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Special assessments may or may not be deductible.Taxes which may not be deducted include "those assessed against local benefits of a kind tending to increase the value of the property assessed."22 The provision which broadens the deduction so as to include assessments which do not increase the value of the property appeared for the first time in the 1918 law and is an improvement over former procedure.23

REGULATION. So-called taxes, more properly assessments, paid for local benefits, such as street, sidewalk and other like improvements, imposed because of and measured by some benefit inuring directly to the property against which the assessment is levied, do not constitute an allowable deduction from gross income. A tax is considered assessed against local benefits when the property subject to the tax is limited to the property benefited. Special assessments are not deductible, even though an incidental benefit may inure to the public welfare. The taxes deductible are those levied for the general public welfare by the proper taxing authorities at a like rate against all property in the territory over which such authorities have jurisdiction. Assessments under the statutes of California relating to irrigation and of Iowa relating to drainage, and under certain statutes of Tennessee relating to levees, are limited to property benefited, and when it is clear that the assessments are so limited, the amounts paid thereunder are not deductible as taxes. When assessments are made for the purpose of maintenance or repair of local benefits, the taxpayer may deduct the assessments paid as an expense incurred in business, if the payment of such assessments is necessary to the conduct of his business. When the assessments are made for the purpose of constructing local benefits, the payments by the taxpayer are in the nature of capital expenditures and are not deductible. Where assessments are made for the purpose of both construction and main

22 Section 214 (a-3-c).

"[Former Procedure] The laws of 1917 and of prior years excluded as deductions all taxes assessed against local benefits. (See 1917 law, section 5 (a), third.]

REGULATION. "So-called 'taxes,' more properly assessments, paid for local benefits, such as street, sidewalk, and other like assessments, imposed because of and measured by some benefit inuring directly to the property against which the assessment is levied, do not constitute an allowable deduction from gross income. Taxes deductible are those levied for the public welfare by the proper taxing authorities at a like rate against all property in the territory over which such authorities have jurisdiction.

"Special assessments, such as are hereinbefore contemplated and which are measured upon the basis of the benefit flowing directly to the property, are not deductible, even though an incidental benefit may inure to the public welfare.” (Reg. 33, 1918, Art. 194.)

tenance or repairs, the burden is on the taxpayer to show the allocation of the amounts assessed to the different purposes. If the allocation can not be made, none of the amounts so paid is deductible. (Art. 133, as amended by T. D. 2937, signed by Commissioner Daniel C. Roper, and dated October 16, 1919.) 24

The regulation recognizes the distinction between capital expenditures and expense as constituting the dividing line between the deductible and the non-deductible types of special assessments. But it also goes further and attempts to apply another test of deductibility, that is, whether an assessment which is not of the nature of a capital expenditure "is necesodry to the conduct of his business." The regulation does not directly state that such assessments when imposed against non-business property are not allowable deductions, but it plainly infers this. Whatever can be said for its equity, such a position is obviously illegal. The law itself when it says "Taxes paid . . . . not including those assessed against local benefits ...." [section 214 (a-3)] practically defines a special assessment as a tax, and when such assessments are not “of a kind tending to increase the value of the property assessed” they are deductible, irrespective of whether they can be shown to be business expenses or not. The tax on a taxpayer's residence has always been an allowable deduction. Under the 1918 law taxes assessed against local benefits which do not increase the value of the property are also made allowable deductions.

ASSESSMENTS WHICH DO NOT INCREASE VALUE OF PROPERTY ARE DEDUCTIBLE.—There is a legal and economic distinc tion of long standing between taxes and special assessments.

This distinction is based upon the fact that the special assessments ordinarily represent the purchase price of equipping the

"[Former Procedure] The editions of Regulations 45 published early in 1919 included the following sentence: "Assessments under Illinois laws relating to drainage districts are not limited to the property benefited and assessments so paid are deductible." The expression, in the sentence which discusses the statutes of several states, “and when it is clear that the assessments are so limited," was introduced by T. D. 2937.

land with facilities, commonly called "improvements"—such as street paving, side-walks, sewers, etc. This equipment normally results in a "benefit inuring directly to the property against which the assessment is levied.” The economic basis for the non-allowance of such assessments consists of the fact that they are in effect expenditures of a capital nature. But it must be recognized that this foundation disappears when the special assessments are levied for purposes transitory in character. Moreover, the use of special assessments for transitory "service” activities—such as lighting and cleaning streets, snow removal, etc.—is becoming more and more widespread. These are essentially expenses and they become allowable deductions under the 1918 law.

Types of special assessments which can be deducted will be found in Massachusetts, where special assessments may be levied to provide funds for street sprinkling, for protection of trees by moth extermination and for current expenses.

Of course, the element of depreciation appears in most public undertakings, but the distinction to be made is whether or not the improvement is one which is properly of a capital nature. If not, the taxes paid on assessments are deductible.

If the improvement is of a capital nature which in time requires renewals, depreciation of its value may possibly be claimed.

SPECIAL ASSESSMENTS WHICH MAY NOT BE DEDUCTED.-In the case of the permanent types of equipment, such as sewers, streets, etc., the justice of placing special assessments on a different basis from taxes depends upon whether their nature as capital expenditures is recognized. Theoretically, the buyer of a tract of land makes his purchase “on notice” that he will be called upon to pay for its equipment with sewers, roads, etc., by the special assessment method, and consequently he makes an allowance in the price he pays for the land for this additional expenditure which must ultimately be made up from the prices he will receive when he sells the lots. It is clear that he should be permitted to include all such expenditures for special assessments as capital in calculating his taxable gain for income tax purposes when he has sold his lots. Unless he fully calculated his future special assessment burden when he purchased the tract he will suffer a loss. The same principle applies to special assessments on improved property.

If there is no element "tending to increase the value of the property” the payment does not constitute a proper capital item, because the property owner would not expect to be able to' add the assessment to the price of the property in the case of sale.

If the assessment does tend to increase the value of the property it is not a deduction for income tax purposes, but it adds to the capital value of the property and should be so regarded in computing the gain or loss in case of sale.

· CERTAIN SO-CALLED TAXES DEDUCTIBLE ONLY AS BUSINESS EXPENSE.—In some places charges for water furnished by a municipality are known as taxes, chiefly because they are assessed by the city and become a lien on real estate if not paid. Likewise, in certain communities25 "assessments” are laid upon residents to raise funds for fire protection, road improvement, etc. These do not bear the stamp of government action; they do not become a lien on real estate when not paid; and they are in fact voluntary purchases of certain services and equipment through a common fund. No such expenditures are deductible as taxes or as expenses except when paid as an incident to the possession of income-producing property or to a business carried on for profit.

Inheritance taxes ruled not deductible.

REGULATION. State inheritance taxes paid by the executor or administrator of an estate of a deceased person, which are provided by law to be deducted from the respective legacies or distributive

2sFor definition of "political subdivision," see page 45. The definition is of importance when considering items of doubtful deductibility.

shares, are not allowable deductions in computing the net income of such estate subject to tax, even though the will contains a direction to pay inheritance taxes out of the residue. An inheritance tax is upon the transfer of the property and not upon the estate of the decedent or upon the executor or administrator, although the latter is required to pay it. In general, taxes paid or accrued.within the year imposed by the authority of any State, or otherwise, are limited to those imposed upon the taxpayer and do not include taxes paid by him on behalf of another, even though he is required by law to make such payment. . . . . Since, moreover, the tax is imposed upon the transfer before the property reaches the legatee or distributee, and merely diminishes the capital share of the estate received by him, such tax is not imposed upon the legatee or distributee and is not an allowable deduction from his income. Similarly, federal estate taxes are not deductible. 26 (Art. 134.)

INTERPRETATION UPHELD BY UNITED STATES DISTRICT Court.—In a recent case under the 1913 law, the United States District Court of the Southern District of New York sustained the government's position that the tax amounts to "an appropriation by the state of a portion of the decedent's estate before the remainder vests in the legatee” and quoted approvingly from the decision in United States v. Perkins27 as follows:

and it is only at The

DECISION. The legacy becomes the property of the United States28 only after it suffered a diminution to the amount of the tax, and it is only upon this condition that the legislature consents to a bequest of it.

2[Former Procedure] The last sentence in this regulation did not appear in the preliminary edition of Regulations 45 issued early in 1919. Before 1919 the only ruling of the Treasury on this point was an informal letter which read as follows:

Ruling. "This office is in receipt of your letter of February 4, 1916, and in reply you are advised that a collateral inheritance tax levied under the laws of the state of New York being, as it is, a charge against the corpus of the estate, does not constitute such an item as can be allowed as a deduction in computing income tax liability to either the estate or a beneficiary thereof." (Letter to Charles J. McDermott, 2 Rector Street, New York, N. Y., signed by Deputy Commissioner G. E. Fletcher, and dated February 10, 1916.)

For arguments in favor of the deductibility of inheritance taxes see Income Tax Procedure, 1919, pages 480-482.

29163 U. S. 625. *The case was one in which the United States was a beneficiary.

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