Partnerships, estates, and insurance companies allowed benefit of net loss provision.

LAW. Section 206. ... (g) The benefit of this section shall be allowed to the members of a partnership, to an estate or trust, and to insurance companies subject to the tax imposed by section 243 or 246, under regulations prescribed by the Commissioner with the approval of the Secretary.

The benefit of the net loss provision is restricted to estates and trusts and excludes the beneficiaries thereunder because the estate and the beneficiaries are separate legal entities, and consequently the loss accruing to the estate does not affect the capital of the beneficiaries and therefore should not be permitted to be applied by the beneficiaries in computing net income for the following year.

In the case of a partnership the deduction would be available to the individual partners in the same proportion as the partnership income is allocated to them. (But see page 676.) A member, however, cannot segregate the net loss from other income and carry it forward independently. To receive the benefits of the provision a member of a partnership must sustain a loss after including his entire income from all sources. (C. B. 2, 58; O. D. 430.)

RULING. Inquiry has been made whether the word "taxpayer" as used in section 204 (b) of the Revenue Act of 1921 includes individuals, partnerships, and corporations within its scope.

Section 2, subdivision (9), of the Revenue Act of 1921 defines this case was entitled to the deduction it claimed not by reason of any implication, which we can not make-we can not read into the tax law a right to deductions or exemptions not specifically there appearing-but that it was entitled to the deduction claimed by it by reason of the express and emphatic provisions, as the court sees them, of the law.

In Harlan's Appeal [1 B. T. A. 1027 (NA)] the Board cited the Carroll Appeal and the Commissioner did not file an answer to the petition. The deficiency therefore was disallowed.

In Patapsco's Appeal [1 B. T. A. 1081 (NA)] the taxpayer was organized May 1, 1918. It was dissolved Aug. 31, 1919. The Board overruled the Commissioner who had denied it the right to take advantage of section 204 (b) of the 1918 law.

In Tacoma Grocery Co.'s Appeal (1 B. T. A. 1062). “Prior to June 30, 1919, the books of the taxpayer were kept and tax returns made upon the basis of a fiscal year ending June 30. Thereafter the taxpayer changed to a calendar year basis and filed a return of its income for the period from July 1, 1919, to December 31, 1919, and a return for the calendar year 1920." The Commissioner refused to allow the loss for the six months' period ended December 31, 1919, as a deduction from its net income for the fiscal year ending June 30, 1919. The Board upheld the Commissioner.

The privilege of carrying forward losses under the 1921 act was not extended to taxpayers who voluntarily changed their fiscal periods under section 226. (Walker's Appeal, 4 B. T. Á. 151; citing Bankers Trust Co. v. Bowers, 295 Fed. 89.)

the word "taxpayer," when used in that Act, as including any person, trust or estate subject to a tax imposed by that Act. Subdivision (1), section 2, provides that "the term 'person' includes partnerships and corporations as well as individuals." It will be seen, then, that the word "taxpayer" as used in section 204 (b) of the Revenue Act of 1921 includes corporations within its meaning, but does not include a partnership because a partnership is "not subject to a tax."

The individual members of a partnership are taxable on their distributive shares of the net income of a partnership, and a net loss as contemplated by section 204 (a) and (b), by a partnership, is deductible by the partners in their individual capacity under the provisions of section 204 (c). (C. B. I-1, 45; I. T. 1252.)

The following ruling, while made under the 1921 law, now has particular significance since the net loss provisions are extended to estates and trusts.

RULING. The decedent was a member of a partnership at the time of his death in 1909. His estate continued the decedent's interest in the partnership, which sustained a net loss for the year, 1921.

It is held that, since the estate is still in process of administration, the net loss is not deductible from the income of the beneficiaries but should be charged against the income of the estate for the following year. (C. B. II-2, 44; I. T. 1771.)

May a net loss of a taxpayer reorganized under section 203 be carried forward to new entity?-Section 206 (b) provides, "If for any taxable year, it appears . . . . that any taxpayer has sustained a net loss, the amount thereof shall be allowed as a deduction in computing the net income of the taxpayer for the succeeding taxable year . . .

The statute limits the deduction to net losses sustained by "the" taxpayer. If as the result of a reorganization within the purview of section 203 a new entity comes into existence, nevertheless the net loss of its predecessor may be an allowable deduction in computing the net income of the new entity since, under section 203 the new entity may be deemed to be, for tax purposes, a continuation of the old taxpayer. The Treasury has applied the principle of the so-called "continuity theory" in many cases. In depreciation the old bases are carried over. In capital gains the two-year period includes the time the assets were held by the old corporation. In White House Milk Co.'s Appeal (2 B. T. A. 860) the Board held that a net loss of a predecessor corporation could not be applied against the taxable income of a successor corporation, but the transaction was not, strictly speaking, a continuing one.

DEFINITION OF "ANY TAXPAYER."- Deductible net losses which can be carried forward properly are limited to "continuing" taxpayers, but a mere change in form should not deprive any taxpayer of the benefit of the deduction. In White House Milk Co.'s Appeal (2 B. T. A. 860) a corporation sold its assets to the representative of the old stockholders who organized a new company. All the stockholders of the new (except one) were stockholders of the old

company. deducted.

The old company had a net loss which the new company

The Commissioner disallowed the deduction. The Board upheld the Commissioner and said:

DECISION. . . . . In our opinion there are too many legal obstacles to overcome to sustain the contention of the taxpayer. There is a difference in taxable years-one calendar and one fiscal-; and there is the difference in legal entities. It is undisputed that the taxpayer was a new corporation composed of a minority of stock and stockholders of the old corporation and that there was an intervening ownership of assets by an individual prior to the formation of the new corporation.

Net losses of affiliated taxpayers.

RULING. If a net loss under section 204 has been sustained by corporations making a consolidated return for 1921, this loss may be claimed as a deduction in the consolidated return for 1922, notwithstanding the fact that the loss was mainly attributable to a subsidiary company and the subsidiary company, though not dissolved, will not be actively engaged in business during the year 1922. (C. B. I-2, 32; I. T. 1386.)

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However, two or more corporations were affiliated for the calenyear 1921, but were not affiliated for the succeeding taxable year. The consolidated return for 1921 disclosed a net loss. If one or more members of the affiliated group sustained a net loss for that year and other members of the group had a net income, the amount of the net loss disclosed by the consolidated return should be apportioned among the several members of the group which, considered separately, sustained net losses, in proportion to the net loss sustained. by each, and the part of the net loss attributable to each of such members may be applied against the net income of such member for the year 1922, and any excess over the net income for that year may be applied against net income for 1923.6

C. B. II-1, 128; I. T. 1655. For ruling dealing with apportionment of net losses under 1918 law, see C. B. III-2, 36; L. O. 1113, and C. B. IV-1, 115; S. R. 4451.

Claim for net loss to be filed with succeeding year's re

turn.

REGULATION. A taxpayer sustaining for any taxable year a "net loss" as defined in section 206 (a) and article 1621 may file a claim therefor with his return for the succeeding taxable year (referred to in article 1623 as the "second year"). The claim should contain a concise statement setting forth the amount of the net loss and all pertinent facts relative thereto, including a schedule showing the computation of the net loss in accordance with section 206 and articles 1621 and 1626. If the evidence furnished satisfies the Commissioner that the taxpayer has sustained a "net loss," the amount of such net loss may be allowed as a deduction in computing the net income of the taxpayer for the succeeding taxable year, and if such net loss is in excess of the net income (computed without such deduction) for that year, the amount of the excess may be carried over and allowed as a deduction in computing the net income for the next succeeding taxable year (referred to in article 1623 as the "third year"). It should be noticed, however, that a “net loss" for a preceding year may not be considered in computing a "net loss" for a succeeding year. (See section 206 (a).) (Art. 1622.)

The net loss is to be shown as an ordinary deduction in the return for the subsequent year and the explanatory schedule referred to in article 1622 is to be attached. No formal claim is required if the deduction is taken in the return for the subsequent year; but if not so deducted, a claim for refund should be filed.

The law specifically provides that taxpayers may deduct for bad debts either: 1

I. A reasonable addition to a reserve for bad debts, or 2. Debts ascertained to be worthless in whole or in part. This chapter deals with the types of bad debts which may be deducted in whole or in part, with the determination of their deductibility, and with the procedure when reserves are maintained.

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

(7) Debts ascertained to be worthless and charged off within the taxable year (or, in the discretion of the Commissioner, a reasonable addition to a reserve for bad debts); and when satisfied that a debt is recoverable only in part, the Commissioner may allow such debt to be charged off in part; . . .

[Former Procedure] The 1913, 1916 and 1917 laws read: "debts due to the taxpayer actually ascertained to be worthless and charged off within the year." The change in the 1918 law was merely verbal. The 1921 and 1924 laws are similar to the 1926 law.