South Dakota is taxable under the 1926 act, but is exempt under previous acts. Many similar instances will be found among the adverse decisions of the Treasury given in Chapter 14 under "Salaries of state officers and employees."

UTILITY EMPLOYEES HELD TO BE EXEMPT.-The solicitor held that employees of the street railways owned by the city of Detroit were subject to tax (S. O. 152, C. B. II-2, 93) on the ground that the maintenance of street railways is not an essential governmental function. The district court in Frey v. Woodworth [2 F. (2d) 725] adopted a large part of the solicitor's opinion, but came to the conclusion that the maintenance of street railways is a governmental function, and hence the salaries of its officers and employees are exempt. The case was carried to the Supreme Court, but was dismissed [70 L. Ed. 397 (Adv. Op.)] on motion of the Government in view of the exactment of section 1211.

But the issue remains for years subsequent to 1924. The Treasury may or may not revise its theories of what is an essentially governmental function.5

Unfortunately, therefore, the whole question of the scope of this exemption is still open.

DISTRICT OF COLUMBIA, TERRITORIES, ETC., ARE NOT "STATES."The 1917 law (section 23) declares that "nothing in this title shall be held to exclude from the computation of net income the compensation paid any official by the governments of the District of ColumPorto Rico, and the Philippine Islands, or the political subdivisions thereof."

bia,

Public-school teachers in the District of Columbia, Alaska, and Hawaii are not in the exempted class for the reason that they are not state employees, and their salaries, or part thereof, are paid by the federal government."

Proceeds of life insurance policies.

EXTENT TO WHICH EXEMPT WHEN PAID TO BENEFICIARIES.

LAW. Section 213.

....

(b) . . . . (1) Amounts received under a life insurance contract paid by reason of the death of the insured,

'See "Tax Exemption of State Employees," by Roswell F. Magill, 35 Yale Law Journal, 956.

C. B. 1, 66; O. D. 12. Income Tax Facts, Treasury Department, 1923. [Former Procedure] See Income Tax Procedure, 1926, page 569.

whether in a single sum or in installments (but if such amounts are held by the insurer under an agreement to pay interest thereon, the interest payments shall be included in gross income);

REGULATION. The proceeds of life insurance policies, paid by reason of the death of an insured to his estate or to any beneficiary (individual, partnership, or corporation, but not a transferee for a valuable consideration), directly or in trust, are excluded from the gross income of the beneficiary. It is immaterial whether the proceeds are received in a single sum or in installments. If, however, such proceeds are held by the insurer under an agreement to pay interest thereon, the interest payments must be included in gross income. .... (Art. 72.)

The proceeds of all life insurance to whomsoever paid upon the death of the insured are definitely exempted.8 A new provision appears in the 1926 law to the effect that when the proceeds are left with the insurer under an agreement to pay interest thereon, the interest is subject to tax. Previous laws were silent upon this point, and there is some doubt as to the validity of rulings issued thereunder.9

EXTENT TO WHICH EXEMPT WHEN PAID TO THE INSURED.—

LAW. Section 213. (b) . . . . (2) Amounts received (other than amounts paid by reason of the death of the insured and interest payments on such amounts) under a life insurance, endowment, or annuity contract, but if such amounts (when added to amounts received before the taxable year under such contract) exceed the aggregate premiums or consideration paid (whether or not paid during the taxable year) then the excess shall be included in gross income. In the case of a transfer for a valuable consideration, by assignment or otherwise, of a life insurance, endowment, or annuity contract, or any interest therein, only the actual value of such consideration and the amount of the premiums and other sums subsequently paid by the transferee shall be exempt from taxation under paragraph (1) or this paragraph; . . . .

Previous laws exempted the return of premiums on life insurance policies only when paid to the insured. The present law exempts payments to any recipient. However, if the total amounts received by any taxpayer otherwise than because of death of the insured exceed the aggregate consideration or premiums paid, the excess is taxable. If the total amounts received are considered to in

*See Section 213 (b-2), page 571.

Policies payable to partnerships (except limited partnerships of the corporate type) are in effect payable to individual beneficiaries. (C. B. 1, 82; T. B. R. 22.)

For rulings under previous laws see Income Tax Procedure, 1926, page

clude dividends,10 such part of the excess should be exempt from normal tax. The same rule applies to endowment and annuity

contracts.

If in any case, say of an endowment contract, the March 1, 1913, surrender value is greater than the aggregate premiums paid to that date, the taxpayer should add to such March 1, 1913, value the premiums paid to maturity, as only the excess over such total is taxable. This is in line with the provision of section 204 (b).

RULING. The holder of a 20-year life policy had three options of settlement on maturity in 1925:

1. Cash dividend and continuation of the policy as paid-up participating insurance payable at death.

2. Conversion of the dividend into paid-up participating additional insurance to be continued with the old policy.

3. Surrender of the policy for a guaranteed reserve and the cash dividend.

Held, that having exercised the first option, taxable income was realized in 1925 only to the extent, if any, that the cash dividend plus any other amounts received under the policy exceeds the aggregate premiums or consideration paid for such insurance. (C. B. V-1, 32; S. M. 5680.)

The Unit had contended apparently that the guaranteed reserve was constructively received. The comments above as to dividends. and surrender value at March 1, 1913, might apply to this case.

Gifts and inheritances exempt.

....

LAW. Section 213. . . . . (b) . . . . (3) The value of property acquired by gift, bequest, devise, or inheritance (but the income from such property shall be included in gross income); . . . .

REGULATION. Property received as a gift, or received under a will or under statutes of descent and distribution, is exempt from the income tax, although the income there from derived from investment, sale, or otherwise is not. An amount of principal paid under a marriage settlement is a gift. (Art. 73.)

The foregoing section merely states that the value of property acquired by gift need not be included in gross income. A gift may be defined as a "voluntary transfer of property, real or personal including money, without a recompense or consideration." 11 Property acquired by gift could not be held to be income, as income has been defined by the United States Supreme Court nor could it be taxed as income. The law attempts to tax such part of the proceeds

10 As to dividends on paid-up policies, see Chapter 26. "Income Tax Facts, Treasury Department, 1923.

of gifts as represents accrued gain at the date of the gift (see Chapter 18). It is claimed that the gift itself is not taxed but only the untaxed gain contained in the gift. Against this is the contention that the imposition of a so-called income tax on donees based on a time and a base over which donees have no legal control, and usually no knowledge at all, is purely and simply a tax on the capital interest with which donees become seized at the date of gift.

No attempt is made to tax to the donees 12 gifts as such; the tax referred to becomes effective only when, as, and if donees sell or exchange the property acquired by gift. It may be said therefore that, as in all other income tax laws, property acquired by gift is exempt from the income tax.

It was so held by the United States District Court (Southern District of New York) in the case of Taft v. Bowers (United States District Court, Southern District of New York, August 5, 1926). The court said:

DECISION. It is my opinion that no part or portion of the value of an outright bona-fide gift as of the date of delivery is, or can, constitute taxable income in the hands of the donee.

If money or other property is acquired in a manner about which. there is a doubt, the transaction may be inquired into. If it is determined that legal consideration is an element, the value of the property may be wholly or in part income, depending on the circumstances of each case.

It is apparent that in many cases the proper course of action for the recipient of a gift which might seem to be somewhat in the nature of compensation for services rendered is determined by the action of the person who made the payment. If the giver desires to deduct the item as an expense, the recipient can scarcely object to reporting any payment of this nature actually received as taxable income. Here, as in so many cases, good faith and a disposition to yield on really doubtful points are essential to the successful administration of the income tax law.

Bequests to executors in lieu of commissions have been held to be non-taxable (U. S. v. Merriam, 263 U. S. 179), but an amount fixed by the will as full "payment for all commissions, percentages and allowances" as executors has been held to be taxable income (Ream v. Bowers, U. S. Dist. Ct., S. D. N. Y., Sept. 9, 1926).

"As to the tax formerly payable on gifts by donors, see Gift Tax Procedure, 1926.

A taxpayer sold her interest in an expected inheritance from her father, who was living at the time of sale and had made no will. The Treasury held that the entire amount received should be treated as income for the period in which received. (C. B. I-2, 60; I. T. 1466.) This decision is questionable.

Transactions in which the element of taxability is stronger than that of exemption are discussed in the appropriate chapters dealing with income from services, gains on sales, etc. Gifts which have been held to contain no element of taxable income are illustrated by the following ruling:

RULING. Personal transportation passes issued by a railroad company to its employees and their families, to be used when not engaged on business for the company, and which are not provided for in the contracts of employment, are considered gifts and the value thereof does not constitute taxable income to the employees. (C. B. 4, 110; O. D. 946.)

COLORABLE GIFTS.-It is reasonable to insist that gifts must be irrevocable and bona fide in order that subsequent realized gains or income will be taxed to the donees instead of to the donors. Usually the element of consideration controls. Where there is no family relation (where the consideration of "love and affection" is sufficient) it should be shown that the consideration is reasonable.

In Sullivan's Appeal (2 B. T. A. 1012) the taxpayer was negotiating the sale of property. Before the details were arranged he transferred the property to his wife.

The Board decided for the taxpayer on the ground "that at the date of such assignment the negotiations for the sale were in an inchoate state and not enforceable."

In Moores' Appeal [3 B. T. A. 301 (A)] taxpayer negotiated sale of property, then made gift to wife and children, then they made the legal sale. The Board overruled the Commissioner and said the gifts were made prior to any agreement for the sale of the stock. The decision is sound but it is very liberal.

In Jemison's Appeal (3 B. T. A. 780) the taxpayer had negotiated the sale of property before he gave it to his wife, but the sale was not legally made until after the gift was made.

The Board said:

DECISION. But we can not disregard the separate legal existence of husband and wife as individuals, or their separate rights to hold property and to make separate income-tax returns under both the general law and the Revenue Acts. So long as avoidance is permitted in this