This chapter deals with the deductibility of taxes in determining net income. Chapter 8 discusses the question of reducing the tax liability by certain tax credits. In one way or the other, as deductions or credits all taxes, except federal income tax and certain types of special assessments, are available to reduce the amount of income tax payable. Taxes Deductible Individuals. LAW. Section 214. (a) In computing net income there shall be allowed as deductions: (3) Taxes paid or accrued within the taxable year except (A) income, war-profits, and excess-profits taxes imposed by the authority of the United States, (B) so much of the income, war-profits, and excess-profits taxes, imposed by the authority of any foreign country or possession of the United States, as is allowed as a credit under section 222, (C) taxes assessed against local benefits of a kind tending to increase the value of the property assessed, and (D) taxes imposed upon the taxpayer upon his interest as shareholder of a corporation, which are paid by the corporation without reimbursement from the taxpayer. For the purpose of this paragraph, estate, inheritance, legacy, and succession taxes accrue on the due date thereof except as otherwise provided by the law of the jurisdiction imposing such taxes; REGULATION. Federal taxes (except income, war-profits, and excessprofits taxes), State and local taxes (except taxes assessed against local benefits of a kind tending to increase the value of the property assessed), and taxes imposed by possessions of the United States or by foreign countries (except the amount of income, war-profits, and excess-profits taxes allowed as a credit against the tax), are deductible from gross income. . . . . (Art. 131.) Corporations. LAW. Section 234. (a) In computing the net income of a corporation subject to the tax imposed by section 230 there shall be allowed as deductions: (3) Taxes paid or accrued within the taxable year except (A) income, war-profits, and excess-profits taxes imposed by the authority of the United States, (B) so much of the income, war-profits, and excess-profits taxes imposed by the authority of any foreign country or possession of the United States as is allowed as a credit under section 238, and (C) taxes assessed against local benefits of a kind tending to increase the value of the property assessed. In the case of obligors specified in subdivision (b) of section 221 no deduction for the payment of the tax imposed by this title, or any other tax paid pursuant to the tax-free covenant clause, shall be allowed, nor shall such tax be included in the gross income of the obligee. The deduction allowed by this paragraph shall be allowed in the case of taxes imposed upon a shareholder of a corporation upon his interest as shareholder, which are paid by the corporation without reimbursement from the shareholder, but in such cases no deduction shall be allowed the shareholder for the amount of such taxes. For the purpose of this paragraph, estate, inheritance, legacy, and succession taxes accrue on the due date thereof except as otherwise provided by the law of the jurisdiction imposing such taxes; Article 131, quoted above, also applies to corporations. The foregoing sections provide a blanket deduction for all taxes except: 1. United States income, war profits and excess profits taxes. profits taxes imposed by a foreign country or possession of 3. Local improvement taxes. 4. Taxes paid pursuant to a tax-free covenant in corporate obligations. (But such tax may be credited against the total tax payable by the obligee.) 5. Taxes on stockholdings, paid by the corporation without reimbursement from the owners of such stock. (Deductible by the corporation but not by the stockholder.) When do taxes accrue?-The law uses the phrase "paid or accrued," and consequently, all proper tax reserves, except those for federal income and excess profits taxes and for certain special assessments, are deductible by taxpayers on the accrual basis. In Hewinson's Appeal (1 B. T. A. 1080) the taxpayer kept his books on a cash basis. In April, 1924, he paid an item of taxes for 1923 which he deducted in his 1923 return. The Commissioner denied the deduction and was upheld by the Board. RULING. A taxpayer on the accrual basis should accrue the income taxes which he will be required to pay on the income accruing during the year, and in computing his net income for such year he is entitled to deduct the State income tax which has accrued on such income. (C. B. V-1, 56; S. M. 4499 A.) The decisions are generally in accord that taxes accrue when they become due and payable, and they may not be accrued before the due date. It is frequently, however, a matter of some difficulty to determine exactly when a particular tax falls due. According to some commentators, the decision in U. S. v. Anderson (269 U. S. 422) has overthrown this general proposition. The taxpayer kept its books on the accrual basis, and accrued during 1916, among other items, taxes on sales of munitions in 1916, which taxes became due and payable in 1917, and were then paid. The taxpayer in making out the return of its income for 1917 deducted the amount of munitions taxes paid in 1917. The Commissioner held that the amount should have been deducted on the 1916 return, and assessed and collected for 1917 an additional income tax on that basis. The taxpayer sued to recover this amount and obtained a judgment in the Court of Claims, but judgment was reversed in the Supreme Court. The court held: DECISION. The appellee's true income for the year 1916 could not have been determined without deducting from its gross income for the year the total costs and expenses attributable to the production of that income during the year. The reserve for munitions taxes set up on its books for 1916 must have been deducted from receivables for munitions sold in that year before the net results of the operations for the year could be ascertained. The taxpayer being unable to make its return on a strict receipts and disbursements basis, and not having attempted to do so, could not have complied with Sec. 13 (d) and Treasury Decision 2433 by deducting either accruals of interest or expenses alone without the other, or without deducting other reserves made on its books to meet liabilities such as the munitions tax, incurred in the process of creating income. Only a word need be said with reference to the contention that the tax upon munitions manufactured and sold in 1916 did not accrue until 1917. In a technical legal sense it may be argued that a tax does not accrue until it has been assessed and becomes due; but it is also true that in advance of the assessment of a tax, all the events may occur which fix the amount of the tax and determine the liability of the taxpayer to pay it. In this respect, for purposes of accounting and of ascertaining true income for a given accounting period, the munitions tax here in question did not stand on any different footing than other accrued expenses appearing on appellee's books. In the economic and bookkeeping sense with which the statute and Treasury decision were concerned, the taxes had accrued. It should be noted that Sec. 13 (d) makes no use of the words accrue or "accrual" but merely provides for a return upon the basis upon which the taxpayer's accounts are kept, if it reflects income-which is precisely the return insisted upon by the Government. We do not think that the Treasury decision contemplated a return on any other basis when it used the terms "accrued" and "accrual" and provided for the deduction by the taxpayer of items "accrued on their books." United States v. Woodward, 256 U. S. 632 (U. S. Tax Cases 580), relied upon by appellees, arose under the Income Tax Law of 1918 (c. 18, Title II, sections 210-214, 219, 1405, 40 Stat. 1062-1067, 1071, 1151). Section 213 (a) and (e) of that Act provided that taxes "paid or accrued" within the taxable year imposed by authority of the United States, except income, war profits and excess profits taxes, might be deducted in ascertaining income. The claim of the taxpayer of the right to deduct estate taxes levied under that Act for the year when due, although paid in a later year, was upheld. It did not appear whether, as here, the taxpayer kept his books on the accrual basis or whether, as here, events had occurred before the tax became due which fixed the amount of it; for it did not appear whether the deductions to be made from the testator's gross estate were ascertainable for the purpose of determining the estate tax. The question which we now have to determine was not raised, considered or decided in that case. The decision, strictly construed, does not involve the question of when the taxes accrued, or how the books should be kept. The decision is that the taxes having been accrued for 1916, and the statute having permitted a return on the basis upon which the taxpayer's accounts were kept, the taxes should have been deducted from 1916 income. It seems reasonably clear that Mr. Justice Stone did not intend to lay down rules as to how books should be kept, but rather merely to decide how a return should have been made under the 1916 act when books had been kept in a particular way. Nevertheless, the Treasury has given unofficial indication that, at least in some cases, taxes should be accrued during the period in respect of which they are levied. (See Excess Profits Tax Procedure, 1926, Chapter 11.) This position accords with bookkeeping practice, but Congress has ignored accounting principles in regard to interest, taxes and other items. Having regard to the wording of the law, how can tax liability be accrued when its amount is wholly uncertain and when the liability itself has not yet arisen? Particularly in the cases of taxes, with frequently recurring changes in rates, exemptions, and credits, and with provisions often retroactive for more than a year, it is questionable accounting and bad law to require an accrual before the liability becomes definite-that is, when the tax becomes due and payable. The decisions relating to accruals discussed below antedate the Anderson case. In the opinion of the author, they are still, except as noted, good law. The Treasury, however, may take the opposite view. Unfortunately the new regulations are no more helpful than the old on this point. FEDERAL TAXES.-The Board held in several cases that accrued federal taxes should not be deducted from invested capital before they were due and payable. (See Excess Profits Tax Procedure, 1926.) These decisions are valuable in answering the general question of when taxes accrue. [See particularly Ayres & Co.'s Appeal 1 B. T. A. 1135 (NA).] The Board has also held that the capital stock tax for the taxable period commencing July 1, 1919 and ending June 30, 1920, accrued July 1, 1919, the tax being payable in advance. [Jamestown Worsted Mills Appeal, 1 B. T. A. 659 (A).] The Treasury has held that the capital stock tax accrues in the taxable year for which due. (C. B. I-2, 101; I. T. 1538.) The Board further held in the same case that the additional capital stock tax liability imposed under the 1918 law accrued on February 24, 1919, the date of approval of the 1918 law. As has already been indicated, the Supreme Court has held that munitions taxes for 1916, accrued on the books in that year, but paid in 1917 when due, are deductible in 1916. |