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partnership is computed, then his distributive share of the net income of the partnership for any accounting period of the partnership ending within the fiscal or calendar year upon the basis of which the partner's net income is computed.....

The regulations, except for the following, do not attempt to elaborate this section of the law :

REGULATION. .... Amounts earned and distributed to a partner by a partnership after the end of its taxable year and before the end of his corresponding taxable year should be accounted for both by the partnership and by the partner in their returns for their next succeeding taxable years. (Art. 322.)

The return of the partnership (form 1065) serves two useful purposes: (1) It is such a compilation as would have to be prepared by the partnership in any event, in order to assemble and segregate the taxable, partly taxable and nontaxable income and the allowable and non-allowable deductions. (2) After the compilation is made the distributive share of each partner is so stated as to set forth clearly the manner of rendering the partners' individual returns.

Net income of a partnership defined.-The tax is to be levied on the distributive shares “of the net income of the partnership,” and this phrase is defined in the law as follows:

Law. Section 218. (d) The net income of the partnership shall be computed in the same manner and on the same basis as provided in section 212 except that the deduction provided in paragraph (ỊT) of subdivision (a) of section 214 shall not be allowed.

Section 212 describes the method of determining the net income of individuals and section 214 (a-11) permits the deduction of gifts to religious, charitable, scientific and educational corporations up to 15 per cent of the taxpayer's net income. The effect of the section of the law quoted above, therefore, is to put a partnership on exactly the same basis as an individual, so far as determining net income is concerned, with the single exception that gifts of the type described may not be deducted. The distributive shares of the partnership profits,

See page 558.

however, form a part of the individual partner's "net income,” from which such gifts may be deducted up to the limit of 15 per cent. Consequently no disadvantage accrues to the partnership because of the provision forbidding the deduction.

CREDITS FOR CERTAIN DIVIDENDS AND INTEREST, NORMAL TAX ONLY.-The “distributive share” upon which the partner is taxable includes certain items which when received directly as a part of an individual's income are subject only to the surtax rates. Such items are dividends and interest on certain government securities whose terms of issue provide for exemption from the normal tax. The law definitely provides that the identity of these items shall be preserved so that each partner may claim as a credit his proportionate share of the income represented by them.

Law. Section 218. (a) .... The partner shall, for the purpose of the normal tax, be allowed as credits, in addition to the credits allowed to him under section 216, his proportionate share of such amounts specified in subdivisions (a) and (b) of section 216 as are received by the partnership.

Subdivisions (a) and (b) of section 216 describe the dividends and interest referred to. These credits consist of dividends from a corporation which is taxable under this law (with an additional provision for dividends from personal service corporations out of income upon which a tax has been imposed) and of interest "upon obligations of the United States and bonds issued by the War Finance Corporation, which is included in gross income under section 213.".

REGULATION. In addition to the credits ordinarily allowed to an individual, a partner is entitled to the following credits: (a) a credit against net income for the purpose of the normal tax only of his proportionate share of such dividends from corporations subject to tax and of such interest not entirely exempt from tax upon obligations of the United States and bonds of the War Finance Corporation as are received by the partnership; and (b) a credit against income tax of the partner's proportionate share of any income, war profits and excess profits taxes of the partnership paid

*See pages 37-39.

or accrued during the taxable year to a foreign country upon income derived from sources therein, or to any possession of the United States, subject to the limitations of section 222 of the statute. .... (Art. 323.)

The procedure regarding exemption for dividends, interest and taxes is fully outlined in the respective chapters dealing with those subjects and in the chapters on returns.

INTEREST ON TAX-EXEMPT BONDS TO BE ENTIRELY OMITTED FROM THE CALCULATION OF NET INCOME.—The basis prescribed for the calculation of net income in section 218 (d), quoted on page 502, plainly excludes entirely interest upon tax-exempt securities."

'[Former Procedure] CREDIT FOR 1917 EXCESS PROFITS TAX RESTRICTED TO 1917 INCOME.

Law. Section 218. "(c) In the case of an individual member of a partnership which makes return for a fiscal year beginning in 1917 and ending in 1918, his proportionate share of any excess-profits tax imposed upon the partnership under the Revenue Act of 1917 with respect to that part of such fiscal year falling in 1917, shall for the purpose of determining the tax imposed by this title, be credited against that portion of the net income embraced in his personal return for the taxable year 1918 to which the rates for 1917 apply."

This provision is equitable. The partner's tax on 1917 profits, not reported until 1918, should be based on 1917 rates; therefore the credit for the 1917 excess profits tax was applicable against the 1917 income, not against 1918 income.

'[Former Procedure) The 1916 and 1917 laws were also specific on this point (section 8 (e)], but the procedure was somewhat different, the interest being apportioned among the partners for deduction by each rather than excluded from the net income of the partnership altogether.

Under the 1913 law the Treasury ruled on April 22, 1915, that interest on tax-exempt bonds might be deducted by partnerships in ascertaining the distributable interest of partnership members. On February 3, 1916, this position was reaffirmed. However, there was a complete reversal a few months later by T. D. 2337 (June 1, 1916), which it should be borne in mind was issued under the 1913 law.

There seems to have been no justification for the reversal. The deduction was specifically corrected in the law of 1916, and a court decision under the 1913 law has declared the position assumed to have been a mistaken one. Unfortunately a large amount of tax was paid under the ruling which has been reversed. Partners who paid these taxes may secure a refund whether or not they paid the taxes under protest.

For full discussion of the foregoing, see Income Tax Procedure, 1919, pages 372-373.

IDENTITY OF INCOME OF PARTNERSHIP-HOW FAR TRACEABLE.—In the gross earnings or expenses of a partnership there may be items other than the specified dividends or interest which would be favorably treated in the returns of individuals if segregated from the partnership profits. If there are such items partners may confidently report them separately unless and until partnerships are taxed as entities.

In United States v. Coulby? the court said:

Decision. The Congress (in the 1913 law), consequently, it would seem, ignored for taxing purposes, a partnership's existence, and placed the individual partner's share in its gains or profits on the same footing as if his income had been received directly by him without the intervention of a partnership name.

It follows from these considerations that legally the defendant's share of the gains and profits of Pickands, Mather & Co., derived from corporations taxable on their net incomes, is to be treated as if the same had been received by him directly from the tax-paying corporations.

Regarding the argument that the insertion of the specific clause permitting deduction of dividends in the 1916 law evidenced a belief of Congress that the 1913 law provided otherwise, the court said :

DECISION. I do not agree with this contention. In my opinion this provision was inserted in the 1916 act to put at rest the present controversy rather than to change the law, and is to be regarded only as a legislative recognition of the scope and intent of the prior law.

'[Former Procedure] A ruling under the old law held as follows:

REGULATION. "The character of partnership profits divisible between persons has no reference (except as otherwise specially provided for in section 8 (e), act of September 8, 1916, as amended) to any character which as income accruing to the partnership it may have borne prior to the receipt by the partnership, and hence, with the exception noted, income received from a partnership can not be traced to its source behind the partnership for the purpose of claiming individual exemption.” (Reg. 33, 1918, Art. 30.)

This regulation was subject to criticism. It happens that under both the 1916 law and the new 1918 law the kinds of partnership income which it is an advantage to "identify" are "specially provided for.” Therefore taxpayers are not concerned at present about the restriction.

'District Court, N. D. Ohio E, D., 251 Fed. 982 (June 26, 1918); affirmed by Circuit Court, 258 Fęd, 27.

INFORMATION NEEDED TO TAKE ADVANTAGE OF CREDITS AND DEDUCTIONS.—In view of the credits and deductions set forth in the preceding paragraphs, the partner should, before preparing his personal return, request specific information regarding the following points in addition to the mere statement of net profit or net loss :S

1. Dividends received:

(a) When not taxable.'
(b) When taxable at 1918 or prior year rates. 10

(c) When taxable at 1919 rates. 11 2. Interest upon "obligations of the United States and bonds issued by the War Finance Corporation which is included in gross income under section 213" of the law.12

3. Gifts.13

DEDUCTION FOR PARTNERSHIP LOSSES.—Partnership losses are, of course, deductible in the returns of the individual partners. The following regulation explains the basis of division among partners:

REGULATION. Losses sustained during the taxable year .... are fully deductible .... if (a) incurred in the taxpayer's trade or business, .... (Art. 141.)

Even though the distributive share on the firm's books is a net profit, if the aggregate of dividends and interest described on page 503 is greater than the net profit the difference is an allowable deduction as a loss to the partner.

If the books of a partnership show a net profit of $40,000 with two equal partners, each is subject to surtax on his dis

$Which it is assumed would be drawn up in accordance with the law and the regulations. See page 87.

"See pages 452, 455.
10 See page 482.
"See page 459.

1.See page 419. Particular care should be exercised to make sure that interest entirely exempt, including that received on farm loan bonds, is reported but not included in the statement of net income.

13See page 559.

(Former Procedure] When fiscal years ended in 1918, other than at December 31, 1918, it was necessary to know the amount of partnership income subject to the 1917 income and excess profits tax rates.

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