There has been great dissatisfaction over this phase of the Income Tax Law for in most cases the only difference between the net profit shown on the books of account and the Income Tax returns has been the item of bad debts. Some bookkeepers and business men have conceived the idea that it is not permissible to set up a reserve for bad debts under the Income Tax Law. This is incorrect; in fact, the failure to set up reserves is opposed to correct accounting and if reflected in a Balance Sheet in some states will subject the person who signs it to severe penalties, including imprisonment for obtaining credit upon a false financial statement. However, under the Treasury regulations, the Income Tax returns must ignore the results shown in the books of account. One can claim as deductions only debts charged off within the year and must not use the amount set up as a reserve for debts not yet charged off. In order to comply with existing regulations, taxpayers should be careful to include in their returns all accounts charged off as bad during the year, whether debited in the books to reserve accounts, to Bad Debts account, or to the Profit and Loss account.

Definition of a Bad Debt. (Regulation No. 33, 1918, 195.) "A bad debt or worthless debt, as contemplated by the Income Tax Law and which may be deducted in a return of income, is a debt which has been actually ascertained to be worthless and charged off within the taxable year."

(Reg. No. 1918, 194.) "Where all of the surrounding and attendant circumstances indicate that a debt is worthless and uncollectible and that legal action to enforce payment would in all probability not result in the satisfaction of execution on a judgment, a showing of these facts will be sufficient showing of the worthlessness of the debt for purposes of deduction."

Bad Debts Charged off and Later Collected Must Be Considered Income. (Reg. No. 33, 1918, ¶14.) [Individuals] "Bad debts which have been claimed and allowed as a deduction in prior returns are considered income if subsequently collected."

(Reg. No. 33, 1918, 380.) [Corporations] "Bad debts or accounts charged off by a corporation because of the fact that they were determined to be worthless, and subsequently recovered, constitute income for the year in which recovered, regardless of the date when the amounts were charged off. Neither the date at which the debt was charged off nor the fact that it was or was not deducted from gross income in any return made for tax purposes will in any way affect its character as income of the year in which recovered.'

Income Corresponding To Bad Debt Must Have Been Represented in Tax Returns In Order To Be Deductible. (Reg. No. 33, 1918, ¶96.) "Debts arising from unpaid wages, salaries, rents and items of similar taxable income will not be allowed as a deduction unless the income they represent has been

included in the return of gross income for the year in which the deduction as a bad debt is sought to be made or in a previous year and the debts themselves have been actually ascertained to be worthless and charged off."

The following questions and answers taken from the Income Tax Primer, 1918, will furnish additional information:

(Question 94.) "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 good will offering, is not held to constitute a bona fide debt."

(Question 96.) "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 cannot be claimed as a deduction."

(Question 91.) "In 1917 a corporation or a firm to which I had loaned money became bankrupt. Can this debt be considered absolutely worthless and claimed as a deduction for 1917?

"No, unless the affairs of the debtor have been finally adjusted, its assets sold for the benefit of, or distributed to, its creditors, and its receiver in bankruptcy discharged. If all this has occurred during the year 1917, so much of the debt as remains unpaid after the receiver is discharged may be claimed as a deduction for the year 1917."

(Question 92). "Is it absolutely necessary that the debtor corporation or firm mentioned in the ninety-first inquiry be declared a bankrupt and its receiver discharged before I can claim a deduction on account of the debt in question?

"No. If the debtor corporation has no assets whatsoever, and it is definitely known that nothing whatsoever can be collected from debtor itself or any person connected with it, a creditor need not go to the expense of instituting bankruptcy proceedings in order to establish his right to claim the worthless debt as a deduction."

5. LEGAL PHASES

An Account Stated. This is defined in Webster's Dictionary as "an account presented and accepted by both parties." Therefore, it would seem to mean an account rendered and agreed to by both the buyer and seller, consequently in a suit

for collection, it would not be neccessary to prove the items composing the account, because each of the parties concerned had previously agreed to them as stated in the account.

Proceedings for the Collection of an Unsecured Debt. When a debt is unsecured, it is first necessary to bring suit and to secure a judgment against the debtor before the court will grant an execution. An execution takes the form of an attachment and a sale by the sheriff of the debtor's property after being advertised in the manner required by law. There are certain exemptions that apply and these are definitely enumerated by the statutes covering the matter in the various states. An execution can only be enforced against property within the jurisdiction of the court granting it, and if there is property belonging to the debtor not in the jurisdiction, it would be necessary to file a transcript of the judgment and secure another execution. It may be necessary to obtain a new judgment for property outside of the state.

An Account "Outlawed." The Statue of Limitations applies to open accounts as well as to notes and judgments. An open account is said to be "outlawed" if not collected within the time limit set by law. This varies in the different states from two to eight years. However, if a part payment is made on an account, then the time limit is automatically extended from that date. The limit on a judgment is much longer than on an open account and varies from five to twenty years. An auditor in verifying accounts receivable should always be on the lookout for accounts long past due. These accounts if more than two years old might be uncollectible. The same is true with regard to a judgment. It would be well for the student to obtain a copy of the Statute of Limitations of his state.

Applying Part Payments on an Account. A debtor has the right by law to indicate on what item his payment shall be applied. Hence, if he owes several amounts and wishes the payment to be applied on any one particular amount and requests it, the credit must be applied on that amount.

A partial payment made on a debt bearing interest is first applied in payment of interest, and if more than sufficient, the remainder is applied in payment of the principal.

Payment at Maturity. Payment of a debt must be made on the day it falls due, unless it be a holiday, in which case it must be made the next secular or business day. If a debt is not paid when it becomes due, it must bear interest from that date until paid. Payment must be made to the creditor personally, or his duly authorized agent, at the creditor's office, residence or wherever he may be, the debtor being required to find his creditor and not the creditor to seek his debtor.

Receipt A Matter of Courtesy. A debtor cannot insist upon a receipt as a condition precedent to payment of a debt when it is his duty to pay. A debtor is not legally entitled to a receipt except as follows:

1. In some instances the statute makes it the duty of a public officer to give a receipt for money paid to him in his official capacity.

2.

In a number of the states it is provided by statute that a person making a tender may demand a receipt in writing, duly signed, as a condition precedent to delivery.

The Sales Contract. There is a There is a difference between "sales" and "contracts to sell." The following definitions are taken from the Uniform Sales Act:*

"A sale of goods is an agreement whereby the seller transfers the property in goods to the buyer for a consideration called the price."

"A contract to sell goods is a contract whereby the seller agrees to transfer the property in goods to the buyer for a consideration called the price."

An actual sale is sometimes called an "executed contract sale," whereas a contract to sell is called an "executory contract of sale."

Essentials of a Valid Sale. All the usual essentials of an ordinary contract apply to sales.

1. Competent parties. Both the seller and buyer, legally known as the vendor and vendee, must be competent to contract.

2. Mutual assent. There must be an agreement between the parties that the title to the thing sold is to be transferred to the buyer.

*The Uniform Sales Act was prepared by a commission on Uniform State Laws. The commission was appointed by the various states to unite in working out uniform laws governing sales. As a result of the work of this committee, we have three different acts relating to sales and allied subjects:

(a) The Uniform Sales Act.

(b) The Uniform Warehouse Receipts Act.

(c) The Uniform Bills of Lading Act.

The Uniform Sales Act has now been adopted in the following states:

3. Legal Subject Matter. The seller must possess ownership of the title of the goods in order to be able to convey title to the buyer. One who sells property to which he has no title such as lost, stolen or borrowed goods, passes no right of possession to an innocent buyer. The seller cannot transfer the ownership of something which is not in existence, or of something which he does not own. He can, however, enter into an executory contract of sale whereby he may agree to sell goods to be manufactured, altered, delivered, etc., before actually passing the title to the buyer.

4. Consideration. There can be no sale without a price. It is this element that distinguishes a sale from a gift or a barter. When property is transferred by gift, title is passed as soon as it is delivered to the recipient and cannot be recovered by the giver. A barter is a trade whereby goods are exchanged for other goods instead of for money.

A contract of sale is valid, however, even though no price is mentioned, because the court will assume that the goods are to be paid for at a reasonable price and the buyer will be charged accordingly. If goods are ordered and it is agreed that the price is to be fixed at a later date, there is neither a sale nor a contract to sell because one of the essentials of the contract has been omitted. However, there may be provisions in the contract to the effect that the price is made dependent on outside cir-` cumstances. For instance, the price may be the market price on the day of delivery, or it may be agreed that the price is to be fixed by a third party. The fact that the price may be inadequate or excessive does not invalidate a sale or a contract to sell. If the parties to a contract are competent and yet one of them enters into a poor bargain, the court will not extend relief or sympathy.

5. Contracts to sell must comply with the Statute of Frauds. The Statute of Frauds applies to contracts to sell where delivery is to be made later and where the value is over a certain amount. This amount varies in the different states, ranging from $30.00 in Arkansas, Maine and Missouri to $500.00 in Arizona, Massachusetts, New Jersey and Rhode Island, and up to $2,500.00 in Ohio, but $50.00 is the usual sum.

Where the Uniform Sales Act has been passed, the value of the goods is the basis, but in many states the statutes specify that the price is the basis. Where the amount is based on the price then it may be fixed by the parties themselves, but when it is based on the value then the actual market value is used. Therefore, any contract to sell goods, amounting in value to more than the specified sum in that state, to be enforceable, must be supported by a written memorandum of the terms of the agreement signed by the party against whom it is sought to force the contract or his agent. This memorandum need not