taken into account in estimating the number of units for purposes of depletion, or if it shall be found in the course of operation that timber included in the estimate is not merchantable as the result of deterioration through rot or otherwise, or that the original estimate was too great, a new estimate of the recoverable units of timber (but not of the cost or the fair market value at a specified date) shall be made and when made shall thereafter constitute a basis for depletion. In the selection of the unit or units of estimate the custom applicable to the given type of timber in the given region should be considered. (Art. 235. Articles 234 and 235 appeared as T. D. 2916, September 5, 1919.)

SPECIAL CLASSES OF TAXPAYERS

TAX ON UNDISTRIBUTED PROFITS OF

CORPORATIONS

Congress has adopted two methods in the course of its attempts to prevent corporations from defeating the purpose of the income tax laws by the simple device of refraining from distributing their earnings. Until the earnings have been distributed as dividends and, consequently, have become subject to the surtax rates in the hands of the individual stockholders the demands of the tax have not been fully met. The first method of forcing distributions in cases in which they are deliberately withheld makes the entire profits "taxable to individual stockholders" and is directed at holding companies or "close" corporations which may refrain from distributing earnings because corporations are not subject to the surtax imposed upon individuals. The law attempts to tax the individual stockholder as if the earnings were actually distributed, thus collecting the surtax. This method under the 1913 and 1916 laws entirely failed in its object. As embodied in the 1918 law it may be more successful. No information is available which would indicate that any individual has been so taxed under this provision of the 1918 law, but the Treasury, in answer to inquiries, has stated that the 1918 law will be invoked whenever it appears that the surtax should be imposed upon undistributed earnings of 1918 and 1919.

The second method ievies an "additional tax on undistributed earnings." It does not attempt to collect a surtax from stockholders, but imposes an additional flat rate tax on the corporation itself. The 1917 law which imposed this tax may be said to have been a failure.1

[Former Procedure]_For_text of previous laws and full discussion thereof, see Income Tax Procedure, 1919, pages 617-624.

When Entire Profits May be Taxable to Individual Stockholders

Profits of corporations taxable to stockholders.

LAW. Section 220. That if any corporation, however created or organized, is formed or availed of for the purpose of preventing the imposition of the surtax upon its stockholders or members through the medium of permitting its gains and profits to accumulate instead of being divided or distributed, such corporation shall not be subject to the tax imposed by section 230, but the stockholders or members thereof shall be subject to taxation under this title in the same manner as provided in subdivision (e) of section 218 in the case of stockholders of a personal service corporation, except that the tax imposed by Title III shall be deducted from the net income of the corporation before the computation of the proportionate share of each stockholder or member. The fact that any corporation is a mere holding company, or that the gains and profits are permitted to accumulate beyond the reasonable needs of the business, shall be prima facie evidence of a purpose to escape the surtax; but the fact that the gains and profits are in any case permitted to accumulate and become surplus shall not be construed as evidence of a purpose to escape the tax in such case unless the Commissioner certifies that in his opinion such accumulation is unreasonable for the purposes of the business. When requested by the Commissioner, or any collector, every corporation shall forward to him a correct statement of such gains and profits and the names and addresses of the individuals or shareholders who would be entitled to the same if divided or distributed, and of the amounts that would be payable to each.

REGULATION. Where a domestic or foreign corporation permits. its gains and profits to accumulate for the purpose of preventing the imposition of the surtax upon such income if distributed to its stockholders, it shall not be subject to the income tax as a corporation, but its stockholders shall be subject to tax in the same way as the stockholders of a personal service corporation, except that the war profits and excess profits tax on the corporation shall first be deducted from its net income before computing the proportionate shares of the stockholders. . . . . (Art. 351.)

Accumulation of earnings to be taxable must be with purpose of evasion.—

REGULATION. The application of section 220 of the statute depends upon the two elements of (a) purpose to escape the surtax and (b) unreasonable accumulation of gains and profits. Prima facie evidence of (a) exists where a corporation has practically no business