many of these expenses the deductibility of a particular item becomes a complicated question involving several of the distinctions referred to in the preceding paragraph, as, for example, when a salary must be shown to be not a gift, a personal expense, a distribution of profit, a distribution of assets nor a payment for property.2

Expenses which are deductible.

LAW. Section 214. [Individuals.] (a) That in computing net income there shall be allowed as deductions:

(1) 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, and including 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.3

Section 234. [Corporations.] (a) That in computing the net

2See page 549.

[Former Procedure]

1916 LAW. Section 5. [Individuals] (a)

First. The neces

sary expenses actually paid in carrying on any business or trade, not including personal, living, or family expenses.'

Section 12. [Corporations] (a) ". First. All the ordinary and necessary expenses paid within the year in the maintenance and operation of its business and properties, including rentals or other payments required to be made as a condition to the continued use or possession of property to which the corporation has not taken or is not taking title, or in which it has no equity; . . . ."

The phrase "maintenance and operation" appearing in section 12 (a) is explained in the following excerpt from the regulations:

REGULATION. "Expenses of operation and maintenance shall include all expenditures for material, labor, fuel, and other items entering into the cost of the goods sold or inventoried at the end of the year, provided such expenditures have not been considered in determining the cost of goods or materials or purchases thereof during the year, when the income derived from operations is ascertained through inventory, and all other disbursements necessary to the operation of the business, except such as are required by the act to be segregated and stated separately in the return.

"Expenditures which are taken into account in determining the cost of products, finished or unfinished, are not to be again deducted as expenses of operation and maintenance. (Reg. 33, 1918, Art. 129.)

For comment on last two lines which were added by the 1916 law, see Chapter XXV, "Deductions for Interest."

income of a corporation subject to the tax imposed by section 230 there shall be allowed as deductions:

(1) 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, and including rentals or other payments required to be made as a condition to the continued use or possession of property to which the corporation has not taken or is not taking title, or in which it has no equity;

REGULATION. In general the deductions from gross income allowed corporations are the same as allowed individuals, except that corporations may deduct dividends received from other corporations subject to the tax and may not deduct charitable contributions, and that insurance companies are permitted special deductions. (Art. 561.)

The principle underlying the deductions for expenses was well expressed in a decision under the 1913 law, as follows:

REGULATION. Only those expenses which are incurred in earning income which is subject to tax under the income tax law constitute allowable deductions in computing net income taxable under the law. (T. D. 2137, January 30, 1915.)

In general, there has been adherence to the foregoing principle. In some cases, however, expenses which have been incurred in earning taxable income have not been allowed.

RESTRICTIONS ON EXPENSE DEDUCTIONS.-The restrictions on deductions for expenses are the following:

LAW. Section 215. [Individuals.] That in computing net income no deduction shall in any case be allowed in respect of(a) Personal, living, or family expenses;

(b) Any amount paid out for new buildings or for permanent improvements or betterments made to increase the value of any property or estate;

(c) Any amount expended in restoring property or in making good the exhaustion thereof for which an allowance is or has been made; or

(d) Premiums paid on any life insurance policy covering the life of any officer or employee, or of any person financially interested in any trade or business carried on by the taxpayer, when the taxpayer is directly or indirectly a beneficiary under such policy."

Section 235. [Corporations] That in computing net income no deduction shall in any case be allowed in respect of any of the items specified in section 215.

Accrued expenses may be deducted.-When the accounts of a taxpayer are kept on the accrual basis all expenses incurred to the end of the taxable year whether paid or not are allowable deductions and should be entered in the books. It is, however, most reprehensible to enter accrued items of expenses unless all items of accrued income are also entered.

The term "expenses. . . . . . incurred" must be taken in its usual commercial sense. It would be improper for a concern to enter as an accrued expense at the end of the taxable year any items of which the business had not received the benefit. An office telephone company sent out notices on December 27, 1918, that the signing of a contract for its service was sufficient to warrant the inclusion of the liability thereby incurred as an allowable expense in the 1918 accounts. The statement was incorrect. In the first place, if the equipment was a capital expenditure it could not be deducted as an expense, and, in the second place, if it was an allowable expense item it should not be allowed until the business received the benefit, which could not occur before the year in which the service was actually installed.

Business Expenses Distinguished from Personal Expenses

Definition of "business or trade."-The law specifies that an individual must not include "personal, living or family expenses" in his computation of deductible expenses. He may subtract under this head merely "the ordinary and necessary expenses paid or incurred. . . . in carrying on any trade or business." "Business" and "trade" are used synonymously and have been defined as follows in an old regulation:

REGULATION. That which occupies and engages the time, attention and labor of anyone for the purpose of livelihood, profit or imSection 214 (a-1).

provement; that which is his personal concern or interest; employment, regular occupation, but it is not necessary that it should be his sole occupation or employment. (T. D. 1989, June 2, 1914.)

It is apparent that this definition is broad enough to include professions of all types, as well as various avocations and "side-lines." Moreover, it is not necessary for a person to own a business in order to be in business or to have business expenses. Salaried officers and employees and persons receiving their remuneration on a commission basis often have business expenses which are necessary and are allowable as deductions. Recognition of this is found in the original edition of Regulations 45.8

REGULATION. . . . . Amounts paid from a salary received for all services rendered and expenses incurred are deductible as business expenses when the expenditures are occasioned by the services in respect of which the salary is paid. . . . . (Art. 292.)

In the April 17, 1919, edition of the regulations the statement was omitted. The omission, however, cannot operate to deprive anyone of a deduction for business expenses which the law permits.

Theory underlying the segregation of business expenses.— In the opinion of the author the exact line between personal and business expenses can be determined with theoretical accuracy by ascertaining whether or not the various items would have been expended had the taxpayer's income been derived from some source, other than business, which required no outlay for business expenses. For example, if a salesman or other employee receives a salary of $3,000 per annum, the query should be propounded: "What would his personal, living or family expenses be if his income of $3,000 were derived from investments?" Theoretically he should be permitted to deduct any additional expenses incurred over and

The excess profits tax law of October 3, 1917, specifically included professions within the definition of "trade" and "business." (See section 200.)

"The preliminary edition of these regulations was issued soon after the enactment of the law.

above those which he would pay if he were free to live wherever he chose and in any manner he chose within the limitations of his $3,000 investment income. If in order to earn his salary he must purchase books, attend lectures and incur similar expenses, they should be proper deductions. If he must belong to a luncheon club and entertain at his own expense prospective or actual customers, the dues and other charges of the club should be business expenses and allowable deductions. If, to be within reach of his place of business, he must live in a community where rents are high, this additional amount should be considered a business expense, as should also the cost of his commutation ticket on the railway.

There are, however, apparent difficulties in applying in practice the theoretical distinction worked out in the preceding paragraph. Moreover, the specific provision of the law forbidding the deduction of actual "personal, living or family expenses" complicates the situation, for, as a matter of fact, items which would ordinarily be classified as “family” and "personal" expenses (such, for example, as house rent) may be and often are at the same time true business expenses as ascertained by the test given above. The law forbids the deduction of the higher rent which A pays to be near his work and the regulations forbid the deduction of the commutation fare of B who prefers to spend time and railway fare rather than rent in order to secure accessibility to his business." Theoretically both deductions should be permitted. To work out a complete solution it is necessary both to change the law, so as to recognize certain "living" expenses as business expenses, and to liberalize the present regulations.'

'Income Tax Primer, 1918, question 65.

10

10The situation has been partly met in England by the establishment of allowances roughly equivalent to annual business expenses of this sort which are difficult to determine exactly, a practice permitted under the following section of the British act of 1913:

"Where the Treasury are satisfied with respect to any class of per