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Method of treatment.—The statute specifies the particular deductions and credits which may be subtracted from gross income to determine taxable net income or from the tax as ascertained under certain sections to determine the net tax to be paid. These deductions and credits are listed separately in the law and differ somewhat with the character of the taxpayer—whether a corporation, a personal service corporation or an individual, or whether a resident or a non-resident. In this book all the peculiarities relating to non-resident aliens, including deductions, are relegated to a special chapter (XXXIII). The deductions and credits allowed to others than non-resident aliens, whether individuals or corporations, are consolidated and are treated topically in the series of chapters which follows. This method of treatment is convenient because most of the deductions apply with equal force to individuals and corporations. Often the wording is exactly the same and in such cases repetition is avoided, for only one construction can be placed upon it. Where there is any variance in the deductions the fact is noted and the comments separated within the chapter, care being taken to make clear the limited application of the statements which relate only to corporations or only to individuals.

Since the law is printed in full in the appendix and since all the provisions relating to deductions are quoted verbatim under the various individual topics in the succeeding chapters, it is not necessary to give here the various lists of allowable deductions. For these the reader is referred to sections 214 (a) and 234 (a) of the statute.

Deductions limited to those specified in the statute.-While the tax is levied on "net income received,” that term is not

the usual "net income” of the accountant's vocabulary. It is a resultant obtained by subtracting from gross income, as determined in the particular manner described in the preceding chapters, certain specified deductions which are discussed in the chapters which follow. In the language of the regulations :

REGULATION. Net income is that portion of the gross income which remains after all proper deductions have been taken into account. The net income of corporations is determined in general in the same manner as the net income of individuals, but the deductions allowed corporations are not precisely the same as those allowed individuals. .... (Art. 531.)

The law expressly excludes certain items usually regarded as legitimate deductions from income, and the Treasury has held that some other items of ordinary expenses are not allowable. Some of these restrictions apply both to individuals and to corporations. Others apply merely to one or the other. Neither individuals nor corporations, for example, may deduct special assessments of certain types or interest on money borrowed to purchase certain tax-exempt securities. On the other hand, an individual may deduct charitable contributions to a limited extent, while a corporation may not. Again, an individual may not deduct personal expenses, which makes it necessary to define personal expenses very carefully, while a corporation, of course, is presumed to have no "personal” expenses. Taxes imposed on an individual's residence and interest on money borrowed for personal use are not considered personal expenses. Moreover, under the 1918 law an individual can deduct the net loss sustained by any “casualty" which happens to his automobile or other property (such as a stock of liquors), a loss which is nothing more than a personal or living expense. Inconsistencies such as these give rise to most of the complications encountered in drawing up returns. Those charged with the preparation of returns should carefully study the provisions of the law bearing on deductions and be prepared to pass on the propriety of including or ex

cluding the various items of expenditures which have been made.

Deductions may be determined by accrual method.

Law. Section 212. (b) The net income shall be computed upon the basis of the taxpayer's annual accounting period (fiscal year or calendar year, as the case may be) in accordance with the method of accounting regularly employed in keeping the books of such taxpayer; but if no such method of accounting has been so employed, or if the method employed does not clearly reflect the income, the computation shall be made upon such basis and in such manner as in the opinion of the Commissioner does clearly reflect the income. ....

Section 200. .... The term "paid,” for the purposes of the deductions and credits under this title, means “paid or accrued” or "paid or incurred,” and the terms "paid or incurred" and "paid or accrued” shall be construed according to the method of accounting upon the basis of which the net income is computed under section 212.

If the taxpayer keeps no regular books of account, and if he does keep books, but on the basis of cash receipts and payments, he must claim his deductions on the basis of cash actually paid out. In all cases where it is possible to do so, the taxpayer should keep his books on an “accrual” basis. If this method, which is now specifically authorized by the regulations, is once adopted it must be followed in subsequent years. The application of the accrual method is thus described in the regulation:

REGULATION. Approved standard methods of accounting will ordinarily be regarded as clearly reflecting income. A method of accounting will not, however, be regarded as clearly reflecting income unless all items of gross income and all deductions are treated with reasonable consistency. . .. . All items of gross income shall be included in the gross income for the taxable year in which they are received by the taxpayer, and deductions taken accordingly, unless in order clearly to reflect income such amounts are to be properly accounted for as of a different period. .... (Art. 23.)

'The form of reconcilement statement which will be found in Excess Profits Tax Procedure, Chapter XV, affords a means of preventing any allowable deduction in the books to be omitted, and as to classification it calls attention to any omission of allowable items not in the books.

Each year's return must be complete within itself.

REGULATION. Each year's return, so far as practicable, both as to gross income and deductions therefrom, should be complete in itself, and taxpayers are expected to make every reasonable effort to ascertain the facts necessary to make a correct return. ... The expenses, liabilities or deficit of one year can not be used to reduce the income of a subsequent year. A person making returns on an accrual basis has the right to deduct all authorized allowances, whether paid in cash or set up as a liability, and it follows that if he does not within any year pay or accrue certain of his expenses, interest, taxes or other charges, and makes no deduction therefor, he can not deduct from the income of the next or any subsequent year any amounts then paid in liquidation of the previous year's liabilities. A loss from theft or embezzlement occurring in one year and discovered in another is deductible only for the year of its occurrence. Any amount paid pursuant to a judgment or otherwise on account of damages for personal injuries, patent infringement or otherwise, is deductible from gross income when the claim is put in judgment or paid, less any amount of such damages as may have been compensated for by insurance or otherwise. If subsequently to its occurrence, however, a taxpayer first ascertains the amount of a loss sustained during a prior taxable year which has not been deducted from the gross income, he may render an amended return for such preceding taxable year, including such amount of loss in the deductions from gross income, and may file a claim for refund of the excess tax paid by reason of the failure to deduct such loss in the original return. . . . . (Art. 111.)

These regulations must be reasonably construed. All business concerns and all individuals have items of receipts and expenses which cannot be incorporated in books of account prior to closing time. In the well-managed concern the amounts are usually insignificant and when subsequently ascertained they are entered as current items in the succeeding period. If the amounts are large the treatment is different and adjustment of the accounts of the prior period and the filing of amended returns are in order, but after the accounts for a fiscal year are once closed there should be no reopening unless it is a matter of substantial importance.

This interpretation is apparently in accord with the general rule laid down in another regulation for the inclusion or

exclusion of insignificant amounts in one year or another. It does not disturb the clear reflection of income.

REGULATION..... The time as of which any item of gross income or any deduction is to be accounted for must be determined in the light of the fundamental rule that the computation shall be made in such a manner as clearly reflects the taxpayer's income. If the method of accounting regularly employed by him in keeping his books clearly reflects his income, it is to be followed with respect to the time as of which items of gross income and deductions are to be accounted for. If the taxpayer does not regularly employ a. method of accounting which clearly reflects his income, the computation shall be made in such manner as in the opinion of the Commissioner clearly reflects it. (Art. 22.)

The regulation quoted on page 530 (Art. 111) makes it plain that the taxpayer may file amended returns on his own initiative. The Commissioner, in turn, may on his part require such returns.

REGULATION. .... If in the opinion of the Commissioner such information indicates that the returns for any previous years did not reflect the true income, amended returns for such years will be required. (Art. 23, as amended by T. D. 2873, June 24, 1919.)

It is the desire of the Treasury to obtain returns which accurately reflect for a given year the actual income and the actual expenses applicable to that year. The Treasury accepts or requires amended returns, if based on meritorious grounds, whether or not the outcome is favorable to the government. The action of some inspectors would lead one to believe that amended returns are in order only when the net result is against the taxpayer, but the responsible officers of the Treasury maintain no such attitude.

Desirability of good records.—Most individuals keep poor accounts or none at all. It is desirable from almost every point of view to keep careful financial records, and the income tax levied at the present high rates makes it almost imperative that this be done. It is important from the point of view of the government in order that no taxable items may be missed. It is important from the point of view of the individual in

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