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CHAPTER XXVI

DEDUCTIONS FOR TAXES

The federal income tax law is generous in allowable deductions for taxes.

All taxes paid in this country, except the federal income tax itself and certain types of special assessments, whether imposed in the course of earning one's income or in spending it, are eliminated in determining net taxable income. Moreover, in the case of foreign income and profits taxes the 1918 law in general adopts the very liberal policy of accepting foreign tax receipts in payment of domestic tax obligations.

Taxes Deductible
Individuals.-

Law. Section 214. (a) That in computing net income there shall be allowed as deductions: .... (3) Taxes paid or accrued within the taxable year imposed (a) by the authority of the United States, except income, war-profits and excess-profits taxes; or (b) by the authority of any of its possessions, except the amount of income, war-profits and excess-profits taxes allowed as a credit under section 222; or (c) by the authority of any State or Territory, or any county, school district, municipality, or other taxing subdivision of any State or Territory, not including those assessed against local benefits of a kind tending to increase the value of the property assessed; or (d) in the case of a citizen or resident of the United States, by the authority of any foreign country, except the amount of income, warprofits and excess-profits taxes allowed as a credit under section 222; or (e) in the case of a nonresident alien individual, by the authority of any foreign country (except income, war-profits and excess-profits taxes, and taxes assessed against local benefits of a kind tending to increase the value of the property assessed), upon property or business;

Corporations.—Deductions (a), (b) and (c) are the same as for individuals. As to (d) corporations receive credit for foreign taxes under section 238, and there are the following deductions which relate solely to corporations:

'For the status of inheritance taxes, see page 620.. Section 234 (a-3).

Law. Section 234. (a) (3) .... (d) in the case of a domestic corporation, by the authority of any foreign country, except the amount of income, war-profits and excess-profits taxes allowed as a credit under section 238; or (e) in the case of a foreign corporation, by the authority of any foreign country (except income, war-profits and excess-profits taxes, and taxes assessed against local benefits of a kind tending to increase the value of the property assessed), upon the property or business: Provided, That in the case of obligors spec'fied in subdivision (b) of section 221 no deduction for the payment of the tax imposed by this title or any other tax paid pursuant to the contract or provision referred to in that subdivision, shall be allowed.

[Former Procedure] The provisions of the 1913 law relating to individuals read simply "all national, state, county, school and municipal taxes paid within the year, not including those assessed against local benefits.” (Section II, B, third.) The corporation section of the 1913 law is as follows: "All sums paid by it (viz., the corporation) within the year for taxes imposed under the authority of the United States or of any State or Territory thereof, or imposed by the government of any foreign country.” [Section II, G (b), fourth.]

Under the law of 1913 taxes paid to a foreign country by citizens or alien residents of the United States were not allowable deductions. The provisions of the law for the deduction of taxes applied only to taxes paid to the United States, or to some state or political subdivision thereof in the United States. It was evidently an oversight on the part of the framers of the law. In his report of December 6, 1915, the Commissioner of Internal Revenue recommended that foreign taxes be made allowable deductions, and the permission was granted in the 1916 law. In considering returns prior to 1916, this change in the law must be kept in mind.

1916 LAW (as amended in 1917). Section 5. "That in computing net income in the case of a citizen or resident of the United States

(a) For the purpose of the tax there shall be allowed as deductions- ...

Third. Taxes paid within the year imposed by the authority of the United States (except income and excess profits taxes) or of its Territories, or possessions, or any foreign country, or by the authority of any State, county, school district, or municipality, or other taxing subdivision of any State, not including those assessed against local benefits."

The phrase "except income and excess profits taxes” was inserted in the 1917 law. The provisions of the 1917 law relating to deductions for taxes paid were exactly the same for individuals and for corporations.

1917 Law (excess profits tax credit). Section 29. “That in assessing income tax the net income embraced in the return shall also be credited It is seen that the law provides a blanket deduction for all taxes except those specifically mentioned. The provisions of the 1918 law must be strictly construed. All taxes, except income and excess profits taxes, which were allowable deductions under the laws of 1913, 1916 and 1917, are still deductible. No restriction is placed upon the deduction of the federal capital stock excise tax, state income or other taxes. The permission to credit the excess profits tax (section 236) places this tax in a peculiar position as to deduction.

Excess profits taxes may be "credited.”—

Law. Section 236. That for the purpose only of the tax imposed by section 230 [income tax rates] there shall be allowed the following credits:....

(b) the amount of any taxes imposed by Title III for the same taxable year: Provided, That in the case of a corporation which makes return for a fiscal year beginning in 1917 and ending in 1918, in computing the tax as provided in subdivision (a) of section 205, the tax computed for the entire period under Title II of the Revenue Act of 1917 shall be cred.ted against the net income computed for the entire period under Title I of the Revenue Act of 1916 as amended by the Revenue Act of 1917 and under Title I of the Revenue Act of 1917, and the tax computed for the entire period under Title III of this Act at the rates prescribed for the calendar year 1918 shall be credited against the net income computed for the entire period under this title:

The method of calculation of excess profits taxes payable is fully described in Excess Profits Tax Procedure, Chapter V. After a return is prepared showing the taxpayer's net income, the next step is the determination of the amount due as excess profits tax. For the sole purpose of calculating the amount due as federal income tax, the amount of the excess profits tax (accrued but not paid) may be entered as an allowable deduction. On the remaining balance of net income, the federal income tax is to be assessed (see Chapter VI). The amount so shown should appear on the books as a liability. The usual procedure is to debit taxes and credit reserve for taxes. If this method is not followed, an entry should be made at the end of fiscal or calendar year debiting taxes and crediting the government. A similar entry should be made for the excess profits tax accrued. For the purposes of the excess profits tax in computing invested capital the tax reserve is counted as invested capital until the tax becomes due and payable in the next taxable year.*

with the amount of any excess profits tax imposed by Act of Congress and assessed for the same calendar or fiscal year upon the taxpayer and, in the case of a member of a partnership, with his proportionate share of such excess profits tax imposed upon the partnership."

Foreign taxes paid may be deducted in full from taxes assessed in United States.-Income or excess profits taxes paid during the taxable year to a foreign country or any possession of the United States may be deducted from the amount determined to be due to the United States. This does not mean that such taxes are a deduction from or credit against gross or net income, but that the items are a deduction from the amount of taxes otherwise payable.

INDIVIDUALS. —

Law. Section 222. (a) That the tax computed under Part II of this title shall be credited with:

(1) In the case of a citizen of the United States, the amount of any income, war-profits and excess-profits taxes paid during the taxable year to any foreign country, upon income derived from sources therein, or to any possession of the United States; and

(2) In the case of a resident of the United States the amount of any such taxes paid during the taxable year to any possession of the United States; and

(3) In the case of an alien resident of the United States who is a citizen or subject of a foreign country, the amount of any such taxes paid during the taxable year to such country, upon income derived from sources therein, if such country, in imposing such taxes, allows a similar credit to citizens of the United States residing in such country; and

(4) In the case of any such individual who is a member of a partnership or a beneficiary of an estate or trust, his proportionate share of such taxes of the partnership or the estate or trust paid during the taxable year to a foreign country or to any possession of the United States, as the case may be.

(b) If accrued taxes when paid differ from the amounts claimed *Reg. 45, Art. 845. See Excess Profits Tax Procedure, Chapter X. as credits by the taxpayer, or if any tax paid is refunded in whole or in part, the taxpayer shall notify the Commissioner, who shall redetermine the amount of the tax due under Part II of this title for the year or years affected, and the amount of tax due upon such redetermination, if any, shall be paid by the taxpayer upon notice and demand by the collector, or the amount of tax overpaid, if any, shall be credited or refunded to the taxpayer in accordance with the provisions of section 252. In the case of such a tax accrued but not paid, the Commissioner as a condition precedent to the allowance of this credit may require the taxpayer to give a bond with sureties satisfactory to and to be approved by the Commissioner in such penal sum as the Commissioner may require, conditioned for the payment by the taxpayer of any amount of tax found due upon any such redetermination, and the bond herein prescribed shall contain such further conditions as the Commissioner may require.

(c) These credits shall be allowed only if the taxpayer furnishes evidence satisfactory to the Commissioner showing the amount of income derived from sources within such foreign country or such possession of the United States, and all other information necessary for the computation of such credits.

CORPORATIONS.—

Law. Section 238. (a) That in the case of a domestic corporation the total taxes imposed for the taxable year by this title and by Title III shall be credited with the amount of any income, warprofits and excess-profits taxes paid during the taxable year to any foreign country, upon income derived from sources therein, or to any possession of the United States.

If accrued taxes when paid differ from the amounts claimed as credits by the corporation, or if any tax paid is refunded in whole or in part, the corporation shall at once notify the Commissioner, who shall redetermine the amount of the taxes due under this title and under Title III for the year or years affected, and the amount of taxes due upon such redetermination, if any, shall be paid by the corporation upon notice and demand by the collector, or the amount of taxes overpaid, if any, shall be credited or refunded to the corporation in accordance with the provisions of section 252. In the case of such a tax accrued but not paid, the Commissioner as a condition precedent to the allowance of this credit may require the corporation to give a bond with sureties satisfactory to and to be approved by him in such penal sum as he may require, conditioned for the payment by the taxpayer of any amount of taxes found due upon any such redetermination; and the bond herein prescribed shall contain such further conditions as the Commissioner may require.

(b) This credit shall be allowed only if the taxpayer furnishes evidence satisfactory to the Commissioner showing the amount of in

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