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[Former Procedure-Continued] 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

[Former Procedure-Continued] 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 a waited 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 ?

[Former Procedure-Continued]

“No. Interest and dividends are held to be items of current income, returnable as such, and they are not to be considered when computing the amount of profit or loss which results from a purchase and sale." (Income Tax Primer, 1918, question 84.)

Two criticisms may be urged against this procedure. The first is its complexity. It was pointed out in The Wall Street Journal, February 26, 1918, that it involves a minute analysis of brokers' statements and the submission of a schedule with a separate line for each occasion upon which one has entered the market. In the second place, it has been urged that, in a speculative venture of this sort, the interest charges and the dividend credits are all integral parts of the transaction; that they are considered not as interest payments and dividends in the ordinary sense, but rather as incidental debits and credits leading to a net gain or loss on the transaction and that all the law was intended to reach was this net result. On the other hand, when losses are fully deductible there is an advantage in reporting dividends as income, because the normal tax has been paid thereon.

Worthless bonds are bad debts deductible without limit.-Under the 1916 law losses arising out of the purchase and sale of stocks and bonds were not allowable deductions except as offsets to profits arising out of similar transactions. Bonds, however, are debts and, if they became entirely worthless, they could be charged off and the cost thereof could be entered under the heading as a deduction, irrespective of the amount. Stocks are not "debts" and credit could not be claimed for those becoming worthless, except as stated on page 645.

CHAPTER XXVIII

DEDUCTIONS FOR BAD DEBTS

The deduction for bad debts is limited by fewer restrictions than most other deductions. In the case of corporations the law prior to 1918 did not specifically mention the deduction for bad debts and consequently it fell under the general permission to deduct losses. To individuals the law gives authority to deduct worthless debts, in language broad enough to include all such debts without limitation as to amount, no matter whether incurred in trade or business or not. The chief problems of procedure which arise have to do, first, with a test by which the worthlessness of debts shall be judged and, second, with the manner in which the deduction shall be allowed—the vexed question of a reserve as compared with the prescribed method of deducting only the specific debts charged off during the year.

Law. Section 214. (a) [Individuals] That in computing net

LAW. Section 2 allowed as deductions: j charged off within the

(7) Debts ascertained to be worthless and charged off within the taxable year;

The deduction for corporations (section 234 (a-5)] is exactly the same.

Only Bona Fide Debts Deductible If an item claimed as a bad debt partakes of the nature of a gift more than of that of a loan, or if, arising during a period when it could or should have been reported, it has not been included in the federal tax reports as gross income, it is not deductible as a bad debt.

"See page 625, footnote 1.

'It will be recalled that individual losses incurred outside an individual's trade or business were during 1916 and 1917, deductible only to the extent of the profits from similar undertakings. Under the 1913 law the Treasury held that they were not deductible at all. (See page 664, footnote.)

The language of this section remained unchanged in the 1913, 1916 and 1917 laws, viz., "debts due to the taxpayer actually ascertained to be worthless and charged off within the year.” The change in the 1918 law is merely verbal.

Loans to friends or relatives.—A question in the Income Tax Primer reads as follows:

Ruling. If, on account of friendship or relationship I advanced a certain sum to assist a needy friend or relative, and at the time such advance was made I had little or no reason to expect that the amount so advanced would ever be returned, may I now claim a deduction to cover such advance?

No. Such an advance, partaking, as it does, somewhat of the nature of a philanthropic donation or a goodwill offering, is not held to constitute a bona fide debt. (Income Tax Primer, 1918, question 94.)

Income corresponding to bad debt must have been reported in tax returns.

REGULATION. Worthless debts arising from unpaid wages, salaries, rents and similar items of taxable income will not be allowed as a deduction unless the income such items represent has been included in the return of income for the year in which the deduction as a bad debt is sought to be made or in a previous year. .... (Art. 152.)

This regulation applies particularly to taxpayers who have rendered returns based on cash receipts and payments. It is well illustrated by the following quotation from the Income Tax Primer:

Ruling. A professional man earned a fee in 1916. As he keeps no books, he reports his income for tax purposes on an actual receipt basis. As this fee has never been reported as income, can it be claimed as a deduction if collection can not be made ?

No; never having been returned as income it can not be claimed as a deduction. (Income Tax Primer, 1918, question 96.)

It must be understood, however, that the rulings quoted do not debar one from claiming the deduction of an item as a bad debt, even though the corresponding income has not been reported, in case the account arose before the federal income tax laws were in force. The effective date for corpora

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