The law provides that in computing the normal tax on the income of individuals, certain credits are to be deducted from net income, thereby exempting these amounts or classes of income from normal tax. Such credits are classified as follows: (1) Dividends of domestic and certain foreign corporations. (3) Personal exemptions. (4) Credit for dependents. A credit is allowed to corporations for interest on United States obligations which is included in gross income and a specific credit is allowed to corporations having a small net income. A credit is also allowed to China Trade Act corporations. Credit for Dividends The classes of dividends which may be used as a credit in computing the net income subject to normal tax are stated in the law as follows: LAW. Section 216. For the purpose of the normal tax only there shall be allowed the following credits: (a) The amount received as dividends (1) from a domestic corporation other than a corporation entitled to the benefits of section 262, and other than a corporation organized under the China Trade 1 Domestic corporations, most of the income of which arises from sources within a possession of the United States. See Chapter 41. Act, 1922, or (2) from a foreign corporation when it is shown to the satisfaction of the Commissioner that more than 50 per centum of the gross income of such foreign corporation for the three-year period ending with the close of its taxable year preceding the declaration of such dividends (or for such part of such period as the corporation has been in existence) was derived from sources within the United States as determined under the provisions of section 217; .... The effect of this provision is to exempt from normal tax dividends received from practically all domestic corporations (even though the paying corporations have no taxable income) and from a comparatively few foreign corporations.2 Foreign corporations receiving more than one-half of their income from sources within the United States should notify their stockholders regarding the right of credit. When stockholders do not receive a notice the credit should not be claimed. If stockholders have reason to think that they should receive the credit, but have received no notice concerning it from the corporation, they should, of course, ask the corporation for information regarding it. A "domestic" corporation is one which is created or organized in the United States or under the law of the United States or of any State or Territory. [Section 2 (3).] It should be noted that Porto Rico and the Philippine Islands are not included in the term "United States" for the purposes of the statute. Dividends received from corporations taxed in those countries, but having no income from sources within the United States, are not allowed as credits against net income of individuals or gross income of corporations. (Art. 1131.) It should be borne in mind that dividends from profits of personal service corporations accumulated between January 1, 1918, and December 31, 1921, are free from both normal and surtaxes, due to the fact that the individual stockholders paid such taxes on their distributive shares for the years in which earned by the corporation. The 1926 law provides as follows: LAW. Section 201. (e) Any distribution made by a corporation, which was classified as a personal service corporation under the provisions of the Revenue Act of 1918 or the Revenue Act of 1921, out of its earnings or profits which were taxable in accordance with the provisions of section 218 of the Revenue Act of 1918 or sec [Former Procedure] As to treatment of dividends paid by personal service corporations and dividends received from foreign corporations under previous acts, see Income Tax Procedure, 1926, page 147, and Excess Profits Tax Procedure, 1926, page 515. tion 218 of the Revenue Act of 1921, shall be exempt from tax to the distributees. .... Such distributions should not be included in gross income, and therefore will not be included in the credit for dividends. Certain dividends deductible by corporations.-Section 234 (a-6) provides for the deduction, not credit, by corporations of dividends therein described. The classes of dividends so deductible are similar to those which may be used as credits by individuals [see section 216 (a) quoted on page 110]. By so deducting dividends of these classes, they are freed from tax when received by corporations. If, however, a corporation is subjected to the tax imposed by section 220 (see Chapter 40), such dividends are not deducted in computing its net income. Credit for Interest Since the interest upon all obligations of the United States is exempt from normal tax (although subject to surtax in some cases when received by individuals), for normal tax purposes a credit is allowed for such interest as must be included in gross income. LAW. Section 216. For the purpose of the normal tax only there shall be allowed the following credits: . . . . (b) The amount received as interest upon obligations of the United States which is included in gross income under section 213;... Corporations may take credit under section 236 (a) for similar interest. The interest here described is that included within the definitions of gross and net income because it exceeds the exemption limitation referred to in section 213 (b-4). For a full discussion see Chapter 24. Personal Exemption The law specifies the credits allowed single persons, heads of families and married persons for the purpose of computing normal tax. LAW. Section 216. .... (c) In the case of a single person, a personal exemption of $1,500; or in the case of the head of a family or a married person living with husband or wife, a personal exemption [Former Procedure] See Income Tax Procedure, 1926, page 148, of $3,500. A husband and wife living together shall receive but one personal exemption. The amount of such personal exemption shall be $3,500. If such husband and wife make separate returns, the personal exemption may be taken by either or divided between them." In computing the surtax, credits may not be deducted from the net income. Therefore, if all of a taxpayer's income is from certain dividends or from Liberty bonds (in excess of the exemption allowed by law), it is possible for him to be subject to a surtax while exempt from the normal tax. Single persons,-The personal exemption of $1,500 applies to a single person (including estates) and to a married person not living with husband or wife. "Head of a family."-A head of a family, as defined below, is entitled to a personal exemption of $3,500. REGULATION. A head of a family is an individual who actually supports and maintains in one household one or more individuals who are closely connected with him by blood relationship, relationship by marriage, or by adoption, and whose right to exercise family control and provide for these dependent individuals is based upon some moral or legal obligation. In the absence of continuous actual residence together, whether or not a person with dependent relatives is a head of a family within the meaning of the statute must depend on the character of the separation. If a father is absent on business, or a child or other dependent is away at school or on a visit, the common home being still maintained, the additional exemption applies. If, moreover, through force of circumstances a parent is obliged to maintain his dependent children with relatives or in a boarding house while he lives elsewhere, the additional exemption may still apply. If, however, without necessity the dependent continuously makes his home elsewhere, his benefactor is not the head of a family, irrespective of the question of support. A resident alien with children abroad is not thereby entitled to credit as the head of a family. (Art. 302.) The foregoing regulation does not impair the right of a parent to claim the $400 for each dependent irrespective of the nationality or place of residence of the dependents. When "without necessity the dependent continuously makes his home elsewhere," it may be reasonable to hold that the taxpayer is not to be considered the head of a family. If, however, a resident alien has children abroad "with" necessity, it would seem that, in [Former Procedure] See Income Tax Procedure, 1926, page 149. Also C. B. 3, 194; O. D. 665, and Income Tax Procedure, 1920, pages 31, 32. addition to the credit of $400 for each dependent, the resident alien should be classed as the head of a family because every resident alien individual is subject to the income tax, even though his income is derived wholly from sources outside the United States. If a taxpayer can qualify as the head of a family under the definition formulated above, he can claim as personal exemption the full $3,500, even though he be not married. On the other hand, it is not necessary that he be the head of a family to claim the $400 for each dependent, provided he supplies the "chief support" of such dependent. Practically every unmarried person who is the chief supporter of a dependent should be able to qualify as a head of a family and avail himself of the additional personal exemption as well as the $400 deduction. A widow or a widower supporting minor children is clearly a "head of a family." A child acting as the main support of a dependent parent or a minor brother or sister is entitled to the higher exemption, plus the $400 exemption for each child under eighteen or dependent person mentally or physically defective.7 It has been held that a child over eighteen years of age, away at school, with an income in excess of $1,000 a year (who filed an income tax return claiming exemption of $1,000), but whose income was insufficient to pay half the cost of its support, is "dependent" on its mother (a widow), who is therefore entitled to exemption as the head of a family. A widower with a daughter over eighteen years of age who receives a nominal income from other sources and is neither physically nor mentally incapable of self-support, is head of a family. (C. B. 2, 159; O. D. 422.) 8 If minors receive income from property, the parent may qualify as head of a family if he actually pays the expenses of maintenance, education and support of the minor children. (C. B. II-1, 123; I. T. 1618.) RULING. A legal guardian is not entitled to the personal exemption of a head of a family, regardless of the fact that she may maintain and support in her home two dependent wards, if they are not connected with Section 210. See also C. B. 3, 195; O. D. 640. In order that the taxpayer may qualify as head of a family, such dependent need not be under eighteen years of age, nor mentally nor physically defective, but must be without income sufficient to support him or her. (Income Tax Facts, Treasury Department, 1923.) C. B. 2, 159; O. D. 474, and C. B. 4, 214; O. D. 775. Under the 1926 law the exemption of the child would be increased from $1,000 to $1,500. |