gross income from sources within and without the United States, see section 119.

(h) Foreign personal holding companies. For provisions relating to gross income of foreign personal holding companies and of their shareholders, see section 334.

(i) Consent dividends. For inclusion in gross income of amounts specified in shareholders' consents, see section 28.

Subpart D-Deductions from Gross
Income

SEC. 23. Deductions from gross income.In computing net income there shall be allowed as deductions:

(a) Expenses.-(1) In general.-All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered; traveling expenses (including the entire amount expended for meals and lodging) while away from home in the pursuit of a trade or business; and rentals or other payments required to be made as a condition to the continued use or possession, for purposes of the trade or business, of property to which the taxpayer has not taken or is not taking title or in which he has no equity.

| solely in the pursuit of a trade or business (see § 9.23 (a)-2), advertising and other selling expenses, together with insurance premiums against fire, storm, theft, accident, or other similar losses in the case of a business, and rental for the use of business property. Penalty payments with respect to Federal taxes, whether on account of negligence, delinquency, or fraud, are not deductible from gross income. The full amount of the allowable deduction for ordinary and necessary expenses in carrying on a business is nevertheless deductible, even though such expenses exceed the gross income derived during the taxable year from such business. As to items not de

ductible under any provision of section 23, see section 24.*†

§ 9.23 (a)-2 Traveling expenses. Traveling expenses, as ordinarily understood, include railroad fares and meals and lodging. If the trip is undertaken for other than business purposes, the railroad fares are personal expenses and the meals and lodging are living ex(2) Corporate charitable contributions.— No deduction shall be allowable under para-penses. If the trip is solely on busigraph (1) to a corporation for any contribu- ness, the reasonable and necessary tion or gift which would be allowable as a traveling expenses, including railroad deduction under subsection (q) were it not fares, meals, and lodging, are business for the 5 per centum limitation therein contained and for the requirement therein that expenses. payment must be made within the taxable year.

§ 9.23 (a)-1 Business expenses Business expenses deductible from gross income include the ordinary and necessary expenditures directly connected with or pertaining to the taxpayer's trade or business, except the classes of items which are deductible under the provisions of §§ 9.23 (b)−1 to 9.23 (q)−1. Double deductions are not permitted. Amounts deducted under one provision

(a) If, then, an individual, whose business requires him to travel, receives a salary as full compensation for his services, without reimbursement for traveling expenses, or is employed on a commission basis with no expense allowance, his traveling expenses, including the entire amount expended for meals and lodging, are deductible from gross income.

(b) If an individual receives a salary and is also repaid his actual traveling expenses, he shall include in gross income the amount so repaid and may deduct such expenses.

of the Act cannot again be deducted under any other provision of the Act. As to charitable contributions by corporations not deductible under section 23 (a), see § 9.23 (a)-13. The cost of goods purchased for resale, with proper adjustment for opening and closing inventories, is deducted from gross sales in computing gross income. (See $9.22 (a)-5.) Among the items included in business expenses are management expenses, commissions, labor, supplies, incidental repairs, operating expenses of A payment for the use of a sample automobiles used in the trade or business, room at a hotel for the display of goods traveling expenses while away from home | is a business expense. Only such ex

(c) If an individual receives a salary and also an allowance for meals and lodging, as, for example, a per diem allowance in lieu of subsistence, the amount of the allowance should be included in gross income and the cost of such meals and lodging may be deducted therefrom.

serve if such account is kept. (See §§ 9.23 (1)-1 to 9.23 (1)-10.) *†

penses as are reasonable and necessary | charged against the depreciation rein the conduct of the business and directly attributable to it may be deducted. A taxpayer claiming the benefit of the deductions referred to herein must attach to his return a statement showing (1) the nature of the business in which engaged; (2) the number of days away from home during the taxable year on account of business; (3) the total amount of expenses incident to meals and lodging while absent from home on business during the taxable year; and (4) the total amount of other expenses incident to travel and claimed as a deduction.

§ 9.23 (a)-3 Cost of materials. Taxpayers carrying materials and supplies on hand should include in expenses the charges for materials and supplies only to the amount that they are actually consumed and used in operation during the year for which the return is made, provided that the cost of such materials and supplies has not been deducted in determining the net income for any previous year. If a taxpayer carries incidental materials or supplies on hand for which no record of consumption is kept or of which physical inventories at the

beginning and end of the year are not taken, it will be permissible for the taxpayer to include in his expenses and de

duct from gross income the total cost of such supplies and materials as were purchased during the year for which the return is made, provided the net income is clearly reflected by this method.*+

§ 9.23 (a)-4 Repairs. The cost of incidental repairs which neither materially add to the value of the property nor appreciably prolong its life, but keep it in an ordinarily efficient operating condition, may be deducted as expense, provided the plant or property account is not increased by the amount of such expenditures. Repairs in the nature of replacements, to the extent that they arrest deterioration and appreciably prolong the life of the property, should be

§ 9.23 (a)-5 Professional expenses. A professional man may claim as deductions the cost of supplies used by him in the practice of his profession, expenses paid in the operation and repair of an automobile used in making professional calls, dues to professional societies and subscriptions to professional journals, the rent paid for office rooms, the cost of the fuel, light, water, telephone, etc., used in such offices, and the hire of office assistants. Amounts currently expended for books, furniture, and professional instruments and equipment, the useful life of which is short, may be

deducted.*+

§ 9.23 (a)-6 Compensation for personal services. Among the ordinary and necessary expenses paid or incurred in carrying on any trade or business may be included a reasonable allowance for salaries or other compensation for personal services actually rendered. The test of deductibility in the case of compensation payments is whether they are reasonable and are in fact payments purely for services. This test and its practical application may be further stated and illustrated as follows:

(1) Any amount paid in the form of compensation, but not in fact as the pur(i) An ostensible salary paid by a corchase price of services, is not deductible. poration may be a distribution of a divi

dend on stock.

in the case of a corporation having few This is likely to occur shareholders, practically all of whom

draw salaries. If in such a case the salaries are in excess of those ordinarily paid for similar services, and the excessive payments correspond or bear a close relationship to the stock holdings of the officers or employees, it would seem likely that the salaries are not paid wholly for services rendered, but that the excessive payments are a distribution of earnings upon the stock. (ii) An ostensible salary may be in part payment for property. This may occur, for example, where a partnership sells out to a corporation, the former partners agreeing to continue in the service of the corporation. In such a case it may be found that the salaries of the former partners are not merely

for services, but in part constitute pay- | income of the recipient and subjected to ment for the transfer of their business. both normal tax and surtax.*† (2) The form or method of fixing com

pensation is not decisive as to deductibility. While any form of contingent compensation invites scrutiny as a possible distribution of earnings of the enterprise, it does not follow that payments on a contingent basis are to be treated fundamentally on any basis different from that applying to compensation at a flat rate. Generally speaking, if contingent compensation is paid pursuant to a free bargain between the employer and the individual made before the services are rendered, not influenced by any consideration on the part of the employer other than that of securing on fair and advantageous terms the services of the individual, it should be allowed as a deduction even though in the actual working out of the contract it may prove to be greater than the amount which would ordinarily be paid.

(3) In any event the allowance for the compensation paid may not exceed what is reasonable under all the circumstances. It is in general just to assume that reasonable and true compensation is only such amount as would ordinarily be paid for like services by like enterprises under like circumstances. The circumstances to be taken into consideration are those existing at the date when the contract for services was made, not those existing at the date when the contract is questioned.*†

§ 9.23 (a)-8 Bonuses to employees. Bonuses to employees will constitute allowable deductions from gross income when such payments are made in good faith and as additional compensation for the services actually rendered by the employees, provided such payments, when

added to the stipulated salaries, do not exceed a reasonable compensation for the services rendered. It is immaterial whether such bonuses are paid in cash or in kind or partly in cash and partly in kind. Donations made to employees the element of compensation or are in and others, which do not have in them excess of reasonable compensation for services, are not deductible from gross income.*+

§ 9.23 (a)-9 Pensions; compensation for injuries. Amounts paid by a taxpayer for pensions to retired employees or to their families or others dependent upon them, or on account of injuries received by employees, and lump-sum amounts paid or accrued as compensation for injuries, are proper deductions as ordinary and necessary expenses. Such deductions are limited to the amount not compensated for by insurance or otherwise. When the amount of the salary of an officer or employee is paid for a limited period after his death to his widow or heirs, in recognition of the services rendered by the individual, such payments may be deducted. As to deductions for payments to employees' pension trusts, see section 23 (p).*†

§ 9.23 (a)-7 Treatment of excessive compensation. The income tax liability of the recipient in respect of an amount ostensibly paid to him as compensation, § 9.23 (a)-10 Rentals. If a leasebut not allowed to be deducted as such hold is acquired for business purposes for by the payor, will depend upon the cir- a specified sum, the purchaser may take cumstances of each case. Thus, in the as a deduction in his return an aliquot case of excessive payments by corpora- part of such sum each year, based on the tions, if such payments correspond or number of years the lease has to run. bear a close relationship to stock hold- Taxes paid by a tenant to or for a landings, and are found to be a distribution lord for business property are additional of earnings or profits, the excessive pay-rent and constitute a deductible item to ments will be treated as a dividend. If such payments constitute payment for property, they should be treated by the payor as a capital expenditure and by the recipient as part of the purchase price. In the absence of evidence to justify other treatment, excessive payments for salaries or other compensation for personal services will be included in gross

the tenant and taxable income to the landlord, the amount of the tax being deductible by the latter. The cost borne by a lessee in erecting buildings or making permanent improvements on ground of which he is lessee is held to be a capital investment and not deductible as a business expense. In order to return to such taxpayer his investment of capital,

(See

an annual deduction may be made from | tomobile if used wholly in the business gross income of an amount equal to the of farming is deductible as an expense; total cost of such improvements divided if used partly for business purposes and by the number of years remaining of the partly for the pleasure or convenience of term of lease, and such deduction shall the taxpayer or his family, such cost may be in lieu of a deduction for depreciation. be apportioned according to the extent of If the remainder of the term of lease is the use for purposes of business and greater than the probable life of the pleasure or convenience, and only the buildings erected, or of the improvements proportion of such cost justly attributmade, this deduction shall take the form able to business purposes is deductible of an allowance for depreciation. as a necessary expense. If a farm is § 9.22 (a)-13.) *† operated for recreation or pleasure and not on a commercial basis, and if the expenses incurred in connection with the farm are in excess of the receipts therefrom, the entire receipts from the sale of products may be ignored in rendering a return of income, and the expenses incurred, being regarded as personal expenses, will not constitute allowable deductions. (See also §§ 9.22 (a)-7, 9.23 (e)-5, and 9.23 (1)−10.) *†

CROSS REFERENCE: For regulations on spread of depreciation or amortization for improvements or cost of lease over term of original lease and renewals, see Part 24.

(see

§ 9.23 (a)-11 Expenses of farmers. A farmer who operates a farm for profit is entitled to deduct from gross income as necessary expenses all amounts actually expended in the carrying on of the business of farming. The cost of ordinary tools of short life or small cost, such as hand tools, including shovels, rakes, etc., may be deducted. The cost of feeding and raising live stock may be treated as an expense deduction, in so far as such cost represents actual outlay, but not including the value of farm produce grown upon the farm or the labor of the taxpayer. Where a farmer is engaged in producing crops which take more than a year from the time of planting to the process of gathering and disposal, expenses deducted may, with the consent of the Commissioner § 9.41-2), be determined upon the crop basis, and such deductions must be taken in the year in which the gross income from the crop has been realized. The cost of farm machinery, equipment, and farm buildings represents a capital investment and is not an allowable deduction as an item of expense. Amounts expended in the development of farms, orchards, and ranches prior to the time when the productive state is reached may be regarded as investments of capital. Amounts expended in purchasing work, breeding, or dairy animals are regarded as investments of capital, and may be depreciated unless such animals are included in an inventory in accordance with § 9.22 (a)-7. The purchase price of an automobile, even when wholly used in carrying on farming operations, is not deductible, but is regarded as an investment of capital. The cost of gasoline, repairs, and upkeep of an au

§ 9.23 (a)-12 Depositors' guaranty fund. Banking corporations which pursuant to the laws of the States in which they are doing business are required to set apart, keep, and maintain in their banks the amount levied and assessed against them by the State authorities as a "Depositors' guaranty fund," may deduct from their gross income the amount so set apart each year to this fund, Provided, That such fund, when set aside and carried to the credit of the State banking board or duly authorized State officer, ceases to be an asset of the bank and may be withdrawn in whole or in part upon demand by such board or State officer to meet the needs of these officers in reimbursing depositors in insolvent banks, And provided further, That no portion of the amount thus set aside and credited is returnable under the laws of the State to the assets of the banking corporation. If, however, such amount is simply set up on the books of the bank as a reserve to meet a contingent liability and remains an asset of the bank, it will not be deductible except as it is actually paid out as required by law and upon demand of the proper State officers.*†

§ 9.23 (a)-13 Corporate contributions. No deduction is allowable under section 23 (a) for a contribution or gift by a corporation if any part thereof is deductible under section 23 (q). Thus, for example, if a corporation makes a

contribution of $5,000, only $4,000 of subscriber) obligations of the United

States issued after September 24, 1917, the interest upon which is wholly exempt from tax, is not deductible. Interest paid or accrued within the year on indebtedness incurred or continued to purchase or carry (a) obligations of the United States issued after September 24, 1917, the interest upon which is not wholly exempt from the taxes imposed by Title I, or (b) (in the case of an original subscriber) obligations of the United States issued after September 24, 1917, the interest upon which is wholly exempt from the taxes imposed by Title I, is deductible in accordance with the general rule.

which is deductible under section 23 (q) (whether because of the 5 percent limitation or requirement of actual payment, or both), no deduction is allowable under section 23 (a) for the remaining $1,000. The limitations provided in paragraph (2) of section 23 (a) and in this section of the regulations apply only to payments which are in fact contributions or gifts to organizations described in section 23 (q). For example, payments by a street railway corporation to a local hospital (which is a charitable organization within the meaning of section 23 (q)) in consideration of a binding obligation on the part of the hospital to Interest paid by the taxpayer on a provide hospital services and facilities for the corporation's employees are not mortgage upon real estate of which he is contributions or gifts within the meaning the legal or equitable owner, even though of section 23 (q) and may be deductible the taxpayer is not directly liable upon under section 23 (a) if the requirements the bond or note secured by such mortof that section are otherwise satisfied. Donations to organizations other than those described in section 23 (q) which bear a direct relationship to the corporation's business and are made with a reasonable expectation of a financial return commensurate with the amount of the donation may constitute allowable deductions as business expenses. For example, a street railway corporation may donate a sum of money to an organization (of a class not referred to in section 23 (q)) intending to hold a convention in the city in which it operates, with a reasonable expectation that the holding of such convention will augment its income through a greater number of people using

its cars.*†

[SEC. 23. Deductions from gross income.] [In computing net income there shall be allowed as deductions:]

(b) Interest.-All interest paid or accrued within the taxable year on indebtedness, except on indebtedness incurred or continued to purchase or carry obligations (other than obligations of the United States issued after September 24, 1917, and originally subscribed for by the taxpayer) the interest upon which is wholly exempt from the taxes imposed by this title.

§ 9.23 (b)-1 Interest. Interest paid or accrued within the year on indebtedness may be deducted from gross income, except that interest on indebtedness incurred or continued to purchase or carry obligations, such as municipal bonds, Panama Canal loan 3 percent bonds, or (in case of a taxpayer not an original

gage, may be deducted as interest on his indebtedness. Payments made for Maryland or Pennsylvania ground rents are not deductible as interest but may, if a proper business expense, be deducted as rent.

Interest calculated for cost-keeping or other purposes on account of capital or surplus invested in the business which does not represent a charge arising under an interest-bearing obligation, is not an allowable deduction from gross income. Interest paid by a corporation on scrip dividends is an allowable deduction. So-called interest on preferred stock which is in reality a dividend thereon, cannot be deducted in comput(See, however, § 9.22 (a)-18 and section 121.) In the case of banks and loan or trust companies, interest paid within the year on deposits such as interest paid on moneys received for investment and secured by interestbearing certificates of indebtedness issued by such bank or loan or trust company may be deducted from gross income. As to other amounts of interest not deductible under section 23 (b), see section 24 (c).*+

ing net income.

[SEC. 23. Deductions from gross income.] [In computing net income there shall be allowed as deductions:]

(c) Taxes generally.-Taxes paid or accrued within the taxable year, except

(1) Federal income, war-profits, and excessprofits taxes (other than the excess-profits tax imposed by section 106 of the Revenue Act of 1935 or by section 602 of this Act);

**For statutory and source citations, see note to § 9.1-1.

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