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

For 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:

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.

"[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.

163 U. S. 625.

The case was one in which the United States was a beneficiary.

The judge remarked that it was "impossible to reconcile the conflicting expressions in judicial opinions," but expressed the belief that his decision would be found to "accord with the results reached by the various cases.'

1129

Tax on undistributed surplus not deductible.—

RULING. Replying to your communication of March 14, 1919, you are informed that the 10 per cent tax which was imposed on corporation's undistributed net income by section 10 (b) of the Revenue Act of September 8, 1916, as amended by the Revenue Act of October 3, 1917, is not an allowable deduction from the gross income of a corporation shown on an income tax return. (Letter to The Corporation Trust Company, signed by Commissioner Daniel C. Roper, and dated April 1, 1919.)

The 10 per cent tax was a tax upon income and for that reason was not deductible.

Postage not deductible as a tax.—

REGULATION.

Postage is not a tax

(Art. 131.)

Postage, of course, is deductible as a necessary business

expense.

30

Federal tax paid by corporations under tax-free covenants not deductible.-The 2 per cent federal tax on "tax-free" bonds, which corporations theoretically withhold at the source, is held to be paid for account of the recipient of the interest, and as it is an allowable credit to the recipient, taxes so paid are not deductible by the corporation. In Notes on the Revenue Act of 1918 the Secretary of the Treasury suggests (page 22) that the law be amended to provide that "such tax may be deducted by the obligor as interest."

REGULATION. Corporations may deduct taxes from gross income to the same extent as individuals, except that in the case of corporate bonds or obligations containing a tax-free covenant clause,

Elizabeth S. Prentiss v. Mark Eisner (260 Fed. 589), quoted in T. D. 2933, signed by Commissioner Daniel C. Roper and dated October 9, 1919. For method of securing advantage of the deduction, see Chapter XVII, “Income from Interest," page 413.

the corporation paying a federal tax, or any part of it, for someone else pursuant to its agreement is not entitled to deduct such payment from gross income on any ground. In the case, however, of corporate bonds or obligations containing an appropriate tax-free covenant clause, the corporation paying a State tax or any other than a federal tax for someone else pursuant to its agreement may deduct such payment as interest paid on indebtedness.31 (Art. 565.)

If the tax paid under the "tax-free covenant" is other than a federal tax, it is deductible.32

SUGGESTION TO CORPORATIONS.-Corporations with "taxfree" covenant bonds are under no necessity to pay a tax on the interest of such bonds as are held by persons whose income is less than the personal exemption ($1,000 for single and $2,000 for married persons, etc.). They can make a saving by giving close attention to the form of certificates filed with them by such persons. Many bondholders with very small incomes are not careful to file the form of certificate which claims the exemption. Wherever feasible the certificates claiming exemption should be substituted for those not claiming exemption.

Accrual Method Permitted

Since January 8, 1917,33 when T. D. 2433,34 (which held that under the 1916 law, effective as of January 1, 1916, accrued liabilities, such as taxes, would be allowable deductions) was issued, the regulations have permitted the deduction of accruals for all taxes which in themselves are eligible sub

[Former Procedure] Article 193 of Regulations 33, 1918, did not state specifically that "a State tax or any other than a federal tax" was deductible as interest.

"[Former Procedure] Under the regulations in force prior to April 17, 1919, a tax, paid pursuant to a covenant, "whether federal, state or otherwise" was not available for deduction, but the regulation did not properly interpret the law and its modification was necessary. "[Former Procedure]

REGULATIONS. "Deductions for taxes, however, should be the aggregate of the amounts actually paid, as shown on the cash book of the corporation." (Reg. 33, 1914, Art. 158.)

"Reserves for taxes cannot be allowed, as the law specifically provides that only such sums as are paid within the year for taxes shall be deducted.' (Reg. 33, 1914, Art. 156.)

24See page 258.