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The present established position of the income tax makes it no longer imperative to discuss in a book on procedure the , general history and theory of this method of distributing public burdens. Today it is not necessary to demonstrate its historical and theoretical justification. Consequently this edition almost entirely eliminates the treatment of these topics except an account of the development of the present federal law. This account, however, is somewhat detailed so that its use in conjunction with the foot-notes headed "Former Procedure” scattered through the book will make possible an intelligent consideration of the questions which arise in the audit of returns for previous years.

Income Taxation in the United States The present federal income tax is the last of a series of such taxes to be imposed for national purposes in the United States, and it is not the only income tax being administered within the country at present, for several states utilize this source of revenue concurrently with the federal government. In fact, important as it is to the federal system, the taxation of incomes is of scarcely less interest to the several states, for it is now accepted as perhaps the most promising means of bringing about state tax reform.

State income taxation.-Because of the unhappy history of early attempts, state income taxes were viewed askance until Wisconsin, with a law introduced in 1911, demonstrated the practicability of such taxes. The Wisconsin precedent was quickly followed by other states, including Connecticut, which began to tax corporations on this basis in 1915," and Massachusetts, which passed a law of limited application in

*For a full discussion of the history of the income tax, see Edwin R. A. Seligman, The Income Tax (2nd edition, New York, 1914). For a detailed description of modern income tax systems, see K. K. Kennan, Income Taxation (Milwaukee, 1910.)

'Laws of 1911, Chapter 658. Bulletin of the National Tax Association, February, 1916, page 8.

1916. A recent but important convert to the plan is the state of New York, which in 1917 imposed a franchise tax on manufacturing and mercantile corporations and in 1919 a personal income tax. The New York franchise law was amended in 1919 to make it more general in its scope and to increase the tax to a charge of 472 per cent of the net income of corporations as reported to the Treasury for federal tax purposes and was intended to be in lieu of all personal property taxes on those corporations. Its success paved the way for the state income tax of 1919, which imposes progressive rates on the incomes of individuals. Since the new law very closely follows the federal statute in its definition of taxable income, making a brief treatment possible, and because of the large number of readers of this book who have interests affected by these recent New York laws, two chapters have been added dealing with New York income tax procedure. One deals with the personal income tax and the other with the franchise tax on corporations.

Evolution of the federal income tax law.-The present federal income tax is a recent development. Income taxes were imposed by the national government during the Civil War, when they were considered to be indirect in their nature and consequently beyond the constitutional prohibition. One was imposed also in 1894, but a year later, when tested, it was declared unconstitutional by the Supreme Court, in the famous case of Pollock v. Farmers' Loan & Trust Company, on the ground that it was a direct tax and as such could only be imposed if apportioned according to population. Such

'Chas. V. Bullock, The Massachusetts Income Tax (Boston, 1916).

"The city of New York is attempting to continue the collection of the personal property tax from foreign corporations and excessive personal property taxes from individuals, in spite of the intention of the legislature. It is expected that taxpayers will be able to frustrate these apparently illegal attempts.

See Chapters XXXVIII and XXXIX.
*Seligman, The Income Tax, page 430 et seq.
°157 U. S. 429; 158 U. S. 601.

an apportionment would lead to such monstrous economic consequences as to render a general income tax entirely unavailable as a federal financial resource until a constitutional amendment had been secured. The sixteenth amendment was finally passed eighteen years later. It provided that:

The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several states, and without regard to any census or enumeration.

The necessary number of states had ratified by February 25, 1913, but as a matter of convenience, March 1, 1913, is referred to as the date since which Congress has had the power to tax incomes without apportionment.

But even before the acquisition of this definite authority, Congress had passed the corporation excise tax of 1909, which was an income tax in fact although not in form. The evolution of the present statute dates from this act. The 1913 law widened the application of the tax to include individuals, and the laws of 1916, 1917 and 1918 represented definite developments and refinements, the more significant details of which are briefly described in the paragraphs which follow. In general there is evident a distinct trend toward elimination of arbitrary limitations on deductions, acceptance of established business customs and institutions and recognition of the accountant's definition of profit and income.

THE CORPORATION SPECIAL EXCISE TAX OF 1909.—The act of August 5, 19091o (hereinafter referred to as "the 1909 law"), provided that every corporation should "be subject to pay annually a special excise tax with respect to the carrying on or doing business by such corporation .... equivalent to one per centum upon the entire net income over and above five thousand dollars received by it from all sources during

1936 Stat. at L. C. 6, page 112; Comp. St. 1910, Supp. 1911, page 946; Pierce Fed. Code, Supp. $1036.

"Every corporation, joint-stock company or association, organized for profit and having a capital stock represented by shares, and every insurance company."

such year. ...." This law was declared constitutional by the Supreme Court of the United States 12 on the ground that it was an excise and not an income tax within the meaning of the federal Constitution, which, by clause four of article I, section II, declares that:

No capitation or other direct tax shall be laid, unless in proportion to the census or enumeration hereinbefore directed to be taken.

To all intents and purposes, except that of overcoming the constitutional difficulty, this was, of course, an income tax. The law directed that “net income” should be ascertained by deducting from gross income received certain costs, expenses paid and losses, but in the administration of the law its requirements as to income received and expenses paid were ignored, and corporations generally paid a tax based on net income as ascertained by commercial practice, i.e., by deducting expenses accrued (whether paid or not) from income earned (whether received or not). The Treasury forms and regulations were designed for and applied to net income, not net receipts.

The statute was brief and general in character, leaving to the administration much latitude in interpretation. However, one specific restriction was imposed: that upon deductions for interest paid-a feature which persisted in the later laws. The corporation could deduct interest actually paid on indebtedness only “to an amount of such bonded or other indebtedness not exceeding the paid-up capital stock of such corporation .... outstanding at the close of the year."'13

Although passed late in the year, the law applied to the incomes of corporations as of the beginning of the calendar year 1909. Consequently the period during which incomes were affected by this act was four years and two months in length, extending from January 1, 1909, to February 28, 1913, when the 1913 law replaced it.

12 Flint v. Stone Tracy Co., 220 U. S. 107. 11909 law, section 38, second.

THE 1913 LAW.-Congress, almost immediately after the ratification of the sixteenth amendment, addressed itself to the task of formulating a general income tax law, and an act was finally approved October 3, 1913, effective as of March 1, 1913 (hereinafter referred to as “the 1913 law”). In spite of its many inconsistencies and ambiguities, this law must be acknowledged to have been on the whole an "intelligent and well-considered effort."'14 It was upheld as constitutional by the Supreme Court.15 Many of the Treasury's interpretations, however, have not been upheld by the Supreme Court.

The personal exemption was high: $3,000 for a single person, with an additional $1,000 for a married couple. The rates, compared with recent levels at least, were very low. A normal tax of i per cent applied to the total net income of individuals and corporations. Surtaxes, levied on individuals only, began with a 1 per cent rate when the net income reached $20,000 and increased gradually to 6 per cent on those portions of incomes which exceeded $500,000.16 The yield the first year was approximately 71 millions.

Eagerness to prevent evasion and to secure a large yield was responsible for several restrictions upon deductions—restrictions which caused endless complications and irritations. Thus, individuals in deducting losses could not subtract those which were not incurred "in trade.” Deductions for depletion of mines, whether owned by individuals or corporations, were restricted to 5 per cent of the output. Corporations were forced to pay tax on dividends received from other corporations whether or not the other corporations were subject to income tax. The restriction upon interest paid by corporations, mentioned as a characteristic of the 1909 law, was continued by the 1913 law in another form. A corporation could now deduct interest on its indebtedness “to an amount of such indebtedness not exceeding one-half of the

"Seligman, The Income Tax, page 703.
15 Brushaber v. Union Pacific R. R., 240 U. S. I.
"For a detailed table of the rates, see Chapter VI.

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