XXII

XVII Credits and Exempt Income

Income from Personal Services-"Earned" Income

Income from Business

Income from Sale of Property on the Installment Plan XXIII Income from Gains upon Sale or Exchange of Property-The Closed Transaction

XXIV Income from Gains upon Sale or Exchange of Property-Computation of Gain and Tax

XXV Income from Gains upon Sale or Exchange of Property Appraisals, with Particular Reference to March 1, 1913

XXVI Income from Gains upon Sale or Exchange of Property-Capital Gains

XXIX

Income from Interest-General

Income from Interest on Obligations of the United States XXX Income from Rents

In addition to the deductions from gross income which are fully discussed in Chapters XXXIV to XLIV, the tax laws have provided other means of reducing tax liability. Taxpayers in receipt of large incomes are chiefly interested in the various classes of wholly exempt income; taxpayers with smaller incomes are chiefly interested in the specific exemption credits. There is this difference between deductions and credits: the former affect surtaxes as well as the normal tax; credits for specific exemptions, dividends and the like, reduce only the normal tax. Credits and exempt income are both discussed at this point because the net effect of each is to reduce

the amount of taxes which would be due if taxpayers merely reported their income from all sources.

Income Exempt from Normal Tax Only-“Credits"

The law imposes a normal tax of 6 per cent1 on the net income of individuals, and graduated surtaxes upon the larger incomes. It imposes a flat 121⁄2 per cent rate (no surtaxes 2) upon the income of corporations. Partnerships are not taxed as independent units, the partners instead being taxed upon their respective shares of the profits whether or not distributed. Certain individual income is exempt from the normal tax, but is nevertheless subject to the surtax rates, the adjustment being made by "crediting" (section 216) these items of income for purposes of the normal tax only. Even in the case of corporations, where no surtax rates apply, there are certain items 5 which, for reasons now obsolete, are entered as "credits" (section 236) rather than as deductions. In this chapter the exemptions and credits alluded to are discussed.

The personal exemptions: wife and dependents.—

LAW. Section 216. (c) In the case of a single person, a personal exemption of $1,000; or in the case of the head of a family or a married person living with husband or wife, a personal exemption of $2,500. A husand and wife living together shall receive but one personal exemption. The amount of such personal exemption shall be $2,500. If such husband and wife make separate returns, the personal exemption may be taken by either or divided between them."

1 Reduced to 2 per cent on the first $4,000 and to 4 per cent on the next $4,000 for citizens and residents. See page 180. For similar provision relating to income from labor or personal services in United States of aliens who are residents of Canada or Mexico see Chapter XLVI.

2

[Former Procedure] Up to December 31, 1921, there was the excess profits tax in addition, but the flat rate of income tax was only 10 per cent from 1919 to 1921. See Excess Profits Tax Procedure, 1921, Chapter IV, and Income Tax Procedure, 1922, pages 161 and 1575.

For a full statement see Chapter XXXIII.

Certain dividends, certain interest, and the personal exemptions.

The specific exemption of $2,000 on incomes of $25,000 or less, and of certain interest.

6

'The effect was to include these items in the term "net income" when the excess profits tax rates were applied and to exclude them when the income tax rates were applied.

7

[Former Procedure] The 1913 law [section II (C)] and the 1916 law [section 7 (a)] permitted the deduction "for the purpose of the normal tax only" and made the exemption $3.000, plus $1,000 additional if the person making the return were married, with husband or wife living with her or him. The normal tax, which was I per cent under the 1913 law, was made 2 per cent in 1916. The 1917 law allowed this arrangement to remain in force,

The personal exemption of $2,500 may be taken by either husband or wife or may be divided between them in whatever amounts seem most satisfactory. Husband and wife together are entitled to a total exemption of $2,500. Therefore when it was found that an amended return of a wife who had originally taken the full exemption showed no taxable income the husband was allowed to amend his return so as to take advantage of the exemption.8

TEST OF DEPENDENCY.—

REGULATION. A taxpayer, other than a non-resident alien who is not a resident of Canada or Mexico, receives a credit of $400 for each person (other than husband or wife), whether related to him or not and whether living with him or not, dependent upon and receiving his chief support from the taxpayer, provided the dependent is either (a) under eighteen or (b) incapable of self-support because defective. The credit is based upon actual financial dependency and not mere legal dependency. It may accrue to a taxpayer who is not the head of a family. But a father whose children receive half or more of their support from a trust fund or other separate source is not entitled to the credit. (Art. 304.)

RULING. A father who furnishes the chief support of his child is entitled to the credit for a dependent whether the custody of the child has been awarded to the mother under the court decree or whether the support is furnished as the result of an agreement between husband and wife not entered into through court proceedings. If the court orders the father to pay the wife alimony and no specific mention is made in the decree as to any amount to be set aside for the support of the child, the father is not entitled to the credit for a dependent, even though the alimony is the only means which the wife has for the support of herself and child. (III-43-1840; I. T. 2096.)

but added what in effect was a second and distinct income tax with an additional normal rate of 2 per cent. For the purpose of this new 2 per cent tax the exemptions of $3,000 and $4,000 provided in the 1916 law were changed to $1,000 and $2,000 (1917 law, Title I, section 3). Consequently there were two sets of exemptions in 1917, one for each normal tax of 2 per cent. The 1918 law provided for one set of exemptions of $1,000 and $2,000 [1918 law, section 216 (c)].

Under the 1921 law the exemption for a married person or for the head of a family was $2,500 if the net income did not exceed $5,000; otherwise the exemption was $2,000 [section 216 (c)]. See Income Tax Procedure, 1924, pages 390-392. Where the net income slightly exceeded $5,000 an adjustment was allowed, see C. B. I.-1, page 200, I. T. 1173.

(d) $400 for each person (other than husband or wife) dependent upon and receiving his chief support from the taxpayer if such dependent person is under eighteen years of age or is incapable of self-support because mentally or physically defective.

9

III-42-1830; I. T. 2090.

[Former Procedure] This is the same as in the 1921 law but is an increase of $200 in the exemption allowed for each dependent under the 1917 and 1918 laws. The 1913 and 1916 laws allowed no exemption for dependents.