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CHAPTER II

APPLICATION OF THE LAW-EXEMPTIONS

The tax is imposed upon “net income,"'1 a term minutely described in the law. In the case of an individual” it means the gross income, which includes earnings from personal services, business and trades, profits from sales of property, interest, rents, royalties, dividends, etc., 3 less deductions for expenses, losses, interest, taxes, depreciation, etc. The surtax which commences at an amount in excess of $5,000 is calculated upon the total net income as thus established.

To determine the basis for the 8 per cent normal tax of an individual there are certain deductions (or “credits" as they are called) for dividends, interest on Liberty bonds, etc., the personal exemption of $1,000 or $2,000 and the exemption for dependents. The first $4,000 of the amount so determined is subject to a normal tax of only 4 per cent in the case of a citizen or resident of the United States.

The gross income of a corporation includes the same items as for individuals, but the deductions are not quite the same. 8 The net income of a corporation is subject to a flat tax of 10 per cent, but to no surtaxes. Moreover, there are certain subtractions from corporate incomes which are allowed under the title of "credits,” a device adopted in order to make the meaning of the term “net income” that which is to be taxed for excess profits.

tively.

'Sections 210, 230 (a). Section 212 (a). *Section 213. Section 214 (a). For the year 1918, the rates were 12 per cent and 6 per cent respectSections 216, 236.. Sections 232, 233 (a).

$ The chief differences are deductions permitted individuals for losses not connected with business or trade and for gifts. 'However, it is subject to the excess profits tax.

The various types of taxable income included under the provisions of section 213 and the various kinds of allowable deductions permitted by sections 214 and 234 are discussed in detail in the series of chapters which constitute the bulk of this book.10 This chapter is primarily concerned with neither the items of gross income nor the deductions but rather with the exemptions. These are of four classes, as follows:

· First. Income which is exempt from the normal tax only, being subject to the surtax. Such income is included in the definition of gross and net income but is relieved of the individual normal tax through the device of "credits” provided in section 216.

Second. Income which is exempt from both normal and surtaxes. Certain items are specifically declared (section 213) to be "exempt from taxation under this title.” These are not included in gross income. 11

Third. Income which is exempt, irrespective of whether or not it is included in the above two classes, because it is received by certain types of corporations, such as those organized for religious or charitable purposes, 12 specifically declared by section 231 to be exempt on grounds of general public policy because of their character.

Fourth. Income which is exempt irrespective of whether or not included in the foregoing three classes because geographically it lies beyond the scope and application of the law.

No individual13 is entirely exempt from the tax merely because of his status or character as an individual unless one construes the personal exemption as an exception to this statement. That exemption, of course, operates to relieve entirely from taxation the person whose income is smaller than the specified amounts.

1°See Part II and Part III.

"Information must be furnished concerning the number, the amount and the income from tax-exempt securities.

"See page 51.

13 This statement includes minors. For the taxable status of minors, see page 32.

If one should receive all his income from interest upon the obligations of a state or any political subdivision thereof or certain of the obligations of the United States or its possessions or securities issued under the provisions of the federal farm loan act of July 17, 1916, he would be subject to no income tax and would not be required to make any return.14 He might receive and enjoy his income as though the tax did not exist. This would be true even though in addition he received taxable income of any amount less than $1,000 during the year. If he received more than $1,000 of such additional taxable income, he would proceed in the same manner as any other taxpayer, segregating and reporting for information purposes only, the income which he received from the obligations and securities specifically mentioned as exempt.

Also, taxpayețs receiving dividends from the stock of American corporations subject to the income tax, or interest on certain government securities, are exempt from the normal taxes on such income but are nevertheless required to report such items annually when their total net income is large enough to justify them in making any return at all.

It is to be noted that the exemptions referred to in the two preceding paragraphs are not exemptions of the person as such but are exemptions of the income, and individuals receiving such income are exempt from the tax only because and to the extent to which their income is from exempt sources.

Income Exempt from Normal Tax Only—“Credits"

The law imposes a normal tax of 8 per cent 15 on the total net income of individuals and graduated surtaxes upon the larger incomes. It imposes a flat 10 per cent rate (no sur

"It is held by some that the Treasury has the power (which it has thus far not chosen to exercise) to require a statement regarding taxexempt securities even from those whose net income is less than the personal exemption, but the author does not agree with this view.

*Reduced to 4 per cent on the first $4,000. See Chapter VI.

taxes16) upon the income of corporations. Partnerships are not taxed as independent units, the partners instead being taxed upon their respective shares of the profits whether or not distributed.? Certain individual income18 is exempt from the normal tax, but is nevertheless subject to the surtax rates, the adjustment being made by "crediting” (section 216) these items of income for purposes of the normal tax only. Even in the case of corporations, where no surtax rates apply, there are certain items?' which, in accordance with the practice in the case of individuals, are entered as "credits” (section 236) rather than as deductions, the effect being to make the term "net income” include these items for excess profits tax purposes. In this section these credits are discussed.

The personal exemptions: wife and dependents.

Law. Section 216. (c) In the case of a single person, a personal exemption of $1,000, or in the case of the head of a family or a married person living with husband or wife, a personal exemption of $2,000. A husband and wife living together shall receive but one personal exemption of $2,000 against their aggregate net income; and in case they make separate returns, the personal exemption of $2,000 may be taken by either or divided between them ;20

(d) $200 for each person (other than husband or wife) dependent upon and receiving his chief support from the taxpayer, if such

16There is the excess profits tax in addition. See Excess Profits Tax Procedure.

"For a full statement, including a discussion of personal service corporations, see Chapter XXII.

18 Certain dividends, certain interest and the personal exemptions.

*Certain interest, excess and war profits taxes and the specific exemption of $2,000.

2[Former Procedure] The 1913 law [section II (C)] and the 1916 law [section 7 (a)] permitted the deduction "for the purpose of the normal tax only” and made the exemption $3,000, plus $1,000 additional if the person making the return were married with husband or wife living with her or him. The normal tax, which was I per cent under the 1913 law, was made 2 per cent in 1916. The 1917 law allowed this arrangement to remain in force, but added what in effect was a second and distinct income tax with an additional normal rate of 2 per cent. For the purpose of this new 2 per cent tax the exemptions of $3,000 and $4,000 provided in the 1916 law were changed to $1,000 and $2,000 (1917 law, Title I, section 3). Consequently there were two sets of exemptions in 1917, one for each normal tax of 2 per cent.

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