The chief problems of procedure connected with deductions for expenses are occasioned by the presence of certain restrictions in the law itself. First of all, the statute forbids the deduction of personal or living expenses. This is quite necessary and proper, but it involves the difficult task of establishing a sharp line of demarcation between business and living expenses. Gifts (see Chapter 39) in the next place, are not generally deductible; but in many cases it is not easy to determine whether a payment, nominally a gift, is not more truly an expense. The law does not permit the deduction of capital expenditures except in the form of depreciation allowances. Care must be taken not to allow any distribution of profits under the guise of business expense. Other difficulties are caused by the prohibition of certain expenditures as contrary to public policy and by the necessity of taking a position on the question of insurance, that is, how far expenses are deductible which seek to safeguard the income from risks of various sorts.

In this chapter the first general section is devoted to the establishment of the distinction between business and personal expenses and is consequently applicable to individuals only. The remainder of the chapter deals with various specific types of expenses and, unless otherwise specified, applies alike to individuals, partnerships and corporations. In many cases the deductibility of a particular item becomes a complicated question involving several of the distinctions referred to in the preceding paragraph, as, for example, when a

salary must be shown to be not a gift, a personal expense, a distribution of profit, a distribution of assets or a payment for property.

Expenses which are deductible.

LAW. Section 214. [Individuals] (a) In computing net income there shall be allowed as deductions:

(1) All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered; traveling expenses (including the entire amount expended for meals and lodging) while away from home in the pursuit of a trade or business; and rentals or other payments required to be made as a condition to the continued use or possession, for purposes of the trade or business, of property to which the taxpayer has not taken or is not taking title or in which he has no equity.

Section 234.

[Corporations] (a) In computing the net income of a corporation subject to the tax imposed by section 230 there shall be allowed as deductions:

(1) All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered, and including rentals or other payments required to be made as a condition to the continued use or possession of property to which the corporation has not taken or is not taking title, or in which it has no equity.

REGULATION. Business expenses deductible from gross income include the ordinary and necessary expenditures directly connected with or pertaining to the taxpayer's trade or business, except the classes of items which are deductible under the provisions of articles 121-261. The cost of goods purchased for resale, with proper adjustment for opening and closing inventories, is deducted from gross sales in computing gross income. (See article 35.) Among the items included in business expenses are management expenses, commissions, labor, supplies, incidental repairs, operating expenses of automobiles used in the trade or business, traveling expenses while away from home solely in the pursuit of a trade or business (see article 102), advertising and other selling expenses, together with insurance premiums against fire, storm, theft, accident, or other similar losses in the case of a business, and rental for the use of business property. A taxpayer is entitled to deduct the necessary expenses paid in carrying on his business from his gross income from whatever source. .... Art. 101.)

The principle underlying the deductions for expenses was well expressed in the following rulings of the Treasury Department:

RULINGS. Only those expenses which are incurred in earning income which is subject to tax under the income tax law constitute allowable deductions in computing net income taxable under the law. (T. D. 2137, January 30, 1915.)

Whether any expenditure is deductible for income tax purposes as a business expense depends not upon what the payment may be called, but upon the purpose and inherent nature of the payment and its relation to the profit-making activities of the taxpayer. The substance, not the form of the payment, is the controlling factor. . . . (C. B. V-1, 227; S. M. 5523.)

The intention of the law is discussed in a case which involved the non-allowance to a corporation of a contribution of $500 toward a fund being raised to purchase land upon which there was erected an ordnance plant of the U. S. Navy. [Thomas Shoe Co.'s Appeal, 1 B. T. A. 124 (A).] The contribution helped business generally in the city of Charleston but it was not shown that it bore any direct relation to the business of the taxpayer. The Board said:

DECISION. To be deductible as a business expense a contribution, charitable or otherwise, must have in a direct sense some reasonable relation to the taxpayer's business.

The Board's decision probably reflects the proper interpretation of the words "ordinary and necessary expenses," although it would not be hard to justify the propriety of considering as ordinary and necessary all expenses which are not purely personal. Few corporate officers would pay $500 towards bringing a new industry to their vicinity unless they could read into the payment some benefit flowing to the corporation. It was in no sense a charitable contribution and it had few of the elements of a personal expenditure. It surely was something, and yet the decision merely throws it out as a business expense and adduces no reason for any other classification.

In Leavenworth's Appeal (1 B. T. A. 754) the taxpayer deducted as business expenses items paid out of his personal bank account. The Commissioner disallowed all of the deductions and was upheld in part and overruled in part. The Board allowed easily provable items such as interest, insurance, repairs, depreciation on automobile. Traveling expenses were not supported by sufficient evidence to convince the Board that they were incurred entirely for business purposes and were disallowed.

Expenditures made by a corporation engaged in the retail shoe business in purchasing from its customers tickets to entertainments were held not deductible. (C. B. IV-1, 32; I. T. 2135.) But the foregoing was overruled in McQuade's Appeal (4 B. T. A. 837). The taxpayer purchased tickets from customers to relieve them of part of their burden. The Commissioner had disallowed the deduc

MEANING OF TERM "ORDINARY AND NECESSARY."-In many cases the Commissioner's interpretation of the words "ordinary and necessary" does violence to the usual and accepted meaning of those words. It is impossible to lay down specific rules properly to govern the efforts of business men to earn profits. What may be an ordinary expense in one business would constitute a personal expense in another. The proprietor of a ladies' hairdressing establishment might legitimately deduct the cost of cigarettes furnished to his patrons but if he claimed a deduction for cigars it should be disallowed. The efforts of the Commissioner, after expenditures have been made, to pass upon their propriety have not always been reasonable. All business executives make mistakes. They plan advertising campaigns which are total failures. Surveyed in after years they appear foolish and unnecessary in the light of results, but if entered into bona fide and in the expectation of success they are just as "ordinary and necessary" as the expenditures which turn out well. Business could not survive if mistakes or out-of-theordinary expenditures were treated on any other basis than wise expenditures.

The term "ordinary and necessary" must be interpreted to include all special and unusual expenditures of a business concern which are made in bona fide attempts to maintain or expand the business. This subject is further discussed in Chapter 39.

In First National Bank of St. Louis' Appeal (3 B. T. A. 807) the Board said as to certain expenses disallowed by the Commissioner:

DECISION.

The fact that they may be unusual in amount or seldom recur can not deprive them of their inherent character as expense items...

In Brandenburg's Appeal (4 B. T. A. 108) the taxpayer was engaged in the dairy business and exhibited horses at horse shows and state fairs. The commissioner disallowed the cost of such exhibitions but was overruled by the Board.

In National Concrete Co.'s Appeal (3 B. T. A. 777) the taxpayer refused to furnish the names of persons to whom money was paid. The Board said: "By not furnishing sufficient evidence of alleged expenditures, the taxpayer has failed in its proof of ordinary and necessary business expense." The foregoing is sound, but the Commissioner and the Board used a rather untenable argument when they said that as the payments were fixed or determin