accounted for as of a year other than the one in which sustained.130 The principle applies to all kinds of expenses, and exception is made only for overlapping items which do not materially disturb the income for any one year. The regulation has some merit and should be followed in most cases, but greater latitude should be given to taxpayers. If, in the opinion of the latter, true net income for the taxable year can be stated by charging items as an expense during the taxable year, taxpayers should not be forced to make amended returns for prior years. The inevitable result will be, if taxpayers are so forced, that for years to come they will be finding that expenses, which ordinarily would and should be charged to current operating accounts, occurred during the years 1918 and 1919 when the tax rates were very high, and acting under the letter of the regulations, amended returns will be made with a resulting saving in tax.

The present regulations appear to modify the rule in cases when taxpayers have actually provided in prior periods for losses finally determined in later years. It is provided that judgments, etc., are deductible in the years when paid "unless taken under other methods of accounting which clearly reflect the correct deduction." It is to be hoped that this refers to reserves which have been set up for accruing and estimated losses and liabilities set up in good faith in order to reflect true net income.

Deductions for probable but uncertain expenses.—

RULING. The freight upon certain goods sold by the taxpayer is not prepaid but the price quoted to the customer includes an estimated amount for freight. The customer, upon receipt of the goods, pays the freight and is given credit by the taxpayer for the freight so paid. The taxpayer maintains a reserve for outgoing freight to care for this estimated freight on shipments, which reserve is not deductible from gross income. The freight is deductible when the account of the customer is credited. (C. B. I-1, page 132; I. T. 1351.)

The foregoing ruling is not sound. The taxpayer contracts a liability for the freight. The so-called reserve is an entry which represents a definite liability. It is deductible under article III of the regulations.

RULINGS. A report of a master in chancery, appointed by an interlocutory decree in a suit for damages for alleged infringement of a patent, assessing damages against the taxpayer, which report was filed during the taxable year, but was not confirmed until the following year when judgment was entered on the report, can not be regarded as a 130 See Art. 1523.

determination of the amount of the claim, and no deduction for the taxable year is permissible in regard to the judgment referred to. (C. B. 1, page 108; S. 923.)

A reserve to cover a contingent liability, representing an estimated amount of claims actually outstanding at the close of the year, which will be paid on account of loss and damage to freight and injuries to persons, is not deductible. Such amounts are deductible only for the year when the claims are put in judgment or paid. (C. B. 4, page 142; O. D. 879.)

In 1918 the M corporation entered into contracts for the installation of certain machinery. In connection with such contracts a "contingent fund" account was set up on the corporation's books in 1919 and 1920 for the payment of unforeseen expenses and bonuses to be paid after the completion of the work and the payment of all liabilities under the contracts, the respective amounts of the bonuses to be determined after taking into consideration the services rendered and the loyalty displayed by the employees.

Held, that the bonuses are deductible only in the year 1922, when they were authorized to be paid. (C. B. I-1, page 131; I. T. 1350.)

A contract for a vessel having been completed in 1920 by delivery and payment in full, amounts expended in a later year to make the equipment of the vessel acceptable represent expenses incurred in the latter year and are not deductible in the year 1920. (C. B. II-2, page 109; I. T. 1731.)

The amounts paid periodically to a trustee by a company to be used for the purpose of compensating injured employees, the amounts so paid being the same as the premiums insurance companies previously charged for carrying the liability insurance, do not constitute allowable deductions. Only claims adjudicated or paid are deductible. (C. B. II-2, page 100; I. T. 1797.)

The question involved in the foregoing rulings is a difficult one to discuss. If it appears that an expense has been incurred but its amount is doubtful, good accounting practice and conservative business methods demand that an estimate be made and entered in the books. It would be a dangerous practice to omit a liability from the books merely because the exact amount thereof was unknown. The law permits the deduction of necessary business expenses and expressly approves the accrual system of accounting. It is therefore safe to assume that when during a taxable year an expense has been incurred or when it is so probable that an expense has been incurred that good practice requires the setting up of the transaction as a liability, the amount of the expense (even though it is an estimate) when entered in the books in good faith will be held by the courts to be deductible in the same period. The controlling idea is that the income of a future period should never have to bear expenses which

belong to a past period. The law need not be amended to effect this. The author has no serious criticism to make of the practice of requiring amended returns so long as the Treasury is consistent, but in no case should substantial expenses and losses applicable to a past period be carried forward to a subsequent period when the taxpayer has made provision for such expenses in the period to which the expenses are chargeable.

Payments to trustee for the ultimate benefit of the taxpayer not deductible.

RULING. Pursuant to the requirements of its by-laws a corporation entered into a trust agreement under the terms of which a sum amounting to not less than a certain per cent of the corporation's paid-in capital stock must be turned over to the trustee annually until a fund has accumulated amounting to r dollars, inclusive of the interest which is required to be added to the principal, when the income therefrom is to be turned over annually to an executive committee of the corporation for a purpose related to the business of the corporation.

Held, that the amounts paid to the trustee by the corporation are not deductible from its gross income.

The interest accruing to the fund is income of the corporation which should be reported by it in its return. (C. B. 5, page 120; O. D. 1047.)

Attorney's fees, when deductible.-Attorney's fees paid by a proprietor of a retail business, who was fined and imprisoned for making illegal sales, have been held to be personal expenses.131

The Treasury holds in effect that gross income earned illegally is taxable. The theory may be commendable but it is doubtful if the ruling is sound. If it is, many other deductions arising from illegal transactions would not be deductible.

When the attorney's fees were paid in connection with litigation regarding the control of certain stock, it was held that the fees were not deductible.132

Legal and traveling expenses were held not deductible when expended in contesting an additional assessment not connected with the taxpayer's trade or business.133

The Treasury's position may or may not be sound. It is at least questionable. The services of attorneys may be for personal or for business purposes. If it can be shown that the transactions are

ordinary business transactions, all incidental expenses are fully deductible, the Treasury to the contrary notwithstanding. The necessary legal expenses of a business man who is charged with the infraction of a business law cannot be deemed to be personal. All of the income from the business is taxable even though the business is more successful than it really ought to be. Likewise, all expenses are deductible even though the business is not conducted as government officers would conduct it. The latter may be wrong. Business men should carry to the courts many of the disallowances discussed in this chapter. The author believes that the courts will confirm the deduction of every expense which is incurred in good faith.

Attorneys' fees and other costs incident to collection of damages for breach of promise to marry "represent personal expenses and as such are not deductible." 134

As it was also held in the foregoing ruling that the damages collected were not income, the expenses of collection could hardly be deducted from other income. Net income is arrived at by including gross income and deducting ordinary and necessary expenses and a few other items of deduction which are not broad enough to include the attorneys' fees in question.

It has also been held that a fine paid by a corporation for violation of the Anti-Trust Act is not deductible as an ordinary and necessary expense.135

Expenses of abandoned project.-A taxpayer who sent an agent to Europe to organize an export business deducted the expenses. The report was unfavorable and the idea was abandoned. Held that it was not an expense of the taxpayer's business because "his income consisted entirely of salaries and interest." But as it was a transaction entered into for profit the expenditure "became a loss which was deductible.” 136

For a distinction without a difference, the foregoing takes first prize.

134 C. B. II-2, page 61; I. T. 1804. 125 C. B. I-1, page 269; I. T. 1174. 196 C. B. I-2, page 112; I. T. 1505.

Prior to 1918, income tax procedure, so far as it related to corporations, was complicated by restrictions upon deductions for interest paid, which made it necessary to distinguish interest payments by corporations very sharply from other payments.1 With the disappearance of this restriction the procedure has become relatively simple.

1

[Former Procedure] The arbitrary restriction imposed by the 1913, 1916 and 1917 laws and its effect is fully discussed in Income Tax Procedure, 1919, pages 454-463. In May, 1922, the Treasury published a ruling, reversing former procedure, distinguishing between "discounts" and "interest" and holding that the former do not fall within the limitations of the 1916 and 1917 laws. (See C. B. I-1, page 276; A. R. R. 880.)

In an important decision recently rendered by the U. S. Court of Claims (Brilliant Coal Co. v. U. S., decided March 31, 1924 (not yet reported), now on appeal to U. S. Supreme Court), it is held that, under the Revenue Act of 1917, a corporation may deduct interest paid during the year 1917, which had accrued in prior years and which was within the limitation provided in the respective acts governing those years, and that the deduction is not restricted merely to interest accrued as well as paid during the current year.

If this decision is sustained it will doubtless furnish a basis for refunds of 1917 taxes in similar cases and will also affect the restoration to invested capital allowed under article 43 of Regulations 41, for 1917 only, provided claims for refund have been filed within the statutory period therefor.