Income Tax Procedure ...

spective of how the balances appear upon the firm's books. Under income tax procedure it is of no importance to the government whether interest is allowed or paid to partners, since the reduction. of partnership income due to interest reduction is exactly offset by the individual's income from such interest.21 It is presumed that this condition was in mind when a recent ruling 22 held that socalled interest placed monthly to the credit of the estate of a deceased member of the partnership was not to be included in the tax return of the estate. Obviously, in arriving at the distributive share of profits, such interest was not to be deducted.

Individual interest deduction too broad.-Congress may be criticized because the interest deduction permitted to individuals is too generous. The law is supposed to proceed on the theory that the specific exemptions are sufficient to cover minimum personal living expenses-to provide the necessary creature comforts. Living expenses above this minimum are not supposed to be deductible. But if a man borrows money to buy an automobile, or places a mortgage on his house, he is permitted under the law to deduct all such interest paid. It is clearly a living expense and theoretically should not be deductible. It would seem equitable that the law should permit the deduction of interest payments only where the interest-bearing debt was incurred in the purchase of property or investments for income-producing purposes. Such a provision raises some practical difficulties, such as that of designating the particular purposes for which the proceeds of a loan are used, but they are not insurmountable.

The Treasury appears to have accepted the author's suggestion in the following ruling:

RULING. The amount of discount which was added to the total amount of the notes executed in payment of an automobile represents additional cost of the automobile purchased and is not an allowable deduction in arriving at the net income of the taxpayer. (C. B. III-1, page 202; I. T. 1912.)

The author is in sympathy with the ruling, but it is not authorized by law. It could be said just as consistently that taxes paid on one's residence is a personal maintenance expense and not deductible.

[Former Procedure] Under the excess profits tax law of 1917 which required a statement of invested capital and a determination of partnership profits as distinguished from the individual's net income, it made a decided difference whether or not interest on partners' loans or capital accounts were entered as a business expense. See Income Tax Procedure, 1922, page 935,

footnote.

22 C. B. II-2, page 159; A. R. R. 2859.

The 1918 law was generous in its treatment of taxpayers, so far as allowances for taxes paid were concerned. The changes which were made by the 1921 law operated in the main to reduce the benefit that might have been claimed by taxpayers, but were still of so reasonable a nature that no great objections could be raised against them. The 1924 law, in the main unchanged from the 1921 law, has been so amended as to render certain of its provisions more equitable.

All taxes paid in this country, except federal income tax and certain types of special assessments, are allowable in determining the amount of income tax payable, either as deductions from the income upon which the income tax is to be calculated, or else as a credit against the amount of taxes payable.

One important change, introduced in the 1921 law, which affected both corporations and individuals receiving income from abroad has been re-enacted in the 1924 law.

The foreign income and profits tax allowed as a credit in such cases cannot exceed the same average rate on the foreign income which the United States income and profits taxes are on the total income from both foreign and domestic sources; or, as the law puts it, that the credit taken shall not exceed the same proportion of tax against which credit is taken, which the foreign income of the taxpayer bears to his entire net income.

The 1924 law allows a credit for taxes accrued or paid to foreign countries during the taxable year of the taxpayer. Since the tax laws of a number of these countries provide for the payment of income taxes during the year following that in which the tax is imposed, it resulted, under the former procedure, that in many cases the credit was taken against the United States tax for the year following the year in which the income was earned on which the foreign tax was imposed. The new law remedies this defect and provides that credits may be taken at the option of the taxpayer in the year in which the taxes of the foreign country accrued.1

Taxes Deductible

Individuals.

LAW. Section 214. (a) In computing net income there shall be

allowed as deductions:

1 For changes made by 1921 law see Income Tax Procedure, 1924, page 954.

Corporations.

LAW. Section 234. (a) In computing the net income of a corporation subject to the tax imposed by section 230 there shall be allowed as deductions:

(3) Taxes paid or accrued within the taxable year except (A) income, war-profits, and excess-profits taxes imposed by the authority of the United States, (B) so much of the income, war-profits and excess-profits taxes imposed by the authority of any foreign country or possession of the United States as is allowed as a credit under section 238, and (C) taxes assessed against local benefits of a kind tending to increase the value of the property assessed. In the case of obligors specified in subdivision (b) of section 221 no deduction for the payment of the tax imposed by this title, or any other tax paid pursuant to the tax-free covenant_clause, shall be allowed, nor shall such tax be included in the gross income of the obligee. The deduction allowed by this paragraph shall be allowed in the case of taxes imposed upon a shareholder of a corporation upon his interest as shareholder, which are paid by the corporation without reimbursement from the shareholder, but in such cases no deduction shall be allowed the shareholder for the amount of such taxes. For the purpose of this paragraph, estate, inheritance, legacy, and succession taxes accrue on the due date thereof except as otherwise provided by the law of the jurisdiction imposing such taxes;

The foregoing section provides a blanket deduction for all taxes except:

1. United States income, war profits and excess profits taxes.
2. A proportionate part of income, war profits and excess
profits taxes imposed by a foreign country or possession of
the United States. [See section 222 (a).]

3. Local improvement taxes.

4. Taxes paid pursuant to a tax-free covenant in corporate obligations. (But such tax may be credited against the total tax payable by the obligee.)

5. Taxes on stockholdings, paid by the corporation without reimbursement from the owners of such stock.

by the corporation but not by the stockholder.)

(Deductible

Accrual method permitted.-Since January 8, 1917, when T. D. 24332 (which held that under the 1916 law, effective as of January 1, 1916, accrued liabilities, such as taxes, would be allowable deductions) was issued, the regulations have permitted the deduction of accruals for all taxes which in themselves are eligible subjects for deduction. Furthermore, the 1921 law plainly stated that the term 2 See footnote, page 963.

"paid" meant "paid or accrued." 3 In the 1924 law the phrases "paid or accrued" and "paid or incurred" are used, instead of the word "paid." Consequently, all tax reserves, except those for federal income and excess profits taxes and for special assessments, are deductible. In these years of highly fluctuating profits, proper reserves for taxes are, of course, of great importance.

In line with the above, taxpayers in New York State keeping their books on an accrual basis were permitted to deduct in 1920 both the accrued New York State personal income tax for that year and the 1919 tax which was paid in that year.*

Similarly, the federal capital stock tax 5 and the New York State franchise tax are deductible in full in the year in which they accrue, by taxpayers whose books are on an accrual basis.

Excise taxes-when deductible?—

RULING. Where the taxpayer's books are kept upon the accrual basis, excise taxes are allowable deductions from gross income only for the year in which they were accrued. O. D. 240 (C. B. I, III) modified. (C. B. III-1, 79; I. T. 2011.)

Federal capital stock tax deductible.

RULING. Federal capital stock tax is deductible in entirety as an accrual for the taxable year in which tax is due. (C. B. I-2, page 101; I. T. 1538.)

New York State franchise tax deductible in year when liability accrues.-A New York corporation in 1918 revised its 1916 and 1917 state franchise tax returns (the tax liability being for 1917 and 1918). It included in its 1918 returns the reserve set up for additional taxes shown to be due, as well as the tax due for 1919. Although the 1917 law allowed as a deduction taxes "paid within the year" the Treasury has ruled that the term "paid” includes "accrued." The Treasury held in this case that the true liability existed in the former years and under the accrual method should have been set up in those years; that "liability for the tax does not at all depend upon knowledge of the existence of that liability"; that the deduction for the additional tax be permitted for the former years and disallowed in 1918.6

3 Section 200 (4).

'C. B. 2, page 121; O. D. 505. The New York State personal income tax was first imposed for the year 1919, payable in 1920.

See further, Chapter LII.

C. B. I-2, page 92; A. R. R. 1153.

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