PROCEDURE WHEN FISCAL YEAR INCLUDES PERIODS WITH DIFFERENT RATES.-The law provides a method of computation for a partner who in his return for his fiscal or calendar year ending in 1918 includes partnership profits for a period preceding January 1, 1918.1

LAW. Section 218.

(b) If a fiscal year of a partnership ends during a calendar year for which the rates of tax differ from those for the preceding calendar year, then (1) the rates for such preceding calendar year shall apply to an amount of each partner's share of such partnership net income 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 rates for the calendar year during which such fiscal year ends shall apply to the remainder,'

To illustrate, assume the fiscal year of a partnership ends June 30. On December 31, 1917, one of the partners reported as taxable income his share of the firm's profits credited to him on the books for the twelve months ended June 30, 1917. On December 31, 1918 (in case he continues to report on the basis of the calendar year), he will report his share of the profits for the twelve months ended June 30, 1918. The higher rates of taxation began as of January 1, 1918, and do not apply to any income accrued by the partnership before that date. Consequently, under the rule laid down in the section of the law quoted above, the partner should calculate his tax on one-half of the partnership profits on the basis of the 1917 rates and on the other half on the basis of the 1918 rates.

A more complicated situation arises when the assumptions in the foregoing illustration are so changed as to cause the partner to report on the basis of a fiscal year instead of a calendar year. In case the fiscal years of both partner and partnership were the same, ending on June 30, there would be no difficulty, but if they were different, the question would arise as to whether or not Section 218 (b), quoted above, con

'For criticism of method see page 74.

For the rates of previous years, see pages 113, 114. For specimen return showing correct computation of tax, see supplement to this book.

stitutes an exception to Section 205, which provides that in case a fiscal year of a taxpayer ends during a calendar year for which the rates of tax differ from those for the preceding calendar year, the net income is to be apportioned according to the parts of the fiscal year falling within the respective calendar years and the rates of those years are to be applied. For instance, following this rule, if the partner's fiscal year in the case quoted above ended November 30, he would be taxable on eleven-twelfths of his share of the profits at 1918 rates. This is certainly not the intention of the drafters of the law. There can be little doubt that Section 218 (b) is to be considered an exception to the general rule laid down in Section 205, and that a partner whose fiscal year ended November 30, but whose partnership fiscal year ended June 30, should report six-twelfths of the firm profits at 1918 rates and eleven-twelfths of his personal income at 1918 rates.

Procedure when personal and partnership accounts are on different bases.-A partner may have been accustomed to keep his personal accounts on a cash basis, while his firm's accounts are on an accrual basis. In such a case he may continue to keep his personal accounts as before if it is not practicable for him to change to an accrual basis, but in reporting his share of firm profits he must include the entire amount which accrued to him on the firm's books for the fiscal or calendar year. It is immaterial how or when he receives his share, and whether or not the firm's books include many accrued items.

Distributions to partners other than in cash.-A partner should return for taxation the exact amount credited to his capital account in the books of the firm at the end of its fiscal year, after deducting tax-exempt interest, etc. Any payments to a partner charged against his capital account are, of course, not returnable because such payments merely represent distributions of capital or of income already reported and taxed.

The same principal applies to partnership distributions

other than in cash. For instance, a firm may own property or securities which it wishes to divide among the partners. The amount at which such items appear on the firm's books as assets determines the book value of the partners' interests therein, and when distribution is made the items should be entered at book valuation.

A firm may carry 1,000 shares of stock at $1,000. If there are two equal partners, there is merged in the capital account of each a credit of $500. The stock may be worth $10,ooo, but, if distributed direct to the partners, the charge to each still should be $500. If charged to the partners at market value, the current profit and loss account would be credited with $9,000, and each partner's account would receive an additional credit of $4,500, upon which he would be taxed, although the shares of stock were not sold.

If the partners kept personal books upon the accrual method it would not be improper to carry the stock at its market value if they desired to do so; but this would subject them to tax sooner than would otherwise be necessary.

Partnerships Must File Returns

The 1918 law for the first time requires annual returns from all partnerships. For details see page 83.

Partnerships Composed of Corporations

It has been held that a partnership composed of corporations should be classed as a partnership rather than as a corporation for income tax purposes.2 In the case referred to, the laws of Hawaii permitted corporations to become members of a partnership. In many of our states the corporation

[Former Procedure] Formerly returns from partnerships were required only when requested by the Commissioner.

'Haiku Sugar Company, et al., v. Johnstone, Circuit Court of Appeals, ninth circuit, April 1, 1918.

laws would not permit a corporation to become a general partner. In other states the position is not so clear. The subject is not of enough general interest to warrant a full discussion in these pages, but it may be said that unless the charter of a corporation expressly prohibits its entering into partnership relations with other corporations or with individuals, it may do so, subject to the further possible restriction that the corporation laws of the state may inhibit such relationship.

Limited Partnerships May or May Not be Partnerships

In a recent regulation, May 9, 1918, the Treasury draws a distinction between different types of limited partnerships, regarding one type as corporations and the other type as partnerships for income tax purposes.1

REGULATION. Article 62 of the income tax regulations classes limited partnerships as corporations for the purpose of the income tax and requires income from the earnings of such partnerships to be treated like dividends on corporate stock. . . . .

So far as limited partnerships of the type of partnerships with limited liability or partnership associations authorized by the statutes of Pennsylvania and of a few other states are concerned, no reason exists for changing the regulations. Such so-called limited partnerships, offering opportunity for limiting the liability of all the members, providing for the transferability of partnership shares, and capable of holding real estate and bringing suit in the common name, are more truly corporations or joint-stock companies than partnerships.

But the regulations require revision with respect to limited partnerships of the type authorized by the statutes of New York and of most of the states. Such limited partnerships, which cannot limit the liability of the general partners, although the special partners enjoy limited liability so long as they observe the statutory conditions, which are dissolved by the death or attempted transfer of the interest of a general partner, and which cannot take real estate or sue in the partnership name, are so like common law partnerships as to render inadvisable the differentiation hitherto existing in the regulations. . . .

'[Former Procedure] All limited partnerships were formerly considered corporations. (Reg. No. 33, 1918, ¶ 305.)

Therefore, for the purpose of the income tax, the war income tax, the excess profits tax and the capital stock tax, limited partnerships of the Pennsylvania type of partnerships with limited liability are corporations or joint-stock companies, and limited partnerships of the New York type are partnerships. Article 62 of the income tax regulations and article 2 of the excess profits tax regulations are modified accordingly. However, in doubtful cases limited partnerships will be treated as corporations unless they submit satisfactory proof that they are not in effect so organized. (T. D. 2711, May 9, 1918.)

5

"Pennsylvania" type of limited partnerships.-Limited partnerships of the Pennsylvania type referred to above are such as are organized under the act of June 2, 1874.1 The limited or special partnerships, created by the acts of March 21, 1836,2 April 6, 1870,3 and June 15, 1871, are not covered. The matter is dealt with in an opinion from the Attorney General's department. In general, so far as T. D. 2711 applies to limited partnerships created under the act of June 2, 1874, it seems to be sound. Such a limited partnership is a quasi-corporation, having many of the characteristics of a corporation. The limited partnerships of 1836, 1870 and 1871 are quite different, and are not within the ruling in Coal Company v. Rogers, nor should they be within T. D. 2711.

In the circumstances it would be better to designate limited partnerships, which must be treated throughout as corporations, as being of the "corporation type" rather than the "Pennsylvania type."

Distributions by limited partnerships.-All divisions of profits by limited partnerships which are of the corporation type should be treated by the partners as dividends. The normal tax will have been paid, so that the recipients will receive credit of 12 per cent thereon in calculating their normal tax.