Plan of treatment.-In the following fifteen chapters are discussed in detail the various types of income subject to the income tax. Income from personal services, business, property, interest, rents, dividends, etc., are taken up in regular order and the procedure peculiar to them is explained. However, in addition to these particular subjects there are many questions which are general in their nature and application. These are brought together for treatment in this introductory chapter.

Variations according to class of taxpayer.-It should be observed that, unless otherwise indicated, statements made in the text are to be accepted as applying to corporations and individuals alike. So much of the procedure applies to all classes of taxpayers that it has been deemed desirable to isolate only the exceptional points, indicating plainly in such cases the limitations upon the application.

"Catch-all" provision.-The law states (section 213) that "gains or profits and income derived from any source whatever" are subject to the tax. To provide for possible lapses in the law and regulations the following "catch-all" provision was included in a previous edition of the regulations. The statements made are still pertinent.

REGULATION. The intent and purpose of the income-tax law is that all gains, profits, and income of a taxable class shall be charged and assessed with the corresponding income tax, normal and additional, and such tax shall be paid by the owner of such income or the proper representative thereof having the receipt, custody, control, or disposal

of the same. In any case where the conditions which obtain do not appear to fall within the law and regulations for the assessment and collection of the income tax, the proper tax shall be assessed in the particular case by the Commissioner of Internal Revenue upon his findings concerning the same. Ownership of income and liability for tax thereon shall be determined as of the year for which the return is required to be rendered. (Reg. 33, 1918, Art. 49.)

Nature of taxable income.-The concept of income adopted in the law is not an entirely clear and logical one. In general it imposes the tax only when the income is reduced to money, but in certain cases this rule is not followed, the law taxing some income in forms other than money.1

What is needed is an authoritative definition of "income." This cannot be found in the decisions of the Supreme Court, because they contain too many differentiations and limitations to make clear what a decision will be in any future case.

The following definition of income is of interest. It should, however, include the word "realized" when applied to taxable income:

Income is the money value of the net accretion to one's economic power between two points of time."

The regulations define income as follows:

REGULATION. . . . In general, income is the gain derived from capital, from labor, or from both combined, provided it be understood to include profit gained through a sale or conversion of capital assets. . (Art. 31.)

It appears from some court decisions that doubt exists as to the taxability of certain transactions which involve so-called capital. The Circuit Court of Appeals, Second Circuit, held that a gift to a corporation is not taxable income. In defining the word "income," 4

1

The 1917 and former laws purported to tax only realized income but the Treasury assessed taxes on many exchanges in which there was no realized income. The 1918 law contained a formula for computing income in the case of exchanges which depended more on par or face value of securities than on actual values.

2 Robert Murray Haig, "The Concept of Income-Economic and Legal Aspects," The Federal Income Tax, Columbia University Press, 1921.

4

U. S. v. Oregon-Washington R. & Nav. Co., 251 Fed. 211.

"However, the tax, though it includes income from all sources,' nevertheless includes 'income' only, and the meaning of that word is not to be found in its bare etymological derivation. Its meaning is rather to be gathered from the implicit assumptions of its use in common speech. The implied distinction, it seems to us, is between permanent sources of wealth and more or less periodic earnings. Of course, the term is not limited to earnings from economic capital; i. e., wealth industrially employed in permanent form. It includes the earnings from a calling, as well as interest, royalties, or dividends, though in the case of corporations this may be of slight importance. Yet the word un

the court said: " . . . . it (income) should not include such wealth as is honestly appropriated to what would customarily be regarded as the capital of the corporation." One judge, dissenting, said: "I find no difficulty in calling it (the gift to the corporation) income."

Under the circumstances, no apology is needed to justify a careful inquiry into the right of Congress or of the Treasury to extend the taxation of income-which is permitted under the sixteenth amendment to the taxation of capital-which is not permitted. Such an inquiry naturally should cover the right to tax any transaction unless there is an actual realization of income, as distinguished from the apparent income which may be, and often is, the result of temporary fluctuations in values.

INCOME IN CASH OR EQUIVALENT."-The use one enjoys of his own property-as, for example, the house in which the owner livesis not considered taxable income. Ordinarily income, to be taxable, must be in the form of money. Thus, the farmer's crop is not taxable until it has been reduced to cash (if the inventory method is not used) and one piece of property exchanged for another "of a like kind" (other than securities) gives rise to no immediate taxable income. However, income from personal services is taxable “in whatever form paid." 8 This is true apparently on the theory that in these cases there is some basis for the determination of the cash value of the income even though the income itself is in a form other than money, such as accounts receivable or mortgages. If an individual reports on a cash basis, however, the accounts receivable would not constitute income until collected.

REGULATION. Items of income and of expenditures which as gross income and deductions are elements in the computation of net income need not be in the form of cash. It is sufficient that such items, if otherwise properly included in the computation, can be valued in terms of money. . . .. (Art. 22.)

CLOSED TRANSACTIONS IN PROPERTY.-The attempt to tax accretions of property values has raised an interesting series of problems questionably imports, at least so it seems to us, the current distinction between what is commonly treated as the increase or increment from the exercise of some economically productive power of one sort or another, and the power itself, and it should not include such wealth as is honestly appropriated to what would customarily be regarded as the capital of the corporation taxed." See Art. 33 and 34. pages 523 and 528.

See Chapter XLIX.

Section 203 (b-1).

Section 213 (a).

turning upon the question: What constitutes a closed transaction or a realization definite enough to serve as the basis for the imposition of a tax? This topic is discussed in detail in Chapters XXIIIXXVI.

"Gross" and "net" income.-The 1924 law devotes, in the case of individuals, one section to the enumeration of the items included and not included in the term "gross income" (section 213) and another to "deductions" (section 214), and declares "net income" to be the remainder obtained by deducting the second from the first. The items, such as dividends, personal exemptions and interest on certain government securities, which are subject to the surtaxes but not to the normal tax, are provided for by a series of "credits" described in another section (section 216). As a result "gross" income is a special term which excludes, by specific direction of the statute, certain items such as gifts and proceeds of insurance policies paid upon the death of the insured, and which likewise excludes, on grounds of the fundamental definition of income, such items as alimony and damages received for personal injuries." "Net" income is also a special term which, in the case of individuals, includes dividends, etc. The same general plan is followed in defining the “gross" and "net" income of corporations (sections 232-236).

The explanation in the regulations of the concepts of gross and net income is as follows:

REGULATION. The tax imposed by the statute is upon income. In the computation of the tax various classes of income must be considered: (a) Income (in the broad sense), meaning all wealth which flows in to the taxpayer other than as a mere return of capital. It includes the forms of income specifically described as gains and profits, including gains derived from the sale or other disposition of capital assets. Income can not be determined merely by reckoning cash receipts, for the statute recognizes as income-determining factors other items, among which are inventories, accounts receivable, property exhaustion, and accounts payable for expenses incurred. (b) Gross income, mean

The

ing income (in the broad sense) less income which is by statutory provision or otherwise exempt from the tax imposed by the statute." (c) Net income, meaning gross income less statutory deductions. statutory deductions are in general, though not exclusively, expenditures, other than capital expenditures, connected with the production of income." ... (d) Net income less credits." . . . . The surtax is imposed upon net income; the normal tax upon net income less credits. Although taxable net income is a statutory conception it follows, subject to certain

C. B. I-1, page 92; Sol. Op. 132, quoted on page 466. 10 See Chapter XVII.

11 See Chapters XXXIV to XLIV.

12 See page 452 et seq.

modifications as to exemptions and as to deductions for partial losses in some cases, the lines of commercial usage. Subject to these modifications statutory "net income" is commercial "net income." This appears from the fact that ordinarily it is to be computed in accordance with the method of accounting regularly employed in keeping the books of the taxpayer. (Art. 21.)

....

Income accrued prior to March 1, 1913, not taxable.—

REGULATION. Any claim existing unconditionally on March 1, 1913, whether presently payable or not and held by a taxpayer prior to March 1, 1913, whether evidenced by writing or not, and all interest which had accrued thereon before that date, do not constitute taxable income, although actually recovered or received subsequent to such date. Interest accruing on or after that date is taxable income. Where an interestbearing claim held on February 28, 1913, is paid in whole or in part after that date, any gain derived from the payment of the claim is taxable. The amount of such gain is the excess of the proceeds of the claim (both principal and interest) exclusive of any interest accrued since February 28, 1913, already returned as income, over the cost thereof (both principal and interest then accrued). However, the gain to be included in gross income where the fair market value of the claim as of March 1, 1913, is greater than the cost thereof, is the excess of the amount received over such value. In the case of an insurance policy its surrender value as of March 1, 1913, may be used as a basis for the purpose of ascertaining the gain derived from its sale or other disposition. Where services were rendered prior to March 1, 1913, but paid for thereafter, the amount received is taxable income to the extent of the excess of such amount over the fair market value on March 1, 1913, of the principal of the claim and any interest which had then accrued. (Art. 90.)

The Treasury has held that this article applies only to claims which are susceptible of capitalization and that unliquidated claims for damages arising out of torts are not within its scope.13

When a valid and valuable claim existed, it would not seem to make much difference whether the right was conditional or unconditional.

DEFINITION OF WORD "PROPERTY."-In a hearing before the Hague Permanent Court of Arbitration, on August 3, 1922, Senator (now Justice) Sutherland agreed with the President of the Court that the word "property" has wide application and includes "rights to have things done."

Investment in non-taxable securities.-Many taxpayers are considering the relative advantages of investments in government and other non-taxable or partly taxable bonds as compared with in

13 III-40-1811; S. M. 2285, overruling C. B. I-1, page 111; I. T. 1294.