thereof shall pay a fine of not exceeding $1,000, or be imprisoned not more than six months, or both, at the discretion of the court. That no bill, memorandum, agreement, or other evi- dence of such sale, or agreement of sale, or agreement to sell, in case of cash sales of products or merchandise for immediate or prompt delivery which in good faith are actually intended to be delivered shall be subject to this tax. Tax on drafts, promissory notes and post-dated checks. 6. Drafts or checks payable otherwise than at sight or on demand, promissory notes, except bank notes issued for circulation, and for each renewal of the same, for a sum not exceeding $100, 2 cents ; and for each ad- ditional $100 or fractional part thereof, 2 cents. Tax on deeds and other instruments of conveyance. 7. Conveyance: Deed, instrument, or writing, whereby any lands, tenements, or other realty sold shall be granted, assigned, transferred, or otherwise conveyed to, or vested in, the purchaser or purchasers, or any other person or persons, by his, her, or their direction, when the consideration or value of the interest or property conveyed, exclusive of the value of any lien or encum- brance remaining thereon at the time of sale, exceeds $100 and does not exceed $500, 50 cents; and for each WAR STAMP TAXES LAW 573 additional $500 or fractional part thereof 50 cents: Provided, That nothing contained in this paragraph shall be so construed as to impose a tax npon any in- strument or writing given to secure a debt. Tax on custom-house entries. 8. Entry of any goods, wares, or merchandise at any custom-house, either for consumption or warehousing, not exceeding $100 in value, 25 cents ; exceeding $100 and not exceeding $500 in value, 50 cents; exceeding $500 in value, $1. Tax on withdrawals from bonded warehouse. 9. Entry for the withdrawal of any goods or merchandise from customs bonded warehouse, 50 cents. Tax on passage tickets. 10. Passage ticket, one way or round trip, for each passenger, sold or issued in the United States for passage by any vessel to a port or place not in the United States, Canada, or Mexico, if costing not exceeding $30, $1 ; costing more than $30 and not exceeding $60, $3; costing more than $60, $5: Provided, That such passage tickets, costing $10 or less, shall be exempt from taxation. Tax on proxies. 11. Proxy for voting at any election for officers, or meeting for the transaction of business, of any incorporated company or association, except re- ligious, educational, charitable, fraternal, or literary so- cieties, or public cemeteries, 10 cents. Tax on powers of attorney. Power of attorney grant- ing authority to do or perform some act for or in behalf of the grantor, which authority is not otherwise vested in the grantee, 25 cents: Provided, That no stamps shall be required upon any papers necessary to be used for the collection of claims from the United States or from any State for pensions, back pay, bounty, or for property lost in the military or naval service or upon powers of attorney required in bankruptcy cases. Tax on playing cards. 13. Playing cards : Upon every pack of playing cards containing not more than fifty- four cards, manufactured or imported, and sold, or re- 574 INCOME AND FEDERAL TAX REPORTS moved for consumption, or sale, after the passage of this Act, a tax of 5 cents per pack in addition to the tax imposed under existing law. 1 Tax upon parcel-post packages. 14. Parcel-post pack- ages: Upon every parcel or package transported from one point in the United States to another by parcel- post on which the postage amounts to 25 cents or more, a tax of 1 cent for each 25 cents or fractional part there- of charged for such transportation, to be paid by the consignor. No such parcel or package shall be transported until a stamp or stamps representing the tax due shall have been affixed thereto. Approved by the President, October 3, 1917. 1 This tax is two cents upon every pack. CHAPTER XXVII WAR TAX ON PUBLIC UTILITIES AND INSURANCE What is taxed. Sections 500 to 505, Title V, of the Act of October 3, 1917, provide for a tax on and after November 1, 1917, npon payments made for domestic freight, express and passenger transportation; trans- portation of oil by pipe line; telegraph, telephone and radio messages; life insurance; marine, inland and fire insurance, and other insurance policies. Transportation denned. The definition of "transpor- tation" in its relation to the business of common car- riers contained in the Interstate Commerce Act of June 29, 1906 (34 Stat. 584), is held to apply to that term as used in section 500 of the Act of October 3, 1917, and is as follows: "The term transportation shall include cars and other vehicles and all instrumentalities and facilities of shipment or carriage, irrespective of ownership or of any contract express or implied, for the use thereof and all services in connection with the receipt, delivery, elevation, and transfer in transit, ventilation, refrig- eration or icing, storage and handling of property transported." Who pays the tax. The tax, in the case of the various charges for transportation and messages, is added to the regular charges and is paid by the public. In the case of insurance, the tax is intended to be borne by the insurance companies and not added to the amount of the premiums. 575 576 INCOME AND FEDERAL TAX REPORTS While, in the case of the tax on transportation, the person or company rendering the service is charged with the duty of collecting the tax and making proper returns and payment to the collector, in a Treasury de- cision of December 1, 1917, it is held that passengers purchasing tickets, if they neglect to pay the tax, are liable to the penalties, as well as the carriers. The penalty provided is a fine of not over $1,000 or impris- onment for not exceeding one year. This decision was made necessary by the laxity as to payment, in the early period of the incidence of the tax. Exemptions relating to transportation and messages. It is provided in section 502 "that no tax shall be im- posed under section five hundred upon any payment received for services rendered to the United States, or any State, territory, or the District of Columbia. The right to exemption under this section shall be evidenced in such manner as the Commissioner of Internal Rev- enue, with the approval of the Secretary of the Treas- ury, may by regulation prescribe." The foregoing is held to apply also to political sub- divisions of States and Territories. Specific exemp- tions include all institutions maintained solely for the exercise of legitimate governmental functions, such as State colleges, public libraries, hospitals, etc. The Food Administration Grain Corporation, Federal Farm Loan Board, Federal land banks, farm loan reg- isters, land bank examiners, and land bank appraisers are exempt from tax under this section, when exercis- ing strictly governmental functions. Decisions of the Treasury Department with regard to specific conditions will be quoted or referred to under the sections below, relating to freight, express and pas- senger transportation. Definitions relating to transportation. The term "United States," as used in section 500 in the phrase "from one point in the United States to another," means the WAR TAX ON PUBLIC UTILITIES 577 States, Territories of Alaska and Hawaii, and the Dis- trict of Columbia. The phrase "for less than 30 miles" means for less than 30 constructive miles in instances where two or more carriers are competing for transportation services. "Commutation or season tickets" include all tickets issued to and intended for the use of the purchaser for a certain number of trips between two given termini, whether limited or unlimited as to the time in which they are to be used. Commutation or season tickets do not include party tickets. Freight. The tax on freight charges, paid by ship- pers, is 3 per cent of the amount paid for the transpor- tation by rail or water or by any form of mechanical motor power when in competition with carriers by rail or water of property by freight consigned from one point in the United States to another. Ferry charges are in- cluded. Carriers transporting their own commodities, except such commodities as are necessary for use in their business as carriers, are required to pay a tax equal to that which would have accrued if the service had been paid for. No tax accrues, however, for transpor- tation by a carrier of a commodity necessary and in- tended to be used in the conduct of its business as such; neither is any tax imposed in a case where such a com- modity is transported for the similar use of another carrier which is a part of the same "system." Government exemptions. The following are Treas- ury decisions relating to cases in which transportation is for services rendered to the Government: All shipments either by freight or express, the charges on which are paid directly by the United States, will be free of the tax imposed by section 500. Shipments of Government property by Government offi- cers will be made on Government bills of lading. Shipments of property belonging to a State, Terri- 578 INCOME AND FEDERAL TAX REPORTS tory, or the District of Columbia, the charges on which are paid by the State, Territory or the District of Co- lumbia, will be made free of the tax imposed by sec- tion 500. The words "State" and "Territory" are held to include the political subdivisions thereof. It will be necessary in all cases of shipments made by freight or express, where Government bills of lading are not used, for the officer or employee of the United States, State, Territory, or the District of Columbia, to satisfy the agent to whom the charges are paid that the service rendered or to be rendered is for the United States, State, Territory, or the District of Columbia, as the case may be, and the agent collecting the charges should note on the records of his office the name of the consignor and consignee, and indicate thereon that such shipment covered service rendered the United States, State, Territory, or the District of Columbia, as the case may be, and was not subject to the tax. Shipments by freight or express of property received by the United States, or any State, Territory, or the District of Columbia, are free of the transportation tax, provided the United States or any State, Territory, or the District of Columbia is liable for and pays the transportation charges on such shipments. Miscellaneous Treasury decisions. In all cases in which shippers have credit arrangements with carriers under which their goods are shipped prepaid but the freight charges were not actually paid until after No- vember 1, 1917, the tax is not imposed on amounts paid for such transportation begun prior to November 1, 1917. If the consignees have credit arrangements with car- riers under which they settle their freight bills on or before the 15th of the month, the tax is not imposed or charged on freight bills for the transportation of goods actually delivered prior to November 1, 1917. No tax is imposed upon amounts paid for transporta- WAR TAX ON PUBLIC UTILITIES 579 tion of goods by freight in any instance in which the property was actually delivered to the consignee prior to November 1, 1917, and by reason of the loss of the bill of lading, dispute as to the amount of charges, or other delay, the payment was not made at the time of delivery. No tax is imposed on the amount paid for transpor- tation on a through bill of lading to or from Canada or Mexico or any foreign country. If however, property is shipped by freight from a point in the United States to a seaport on one bill of lading and is then reconsigned for export, the tax is imposed on the amount paid for the transportation to the seaport. Goods which are imported into the United States and reconsigned at port of entry to a point in the United States are subject to the tax upon the amount paid for transportation from. the port of entry to destination in the United States. If the property is consigned from a foreign port to a point within the United States with- out being reconsigned at the port of entry, the tax is not to be imposed. A railroad transporting a circus train should appor- tion the charges for the service rendered between the freight and passenger service, and the tax imposed by subdivision (a) of section 500 should be collected in the case of the former, and the 8 per cent tax imposed by subdivision (c) of said section should be collected in the case of the latter. Where the charge for transportation includes the charge for lighterage, which service is performed on or after November 1, 1917, the tax collected on or after that date should be based upon the entire charge for transportation. Logging companies which do a carrier business are subject to the tax imposed by section 500 upon the transportation of commodities owned by them which are not necessary for their use in the conduct of their 580 INCOME AND FEDERAL TAX REPORTS business as carriers and are not intended to be so used or have not been so used. Where a railroad company carries materials for a telegraph company free in consideration of messages sent free over the lines of the telegraph company, the tax attaches upon the amounts which the railroad com- pany and the telegraph company would otherwise re- ceive for services performed but for the comity of rela- tions between them. Tax attaches upon the amount paid for transporta- tion of goods from one pier to another in the same harbor. Tax does not attach separately on the following mis- cellaneous services rendered by a carrier when the charge for such services is included and paid in the through tariff rate for the road haul: (a) switching and drayage; (b) wharfage, storage and lighterage; (c) compressing in transit; (d) milling in transit; (e) dress- ing and refining in transit; (f) diversion and recon- signing charges; (g) refrigeration; (h) car service; (i) demurrage; (j) charge for consigning freight to order notify; (k) storage; (1) car rental; (m) switch charges for return of empty cars over belt or switch- ing lines; (n) weighing charges; (o) feeding and water- ing stock in transit. However, if the through tariff rate does not include such services, the amounts paid for the same are tax- able if such services are a part of the transportation by the carrier. In instances in which the amount paid for transpor- tation by freight is a lump sum the tax should be im- posed upon such sum without regard to the individual items which make up the total. In computing the tax, a fraction of a cent should be disregarded unless it amounts to one half cent or more, in which case it should be increased to 1 cent. When property is transported part of the way by WAR TAX ON PUBLIC UTILITIES 581 freight and part of the way by express the tax will be 3 per cent on the amount paid for the freight move- ment and 1 cent for each 20 cents or fraction paid for the movement by express. Express. The tax on express charges is "1 cent for each 20 cents or fraction thereof paid to any person, corporation, partnership or association, engaged in the business of transporting parcels or packages by ex- press over regular routes between fixed terminals, for the transportation of any package, parcel or shipment by express from one point within the United States to another." The tax is to be paid by the shipper. Exemptions. The exemptions in favor of the Gov- ernment and States set forth above under "Freight" ap- ply also to shipments by express. Separate items of a shipment need not be listed. The question as to whether or not under paragraph (b), section 500, newspapers or similar articles shipped by express shall be accounted for for taxing purposes in separate packages or in bulk shipments is answered in the following Treasury decision: From the facts presented it appears that the method of transporting newspapers by express is to deliver to the express company in bulk, tied or fastened together, an entire shipment, and to base and pay the express charges thereon without regard to enclosed subdivisions to be thrown off or delivered at way stations; that is to say: if 500 pounds of newspapers should be shipped on a single car at one time, to be distributed at 10 dif- ferent stations, the package would be received as one shipment and the total express charge would be for the aggregate amounts of the 10 sub- divisions, and not upon the basis of the 10 deliveries. As this was a fact and a commercial condition at the time of the pas- sage of the Act, Congress is assumed, if the contrary does not otherwise appear in the law, to have enacted the taxing provision relative to express shipments in view of and to meet such existing commercial conditions and practice. It will be observed that the tax is laid upon the transportation of "any package, parcel, or shipment by express from one point in the United States to another." These shipments, as indicated in the above example, would be from one point to 10 different points, and a literal interpretation of the law, taken 582 INCOME AND FEDERAL TAX REPORTS in connection with the use of the words "package, parcel or shipment,'* might require the payment of this tax upon the parcel, or separate deliv- ery basis. This seems to have been in the mind of Congress at the time of the en- actment of the law, but the proviso immediately following was doubtless intended to cure the difficulties or delays that might arise out of the lit- eral interpretation of the language used. That proviso reads as follows: Provided: That nothing herein contained shall be construed to require the carrier collecting such tax to list separately in any bill of lading, freight receipt, or similar document, the amount of the tax herein levied, if the total amount of the freight and tax be therein stated. It is manifest from the foregoing that it will not be necessary to specify in each express receipt the separate parcels marked with the name of the point of delivery or to pay the tax upon that basis, if the total amount paid for transportation of the entire shipment and the tax due and paid be stated in such receipt. All transportation of milk and cream by express com- panies is "by express" and is taxable as such. If trans- portation is by trolley line the classification employed by the trolley line as "by freight" or "by express" will govern, and the tax will be imposed accordingly. Charges for delivery of packages by horse-drawn ve- hicles will not be included in the taxable express charges, since the tax applies only to transportation by mechanical motor power. Passenger transportation. The tax on passenger trans- portation is 8 per cent of the fare (except where fare is 35 cents or less or where season or commutation tickets are used for trips of less than 30 miles), pay- able by the passenger, although the tax return and actual payment to the collector is made by the carrier. The transportation so taxable is, as in the case of freight and express transportation, that which is over a regularly established line, rail or by water, in com- petition with other carriers. Automobile carriers oper- ating on a regularly established route are included in cases where the fare is over 35 cents. The tax attaches in each case where the distance trav- eled in a continuous journey is 30 miles or more, or where the total fare is 35 cents or more. Bound-trip WAR TAX ON PUBLIC UTILITIES 583 tickets costing 70 cents or more are taxable. The tax is to be collected pro rata in cases where the fare is collected in amounts of less than 35 cents, as some- times happens in the "zone" system. The tax is col- lectible notwithstanding the passenger may pay cash for part of the transportation and give commutation tickets for another part. In the case of passenger transportation, the tax ap- plies not only to points within the United States, but also to transportation to Canada or Mexico, if the tick- ets therefor are sold and issued in the United States. Pullmcm berths, staterooms, etc. There is also a tax of 10 per cent for seats, berths, and staterooms in par- lor cars, sleeping cars, or on vessels. Where the price of the ticket includes charges for berth, stateroom and meals, which cannot be segregated, a tax of only 8 per cent of the amount paid for the ticket is collectible. Exemptions. Exemptions in favor of the Government are described in the Treasury decisions given below: When officers or employees of the United States, or of any State, Territory, or the District of Columbia, travel on transportation requests, the transportation re- quests will be sufficient evidence that the tickets ob- tained thereon either for transportation by rail or water, or for seats, berths, or staterooms in parlor cars, sleeping cars or on vessels, were received from the agent without the payment of tax imposed by section 500. The agent of the transportation company who issues the ticket should note on the records of his office the number of the Government transportation request. Where travel is made by officers or employees of a State, Territory, or the District of Columbia, upon transportation requests, a notation should be made on the records of the agent issuing the ticket so that a verification can be made, as in case of Government transportation requests. 584 INCOME AND FEDERAL TAX REPORTS When an officer or employee of the United States, or of a State, Territory, or the District of Columbia, is traveling on official business and pays cash for his transportation, or presents a mileage book purchased prior to November 1, 1917, he will give to the agent from whom tickets are obtained for transportation by rail, or water, or vessels, or the conductor or agent to whom he presents the mileage book, his certificate stat- ing that the service to be rendered from the place named is on account of official business and not for private purposes. Transportation agents should not accept such certificate unless the officer or employee presenting same shows satisfactory credentials. In case a ticket, obtained either on a transportation request or by purchase and not partially used prior to November 1, 1917, is presented for travel on official business on or after November 1, 1917, a certificate made in the form indicated above should be given to the conductor to whom such ticket is first presented. Commutation, season, and party tickets. "Commuta- tion or season tickets" include all tickets issued to and intended for the use of the purchaser for a certain num- ber of trips between two given termini, whether lim- ited or unlimited as to the time in which they are to be used; commutation or season tickets do not include party tickets. The tax must be paid on such tickets at the time of purchase, where the length of the specified journeys is 30 miles or more, or the fare for each jour- ney is 35 cents or more. Mileage books. A mileage book purchased on or after November 1, 1917, is subject to tax upon the full purchase price at the time of purchase; where a mile- age book purchased prior to November 1, 1917, is used on or after that date, the person presenting such book, whether the transportation fare to be used is more or less than 35 cents, must pay to the conductor or other agent the tax on such proportionate amount of the cost WAR TAX ON PUBLIC UTILITIES 585 of the book as the unused mileage bears to the total mileage originally in the book. Baggage. Amount paid for transportation of excess baggage is held to be part and parcel of the amount paid for transportation of persons and is therefore sub- ject to tax at a like rate; no tax is imposed under the Act of October 3, 1917, on amounts paid for the storage of baggage. Through transportation. Where through transporta- tion is paid in full, for example, from New York to Hongkong by way of Vancouver, British Columbia, the railway ticket from New York to Vancouver would be subject to tax under section 500, and the steamship ticket from Vancouver to Hongkong would be subject to the tax imposed on passage tickets. A through ticket purchased in Hongkong for Habana, Cuba, routed trans-Pacific steamer to San Francisco, rail lines thence to New Orleans, and steamship line thence to Habana, the ticket containing an order "Good for exchange in San Francisco for a railroad ticket from San Francisco to New Orleans, and in New Or- leans for a steamship ticket from New Orleans to Ha- bana," is subject to the tax imposed by subdivision (c) of section 500 on the amount paid for the transporta- tion from San Francisco to New Orleans, and to the tax imposed .by paragraph (10) 1 of Schedule A, Title VIII, of the Act of October 3, 1917, on amounts paid for transportation from New Oreans to Habana, Cuba- Corpses. Where a corpse is transported under tariffs requiring one first-class ticket therefor and one first- class ticket for an attendant, under the carrier's regu- lations, the tax is imposed as in the case of passenger transportation on both tickets ; where a corpse is trans- ported by freight or express, the amount paid for such transportation would be subject to the tax imposed in the case of freight or express transportation. i Passage Tickets for Foreign Ports. 586 INCOME AND FEDERAL TAX REPORTS Telegraph, telephone and radio messages. A tax of 5 cents for each such message is imposed, payable by the sender on each such message originating within the United States and for the transmission of which a charge of 15 cents or more is made. Only one tax is imposed, notwithstanding the lines or stations of more than one concern be used for trans- mission. Exemptions. All telegraph, telephone or radio mes- sages of officers and employees of the United States, or of a State, Territory, or the District of Columbia, or political subdivision thereof, on official business, are exempt from tax, and should not be reported in the monthly return of the telegraph, telephone or radio com- pany. Such messages, conversations and dispatches, to be exempt, must not only relate to Government business but must be a charge against and actually be paid for out of Government funds. In case of a telegraph or radio message, the officer or employee sending such mes- sage should certify thereon that it is on account of offi- cial business and not for private purposes. This cer- tificate may be in the following form: "I certify that this message is on official business and not for private purposes. (Title)." Oil pipe-lines. A tax of 5 per cent is imposed on all charges for transportation of oil by pipe-line. Returns. Returns on all the taxes mentioned above are required monthly in duplicate, as provided in sec- tion 503. The first return is due on or before Feb- ruary 28, 1918, covering the month of November, 1917. Returns for each month thereafter must be made and tax paid over on or before three months from the last day of the month covered by the return. WAR TAX ON PUBLIC UTILITIES 587 Penalties. The penalty for failure to comply with the provisions of section 500 is a fine of not more than $1,000 or imprisonment for not more than one year, or both. The penalty is imposed not only upon the person or corporation required to make the return and pay over the tax, but also upon the person failing to pay the tax at the time he pays the transportation charges. Insurance. The taxes imposed upon the various forms of insurance effective November 1, 1917, are as follows, no policies of reinsurance * being taxable : (a) Life insurance. The tax imposed on life insur- ance policies is 8 cents on each $100 or fractional part thereof of the amount for which any life is insured under any form of policy, except policies issued by persons, corporations, partnerships or associations whose income is exempt from taxation under Title I of the Act of September 8, 1916. Life insurance policies for an amount not in excess of $500 and issued on the industrial or weekly payment plan are taxed at the rate of 40 per cent of the amount of the first weekly premium. The tax does not apply to Soldiers' and Sailors' In- surance written by the War Eisk Bureau. (b) Marine, inland and fire insurance. The tax on policies of property insurance of any description (in- cluding rents and profits) made or renewed on or after November 1, 1917, is at the rate of 1 cent on every dol- lar or fractional part thereof of the premium charged. (c) Casualty insurance. The tax on casualty insur- ance policies- is 1 cent on each dollar or fractional part thereof of the premium charged. Companies insuring or guaranteeing any loss that might be occasioned by reason of accepting mortgages that cannot be foreclosed or in any manner recovered upon are subject to tax under paragraph (c). i Reinsurance is the underwriting of part of the liability of one company by another company. 588 INCOME AND FEDERAL TAX REPORTS Associations composed of employers or others who band themselves together for mutual protection in is- suing life and casualty insurance are subject to tax under paragraph (c) unless exempted from income tax under Title I of the Act of September 8, 1916, and as amended. If mutual fire or tornado insurance companies are ex- empt under the income tax law, no tax is imposed by this Act. Said Income Tax Law is, in part, as follows: "Farmers' or other mutual, hail, cyclone, or fire in- surance company * * * or organization of a purely local character, the income of which consists solely of assessments, dues, and fees collected from members for the sole purpose of meeting expenses." Insurance policies issued by organizations of the above description are exempt. Miscellaneous Treasury decisions. Brokers who place risks for clients with insurance companies are not sub- ject to tax under section 504 (War Tax on Insurance Policies), as the tax is imposed upon the companies issuing the insurance. No tax on insurance is imposed on the insured. The tax is imposed by section 504 upon the person, firm, or corporation writing the insurance, the necessary re- turns for which will be rendered to the collector of the district in which the principal place of business is lo- cated. The tax is imposed on newly written policies and on premiums paid on "open" policies, but not on amounts paid on policies of reinsurance. Consequently, where an insurance company reinsures the risks of an- other company the transaction is termed reinsurance, and would not be taxable. The tax is imposed on in- surance without regard to sex or age of the insured. Reinsurance is regarded as that insurance taken out by a company which has overinsured and obtained an- other company to underwrite for it a part of the lia- bility. WAR TAX ON PUBLIC UTILITIES 589 Tax accrues on insurance policies issued within the United States, irrespective of the residence of the in- sured. Tax under section 504 is imposed on the premium charged, each separate premium collected being re- garded as a separate item for the computation of the tax, and not on the gross amount of the premiums col- lected for any one month. So far as the tax is concerned, the issuance of a pol- icy is considered to be of the date when the policy is delivered to the insured or in any other manner becomes a valid claim and effective for insurance. Returns. Eeturn for tax on insurance may be filed either direct from the home office, or by the State or district superintendent or agent, where such is ap- pointed or employed. Such State or territorial agents should be given authority, in writing, from the main office, to make such returns and account for the tax due on policies written. Single reports, prepared by home offices, however, are preferred. Local insurance agents will not be required to make returns. Blank forms of returns required by section 505 will be furnished to insurance companies monthly by the Commissioner of Internal Kevenue. Eeturns showing the name and address of each per- son to whom an indemnity is paid are not required. Permission will be granted to take credit in a sub- sequent month's report for any overpayment of tax for a prior month. The first return was due December 15, 1917, covering the month of November. Each return must be made on or before the 15th day of each month, covering all poli- cies issued during the preceding month. CHAPTER XXVIII WAR TAX ON UTILITIES AND INSURANCE LAW BEING TITLE V OF "AN ACT TO PROVIDE REVENUE TO DEFRAY WAR EXPENSES, AND FOR OTHER PURPOSES," APPROVED OCTOBER 3, 1917. (PUBLIC No. 50 65th CONGRESS.) IN EFFECT OCTOBER 4, 1917, UNLESS OTHERWISE SPECIALLY PROVIDED. TITLE V. WAR TAX ON FACILITIES FURNISHED BY PUBLIC UTILITIES, AND INSURANCE. Freight and express shipments, passenger traffic, etc. Sec. 500 [of the general revenue Act of which this Title is a part]. That from and after the first day of No- vember, nineteen hundred and seventeen, there shall be levied, assessed, collected, and paid (a) a tax equivalent to three per centum of the amount paid for the trans- portation by rail or water or by any form of mechanical motor power when in competition with carriers by rail or water of property by freight consigned from one point in the United States to another; (b) a tax of 1 cent for each 20 cents, or fraction thereof, paid to any person, corporation, partnership, or association, en- gaged in the business of transporting parcels or pack- ages by express over regular routes between fixed ter- minals, for the transportation of any package, parcel, or shipment by express from one poiflt in the United States 590 WAR TAX ON UTILITIES 591 to another: Provided, That nothing herein contained shall be construed to require the carrier collecting such tax to list separately in any bill of lading, freight re- ceipt, or other similar document, the amount of the tax herein levied, if the total amount of the freight and tax be therein stated; (c) a tax equivalent to eight per cen- tum of the amount paid for the transportation of per- sons by rail or water, or by any form of mechanical motor power on a regular established line when in competition with carriers by rail or water, from one point in the United States to another or to any point in Canada or Mexico, where the ticket therefor is sold or issued in the United States, not including the amount paid for commutation or season tickets for trips less than thirty miles, or for transportation the fare for which does not exceed 35 cents, and a tax equivalent to ten per centum of the amount paid for seats, berths, and staterooms in parlor cars, sleeping cars, or on vessels. If a mileage book used for such transportation or accommodation has been purchased before this section takes effect, or if cash fare be paid, the tax imposed by this section shall be collected from the person presenting the mileage book, or paying the cash fare, by the conductor or other agent, when presented for such transportation or ac- commodation, and the amount so collected shall be paid to the United States in such manner and at such times as the Commissioner of Internal Kevenue, with the ap- proval of the Secretary of the Treasury, may prescribe ; if a ticket (other than a mileage book) is bought and partly used before this section goes into effect it shall not be taxed, but if bought but not so used before this section takes effect, it shall not be valid for passage until the tax has been paid and such payment evidenced on the ticket in such manner as the Commissioner of In- ternal Eevenue, with the approval of the Secretary of the Treasury, may by regulation prescribe; (d) a tax equivalent to five per centum of the amount paid for the 592 INCOME AND FEDERAL TAX REPORTS transportation of oil by pipe line; (e) a tax of 5 cents upon each telegraph, telephone, or radio, dispatch, mes- sage, or conversation, which originates within the United States, and for the transmission of which a charge of 15 cents or more is imposed: Provided, That only one payment of such tax shall be required, notwithstanding the lines or stations of one or more persons, corpora- tions, partnerships, or associations shall be used for the transmission of such dispatch, message, or conversation. Sec. 501. That the taxes imposed by section five hun- dred shall be paid by the person, corporation, partner- ship, or association paying for the services or facilities rendered. In case such carrier does not, because of its ownership of the commodity transported, or for any other reason, receive the amount which as a carrier it would other- wise charge, such carrier shall pay a tax equivalent to the tax which would be imposed upon the transportation of such commodity if the carrier received payment for such transportation: Provided, That in case of a car- rier which on May first, nineteen hundred and seven- teen, had no rates or tariffs on file with the proper Fed- eral or State authority, the tax shall be computed on the basis of the rates or tariffs of other carriers for like services as ascertained and determined by the Commis- sioner of Internal Revenue: Provided further, That nothing in this or the preceding section shall be con- strued as imposing a tax (a) upon the transportation of any commodity which is necessary for the use of the carrier in the conduct of its business as such and is intended to be so used or has been so used; or (b) upon the transportation of company material transported by one carrier, which constitutes a part of a railroad sys- tem, for another carrier which is also a part of the same system. United States and States exempt from tax. Sec. 502. That no tax shall be imposed under section five hundred WAR TAX ON UTILITIES 593 upon any payment received for services rendered to the United States, or any State, Territory, or the Dis- trict of Columbia. The right to exemption under this section shall be evidenced in such manner as the Com- missioner of Internal Revenue, with the approval of the Secretary of the Treasury, may by regulation prescribe. Tax returns and payment. Sec. 503. That each person, corporation, partnership, or association receiving any payments referred to in section five hundred shall collect the amount of the tax, if any, imposed by such section from the person, corporation, partnership, or associa- tion making such payments, and shall make monthly re- turns under oath, in duplicate, and pay the taxes so col- lected and the taxes imposed upon it under paragraph two of section five hundred and one to the collector of internal revenue of the district in which the principal office or place of business is located. Such returns shall contain such information, and be made in such manner, as the Commissioner of Internal Eevenue, with the ap- proval of the Secretary of the Treasury, may by regu- lation prescribe. War tax on insurance policies. Sec. 504. That from and after the first day of November, nineteen hundred and seventeen, there shall be levied, assessed, collected, and paid the following taxes on the issuance of insur- ance policies: (a) Life insurance: A tax equivalent to 8 cents on each $100 or fractional part thereof of the amount for which any life is insured under any policy of insurance, or other instrument, by whatever name the same is called : Provided, That on all policies for life insurance only by which a life is insured not in excess of $500, issued on the industrial or weekly payment plan of insurance, the tax shall be forty per centum of the amount of the first weekly premium: Provided further, That policies of reinsurance shall be exempt from the tax imposed by this subdivision; (b) Marine, inland, and fire insurance: A tax equivalent to 1 cent 594 INCOME AND FEDERAL TAX REPORTS on each dollar or fractional part thereof of the pre- mium charged under each policy of insurance or other in- strument by whatever name the same is called whereby insurance is made or renewed upon property of any de- scription (including rents or profits), whether against peril by sea or inland waters, or by fire or lightning, or other peril: Provided, That policies of reinsurance shall be exempt from the tax imposed by this subdi- vision ; (c) Casualty insurance: A tax equivalent to 1 cent on each dollar or fractional part thereof of the premium charged under each policy of insurance or obligation of the nature of indemnity for loss, damage, or liability (except bonds taxable under subdivision two of Sched- ule A of Title VIII) issued or executed or renewed by any person, corporation, partnership, or associa- tion, transacting the business of employer's liability, workmen's compensation, accident, health, tornado, plate glass, steam boiler, elevator, burglary, automatic sprink- ler, automobile, or other branch of insurance (except life insurance, and insurance described and taxed in the pre- ceding subdivision) : Provided, That policies of rein- surance shall be exempt from the tax imposed by this subdivision ; (d) Policies issued by any person, corporation, part- nership, or association, whose income is exempt from Taxation under Title I of the Act entitled "An Act to increase the revenue, and for other purposes," approved September eighth, nineteen hundred and sixteen, shall be exempt from the taxes imposed by this section. Insurance tax returns and payment. Sec. 505. That every person, corporation, partnership, or association, issuing policies of insurance upon the issuance of which a tax is imposed by section five hundred and four, shall, within the first fifteen days of each month, make a re- turn under oath, in duplicate, and pay such tax to the collector of internal revenue of the district in which WAR TAX ON UTILITIES 595 the principal office or place of business of such person, corporation, partnership, or association is located. Such returns shall contain such information and be made in such manner as the Commissioner of Internal Eevenue, with the approval of the Secretary of the Treasury, may by regulation prescribe. Approved by the President, October 3, 1917. CHAPTER XXIX WAR TAX ON ADMISSIONS AND DUES What is taxed. The war tax on admissions l and dues, effective on and after November 1, 1917, is a tax of 1 cent for each 10 cents or fraction thereof, and in some cases of 10 per cent, of charges made for admis- sion to any place to which an admission charge is made for private or personal profit. Among the classes of admissions so taxable are those to theaters, cabarets, club memberships and athletic and racing associations. The tax payable in each case is specified below under the appropriate heading. The tax being upon the privilege of admission, lia- bility to tax upon any admission or dues depends, as has recently been decided by the Treasury Department, not upon the date of the payment, but upon the date of the admission or the period for which the dues are paid. Earlier rulings, no longer in effect, had imposed the tax, for example, also upon amounts paid for dues in ar- rears, if such amounts were actually received after the tax became effective. The object of the tax, like that of the war excise tax, seems to be to collect a revenue from the nation's ex- penditures for what may be called "near-luxuries." It is at the other extreme in principle from the ancient expedient, not yet wholly abandoned in some parts of the world, of taxing absolute necessities, such as salt. It will be seen that few, if any, of the admissions and i The term "admission" includes seats and tables, reserved or otherwise, and other similar accommodations, and the charges made therefor. 596 WAR TAX ON ADMISSIONS AND DUES 597 dues taxable are other than those that represent the price the public is willing to pay for amnsements or social exclusiveness, neither of which are absolutely necessary for the maintaining of life, however helpful they may be in maintaining the life to which the pub- lic has become accustomed. Exemptions. General exemptions from the tax are as follows : (1) Admission to a place the maximum charge for admission to which is 5 cents, or to shows, rides and other amusements (the maximum charge for admission to which is 10 cents) within outdoor general amusement parks, or to such outdoor general amusement parks. (2) Admissions, all the proceeds x of which inure exclusively to the benefit of religious, educational, or charitable institutions, societies, or organizations 2 or admissions to agricultural fairs none of the profits of which are distributed to stockholders or members of the association conducting the same. (3) Amounts paid as dues or fees to a fraternal beneficiary society, order, or association operating un- der 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 so- ciety, order or association, or their dependents. Specific cases concerning exemptions passed on by the Treasury Department include the following: Dues charged by the Y. M. C. A. and the Y. M. H. A. are exempt. Complimentary tickets issued to benefit concerts or entertainments for a charity hospital or for other similar institutions, the proceeds of which are exempt iThe word "proceeds" is held to mean gross receipts less payments of proper expenses; or, in other words, "net proceeds." 2 To be a religious, educational, or charitable institution, society or or- ganization, such purposes must be its primary or principal function. 600 INCOME AND FEDERAL TAX REPORTS tax is computed on the basis of the price paid for simi- lar boxes at single performances by parties who pay for each performance severally. The tax may be com- puted, if there are no other boxes of similar size, by taking as a basis the price charged for a single seat in smaller or larger boxes, or if there are no other boxes, the price of a single seat in the same part of the house, and multiplying this price by the number of seats in the box in question. In the case of admission by season ticket or subscrip- tion, the amount of the tax is equivalent to 1 cent for each 10 cents of the proportion of the amount paid for such season or subscription covering admissions on or after November 1, 1917. On and after December 15th no person may be ad- mitted to any place to which admission is charged unless the ticket, card or pass by which he is admitted bears evidence that the tax due in respect of the admis- sion covered by it has been paid. This evidence must consist of the printing or stamping upon the ticket, card, pass or other papers evidencing the right to ad- mission the words "tax paid." Each proprietor of any place to which admission is charged not specifically exempted from taxation by the Act must provide him- self with such a stamp as may be necessary for this purpose. Such stamp must be applied to the ticket, card, pass, or other evidence of the right to admission, at the place where it is issued. All tickets, passes, cards or other evidence of the right to admission issued before November 1, but used after November 1, must be "validated" before they are used by collecting the tax and stamping them in accordance with the above requirements. Where there is no box office price, the amount so paid for admission is taxable. Traveling theatrical companies paying special taxes as theaters, not showing in regular buildings built and WAR TAX ON ADMISSIONS AND DUES 601 rented for that purpose, should collect the tax on ad- missions. If they show in regular theaters or opera houses the owners of such houses should collect and file the returns. Where the proprietor of a theater leases his premises and reserves a box for his own use, the tax collected on this box is the same as that col- lected on any other box or like accommodation at the same theater. One who rents or leases a theater out- right for one or more performances must make return and pay the tax, but the proprietor of the theater is required to show in his returns the dates when and the parties to whom he rents or leases the place. Where theaters are not permitted to charge admis- sion but overcome the difficulty by taking a "silver col- lection" at the door there is no objection to selling revenue tickets with each contribution, a ten-cent con- tributor paying 11 cents. The following is an illustration of the computation of the tax on admissions applicable to theaters and other places where the rate of tax is 1 cent for each 10 cents or fraction: Admission 35 cents tax 4 cents total to be collected 39 cents Reserved Seats 25 cents Reserved Seats 15 cents Admission 25 cents Admission 10 cents Admission (child) .... 5 cents There is no stamp tax on such tickets: the seller of the ticket collects the tax computed on each ticket sepa- rately. Daily cash register receipts cannot be taken as a basis for computing the amount of tax due, unless all admissions are 10 cents or multiples of 10 cents. The aggregate amount of tax is to be entered in the return, computed as above directed, upon each admis- sion and each free admission separately. In comput- ing the tax upon each payment, a fraction of a cent is to be disregarded unless it amounts to one half cent or more, in which case it is to be counted as one cent. " 3 cents tt a 28 cents " 2 cents " " 17 cents " 3 cents H M 28 cents " 1 cent H u ' 11 cents " 1 cent a ti ' 6 cents 602 INCOME AND FEDERAL TAX REPORTS Airdomes. Airdomes do not come within the ex- emption of open-air parks, and admissions thereto are taxable. Dance halls. Admissions to dance halls are taxable, but charges for the privilege of dancing, in addition to the charges for admission, are not taxable. If a group of people get together and take up a collection or con- tribution of money to pay for the music, such collec- tion or contribution would not be regarded as price paid for admission to a dance. Sums paid for private dancing or class lessons are not subject to tax. Cabarets. In the case of cabarets or other similar en- tertainments to which the charge for admission is wholly or in part included in the price paid for refreshment, service, or merchandise, the amount paid for admission is estimated by the Treasury Department as being one- fifth of the patron's total bill. The tax, accordingly, is 1 cent for each 10 cents or fraction thereof of an amount equal to 20 per cent of the bill, unless satisfactory evi- dence is presented to the Collector that a different per- centage should be fixed. For example : if the bill amounts to $5, the tax is 10 cents. A fraction of a cent is to be disregarded unless it amounts to one half cent or more, in which case it is increased to 1 cent. Tips are not to be included in the amount which forms the basis of the tax. Cabarets include any place in which any enter- tainment is conducted in connection with the sale of food, refreshments, etc., except that the tax does not ap- ply to hotels, restaurants, etc., where only instrumental music is furnished, but does apply if there is dancing by the patrons. Eeturns, in the case of cabarets, must be made on or before the 10th day of each month. (T. D. 2603.) Miscellaneous admissions. Taxable admissions include those to Sunday afternoon orchestral concerts, admis- sions to caves and similar exhibitions, and admissions to food shows. WAR TAX ON ADMISSIONS AND DUES 603 Athletic and racing associations. Admissions to college athletic exhibitions, as well as to any other similar ex- hibitions, such as track meets, football and baseball games, are taxable, unless all the net proceeds are given to the college itself, or to some other institution exempt from taxation under the Act. The tax attaches upon subscriptions to racing asso- ciations regardless of whether or not the subscriber at- tends any of the meets. The association itself may pay the tax due for any person admitted free. The provision of the section which allows bona-fide employees to be admitted tax-free applies only to actual employees of the association and not to employees of the owners of racing horses. Fairs. Agricultural fair associations must collect and pay the tax if any of the proceeds are distributed to members or stockholders of the association. If no such profits are to be so distributed the tax does not attach to admission charges. Club dues. Dues or fees admitting to membership in social clubs are taxable at the rate of 10 per cent, if such dues exceed $12 a year. Any organization which maintains headquarters for the purpose of affording its members the opportunity of informally congregating for social intercourse is a social club within the meaning of the law, and the dues therefore are taxable. Business men's oganizations, such as Chambers of Commerce, are not taxable, however, by reason of the fact that social features may be included in their meetings with the object of maintaining their membership for business purposes. Tax must be paid upon all dues representing mem- bership privileges for any time elapsing after October 31, 1917, regardless of the time of payment. Thus, in a case of dues exceeding $12 a year paid for the calen- dar year 1917, a tax will be due on one-sixth of the full amount paid for such calendar year, irrespective of the date of payment 604 INCOME AND FEDERAL TAX REPORTS Where a club charges an initiation fee in addition to annual dues the taxability of the club is estimated upon the annual dues plus the initiation fee. Assessment dues; life membership fees; college fra- ternity dues; and "green fees" paid by a member of a golf club for a guest are all taxable. Where the annual dues exceed $12, but are paid in two or more annual installments, the payments are tax- able when made, pro rata. The tax does not attach in a case where the only initiation fee charged is the purchase of a share of stock in the club. Where membership entitles a member to admission with one guest, no further tax is required for admis- sion of such guest. Other guests admitted free of charge, however, must pay the tax. The tax on club dues may be paid by the clubs them- selves. Y. M. C. A. and Y. M. H. A. dues and admissions are not taxable. Returns. Every person, corporation, partnership or association receiving payment for admissions, or admit- ting any person free, is obligated to collect the tax due in each case and to make returns as provided in section 503 of the Act. Eeturns must be made in duplicate on or before the last day of each month covering the preceding month (in the case of cabarets on the 10th of each month), and the tax required to be collected must be paid over to the collector of the district in which is situated the principal office or place of business. This return is made on Form 729. There must be kept in each box or ticket office of every theater, place of amusement, or other place to which admissions subject to the tax are charged a daily rec- ord of the number and kind of tickets sold and the tax collected thereon. Such record must also show the num- WAR TAX ON ADMISSIONS AND DUES 605 ber of passes used for admission each day and the tax collected thereon and the number of admissions of chil- dren under twelve years of age and the tax collected thereon. Each separate class of tickets sold must be so distinctly indicated as to be capable of ready verifica- tion by the Internal Eevenue Department. A separate record must be kept of the number and kind of tickets, cards, passes or other evidence of right to admission on or after November 1, 1917, paid for or issued prior to November 1 and of the tax collected in respect thereof. The monthly return required to be filed by proprietors of all places to which admission is charged, not expressly exempt from taxation, must include and cover amounts collected on validation of tickets, passes, cards, or other evidence of the right to admission. In computing the tax, a fraction of a cent is to be dis- regarded unless it amounts to one half cent or more, in which case it is to be counted as one cent. Such frac- tions, however, are likely to be encountered only in cases where the tax is a straight percentage of the charge for admission. Where the tax is 1 cent for each 10 cents or fraction thereof of the price of admission, no frac- tions of cents will be encountered. Penalties. The penalties are: for failure to submit a return within the time prescribed, a fine of not more than $1,000 or imprisonment for not more than one year, or both; and for failure to collect or truly to account for and pay over the tax, an additional penalty of double the tax not collected or accounted for. A recent decision of the Treasury Department in the case of the stamp tax on railroad tickets construes the penalty for non-payment as being also upon the pur- chaser of the ticket ; it seems possible that a similar con- struction of the law might be made to apply in the case of the tax on admissions and dues. 604 INCOME AND FEDERAL TAX REPORTS Where a club charges an initiation fee in addition to annual dues the taxability of the club is estimated upon the annual dues plus the initiation fee. Assessment dues; life membership fees; college fra- ternity dues; and "green fees" paid by a member of a golf club for a guest are all taxable. Where the annual dues exceed $12, but are paid in two or more annual installments, the payments are tax- able when made, pro rata. The tax does not attach in a case where the only initiation fee charged is the purchase of a share of stock in the club. Where membership entitles a member to admission with one guest, no further tax is required for admis- sion of such guest. Other guests admitted free of charge, however, must pay the tax. The tax on club dues may be paid by the clubs them- selves. Y. M. C. A. and Y. M. H. A. dues and admissions are not taxable. Returns. Every person, corporation, partnership or association receiving payment for admissions, or admit- ting any person free, is obligated to collect the tax due in each case and to make returns as provided in section 503 of the Act. Returns must be made in duplicate on or before the last day of each month covering the preceding month (in the case of cabarets on the 10th of each month), and the tax required to be collected must be paid over to the collector of the district in which is situated the principal office or place of business. This return is made on Form 729. There must be kept in each box or ticket office of every theater, place of amusement, or other place to which admissions subject to the tax are charged a daily rec- ord of the number and kind of tickets sold and the tax collected thereon. Such record must also show the num- WAR TAX ON ADMISSIONS AND DUES 605 ber of passes used for admission each day and the tax collected thereon and the number of admissions of chil- dren under twelve years of age and the tax collected thereon. Each separate class of tickets sold must be so distinctly indicated as to be capable of ready verifica- tion by the Internal Kevenue Department. A separate record must be kept of the number and kind of tickets, cards, passes or other evidence of right to admission on or after November 1, 1917, paid for or issued prior to November 1 and of the tax collected in respect thereof. The monthly return required to be filed by proprietors of all pJaces to which admission is charged, not expressly exempt from taxation, must include and cover amounts collected on validation of tickets, passes, cards, or other evidence of the right to admission. In computing the tax, a fraction of a cent is to be dis- regarded unless it amounts to one half cent or more, in which case it is to be counted as one cent. Such frac- tions, however, are likely to be encountered only in cases where the tax is a straight percentage of the charge for admission. Where the tax is 1 cent for each 10 cents or fraction thereof of the price of admission, no frac- tions of cents will be encountered. Penalties. The penalties are: for failure to submit a return within the time prescribed, a fine of not more than $1,000 or imprisonment for not more than one year, or both; and for failure to collect or truly to account for and pay over the tax, an additional penalty of double the tax not collected or accounted for. A recent decision of the Treasury Department in the case of the stamp tax on railroad tickets construes the penalty for non-payment as being also upon the pur- chaser of the ticket ; it seems possible that a similar con- struction of the law might be made to apply in the case of the tax on admissions and dues. -J CHAPTER XXX WAR TAX ON ADMISSIONS AND DUES LAW BEING TITLE VII OF "AN ACT TO PROVIDE REVENUE TO DEFRAY WAR EXPENSES, AND FOR OTHER PURPOSES," APPROVED OCTOBER 3, 1917. (PUBLIC No. 50 65th CONGRESS). IN EFFECT OCTOBER 4, 1917, UNLESS OTHERWISE SPECIALLY PROVIDED. TITLE VII. WAR TAX ON ADMISSIONS AND DUES, EFFECTIVE NOV. 1, 1917. Amount of tax on admissions. Sec. 700 [of the general revenue Act of which this Title is a part]. That from and after the first day of November, nineteen hundred and seventeen, there shall be levied, assessed, collected, and paid, (a) a, tax of 1 cent for each 10 cents or frac- tion thereof of the amount paid for admission to any place, including admission by season ticket or subscrip- tion, to be paid by the person paying for such admis- sion: Provided, That the tax on admission of children under twelve years of age where an admission charge for such children is made shall in every case be 1 cent; and Tax on free admissions and passes, except in certain cases. {b) In the case of persons (except bona fide em- ployees, municipal officers on official business, and chil- dren under twelve years of age) admitted free to any place at a time when and under circumstances under which an admission charge is made to other persons of the same class, a tax of 1 cent for each 10 cents or 606 / WAR TAX ON ADMISSION 607 fraction thereof of the price so charged to such other persons for the same or similar accommodations, to be paid by the persons so admitted; and Tax on cabarets. (c) A tax of 1 cent for each 10 cents or fraction thereof paid for admission to any public performance for profit at any cabaret or other similar entertainment to which the charge for admission is wholly or in part included in the price paid for refreshment, service, or merchandise; the amount paid for such ad- mission to be computed under rules prescribed by the Commissioner of Internal Eevenue, with the approval of the Secretary of the Treasury, such tax to be paid by the person paying for such refreshments, service, or merchandise. Tax on reserved boxes or seats. In the case of persons having the permanent use of boxes or seats in an opera house or any place of amusement or a lease for the use of such box or seat in such opera house or place of amusement there shall be levied, assessed, collected, and paid a tax equivalent to ten per centum of the amount for which a similar box or seat is sold for performance or exhibition at which the box or seat is used or reserved by or for the lessee or holder. When 5 and 10-eent admissions are exempt. These taxes shall not be imposed in the case of a place the maxi- mum charge for admission to which is 5 cents, or in the case of shows, rides, and other amusements, (the maxi- mum charge for admission to which is ten cents) within outdoor general amusement parks, or in the case of ad- missions to such parks. Other exemptions. No tax shall be levied under this title in respect to any admissions all the proceeds of which inure exclusively to the benefit of religious, ed- ucational, or charitable institutions, societies, or organi- zations, or admissions to agricultural fairs, none of the profits of which are distributed to stockholders or mem- bers of the association conducting the same. 608 INCOME AND FEDERAL TAX REPORTS Definition of admission. The term "admission" as used in this title includes seats and tables, reserved or other- wise, and other similar accommodations, and the charges made therefor. Tax on dues and membership fees. Sec. 701. That from and after the first day of November, nineteen hundred and seventeen, there shall be levied, assessed, collected, and paid, a tax equivalent to ten per centum of any amount paid as dues or membership fees (including in- itiation fees), to any social, athletic, or sporting club or organization, where such dues or fees are in excess of $12 per year ; such taxes to be paid by the person pay- ing such dues or fees : Specific exemptions. Provided, That there shall be exempted from the provisions of this section all amounts paid as dues or fees to a fraternal beneficiary society, order, or association, operating under the lodge system or for the exclusive benefit of the members of a fratern- ity itself operating under the lodge system, and provid- ing for the payment of life, sick, accident, or other benefits to the members of such society, order, or asso- ciation or their dependents. Method of payment of taxes. Sec. 702. That every person, corporation, partnership, or association (a) re- ceiving any payments for such admission, dues, or fees, shall collect the amount of the tax imposed by section seven hundred or seven hundred and one from the per- son making such payments, or (b) admitting any person free to any place for admission to which a charge is made shall collect the amount of the tax imposed by sec- tion seven hundred from the person so admitted, and (c) in either case shall make returns and payments of the amounts so collected, at the same time and in the same manner as provided in section five hundred and three of this Act. Approved by the President, October 3, 1917. CHAPTER XXXI COLLECTION DISTRICTS AND NAMES AND ADDRESSES OF COLLECTORS. ( The name of the collection district is the same, unless otherwise indicated, as the name of the State in which the collector has his residence.) ALABAMA (Includes Mississippi), John D. McNeel, Birmingham. ALASKA (See Washington). ARIZONA (See New Mexico). ARKANSAS, Jack Walker, Little Rock. CALIFORNIA: First District. The counties of Alameda, Alpine, Amador, Butte, Calaveras, Colusa, Contra Costa, Del Norte, Eldorado, Fresno, Glenn, Humboldt, Inyo, Kings, Lake, Lassen, Madera, Marin, Mariposa, Mendocino, Merced, Modoc, Mono, Monterey, Napa, Nevada, Placer, Plumas, Sacramento, San Benito, San Francisco, San Joaquin, San Mateo, Santa Clara, Santa Cruz, Shasta, Sierra, Siskiyou, Solano, Sonoma, Stanislaus, Sutter, Tulare, Tehama, Trin- ity, Tuolumne, Yolo, Yuba, and the State of Ne- vada, Justus S. Wardell, San Francisco. Sixth District. The counties of Imperial, Kern, Los Angeles, Orange, Riverside, San Bernardino, San Diego, San Luis Obispo, Santa Barbara, and Ventura, John P. Carter, Los Angeles. COLORADO (Including Wyoming), Mark A. Skinner, Denver. 609 610 INCOME AND FEDERAL TAX REPORTS CONNECTICUT (Includes Khode Island), James J. Walsh, Hartford. DELAWARE (See Maryland). DISTRICT OF COLUMBIA (See Maryland). FLORIDA, James M. Cathcart, Jacksonville. GEORGIA, Aaron 0. Blalock, Atlanta. HAWAII, John F. Haley, Honolulu. IDAHO (See Montana). ILLINOIS: First District. The counties of Boone, Carroll, Cook, DeKalb, Dupage, Grundy, Jo Daviess, Kane, Kankakee, Kendall, Lake, Lasalle, Lee, McHenry, Ogle, Stephenson, Whiteside, Will, and Winnebago, Julius F. Smietanka, Chicago. Fifth District. The counties of Bureau, Hender- son, Henry, Knox, Marshall, Mercer, Peoria, Put- nam, Eock Island, Stark, and Warren, Edward D. McCabe, Peoria. Eighth District. The counties of Adams, Bond, Brown, Calhoun, Cass, Champaign, Christian, Coles, Cumberland, Dewitt, Douglas, Edgar, Ford, Fulton, Greene, Hancock, Iroquois, Jersey, Livingston, Logan, McDonough, McLean, Macon, Macoupin, Mason, Menard, Montgomery, Morgan, Moultrie, Piatt, Pike, Sangamon, Schuyler, Scott, Shelby, Tazewell, Vermilion, and Woodford, John L. Pick- ering, Springfield. Thirteenth District. The counties of Alexander, Clark, Clay, Clinton, Crawford, Edwards, Effing- ham, Fayette, Franklin, Gallatin, Hamilton, Hardin, Jackson, Jasper, Jefferson, Johnson, Lawrence, Madison, Marion, Massac, Monroe, Perry, Pope, Pulaski, Randolph, Richland, St. Clair, Saline, Union, Wabash, Washington, Wayne, White, and Williamson, John M. Rapp, East St. Louis. COLLECTION DISTRICTS 611 INDIANA: Sixth District. The counties of Adams, Allen, Bartholomew, Benton, Blackford, Brown, Cass, Dearborn, Decatur, Dekalb, Delaware, Elkhart, Fay- ette, Franklin, Fulton, Grant, Hamilton, Hancock, Hendricks, Henry, Howard, Huntington, Jackson, Jasper, Jay, Jefferson, Jennings, Johnson, Kos- ciusko, Lagrange, Lake, Laporte, Lawrence, Madi- son, Marion, Marshall, Miami, Monroe, Morgan, Newton, Noble, Ohio, Porter, Pulaski, Eandolph, Eipley, Rush, St. Joseph, Shelby, Starke, Steuben, Switzerland, Tipton, Union, Wabash, Wayne, Wells, White, and Whitley. Peter J. Kruyer, Indianapolis. Seventh District. The counties of Boone, Car- roll, Clark, Clay, Clinton, Crawford, Daviess, Du- bois, Floyd, Fountain, Gibson, Greene, Harrison, Knox, Martin, Montgomery, Orange, Owen, Parke, Perry, Pike, Posey, Putnam, Scott, Spencer, Sul- livan, Tippecanoe, Vanderburg, Vermilion, Vigo, Warren, Warrick, and Washington. Isaac R. Strouse, Terre Haute. IOWA, Louis Murphy, Dubuque. KANSAS, Wm. H. L. Pepperell, Wichita. KENTUCKY: Second District. The counties of Allen, Ballard, Barren, Breckenridge, Butler, Caldwell, Calloway, Carlisle, Christian, Clinton, Crittenden, Cumber- land, Daviess, Edmonson, Fulton, Graves, Gray- son, Hancock, Hart, Henderson, Hickman, Hopkins, Livingston, Logan, Lyon, McCracken, McLean, Marshall, Metcalfe, Monroe, Muhlenberg, Ohio, Rus- sell, Simpson, Todd, Trigg, Union, Warren, and Webster, Josh T. Griffith, Owensboro. Fifth District. The city of Louisville and the counties of Adair, Bullitt, Casey, Green, Hardin, Henry, Jefferson, Larue, Marion, Meade, Nelson, 612 INCOME AND FEDERAL TAX REPORTS Oldham, Owen, Shelby, Spencer, Taylor, and Wash- ton, Thomas S. Mayes, Louisville. Sixth District. The counties of Boone, Bracken, Campbell, Carroll, Gallatin, Grant, Harrison, Ken- ton, Pendleton, Eobertson, and Trimble, Charlton B. Thompson, Covington. Seventh District. The counties of Bath, Bour- bon, Boyd, Carter, Clark, Elliott, Fayette, Fleming, Franklin, Greenup, Johnson, Lawrence, Lewis, Martin, Mason, Menifee, Montgomery, Morgan, Nicholas, Powell, Eowan, Scott, and Woodford, Ben Marshall, Lexington. Eighth District. The counties of Anderson, Bell, Boyle, Breathitt, Clay, Estill, Floyd, Garrard, Har- lan, Jackson, Jessamine, Knott, Knox, Laurel, Lee, Leslie, Letcher, Lincoln, Madison, Magoffin, Mercer, McCreary, Owsley, Perry, Pike, Pulaski, Rock- castle, Wayne, Whitley, and Wolfe, John W. Hughes, Danville. LOUISIANA, John Y. Fauntleroy, New Orleans. MAINE (See New Hampshire). MARYLAND, Joshua W. Miles, Baltimore. District of Maryland consists of the following- named territory : The State of Maryland and Dela- ware, the District of Columbia, and the counties of Accomac and Northampton of the State of Virginia. MASSACHUSETTS, John F. Malley, Boston. This district is officially designated as the Third District of Massachusetts. MICHIGAN, First District. Counties of Alcona, Alpena, Are- nac, Bay, Branch, Calhoun, Cheboygan, Clare, Clin- ton, Crawford, Genessee, Gladwin, Gratiot, Hills- dale, Huron, Ingham, Iosco, Isabella, Jackson, La- peer, Lenawee, Livingston, Macomb, Midland, Mon- roe, Montmorency, Oakland, Ogemaw, Oscoda, Ot- COLLECTION DISTRICTS 613 sego, Presque Isle, Eoscommon, Saginaw, Sanilac, Shiawassee, St. Clair, Tuscola, Washtenaw, and Wayne, James J. Brady, Detroit. Fourth District. Counties of Alger, Allegan, An- trim, Baraga, Barry, Benzie, Berrien, Cass, Charle- voix, Chippewa, Delta, Dickinson, Eaton, Emmet, Gogebic, Grand Traverse, Houghton, Ionia, Iron, Kalamazoo, Kaikaska, Kent, Keweenaw, Lake, Lee- lanau, Luce, Mackinac, Manistee, Marquette, Mason, Mecosta, Menominee, Missaukee, Montcalm, Muske- gon, Newaygo, Oceana, Ontonagon, Osceola, Ottawa, St. Joseph, Schoolcraft, Van Buren, and Wexford, Emanuel L. Doyle, Grand Rapids. MINNESOTA, Edward J. Lynch, St. Paul. MISSISSIPPI (See Alabama). The State of Mississippi detached from the Dis- trict of Louisiana and added to the District of Ala- bama June 1, 1908. MISSOURI, First District. The counties of Adair, Audrain, Bollinger, Boone, Butler, Callaway, Cape Girardeau, Carter, Clark, Crawford, Dent, Dunklin, Franklin, Gasconade, Howard, Iron, Jefferson, Knox, Lewis, Lincoln, Linn, Macon, Madison, Maries, Marion, Mississippi, Montgomery, Monroe, New Madrid, Oregon, Osage, Pemiscot, Perry, Phelps, Pike, Pu- laski, Ralls, Randolph, Reynolds, Ripley, St. Charles, St. Francois, Ste. Genevieve, St. Louis, Schuyler, Scotland, Scott, Shannon, Shelby, Stod- dard, Warren, Washington, and Wayne, George H. Moore, St. Louis. Sixth District. The counties of Andrew, Atchi- son, Barry, Barton, Bates, Benton, Buchanan, Cald- well, Camden, Carroll, Cass, Cedar, Chariton, Christian, Clay, Clinton, Cole, Cooper, Dade, Dallas, Daviess, Dekalb, Douglas, Gentry, Greene, Grundy, 614 INCOME AND FEDERAL TAX REPORTS Harrison, Henry, Hickory, Holt, Howell, Jackson, Jasper, Johnson, Laclede, Lafayette, Lawrence, Liv- ingston, McDonald, Mercer, Miller, Moniteau, Mor- gan, Newton, Nodaway, Ozark, Pettis, Platte, Polk, Putnam, Ray, St. Clair, Saline, Stone, Sullivan, Taney, Texas, Vernon, Webster, Worth, and Wright, Edgar M. Harber, Kansas City. MONTANA (Includes Utah and Idaho), William C. Whaley, Helena. NEBRASKA, Geo. L. Loomis, Omaha. NEVADA (See First California). NEW HAMPSHIRE (Includes Maine and Vermont), Seth W. Jones, Portsmouth. NEW JERSEY: First District. The counties of Atlantic, Burling- ton, Camden, Cape May, Cumberland, Gloucester, Mercer, Monmouth, Ocean, and Salem, Samuel Ire- dell, Camden. Fifth District. The counties of Bergen, Essex, Hudson, Hunterdon, Middlesex, Morris, Passaic, Somerset, Sussez, 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 old first, second, third, fourth, fifth, sixth, eighth, ninth, and fifteenth wards of New York City; that portion of the old fourteenth ward lying west of the centre of Mott Street ; that portion of the old sixteenth ward lying south of the centre of West Twenty-fourth Street, and Governors Island, William H. Edwards, Cus- tom House, New York. COLLECTION DISTRICTS 615 Third District. The old seventh, tenth, eleventh, twelfth, thirteenth, seventeenth, eighteenth, nine- teenth, twentieth, twenty-first, and twenty-second wards of New York City ; that part of the old four- teenth ward lying east of the centre of Mott Street ; that part of the old sixteenth ward lying north of the center of West Twenty-fourth Street, and Black- wells, Randalls, and Wards Islands, Mark Eisner, 1150 Broadway (27th Street), New York. Fourteenth District. The counties of Albany, Clinton, Columbia, Dutchess, Essex, Fulton, Greene, Hamilton, Montgomery, Orange, Putnam, Rens- selaer, Rockland, Saratoga, Schenectady, Schoharie, Sullivan, Ulster, Warren, Washington, and West- chester, and the old twenty-third and twenty-fourth wards of New York City, Roscoe Irwin, Albany Twenty-first District. The counties of Broome, Cayuga, Chenango, Cortland, Delaware, Franklin, Herkimer, Jefferson, Lewis, Madison, Oneida, Onon- daga, Oswego, Otsego, St. Lawrence, Schuyler, Sen- eca, Tioga, Tompkins, and Wayne, Neil Brewster, Syracuse. Twenty-eighth District. The counties of Alle- gany, Cattaraugus, Chautauqua, Chemung, Erie, Genes see, Livingston, Monroe, Niagara, Ontario, Orleans, Steuben, Wyoming, and Yates, Vincent H. Riordan, Buffalo. NORTH CAROLINA: Fourth District. The counties of Alamance, Beaufort, Bertie, Bladen, Brunswick, Camden, Car- teret, Caswell, Chatham, Chowan, Columbus, Cra- ven, Cumberland, Currituck, Dare, Duplin, Durham, Edgecombe, Franklin, Gates, Granville, Greene, Halifax, Harnett, Hertford, Hyde, Johnston, Jones, Lenoir, Martin, Montgomery, Moore, Nash, New Hanover, Northampton, Onslow, Orange, Pamlico, Pasquotank, Pender, Perquimans, Person, Pitt, 616 INCOME AND FEDERAL TAX REPORTS Richmond, Robeson, Sampson, Scotland, Tyrrell, Vance, Wake, Warren, Washington, Wayne, and Wilson, Josiah W. Bailey, Raleigh. Fifth District. The counties of Alexander, Alle- gany, Anson, Ashe, Buncombe, Burke, Cabarrus, Caldwell, Catawba, Cherokee, Clay, Cleveland, David- son, Davie, Forsyth, Gaston, Graham, Guilford, Haywood, Henderson, Iredell, Jackson, Lincoln, Mc- Dowell, 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, Aber- deen, S. Dakota. OHIO: First District. The counties of Brown, Butler, Clarke, Clermont, Clinton, Fayette, Greene, Hamil- ton, Highland, Miami, Montgomery, Preble, and Warren, Andrew C. Gilligan, Cincinnati. Tenth District. The counties of Allen, Auglaize, Champaign, Crawford, Darke, Defiance, Erie, Ful- ton, Hancock, Hardin, Henry, Huron, Logan, Lucas, Mercer, Ottawa, Paulding, Putnam, Sandusky, Seneca, Shelby, Van Wert, Williams, Wood, and Wyandot, Frank B. Niles, Toledo. Eleventh District. The counties of Adams, Athens, Coshocton, Delaware, Fairfield, Franklin, Gallia, Guernsey, Hocking, Jackson, Knox, Law- rence, Licking, Madison, Marion, Meigs, Morgan, Morrow, Muskingum, Noble, Perry, Pickaway, Pike, Ross, Scioto, Union, Vinton, and Washington, Beriah E. Williamson, Columbus. Eighteenth District. The counties of Ashland, Ashtabula, Belmont, Carroll, Columbiana, Cuya- hoga, Geauga, Harrison, Holmes, Jefferson, Lake, COLLECTION DISTRICTS 617 Lorain, Mahoning, Medina, Monroe, Portage, Rich- land, 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, Lehigh, Montgomery, Philadel- phia, and Schuylkill, Ephraim Lederer, Philadelphia. Ninth District. The counties of Adams, Bedford, Blair, Cumberland, Dauphin, Franklin, Fulton, Huntingdon, Juniata ; Lancaster, Lebanon, Mifflin, Perry, Snyder, York, Benjamin F. Davis, Lancaster. Twelfth District. Bradford, Carbon, Center, Clinton, Columbia, Lackawanna, Luzerne, Lycom- ing, Monroe, Montour, Northampton, Northumber- land, Pike, Potter, Sullivan, Susquehanna, Tioga, Union, Wayne, Wyoming. (Twelfth District re- established May 1, 1915.) Fred C. Kirkendall, Scranton. Twenty-third District. The counties of Alle- gheny, Armstrong, Beaver, Butler, Cambria, Cam- eron, Clarion, Clearfield, Crawford, Elk, Erie, Fay- ette, Forest, Greene, Indiana, Jefferson, Lawrence, McKean, Mercer, Somerset, Venango, Warren, Washington, and Westmoreland, C. Gregg Lewellyn, Pittsburgh. PHILIPPINE ISLANDS, James J. Rafferty, Manila. RHODE ISLAND (See Connecticut). SOUTH CAROLINA, Duncan C. Hey ward, Columbia. SOUTH DAKOTA (See North and South Dakota). TENNESSEE, Edward B. Craig, Nashville. TEXAS, Alexander S. Walker, Austin UTAH (See Montana). VERMONT (See New Hampshire). 618 INCOME AND FEDERAL TAX REPORTS VIRGINIA: Second District. The counties of Amelia, Ap- pomattox, Brunswick, Buckingham, Caroline, Charles City, Chesterfield, Cumberland, Dinwiddie, Elizabeth City, Essex, Fluvanna, Gloucester, Gooch- land, Greensville, Hanover, Henrico, Isle of Wight, James City, King and Queen, King George, King William, Lancaster, Louisa, Lunenburg, Mathews, Middlesex, Nansemond, New Kent, Norfolk, North- umberland, Nottaway, Powhatan, Prince Edward, Prince George, Princess Anne, Kichmond, Stafford, Southampton, Spottsylvania, Surry, Sussex, War- wick, Westmoreland, and York, Richard C. L. Mon- cure, Eichmond. Sixth District. The counties of Albemarle, Alex- andria, Alleghany, Amherst, Augusta, Bath, Bed- ford, Bland, Botetourt, Buchanan, Campbell, Car- roll, Charlotte, Clarke, Craig, Culpeper, Dickenson, Fairfax, Fauquier, Floyd, Franklin, Frederick, Giles, Grayson, Greene, Halifax, Henry, Highland, Lee, Loudoun, Madison, Mecklenburg, Montgomery, Nelson, Orange, Page, Patrick, Pittsylvania, Prince William, Pulaski, Eappahannock, Eoanoke, Eock- bridge, Eockingham, Eussell, Scott, Shenandoah, Smyth, Tazewell, Warren, Washington, Wise, and Wythe, John M. Hart, Eoanoke. 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, Monitowoc, Marinette, Marquette, Milwaukee, Oconto, Outogamie, Ozau- COLLECTION DISTRICTS 619 kee, Eacine, Shawano, Sheboygan, Walworth, Wash- ington, Waukesha, Waupaca, Waushara, Winne- bago, and county of Langlade with exception 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, Buffalo, Burnett, Chippewa, Clark, Columbia, Crawford, Dane, Douglas, Dunn, Eau Clair, Grant, Green, Iowa, Iron, Jackson, Jef- ferson, Juneau, La Crosse, Lafayette, Lincoln, Marathon, Monroe, Oneida, Pepin, Pierce, Polk, Portage, Price, Eichland, Eock, Eusk, St. Croix, Sauk, Sawyer, Taylor, Trempealeau, Vernon, Vilas, Washburn, Wood, and the eight townships in the western part of Langlade County which were for- merly in Lincoln County, Burt Williams, Madison. WYOMING (See Colorado). A list of the several INTERNAL REVENUE DIVISIONS with the Names and Addresses of Agents in Charge Corrected to July 25, 1917 ALABAMA See Nashville Division. ALASKA See Portland Division. AEIZONA See Denver Division. AEKANSAS See Little Eock Division. CALIFOENIA See San Francisco Division. COLOEADO See Denver Division. CONNECTICUT See New Haven Division. DELAWAEE See Baltimore Division. DIST. OF COLUMBIA. See Baltimore Division. FLOEIDA See Atlanta Division. GEOEGIA See Atlanta Division. 620 INCOME AND FEDERAL TAX REPORTS HAWAII See San Francisco Division. IDAHO See Salt Lake Division. ILLINOIS See Chicago and Springfield Di- visions. INDIANA See Indianapolis Division. IOWA See Omaha Division. KANSAS See Little Rock Division. KENTUCKY See Huntington and Louisville Divisions. LOUISIANA See New Orleans Division. MAINE See Boston Division. MARYLAND See Baltimore Division. MASSACHUSETTS ... See Boston Division. MICHIGAN See Detroit Division. MINNESOTA See St. Paul Division. MISSISSIPPI See New Orleans Division. MISSOURI See St. Louis Division. MONTANA See Salt Lake Division. NEBRASKA See Omaha Division. NEVADA See San Francisco Division. NEW HAMPSHIRE. . . See Boston Division. NEW JERSEY See Elizabeth Division. NEW MEXICO See Denver Division. NEW YORK See Buffalo, New Haven and New York Divisions. NORTH CAROLINA.. . See Greensboro Division. NORTH DAKOTA See St. Paul Division. OHIO See Cincinnati and Cleveland Di- visions. OKLAHOMA See Little Rock Division. OREGON See Portland Division. PENNSYLVANIA See Philadelphia and Pittsburgh Divisions. RHODE ISLAND See New Haven Division. SOUTH CAROLINA. . . See Greensboro Division. SOUTH DAKOTA See St. Paul Division. TENNESSEE See Nashville Division. COLLECTION DISTRICTS 621 TEXAS See San Antonio Division. UTAH See Salt Lake Division. VEBMONT See Boston Division. VIRGINIA See Bichmond Division. WASHINGTON See Portland Division. WEST VIRGINIA See Huntington Division. WISCONSIN See Milwaukee Division. WYOMING See Denver Division. Atlanta Division, E. C. Yellowley, Atlanta, Ga. Georgia and Florida. Baltimore Division, E. A. Forbes, Baltimore, Md. Maryland, Delaware and District of Columbia. Boston Division, R. C. Shelley, Boston, Mass. Maine, New Hampshire, Vermont and Massachu- setts. Buffalo Division, S. D. Amen, Buffalo, N. Y. 21st and 28th Districts of New York. Chicago Division, Dan J. Chapin, Chicago, 111. 1st and 5th Districts of Illinois. Cincinnati Division, T. E. Stone, Cincinnati, Ohio. 1st and 11th Districts of Ohio. Cleveland Division, W. H. Collier, Cleveland, Ohio. 10th and 18th Districts of Ohio. Denver Division, Harvey H. Sltjsser, Denver, Col. Colorado, Wyoming, New Mexico and Arizona. Detroit Division, Lee A. Miller, Detroit, Mich. 1st and 4th Districts of Michigan. Elizabeth Division, D. K. Donaldson, Elizabeth, N. J. 1st and 5th Districts of New Jersey. Greensboro Division, T. H. Vanderpord, Greensboro, N. C. North and South Carolina. Huntington Division, James O'Brien, Huntington, W. Va. West Virginia and the 7th District of Kentucky. 622 INCOME AND FEDERAL TAX REPORTS Indianapolis Division, Geo. W. Trowbridge, Indianapolis, Ind. 6th and 7th Districts of Indiana. Little Rock Division, Jas. S. Barkman, Little Eock, Ark. Arkansas, Oklahoma and Kansas. Louisville Division, Wm. D. Chandler, Louisville, Ky. 2nd, 5th, 6th, and 8th Districts of Kentucky. Milwaukee Division, James W. McGinnis, Milwaukee, Wis. 1st and 2nd Districts of Wisconsin. Nashville Division, Daniel L. Porter, Nashville, Term. Tennessee and Alabama. New Haven Division, Theo. M. Byxbee, New Haven, Conn. Ehode Island, Connecticut, and 14th District of New York, except Westchester County, and the 23rd and 24th Wards of New York City, being a part of the 14th District of New York. New Orleans Division, J. 0. Bender, New Orleans, La. Louisiana and Mississippi. New York Division, L. G. Nutt, New York, N. Y. 1st, 2d and 3d Districts of New York, and Westches- ter County, and the 23rd and 24th Wards of New York City, being a part of the 14th District of New York. Omaha Division, John A. McCabe, Omaha, Neb. Iowa and Nebraska. Philadelphia Division, John W. Sinsel, Philadelphia, Pa. 1st and 12th Districts of Pennsylvania. Pittsburgh Division, Frank L. Boyd, Pittsburgh, Pa. 9th and 23rd Districts of Pennsylvania. Portland Division, Allen Carnes, Portland, Ore. Oregon, Washington and Alaska. Richmond Division, S. E. Brame, Eichmond, Va. 2nd and 6th Districts of Virginia. Salt Lake Division, W. H. Chapman, Salt Lake, Utah. Utah, Montana and Idaho. COLLECTION DISTRICTS 623 San Antonio Division, Jas. J. Drakeford, San Antonio, Texas. San Francisco Division, C. E. Boulden, San Francisco, Cal. California, Hawaii and Nevada. Springfield Division, W. P. Smith, Springfield, 111. 8th and 13th Districts of Illinois. St. Louis Division, John M. Eodgers, St. Louis, Mo. 1st and 6th Districts of Missouri. St. Paul Division, W. W. Anderson, St. Paul, Minn. Minnesota and North and South Dakota. Collection Districts for New York City. New York City (Greater New York) is embraced within four collection districts; the First, the Second, the Third and the Fourteenth New York. First District. The Boroughs of Brooklyn, Queens and Eichmond are in the First District; Office, Post Office, Brooklyn. Second District. The Borough of Manhattan (Man- hattan Island) itself consists of two collection districts, the Second and the Third. The Second District (Office Custom House) consists of that portion of Manhattan Borough which is bounded by the East Eiver from the center of Catharine Slip (Pier 26, E. E., four blocks north of Brooklyn Bridge) to the Battery; by the North Eiver from the Battery to the center of West 24th Street (Pier 64, N. E.) ; and by a line, beginning at the North (Hudson) Eiver, running east along the center of West Twenty-fourth Street to the center of Sixth Ave- nue, down the center of Sixth Avenue to the center of Fourteenth Street, east along the center of Fourteenth Street to the center of Fourth Avenue, down the center of Fourth Avenue to Cooper Square, around the north and east sides of Cooper Square (i. e., all of Cooper Square is in the Second District) to the east side of the Bowery, down the east side of the Bowery to the center of 624 INCOME AND FEDERAL TAX REPORTS East Houston Street (i. e., both sides of the Bowery north of East Houston Street are in the Second District), west along the center of East Houston Street to the center of Mott Street, down the center of Mott Street to the center of Canal Street, east along the center of Canal Street to the center of the Bowery, down the center of the Bowery to the center of Catharine Street (at Division Street), along the center of Catharine Street to Catharine Slip and across the center of Catharine Slip to the East Eiver (Pier 26, E. E.). The Second District includes Governors Island also. Third District The Third District (Office, 1150 Broadway, between 26th and 27th Streets) embraces all of the rest of Manhattan Island; that is, all of Manhat- tan Borough not included within the boundaries of the Second District outlined above, together with Black- well's, Bandall's and Ward's Islands. Fourteenth District. The rest of Greater New York, that is, all of Bronx Borough, which lies north and east of the Harlem Ship Canal and the Harlem Eiver, is in the Fourteenth District (Office, Albany). CHAPTER XXXII WAR EXCESS PROFITS TAX LAW BEING TITLE II OF "AN ACT TO PROVIDE REVENUE TO DEFRAY WAR EXPENSES, AND FOR OTHER PURPOSES," APPROVED OCTOBER 3, 1917 (PUBLIC No. 50 65th CONGRESS) IN EFFECT OCTOBER 4, 1917, UNLESS OTHERWISE SPECIALLY PROVIDED TITLE II. WAR EXCESS PROFITS TAX, EFFECTIVE OCTOBER 4, 1917. Definitions. Sec. 200 [of the general revenue Act of which this Title is a part]. That when used in this title The term "corporation" includes joint-stock com- panies or associations, and insurance companies; The term "domestic" means created under the law of the United States, or of any State, Territory, or District thereof, and the term "foreign" means created under the law of any other possession of the United States or of any foreign country or government; The term "United States" means only the States, the Territories of Alaska and Hawaii, and the District of Columbia ; "Taxable year." The term "taxable year" means the twelve months ending December thirty-first, excepting in the case of a corporation or partnership which has fixed its own fiscal year, in which case it means such 625 626 INCOME AND FEDERAL TAX REPORTS fiscal year. The first taxable year shall be the year ending December thirty-first, nineteen hundred and sev- enteen, except that in the case of a corporation or part- nership which has fixed its own fiscal year, it shall be the fiscal year ending during the calendar year nineteen hundred and seventeen. If a corporation or partner- ship, prior to March first, nineteen hundred and eight- teen, makes a return covering its own fiscal year, and includes therein the income received during that part of the fiscal year falling within the calendar year nine- teen hundred and sixteen, the tax for such taxable year shall be that proportion of the tax computed upon the net income during such full fiscal year which the time from January first, nineteen hundred and seventeen, to the end of such fiscal year bears to the full fiscal year; and "Pre-war period." The term "pre-war period" means the calendar years nineteen hundred and eleven, nine- teen hundred and twelve, and nineteen hundred and thirteen, or, if a corporation or partnership was not in existence or an individual was not engaged in a trade or business during the whole of such period, then as many of such years during the whole of which the cor- poration or partnership was in existence, or the indi- vidual was engaged in the trade or business. "Trade" and "business." The terms "trade" and "busi- ness" include professions and occupations. "Net income" in case of foreign corporations and others. The term "net income" means in the case of a foreign corporation or partnership or a non-resident alien in- dividual, the net income received from sources within the United States. Rates of Tax. Sec. 201. That in addition to the taxes under existing law and under this Act there shall be levied, assessed, collected, and paid for each taxable year upon the income of every corporation, partnership, or individual, a tax (hereinafter in this title referred WAR EXCESS PROFITS TAX LAW 627 to as the tax) equal to the following percentages of the net income: Twenty per centum of the amount of the net income in excess of the deduction (determined as hereinafter provided) and not in excess of fifteen per centum of the invested capital for the taxable year; Twenty-five per centum of the amount of the net in- come in excess of fifteen per centum and not in excess of twenty per centum of such capital; Thirty-five per centum of the amount of the net in- come in excess of twenty per centum and not in excess of twenty-five per centum of such capital; Forty-five per centum of the amount of the net in- come in excess of twenty-five per centum and not in excess of thirty-three per centum of such capital; and Sixty per centum of the amount of the net income in excess of thirty-three per centum of such capital. All income of corporation or partnership deemed received from its business. For the purpose of this title every corporation or partnership not exempt under the pro- visions of this section shall be deemed to be engaged in business, and all the trades and businesses in which it is engaged shall be treated as a single trade or busi- ness, and all its income from whatever source derived shall be deemed to be received from such trade or business. Certain incomes not subject to this tax. This title shall apply to all trades or businesses of whatever descrip- tion, whether continuously carried on or not, except (a) In the case of officers and employees under the United States, or any State, Territory, or the District of Columbia, or any local subdivision thereof, the com- pensation or fees received by them as such officers or employees ; (b) Corporations exempt from tax under the pro- visions of section eleven of Title I of such Act of Sep- tember eighth, nineteen hundred and sixteen, as amended 628 INCOME AND FEDERAL TAX REPORTS by this Act, and partnerships and individuals carrying on or doing the same business, or coming within the same description [for exempt corporations see p. 315], and (c) Incomes derived from the business of life, health, and accident insurance combined in one policy issued on the weekly premium payment plan. Sec. 202. That the tax shall not be imposed in the case of the trade or business of a foreign corporation or partnership or a non-resident alien individual, the net income of which trade or business during the tax able year is less than $3,000. Deductions allowed domestic corporations. Sec. 203. That for the purposes of this title the deduction shall be as follows, except as otherwise in this title provided (a) In the case of a domestic corporation, the sum of (1) an amount equal to the same percentage of the invested capital for the taxable year which the average amount of the annual net income of the trade or busi- ness during the pre-war period was of the invested capital for the pre-war period (but not less than seven or more than nine per centum of the invested capital for the taxable year), and (2) $3,000; Deductions allowed domestic partnerships, citizens and residents. (b) In the case of a domestic partnership or of a citizen or resident of the United States, the sum of (1) an amount equal to the same percentage of the in- vested capital for the taxable year which the average amount of the annual net income of the trade or busi- ness during the pre-war period was of the invested capital for the pre-war period (but not less than seven or more than nine per centum of the invested capital for the taxable year), and (2) $6,000; Deductions allowed foreign corporations, partnerships and non-resident aliens. (c) In the case of a foreign corpor- ation or partnership or of a non-resident alien individ- ual, an amount ascertained in the same manner as WAR EXCESS PROFITS TAX LAW 629 provided in subdivisions (a) and (b) without any exemption of $3,000 or $6,000. Deductions when income of pre-war period cannot satis- factorily be determined. (d) If the Secretary of the Treasury is unable satisfactorily to determine the aver- age amount of the annual net income of the trade or business during the pre-war period, the deduction shall be determined in the same manner as provided in section two hundred and live. Deductions allowed when corporation or partnership not in existence in pre-war period. Sec. 204. That if a cor- poration or partnership was not in existence, or an individual was not engaged in the trade or business, during the whole of any one calendar year during the pre-war period, the deduction shall be an amount equal to eight per centum of the invested capital for the tax- able year, plus in the case of a domestic corporation $3,000, and in the case of a domestic partnership or a citizen or resident of the United States $6,000. Reorganized business considered continuous. A trade or business carried on by a corporation, partnership, or individual, although formally organized or reorganized on or after January second, nineteen hundred and thir- teen, which is substantially a continuation of a trade or business carried on prior to that date, shall, for the purposes of this title, be deemed to have been in ex- istence prior to that date, and the net income and in- vested capital of its predecessor prior to that date shall be deemed to have been its net income and invested capital. Deductions allowed when no pre-war income or when percent of pre-war income was low. Sec. 205. (a) That if the Secretary of the Treasury, upon complaint, finds either (1) that during the pre-war period a domestic corporation or partnership, or a citizen or resident of the United States, had no net income from the trade or business, or (2) that during the pre-war period the per- 630 INCOME AND FEDERAL TAX REPORTS centage, which the net income was of the invested capi- tal, was low as compared with the percentage, which the net income during such period of representative corporations, partnerships, and individuals, engaged in a like or similar trade or business, was of their invested capital, then the deduction shall be the sum of (1) an amount equal to the same percentage of its invested capital for the taxable year which the average deduc- tion (determined in the same manner as provided in section two hundred and three, without including the $3,000 or $6,000 therein referred to) for such year of representative corporations, partnerships or individuals, engaged in a like or similar trade or business, is of their average invested capital for such year, plus (2) in the case of a domestic corporation $3,000, and in the case of a domestic partnership or a citizen or resident of the United States $6,000. The percentage which the net income was of the in- vested capital in each trade or business shall be deter- mined by the Commissioner of Internal Eevenue, in accordance with the regulations prescribed by him, with the approval of the Secretary of the Treasury. In the case of a corporation or partnership which has fixed its own fiscal year, the percentage determined by the cal- endar year ending during such fiscal year shall be used. (b) The tax shall be assessed upon the basis of the deduction determined as provided in section two hun- dred and three, but the taxpayer claiming the benefit of this section may at the time of making the return file a claim for abatement of the amount by which the tax so assessed exceeds a tax computed upon the basis of the deduction determined as provided in this section. In such event, collection of the part of the tax covered by such claim for abatement shall not be made until the claim is decided, but if in the judgment of the Com- missioner of Internal Revenue the interests of the United States would be jeopardized thereby he may re- WAR EXCESS PROFITS TAX LAW 631 quire the claimant to give a bond in such amount and with such sureties as the Commissioner may think wise, to safeguard such interests, conditioned for the payment of any tax found to be due, with the interest thereon, and if such bond, satisfactory to the Commissioner, is not given within such time as he prescribes, the full amount of tax assessed shall be collected and the amount overpaid, if any, shall upon final decision of the appli- cation be refunded as a tax erroneously or illegally collected. Ascertainment of net income of a corporation for pre-war period. Sec. 206. That for the purposes of this title the net income of a corporation shall be ascertained and returned (a) for the calendar years nineteen hundred and eleven and nineteen hundred and twelve upon the same basis and in the same manner as provided in section thirty-eight of the Act entitled "An Act to provide revenue, equalize duties, and encourage the industries of the United States, and for other purposes," approved August fifth, nineteen hundred and nine, except that income taxes paid by it within the year imposed by the authority of the United States shall be included; (b) for the calendar year nineteen hundred and thir- teen upon the same basis and in the same manner as provided in section II of the Act entitled "An Act to reduce tariff duties and to provide revenue for the Government, and for other purposes," approved October third, nineteen hundred and thirteen, except that in- come taxes paid by it within the year imposed by the authority of the United States shall be included, and except that the amounts received by it as dividends upon the stock or from the net earnings of other cor- porations, joint-stock companies or associations, or in- surance companies, subject to the tax imposed by sec- tion II of such Act of October third, nineteen hundred and thirteen, shall be deducted; and 632 INCOME AND FEDERAL TAX REPORTS (c) for the taxable year upon the same basis and in the same manner as provided in Title I of the Act entitled "An Act to increase the revenue, and for other purposes," approved September eighth, nineteen hundred and sixteen, as amended by this Act, except that the amounts received by it as dividends upon the stock or from the net earnings of other corporations, joint-stock companies or associations, or insurance com- panies, subject to the tax imposed by Title I of such Act of September eighth, nineteen hundred and sixteen, shall be deducted. Ascertainment of net income of a partnership or indi vidual for pre-war period. The net income of a part- nership or individual shall be ascertained and returned for the calendar years nineteen hundred and eleven, nineteen hundred and twelve, and nineteen hundred and thirteen and for the taxable year upon the same basis and in the same manner as provided in Title I of such Act of September eighth, nineteen hundred and sixteen, as amended by this Act, except that the credit allowed by subdivision (b) of section five of such Act shall be deducted. There shall be allowed (a) in the case of a domestic partnership the same deductions as allowed to indi- viduals in subdivision (a) of section five of such Act of September eighth, nineteen hundred and sixteen, as amended by this Act; and (b) in the case of a foreign partnership the same deductions as allowed to individuals in subdivision (a) of section six of such Act as amended by this Act. Definition of "invested capital." Sec. 207. That as used in this title, the term "invested capital" for anv year means the average invested capital for the year, as defined and limited in this title, averaged monthly. As used in this title "invested capital" does not include stocks, bonds (other than obligations of the United States), or other assets, the income from which WAR EXCESS PROFITS TAX LAW 633 is not subject to the tax imposed by this title, nor money or other property borrowed, and means, subject to the above limitations; "Invested capital" of a corporation or partnership. (a) In the case of a corporation or partnership: (1) actual cash paid in, (2) actual cash value of tangible property paid in other than cash, for stock or shares in such corporation or partner- ship, at the time of such payment (but in case such tangible property was paid in prior to January first, nineteen hundred and fourteen, the actual cash value of such property as of January first, nineteen hundred and fourteen, but in no case to exceed the par value of the original stock or shares specifically issued therefor), and (3) paid in or earned surplus and un- divided profits used or employed in the business, ex- clusive of undivided profits earned during the taxable year: Provided, That (a) the actual cash value of patents and copyrights paid in for stock or shares in such corporation or partnership, at the time of such payment, shall be included as invested capital, but not to exceed the par value of such stock or shares at the time of such payment, and (b) the good will, trade marks, trade brands, the franchise of a corporation or part- nership, or other intangible property, shall be included as invested capital if the corporation or partnership made payment bona fide therefor specifically as such in cash or tangible property, the value of such good will, trade mark, trade brand, franchise, or intangible prop- erty, not to exceed the actual cash or actual cash value of the tangible property paid therefor at the time of such payment; but good will, trade marks, trade brands, franchise of a corporation or partnership, or other intangible property, bona fide purchased, prior to March third, nineteen hundred and seventeen, for and with interests or shares in a partnership or for and with shares in the capital stock of a corporation 634 INCOME AND FEDERAL TAX REPORTS (issued prior to March third, nineteen hundred and seventeen), in an amount not to exceed, on March third, nineteen hundred and seventeen, twenty per centum of the total interests or shares in the partnership or of the total shares of the capital stock of the cor- poration, shall be included in invested capital at a value not to exceed the actual cash value at the time of such purchase, and in case of issue of stock therefor not to exceed the par value of such stock; "Invested capital" of individual. (b) In the case of an individual, (1) actual cash paid into the trade or business, and (2) the actual cash value of tangible property paid into the trade or business, other than cash, at the time of such payment (but in case such tangible property was paid in prior to January first, nineteen hundred and fourteen, the actual cash value of such property as of January first, nineteen hundred and fourteen), and (3) the actual cash value of patents, copyrights, good will, trade marks, trade brands, fran- chises, or other intangible property, paid into the trade or business, at the time of such payment, if payment was made therefor specifically as such in cash or tangi- ble property, not to exceed the actual cash or actual cash value of the tangible property bona fide paid therefor at the time of such payment. "Invested capital" of foreign corporation or partner- ship or non-resident alien. In the case of a foreign corp- oration or partnership or of a non-resident alien indi- vidual the term "invested capital" means that propor- tion of the entire invested capital, as defined and lim- ited in this title, which the net income from sources within the United States bears to the entire net income. "Invested capital" in case of reorganization, consolida- tion or change of ownership. Sec. 208. That in case of the reorganization, consolidation, or change of owner- ship of a trade or business after March third, nine- teen hundred and seventeen, if an interest or control in WAR EXCESS PROFITS TAX LAW 635 such trade or business of fifty per centum or more re- mains in control of the same persons, corporations, as- sociations, partnerships, or any of them, then in as- certaining the invested capital of the trade or business no asset transferred or received from the prior trade or business shall be allowed a greater value than would have been allowed under this title in computing the in- vested capital of such prior trade or business if such asset had not been so transferred or received, unless such asset was paid for specifically as such, in cash or tangible property, and then not to exceed the actual cash or cash value of the tangible property paid therefor at the time of such payment. Assessment of tax of business having nominal capital. Sec. 209. That in the case of a trade or business having no invested capital or not more than a nominal capital there shall be levied, assessed, collected, and paid, in addition to the taxes under existing law and un- der this act, in lieu of the tax imposed by section two hundred and one, a tax equivalent to eight per centum of the net income of such trade or business, in excess of the following deductions: in the case of a domestic corporation, $3,000, and in the case of a domestic part- nership or a citizen or resident of the United States, $6,000; in the case of all other trades or business, no deduction. Deduction when invested capital cannot satisfactorily be determined. Sec. 210. That if the Secretary of the Treasury is unable in any case satisfactorily to deter- mine the invested capital, the amount of the deduction shall be the sum of (1) an amount equal to the same proportion of the net income of the trade or business received during the taxable year as the proportion which the average deduction (determined in the same manner as provided in section two hundred and three, without including the $3,000 or $6,000 therein referred to) for the same calendar year of representative corpo 636 INCOME AND FEDERAL TAX REPORTS rations, partnerships, and individuals, engaged in a like or similar trade or business, bears to the total net in- come of the trade or business received by such corpora- tions, partnerships, and individuals, plus (2) in the case of a domestic corporation $3,000, and in the case of a domestic partnership or a citizen or resident of the United States $6,000. For the purpose of this section the proportion be- tween the deduction and the net income in each trade or business shall be determined by the Commissioner of Internal Eevenue in accordance with regulations pre- scribed by him, with the approval of the Secretary of the Treasury. In the case of a corporation or partner- ship which has fixed its own fiscal year, the proportion determined for the calendar year ending during such fiscal year shall be used. Returns to be rendered by partnerships. Sec. 211. That every foreign partnership having a net income of $3,000 or more for the taxable year, and every domestic partnership having a net income of $6,000 or more for the taxable year, shall render a correct return of the income of the trade or business for the taxable year, setting forth specifically the gross income for such year, and the deductions allowed in this title. Such returns shall be rendered at the same time and in the same manner as is prescribed for income-tax returns under Title I of such Act of September eighth, nineteen hun- dred and sixteen, as amended by this Act. Administration of Act. Sec. 212. That all adminis- trative, special, and general provisions of law, including the laws in relation to the assessment, remission, col- lection, and refund of internal-revenue taxes not here- tofore specifically repealed and not inconsistent with the provisions of this title are hereby extended and made applicable to all the provisions of this title and to the tax herein imposed, and all provisions of Title I of WAR EXCESS PROFITS TAX LAW 637 such Act of September eighth, nineteen hundred and six- teen, as amended by this Act, relating to returns and payment of the tax therein imposed, including penalties, are hereby made applicable to the tax imposed by this title. Regulations. Sec. 213. That the Commissioner of Internal Bevenue, with the approval of the Secretary of the Treasury, shall make all necessary regulations for carrying out the provisions of this title, and may re- quire any corporation, partnership or individual, sub- ject to the provisions of this title, to furnish him with such facts, data, and information as in his judgment are necessary to collect the tax imposed by this title. Repeal of excess profits tax law of March 3, 1917. Sec. 214. That Title II (sections two hundred to two hundred and seven, inclusive) of the Act entitled "An Act to provide increased revenue to defray the expenses of the increased appropriations for the Army and Navy, and the extension of fortifications, and for other purposes," approved March third, nineteen hundred and seventeen, is hereby repealed. Credit for taxes paid under that law. Any amount heretofore or hereafter paid on account of the tax im- posed by such Title II, shall be credited toward the pay- ment of the tax imposed by this title, and if the amount so paid exceeds the amount of such tax the excess shall be refunded as a tax erroneously or illegally collected. Amendment of Munition Manufacturer's Tax. Sub- division (1) of section three hundred and one of such Act of September eighth, nineteen hundred and sixteen, is hereby amended so that the rate of tax for the taxable year nineteen hundred and seventeen shall be ten per centum instead of twelve and one-half per centum, as therein provided. Subdivision (2) of such section is hereby amended to read as follows: 638 INCOME AND FEDERAL TAX REPORTS "(2) This section shall cease to be of effect on and after January first, nineteen hundred and eighteen." TITLE X. Administrative Provisions. TITLE XIII. General Provisions. Invalidating and repealing clause. See Sec. 1300. Approved by the President, October 3, 1917. CHAPTER XXXIII EXCESS PROFITS TAX Importance of Excess Profits Tax. The tax commonly known as the Excess Profits tax, or more properly the War Excess Profits tax, is really more important than the Income tax. True, it is intended to be a means of getting special revenues to meet war expenses, and is therefore likely to be temporary only. In that respect it is not so important as the Income tax, which will probably in one form or another be used indefinitely to provide revenues to meet the ordinary expenses of run- ning the government. But from the standpoint of the present situation the Excess Profits tax is more im- portant than the Income tax. In the first place, as we have seen, the Excess Profits tax is a new experiment in American taxation practice. In the next place, this tax is likely to yield the government larger revenues than the Income tax. Experts of the Treasury Depart- ment and Senate Finance Committee, shortly after the War Eevenue Law was enacted, estimated that the In- come tax would yield $851,000,000 as against $1,000,000,- 000 from the Excess Profits tax. While a larger num- ber of individuals and businesses will pay income taxes, the amounts paid by leading industrial concerns on ac- count of the Excess Profits tax will be prodigious com- pared with the amounts paid for the Income tax. One statistician estimated that the United States Steel Cor- poration would pay for the year 1917 about $27,000,000 for the Income tax and $150,000,000 for the Excess Profits tax about a half million dollars for every ordi- nary working day. 639 640 INCOME AND FEDERAL TAX REPORTS But another, and the most important, reason why the Excess Profits tax outshadows the Income tax is that the former must be ascertained before the latter can be computed. Persons subject to the two taxes are per- mitted to subtract from their income, in calculating the net income on which they will pay an income tax, sums equal to the amount which they will have to pay for the Excess Profits tax. General statement as to who is liable. Liability for this tax will be discussed in detail a little farther along, but in order to save those who may not be concerned with this tax from going any further into this chapter it may be stated here that, in general, returns must be filed, and the tax, if any, be paid only by domestic corpora- tions with incomes of $3,000 a year or more ; by domestic partnerships with incomes of $6,000 a year or more ; by citizens or residents with incomes in excess of $6,000 a year; and by foreign corporations, foreign partnerships and non-resident alien individuals with a net income of $3,000 a year or more from sources within the United States (Regulations 41, Art. 10, 11, 12). A married woman who is a sole trader or is entitled to any taxable income to her sole and separate use, may, for purposes of the Excess Profits tax, make a separate return in the same manner as any other individual. (Regulations 41, Art. 76.) A summary of how the law works. The reader will get a much better idea of what is to be explained if he will study this paragraph carefully and try to under- stand the purposes of the Excess Profits Tax law. The explanation of various terms will then seem reasonable and not merely a lot of disconnected rules. Remember, however, that the explanation here given is only of gen- eral application ; special cases are taken up in detail later. The Excess Profits Tax of October 3, 1917, is com- puted in one of two ways, depending upon whether the EXCESS PROFITS TAX 641 trade or business under consideration uses invested capi- tal or does not use invested capital. Where the trade or business has no invested capital or merely a nominal capital, the tax will be computed at the rate of 8 per cent on the amount of net income in excess of a specific deduction. Where the trade or business has an invested capital the tax will be computed at graduated rates on the amount of net income in excess of a deduction based in part upon the rate of income for the pre-war period. The same income cannot be taxed on both bases but an individual may be taxed upon different portions of his income on different bases. Leaving aside the question of the distinction between invested capital and nominal capital, which is discussed elsewhere in this chapter, we must consider the general working of the graduated tax. A corporation, we will say, had an average invested capital of $100,000 during 1911-1913 and made an aver- age annual profit of $50,000. The rate of profits of this concern during the pre-war period was 50 per cent, but the present law does not say that for present purposes only a rate of profit above 50 per cent for that concern would be excessive, subjecting the concern, therefore, to the War Excess Profits tax; it says, that the maximum rate exempt under any circumstances is 9 per cent, and that any income will be subject to the Excess Profits tax if during the present taxable year it is above 9 per cent of the present invested capital, no matter what the rate of income was in the pre-war period. In any event, then, this concern would be taxed on all income in excess of any amount equal to 9 per cent on its in- vested capital for the taxable year. (A specific deduc- tion of $3,000 in addition to the 9 per cent on its capital is also allowed.) Having then determined the rate of untaxed profits for this concern, we turn to its present profits to see what they are. To get the rate of profits 642 INCOME AND FEDERAL TAX REPORTS we must know the amount of profits and the capital on which those profits are being earned. If the present rate is less than 9 per cent the concern will escape the Excess Profits tax, since its pre-war rate was more than 9 per cent, and in such a case 9 per cent will be allowed as a deduction. If, on the other hand, its pre-war profits had been less than 7 per cent, a deduction of only 7 per cent would now be allowed. There are two ways in which the rate may become less than 9 per cent. (1) If, for example, the company had the same net income, $50,000, but if its invested capital had increased to $700,- 000, the profits of $50,000 would amount to only about 7 per cent of the invested capital. It therefore is to the interest of the owners of the business to make the pres- ent invested capital appear as large as possible, and conversely it is to the interest of the government to limit very carefully the items that can be claimed as invested capital. That, we shall see, is the chief diffi- culty we shall have to meet in interpreting this law ; the difficulty of determining what is and what is not invested capital. (2) Or, if we assume that the capital remained as it was during the pre-war period, viz., $100,000, but the income fell to $7,000, again the rate of profits would fall below the pre-war rate of 9 per cent and the concern would not be taxable. In such a case, however, we would have little difficulty, for the Excess Profits Tax law provides that profits are to be determined by the detailed rules applicable to the Income tax. That, in very brief outline, is the way the law works. Before we examine it in detail, let us summarize the facts that must be determined before the tax can be computed. GENERAL DEFINITIONS Before going into a discussion of the application of the law it would be advisable to define some of the terms that will be used throughout this chapter. EXCESS PROFITS TAX ' J}43 Corporation. "Corporation" is denned as including joint-stock companies or associations and insurance com- panies and limited partnerships. United States. "United States" is defined by the law as "only the States, the Territories of Alaska and Hawaii, and the District of Columbia." Domestic Corporation. A domestic corporation is therefore one created under the laws of the United States, or of any State, Territory or District included in the definition above. Foreign Corporation. A foreign corporation is one formed under the laws of any other possession of the United States or of any foreign country. Corporations organized in Porto Rico, the Philippines, or the Canal Zone are therefore to be considered "foreign." Exempt concerns. Corporations which are exempt from the Income tax are also exempt from the Excess Profits tax. Partnerships carrying on the same business or coming within the same description, and individuals to the extent they carry on or do the same kind of business or come within the same description as that of an exempt corporation are also exempt. Foreign partnership. Domestic and foreign partner- ships are defined in the same way as are foreign and domestic corporations. It is difficult to decide whether a partnership is organized in the United States or in some foreign country. When, for instance, is a part- nership organized or created under the laws, say of Eng- land! It may do business both in the United States and in England, and one of its partners may live here and one in England. Moreover, one may have signed a duplicate copy of partnership articles of agreement here, and the other may have signed a duplicate copy in Eng- land. Two sets of books may be kept, one here and one in England. The office here may be just as important but no more so than the one in England. What is the test! In the last analysis the Treasury Department 644 INCOME AND FEDERAL TAX REPORTS must solve this question. The tendency undoubtedly will be to class such partnerships as domestic. Pre-war period. The term pre-war period means the calendar years 1911, 1912, 1913 (the rate of earnings for which period form the bases of the amount of income exempt from the tax), or if the concern was not en- gaged in trade or business during the whole of such three years, then as many of such years during the whole of which the concern was engaged in trade or business. Trade or business. The terms "trade" and "business" are defined to include professions and occupations. Net income. The term "net income" as used in refer- ence to foreign corporations or partnerships or non- resident alien individuals means the net income received from sources within the United States. THE 8 PER CENT TAX The 8 per cent Excess Profits tax. As stated before, individuals, partnerships, or corporations engaged in trade or business not employing any invested capital or employing only a nominal capital are subject to a tax at the rate of 8 per cent on their net income in excess of a certain specific deduction. A general statement of those liable to pay the tax is found on page 640. Income subject to the tax. The income subject to this tax includes salaries, wages, commissions, bonuses and profits from businesses not employing invested capital. Non-resident aliens, partnerships and corporations are taxed on such portion of their net income as is from sources within the United States. Individuals and part- nerships, as explained later, may pay themselves salaries for services rendered, and such salaries would come under this tax. In the case of a corporation or partnership, all income from whatever source derived is deemed to be from its trade or business and is therefore subject to the tax EXCESS PROFITS TAX 645 (after deducting $3,000 or $6,000, as the case may be, and income exempt from taxation). In the case of an individual, however, only such income is subject to this tax as is derived from "all his activities for gain, profit or livelihood entered into with sufficient frequency, or occupying such portion of his time or attention as to con- stitute a vocation, including occupations and professions. When such activities constitute a vocation they shall be construed to be a trade or business whether continuously carried on during the taxable year or not, and all the income arising therefrom shall be included in his return for excess-profits tax. "In the following cases the gain or income is not subject to excess profits tax, and the capital from which such gain or income is derived shall not be included in 'invested capital': (a) Gains or profits from transactions entered into for profit, but which are isolated, incidental, or so infrequent as not to constitute an occupation, and (b) the income from property aris- ing merely from its ownership, including interest, rent, and similar income from investments except in those cases in which the management of such investments really constitutes a trade or business." (Reg. 41, Art. 8.) Exempt income. Fees or compensation received by officers and employees under the United States, or any State, Territory, or the District of Columbia, or any local subdivision thereof, for work as such officers or employees, is exempt. It is held that Congressmen and Senators are not such officers or employees of the United States ; their salaries, therefore, are not exempt. Income exempt from taxation under section 4 of the Income Tax law of 1916 (see page 39) is also exempt. Income derived from the business of life, health and accident insurance combined in one policy issued on the weekly premium payment plan is exempt. Specific Exemptions. Domestic corporations are al- lowed an exemption of $3,000. Domestic partnerships and individuals are allowed an exemption of $6,000. No exemption is allowed to non-resident alien individ- uals or to foreign partnerships or corporations. Importance of determining what is nominal capital. We saw that the tax was computed in two different ways, 646 INCOME AND FEDERAL TAX REPORTS one method being used for concerns with no capital or with only nominal capital, and the other method for concerns with invested capital. Nominal capital is de- fined as meaning "in general a small or negligible cap- ital whose use in a particular trade or business is in- cidental." Concerns, therefore, are divided into two classes Class A being those with no capital or only- nominal capital, and Class B being those with "invested capital." This distinction is fundamental, and the tax- payer should determine at the outset whether he belongs to Class A or Class B. Corporations or partnerships must be in one class or the other. Individuals may be in both classes, i.e., they may be required to file two re- turns, one for one income, to be taxed under Class A, and one for the other income, to be taxed under Class B. Class A concerns pay a flat 8 per cent tax, while the Class B concerns pay the graduated tax. When does a concern have no capital, or only nominal capital? The Treasury Begulations make it quite plain that the nature of the business carried on by a con- cern is the one most important factor in determining whether it belongs to Class A or Class B. Since the Government is likely to derive more revenue from a concern by placing it in Class B than in Class A, the regulations are so framed that doubts as to classification are generally settled by putting the concern in Class B, but the taxpayer will do well to study the rules care- fully before coming to a conclusion. In Class A, it was intended by the law to put con- cerns that depended chiefly on the personal service and ability of the owners. The mere fact that a concern sells or renders personal service instead of making and selling goods will not bring the concern to Class A un- less the earnings of the concern "are to be ascribed primarily to the activities of the owners." A law firm or an accounting firm has nominal capital only, because the reputation of the partners is the chief element of EXCESS PROFITS TAX 647 earnings, and this would seem to be true if the num- ber of employees is many times as great as the number of the partners, and even if the concern is required to maintain a fairly large capital in the form of bank bal- ances to pay salaries and wages. (Reg. 41, Art. 72.) Moreover, if a firm, corporation or individual renders personal services or professional services and employs capital in the form of office furniture, accommodations and equipment, it will not for that reason be taken out of Class A. Nor does the fact that the concern hap- pens to be organized as a corporation affect its status. The chief question to ask, is, are the earnings of the concerns rendering the service such as is being rendered by this concern ordinarily and necessarily procured primarily through the activities of their owners? Amount of capital employed not a determining factor in classifying concerns. A firm with large capital, then, may come under Class A while another with small cap- ital may come under Class B. The Regulations say "Business concerns which render professional or per- sonal service . . . shall not be taken out of (Class A) because of the size of the capital, if the employment of capital is necessitated by delay or irregularity in the receipt of fees, etc." If the concern is one of the kind that ordinarily falls in Class B, but for some reason its "invested capital," as defined by the law, is "seri- ously disproportionate to the taxable income," it will, nevertheless, be left in Class B, but it will be treated as "one, the amount of whose invested capital the Sec- retary of the Treasury cannot determine." (Reg. 41, Art. 52 and 74, and also see pages 689, 693.) When concerns will be deemed not to have nominal cap- ital. Some general rules have been laid down for the guidance of concerns, all of which state conditions which may exist without bringing a concern into Class A. (a) A corporation may, during a taxable year, because of war conditions or because of any other circumstances 648 INCOME AND FEDERAL TAX REPORTS have income quite disproportionate to the invested cap- ital. The purpose of the law was to get at precisely that income, and such concerns therefore will not be per- mitted to claim that they belong in Class A. "In the determination of doubtful cases, stress will be laid upon the normal of net income to capital during pre-war years," and, it may be proper to add, this applies to the relation of income to capital during pre-war years of concerns engaged in the same line of business and not alone to the particular concern in question. (b) A concern will not be taken out of Class B be- cause its capitalisation (stocks and bonds of a corpora- tion, or stated capital of a partnership, the liability item of capital invested, not including surplus) is nomi- nal. If they employ a substantial capital, that is, if they use a large amount of capital assets, and do not render personal or professional services, they will be taxed in Class B. The excess of capital assets over capitalization, we shall see, may be taken care of by in- cluding, under certain restrictions, the surplus in the amount of "invested capital." (c) The mere fact, that a concern, that would other- wise be included in Class B, has invested a large part of its assets in stocks or bonds (other than obligations of the United States) or in other assets the income from which is not subject to the Excess Profits tax, and there- fore has but a nominal amount of what is technically defined as "invested capital," does not bring this con- cern into Class A; it must seek redress by claiming the advantage of the rule in respect to concerns whose cap- ital the Secretary of the Treasury has difficulty in de- termining. (See page 693, post.) (d) A concern is not to be put in Class A merely be- cause most of its capital was acquired through borrowed funds. (e) A concern whose original capital was small but has appreciated in value, and whose "invested capital," EXCESS PROFITS TAX 649 as defined by the law, therefore is relatively small, will not for that reason be taken out of Class B. (f) A concern with intangible assets "built up or de- veloped by expenditures which have been regularly de- ducted as items of current expense," will not be per- mitted to claim that it shall be taxed in Class A, merely because its "invested capital," as the law defines it, is relatively small. For example, a corporation may spend $500,000 a year in advertising, and have an item of good-will easily worth several million worth several million because it could sell that good-will for that price. This good-will is not included as "invested capital" un- der the law, because it has not been paid for with stock, cash, or tangible property. (See page 685, et seq.) In cases (d), (e), and (f), while the concern will be classed in Class B, it may still claim the benefit of Sec- tion 210 respecting concerns whose capital cannot satis- factorily be established. (Beg. 41, Arts. 52 and 74.) Brokers and commission merchants. The Treasury Reg- ulations make a fine distinction between brokers and commission merchants. Technically speaking, the dif- ference between a broker and a commission merchant is rather shadowy. Both sell goods for others, but the broker does not get possession of the goods before the sale, while the commission merchant does get possession. But men frequently term themselves brokers while in fact they sometimes do get possession of the goods be- fore the sale is made. For example, stock brokers are frequently given certificates of stock to sell. A careful examination of this regulation leads to this conclusion: if a broker uses capital to finance his busi- ness operations, he will be deemed to be employing cap- ital and therefore comes in Class B ; if, however, he uses capital to finance himself, i.e., to pay salaries of his em- ployees, to pay rent of an office, etc., he will come under Class A. (The Regulation reads: "Agents and brokers requiring and using no capital or merely a nominal cap- 650 INCOME AND FEDERAL TAX REPORTS ital in their business are taxable under Class A, but commission houses regularly employing a substantial amount of capital, whether to lend to principals or to carry goods on their own account, are not deemed to be agents or brokers and are taxable under the provisions of Article 16 [relating to Class B]." Returns Required. Citizens, and residents of the United States, non-resident aliens, and corporations, both foreign and domestic, are required to make re- turns of their net income under the provisions of the Income Tax Law. The calculation of this 8 per cent Excess Profits tax will undoubtedly be made on the regular Income Tax form (as in the case of citizens and residents of the United States where the Excess Profits tax is calculated on Form 1040, the standard Income Tax form.) (See footno.te, p. 663, post.) No returns were required of partnerships, either do- mestic or foreign, under the Income Tax Law, the tax being levied on the individual partners. For the purposes of the Excess Profits tax, however, a partnership is treated as separate and distinct from its members, and the partnership as such must file a separate return, provided its net income is $6,000 or more if domestic or $3,000 if foreign. It will be noticed that while foreign partnerships are not given any exemption, they are not required to file a return unless their net income is $3,000 or more. This provision is evidently an error on the part of Congress, as the difference of one cent in the income ($2,999.99 to $3,000) would cost the partnership a tax of $240. Until regulations are issued to the contrary, no returns will be required of non-resident partnerships unless their income is $3,000 or more. THE GRADUATED EXCESS PROFITS TAX Who is liable to pay the tax. An individual or con- cern, falling within one of the classes mentioned on p. EXCESS PROFITS TAX 651 640, and employing invested capital, is subject to this tax. It must be remembered that non-resident aliens are liable to the tax only on their income from sources within the United States. The "United States," it must be remembered, for the purpose of this tax, includes, besides the continental territory including Alaska, only Hawaii, so that residents of Porto Eico or the Philip- pines are to be looked upon as foreigners, and income derived from one of those islands is income derived from outside the United States. What income is to be included. Inasmuch as a cor- poration or partnership is evidently organized for the purpose of engaging in business, all its activities are held to be business. Partnerships and corporations are therefore taxed on their entire net income from all tax- able sources. The income of an individual, however, is to be limited, as stated on p. 645. It will be noticed that the law (sec. 201) provides that wherever a partnership or corporation (not an in- dividual) is engaged in several trades or businesses, all the trades or businesses in which it is engaged "shall be treated as a single trade or business, and all its in- come from whatever source derived shall be deemed to be received from such trade or business." Its entire income will be held to be subject to the same tax rate; so that if a corporation or partnership employed "in- vested capital" in one part of its business, and no cap- ital in another part, all its income will be subject to the graduated Excess Profits tax. In the case of an indi- vidual, however, the net income may be classified in two groups : Class A, income derived from business or trade employing no invested capital (subject to 8 per cent tax), and Class B, income derived from trade or busi- ness having invested capital (subject to the graduated tax). (Eeg. 41, Art. 14.) The total income from each class is then reported separately. 652 INCOME AND FEDERAL TAX REPORTS Summary of facts to be ascertained before the amount of tax can be determined. We shall need to ascertain these facts in order to determine the amount of the excess profits tax: 1. The rate of pre-war profits, which necessitates as- certaining a. pre-war net income. b. pre-war invested capital on which this income was applied to find the rate of profits. (Incidentally, it may be mentioned here, it is neces- sary to determine whether the rate of profits so ascer- tained is fairly comparable with the rate of profits earned during the same period by other concerns in the same general line of business or whether the rate of the given concern is subnormal. If it is subnormal (i.e., lower by one per cent or more than the normal rate), its own rate of profits is discarded and the normal rate is used in its place. Moreover, if the rate of profits for the pre-war period was less than 7 per cent, 7 per cent will be used as the rate, or if the rate was more than 9 per cent, 9 per cent will be used as the rate.) 2. The net income in the taxable year. 3. The invested capital in the taxable year. 4. The specific exemption to which the taxpayer is entitled. 5. A sum (known as the deduction), found by apply- ing the rate of pre-war profits (see above) to the in- vested capital of the concern in the taxable year. The tax then will be applied to the amount of net income in the taxable year, less the deduction and the specific exemption. The rate of tax is based, not on the amount of net income, but on the percentage such net income is of the invested capital. This method of computing the tax is applicable only where the trade or business has invested capital. Where there is no invested capital, or only a nominal invested EXCESS PROFITS TAX 653 capital, including, in the case of an individual, salaries, wages, fees, or other compensations, a flat tax of 8 per cent is levied on the taxable net income in excess of the specific deduction (see page 644). NET INCOME FOR PRE-WAR PERIOD Definition "Taxable year" and "Pre-war period." The term "taxable year" is clearly defined in the law. For individuals, partnerships and corporations it means the calendar year, excepting in the case of partnerships and corporations which have a fiscal year which does not coincide with the calendar year, in which case the tax- able year means the fiscal year. The first taxable year is the year ending December 31, 1917, except in the case of a corporation or partnership which has its own fiscal year, in which case it will be the fiscal year ending during the calendar year 1917. If a corpora- tion or partnership, prior to March 1, 1918, makes a return covering its own fiscal year, and includes therein income received during that part of the fiscal year fall- ing within the calendar year 1916, the tax for the tax- able year will be "that proportion of the tax computed upon the net income during such full fiscal year which the time from January 1, 1917, to the end of such fiscal year bears to the full fiscal year." In order to determine whether a person or corpora- tion may deduct from his income seven or nine per cent (or any percentage between them) of his capital, it is necessary, as we have seen, to ascertain the rate of profits made by such person or corporation during the pre-war period. The law describes the pre-war period as the calendar years 1911-1913 inclusive. But if a corporation or partnership was not in existence or a person was not engaged in a trade or business during the whole of such period, then as many of such years during the whole of which the corporation or partner- ship was in existence or the individual was engaged in 654 INCOME AND FEDERAL TAX REPORTS trade or business will be taken to constitute the pre- war period. What is to be done with corporations, part- nerships and individuals that do not come even under this second rule is explained later. No report of net income for pre-war period required in certain cases. No report of the net income for the pre- war period will be required of either individual, part- nership or corporation in the following cases: (1) If the taxpayer is willing to accept the minimum percentage, i.e., 7 per cent, as the percentage to be used in computing the deduction under section 203 of the law. Therefore, if the taxpayer's pre-war rate of in- come on his pre-war "invested capital" was 7 per cent or less, he will not make a report of pre-war income and pre-war "invested capital." (2) If the trade or business has no invested capital, or not more than a nominal invested capital, and is taxable only at the 8 per cent rate under section 209 of the law. In either of the above cases, however, a return of information as to all facts which may be necessary for the ascertainment of the capital and income for the taxable year will be required, except in the case of those who are exempt from the tax. Net income of citizens or residents for pre-war period. The intention of the law is to tax the excess profits (of businesses having more than a nominal invested capital) of the present taxable year as compared with the profits of the pre-war period. It is therefore nec- essary to calculate the pre-war profits on the same basis as the taxable year profits (see pp. 644, 686). If, therefore, in computing the net income for the taxable year an individual deducts a reasonable amount desig- nated as salary (p. 659), he must also, in computing net income for the pre-war period, make a corresponding deduction (Reg. 41, Art. 40). EXCESS PROFITS TAX 655 Net income of individuals for the pre-war period when they were not engaged in trade or business, and in other exceptional cases. (1) Where the citizen or resident was not engaged in a trade or business during the pre-war period. Where the individual was not in trade or busi- ness during the pre-war period (as that period is de- fined above) the law in effect assumes that during such period the individual's net income was 8 per cent of his invested capital (section 204). (2) (a) Where the citizen's or resident's income for the pre-war period cannot be satisfactorily determined, or (b) where pre-war profits were lower by one per cent or more of the net income to the invested capital of representative concerns engaged in a similar trade or business during the same period, or (c) where he made no profits though he was engaged in business. If the Secretary of the Treasury, upon complaint, finds that any of the conditions mentioned in the heading of this paragraph exists then the pre-war rate of profits is to be taken as being the same as that of representative concerns in the same line of business, not, however, less than 7 per cent or more than 9 per cent. Whether an individual's rate of profits was subnor- mal or not, is to be ascertained by comparing it with the rate of profits of representative concerns. This means, of course, that sooner or later the Treasury De- partment will have to determine the average pre-war rate of profits in various lines of business. As this will not be done till after the returns are due, in cases aris- ing under subdivisions (a) or (c), the return will be filed and the tax assessed in the first instance, assuming a 7 per cent pre-war rate of profit; and in cases aris- ing under (b) the return will be filed and the tax as- sessed in the first instance on the basis of the actual subnormal pre-war rate of profits, but not less than 7 per cent. In any of these cases the taxpayer should file with his return a claim for abatement (Form 47) of 656 INCOME AND FEDERAL TAX REPORTS the amount of tax by which the tax so assessed exceeds a tax computed on the basis of the pre-war rate of profits of representative concerns (Law, Section 205, [&]). See also p. 698, Claims for abatement. Perhaps an illustration will make this clear. An in- dividual was in business in 1911-1913 but made no profits. He had continuously invested in his business $100,000 of capital. His income for 1917 was $25,000. He would have to pay the excess profits tax on $25,000 less $7,000 (the minimum deduction being 7 per cent of the invested capital) and less the specific exemp- tion of $6,000. If, however, representative concerns in the same line of business had made 8 per cent dur- ing the pre-war period, by "complaining" and filing his claim for abatement along with his return, he would eventually, when the claim was adjusted, pay a tax on $25,000 less 8 per cent and less the specific exemption of $6,000. That is, he would pay a tax on $25,000 less $8,000, less the specific exemption of $6,000. If his capital had been only $50,000, his taxable net income would be $25,000 less $4,000 (i.e., 8 per cent of $50,000) less the specific exemption of $6,000. Net income for pre-war period of non-resident aliens. The pre-war rate of profits of non-resident aliens is worked out on the basis of income from sources within the United States only, and is found for non-resident aliens, as it is for citizens or residents. However, non- resident aliens are not entitled to the rule pertaining to businesses having no net income, although in existence during the pre-war period (Case 2 (c), p. 655), but they are entitled to the application of the rule for finding a standard of pre-war profits, in cases (a) and (b), men- tioned on p. 655, and where they are not engaged in business or trade during the pre-war period (section 204). In any event, they may take at least 7 per cent instead of the actual pre-war rate of income. (Section 203, subdivision [c].) EXCESS PROFITS TAX 657 Pre-war profits of partnerships. The net income of a partnership for each of the years 1911, 1912 and 1913 is determined in the same manner as the net income for the taxable year. Dividends from stock or from the net earnings of corporations, joint-stock companies, or associations, or insurance companies, subject to the tax imposed by the laws of 1909 or 1913 are to be deducted. Moreover, if salaries of partners (p. 660) and interest (p. 661) are deducted in the taxable year, a correspond- ing deduction must also be made from net income of the years 1911, 1912, and 1913. (Reg. 41, Art. 34). The other rules for finding the pre-war profits of domestic partnerships are the same as those applying to resi- dents and citizens, while those for foreign partnerships are the same as those for non-resident aliens. Pre-war profits of domestic corporations. To find the profits for 1911, the corporation simply refers to its report covering the income for that year under the law of 1909, and adds the tax paid under that law in 1911 on income earned in 1910, as this income tax was subtracted in the report filed in 1911 in arriving at net income. The same process is repeated in finding the profits for 1912. To find the net income for 1913, add to the net income as shown in the return filed in that year the income tax paid within the calendar year 1913 and deduct from the total so obtained the dividends re- ceived from corporations, etc., subject to that tax. (Reg. 41, Art. 29.) (The law of 1909 provided that such divi- dends should be deducted, and hence that matter was taken care of in the reports filed in pursuance of that law.) Pre-war profits of domestic corporations not in existence before the war. The same rule applies here as applies to citizens and residents: the pre-war profits are as- sumed, for the purpose of the law, to be 8 per cent of the capital in the taxable year. 658 INCOME AND FEDERAL TAX REPORTS Pre-war profits of domestic corporations, where such profits cannot be satisfactorily determined, or where sub- normal or where the corporation, though in existence, made no profits. "What was said on this subject with respect to citizens and residents applies to domestic corpora- tions as well. (See page 655.) Pre-war profits of foreign corporations. The pre-war profits of foreign corporations are found in the same way as are those of domestic corporations, except that the examination of the income is restricted to that com- ing from sources within the United States. As in the case of individuals and partnerships, foreign corpora- tions come under the rule applicable to domestic con- cerns in cases where such foreign corporations were not in existence during the pre-war period, and to the rules applicable to cases (a) and (b) on p. 655, but they are not entitled to the rule pertaining to claims for abatement of tax where the corporation was in existence in the pre-war period but made no profits. In any case they may, however, take 7 per cent instead of the actual pre-war rate of income, if that is lower. Pre-war capital. The capital of the concern during the pre-war period to which the profits are to be ap- plied in order to discover the pre-war rate of profits is calculated for that period in the same way that capital is calculated for the taxable year. (See the discussion in the following pages.) NET INCOME DURING THE TAXABLE YEAR Net income of individuals. The net income of an indi- vidual employing no invested capital or only nominal capital in his trade or business is determined by select- ing from the income tax return for the year those items mentioned on p. 644 under "Income subject to tax." When there is invested capital employed in the trade or business, the same method is followed, except that from such income there may be deducted a reasonable EXCESS PROFITS TAX 659 salary. (See next paragraph.) Moreover, dividends re- ceived from corporations, joint-stock companies or asso- ciations, which are subject to the income tax are not subject to this Excess Profits tax. An individual dealing in securities, however, must include (1) the amount of interest received on bonds or obligations of the United States, issued after September 24, 1917, in excess of $5,000 principal of such bonds or obligations, and (2) the proportion of dividends received upon the stock of foreign corporations which the net income of such cor- porations from sources outside the United States is of their entire net income. (Reg. 41, Art. 36.) Contributions to religious and charitable organizations, etc. (see page 113), subject to the limitations there men- tioned, may be deducted in computing the net income of the trade or business for the purpose of the Excess Profits tax, providing it is shown to the satisfaction of the Commissioner of Internal Revenue that such con- tributions are made by the trade or business and not by the individual in his personal capacity. (Reg. 41, Art. 37.) Deduction of salary by individual employing invested cap- ital. An individual carrying on a trade or business hav- ing an invested capital may, for the purpose of the Ex- cess Profits tax, designate a reasonable amount as salary for services actually rendered by him in the conduct of his trade or business, and he may deduct such salary from the net income of the trade or business, thus making the excess profits for the trade or business smaller. But any such salary is subject to the Excess Profits tax, if any (i.e., if this salary and other sal- aries received by the individual amount to more than $6,000), at the 8 per cent rate under Section 209 (Form 1040). The balance of the income in excess of the allowed deductions derived from the trade or business is subject to the graduated rates prescribed in Section 201 (Form 1103). The Treasury Depart- 660 INCOME AND FEDERAL TAX REPORTS ment has ruled (T. D. 2611) that "in no case shall the amount of such salary so designated be in excess of the salaries or compensation customarily paid for similar services under like responsibilities by corporations or partnerships engaged in like or similar trades or busi- nesses. In the case of a non-resident alien individual, the amount shall be limited to that portion of the sal- ary or compensation which is for service rendered with respect to trade or business carried on in the United States." It will appear, therefore, that where an individual conducts a business with "invested capital" he should, for Excess Profits tax purposes, deduct a salary in the following case: Where the net income during the tax- able year exceeds the deduction (see page 691) plus the specific exemption (see page 690). The amount of sal- ary to be deducted will depend on the relative size of the individual's salary and the business' excess profits, taking into consideration the higher rates imposed on the latter profits. (The graduated taxes on businesses with invested capital are higher than the tax on salaries at the flat 8 per cent rate.) Where a person derives income from his interest in a partnership, such income in his hands will not be subject to the Excess Profits tax. This income is treated as income from dividends received from a cor- poration. Such share of the profits (like dividends of a corporation), distributed or distributable to the in- dividual partner, is not deductible by the partnership in determining its net income for Excess Profits tax purposes. But where the partnership deducts as an expense (for the purpose of the Excess Profits tax) reasonable salaries paid to the individual partners for services actually rendered during the taxable year, 1 the individual partner's salary (including any amount al- lowed to the partnership as a deduction on his account i See page 661, post. EXCESS PROFITS TAX 661 for the period prior to March 1, 1918) is subject, in the hands of the recipient, to the Excess Profits tax, if any, at the 8 per cent rate under Section 209. (T. D. 2612.) Net income of partnerships for the taxable year. The net income of partnerships is figured in the same way as that of individuals (salaries paid to partners and interest paid on loans by partners may be deducted), foreign partnerships for this purpose being treated as non-resident aliens, and domestic partnerships as citi- zens or residents. In determining the net income of the partnership, the interest on bonds, etc., of the United States issued after September 24, 1917, in excess of the interest on $5,000 of such bonds, is to be included as income; and divi- dends received from corporations, etc., subject to the income tax may be deducted. (Reg. 41, Art. 30.) But only that proportion of the dividends received on stock of foreign corporations may be deducted as the net in- come of such foreign corporation from sources within the United States is of its entire net income. (Reg. 41, Art. 27.) In computing net income for the purpose of the Ex- cess Profits tax, a partnership will be allowed to de- duct as an expense reasonable salaries or compensation paid to individual partners for personal services actu- ally rendered during the taxable year, if the payments are made in accordance with prior agreements and are properly recorded on the books of the partnership. In no case may the salaries or compensation so deducted be in excess of the salaries or compensation custom- arily paid for similar services under like responsibili- ties by corporations engaged in like or similar trades or businesses. With respect to any period prior to March 1, 1918, where no previous agreement has been made as to salaries or compensation, a similar deduction will be allowed for services actually rendered. 662 INCOME AND FEDERAL TAX REPORTS In the case of a foreign partnership the deduction will be limited to those portions of salaries or com- pensation which are paid for services rendered with respect to trade or business carried on in the United States. (T. D. 2611.) A partnership with "invested capital" should, there- fore, for the purpose of the Excess Profits tax, deduct and pay salaries (instead of a share of the profits) to partners in the following case: when the net income of the partnership in the taxable year exceeds the deduc- tion (see page 691) and the specific exemption (see page 690). The amount of salary paid (instead of a share in the profits) will depend upon the relative size of the salary of each partner and of the excess profits of the partnership, it being remembered that the graduated rates of tax on excess profits are considerably more than the flat 8 per cent rate imposed on salaries in excess of $6,000. A partnership may also deduct interest paid to an individual partner on any bona-fide loan, but no deduc- tion for so-called interest on capital will be allowed. (Eeg. 41, Art. 33.) Net income of domestic corporations for the taxable year. The net income of domestic corporations for the tax- able year is found in the same way as that used for income tax purposes, adding to that income the amount, if any, received as interest on bonds or other obligations of the United States, issued after September 1, 1917, in excess of the interest on $5,000 principal of such bonds or obligations, and deducting from the total the dividends received from corporations, etc., subject to the income tax. The rule as to the deduction of divi- dends on foreign corporations is the same as that found on p. 661. Net income of foreign corporations for the taxable year. Foreign corporations figure their net income for the taxable year in the same way that domestic corporations EXCESS PROFITS TAX 663 do, except that they confine themselves to income de- rived from sources within the United States. COMPUTATION OF INVESTED CAPITAL When invested capital must be computed. Where a con- cern must make a return and it does not come under the class whose capital is nominal, it becomes neces- sary for it to compute its invested capital. 1 It must be remembered that its invested capital consists of its assets, which are listed on the assets side of its balance sheet, and which may be classified as follows: (a) cash; (b) tangible property; (c) patents and copyrights; (d) good- will, trade-marks, trade brands and other intangible property. Tangible and intangible property. Of the kinds of as- sets mentioned in the foregoing paragraph, cash and patents and copyrights are self-explanatory. A word about the difference between tangible and intangible property may not be out of place. Intangible property is specifically defined in the law and regulations as "property of a character similar to good-will, trade- marks and trade brands." (In the regulations and in this book the term "intangible property" does not in- clude patents or copyrights.) Possibly other forms are "the going-concern value" of public utilities, organiza- tion expenses and the like ; but as to these, whether they are to be considered assets at all, or as tangible assets, the Treasury Department says it will make rulings as occasion may demand. The following classes of prop- erty, when paid in for stock or shares in a corporation or partnership, will be regarded as tangible property so paid in: stocks, bonds, bills and accounts receiv- able, notes and leaseholds. Average invested capital. The amount of invested cap- ital is not necessarily constant during the entire pre- i Even corporations claiming to have nominal capital only, or claiming that they cannot satisfactorily determine the amount of their invested capital, must fill out Form 1103 as far as practicable to show the facts necessary for action on their claim. 664 INCOME AND FEDERAL TAX REPORTS war or taxable year. To determine the invested capital for any year, the law requires that an average amount be ascertained on a monthly basis. The amounts of capital invested in each month of the year are added together and the total divided by twelve. If a change in the capital investment is made during a month, the average amount for that month may be ascertained by multiplying the investment as of the first day by the number of days from the first to the date of change, adding to that amount the product of the new invested capital times the number of days remaining, including the date of change, and dividing the result by the num- ber of days in the month. The method of averaging- invested capital prescribed by Form 1103. The Eegulations (Art. 43) seem to provide the method of averaging the capital just described; it is applied in the solution of the problem on page 685. The form of return, however, requires a different meth- od. Suppose the capital at the beginning of the year is $2,970,000 (see the problem, page 684) and that it is increased on September 15th by $500,000 and decreased on November 10th by $50,000. Form 1103 requires each change to be averaged over the year. Thus the increase was effective for 16 days in September and during the three months of October, November and December, or in all 3 16/30 months. (If September had been a 31-day month the fraction would be 17/31.) $500,000 then is multiplied by 316/31 and divided by 12 the number of months in the year. The result, $147,222 2/9 is added to the invested capital at the beginning of the year. In the same way the decrease of $50,000 was effective 121/30 months and the aver- age decrease for the year, therefore, was $7,083 1/3. This is subtracted from the invested capital. The net result of the two changes makes the invested capital $3,110,138 the same result as is found on page 685. EXCESS PROFITS TAX 665 Invested capital of foreign corporations or partnerships or non-resident alien individuals. In the case of foreign- ers, the Kegnlations provide that they must figure out their entire invested capital and then for the purpose of calculating the tax take that proportion which their net income from sources within the United States is of the entire net income. (Reg. 41, Art. 48.) Perhaps many such concerns, however, will take refuge in an- other regulation which says that Section 210 of the law relating to tax on concerns whose capital cannot be determined will apply. When form of organization has been changed. The in- tent of the law is undoubtedly to tax a business as such and to look behind the formal organization in which it may be clothed. If, therefore, a business after Janu- ary 2, 1913, is substantially the same business as it was on or before that date, though it may change the form of its legal organization after that date, the net income and capital of the predecessor concern prior to January 2, 1913, will be deemed to have been its net income and invested capital for the pre-war period. Changes of ownership after March 3, 1917. The law (Sec. 208) makes provision for a special case that may arise where a trade or business may, after March 3, 1917, change ownership by consolidation, reorganiza- tion or otherwise, though at least a one-half control of it remains in the control of the same person, corpora- tion, association, partnership, or any of them. In such special cases the following rules will apply in ascer- taining the invested capital of the new organization: 1. No asset transferred or received from the prior trade or business shall be allowed a greater value than would have been allowed in computing the invested capital of such prior trade or business if such asset had not been so received or transferred. 2. By way of exception to the above rule, if the transferred asset was paid for specifically in cash or 666 INCOME AND FEDERAL TAX REPORTS tangible property, the value of the asset may be assumed to be the actual cash or cash value of the tangible prop- erty paid therefore at the time of such payment. (The meaning of "tangible property" is discussed later.) INVESTED CAPITAL OF PARTNERSHIPS AND CORPORATIONS How invested capital of a corporation or partnership is computed. The invested capital, as we saw, consists of the concern's assets and it would seem that in the last analysis the invested capital cannot be any greater than the value of these. But it must be remembered that not all the assets a company has at any given moment of time can be called capital. Funds passing in and out are not capital. Besides all of its capital is not "invested" capital. The word "invested" connotes ownership. Congress intended in effect practically to make "invested" capital and owned capital synonymous terms. The question then arises, how shall we measure the owned capital of a concern? The law and regulations say that we are to go about this in the ordinary way that any business man would use. We simply take the proprietorship in the case of corporation the stock plus the surplus, and in the case of partnerships the stated capital plus the surplus, and in the case of individuals the capital account and make certain adjustments in the accounts representing proprietorship that they may tell the true story of invested capital, as invested capital is denned by the law. We begin then by turning to the liability side of the concern's balance sheet and for the present we shall speak of corporations and partnerships only. We find on the liability side of the balance sheet four classes of liabilities: (a) capital stock of corpo- rations, or nominal capital investment in a partnership. These will be spoken of hereafter, respectively, as stock and shares, the shares being the amounts stated EXCESS PROFITS TAX 667 in the partnership's balance sheet as the amounts con- tributed by the partners. (b) Funded indebtedness, the same being the long term bond issues spoken of in some of the Eegulations as "permanent indebtedness." (c) Short term or current liabilities. (d) Surplus and undivided profits the difference be- tween the assets and the three other classes of liabilities. In computing invested capital, every corporation or partnership shall add together its paid-in capital and its paid-in or earned surplus and undivided profits. 1 This is the basis of computation of the invested capital. To find the true invested capital intended by the law, certain adjustments have to be made, and these can be made only by going into the financial history of the concern and finding out how the stock was issued or the circumstances under which the partners' shares were written into the accounts, and how the surplus came to be created. The procedure to be followed is to find out what assets were acquired through the issue of stock and then to adjust the amount of stock and the value of the asset to each other, valuing the assets in each case as prescribed by the Eegulations. After all the stock has been examined the surplus account is taken up. Certain adjustments are made in the surplus account as provided in the regulations and as will be explained hereafter. When the capital account and the surplus account have been thus adjusted, their sum will repre- sent the invested capital, subject, however, to one pos- sible item of increase a percentage of the funded indebtedness and to one possible cause for reduction i Reserves, such as those for bad debts, for insurance, for dividend equalization, for working capital and for pensions in fact, all except the depreciation reserves consisting of amounts not deductible in the computation of net income under the Income Tax law, msy, if properly explained, be included as part of the surplus for the purpose of com- puting invested capital. 668 IX CO ME AND FEDERAL TAX REPORTS where the sum thus ascertained exceeds the sum of the admissible assets on the assets side of the balance sheet. The admissible assets are all the assets when valued in accordance with the Regulations, except stocks, bonds (other than bonds of the United States), the in- come from which is not subject to the Excess Profits Tax. We are now ready to see what adjustments must be made in the capital and surplus accounts. Adjustment of capital account for intangible property acquired on or subsequent to March 3, 1917. If in looking through our capital account we find that shares were issued, on or subsequent to March 3, 1917, for good- will, trade-marks or trade brands, the item must be crossed out and the capital account reduced by that amount. On March 3, 1917, the first Excess Profits Tax law was passed and it would have been to the interest of concerns to capitalize good-will and other intangible property by issuing stock or shares therefor. To prevent such wholesale writing up of the capital account, the law provides that intangible property can- not be included if acquired for stock or shares after March 3, 1917. (Sec. 207.) Notice that the item must be crossed out in either case: (a) if the intangible property was acquired on or subsequent to March 3, 1917, and (b) if the stock or shares were issued on or subsequent to March 3, 1917, though the property was acquired prior to that time. Adjustment of stock or shares issued for intangible prop- erty prior to March 3, 1917. We search through our capital account further to find out if any stock or shares were issued prior to March 3, 1917, for intangible property acquired prior to March 3, 1917. If we find such a case the capital account will have to be adjusted as follows: a. Find the actual value of the intangible property at the date acquired. EXCESS PROFITS TAX 669 b. Find the par value of the stock or shares issued in payment therefor. c. Find out the stock or shares outstanding on March 3, 1917, and figure out what 20 per cent of it would be. (Where stock has no par value, we give them the mar- ket or book value they had on March 3, 1917.) (Reg. 41, Art. 58.) Wherever stock has been issued for intangible prop- erty in excess of a, the amount of capital should be reduced by an amount equal to the excess. Thus, if we find that a trade-mark was worth $50,000 but $100,000 in stock was issued therefor, the stock account is written down to $50,000 and the asset which was carried at $100,000 should also be written down to its actual cash value. After separate adjustments have been made in this way for each piece of intangible property acquired through the issue of stock or shares, all of the intan- gible property thus adjusted is added up and the sum is reduced, if necessary, to the 20 per cent of the capital as figured out in c. (Reg. 41, Art 57-8.) It is essential to bear in mind that a, b, or c applies, "whichever is the lowest." Adjustments for stock or shares issued for patents or copyrights. We next ascertain, in searching through the capital account in the books of account, if at any time stock or shares were issued for patents or copyrights. If so, we must find out the following facts about the transactions : a. What was their actual cash value at the time they were acquired. b. What was the par value of the stock or shares issued for them at the time. The capital account, if necessary, is then written down to either a or fe, which- ever is lower. Adjustment of stock or shares issued for tangible prop- erty acquired prior to January 1, 1914. We then go over 670 INCOME AND FEDERAL TAX REPORTS the capital account again to see if any stock or shares were issued for tangible property prior to January 1, 1914. If so, we establish the following facts: a. The actual cash value of the property on January 1, 1914. Probably any reasonable appraisal placed on the property by the taxpayer will be accepted as prima facie evidence of its value on that date, but if neces- sary the taxpayer may be required to sustain his opinion with other evidence, such as the appraisal of some disinterested authority, statement of assessed value in case of real estate, or the market price on January 1, 1914, if that is a matter of general public information. Notice that the original value at the time it was acquired does not enter into the discussion at all (if the property was acquired prior to January 1, 1914). b. The par value of the stock or shares issued for the property. The capital account is thus adjusted, if necessary, down to a or b, whichever is lower. 1 Adjustment of stock or shares issued for tangible prop- erty on or after January 1, 1914. If stock or shares were issued for tangible property on or after January 1, 1914, the capital account must be adjusted to the actual cash value at the time of payment. (Reg. 41, Art. 55.) Adjustments for issue of stock or shares for mixed tan- gible and intangible property. Where it has been dis- covered that stock or shares were issued for a lump amount of property, part of which was tangible and part intangible, some difficulty would be experienced in applying the foregoing rules relating to adjustments. In such cases some attempt must be made to separate the property and apportion the stock or shares issued to each class of property. If this is done adjustments can be made in accordance with the rules already given. i In filling out Form 1103 notice that the instructions on the blank referring to Schedule c, item 6, contradict the law and the Regulations (Art. 55). Item (b) in the explanation of Schedule c, item 6, should probably read, "amount of cash paid therefor, or if purchased before January 1, 1914, value on that date." EXCESS PROFITS TAX 671 For separating the property into different classes the following rules are to be applied: (1) In the absence of satisfactory evidence to the contrary, it will be presumed, in the case of a corpo- ration, that its stock was issued for the following pur- poses in the order named: (a) Good-will or other intangible property, (b) Patents and copyrights, and (c) Tangible property. (2) Upon the production by the taxpayer of evidence satisfactory to the Commissioner of Internal Revenue as to the actual values at the date of acquisition of (a) the tangible property and (b) the patents and copyrights, the sum of these two items may be applied against the total par value of the securities issued and the remainder will then be deemed to represent the par value of the securities issued for the good-will or other intangible property. It may be that so much mixed property was acquired for stocks and shares that the whole calculation of invested capital is thrown out on account of the in- ability of the Secretary of the Treasury to determine satisfactorily the respective values of the several classes of property at the time of payment. In such cases it may be necessary to abandon the attempt to fix the amount of invested capital and to calculate the tax as provided by the law for cases where it is impossible to calculate the invested capital. This subject is dis- cussed at length later. Adjustments where stock has been returned to the cor- poration by way of gift. Frequently, in order to get around the State laws requiring that stock must not be sold at less than par, the promoters of a company will issue to themselves all of the stock of the com- pany for a mine, or for good-will, or a patent, or other property of uncertain value. A value will be placed on the property equal to the capital stock issued and 672 INCOME AND FEDERAL TAX REPORTS the stock will be called full-paid. In order to get cash, the promoters will then donate a large part of their stock back to the corporation and since this has been paid for in full it may be issued at any price. It may be sold, say, for $75 a share, although the par value is $100. If, in searching through the capital account, such a situation as this is discovered, the original trans- action as far as the donated stock is concerned will be disregarded and the stock account will be adjusted in accordance with the rules above given just as though the second issue had been 'the original issue. Adjustment of surplus account for tangible property paid in for stock or shares substantially below their par value. It may be found in going through the capital account that stock was issued, say, up to $100,000 for tangible property worth $150,000. If the transaction was en- tered on the books by debiting the property account with $150,000 and crediting the stock account with $100,000 and the surplus account with $50,000, appar- ently no further adjustment need be made. But the property account may have been debited only with $100,000 and the surplus account credited with nothing. In such a case the following rule would apply: Where it can be shown by evidence satisfactory to the Com- missioner of Internal Eevenue that tangible property has been conveyed to a corporation or partnership by gift or at a value accurately ascertainable or definitely known as at the date of conveyance, clearly and sub- stantially in excess of the cash or the par value of the stock or shares paid therefor, then the amount of the excess will be classed as paid in surplus, and may be added to the surplus account. Another example of how this rule works may be help- ful. Suppose a company is offered a factory site and a factory building if it will locate its plant in a certain town. The offer is accepted, the property is occupied, and the company enters the transaction on its books. EXCESS PROFITS TAX 673 It would be justified in adding to its surplus (and placing "real estate and plant" on its asset side of its balance sheet) an amount equal to the ascertainable or definitely known value of the plant or real estate at the time it was acquired. What is meant by the expression "ascertainable or definitely known" is clearly indicated by an example given in the Eegulations. Suppose a concern had been given a plot of land as a subsidy to enable it to develop a demand for its services by colonization of the donated land, and that it transpired subsequently that the land was very valuable for the ores it contained. If the value of the land had not been added to surplus at all, the only amount that now could be added would be the value of the land which it had for colonization purposes. How can it be established, to revert to the example first given in this section, that the property which at the time was entered on the books at $100,000 was really worth $150,000? The Regulations say as to this: "Evidence tending to support a claim for a paid-in surplus under these circumstances must be as of the date of conveyance, and may consist, among other things, of (1) an appraisal of the property by disin- terested authorities, (2) assessed value in the case of real estate, and (3) the market price in excess of the par value of the stock or shares." (Reg. 41, Art. 63.) Adjustment of surplus account additions for tangible property. The concern may be able to show that it has really been using capital assets that have never ap- peared on the books as such. For example, in 1910 it may have bought 100 typewriters and charged them to expense. These may now be added as assets and an equivalent amount added to the surplus, subject, how- ever, to the following restrictions: 1. They must be tangible property. 674 INCOME AND FEDERAL TAX REPORTS 2. They must have a life extending substantially be- yond the year in which the expenditure was made. 3. They must have been charged as current expense. 4. They must still be owned and be in actual use by the taxpayer during the taxable year. 5. They must have been acquired prior to March 1, 1913, or 6. If acquired after March 1, 1913, they cannot be included if their cost was included in the Income Tax return for the year in which they were acquired as items of expense deductible from gross income in com- puting the net taxable income. These special rules are applicable to special tools, patterns and similar assets: 1. Their value may not be added to surplus if that value "has been recorded through having been included in the price of goods." 2. If their cost has not been included in the price of goods, and they are held for only occasional use, they shall not be assigned a value in excess of the fair value based upon the earnings actually arising from their current use. 3. If such assets are not used currently or occasion- ally, they may be included only at scrap value. Remember that none of these adjustments need be made if the assets were originally charged to the capi- tal account. The rules apply only when assets have been improperly charged to the expense account. Wher- ever an adjustment is found necessary, the burden of establishing the fact that the assets were charged to expense is on the taxpayer and in his return he must make a statement of the proposed additions, specifying the kinds and amount of property involved, the years in which the expenditures were made, and the method followed in distinguishing between capital outlays and current expenses. (Reg. 41, Art. 64.) EXCESS PROFITS TAX 675 Adjustments not allowed for good- will, etc., acquired through expense items. For ten years a concern may have spent a budget of $500,000 per year on advertis- ing its trade-marked product. The trade-mark thus acquired would probably be worth thousands of dollars. If all or a part of the amounts expended were charged to capital, an asset good-will or trade-mark being placed on the asset side, say with a value at $5,000,000 and an equivalent amount were added to surplus, it would seem that this would be allowed to stand, since the Eegulations made no specific direction for the reduc- tion of surplus even though the asset was paid for in cash not specifically spent for good-will, but indirectly for good-will by buying advertising space. It must be confessed that this is somewhat contrary to a strict reading of the law, but is in accord with the spirit of the Eegulations. Perhaps the safe method would be to make no adjustment in a case of this kind, but to leave the matter to the decisions of the collector in each specific case. (See later the discussion on ap- preciation.) Suppose, however, none of the advertising budget was charged to capital, but was all charged to expense. In such a case the concern cannot readjust its capital account by adding good-will to assets and an equivalent amount to surplus. The Eegulations are specific; they insist upon a literal compliance with the law. The assets cannot be added unless the good-will was spe- cifically paid for as such. If, for example, this same good-will was sold to another corporation for stock prior to March 3, 1917, that other corporation could include the asset at its true value or at the par value of the stock issued for it, whichever was lower. In the hands of the original corporation the good-will cannot be included in the invested capital by being written into capital account. Where, in a case like this, a concern through ultra-conservative accounting has kept good- 676 INCOME AND FEDERAL TAX REPORTS will off its books, it may apply for redress under Sec- tion 210 of the law. (Reg. 41, Art. 52.) Suppose, now, another corporation did buy this good- will for, say, $1,000,000, back in 1900, and had written it off $100,000 a year till in 1910 it had disappeared as an asset. The company could reconstruct its surplus account, as far as this item is concerned, and could add $1,000,000 to its surplus and an equivalent amount to its asset item, good-will. Adjustments in accounts of concerns that have gone through some form of reorganization. Adjustments can be made as hereinbefore provided, using the books of a predecessor concern in calculating the invested capital for the pre-war period if the present concern is a re- organization of the predecessor, which took the place of the old concern after January 2, 1913, and if the pres- ent business is substantially a continuation of the old business. Adjustments of the invested capital for the taxable year should also be made to comply with Sec- tion 208 of the law with respect to reorganization, etc., after March 3, 1917. Study Sections 204 and 208 of the law and the Regulations, Arts. 49-50. Adjustments of surplus on account of appreciation taken up. Another adjustment of surplus is provided for by the Regulations for appreciation of assets that has been taken up on the books with a consequent increase in surplus. If tangible property has appreciated and the appreciation has been written up on the books, the amount of appreciation subsequent to January 1, 1914, should be written off, unless in the income tax return the appreciation was included as taxable income for the purpose of providing a new value for the asset upon which to calculate depreciation. Appreciation of tan- gible assets up to January 1, 1914, is not to be written off unless the depreciation brings the asset up above the par value of the stock or shares for which it was acquired, and in such a case it should be writ- EXCESS PROFITS TAX 677 ten off to bring the asset down to the par value of the stock. Appreciation of intangible property is not permitted by the Income Tax law, and since under the Income Tax law good-will, for example, cannot be appreciated in such a way as to make the appreciation an item of in- come subject to the tax, it would seem that any appre- ciation of intangible assets that has taken place, with a consequent inflation of the surplus, would call for an adjustment of the surplus account by subtracting from that account the amount of appreciation. These adjustments, of course, can only be made after a careful study of the various capital asset accounts. Adjustments in the surplus account by reason of insuffi- cient allowance for depletion, depreciation and obsolescence. After the various adjustments described above have been made, another careful survey of the assets must be made to see if any of them are listed in the taxable year at some original value or adjusted value without taking into account losses or expenses sustained from the original organization of the business concern down to the taxable year. For example, if stock had been issued for an automobile purchased in 1913, the value of the automobile at the time it was acquired having been $3,000, and the amount of stock paid therefor $2,500, while its value on January 1, 1914, had fallen to $2,000, under the rules stated above the stock account of $2,500 would have to be reduced to $2,000 the value of the automobile on January 1, 1914. Let us suppose, now, that through a period of four years the asset has de- preciated $600 per year. Its true value on January 1, 1917, was $600. If no depreciation had been charged against this asset but it had been kept on the books at its original value of $3,000, under the rule explained above the capital stock would have been reduced from $2,500 to $2,000; now the surplus account would be re- duced by an amount equal to the difference between 678 INCOME AND FEDERAL TAX REPORTS $2,000, the value of the automobile on January 1, 1914, and $600, the value of the automobile at the beginning of the taxable year. Thus the surplus would be reduced by $1,400 and the asset would be written down to $600. Amounts added on account of bonded indebtedness. After all the calculations have been made as above de- scribed, the amount of invested capital may be increased in the case of a corporation (not of a partnership) by a certain proportion of the funded indebtedness. 1 This increase in the invested capital is not permissible un- der any section of the law, but is permitted by the Regu- lations (Art. 44), almost, if not quite, contrary to the provision of the law (Section 207), but was provided in the Regulations to bring the law into agreement with the provision of the Income Tax law. The Regulation reads : "A corporation which under the Income Tax law is allowed to deduct only a part of the entire interest paid upon its indebtedness, may include in its invested capital such a proportion of its permanent indebtedness as the amount of interest upon such indebtedness which the corporation is not allowed to deduct is of the total amount of interest paid upon such indebtedness during the taxable year." Illustration: a corporation has $100,000 of stock and $600,000 of bonds bearing 5 per cent interest. Under the Income Tax law (Section 1207) this company could deduct from its gross income the interest at 5 per cent on its capital stock plus one-half its bonded indebtedness, ie., on $400,000. We can deduct 5 per cent on $400,000 or $20,000 out of $30,000 of interest actually paid. Since one-third of its interest is not deductible under the Income Tax, it may add to its invested capital one- third of its bonded indebtedness of $600,000, or $200,000. Adjustments to be made in the assets side of the balance sheet. We have gone through various adjustments in the liability side of the balance sheet. Each time that an adjustment is made in the capital account or in the i It may, however, be increased in the case of a limited partnership, inasmuch as a limited partnership is subject to the same restriction as to the amount of interest deductible as a corporation. EXCESS PROFITS TAX 679 surplus account, an equivalent adjustment must be made in the asset account to which the capital account or the surplus account corresponds. For example, if a patent was carried on the books at $100,000 because that amount of stock (par value) had been issued, while the actual cash value was only $50,- 000, the capital account would be reduced by $50,000 and the patent account by $50,000. Final adjustment of invested capital as of beginning of year. A. We have now (1) a sum obtained by adding adjusted capital, adjusted surplus, and, in the case of a corporation, an allowable proportion of funded indebt- edness. B. On the assets side, we have adjusted assets, ad- justed as described in the preceding paragraphs. (2) These are added up, first excluding inadmissible assets. The inadmissible assets are stocks and bonds held by the concern with the exception of United States bonds, and such assets as may not come under the class of either (a) cash, (b) tangible property, (c) patents or copyrights, (d) good- will, trade-marks, trade brands, and other intangible property. Tax-free securities and stocks in foreign corporations may be included as ad- missible assets to the extent authorized in Articles 45 and 46 of Regulations 41, which provide: "Whenever income consists partly of profits arising from trading in stocks, bonds, etc., the dividends or interest on which are not subject to such tax, and partly of such dividends or interest, then, subject to the limitations as to borrowed money, there shall be included in the invested capital an amount which bears the same ratio to the total amount invested in such stocks or bonds as the amount of such gains or profits bears to the total amount of such income," and "in the case of domestic corporations or partnerships and of citizens or residents of the United States holding stock in a foreign corporation part of whose net income is sub- 680 INCOME AND FEDERAL TAX REPORTS ject to the Income Tax, there shall be included in invested capital such proportion of the value of the stock in such foreign corporation as the net income of such foreign corporation from sources outside the United States is of its entire net income." Fictitious items like Bond Discount, for example, would have to be excluded as inadmissible items, since it does not come under Class (a), (b), (c) or (d). There would also have to be subtracted an amount equal to all current liabilities, and an amount equal to that part of all funded or permanent indebtedness, the interest on which is permitted to be deducted from income in ascer- taining net income. The result we now have is the sum of the admissible assets. C. The total of invested capital, as shown in para- graph A, is now compared with the total of admissible assets, as shown in paragraph B, and if the invested capital thus shown is larger than the admissible assets, the invested capital must be reduced to the total of the admissible assets. This amount is the invested capital of the concern. Further adjustments for changes in invested capital dur- ing the taxable year. No adjustment need be made of the invested capital as determined in the preceding paragraphs when the capital stock outstanding has not been changed during the year nor where the surplus account has been neither increased nor decreased. In no case may the invested capital include any surplus or undivided profits earned during the taxable year ex- cept in the case of individuals, see page 686. Where capital stock has been increased during the taxable year for the acquisition of assets permitted to be included in invested capital, such capital stock under the regula- tions heretofore explained may be added to the invested capital, but the amount of invested capital will have to be averaged over the year. Where the surplus has been reduced during the year, the same rule applies. Ulus- EXCESS PROFITS TAX 681 tration: capital stock, $100,000; surplus, $50,000, as of January 1, 1917; earnings up to June 30, 1917, $50,000; on July 1, 1917, a cash dividend of $50,000 was declared as being paid from earnings accrued prior to January 1, 1917; the invested capital in this case would be as follows : $150,000 X 6 months = $900,000 100,000 X 6 months 600,000 12 ) $1,500,000 ( $125,000 The corporation in this case has penalized itself by stating that dividends were paid from 1916 earnings instead of 1917 current profits. If the corporation had declared the dividend from 1917 profits the amount of capital invested for the entire year 1917 would have been $150,000, instead of $125,000. In this particular case, the stockholders receiving the dividend have bene- fited at the expense of the corporation, since the former under the Income Tax are taxed only at the super-tax rates under the Income Tax law that was in effect for the year 1916 upon such dividends paid. EXAMPLE OF COMPUTATION OF INVESTED CAPITAL Balance Sheet, December 31, 1916 (1) Cash $100,000 Capital Stock $3,000,000 (2) Real estate, plant and Bonds 1,000,000 equipment 1,250,000 Accounts payable 500,000 (3) Inventories 50,000 Reserves 100,000 (4) Accounts receivable.. 60,000 Surplus 2,050,000 (5) Liberty bonds 40,000 (6) Stocks 1,000,000 (7) Patents and copy- rights 2,100,000 (8) Good-will, etc 2,000,000 (9) Bond discount 50,000 Total $6,650,000 Total $6,650,000 682 INCOME AND FEDERAL TAX REPORTS Capital Stock Adjustments IfTd- Capital Stock issued; a iSff Asset How merit of adjustment ck affected I $1,0000,000 issued Jan. 15, 1915, for trade-mark actually worth $800,000 $800,000 (8) -$200,000 II $50,000 issued for a patent proved to be worthless (7) - 50,000 III $10,000 issued for plant, then worth $25,000, acquired January 10, 1910. Plant worth $20,000 Jan. 1, 1914. Adjusted to which- ever is lower, stock issued or value on Jan. 1, 1914. The difference is treated under adjustment of surplus 10,000 (2) IV $400,000 issued for $400,000 in cash Feb. 5, 1911; no adjustment necessary 400,000 (1) V $500,000 issued Sept. 13, 1906, for a plant worth at that time $200,- 000, but worth $350,000 on Jan. 1, 1914. Value is par value of stock issued or cash value as of Jan. 1, 1914 350,000 (2) -150,000 VI $1,000,000 issued for a patent in 1900. $500,000 returned as a gift, and same sold for $300,000. This stock received must be en- tered at only $300,000 800,000 (7) -200,000 VII $40,000 issued July 1, 1913, for Company A's entire assets includ- ing furniture and fixtures, good- will, etc. Company offers evi- dence to show tangible assets were worth $25,000 on Jan. 1, 1914; rest will be deemed intan- gible 40,000 .... $2,400,000 VIII Adjustment for intangibles pur- chased with stock* 215,000 (8) -$215,000 Total adjusted stock $2,185,000 The stock must therefore be written down from $3,000,000 to $2,185,000, and the decrease of $815,000 corresponds with the decrease indicated in the assets of $815,000. * Regulations 41, Art. 58, provide: "The 20 per cent, limitation upon intangible property purchased prior to March 3, 1917, for or with stock or shares of the corporation or partner- ship, applies not to each item or class of intangible property separately, but to the aggregate amount of all such property so purchased. Such intangible property may be included in the invested capital only up to an amount not exceeding 20 per cent, of the total stock or shares of the corporation or partnership on March 3, 1917, even though the aggregate amount of such intangible property be greater in value than such 20 per cent, of the par value of the total stock or shares." Here we assume that $815,000 was issued for intangible property (Adjustments VI, VII). Since 20 per cent, of the stock outstanding on March 3, 1917 ($3,- 000,000) is $600,000 and is less than the $815,000 of intangible property paid for with stock, the adjustment in the example is necessary, the $215,000 subtracted being the difference between the $600,000 (20 per cent, of capital stock outstanding on March 3, 1917) and $815,000, the total of intangibles bought with stock. EXCESS PROFITS TAX 683 Surplus Adjustments a . /. Correspond- jt Nature of adjustment aJjZlent ^Jj affecZd IX Jan. 10, 1910, stock of $10,000 issued for tangible property worth $25,000, entered on books at $10,- 000. Value of property on Jan. 1, 1914, $20,000. Since tangible property is to be valued as of Jan. 1, 1914, the difference between $10,000 and the value on Jan. 1, 1914, should be added to surplus. +$10,000 (2) +$10,000 X Sums charged to expense prior to March 1, 1913, for furniture and fixtures, tools, etc., still in exist- ence. Original cost $60,000, less depreciation of $40,000 equals $20,000 +20,000 (2) +20,000 XI Jan. 12, 1916, good-will was written up $35,000. This appre- ciation must be deducted -35,000 (8) 35,000 XII On July 1, 1917, stock held by company was reappraised and written up by the sum of $200,000. This amount of appreciation must be written off, since it could not be entered as income in the calcu- lation of net income -200,000 (6) -200,000 XIII A reserve for $100,000 was set up, but upon examination it is found that all assets are carried at origi- nal value. A careful examination shows that an additional deduc- tion of $150,000 should be made to bring the assets to their true value. This calculation is made by a careful consideration of the various asset accounts 150,000 (2) 50,000 (7) -100,000 XIV Certain of the accounts receiv- able, amounting to $10,000, are discovered to be outlawed -10,000 (4) -10,000 XV It was discovered that an unin- sured building was destroyed by fire and that no charge was made in the books to cover the loss. The building was carried on the books at $50,000 -50,000 (2) -50,000 Net change in surplus $415,000 Surplus as adjusted $1,635,000 684 INCOME AND FEDERAL TAX REPORTS Final Adjustments Invested capital Adjusted assets and items of adjust- Adjusted capital stock. . . $2,185,000 ment affecting the asset Adjusted surplus 1,635,000 Adjustment Add proportion of the amounts bonded indebtedness, if (1) Cash, I $100,000 necessary. The bonds (2) Real estate, etc 1,030,000 pay 5%. Since the inter- V, IX, X, XIII, XV. est on the bonds, $50,000, (3) Inventories 50,000 is less than the interest on (4) Accounts receivable, the stock plus one-half XIV 50,000 the bonded indebtedness, (5) Liberty bonds 40,000 no part of the bonded in- (6) Stocks, XII 800,000 debtedness may be added (7) Patents, VI, XII. . . . 1,750,000 (8) Good-will, II, VIII, XI 1,550,000 (9) Bond discount 50,000 Total invested capital . $3,820,000 Total $5,420,000 Subtract : Stocks $800,000 Bond discount (fictitious) 50,000 Amount of indebtedness, including all cur- rent debts, reserves and all funded debts except that added in other column, which in this case happens to be nothing 1,600,000 2,450,000 Admissible assets as adjusted $2,970,000 Since the invested capital as calculated in the left-hand column is greater than the adjusted admissible assets, the invested capital will have to be reduced to the amount of the adjusted admissible assets, and the invested capital of this concern, therefore, at the beginning of the year, will be $2,970,000. Certain adjustments may have to be made for changes in capital during the year. Let us assume that on June 1, 1917, $250,000 additional capital stock was issued for a trade-mark, on Sept. 15, 1917, $500,000 of additional stock was issued for real estate reasonably worth that much, and that on Nov. 10, a dividend of $50,000 was paid and that this dividend was stated to be paid from earnings of 1916. No adjustment is necessary for surplus or undivided profits earned during the year (Reg. 41, Art. 47) . Since the $250,000 of capital stock was issued for intangible property after March 3, 1917, it may be disregarded entirely. The $500,000 issued for real estate will have to be added, and the $50,000 taken out of capital surplus instead of current earnings will have to be subtracted. The company, therefore, had $2,970,000 of invested capital up to Sept. 15. From that date to Nov. 10, it had invested capital of $3,470,000, and from Nov. 10 to the end of the year its invested capital was $3,420,000. The company, therefore, will have to average its EXCESS PROFITS TAX 685 capital monthly over the year as follows, and will have to attach to its return a balance sheet as of Jan. 1, 1917, and as of Dec. 31, 1917. January $2,970,000 February 2,970,000 March 2,970,000 April 2,970,000 May 2,970,000 June 2,970,000 July 2,970,000 August 2,970,000 September 3,236,667 October 3,470,000 November 3,435,000 December 3,420,000 12)$37,321,667 $3,110,138 Invested capital for the year. Computation for September: $2,970,000 x 14 $41,580,000 $3,470,000 x 16 55,520,000 30) $97,100,000 $3,236,667 Computation for November: $3,470,000 x 9 $31,230,000 $3,420,000 x 21 71,820,000 30)103,050,000 $3,435,000 INVESTED CAPITAL OF INDIVIDUALS Items to be included. The Treasury Eegulations pro- vide that the invested capital of an individual shall be measured by the total of the following items: (a) Actual cash paid into the trade or business; (b) Tangible property paid into the trade or busi- ness; (c) Intangible property, such as patents and copy- rights, and good-will, trade-marks, trade brands and franchises. (Eeg. 41, Art. 66.) Valuation of tangible property. If purchased in cash, tangible property must be valued at the cost at the time purchased. If the cost is not accurately known, it should be estimated. (Eeg. 41, Art. 67.) If, however, the tangible property was "paid in as such," i.e., was received by the individual in lieu of cash, prior to January 1, 1914, the property must be valued 686 INCOME AND FEDERAL TAX REPORTS at its actual cash value ou January 1, 1914. "Adequate evidence of such value must be furnished by the tax- payer." If the tangible property was paid in on or after January 1, 1914, the actual cash value at the time of payment will govern. "It will be presumed that the tangible assets em- ployed in the trade or business have been acquired with cash, which has been either paid in directly or derived from earnings of the trade or business; but the tax- payer will be entitled to show such assets were paid in as tangible property." (Eeg. 41, Art. 67.) Depreciation of tangible property. The same general rules apply to the depreciation of the tangible property of an individual as have been previously explained in the determination of the "invested capital" of corpora- tions and partnerships. (See page 677, ante.) Valuation of intangible property. Intangible assets of an individual, such as patents and copyrights, and good- will, trade-marks, trade brands and franchises, "may be included in invested capital at a value not to exceed the actual cash paid therefor as the actual cash value at the time of payment of the tangible property paid therefor, but only if bona-fide payment was made there- for specifically as such in cash or tangible property." (Reg. 41, Art. 68.) The italics are the writer's, to bring out the important part of the regulation. Payment must have been made specifically for the intangible property, and not for another account, such as adver- tising or expense. It is interesting to note that the 20 per cent limitation placed upon the value of the in- tangible assets of a corporation or partnership in the computation of its "invested capital" does not apply to individuals. Profits earned during taxable year, We have seen that corporations and partnerships are not permitted to in- clude as invested capital any profits earned during the taxable year. Individuals, however, may do so. EXCESS PROFITS TAX 687 The profits of the taxable year remaining in the trade or business are considered to have arisen ratably during the year. The amount of these earnings that may be included in the invested capital is the total amount of such earnings averaged monthly over the year. To illustrate: the undivided profits of an indi- vidual earned during a taxable year and remaining in the business at the close of that year amount to $24,000. The Eegulations assume that this has been earned ratably during the year; in other words, that $2,000 of it was earned during the first month, $2,000 during the second month, $2,000 during the third month, etc. The amounts of such earnings would therefore be as follows at the end of each month: First month $2,000 Second month 4,000 Third month 6,000 Fourth month 8,000 Fifth month 10,000 Sixth month 12,000 Seventh month 14,000 Eighth month 16,000 Ninth month 18,000 Tenth month 20,000 Eleventh month 22,000 Twelfth month 24,000 12 )$156,000( $13,000 The average amount is therefore $13,000, which may be included by the individual in his invested capital. A simpler method of determining this amount is to add the ratable amount for first month, $2,000, to the total for the twelve months, $24,000, and divide the result, $26,000, by two, since the average of any arithmetic progression is one-half the sum of the first and last numbers. 688 INCOME AND FEDERAL TAX REPORTS Computation of invested capital. Two methods for de- termining the invested capital of an individual are pre- scribed, the choice of which is dependent upon whether or not the individual keeps books of account. If the individual does keep such books, the amount of his invested capital appears in the capital account (pro- prietorship or whatever it may be called). This amount is subject to the adjustments previously mentioned, and must not exceed the total of the admissible assets on the books of the individual. Otherwise the invested capital must be the amount of such assets. Admissible assets have been explained previously under the in- vested capital computations of corporations and part- nerships. If the individual does not keep books of account "he should prepare and preserve a statement as at the be- ginning of the taxable year and as the end of the tax- able year, showing in full all his assets valued in ac- cordance with these regulations (see page 663, ante), and all his liabilities. The excess of such assets over such liabilities at the beginning of the year and again at the end of the year will constitute the invested cap- ital of the individual on those dates, respectively, pro- vided, that in each case the assets other than those not allowed to be included, equal or exceed the amount of such excess. Otherwise, the invested capital shall be the amount of such assets. "The amount of the difference between the capital thus shown as at the beginning of the year and at the end of the year will, in the absence of evidence to the contrary, be deemed to have arisen ratably during the year, and the capital at the beginning of the year will be increased or decreased, as the case may be, by such amount averaged monthly over the year." (See page 663, ante.) Individual engaged in more than one business. If an individual is engaged in more than one trade or busi- EXCESS PROFITS TAX 689 ness having invested capital, his total invested capital will be considered as being the total invested capital of all the businesses. This applies apparently to an indi- vidual solely interested in more than one business, and under such a condition he makes a single return in Class B. The average individual who may be interested in more than one business, one having a nominal capital or no capital at all, would probably come in both Class A and Class B. The income from his principal busi- ness would be determined as explained under Net In- come of Individuals, and his invested capital in the business would be determined as just explained, and the return would come in Class B. The income from his other interests would be probably reportable under Class A. (See page 645, et seq.) Assets and liabilities of individual restricted. The term "assets" and "liabilities," as applied to an individual under the Excess Profits Tax law, relate only to the assets and liabilities of his trade or business, and not to his personal assets and liabilities. (Reg. 41, Art. 70.) When invested capital will be deemed indeterminable. In certain cases, the law and regulations provide that invested capital, as calculated under the law, shall not be considered the invested capital of the concern, but the Secretary of the Treasury may decide that the in- vested capital cannot be determined. The Regulations give a number of instances where such cases may arise. 1. Where, through defective accounting or the lack of adequate data, it is impossible accurately to compute the invested capital. 2. Where, upon application by a foreign taxpayer, the Secretary of the Treasury finds that the expense of securing the data necessary for the computation of the invested capital would be unreasonable in view of the amount of the tax involved, or that it is impracticable to determine either the "entire invested capital" or the "entire net income." 690 INCOME AND FEDERAL TAX REPORTS 3. Where long-established concerns have practised ultra-conservative accounting, and have charged items to expense, such as the cost of trade-marks, advertising expenditures, and the like, and therefore have a small good-will account as compared with representative con- cerns that have made liberal charges against capital for these items, the ultra-conservative concerns are likely to be placed at a serious disadvantage and may there- fore claim the benefit of the rule applying to concerns whose invested capital cannot be determined. 4. Where the invested capital is seriously dispropor- tionate to the taxable income. Such cases may arise through : (a) The realization in one year of the earnings of cap- ital unproductively invested through a period of years or of the fruits of activities antedating the taxable year; or, (b) Inability to recognize or properly to allow for amortization, obsolescence, or exceptional depreciation due to the present war, or to the necessity in connec- tion with the present war, of providing a plant which will not be wanted for the purpose of the trade or busi- ness after the termination of the war. DETERMINATION OF THE AMOUNT OF THE GRADUATED TAX Summary. We can assume now that the following facts have been determined: (1) the pre-war income; (2) the pre-war capital; (3) the net income of the tax- able year, and (4) the invested capital in the taxable year. From these we can determine (5) the pre-war rate of profits, and (6) the rate of profits in the tax- able year. To find the tax to which a corporation or foreign partnership is liable, we must find what its "specific exemption" is and what its "deduction" is. Specific exemptions. The specific exemptions are aa follows: domestic corporations, $3,000; domestic partner- EXCESS PROFITS TAX 691 ships, residents or citizens, $6,000. Foreign corporations and partnerships and non-resident aliens are not en- titled to any specific exemptions. Deductions in ordinary cases. In ordinary cases, where the corporation or partnership has been in ex- istence or where the individual has been engaged in business or trade during the pre-war period, the deduc- tion will be that percentage of the invested capital in the taxable year which is determined by dividing the pre-war profits by the pre-war invested capital. In no case, however, may this percentage be less than 7 per cent or more than 9 per cent. Example: Pre-war profits, $10,000; pre-war capital, $100,000; taxable year profits, $50,000; taxable year capital, $200,000. Deduction: 9 per cent of $200,000 (since the pre-war rate of profits was 10 per cent, the deduction rate will be the maximum, 9 per cent). If in the foregoing example the pre-war profits had been $6,000, the deduction would be 7 per cent of $200,000, since the pre-war rate would be 6 per cent, and the law states the minimum to be 7 per cent. Notice that the pre-war capital and the pre-war profits are to be taken as a whole. Thus, if in the years 1911, 1912, and 1913, the capital was $100,000, $200,000 and $300,000 respec- tively, and the pre-war profits were $10,000, $20,000 and $60,000, the rate of profits for the pre-war period would be ($100,000 + $200,000 + $300,000) -- 3 - $200,- 000, divided into $10,000 + $20,000 + $60,000 -f- 3 = $30,- 000, giving 15 per cent. Some people may possibly assume that the rate of profits would be the average of the rates for each of the three years, i.e., 10% + 10% + 20% -f- 3 13^%. That method of finding the pre-war rate of profits clearly is wrong. Deductions where corporation or partnership was not in existence or individual not in business during' the pre-war period. In cases where the concern was not in exist- 692 INCOME AND FEDERAL TAX REPORTS ence as such the deduction will consist of 8 per cent of the invested capital in the taxable year. Example: A corporation was organized in 1915. Its invested capital in 1917 was $100,000. Its deduction would be $8,000. Notice that if this corporation was a reorganization of a company organized in 1910, and remained substan- tially in the control of the same interests, the latter' s invested capital during 1911, 1912 and 1913 and its profits during those years would determine the percent- age of the invested capital to be taken as a deduction. (Section 204.) Deductions where a concern has no income or subnormal income during the pre-war period. What is subnormal income is for the Secretary of the Treasury to deter- mine in each case after due consideration has been given to the earnings of the given corporation and to the earnings of representative concerns engaged in the same line of business. The deduction in the return will be figured out in the ordinary way, but a claim will be made for abatement and filed with the return. Two questions arise here: (1) when are earnings sub- normal? (2) what are the earnings of representative firms ? Both of these questions, in fact, hinge on the question, what is normal for the general run of con- cerns engaged in the same line of business? In the final analysis the question will be determined by the Commissioner of Internal Eevenue, who, in accordance with regulations prescribed by him, and with the ap- proval of the Secretary of the Treasury, is to determine the percentage which the net income was of the in- vested capital in each trade or business. Example: Company A had an invested capital of $1,000,000 and net earnings of $60,000 during the pre- war period. It happened that ordinarily its earnings are more than 6 per cent of its capital and that other concerns in the same line of business made above 9 per EXCESS PROFITS TAX 693 cent on their invested capital during the pre-war period. A would file its return in the usual way, but would file a claim for abatement, asking that its tax be fixed on the basis of a 9 per cent deduction instead of a 7 per cent deduction. Deduction where the Secretary of the Treasury cannot sat- isfactorily determine invested capital. Provision is made for cases where the government cannot satisfactorily de- termine the invested capital of a given concern. In such cases the deduction shall be an amount equal to the same proportion of the net income of the trade or business received during the taxable year as the aver- age deduction (decided in the same manner as was de- scribed in the foregoing section) for the same calendar year of representative concerns engaged in the same business bears to the total net income of the business received by such concerns. Where a corporation or partnership uses a fiscal year of its own, the basis of the deduction shall be the same as though its fiscal year had been the calendar year which terminated in its fiscal year. Example: Company A has a fiscal year ending June 30, 1917. Its capital cannot satisfactorily be ascer- tained. The deduction will be that proportion of its net income as was found for the calendar year ending December 31, 1916, in representative concerns in the same line of business by dividing their deduction by their net income. Rate of tax. The rate of tax is graduated, and the tax itself is found for concerns with invested capital subject to the conditions described in the foregoing sec- tions on deductions, in the following manner: (1) Di- vide the net income in the taxable year into different classes or brackets, the first bracket being all the net income up to and including 15 per cent of the invested capital; (2) all the net income in excess of 15 per cent of the capital and not in excess of 20 per cent of the 694 INCOME AND FEDERAL TAX REPORTS capital; (3) all the net income in excess of 20 per cent and not in excess of 25 per cent of the capital; (4) all the net income .in excess of 25 per cent and not in ex- cess of 33 per cent of the capital; and (5) all the net income in excess of 33 per cent. After these brackets have been computed the deduc- tion and exemption are subtracted first from the first bracket, and if the deduction plus the exemption is greater than the first bracket, nothing further is done about that bracket, but the difference between the de- duction plus the exemption and the amount of the first bracket is subtracted from the second bracket and so on till the deduction plus the exemption has been ex- hausted. Whatever remains in each bracket after this has been done is then taxed at the following rates: for the first bracket, 20 per cent ; second, 25 per cent ; third, 35 per cent; fourth, 45 per cent; and fifth, 60 per cent. Example: Company A's pre-war rate of profits was 10 per cent; the invested capital for the taxable year was $24,000 and the net income for the taxable year was $25,000. A's deduction would be $2,160 (9 per cent of $24,000) and its specific exemption (A being a domes- tic corporation), $3,000. Deduction and Exemption racket Am't. in applicable to Amount Amount No. Bracket Bracket Taxable Rate Tax 1 $3,600 $3,600 20% 2 1,200 1,200 25 3 1,200 360 840 35 294 4 1,920 1,920 45 864 5 17,080 17,080 60 10,248 Total $25,000 $5,160 $19,840 $11,406 The return covering trade or business with invested capital will be made on Forms 1101, 1102 and 1103. Computation of tax for fiscal year, part of which falls in 1916. If a corporation or partnership makes a return for a fiscal year part of which falls within the calendar year 1916, the tax for the first taxable year is that pro- EXCESS PROFITS TAX 695 portion of the tax computed upon the net income for such fiscal year which the number of months from Jan- uary 1, 1917, to the end of such fiscal year bears to the entire number of months in such fiscal year. (Reg. 41, Art. 19.) Computation of tax for period less than 12 months. If a corporation or partnership makes a return for any reason for a period of less than 12 months, the deduc- tion and exemption allowed will be an amount which bears the same ratio to the deduction allowable for a full year as the number of months in such period bears to 12 months. DETERMINATION OF TAX WHERE INVESTED CAPITAL IS NOMINAL OR WHERE THERE IS NO INVESTED CAPITAL Rate of tax in cases without capital. Where a concern without invested capital or with nominal capital only, or an individual engaged in an occupation or profession without capital, comes under the rules already given for determining who is subject to the tax (e.g., domes- tic corporations with incomes of $3,000 and citizens with incomes of $6,000, etc.), the rate of tax is 8 per cent, and it is imposed on the net income for the tax year in excess of $3,000 in the case of domestic cor- porations, and in excess of $6,000 in the case of domes- tic partnerships and citizens and residents. The rate of tax on foreign corporations and partnerships and non- resident aliens is 8 per cent on the entire net income, from sources within the Unitpd States. However, inas- much as foreign partnerships are not required to file a return unless their net income is $3,000 or more (Sec. 211), it appears that no tax will be paid by a foreign partnership having a net income of $2,999.99. Example: M, a citizen or resident, owns a store with an invested capital of $10,000, the net income of which is $9,000. He also owns a farm, em- ploying a capital of $12,000, the net income of which is $7,000. He also receives a salary of $4,000 as president of a hank, and $3,000 as special counsel. Assume that in the businesses employing capital he is entitled 696 INCOME AND FEDERAL TAX REPORTS to the maximum deduction of 9 per cent. M allows himself a salary of $3,000 for managing the store and $2,500 for managing the farm. M also receives $1,000 in dividends. This $1,000 is not taxable, as it is derived from an investment not connected with his trade. M will make out two returns, (a) for income from salaries and compensation from services, and (b) for income from trade or business employing invested capital. In (a) he would include the $4,000 salary, the $3,000 fees and the $3,000 and $2,500 salaries, making a total of $12,500. This may be reported on Form 1040. The excess profits tax will be 8 per cent of $6,500 ($12,500 $6,000, the specific exemption), or $520. The (b) income will be reported on Form 1101. M will report on this form a net income of $6,000 from store ($9,000 $3,000 salary), and $4,500 from farm ($7,000 $2,500 salary), total $10,500. From this is deducted a specific exemption of $6,000 and the deduction of $1,980 (9 per cent on $22,000, i.e., $10,000 capital in store plus $12,000 capital in farm). The balance, $2,520, is taxable at the grad- uated rates mentioned on p. 683. ADMINISTRATIVE PROVISIONS When returns are to be filed. Returns for the Excess Profits tax are due at the same time as those for the Income tax. Upon application to the proper Collector of Internal Eevenue returns of corporations and part- nerships may be based on a fiscal year other than the calendar year and in such event the returns are due within 60 days after the close of the fiscal year. Information to be furnished by affiliated corporations. Reg. 41, Art. 77, provides: For the purpose of the excess profits tax every corporation will describe in its return all its intercorporate relationships with other corporations with which it is affiliated, and will furnish such information in relation thereto as will enable the Commissioner of Internal Revenue to compute the amount of the tax properly due from each corporation on the basis of an equitable and lawful accounting. For the purpose of this regulation two or more corporations will be deemed to be affiliated ( 1 ) when one such corporation owns directly or con- trols through closely affiliated interests or by a nominee or nominees, all or substantially all of the stock of the other or others, or when substan- tially all of the stock of two or more corporations is owned by the same individual or partnership, and both or all of such corporations are en- gaged in the same or a closely related business; or (2) when one such corporation (a) buys from or sells to another products or services at prices above or below the current market, thus effecting an artificial dis- tribution of profits, or (b) in any way so arranges its financial rela- tionship with another corporation as to assign to it a disproportionate share of net income or invested capital. EXCESS PROFITS TAX 697 Consolidated concerns may be required to make consoli- dated return. Beg. 41. Art. 77, provides that: Whenever necessary to more equitably determine the invested capital or taxable income, the Commissioner of Internal Revenue may require cor- porations classed as affiliated under the foregoing rule to furnish a con- solidated return of net income and invested capital. Where such consolidated return is required it may be made by any one or more of such corporations or by all of them acting jointly; but if such affiliated corporations, when requested to file such consolidated returns, neglect or refuse to do so, the Commissioner of Internal Revenue may cause an examination of the books of all such corporations to be made and a consolidated statement to be made from such examination. In cases where consolidated returns are accepted, the total tax will be com- puted in the first instance as a unit upon the basis of the consolidated return and will be assessed upon the respective affiliated corporations in such proportions as may be agreed among them. If no such agreement is made the tax will be assessed upon each such corporation in accordance with the net income and invested capital properly assignable to it. When tax is to be paid. The tax is payable on or be- fore June 15th in each year. Corporations and part- nerships filing returns based on a fiscal year instead of the calendar year must pay the tax within 105 days after the return is due. Credit for taxes under the law of March 3, 1917. In certain cases, where corporations or partnerships had a fiscal year other than the calendar year reports were made during 1917 under the provision of the Excess Profits Tax law of March 3, 1917, and the amount of the tax assessed and paid. Since that law has been repealed by the law of October 3, 1917, provision was made in the latter law, that amounts so paid shall be credited toward the payment of the tax imposed by the law of October 3, 1917, and if the amount so paid ex- ceeds the amount of the tax, the excess shall be re- funded as a tax erroneously or illegally collected. Partnership tax, how paid and deducted for Income Tax computation. It will be remembered that partnerships as such pay the Excess Profits tax, but not the Income tax. Since a person paying the Income tax is entitled to subtract the amount of the Excess Profits tax from 698 INCOME AND FEDERAL TAX REPORTS income before arriving at the amount of net income taxable under the Income tax law, the partners should calculate the Excess Profits tax for the partnership and each partner should give himself credit for that propor- tion of the tax in calculating his net income for Income tax purposes as his share in the business bears to the entire proprietorship. Claims for abatement. If a taxpayer files a claim for abatement of taxes on Form 47 (see p. 655, et seq.), collection of the portion of the tax covered by the claim in abatement will not be made till a decision is rendered on the merits of the claim. If, however, the Commis- sioner of Internal Eevenue deems it advisable, he may require a bond for the payment of the amount with- held as an abatement. If in such cases a bond is de- manded and not furnished the full amount of the tax will be required. If, thereafter, the claim is decided favorably to the taxpayer, a refund of the amount will be made. Penalties. Since the Excess Profits law provides that all administrative, special and general provisions of law, including the laws in relation to the assessment, remission, collection and refund of internal revenue taxes not inconsistent with this law, as well as those provisions of the Income Tax law applicable to returns and payment, including penalties, are made applicable to the Excess Profits tax, the reader is referred to the chapter on the administration of the Income Tax for explanation of penalties, etc., under this law. (See Chapter II.) Extension of time for filing returns on basis of fiscal year. A universal extension of time to April 1, 1918, to file returns has been granted to all corporations and part- nerships making returns based on a fiscal year ending during 1917. The law requires returns to be made within 60 days after the fiscal year closes, but this ex- tension has been necessary on account of the delay in issuing the official forms. WAR EXCESS PROFITS TAX REGULATIONS NO. 41 DEFINITIONS Article I. Definitions. When used in these regulations the terms de- fined in articles 2 to 9, inclusive, shall, unless otherwise indicated by the context, be deemed to be used only with the scope or meaning ascribed to them respectively in such articles. 2. Corporation. The term "corporation" includes joint-stock com- panies or associations, no matter how created or organized, insurance companies, and limited partnerships. 3. Domestic and foreign. The term ' ' domestic ' ' means created under the law (statutory or other) of the United States or any State thereof, Alaska, Hawaii, or the District of Columbia, and the term "foreign" means created under the law (statutory or other) of any other posses- sion of the United States or of any foreign country or government. 4. United States. The term "United States" (when used in a geo- graphical sense) means only the States thereof, Alaska, Hawaii, and the District of Columbia. 5. Taxable year. The term "taxable year" means the 12 months ending December 31 of each year, except in the case of a corporation or partnership which has fixed its own fiscal year, in which case it means such fiscal year. The first taxable year is the year ending December 31, 1917, except that in the case of a corporation or partnership which has fixed its own fiscal year, the first taxable year is the fiscal year ending during the calendar year 1917. (For special provisions as to prorating the amount of tax due for the portion of any fiscal year ending during the calendar year 1917, see articles 19 and 20.) 6. Pre-war period. The term "pre-war period" means the calendar years 1911, 1912, and 1913, or if a corporation or partnership was not in existence or an individual was not engaged in the trade or business during the whole of such three years, then as many of such years dur- ing the whole of which the corporation or partnership was in existence or the individual was engaged in the trade or business. 7. "Trade," "business," "trade or business" in case of corporations and partnerships. In the case of a corporation or partnership all in- come from whatever source derived is deemed to be received from its trade or business, and the terms "trade," "business," and "trade or business" include all sources of income. 8. "Trade" in the case of individuals. In the case of an individual, the terms "trade," "business," and "trade or business" comprehend all his activities for gain, profit, or livelihood, entered into with suffi- cient frequency, or occupying such portion of his time or attention as to constitute a vocation, including occupations and professions. When such activities constitute a vocation they shall be construed to be a trade or business whether continuously carried on during the taxable year or not, and all the income arising therefrom shall be included in his return for excess-profits tax. 699 700 INCOME AND FEDERAL TAX REPORTS In the following cases the gain or income is not subject to excess- profits tax, and the capital from which such gain or income is derived shall not be included in "invested capital": (a) Gains or profits from transactions entered into for profit, but which are isolated, incidental, or so infrequent as not to constitute an occupation, and (b) the income from property arising merely from its ownership, including interest, rent, and similar income from investments except in those cases in which the management of such investments really constitutes a trade or business. 9. "Dividend." The term "dividend" has the same meaning as in section 31 of the act of September 8, 1916, as amended by the act of Oc- tober 3, 1917. (See Income Tax Eegulations, art. 106.) CORPORATIONS, PARTNERSHIPS AND INDIVIDUALS SUBJECT TO THE TAX 10. Corporations. Every domestic corporation which has for the tax- able year a net income of $3,000 or more is, unless exempt under article 13, required to make a return and to pay the tax, if any. Every foreign corporation which has for the taxable year a net income of $3,000 or more from sources within the United States is, unless ex- empt under article 13, required to make a return and to pay the tax, if any. 11. Partnerships. Every domestic partnership which has for the tax- able year a net income of $6,000 or more is, unless exempt under article 13, required to make a return and to pay the tax, if any. Every foreign partnership which has for the taxable year a net in- come of $3,000 or more from sources within the United States is, unless exempt under article 13, required to make a return and to pay the tax, if any. 12. Individuals. Every citizen or resident of the United States who has for the taxable year an aggregate net income in excess of $6,000 from trades, businesses, occupations or professions, is, unless exempt un- der article 13, required to make a return and to pay the tax, if any. Every non-resident alien individual who has for the taxable year an aggregate net income of $3,000 or more from trades, businesses, occupa- tions, or professions carried on within the United States, is, unless ex- empt under article 13, required to make a return and to pay the tax, if any. 13. Exemptions. The following are exempt from the tax: (a) Corporations exempt under the provisions of section 11 of Title I of the act of September 8, 1916, from the tax imposed by such title. (See Income Tax Regulations, arts. 67, ff.) (b) Partnerships carrying on or doing the same kind of business or coming within the same description. (c) Individuals to the extent that they carry on or do the same kind of business or come within the same description. RATES AND COMPUTATION OF TAX 14. Classification of net income. For the purposes of the excess profits tax net income which is subject to the tax shall be divided into two classes, as follows: A. Net income which is derived from a trade or business having no invested capital, or not more than a nominal capital, including, in the case of an individual, salaries, wages, fees, or other compensations; and B. Net income which is derived from a trade or business having in- vested capital. In the case of a corporation or partnership, all the trades and busi- nesses in which it is engaged will be treated as a single trade or business WAR EXCESS PROFITS TAX 70 1 (as provided in sec. 201), and its entire income will be held to be of the same class as the income from its principal trade or business. In the case of an individual, the net income subject to the excess profits tax shall be classified as provided in this article. Net income of class A shall be taxed as provided in article 15, and net income of class B shall be taxed as provided in article 16. 15. Bate of tax on income of class A. The tax upon net income of class A, as defined in article 14, shall be computed at the rate of 8 per cent upon the amount thereof in excess of $3,000 in the case of a do- mestic corporation; upon the amount thereof in excess of $6,000 in the case of a domestic partnership or of a citizen or resident of the United States; and upon the whole thereof in the case of a foreign corporation or partnership or of a non-resident alien individual. 16. Rate of tax on income of class B. The tax upon net income of class B, as defined in article 14, shall, except as otherwise provided in article 17, be computed at the following rates: Twenty per cent of the amount of the net income in excess of the deduction (determined as provided in articles 21, 23 and 24) and not in excess of 15 per cent of the invested capital for the taxable year; Twenty-five per cent of the amount of the net income in excess of 15 per cent and not in excess of 20 per cent of such capital; Thirty-five per cent of the amount of the net income in excess of 20 per cent and not in excess of 25 per cent of such capital; Forty-five per cent of the amount of the net income in excess of 25 per cent and not in excess of 33 per cent of such capital; Sixty per cent of the amount of the net income in excess of 33 per cent of such capital. Illustrations. (1) A corporation has a capital of $100,000, pre-war earnings of 7 per cent, and a net income for the taxable year of $75,000. The deduction allowed will be 7 per cent of the capital, or $7,000, plus $3,000 specific deduction, a total of $10,000. The amount of the net income taxable at each rate will be as follows: In excess of the deduction and not in excess of 15 per cent of the capital (rate, 20 per cent) $5,000 In excess of 15 per cent of the capital and not in excess of 20 per cent thereof (rate, 25 per cent) 5,000 In excess of 20 per cent of the capital and not in excess of 25 per cent thereof (rate, 35 per cent) 5,000 In excess of 25 per cent of the capital and not in excess of 33 per cent thereof (rate, 45 per cent) 8,000 In excess of 33 per cent of the capital (rate, 60 per cent) 42,000 The tax would then be computed as follows: 20 per cent of $5,000 $1,000 25 per cent of $5,000 1,250 35 per cent of $5,000 1,750 45 per cent of $8,000 3,600 60 per cent of $42,000 25,200 Total tax $32,800 (2) An individual or partnership has a capital of $100,000, pre-war earnings of 8 per cent, and a net income for the taxable year of $22,500. The deduction allowed will be 8 per cent of the capital, or $8,000, plus $6,000 specific deduction, a total of $14,000. The amount of the net income taxable at each rate will be as follows: 702 INCOME AND FEDERAL TAX REPORTS In excess of the deduction and not in excess of 15 per cent of the capital (rate, 20 per cent) $1,000 In excess of 15 per cent of the capital and not in excess of 20 per cent thereof (rate, 25 per cent) 5,000 In excess of 20 per cent of the capital and not in excess of 25 per cent thereof (rate, 35 per cent) 2,500 The tax would then be computed as follows: 20 per cent of $1,000 $200 25 per cent of $5,000 1,250 35 per cent of $2,500 875 Total tax $2,325 17. When deduction exceeds 15 per cent of invested capital. In any case in which the deduction determined as provided in articles 21, 23 and 24 is greater than 15 per cent of the invested capital and therefore cannot be fully allowed under the first rate or bracket of article 16, then any remaining portion of the deduction will be allowed under the second bracket, and continued if necessary into the succeeding bracket or brackets until the entire amount of the deduction is allowed. Illustrations. (1) A corporation has a capital of $9,000; pre-war earnings of 9 per cent; and a net income for the taxable year of $10,000. The deduction allowed will be 9 per cent of the capital, or $810, plus $3,000 specific deduction, a total of $3,810. The amount of the net income in each bracket will be as follows: 15 per cent of the capital $1,350 In excess of 15 per cent of the capital and not in excess of 20 per cent thereof 450 In excess of 20 per cent of the capital and not in excess of 25 per cent thereof 450 In excess of 25 per cent of the capital and not in excess of 33 per cent thereof 720 In excess of 33 per cent of the capital 7,030 It is evident that the total deduction of $3,810 is greater than 15 per cent of the capital and so is not fully absorbed by the amount of net income not in excess of 15 per cent of the capital. In such case, apply- ing article 17, the total deduction of $3,810 will be distributed as follows: $1,350 in the first bracket, leaving nothing to be taxed at the 20 per cent rate. $450 in the second bracket, leaving nothing to be taxed at the 25 per cent rate. $450 in the third bracket, leaving nothing to be taxed at the 35 per cent rate. $720 in the fourth bracket, leaving nothing to be taxed at the 45 per cent rate. There still remains $840 of the deduction to be allowed in the fifth bracket against the $7,030 of income which would otherwise be taxable under that bracket. There would then be $6,190 of net income left to be taxed at the 60 per cent rate under the fifth bracket. Hence, the total excess profits tax in this case would be $3,714. (2) An individual or partnership has a capital of $40,000, pre-war earnings of 9 per cent, and a net income for the taxable year of $12,000. The deduction allowed will be 9 per cent of the capital, or $3,600, plus $6,000 specific deduction, a total of $9,600. The amount of the net income in each bracket will be as follows: WAR EXCESS PROFITS TAX 703 15 per cent of the capital $6,000 In excess of 15 per cent of the capital and not in excess of 20 per cent thereof 2,000 In excess of 20 per cent of the capital and not in excess of 25 per cent thereof 2,000 In excess of 25 per cent of the capital and not in excess of 33 per cent thereof 2,000 It is evident that the total deduction of $9,600 is greater than 15 per cent of the capital and so is not fully absorbed by the amount of net in- come not in excess of 15 per cent of the capital. In such case, applying article 17, the total deduction of $9,600 will be distributed as follows: $6,000 in the first bracket, leaving nothing to' be taxed at the 20 per cent rate. $2,000 in the second bracket, leaving nothing to be taxed at the 25 per cent rate. $1,600, the balance of the deduction, to be allowed against the $2,000 of income in the third bracket. There would then be $400 of income left in the third bracket to be taxed at the 35 per cent rate, and $2,000 in the fourth bracket to be taxed at the 45 per cent rate. Hence, the total excess profits tax in this case would be $1,040. 18. Constructive capital for application of rates. Where the deduc- tion allowed to a taxpayer is determined under article 24, the invested capital for the purpose of applying the rates of taxation under article 16 shall be deemed to be an amount which bears the same ratio to the net income of the trade or business for the taxable year which the aver- age invested capital for the corresponding calendar year of representa- tive corporations, partnerships and individuals engaged in a like or similar trade or business bears to their average net income. The Commissioner of Internal Revenue in determining for any calen- dar year the ratio which the average invested capital of representative corporations, partnerships and individuals engaged in any particular trade or business bears to their average net income, will include the invested capital and net income of representative corporations and part- nerships for fiscal years ending during such calendar year. For the purpose of applying this article in the case of a corporation or partnership which has fixed its own fiscal year, the ratio determined for the calendar year ending during such fiscal year shall be used. 19. Computation of tax for fiscal year, part of which falls within cal- endar year 1916. If a corporation or partnership prior to March 1, 1918, makes a return for a fiscal year, part of which falls within the cal- endar year 1916, the tax for the first taxable year shall be that pro- portion of the tax computed upon the net income for such fiscal year which the number of months from January 1, 1917, to the end of such fiscal year bears to the entire number of months in such fiscal year. 20. Computation of tax for period of less than 12 months. If a cor- poration or partnership at any time, either because it has just designated a fiscal year as provided in sections 8 or 13 of the act of September 8, 1916 (see Income Tax Regulations, arts. 31 and 211), or for any other reason, makes a return for a period of less than 12 months, the deduc- tion will be an amount which bears the same ratio to the deduction allowable for a full year as the number of months in such period bears to 12 months. COMPUTATION OF THE DEDUCTION 21. Trade or business having invested capital. The deduction used in computing the rates of tax under article 16 shall, except in cases coming within the conditions specified in articles 23 and 24, be as follows: (a) In the case of a domestic corporation the sum of (1) an amount 704. INCOME AND FEDERAL TAX REPORTS equal to the same percentage of the invested capital for the taxable year which the average amount of the annual net income of the trade or business during the pre-war period was of the invested capital for the pre-war period (except that 7 per cent shall be used if such per- centage was less than 7 per cent, and 9 per cent shall be used if such percentage was more than 9 per cent, and 8 per cent shall be used if the corporation was not in existence during the whole of at least one calen- dar year during the pre-war period), and (2) $3,000. (b) In the case of a domestic partnership or of a citizen or resident of the United States, the sum of (1) an amount equal to the same per- centage of the invested capital for the taxable year which the average amount of the annual net income of the trade or business during the pre-war period was of the invested capital for the pre-war period (ex- cept that 7 per cent shall be used if such percentage was less than 7 per cent, and 9 per cent shall be used if such percentage was more than 9 per cent, and 8 per cent shall be used if the partnership was not in existence or the individual was not engaged in the trade or business during the whole of at least one calendar year during the pre-war period), and (2) $6,000. (c) In the case of a foreign corporation or partnership or of a non- resident alien individual, an amount equal to the same percentage of the invested capital for the taxable year which the average amount of the annual net income of the trade or business during the pre-war period was of the invested capital for the pre-war period (except that 7 per cent shall be used if such percentage was less than 7 per cent, and 9 per cent shall be used if such percentage was more than 9 per cent, and 8 per cent shall be used if the corporation or partnership was not in existence or the individual was not engaged in the trade or business dur- ing the whole of at least one calendar year during the pre-war period) 22. Trade or business reorganized on or after January 2, 1913. If a trade or business carried on by a corporation, partnership or individual was formerly organized or reorganized on or after January 2, 1913, but is substantially a continuation of a trade or business carried on prior to that date, then the corporation or partnership shall be deemed to have been in existence, or the individual shall be deemed to have been en- gaged in the trade or business, prior to that date, and for the purpose of computing the deduction the net income and invested capital of the predecessor shall be deemed to have been the net income and invested capital of the present owner for the pre-war period. 23. When income for pre-war period cannot be satisfactorily deter- mined, or when net income was low during pre-war period, or when there was no net income during pre-war period. In the following cases the deduction shall be determined as provided in this article: (a) If the Secretary of the Treasury is unable satisfactorily to deter- mine the average amount of annual net income of the trade or business for the pre-war period; (b) If the Secretary of the Treasury upon complaint finds that during the pre-war period the percentage of the net income to the invested cap- ital of the taxpayer was lower by one per cent or more than the per- centage of the net income to the invested capital of representative cor- porations, partnerships or individuals engaged in a like or similar trade or business during the same period. (c) If, in the case only of a domestic corporation or partnership which was in existence during the pre-war period, or of a citizen or resident of the United States who was engaged in the trade or business during the pre-war period, the Secretary of the Treasury upon complaint finds that during the pre-war period there was no net income from the trade or business. Jn such cases the deduction shall be (1) An amount equal to the same percentage of the invested capital WAR EXCESS PROFITS TAX 705 for the taxable year which the average deduction (determined in the same manner as provided in article 21, without including the $3,000 or $6,000 therein referred to) for such year of representative corporations, partnerships or individuals engaged in a like or similar trade or busi- ness, is of their average invested capital for such year, plus (2) In the case of a domestic corporation, $3,000, and in the case of a domestic partnership or a citizen or resident of the United States, $6,000. In cases arising under subdivision (a) or (c) of this article the tax shall be assessed in the first instance upon the basis of a deduction com- puted by the use of 7 per cent. In cases arising under subdivision (b) the tax shall be assessed in the first instance upon the basis of a deduc- tion determined as provided in article 21. In any case under this article a taxpayer claiming the benefit of this provision shall at the time of making the return file a claim for abate- ment (Form 47) of the amount by which the tax so assessed exceeds a tax computed upon the basis of the deduction determined as provided in this article. In cases coming within the provisions of this article payment of that portion of the tax covered by the claim for abatement will not be required until the claim is decided. If, however, in the judgment of the Commissioner of Internal Eevenue, the interests of the United States would be jeopardized thereby, the right is reserved to require the claimant to give a bond of such amount and with such sureties as the commissioner thinks wise to safeguard such interests. The bond shall be conditioned for the payment of any tax found to be due with interest thereon, and if a bond satisfactory to the commis- sioner is not given within such time as he prescribes, the full amount of the tax assessed will become, immediately due and the amount over- paid, if any, will, upon final decision of the application, be refunded as a tax erroneously or illegally collected. 24. When invested capital cannot be satisfactorily determined. If the Secretary of the Treasury is unable satisfactorily to determine the invested capital, the deduction shall be the sum of (1) An amount equal to the same proportion of the net income of the trade or business for the taxable year as the average deduction (de- termined in the same manner as provided in article 21 without includ- ing the $3,000 or $6,000 therein referred to) for the corresponding cal- endar year, of representative corporations, partnerships and individuals engaged in a like or similar trade or business, is of their average net income, plus (2) In the case of a domestic corporation, $3,000, and in the case of a domestic partnership or a citizen or resident of the United States, $6,000. The Commissioner of Internal Eevenue in determining for any calen- dar year the proportion which the average deduction of representative corporations, partnerships and individuals engaged in any particular trade or business is of their average net income, will include the deduc- tions and net income of representative corporations and partnerships for fiscal years ending during such calendar year. For the purpose of applying this article in the case of a corporation or partnership which has fixed its own fiscal year, the proportion deter- mined for the calendar year ending during such fiscal year shall be used. In every case of a trade or business having invested capital a return shall be made in the first instance in accordance with article 21 or 23, but the taxpayer may submit therewith a statement of reasons why in his opinion the tax should be assessed in accordance with this article. NET INCOME GENERAL PROVISIONS 25. Exemptions. The following classes of income are exempt from the tax: (a) Income exempt from taxation under section 4 of the act of Sep- tember 8, 1916, as amended. (See Income Tax Eegulations, art. 5.) 706 INCOME AND FEDERAL TAX REPORTS (b) Income derived from the business of life, health, and accident in- surance combined in one policy issued on a weekly premium payment plan. (c) Compensation or fees received by officers and employees under the United States or any State, Territory or the District of Columbia for their services as such. 26. Net income of foreign corporations, partnerships and non-resident alien individuals. In the case of a foreign corporation or partnership or a non-resident alien individual the net income shall be the net income from sources within the United States. 27. Dividends received from a foreign "corporation which is subject to Federal income tax. In the case of income derived by a corporation or partnership from dividends upon the stock of a foreign corporation, part of whose net income is subject to the income tax, there shall be deducted only that proportion of the dividends received upon such stock which the net income of such foreign corporation from sources within the United States is of its entire net income. Where dividends upon the stock of a foreign corporation are received by an individual, as a part of his income from trade or business, there shall be included in the net income that proportion of the dividends re- ceived upon such stock which the net income of such corporation from sources outside the United States is of its entire net income. NET INCOME CORPORATIONS 28. Taxable year. The net income of a corporation for the taxable year shall be determined by adding (1) the amount of net income ascer- tained and returned for income tax purposes for such taxable year as provided in Title I of the act of September 8, 1916, as amended, and (2) the amount, if any, received as interest on bonds or other obligations of the United States, issued after September 24, 1917 (other than the in- terest received on an amount of such bonds or obligations the aggregate principal of which does not exceed $5,000), and deducting from the total so obtained the amounts received during the taxable year as divi- dends upon the stock or from the net earnings of other corporations, joint-stock companies or associations, or insurance companies, subject to the income tax imposed by Title I of such act of September 8, 1916, as amended, except as otherwise provided in article 27. 29. Pre-war period. The net income of a corporation for the pre-war period shall be computed as follows: (a) For the calendar year 1911 by adding (1) the amount of net in- come shown in item 9 of the return made under section 38 of the act of August 5, 1909, for the calendar year 1911, and (2) the amount of taxes paid to the United States within the calendar year 1911 under section 38 of such act; (b) For the calendar year 1912 by adding (1) the amount of net in- come shown in item 9 of the return made under section 38 of the act of August 5. 1909, for the calendar year 1912, and (2) the amount of taxes paid to the United States within the calendar year 1912 under section 38 of such act; and (c) For the calendar year 1913 by adding (1) the amount of the en- tire net income shown in item 8 of the return made under Section II of the act of October 3, 1913, for the calendar year 1913, and (2) the amount of taxes paid within the calendar year 1913 under section 38 of the act of August 5. 1909, and Section II or IV of the act of Oc- tober 3, 1913, and deducting from the total so obtained the amounts re- ceived during the calendar year 1913 as dividends upon the stock or from the net earnings of other corporations, joint-stock companies or associa- tions, or insurance companies, subject to the income tax imposed by Sec- tion II of the act of October 3, 1913. WAR EXCE88 PROFITS TAX 707 NET INCOME PARTNERSHIPS 30. Taxable year. The net income of a partnership for the taxable year shall be determined by adding the amount of its entire net income (or in the case of a foreign partnership, its entire net income from sources within the United States) ascertained upon the same basis and in the same manner as provided with respect to individuals for income- tax purposes by Title I of the act of September 8, 1916, as amended (see Income Tax Regulations, art. 30), including the amounts, if any, received during the year as interest on bonds or other obligations of the United States issued after September 24, 1917 (other than the interest on an amount of such bonds or obligations, the aggregate principal of which does not exceed $5,000), and deducting therefrom (1) The amounts received during the taxable year as dividends upon the stock or from the net earnings of corporations, joint-stock companies or associations, or insurance companies, subject to the income tax imposed by Title I of the act of September 8, 1916, as amended, except as other- wise provided in article 27; and (2) The deductions, if any, for salaries or interest allowed by articles 32 and 33, if such deductions have not already been made. 31. Pre-war period. The net income of a partnership for each of the calendar years 1911, 1912 and 1913 shall be determined in the same manner as the net income for the taxable year, except that dividends upon the stock or from the net earnings of corporations, joint-stock com- panies or associations, or insurance companies, subject to the tax imposed by section 38 of the act of August 5, 1909, or by Section II of the act of October 3, 1913, shall be deducted. (See art. 30.) 32. Deductions allowed for salaries paid to partners. In computing net income for purposes of the excess profits tax a partnership will be allowed to deduct as an expense reasonable salaries or compensation paid to individual partners for personal services actually rendered during the taxable year, if the payments are made in accordance with prior agree- ments and are properly recorded on the books of the partnership. In no case shall the salaries or compensation so deducted be in excess of the salaries or compensation customarily paid for similar services under like responsibilities by corporations engaged in like or similar trades or businesses. With respect to any period prior to March 1, 1918, regardless of whether a previous agreement has been made as to salaries or compen- sation, a similar deduction will be allowed for services actually ren- dered. In the case of a foreign partnership the deduction shall be limited to those portions of salaries or compensation which are paid for services rendered with respect to trade or business carried on in the United States. A partner in his individual capacity is, however, subject to the excess profits tax, if any, at the 8 per cent rate under article 15 with respect to any salary or compensation from the partnership for personal services (including any amounts allowed to the partnership as a deduction on his account for the period prior to March 1, 1918). 33. Deductions allowed for interest on bona fide loans by partners In computing net income for purposes of the excess profits tax a part- nership will be allowed to deduct amounts paid during the year to an individual partner as interest upon any bona fide loan, but no deduction for so-called interest upon capital will be allowed. 34. If deduction is made under article 32 or 33, corresponding deduc- tion must also be made for pre-war period. If, in computing net income for purposes of the excess profits tax, a partnership makes a deduction as allowed by article 32 for salaries paid to partners during the taxable year, it must also, in computing net income for the pre-war period, make 708 INCOME AND FEDERAL TAX REPORTS a corresponding deduction; and if it makes such a deduction as allowed by article 33 for interest paid to partners, it must also, in computing net income for the pre-war period, make a corresponding deduction for any- such interest actually paid during that period. NET INCOME INDIVIDUALS 35. Determination of net income where there is no invested capital or only nominal capital. The net income which is derived from a trade or business having no invested capital or not more than a nominal capital, including salaries, wages, fees or other compensations (constituting net income of class A as denned in art. 14) shall be determined for the tax- able year by adding the total net income from all such sources (or in the case of a non-resident alien individual the total net income from all such sources within the United States) as reported for income tax pur- poses for the same year. 36. Determination of net income for taxable year when there is in- vested capital. The net income which is derived from a trade or busi- ness having invested capital (constituting net income of class B, as de- fined in art. 14) shall be determined for the taxable year by adding the total net income from such sources (or in the case of a non-resident alien individual the total net income from such sources within the United States) as reported for income tax purposes for the same year and de- ducting therefrom the deduction, if any, for salary allowed by article 39, if such deduction has not already been made. There shall be excluded the amounts received during the year upon the stock or from the net earnings of corporations, joint-stock companies or associations, or insurance companies, subject to the income tax imposed by Title I of the act of September 8, 1916, as amended. In the case, however, of an individual dealing in securities or other- wise using securities in trade or business there shall be included (1) the amount, if any, received as interest on bonds or obligations of the United States, issued after September 24, 1917 (other than the interest received on an amount of such bonds or obligations the aggregate principal of which does not exceed $5,000), and (2) such proportion of dividends re- ceived upon the stock of foreign corporations as is required to be included by article 27. Elustration. An individual owns a farm representing an invested cap- ital of $25,000, a country store with an invested capital of $6,000, and a flour mill with an invested capital of $10,000. His net income from the farm is $4,000, from the store $3,000, and from the mill $3,000. Thus his total net income of class B is $10,000. His total invested capital is $41,000. Assuming that his deduction is at the rate of 8 per cent, his total deduction will be $3,280 plus $6,000, or $9,280, to be applied against his net income of $10,000 in computing the tax at the graduated rates un- der articles 16 and 17. The same individual allows himself a salary of $1,000 for working the farm and $900 for running the store, draws a salary of $1,200 as presi- dent of the local bank, and receives $250 in compensation for personal services of various kinds, such as road work, helping neighbors in har- vest, etc. He also receives $300 in dividends on an investment in cer- tain stocks and $100 as supervisor's fees. The last item that is, super- visor's fees is exempt under the law (sec. 201, subdivision a). The $300 in dividends is not taxable, inasmuch as it is derived from a mere investment not connected with his trade or business. His net income of class A will therefore consist of his salaries and his compensation for personal services, a total of $3,350. Since he is entitled to a deduction of $6,000 as to this class of income, he will have no tax to pay at the 8 per cent rate under article 15. 37. Deduction of contributions for religious, charitable, etc., purposes. WAR EXCESS PROFITS TAX 709 Contributions or gifts for religious, charitable, etc., purposes allowed as a deduction for purposes of the income tax under paragraph "Ninth" of subdivision (a) of section 5 of the act of September 8, 1916, as amended, may, subject to the limitations therein contained, be deducted in computing the net income of the trade or business for purposes of the excess profits tax only when it is shown to the satisfaction of the Com- missioner of Internal Revenue that such contributions or gifts are made by the trade or business and not by the individual in his personal ca- pacity. 38. Determination of net income for the pre-war period where there is invested capital. The net income which is derived from a trade or busi- ness having invested capital (constituting net income of class B as de- fined in article 14) shall be determined for each of the calendar years 1911, 1912 and 1913 upon the same basis and in the same manner as pro- vided in article 36. 39. Deduction allowed for salary to himself. An individual carrying on a trade or business having an invested capital may, in computing the net income of the trade or business for purposes of the excess profits tax, deduct a reasonable amount designated by him as salary or compensa- tion for personal service actually rendered by him in the conduct of such trade or business. In no case shall the amount so designated be in excess of the salaries or compensation customarily paid for similar serv- ice under like responsibilities by corporations or partnerships engaged in like or similar trades or businesses. In the case of a non-resident alien individual, the amount deducted shall be limited to that portion of the salary or compensation which is for service rendered with respect to trade or business carried on in the United States. The amount so designated shall, however, be included in computing his net income of class A under article 35; and the balance of the income from his trade or business shall be included in computing his net income of class B under article 36. Illustration. An individual owns and runs a newspaper having an in- vested capital of $50,000. The net income from the newspaper, without making any allowance for the salary of the owner, is $20,000, and, as income of class B, is subject to the graduated rates prescribed in article 16. His deduction, as provided for in subdivision (b) of article 21, would be $4,500 (9 per cent of his capital), plus $6,000, a total of $10,500. If, however, he allows himself a salary of $3,000, the net income from the newspaper will be $17,000, and the deduction of $10,500 will be applied against that amount. His salary of $3,000 must be included in his return as income of class A, which is subject to the 8 per cent rate under article 15. If it consti- tutes his only income of that class he will pay no tax thereon, inasmuch as it is less than the deduction of $6,000 to which he is entitled as to that class of income. But if, for example, he receives in addition a sal- ary of $4,000 as president of the local bank, his total net income of class A will be $7,000, and he will be required to pay a tax of 8 per cent on $1,000 thereof, or $80. 40. If deduction is made under article 39 corresponding deduction must also be made for pre-war period. If, in computing net income for pur- poses of the excess profits tax, an individual deducts a reasonable amount designated as salary or compensation for personal services rendered by himself, as allowed by article 39, he must also, in computing net income for the pre-war period, make a corresponding deduction. 41. Individual member of partnership. Inasmuch as a partner in his individual capacity is not considered to be engaged in trade or business with respect to his share in the profits of the partnership, he is not sub- ject to excess profits tax thereon. Consequently, in computing his net 710 INCOME AND FEDERAL TAX REPORTS income for purposes of the excess profits tax, he need not include his share of the partnership profits. He shall, however, in computing his net income of class A under article 35, include any salary or compensation from the partnership for personal services (including any amount allowed to the partnership as a deduction on his account for the period prior to March 1, 1918, in accord- ance with article 32). INVESTED CAPITAL GENERAL PROVISIONS 42. Allowance for depletion, depreciation, and obsolescence in compu- tation of invested capital. The term "invested capital" as used in the excess profits tax law means the invested capital of the present owner. The basis, or starting point, in the computation of invested capital is found in the amount of cash and other property paid in, the original values of such other property being determined in accordance with the rules laid down in these regulations. But the computation does not stop with such original entries or amounts; it must take properly into ac- count the surplus and undivided profits. In the computation of surplus and undivided profits, however, full recognition must first be given to expenses incurred and losses sustained from the original organization of the business concern down to the taxable year, including among such ex- penses and losses a reasonable allowance for depletion, depreciation, or obsolescence of property originally acquired for cash or for stock or shares or in any other manner. If value appreciation of a kind not subject to income tax (other than that allowed under article 55) has been taken up in the accounts, a deduction must be made in respect of such appreciation so taken up. In the computation of the invested capital for any year full effect must also be given to any liquidation of the original capital. 43. How to ascertain average invested capital for the year, averaged monthly. The invested capital for any pre-war or taxable year (or where the tax is computed upon the basis of a period less than a year, for such period) is the average invested capital for the year or period averaged monthly, according to the following rules: (a) Add the capital for each of the several months during which no change occurs, and the average capital (ascertained as provided in sub- division (b) of this article) for each month in which a change occurs and divide the total by the number of months in the year or period. (b) To ascertain the capital for any month in which a change occurs multiply the capital as of the first day of the month by the number of days it remains constant and the capital after each change by the num- ber of days (including the day on which the change occurs) during which it remains constant, add the products, and divide the sum by the number of days in the month. 44. Items not allowed to be included in invested capital. The second paragraph of section 207 of the excess profits law specifies certain items which may not be included in invested capital, namely: (a) Stocks, bonds (other than obligations of the United States), or other assets, the income from which is not subject to the excess profits tax; and (b) Money or other property borrowed. The term "money or other property borrowed" as used in section 207 and these regulations includes not only cash or other borrowed prop- erty which can be identified as such, but current liabilities and tem- porary indebtedness of all kinds, and any permanent indebtedness upon which the taxpayer is entitled to an interest deduction in computing net income. A corporation which under the income-tax law is allowed to deduct only a part of the entire interest paid upon its indebtedness, may include in its invested capital such a proportion of its permanent indebt- WAR EXCESS PROFITS TAX 7U edness as the amount of interest upon such indebtedness which the cor- poration is not allowed to deduct is of the total amount of interest paid upon such indebtedness during the taxable year. 45. When income from tax-free securities consists partly of trading profits and partly of interest, dividends, etc. Whenever income consists partly of gains or profits subject to the excess profits tax arising from trading in stocks, bonds, etc., the dividends or interest on which are not subject to such tax, and partly of such dividends or interest, then, sub- ject to the limitations as to borrowed money, there shall be included in the invested capital an amount which bears the same ratio to the total amount invested in such stocks or bonds as the amount of such gains or profits bears to the total amount of such income. 46. Treatment of stock of foreign corporations when held by domes- tic corporations or partnerships or by citizens or residents of the United States. In the case of domestic corporations or partnerships and of citi- zens or residents of the United States holding stock in a foreign cor- poration part of whose net income is subject to the income tax, there shall be included in invested capital such proportion of the value of the stock in such foreign corporation as the net income of such foreign cor- poration from sources outside the United States is of its entire net income. 47. Construction of terms "tangible property" and "intangible prop- erty." The term "other intangible property" as used in section 207 will be construed to mean property of a character similar to good will, trade-marks, and the other specific kinds of property enumerated in the same clause. With respect to property not clearly of such a character, rulings will be issued as occasion may demand to indicate whether it shall be regarded as tangible or intangible. The following classes of property, when paid in for stock or shares in a corporation or partnership, will be regarded as tangible property so paid in: (a) Stocks. (b) Bonds. (c) Bills and accounts receivable. (d) Notes and other evidences of indebtedness. (e) Leaseholds. But when a corporation pays for intangible property by the issuance of its own stock or bonds, this will not be regarded as being a payment bona fide made in cash or tangible property within the meaning of sec- tion 207. 48. Invested capital of foreign corporations or partnerships or non- resident alien individuals. When used with reference to a foreign corpo- ration or partnership or a non-resident alien individual, the term "in- vested capital" means that proportion of the entire invested capital as defined and limited by these regulations which the net income from sources within the United States is of the entire net income. 49. Reorganization on or after January 2, 1913. A trade or business carried on by a corporation, partnership, or individual, which has been formerly organized or reorganized on or after January 2, 1913, but which is substantially a continuation of a trade or business carried on prior to that date, shall, for the purposes of the excess profits tax, be deemed to have been in existence prior to that date and the invested capital of its predecessor prior to that date shall be deemed to have been its invested capital. This article relates to the pre-war period and does not apply to the invested capital for the taxable year. 50. Reorganization after March 3, 1917. In case of the reorganiza- tion, consolidation, or change of ownership of a trade or business after March 3, 1917, if an interest or control in such trade or business of 50 per cent or more remains in control of the same persons, corporations, associations, partnerships, or any of them, then in ascertaining the in- vested capital of the trade or business no asset transferred or received 712 INCOME AND FEDERAL TAX REPORTS from the prior trade or business shall be allowed a greater value than would have been allowed under these regulations in computing the invested capital of such prior trade or business if such asset had not been so transferred or received, unless such asset was paid for specifically as such, in cash or tangible property, and then not to exceed the actual cash or actual cash value of the tangible property paid therefor at the time of such payment. 51. Invested capital for pre-war period. The invested capital for the pre-war period shall, in general, be determined in the same manner as for the taxable year, except that the valuation as of January 1, 1914, shall not apply to tangible property paid in for stock or shares. 52. Scope of section 210. Section 210 provides for exceptional cases in which the invested capital can not be satisfactorily determined. In such cases the taxpayer may submit to the Commissioner of Internal Revenue evidence in support of a claim for assessment under the pro- visions of section 210. (See articles 18 and 24.) Such exceptional cases may consist, among others, of the following: (1) Where, through defective accounting or the lack of adequate data, it is impossible accurately to compute invested capital. (2) Where upon application by a foreign taxpayer the Secretary of the Treasury finds that the expense of securing the data necessary for the computation of the invested capital would be unreasonable in view of the amount of tax involved, or that it is impracticable to determine either the "entire invested capital" or the "entire net income." (3) Long-established business concerns which by reason of ultra-con- servative accounting or the form and manner of their organization would, through the operation of section 207, be placed at a serious dis- advantage in competing with representative concerns in a like or similar trade or business. (4) Where the invested capital is seriously disproportionate to the taxable income. Such cases may arise through: (a) The realization in one year of the earnings of capital unproduc- tively invested through a period of years or of the fruits of activities antedating the taxable year; or, (b) Inability to recognize or properly allow for amortization, obso- lescence, or exceptional depreciation due to the present war, or to the necessity in connection with the present war of providing plant which will not be wanted for the purposes of the trade or business after the termination of the war. INVESTED CAPITAL CORPORATIONS AND PARTNERSHIPS 53. Rule for computing invested capital. In computing invested cap- ital, every corporation or partnership paying taxes at the graduated rates prescribed in section 201 (see art. 16), shall add together its paid in capital and its paid in or earned surplus and undivided profits (under whatever name the same may be called) as shown by its books at the beginning of the taxable year. The total thus obtained shall be ad- justed for any asset or item which it covers that is not carried on the books at the valuation prescribed by law or by these regulations. When necessary, adjustment (addition or subtraction) shall be made in respect of the following: ADJUSTMENTS 1. Stock or shares issued in the purchase of intangible property prior to March 3, 1917, which cannot be included in an amount exceeding (a) 20 per cent of the par value of the total stock or shares outstanding on that date, (b) the actual value of such intangible property at the date acquired, or (c) the par value of the stock or shares issued in payment therefor, whichever is the lowest. (See arts. 57 and 58.) WAR EXCESS PROFITS TAX 713 2. Stock or shares issued for a mixed aggregate of tangible property, patents and copyrights, and good will or other intangible property. (See art. 59.) 3. Stock or shares issued for patents and copyrights, valued at (a) their actual cash value at the time of payment, or (b) the par value of the stock or shares issued therefor, whichever is lower. (See art. 56.) 4. Stock or shares issued for tangible property prior to January 1, 1914, valued at (a) the actual cash value of such property on January 1, 1914, or (b) the par value of the stock, whichever is the lower. (See art. 55.) 5. Stock originally issued for property and subsequently returned to the corporation as a gift, etc. (See art. 54.) 6. Add any proportion of its permanent indebtedness which may be included under article 44. 7. Add value of tangible property paid in for stock or shares in excess of the par value of such shares, when authorized by article 63. 8. Add amounts expended in the past for (a) the acquisition of tan- gible property or (b) specifically for good will and other similar intan- gible property, when authorized by article 64. 9. For the valuation of assets acquired in reorganizations, etc., (a) effected after March 3, 1917, see article 50; (b) as to the pre-war period, see articles 49 and 51. 10. Deduct amounts representing appreciation excluded by article 42. 11. Make any additional deductions required by reason of insufficient allowances in the accounts of the taxpayer for depletion, depreciation and obsolescence. (See art. 42.) Whenever any corrections are made in respect of the capital stock and surplus, corresponding corrections must be made in the respective asset items in the balance sheet of the taxpayer. After making any adjustments required under paragraphs 1 to 11 above, the adjusted total of the capital and surplus account will repre- sent the invested capital at the beginning of the taxable year, except that in any case where the admissible assets (and these include all assets when valued in accordance with these regulations, except stocks, bonds other than obligations of the United States the income of which is not subject to excess profits tax) are less than the amount of such adjusted total, then the invested capital must be further reduced to an amount equal to the sum of the admissible assets. Tax-free securities and stock in foreign corporations may be included as admissible assets to the extent authorized in articles 45 and 46. If there has been any change made during the taxable year in the amount of the invested capital, the monthly average shall be taken (see art. 43), but in no case may the invested capital include any surplus or undivided profits earned during the taxable year. With respect to the taxable year 1917, every such corporation and partnership will be required to submit a balance sheet as at the first day of the taxable year and also a balance sheet as at the close of the taxable year. Thereafter every such corporation and partnership will be re- quired to submit a balance sheet as at the close of each taxable year. Balance sheets should be made in accordance with the books of the tax- payer and changes in respect of any items therein made pursuant to these regulations should be explained in a separate statement attached to the balance sheet to which it relates. 54. Stock returned to corporation. For the purpose of computing in- vested capital, in cases where the stock of a corporation is issued or ex- changed for property (tangible or intangible), the following rule will apply: When any of such stock is returned to the corporation as a gift or for a consideration substantially less than its par value, the stock so re- turned shall not be treated as a part of the stock issued or exchanged 714 INCOME AND FEDERAL TAX REPORTS for such property. The proceeds derived in cash or its equivalent from the resale of the stock so returned shall, however, be included in the in- vested capital if retained and employed in the business. 55. Valuation of tangible property paid in for stock or shares. Tan- gible property paid in for stock or shares prior to January 1, 1914, must be valued at either (a) the actual cash value of such property on Jan- uary 1, 1914, or (b) the par value of the stock or shares specifically issued therefor, whichever is lower. This is one of the few eases in which the law permits allowance to be made for appreciation, and here no appreciation can be recognized unless the original stock or shares were specifically issued in exchange for such tangible property. Tangible property paid in for stock or shares on or after January 1, 1914, will be taken at the actual cash value of such property at the time of payment, irrespective of the par value of the stock or shares. 56. Patents and copyrights. Patents and copyrights paid in for stock or shares must be valued at either (a) the actual cash value at the time of payment or (b) the par value of the stock or shares issued therefor, whichever is lower. 57. Valuation of intangible property. If good will, trade marks, trade brands, franchises of a corporation or partnership, or other intangible property has been purchased with stock or shares issued prior to March 3, 1917, the amount that may be included in invested capital must not exceed (a) 20 per cent of the par value of the total stock or shares out- standing on that date, nor (b) the actual value of the asset at the date acquired, nor (c) the par value of the stock issued in payment for the asset. 58. Application of 20 per cent limitation upon intangible property. The 20 per cent limitation upon intangible property purchased prior to March 3, 1917, for or with stock or shares of the corporation or partner- ship, applies not to each item or class of intangible property separately, but to the aggregate amount of all such property so purchased. Such in- tangible property may be included in the invested capital only up to an amount not exceeding 20 per cent of the total stock or shares of the cor- poration or partnership on March 3, 1917, even though the aggregate amount of such intangible property be greater in value than such 20 per cent of the par value of the total stock or shares. Intangible property bona fide purchased prior to March 3, 1917, with stock having no par value may be included in invested capital at a value not exceeding the actual cash value of such intangible property at the time of the purchase and in an amount not exceeding 20 per cent of the total shares of stock outstanding on March 3, 1917, measured by their value as at the date or dates of issue. 59. Rules to govern cases where shares or securities are issued for mixed aggregate of tangible and intangible property. Where stock or shares (or stocks or shares and bonds or other obligations) have, prior to March 3, 1917, been issued for a mixed aggregate of (a) Tangible property, (b) Patents and copyrights, and (c) Good will or other intangible property, the following rules will govern: (1) In the absence of satisfactory evidence to the contrary, it will be presumed, in the case of a corporation, that its stock was issued for the following purposes in the order named: (a) Good will or other intangible property, (b) Patents and copyrights^ and (c) Tangible property. (2) Upon the production by the taxpayer of evidence satisfactory to the Commissioner of Internal Revenue as to the actual values at the date of acquisition of (a) the tangible property and (b) the patents and copy- rights, the sum of these two items may be applied against the total par WAR EXCESS PROFITS TAX 715 value of the securities issued and the remainder will then be deemed to represent the par value of the securities issued for the good will or other intangible property. (3) Cases where mixed aggregates of tangible and intangible property have been paid in for stock and bonds shall, if the Secretary of the Treasury is unable to determine satisfactorily the respective values of the several classes of property at the time of payment, be treated as coming under articles 18 and 24 and the tax shall be assessed accordingly. 60. Valuation of intangible assets purchased. Good will and other similar intangible assets purchased with cash or tangible property must be taken at a value not in excess of the cash or actual cash value of the tangible property specifically paid therefor. 61. Surplus or undivided profits earned during any year excluded in computing invested capital for such year. Profits earned during any taxable year or pre-war year shall not be included in the computation of the invested capital for such year, even though set up as "surplus" upon the books or distributed in the form of stock dividends. 62. Scope of phrase "surplus and undivided profits." Clause (3) of subdivision (a) of section 207 authorizes the inclusion in invested cap- ital of earned surplus and undivided profits used or employed in the business. Inasmuch as section 201 provides that all the income of a cor- poration or partnership shall be deemed to be received from its trade or business, all the surplus and undivided profits of a corporation or part- nership (exclusive of undivided profits earned during the year), from whatever source derived, will, unless invested in stocks, bonds (other than obligations of the United States), or other assets, the income from which is not subject to the excess profits tax, be deemed to be used or employed in the business and may be included in the invested capital. 63. When tangible property may be included in surplus. Where it can be shown by evidence satisfactory to the Commissioner of Internal Eevenue that tangible property has been conveyed to a corporation or partnership by gift or at a value, accurately ascertainable or definitely known as at the date of conveyance, clearly and substantially in excess of the cash or the par value of the stock or shares paid therefor, then the amount of the excess shall be deemed to be paid in surplus. The adopted value shall not cover mineral deposits or other properties dis- covered or developed after the date of conveyance, but shall be confined to the value accurately ascertainable or definitely known at that time. Evidence tending to support a claim for a paid-in surplus under these circumstances must be as of the date of conveyance, and may consist, among other things, of (1) an appraisal of the property by disinterested authorities, (2) the assessed value in the case of real estate, and (3) the market price in excess of the par value of the stock or shares. 64. Reconstruction of surplus and undivided profits accounts. Where through failure to provide for depletion, depreciation, obsolescence, or other expenses or losses, or where for any other cause or reason the books of account of the taxpayer do not show the true paid-in or earned sur- plus and undivided profits, in the computation of invested capital such adjustments shall be made as are necessary to arrive at a statement of the correct amount. Where a taxpayer claims additions to the capital account, the books of account will be presumed to show the true facts and the burden of proof will rest upon the taxpayer. Such additions will be accepted only to the extent and under the conditions stated below: (1) Amounts which have been expended in the past for the acquisi- tion of plant, equipment, tools, patterns, furniture, fixtures, or like tan- gible property, having a useful life extending substantially beyond the year in which the expenditure was made, and which have been charged as current expenses, may (less proper reduction for depreciation or obso- lescence) be added to the surplus account in computing invested capital 716 INCOME AND FEDERAL TAX REPORTS when such assets are still owned and in active use by the taxpayer dur- ing the taxable year. Special tools, patterns, and similar assets shall not be assigned any value if their cost has been recovered through hav- ing been included in the price of goods. If their cost has not been so recovered and they are held for only occasional use, they shall not be assigned a value in excess of the fair value based upon the earnings actually arising from their current use. Assets of this kind not in cur- rent use shall not be valued at more than their nominal or scrap value. (2) Amounts expended in the past for good will, trade-marks, trade brands, franchises, and other intangible assets of a like character, are controlled by the language of the statute, which provides that such assets "shall be included in invested capital if the corporation or partnership made payment bona fide therefor specifically as such in cash, or tangible property." The Commissioner of Internal Revenue will recognize addi- tions to invested capital on account of intangible assets only if such assets have been explicitly paid for in the manner prescribed by the statute. Where expenditures have been made for the general develop- ment of intangible assets, and charged as current expense, no readjust- ment thereof will be allowed. (3) Amount's under (1) and (2) above, expended on or after March 1, 1913, will, in the case of a corporation, be limited strictly to items which have not been deducted in computing taxable income upon its in- come tax return. Whenever a corporation has claimed and the depart- ment has allowed a deduction in respect to its income tax, the item upon which the deduction is based shall not be restored to the surplus account nor included in the invested capital. (4) The taxpayer shall in his return to the Commissioner of Internal Revenue make a statement of the proposed additions, specifying the kinds and amounts of property involved, the years in which the expen- ditures were made, and the method followed in distinguishing between capital outlays and current expenses. (5) The taxpayer shall also show that adequate provision has been made for the depletion, depreciation, or obsolescence of such of the assets so acquired as are, under the rulings of the department, subject to recognized depreciation. 65. Invested capital of insurance companies. (a) The invested cap- ital of a mutual insurance company will be deemed to consist of the sum of (1) any surplus or contingent reserves maintained for the gen- eral use of the business, plus (2) any legal reserves the net additions to which are included in the net income subject to the tax subject to the restrictive provisions of article 44 requiring the exclusion of tax-fiee assets other than obligations of the United States. (b) The invested capital of a stock insurance company will be deemed to consist of its capital stock, paid in or earned surplus and undivided profits (subject to the same restrictive provision or art. 44), computed in accordance with the provisions of article 53. INVESTED CAPITAL INDIVIDUALS 66. Items included in invested capital. Subject to the limitations stated in these regulations the invested capital of an individual is meas- ured by the total of three items: (1) Actual cash paid into the trade or business. (2) Tangible property paid into the trade or business. (3) Patents and copyrights, and good will, trade-marks, trade brands, franchises, and other intangible property. (See art. 68.) 67. Valuation of tangible property. Subject to the requirements of article 42 as to allowance for depletion, depreciation and obsolescence, valuation of tangible property will be as follows: WAR EXCESS PROFITS TAX 717 In the case of tangible property purchased with cash, the valuation will be based upon the cost (estimated if not known) in cash at the time purchased. In the case of tangible property paid in as such prior to January 1, 1914, the valuation will be based upon its actual cash value as of that date. Adequate evidence of such value must be furnished by the tax- payer. In the case of tangible property paid in on or after January 1, 1914, the valuation will be based upon its actual cash value at the time of payment. It will be presumed that the tangible assets employed in the trade or business have been acquired with cash which has been either paid in directly or derived from earnings of the trade or business; but the tax- payer will be entitled to show that such assets were paid in as tangible property. 68. Valuation of intangible property. Patents and copyrights, and good will, trade-marks, trade brands, franchises, and other similar in- tangible assets may be included in invested capital at a value not to exceed the actual cash paid therefor or the actual cash value at the time of payment of the tangible property paid therefor, but only if bona fide payment was made therefor specifically as such in cash or tangible property. 69. Profits earned during taxable year may be included. The restric- tion in respect of undivided profits earned during the taxable year which is imposed upon corporations and partnerships does not apply to indi- viduals, and therefore, unless otherwise shown, the profits of the taxable year remaining in the trade or business will be deemed to have arisen ratably throughout the year, and the capital at the beginning of the year may be increased by the total amount of such profits remaining in the trade or business averaged monthly over the year. 70. Rule for computing invested capital. Where an individual keeps books of account his invested capital will be found in his capital ac- count (under whatever name it may be called) after making therein any adjustments or corrections required by these regulations, provided that the assets other than those not allowed to be included equal or exceed the amount of such capital account. Otherwise the invested capital shall be the amount of such assets. Where an individual does not keep books of account he should pre- pare and preserve a statement as at the beginning of the taxable year and as at the end of the taxable year, showing in full all his assets val- ued in accordance with these regulations, and all his liabilities. The excess of such assets over such liabilities at the beginning of the year and again at the end of the year will constitute the invested capital of the individual on those dates, respectively, provided, that in each case the assets other than those not allowed to be included equal or exceed the amount of such excess. Otherwise the invested capital shall be the amount of such assets. The amount of the difference between the cap- ital thus shown as at the beginning of the year and at the end of the year will, in the absence of evidence to the contrary, be deemed to have arisen ratably throughout the year, and the capital at the beginning of the year will be increased or decreased, as the case may be, by such amount averaged monthly over the year. If an individual is engaged in more than one trade or business having invested capital, then his invested capital for the purposes of comput- ing the deduction and applying the rates of taxation will be determined by taking the total invested capital of all such trades or businesses. The terms "assets" and "liabilities" as used in this article relate only to the assets or liabilities of the trade or business. 718 INCOME AND FEDERAL TAX REPORTS NOMINAL CAPITAL 71. Application of section 209. Section 209 (see art. 15) applies pri- marily to occupations, professions, trades and businesses engaged prin- cipally in rendering personal service in which the employment of capital is not necessary and the earnings of which are to be ascribed primarily to the activities of the owners. In determining whether a trade or business is taxable under article 15 no weight will be given to the fact that it is carried on by means of personal service unless the principal owners are regularly engaged in the active conduct of the trade or business. 72. Application of section 209 not to be affected by mere size of cap- ital, form of organization, etc. Business concerns which render profes- sional or personal service and are of the class normally taxable under article 15 shall not be taken out of that class merely because of the size of the capital if the employment of such capital is necessitated by delay and irregularity in the receipt of fees, etc., or if such capital is wholly or mainly used as a fund from which to advance salaries, wages, etc., or to provide office furniture, accommodations, and equipment, nor because of the form of organization, whether corporation or partnership, nor in the case of a partnership because of the number of partners. 73. Agents and brokers. Agents and brokers requiring and using no capital or merely a nominal capital in their business are taxable under article 15, but commission houses regularly employing a substantial amount of capital, whether to lend to principals or to carry goods on their own account, are not deemed to be agents or brokers and are tax- able under the provisions of article 16. 74. Meaning of ''nominal capital"; businesses which will not be deemed to have nominal capital. The term "nominal capital" as used in section 209 means in general a small or negligible capital whose use in a particular trade or business is incidental. The following will not be construed as businesses having a nominal capital for purposes of excess profits* tax : (a) A business which because of conditions arising from the war or exceptional opportunities for profits earns a disproportionately high rate of profit during the taxable year, if it belongs to a class which neces- sarily and customarily requires capital for its operation. In the de- termination of doubtful cases stress will be laid upon the normal rela- tion of net income to capital during pre-war years; (b) Corporations which, although their capitalization is nominal, em- ploy a substantial amount of capital in their business; (c) A business having a substantial capital, but whose invested cap- ital within the meaning of section 207 is reduced to a nominal amount by the operation of the restrictive clauses of that section, e. g., where the capital, consisting originally of a small amount of cash paid in, has since appreciated in value, or where the capital is largely covered by indebtedness or consists principally of tax-free securities or of intan- gible assets built up or developed by expenditures which have been regu- larly deducted as items of current expense. RETURNS 75. When a return of information as to the invested capital and net income for the pre-war period will not be required. For the purposes of the excess profits tax, a return of information with respect to the invested capital and net income for the pre-war period will not be required of a corporation, partnership or individual in the following cases: (1) If the taxpayer accepts the minimum percentage, viz., 7 per cent, as the percentage to be used in computing the deduction under article 21; or WAR EXCESS PROFITS TAX 7 19 (2) If the trade or business is taxable only at the 8 per cent rate un- der article 15. This article must not be construed as not requiring a return of infor- mation as to all facts which may be necessary for the ascertainment of the capital and income for the taxable year whenever such a return is required by the Commissioner of Internal Eevenue. 76. A married woman may make separate return. A married woman who is a sole trader or is entitled to any taxable income to her sole and separate use may, for purposes of the excess profits tax, make a separate return in the same manner as any other individual. 77. When affiliated corporations must furnish information as to inter- corporate relations. For the purpose of the excess profits tax every corporation will describe in its return all its intercorporate relationships with other corporations with which it is affiliated, and will furnish such information in relation thereto as will enable the Commissioner of In- ternal Revenue to compute the amount of the tax properly due from each corporation on the basis of an equitable and lawful accounting. For the purpose of this regulation two or more corporations will be deemed to be affiliated (1) when one such corporation owns directly or controls through closely affiliated interests or by a nominee or nominees, all or substantially all of the stock of the other or others, or when sub- stantially all of the stock of two or more corporations is owned by the same individual or partnership, and both or all of such corporations are engaged in the same or a closely related business; or (2) when one such corporation (a) buys from or sells to another products or services at prices above or below the current market, thus effecting an artificial distribution of profits, or (b) in any way so arranges its financial rela- tionships with another corporation as to assign to it a disproportionate share of net income or invested capital. 78. When affiliated corporations may be required to make consolidated return. Whenever necessary to more equitably determine the invested capital or taxable income, the Commissioner of Internal Eevenue may require corporations classed as affiliated under article 77 to furnish a consolidated return of net income and invested capital. Where such consolidated return is required it may be made by any one or more of such corporations or by all of them acting jointly; but if such affiliated corporations, when requested to file such consolidated returns, neglect or refuse to do so, the Commissioner of Internal Revenue may cause an examination of the books of all such corporations to be made and a consolidated statement to be made from such examination. In cases where consolidated returns are accepted, the total tax will be computed in the first instance as a unit upon the basis of the consolidated return and will be assessed upon the respective affiliated corporations in such proportions as may be agreed among them. If no such agreement is made the tax will "be assessed upon each such corporation in accordance with the net income and invested capital properly assignable to it. ASSESSMENT AND COLLECTION 79. Assessment and collection governed by income tax regulations. All excess profits taxes to which any taxpayer is subject shall be assessed and collected at the same times and in the same manner as provided with respect to income taxes in the income tax regulations in so far as the same are applicable. INDEX (Figures in italics refer to law) Abatement, claims for, 27, 698 Accident insurance, 77; losses, 116 Accounting, corporation, 180, 189 Accrual basis, 102, 207; salaries, 209 Accrued interest on bonds, 193 Additional tax, 131, 341 Additions to property, 216-221 Ad interim certificates, tax on, 526 Adjustment of surplus account, un- der Excess Profits tax, 672; exam- ple, 683 Administration of tax laws, 17-31, 329, 345 Administrator, defined, 282; ancil- lary, 287 Admissions, defined, 608; free, 598, 606] exemptions, 607 Admissions and dues, tax on, 596, 606 Admissions, returns, 604; penalties, 605 Advance payment of tax, 161 Advisory Boards, "Legal" and "Excess Profits," 17 Affiliated corporations, 696, 719 Agents and brokers using nominal capital, 718 Agricultural corporations, 170-177 Airdomes, tax on proprietors of, 463 Alimony, 78, 104 American Eadiator Co., dividends paid from surplus earned prior to March 1, 1913, 83 Amortization, 68, 193; munitions tax, 447 Ancillary administrator, 287 Annuities, 40 "Appendages," Munitions tax, 438 Appreciation of assets, 202; adjust- ments for under Excess Profits tax, 676 Assessments on stockholders, 107, 198 Assessment and administration, 309, 326; Excess Profits tax, 719 Assets, revaluation of, 80; sale of, 199, 202; cost of, 223; life of, 224 Associations, 165; charitable, 175 Athletic associations, 603, 608 Audit of returns, 26 Automobile accidents, cost of, when deductible, 117 Automobiles, upkeep, when deduct- ible, 104 Bad debts, 78, 120; classes of, de- ductible, 120; individual, partner- ship and corporation bad debt losses, 121, 198, 220 Bank deposits, interest on, 67 Banks, private, 79, 171; co-opera- tive, 174 Baumbach vs. Sargent decision, 354 Beer, ale and porter, war tax on, 516 Beneficiaries, duties of under estate tax, 397 Beneficiary, defined, 283; foreign, 287; tax paid by, 294 Bethlehem Steel Corporation, divi- dend paid by, 86 Beverages, tax on, 493 Billiard rooms, tax on, 467 Boats, tax on, 487, 4-91 Bond yields, effect of tax on, 136- 137 (Charts) Bonded indebtedness, reduction of, 198 Bonds purchased above or below par, 68, 69, 193, 200; Stamp Tax on, 522 Bonuses, 51, 210 Book appreciation, 57, 200; depre- ciation, 218 Bowling alleys, tax on, 467, 473 Brackets, in Excess Profits grad- uated tax computation, 693 Branch corporations, 171, 172 Brokers, losses, when deductible, 120; tax on, 459, 471; under Ex- cess Profits tax, 649 Building and loan shares, 98, 174 721 722 INDEX Buildings, losses in reconstruction of, 118; on leased ground, 216 Business, income from, 52; losses, 113; defined, 114; transaction of, defined, 353; individual engaged in more than one, 688 Cabarets, 602, 607; time of filing returns, 604 Cameras, tax on, 486, 490 Campaign contributions, 211 Capital, constructive, 703 Capital account, adjustment of, for intangible property, 668; tangible property, 669, 670; mixed tan- gible and intangible property, 670; example, 682 Capital assets, sale of, 202 Capital stock certificates, tax on, 525 Capital stock, valuation of, 362; earnings required to maintain par value, 365 Capital stock, tax on original issue, 569; sales or transfers, 526, 569; regulations, 528-543 Capital Stock tax, 347; corporations liable, 348; basis of, 361; rate and computation, 375, 381-384; on foreign corporations, 376 Casualty insurance, tax on, 587, 594 Cash discounts, 186 Cemetery companies, 175 Certificates of indebtedness, 524 Champagne, tax on, 517 Charts of tax rates, 127, 133-137; interest, 164; depreciation, 225 Checks, in tax payment, 346 Cigarettes and cigars, see Tobacco Circuses, tax on proprietors of, 464, 472 Citizen, defined, 36 Civic leagues, 175 Civil War and other taxes, 1-12 Clearing house, defined, 529, 545; records kept by, 550, 552; returns made by, 554 Clergymen, income of, defined, 50 Close corporations, 168 Clothing, expense not deductible, 104 Club dues, tax on, 603 Clubs, social, 175 Collection districts and collectors, 609; New York City, 623 Collector, returns made by, 331 Commissions, real estate, 106 Commutation, expense not deduc- tible, 48, 106 Composition in bankruptcy, 121 Compromise, of tax suits, 28; of in- debtedness, 121, 198 Conservator, defined, 282 Consolidated concerns, 697; returns of, 697 Consolidated returns, 719 Constructive capital for application of rates, 703 Contracts, uncompleted, 57, 189; paid for in stock, 208 Contributions, 100, 113, 302, 709 Corporations owned by exempt or- ganizations, 168; in existence for part of year, 168; dissolved, 168; in liquidation, 169; not transact- ing business, 169; not entirely or- ganized, 170; exempt, 172 Cost or market valuation, 54, 183, 184 Credit insurance, premiums deduc- tible, 221 Custom house brokers, tax on, 462 Custom house entries and withdraw- als, tax on, 558, 573 Customs duties deductible, 112 Damages recovered, 77 Dance halls, tax on admission to, 602 Dealer in securities, 115, 185 Debentures, 524 Debts, deductible, 302, 304 Decedent's estate, 128; non-resident, 285, 287, 393 Declining balance methods of calcu- lating depreciation, 227 Deduction at the source, 258 Deductions, under Income Tax, indi- viduals, 99; corporations, 206; under Excess Profits tax, 691 Deferred dividends, 191 Depletion, defined, 233; of mines, 233; basis for value as of March 1, 1913, 233; cost basis, 234; cal- culation of depletion, 235; book- keeping requirements, 235; lessees, 236; oil and gas wells, 237; of oil field, 239; of timber land, 241; of agricultural land, 242 Depositors' guaranty fund, 214 Depreciation, 100; on buildings, 119; on idle plant, 122; limited to cost, 123; accounting methods, 123; rate of, 223; chart, 225; of intangible assets, 230; under Mu- nitions tax, 447; Excess Profits tax, 677 INDEX 723 Depreciation reserve, conversion into tangible assets, 233; of in- surance companies, 243 Dictaphones, 482 Discount on bonds, in accounting, 69; tables, 413-416 Discounts, 186 Dissolved corporations, 168; inac- tive, 169 Distributable profits, of partner- ship, 114 Dividends, 78-87, 128-130; of other corporations, 167; income from, 195, 297; paid out of most re- cently accumulated surplus, 197; salaries representing, 210; with- holding provisions, 270 Division of business co-operation, 19 Divisions, Internal Eevenue, and agents in charge, 619 Divorced persons, 78 Domiciliary administrator, 287 Donations, 212 Drafts, stamp tax on, 557, 572 Dues, 105; tax on, 596 Duties, customs, deductible, 112 Electric motor boats, taxable, 439 Employees' accident insurance, 77 Employees, retired, 210 Endorsement of note of insolvent, 122 English Excess Profits tax, 8-13 Estate during period of settlement, 286; income of reported by fidu- ciary, 289, 298 Estates, exemption allowed, 132 Estate tax, 385, 422, 430, 482; ear- lier measures, 385-387; definitions, 387; gross estate, 388; net estate, residents ', 391 ; non-residents ', 931 ; specific exemption, 391; "30-day notice," 394; duties of executors and administrators, 394, 426; of beneficiaries, 397; of banks and safe deposit companies, 401; of agents of non-resident decedents, 404; of corporate agents, 406; re- turns, 408; tentative and final re- turns, 409; gifts in contemplation of death, 410, 424; valuation of stocks and bonds, 411; discount for prepayment, 414; discount ta- bles, 416; rates of tax, 418, 423, 431, 432; payment, 419, 425, 427; penalties, 421, 429 Ethyl and denatured alcohol, 512 Excess Profits Advisory Board, 17, 18 Excess Profits tax, 8; English, 9; law, 625-638; chapter on, 639-698; regulations, 699-719; who must pay, 640, 700; 8 per cent tax, 644; income exempt, 627, 645; specific exemptions, 645; returns, 650; graduated tax, 650; income taxable, 651; amount how deter- mined, 652; rates, 626; deductions, 628; law of March 3, 1917, re- pealed, 637; credit for taxes paid under, 637; example of computa- tion of invested capital, 681; consolidated returns under, 697; deduction for income tax, 697; claims for abatement, 697; rate and computation, 700 Exchange of securities, 61 Excise tax on corporations, 375 Excise taxes on commodities, 477, 490 Executor defined, 282 Exempt corporations, 315 Exempt income, 39-46; earned prior to 1913, 44, 300, 305; of foreign governments, 338 Exemptions, personal, 127, 305 Expenses, when deductible, 48; al- lowance for traveling, 50; busi- ness and partnership, 102; per- sonal, 103; landlord's, 106; ordi- nary and necessary, 206; capital expenses and income expenses dif- ferentiated, 206; cash, accrued or prepaid expenses, 207; other than cash, 208; distinguished from gra- tuities, 212; organization, 214 Explosives, tax on manufacturers of, 438 Express charges, tax on, 581, 590 Express companies, tax on, 460 Extensions, 307 Fair market price, 64, 203 Fairs, tax on, 603 False or fraudulent returns, see Pen- alties Farm, income from, 52, 65; deduc- tions, 107; expenses, 102 Farm loan associations exempt, 177 Farm products, held for higher prices, 108 Farmer, defined, 65; deductions al- lowed, 107 Farmers' associations, 177 Federal estate tax, 385 Federal farm loans, income from, 39 724 INDEX Federal Keserve banks, dividends of, 198 Fees, professional and vocational, 52 Fidelity bond premiums, 105 Fiduciaries, 70, 151; defined, 281; returns of information by, 278 Fiduciaries, returns filed by, 283, 289, 307; taxes paid by, 284-294; gross income reported by, 289 Filing returns, see Eeturns Firearms, 438 Fire losses, 116 Fiscal year, partnership, 132, 151; of corporation, 253, 698; rates ap- plicable to, 253; returns on basis of, 255 "Fixed percentage," depreciation, 226 Floor taxes on commodities, 478, 490, 512, 517 Foreign concerns, income from U. S., 75; from foreign sources, 75 Foreign corporations, 171, 259, 320, 628; subject to capital stock tax, 348, 360, 382 Foreign income, 75 Foreign tax payments, 35 Fraternal societies, 174 Fraudulent returns, see Penalties Freight charges, tax on, 577, 590 Fruit growers' associations, 173, 177 Future sales, tax on, 544 Gain or loss, computation of by in- ventory method, 181 Gas wells, depletion of, 237 Gifts and legacies, property ac- quired through, 41, 144 Gifts or bonuses, when classed as income, 50, 210 Good-will, 60, 202, 231; donations for obtaining, 212; under Excess Profits tax, 675; not subject to appreciation or depreciation, 676 Government officials, expenses of, 43, 49; reimbursement of, 49 Greenhouse losses, by frost, etc., 116 Graduated tax, determination of amount of, 690; where concern not in business during pre-war period, 691 Gross estate, defined, 388, U23; net estate, 391 Gross income of individuals, 44; of corporations, 180; of insurance companies, 189 Gross profit, computing, 53 Gross receipts and deductions, 142 Guardian, defined, 127, 128, 281 Gulf Oil Corporation vs. Lewellyn, 83 Head of family, 1916 law, 130; 1917 law, 132, 306 Heirs and other beneficiaries, 397; 30-day notice filed by, 399 Holding companies, 195, 350 Husband and wife, 127 Hypothecation of stock, 97 Improvements to property, 123, 302 Inactive corporations, 169; not sub- ject to Capital Stock tax, 349, 382 Income, defined, 37; when report- able, 39, 44, 46, 78; total net, 151; deductions allowed, 38; ex- empt, 39, 300; earned in previous years, 44, 45; book value appre- ciation of, 57; from business, 52; from sales of property, 59; from farm, 65; from interest, 67; from tenants' improvements, 67; from fiduciaries, 70; from partnerships, 71-74; from special sources, 76; from bad debts, 79; from private banks, 79; from rentals, 191; from dividends, 297; not tax -paid, 145; taxable and non-taxable, 199; of individuals, defined, 298; subnor- mal, how determined, 692 Income Tax, 296; of 1894, 2; 1909, 1913, 3; 1916, 4; present law, 32; when deductible, 111; rate of tax, 252 Indebtedness outstanding, 249 Indemnity bonds, tax on, 525 Individual gross income, deductions from, 99 Individual income tax, 32; rate of tax, 126; computation, 155 Individuals liable to tax, 126 Information at source, 258, 277 336 Inheritance of property, 41 Inheritance taxes, not deductible, 111; Federal Inheritance tax, 385 Insane persons, income of, 285-288 Insanitary buildings, destruction of, 119 Insurance, 40, 41; commissions of agents, 51; accident, 77; pre- miums, 106; paid in advance, 207; tax on, 587, 593 Insurance companies, depreciation, 189-191; reserves of, 243 INDEX 725 Intangible property, when invested capital, 633, 663; average, 663; adjustment of capital account, 668; valuation of, 686; defined, 711; "20 per cent limitation," 714; valuation of, 715, 717 Intercorporate relations, informa- tion of required, 719 Interest received, 67-75, 192-194, 246; paid, 109, 243, 246, 301, 320; on loans for purchase of Liberty bonds, 109, 153; on U. S. bonds, 130, 144; on sinking fund, 194; paid for use of property, 245; calculation of amount deductible, 247, 249 Internal Revenue, organization, 18 Interpretation of tax laws, 19 Inventory valuation, at cost or mar- ket, 54; practical considerations, 54; at end of fiscal year, 55, 142, 185 Invested capital, defined, 632; of corporation or partnership, 633, 666; of individual, 634, 685, 716; of foreign corporation or partner- ship, 634; of non-resident alien, 634; indeterminable, 635, 689, 705; when ownership has changed, 665; computation of, 663, 666, 681, 688, 717; adjustments, 679, 681, 684, 712; general provisions, 710; for pre-war period, 712; in exceptional cases, 712 Irrigation companies, mutual, 176 Jewelry, tax on, 483, 489 Joint-stock companies, 165; Capital Stock tax on, 348, 382 (see Massa- chusetts Trusts) Labor, cost of, as a deduction, 142 Labor unions, 173 Land, no depreciation admitted, 226 Land banks exempt, 177 Landlord's expenses deductible, 106 Legacies and gifts, 41, 144 Legal advisory board, 17 Lessee corporations, 191 Lessor corporations, 170 Liability for filing return, 141 Liberty Loan bonds, income from, 42, 109, 130, 192 License for collecting foreign in- come, 279 Life insurance companies, 191 Life insurance policies, premiums on, 106, 107, 201, 213, 339; pro- ceeds from, 40, 200, 300; tax on, 587 Life of asset, 224; chart, 225 Limited partnerships, 79, 165 Liquors, tax on, 493 Live-stock, cost of, 108 Loans to stockholders, 253 Losses in business, 113, 301, 304; other than business, 117; by theft, 115; fire, crops, accident, 116; live-stock, 108; bad debts, 120; mortgage foreclosure, 122; bonds, 122; depreciation and de- pletion, 217; sale of bonds, 218; real estate, 219; stock transac- tions, 219; classes deductible, 217 Magazines and books, when cost is deductible, 105 Manufacturer, defined, 435, 480 Manufacturing corporation, inven- tories of, 187 Market value, inventory at, 184, 188 Maryland Casualty Co. vs. U. S., 243 Massachusetts Trusts, 165, 351 McCoach vs. Ins. Co. of North America, 243 Medicinal preparations, tax on, 485, 480 Membership dues, 105 Mercantile corporation, valuation of stock, 365 Mineral waters, tax on, 518 Mines, depletion of, 233, 302 Mining corporation, valuation of stock, 365 Minors, 127, 128, 281, 285, 288 Mortgage foreclosure losses, 122 Motor boats, tax on, 439 Motor vehicles, 481, 488 Moving picture films, tax on, 483, 488 Munition Manufacturer's Tax, 434, 451 ; manufacturer defined, 435; time when effective, 434, 452, 457; basis of tax, 435; rate of tax, 435, 452; computation, 436; articles taxable, 436, 451; part, defined, 437; net income, how determined, 440; gross income, 440; deductions allowable, 442, 452 ; raw materials, 442; expenses deductible, 443; returns, 448, 453; assessment and payment, 448, 454 ; penalties, 449, 455; expiration of, 637 726 INDEX Munitions, articles classed as, 437- 439, 451 Musical instruments, 482; tax on, 488 Mutual fire insurance companies, 190; marine, 190 Mutual insurance companies, 176 Mutual savings banks, 173 Net estate, defined, 391, 424 Net income, 37, 145, 146, 147, 151; deductions allowable in comput- ing, 99; under Excess Profits tax, 700; general provisions, 708; of corporations, 706; of partnerships, 707; of individuals, 708 Nipissing Mines Co. decision, 359 Nominal capital, 147; defined, 718; determination of tax on, 695; rate of tax on business having, 635; distinguished from invested cap- ital, 646 Non-resident aliens, returns by, 33, 37, 44; deductions, 100; distin- guished from citizens, 101; con- tributions to charitable organiza- tions, 113; liability to tax, 126; withholding against individuals, 259; corporations, 260 Normal tax, calculation of, 158 Notes, promissory, tax on, 557, 572 Notice, of assessment, 25 Obsolescence, 224; in computation of invested capital, 710 Occupational Tax, 458; persons lia- ble to, 458; exemptions. 466; to- bacco manufacturers, 467-470; penalties, 470, 474 Oil pipe lines, tax on, 586 Oil wells, depletion of, 237 Operations, income from, 181 Organization expenses, 214 Organizations, charitable, 113 Overhead, 188 Parcel post packages, tax on, 561, 574 Parent companies, 166-168 Partial payments of tax, 161 Partners, returns of individual, 308 Partnership Excess Profits tax, de- ductible from Income tax paid by members, 697 Partnerships, income from, 57, 71; interest on Liberty bonds, 73; lim- ited, 79; deductions, 132, 145; fis- cal year of, 132, 309; subject to Munitions tax, 434; Excess Profits tax, 636, 707 Patent rights, 76, 192, 230, 714 Pawnbrokers, tax on, 461, 471 Payment of tax, 160; in advance, 161; with Treasury certificates, checks, 346; refund, 327 Penalties for negligence and for fraud, 22-24, 333 Pensions, 77, 210 Perfumes, tax on, 485 Personal expenses, not deductible, 103 Philippine and Porto Kican resi- dents, 21, 126, 335, 345 Piano players, tax on, 482 Playing cards, tax on, 559, 573 Political sub-division, defined, 41; taxability of interest on mort- gages of, 42 Porto Eico and Philippines, taxes in, 21, 126, 335, 345 Powers of attorney, tax on, 559, 573 Preferred stock, valuation of, 374 Premium paid on bonds, 69 Premiums, insurance, 105 Prepaid expenses, 207 Prepayment of taxes, 345 Pre-war income of non-resident aliens, 656; of partnerships, 657; of domestic corporations, 657; of foreign corporations, 658 Pre-war period, 626, 631, 704; in- come of, 653; when citizen or resi- dent not then engaged in business, 655; where income cannot be de- termined, 655 Private banks, 171 Produce sales on exchanges, 520, 571 Professional and vocational fees, 52 Profit, gross, 53; from property ac- quired by gift, 64; from partner- ships, 71; from sale of property, 59, 204; not used in business, ad- ditional tax on, 252; not dis- tributed or used in business, 299; averaged, for Excess Profits tax, 686 Promissory notes, tax on, 557, 572 Property, bequeathed, 41; deprecia- tion on, 122; leased by corpora- tions, 170; repairs to, 221; pur- chased for capital stock, 205 Proxies, tax on, 559 Public exhibitions, tax on, 465, 473 Public utilities and insurance tax, 575 Public utility corporations. 178 Public utility earnings, 216; valua- tion, 365 Pullman tickets, tax on, 583, 591 INDEX 727 Bacing associations, tax on, 603 Badio messages, tax on, 586 Bate of tax, 1916 law, normal, 127; deductions from normal tax, 127; super- tax, 129; 1917 law, 131; table of additional rates, 131; chart of rates, 133-137, 160; of in- come tax, 252; additional war tax, 341; Excess Profits tax, 693 Eaw materials, 187 Eeal estate, profits, 59, 143; losses, 219; agents' commissions, 106; conveyances of tax on, 558 Eealty corporations, 177 Eeceiver, defined, 282, 352 Eectified spirits and wines, tax on, 513 Eedemption of unused stamps, 508, 562 Eefund, 27; of stock dividend taxes, 98; of tax withheld in 1907, 340 Eegistered bonds, withholding pro- vision, 264 ff. Eegulations, Excess Profits, 699 Eelease of tax withheld at source, 276 Eeligious and charitable associa- tions, 175 Eenewals, 221 Eent, defined, 66; when reportable, 66; in considerations other than cash, 66; paid in improvements to property, 67; in crop shares, 65; of rooms used for business, 104; of residence not deductible, 112 Eentals, classified, 215 Eents, royalties and interest, 191 Eeorganized business, deemed con- tinuous, 629 Eepairs, 123, 213; defined, 221 Eeserved seats, tax on, 607 Eeserves, dividends from, 80; for losses, 220, 323 Eesidence, defined, 36; legal, 139; taxes on, 111 Eeturns, failure to file, 22; access to, 29; by whom filed, 32, 38; auditing of, 26, 181, 329', of infor- mation, 277, 718; of withholding corporations, 275 Eesidual value, 223 Eevaluation of assets, 80 Eights to subscribe, 63 Eoyalties, patent rights, etc., 76, 191 "Bulings," "Eegulations," "De- cisions," etc., defined, 19, 20 Salaries, wages and commissions, 48, 142, 208 Salary, when deductible, under Ex- cess Profits tax, 659; paid to part- ners, 707; paid to self, 709; when treated as dividends, 210; of sol- diers, 210 Sales, yearly, 182 Salesmen's "treating money," 212 Scrip dividends, 82 Season tickets, 600 Second Liberty Loan bonds, 192 Securities, profits from sale of, 64; left by decedent, 64; dealers in, 115; issued for mixed tangible and intangible property, 714 Separate returns, by married per- sons, 719 Servants' wages, 104 Ship brokers, tax on, 461, 471 Sinking fund, interest on, 194; de- preciation, 228 Specific exemptions (normal tax), 127 Source, withholding, deduction and information at, 258 "Sources within U. S.," defined, 44, 58, 101 S. P. E.E, vs. Lowe, 196 Spirits, wine, 497; distilled, 509', floor tax on, 512 Sporting goods, tax on, 485, 489 Stamp taxes, 520, 564; documents taxable, 520; Schedule A, 568 Stamps, sale of, 542; requisitions for, 542; redemption of, 562; pen- alties for fraudulent use of, 563, 565 State officers and employees, 43 State profits from public utilities exempt, 179 Stock brokers, registration of, 530 Stock dividends, 87, 156; double tax- ation of, 88; under 1913 law, Towne vs. Eisner, 88; taxable un- der present laws, 91; "Times" editorial on, 92 Stockholders' salaries, 209 "Stock in trade" inventoried, 184 Stock returned to corporation, 713; tax on issue, sale or transfer of, 525 Stock transactions, profits from, 60; losses in, 114, 120, 219 Submarines, taxable, 439 Subnormal income, 692 Subsidiaries, 166-168, 195, 374 Suit for refund, 28 Super-tax, 129, 130; calculation, 153; chart, 154 Supplemental statement, tax-exempt securities, 193 728 INDEX Surplus, dividends from, 80; when earned, 197; earned prior to 1913, 82; included in invested capital, 715 Surplus account, adjustment of, un- der Excess Profits tax, 672 Tangible property, adjustment of shares of stock issued for, 669, 670; valuation of, 685; defined, 711 Taxable year defined, 625, 653; net income during, of individuals, 658; partnerships, 661; corporations, 662 Tax-free covenant bonds, 151; with- holding provisions, 266 Taxes, deductible, 110, 250, 304, 320; State taxes, 251; prepaid taxes, 207, 251; paid by banks for stock- holders, 112, 251; on tax-free covenant bonds, 251, 711 Telegraph messages, tax on, 586 Telephone companies, mutual, 176 Telephone messages, tax on, 586 Temporary bonds, 523 Tenant, betterments made by, 66, 67, 216 Tentative returns, 257 Theaters, tax on admission to, 599; on proprietors of, 462, 472 Theft, losses from, 115 Thirty-day notice, 405 Tickets, foreign passage, 559, 573 Timber land, depletion of, 241 Time policies of insurance, 201 Tobacco manufacturers, tax on, 467- 470, U73 Toilet articles, tax on, 485, 489 Towne vs. Eisner, 89-91 Trade, defined, 114, 699; losses in, 114, 115; income from, 52 Transaction, closed or completed, 63; entered into for profit, 117, 700 Transportation, tax on, 575, 582, 590 Traveling expenses, 50 Total net income, 151 Treasury certificates, in tax pay- ment, 346 Treasury decisions, etc., defined, 19, 20 Trustee, defined, 281 Trust estate, income of, 285 Uncompleted contracts, 189 Undistributed profits, tax on, 252, 299, 314 United States, defined, 21, 36 Valuation, inventory, 187; of stock, 361 Value as of March 1, 1913, how de- termined, 64 Wages, servants', 104 War Estate tax, 430; rate, 431 War Excess Profits tax, 625, 639; Regulations No. 41, 699 War Excise taxes, 477; articles tax- able, 478; by whom paid, 480; re- turns, 480, 486; penalties, 487 War Income Tax, 341; on corpora- tions, 344 "Weighted year" method, deprecia- tion, 226 Wine, tax on, 493 Withholding at the source, 258, 310, 326; fiduciaries, 293; rate of tax withheld (chart), 261; refund of tax withheld, 263; tax on bond in- terest withheld, 264 ff. Worthless stock, losses from, 114 Yachts, tax on, 487, 491 Yield of war taxes, 13 /%xr TOT! LAST DATE RETURN CIRCULATION DEPARTMENT 202 Main Library t >42-3403 RETURN CIRCULATION DEPARTMENT TO 202 Main Library LOAN PERIOD 1 HOME USE 2 3 4 5 6 E nped below ALL BOOKS MAY BE RECALLED AFTER 7 DAYS 1 -month loans may be renewed by calling 642-3405 6-month loans may be recharged by bringing books to Circulation Desk Renewals and recharges may be made 4 days prior to due date DUE AS STAMPED BELOW i NOV 13 1978 sen mm nrr i c r*A A, BERKELEY 720 UNIVERSITY OF CALIFORNIA, BERKELEY FORM NO. DD6, 40m, 3/78 BERKELEY, CA 94720 YD 05474 UNIVERSITY OF CALIFORNIA LIBRARY