Limitation on losses incurred in transactions outside business or trade.-Under the 1918 law all losses incurred in trade, or arising from transactions entered into for profit, are deductible, but under former laws there were limitations on the deductions.

For several years the author has contended that the Treasury did not properly interpret the earlier laws and that many losses which were disallowed were in fact allowable deductions. During 1919 a case was decided in a United States district court wherein the court held that the Treasury was in error in disallowing a loss which the taxpayer claimed as having been incurred in trade. The taxpayer received a large block of stock in an industrial company to whose affairs she evidently devoted some time and attention.

DECISION. The transactions . . . were complicated in character, involved a very large sum of money, and must have required much of her time and attention, and I am of the opinion that they were of the character contemplated by Congress as "incurred in trade." [Bryce et al. v. Keith, Collector, 257 Fed. 133 (March 26, 1919).]

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The 1913 law merely allowed as a deduction losses "actually sustained during the year incurred in trade" and arising from certain casualties. No specific provision was included like that of 5 (a) fifth of the 1916 law, definitely permitting the limited deduction of losses in transactions, entered into for profit but outside one's business or trade, or definitely excluding them. Consequently the definition of the term "in trade" became of the very greatest importance and upon its interpretation rested the question whether or not the Treasury would recognize the entire deductibility of certain losses, because losses outside one's "trade" under this law might be construed to be not deductible at all (unless they were of the nature of the casualties described) whereas under the 1916 law they were deductible to the extent of gains from similar transactions.

At first the Treasury placed a liberal interpretation upon the phrase "losses incurred in trade," including, for example, transactions in securities by persons not dealers.

RULING. "If securities were purchased prior to March 1, 1913, and disposed of at a profit or loss during 1913, and no annual adjustment is made on the books, the profit or loss as ascertained when sold (that is, the difference between the cost and the selling price), shall be prorated and the proportionate profit or loss from March I would be gain or allowable deduction.

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"If the stock was purchased after March 1, 1913, and sold at a later date, during that year, the entire profit or loss in the transaction would be considered a gain or an allowable deduction in computing the net income." (Deputy Commissioner Speer, early in 1914.)

Moreover, this liberal interpretation appears to have been in conformity with the intention of the framers of the law. (See Congressional Record, April 26, 1913.)

This broad interpretation of the term was short-lived, however, for a Treasury decision issued June 2, 1914, took the following form:

REGULATION.""In trade' is synonymous with business.
"Business' has been defined as:

"That which occupies and engages the time, attention and labor of anyone for the purpose of livelihood, profit or improvement; that which is his personal concern or interest; employment, regular occupation, but it is not necessary that it should be his sole occupation or employment. The doing of a single act incidentally or of necessity not pertaining to the particular business of the person doing the same will not be considered engaging in or carrying on the business.'

Still further restrictions were added a few months later, December 14, 1914.

REGULATION. ". . . . A person can be engaged in more than one business, but it must be clearly shown in such cases that he is actually a dealer, or trader, or manufacturer, or whatever the occupation may be, and is actually engaged in one or more lines of recognized businesses before losses can be claimed with respect to either or more than one line of business, and his status as such dealer must be clearly established." (T. D. 2090.)

In refusing to modify the foregoing decisions the Treasury position was made still more clear and definite.

RULING. "The act of Congress requires that the tax shall be paid 'upon the entire net income arising or accruing from all sources,' permitting the deduction of certain specified kinds of expenses and losses, one of which is 'losses actually sustained during the year, incurred in trade.' I have no authority to permit any other losses to be deducted than those which Congress provides for. If Congress had intended that all losses might be deducted, it would doubtless have so drafted the law. Therefore, forbidding the deduction from income tax returns of losses incurred outside the ordinary course of business, but requiring_the_inclusion of profits made outside the business, is not the act of the Treasury Department, but of Congress." (Extract from letter to S. C. Mead, Secretary of the Merchants' Association of New York, signed by Secretary of the Treasury W. G. McAdoo and dated February 27, 1915.)

The attempt to apply the restriction as outlined above has involved many inconsistencies and injustices. Many taxpayers ignored the regulations and in their returns took credit for losses which no doubt will be disallowed. In such cases the tax should be paid under protest for there is at least a reasonable chance that it will be refunded some day.

The 1916 law [section 5 (a)] provided that in transactions entered into for profit but not connected with one's business or trade "the losses actually sustained therein during the year" were deductible only to an

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amount not exceeding the profits arising therefrom. This, of course, was interpreted to permit gathering together in one sum the profits of all such transactions and in another sum all of the losses which are deductible to an amount not exceeding the sum of the profits. For example, if one dabbled in stocks and in real estate, both being outside one's "business or trade," losses in stock transactions needed not to be measured against gains from stocks alone in determining their deductibility, but could be measured against the total profits from both stock and real estate transactions.

Dividends received could not be designated as profits. The term "profits arising from transactions entered into for profit" might include dividends on stocks carried in a speculative account but would not include dividends received from investment stocks.

Definition of business or trade.—In imposing the above limitation the law burdened the taxpayer with the task of separating transactions connected with his business or trade from those which were not connected therewith. In making this classification he had as a guide the following regulation:

REGULATION. "The difference between 'losses. . . . incurred in his business or trade' (4th deduction) and losses 'in transactions entered into for profit but not connected with his business or trade' (5th deduction), is illustrated by the difference between the definitions of ‘avocation': That which takes one from his regular calling; a minor occupation; and 'vocation': The occupation or pursuit to which one devotes his time or life, a calling. It is possible for a man to give sufficient time, attention and capital to the pursuit of different lines of business to constitute more than one avenue of 'business or trade or employment,' his business or trade.

"Paragraph 4 of section 5 (a), act of September 8, 1916, provides for losses 'actually sustained during the year, incurred in his business or trade, etc.' These would be losses under the head of vocation.

"Paragraph 5 of section 5 (a), act of September 8, 1916, provides for losses actually sustained during the year in transactions entered into for profit but not connected with his business or trade; that is, losses under the head of 'avocation': that which takes one from his regular calling; a minor occupation. Losses under the head of ‘avocation' may be deducted 'to an amount not exceeding the profits arising from transactions under this head.'" (Reg. 33, 1918, Art. 8.)

The Primer illustrates this distinction by the following example: RULING. "For example: 'A' is regularly engaged in buying improved or unimproved real property with the intention of selling the same as early as possible at a profit. In one or more instances the property purchased may be sold at a loss, and that loss may be claimed by him as a deduction under the provisions of the fourth paragraph for the reason that he is regularly engaged in buying and selling real estate. Now, 'B' buys a home or, perhaps, he buys two or three pieces of property in the course of several years. He is not regularly engaged in buying and selling real estate and, therefore, any loss he may suffer through such a transaction can only be claimed by him as a deduction under the provisions of the fifth paragraph of section 5; that is, only so much of his

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losses as does not exceed the amount of gain or profit derived during the same year from other transactions entered into for profit, but not connected with his regular business or trade, can be claimed. If 'B,' in 1917, sold one property at a loss of $2,000 and another property at a gain of $1,000, he must report the gain of $1,000 under 'gross income' and can claim only that amount as a loss.

"This same rule is applicable in the case of losses arising from purchases and sales of stocks and bonds. If the taxpayer is regularly engaged in buying and selling such securities, any loss he may suffer may be claimed under the provisions of the fourth paragraph. If he is not so engaged it may only be claimed under the provisions of the fifth paragraph." (Income Tax Primer, 1918, question 83.)

The example given in the foregoing ruling appears to agree with the interpretation placed upon the phrase "business or trade" by the Treasury in past years, which the author considers to be unjustifiably narrow. This interpretation, for example, would put into the "non-business" group losses on all stock transactions undertaken by anyone not a dealer in stocks. The "vocation-avocation" distinction enunciated by Regulations 33, quoted above, could be so interpreted as to solve the problem in a much more satisfactory fashion. As a matter of fact there are times when a business man who is not a dealer or broker in stocks enters into a stock transaction as a part of his "business or trade."

Thus if a man in the automobile business bought 100 shares of Union Pacific at 150 and sold them at 100, the loss of $5,000 was clearly not allowable under the 1916 law, unless he had profits to offset, because he was not in the railroad business and the purchase of the railroad stock had no connection with the success or failure of his automobile business. But suppose he bought 1,000 shares of the Radium Automobile Company of Detroit-the manufacturer of the car he was selling in New York. In good faith he assumed that the purchase of the stock would favorably affect his relations with the company with which he dealt.

The idea that a corporation has no soul is true as to some things but untrue as to others. It has been held by the courts time and time again that the identity of stockholders cannot be ignored; that every corporation, in the last analysis, is owned, managed, controlled by individuals; that it cannot act of itself, but only through and by individuals. It is not likely that the courts will change front on this. They are more likely to extend the doctrine.

The automobile man found he had gained prestige with the manufacturers who recognized him as one of themselves: that is, one of their large stockholders, and as such entitled to a vote-legally—and a voice in the management-morally. Unfortunately, the automobile market became oversold, the demand fell off, profits decreased and then disappeared. The New York man decided to embark in some other business and sold out as quickly as possible. He paid 200 for his stock; he sold it for 50, and lost $150,000. Was he entitled to deduct all of the loss as "incurred in his business or trade," or was he denied the right to deduct, or limited in

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this right because the transaction was "not connected with his business or trade"? In the author's opinion it was strictly connected with his business and the fact that he was not a dealer in stocks did not make it any the less so.

There were many transactions in which the connection was close enough to leave little doubt. There were many others in which obviously there was no connection. There is another class, not so large as either one of the others, where there was some difficulty in determining the liability for tax. There the circumstances should have been investigated carefully and a decision should have been made in good faith. If in good faith it seemed that a loss was fully deductible because it arose out of a transaction "connected with his business or trade," the taxpayer should have claimed the deduction, and, if disallowed, he should have paid the tax under protest and awaited the decision of the courts. The words in the 1916 law "not connected with his business or trade" should have been taken in their usual meaning. The courts will not sanction any strained or forced interpretation of the words. The Supreme Court of the United States may be expected to define the words "not connected" as the man in the street defines them. Otherwise no citizen would be safe in his attempt to obey a law framed in words which he thinks he understands, because an officer of the government might place upon the wording of the statute an entirely different construction.

Morrill v. Jones (106 U. S. 466) holds that the Secretary of the Treasury cannot, by regulation, alter or amend a revenue law, nor put into the body of the statute a limitation which Congress did not think it necessary to prescribe. So that, where the statute provided for the admission, free of duty, of "animals, alive, specially imported for breeding purposes, from beyond the seas," a regulation by the Secretary of the Treasury that before a collector admits such animals free, he must "be satisfied that the animals are of superior stock, adapted to improving the breed in the United States," is in excess of his powers.

Losses on stocks carried on margin must be isolated.-A very troublesome effect of the limitation on the deduction of losses just discussed manifested itself when one attempted to report the results of a transaction where stocks were carried on margin with a broker, interest being charged on money borrowed to carry the stock and dividends being credited to the account as they were received. The Treasury ruled that such dividends must be reported by the individual as income and that the interest might be deducted by him on the theory that this would clear away all extraneous items so that the profit or loss on the stock transaction might be shown.

RULING. "In computing amount of profit or loss resulting from purchase and sale of securities which is to be returned or claimed as a deduction under the provisions of the fifth paragraph of section 5 of the act of September 8, 1916, is interest or dividends received on the securities during the tax year to be taken into consideration?