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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."29

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.

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, 30 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, 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.)

Elisabeth 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.

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 subjects for deduction. Furthermore, the 1918 law plainly states that the term "paid” means “paid or accrued."'35 Consequently, all tax reserves, except those for federal income and excess profits taxes and for special assessments, are deductible. In these years of highly fluctuating profits, proper reserves for taxes are, of course, of great importance.

[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.)

**See page 258.

3-Section 200.

DEDUCTIONS FOR LOSSES

Preceding chapters discuss the deductions for expenses, interest and taxes. It remains to discuss the deductions embraced within the comprehensive term “losses." It is desirable to subdivide this subject and to devote separate chapters to the special items, namely, losses due to bad debts, depreciation, obsolescence and depletion. (Chapters XXVIII to XXXI.) Consequently the subject matter of this chapter is a residuum consisting of the losses due to general and miscellaneous causes, including Aluctuation in market values, to disasters and accidents of various kinds, to dishonesty, to faulty judgment, etc., etc.

Both individuals and corporations may deduct the losses discussed in this chapter without limitation. Until the 1918 act became effective, individuals were subject to a very definite restriction in that losses incurred by them in transactions entered into for profit outside their regular trade or business were deductible only to an amount not exceeding profits arising from similar transactions. In the next place the

'[Former Procedure] The provision of the 1913 law relating to the deduction of losses by individuals was as follows:

1913 Law. Section II (b) . . . . fourth, . . . . losses actually sustained during the year, incurred in trade or arising from fires, storms or shipwreck, and not compensated for by insurance or otherwise. ....

The 1916 law introduced the March 1, 1913, basis of valuation and the provision permitting "outside" losses, equal to profits arising from similar transactions, to be deducted.

The 1916 law was as follows:

1916 Law. Section 5. [Individuals) .... (a) .... Fourth. Losses actually sustained during the year, incurred in his business or trade, or arising from fires, storms, shipwreck, or other casualty, and from theft, when such losses are not compensated for by insurance or otherwise : ....

Fifth. In transactions entered into for profit but not connected with his business or trade, the losses actually sustained therein during the year to an amount not exceeding the profits arising there from; ,

1918 law included certain "relief" provisions, designed to prevent hardship during the period following the war from possible violent changes in inventory values. The chief ploblems here are, therefore, the determination of procedure under these special “relief" provisions and the establishment of the standard by which to measure losses due to diminution in values. This second problem is similar to that discussed in Chapter XV, “Income from Exchanges and Sales of Property.”

Individuals.

Law. Section 214. (a) That in computing net income there shall be allowed as deductions: ...

(4) Losses sustained during the taxable year and not compensated for by insurance or otherwise, if incurred in trade or business;

(5) Losses sustained during the taxable year and not compencated for by insurance or otherwise, if incurred in any transaction entered into for profit, though not connected with the trade or business; but in the case of a nonresident alien individual only as to such transactions within the United States;

(6) Losses sustained during the taxable year of property not connected with the trade or business (but in the case of a nonresident alien individual only property within the United States) if arising from fire, storms, shipwreck, or other casualty, or from theft, and if not compensated for by insurance or otherwise;

Corporations.

Law. Section 234. (a) .... (4) Losses sustained during the taxable year and not compensated for by insurance or otherwise.

"[Former Procedure. The corresponding clause in the 1913 law read:

Law. Section II, G (b).... "all losses actually sustained within the year and not compensated by insurance or otherwise."

1916 Law. “Section 12. (a) .... Second. All losses actually sustained and charged off within the year and not compensated by insurance or otherwise. ...."

It should be noted that the 1916 law reads "actually sustained and charged off.” The words "and charged off" did not appear in the section relating to individuals and were inserted in the corporation section only in 1916. This added restriction was proper. No corporation should be permitted to claim deductions in an income tax return which it is unwilling to set up on its books. If the question of a reserve enters into the disposition of a loss, the item is subject to the comments on page 680.

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