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Depreciation may be claimed on books purchased for the taxpayer's library. Premiums paid on a fidelity bond is considered a business expense. Traveling expenses (including the entire amount expended for meals and lodging) while away from home in the pursuit of a trade or business, are deductible from gross income in computing net income. Insurance on business property may be deducted, but insurance paid on the home in which the taxpayer lives is not deductible. The premiums on life insurance or personal insurance of any kind is not deductible. Lobbying expenses and campaign contributions are not regarded as deductible expenses.

Distinction Between Business Expense and Capital Outlay. It is sometimes quite difficult to determine when an expenditure should be considered as an expense and when it should be considered as a capital investment. A few illustrations will be given to serve as a guide. The expenses incurred in the organization of a corporation cannot be treated as an expense but are considered as capital expenditures. Assessments on capital stock are not regarded as an expense to the stockholder, but as an additional investment. Expenses such as insurance, the benefit of which may be derived for a period of years, should not be treated as an expense at the time of its occurrence, but should be spread over the period which is to be benefited. Maintenance expense and repairs are deductible, but betterments to property are not. The defending and protecting of title to property is considered as a capital charge and not as a business expense. Architects' fees in connection with the construction of a building is considered as part of its cost and not as an expense. The cost of copyrights and patents are not deductible, although depreciation may be claimed in connection therewith.

Interest. It is interesting to note in the study of the Income Tax Law that the treatment of interest is not consistent with the treatment of expenses. The Law has clearly distinguished between business and personal living or family expenses. While the former are deductible, the latter are not. With reference to interest, the Law prescribes that "all interest on indebtedness, with certain exceptions, is deductible". This includes the interest on both business and personal indebtedness. This seems rather illogical, but nevertheless it is permissible under the Law. At one time the Commissioner of Internal Revenue ruled that the Law referred only to interest paid on the indebtedness of the taxpayer incurred in the conduct of his business. This decision, however, was later overruled and at the present time interest on both personal indebtedness and business indebtedness can be deducted. It will be noticed that interest on indebtedness incurred to purchase securities, the income of which is exempt, is not deductible. The loss resulting from inability to collect interest accrued on securities may be included as a deduction only when such interest has been included in the gross income. It is usually best to ignore it

entirely for nothing is gained in including such interest in gross income and then claiming it as a deduction.

Interest paid or accrued within the year on indebtedness may be deducted from gross income except that interest on indebtedness incurred or continued to purchase or carry securities such as municipal bonds, and First Liberty Loan 32% Bonds, the interest upon which is wholly exempt from tax, is not deductible. Since other obligations of the United States issued after September 24, 1917, are not wholly exempt from taxation under this title, interest paid on indebtedness incurred or continued to purchase such obligations (whether or not originally subscribed for by the taxpayer) is deductible. Interest on capital of the taxpayer invested in the business is not deductible. Interest, like other expenses, may be reported on either the cash or accrual basis but, of course, the method employed must be the same for all expenses.

Taxes. Individuals may deduct all taxes paid or accrued except income taxes levied by the United States and assessments levied for local benefits. Examples of the latter kind are assessments paid by the property owner for the paving or extension of streets in a city, or by the landowner for irrigation or drainage in agricultural districts. These assessments are not regarded as a deductible expense because they are supposed to increase the value of the property to the extent imposed.

Inheritance taxes are not deductible, for they are charged against the corpus or body of the estate and not against its income. Taxes paid on property used as a home may be treated as a deduction. It will be noticed that though insurance on a home and rent paid for a home are not deductible, the taxes paid on a home or interest paid on indebtedness, incurred in order to purchase a home, are deductible. Although this seems somewhat inconsistent, it has been the holding of the Treasury Department since the passage of the first income tax law, therefore, there is little chance of its being changed. In case of customs duties, such as duties imposed by the tariff, they are deductible if paid on goods for resale by a business, but are not deductible if incurred upon personal property.

Losses. Losses may be divided into three classes:
(a) Losses incurred in trade or business.

(b) Losses incurred in transactions entered into for profit
but not connected with trade or business.

(c) Losses incurred through casualty or theft.

Losses must usually be evidenced by closed and completed transactions. Such losses must not be compensated for by insurance or otherwise. The loss must be sustained during the taxable year. In determining the amount of loss incurred as a result of casualty or theft, the basis will be the difference between the cost of the property less proper adjustment for depreciation, and the salvage value thereof, if any, provided the property was acquired after February 28, 1913. If acquired before March

1, 1913, the deductible loss is the difference between the fair market value of the property as of that date, less proper adjustment for depreciation, and the salvage value thereof, if any. If the loss is compensated for in full by insurance, no loss is sustained. If compensated for by insurance in part, the difference between the amount of insurance collected and the cost or fair market value of the property, will represent the amount of deductible loss.

A loss on the sale of residential property is not deductible unless the property was purchased or constructed by the taxpayer with a view to sale at a profit. Thus, if a taxpayer sells the house in which he resides, at a loss, this loss is not deductible. If, however, the house had been built for sale at a profit but, for any reason, the taxpayer sells it at a loss, the loss is deductible.

In the sale of assets, the loss should be computed in the same manner as the gain would have been computed had the assets been sold at a profit. This was discussed in Unit Two under the title of "Profit from Sale of Real Estate".

If personal property such as jewelry, automobiles, etc. are stolen or destroyed by fire or other elements, the loss may be deducted unless covered by insurance. Thefts of merchandise are not treated as a deduction since the loss thus incurred will be taken care of when the inventory is taken. If a loss of this nature is covered by insurance, the amount of the insurance received will be reported as income. In the case of losses incurred through accidents, they are deductible if incurred within the scope of the business, otherwise not.

It has been held that where an old building is removed in order that it may be replaced by a new one, the cost of removal is a capital charge and cannot be treated as an expense. Likewise, in case of loss by destruction of buildings pursuant to orders of government authority because of their unsafe or unsanitary condition, no deduction is permitted.

The following cases will be cited to illustrate losses which may be claimed as deductions on the Income Tax Return:

Robert Klein buys one-half of the capital stock of a corporation which was organized for the purpose of operating a moving picture theater. The assets of the company consist of a lease for two years of premises where the moving picture theater is operated. He pays $900.00 for his stock. Ďuring the first two years, the earnings of the company average $100.00 per month, but at the end of that time when the lease expired, the stock became worthless owing to the fact that the company was unable to secure an extension of the lease or to secure other suitable quarters. It was, therefore, decided to discontinue the business and dissolve the company. Mr. Klein received nothing for his stock. He is, therefore, entitled to claim the loss of $900.00 as a deduction on his Income Tax Return for the year in which the stock was estimated to be worthless.

The

Assume that Mr. Klein is regularly engaged in the business of buying oil leases and in the producing and marketing of oil. During the current year, he suffers business losses to the amount of $5,000.00, due to the drilling of dry holes. He also receives as dividends from oil corporations the sum of $10,000.00. losses sustained, due to the drilling of dry holes, may be deducted from the amount received as dividends. In this case, the deduction serves to reduce the surtax, dividends not being subject to any normal tax.

A net loss of one year may be offset against the net income of succeeding years. By net loss is meant the loss resulting from the operation, during the taxable year, of any trade or business regularly carried on by the taxpayer. The loss is computed by subtracting the allowable deductions from the gross income with the following exceptions and limitations.

(a) As used in this section the term "net loss" means the excess of the deductions allowed by section 214 or 234 over the gross income, with the following exceptions and limitations:

(1) Deductions otherwise allowed by law not attributable to the operation of a trade or business regularly carried on by the taxpayer shall be allowed only to the extent of the amount of the gross income not derived from such trade or business;

(2) In the case of a taxpayer other than a corporation, deductions for capital losses otherwise allowed by law shall be allowed only to the extent of the capital gains;

(3) The deduction for depletion shall not exceed the amount which would be allowable if computed without reference to discovery value;

(4) The deduction provided for in paragraph (6) of subdivision (a) of section 234 of amounts received as dividends shall not be allowed;

(5) There shall be included in computing gross income the amount of interest received free from tax under this title, decreased by the amount of interest paid or accrued and losses sustained which is not allowed as a deduction by paragraph (2) of subdivision (a) of section 214 or by paragraph (2) of subdivision (a) of section 234.

(Section 206-1924 Act)

The following proposition will be used as a basis of an illustration of the correct method of computing the net loss in accord with the provisions of the Law.

Proposition A

E. F. Hilbert is conducting a business and, in making up his return at the end of the year, he ascertains the following facts from his books:

(1) His entire gross income is $25,000.00.

(2) The total of his allowable deductions amount to $50,000.00.

(3) Included in his schedule of deductions is an item of $5,000.00 which represents a loss, by fire, of property occupied by him as a residence. This property was not used in any way in connection with his business.

(4) His deductible losses on account of transactions entered into outside of the business were $1,500.00.

(5) His taxable gains from transactions entered into for profit outside of the business are $2,500.00.

(6) During the year, he made a donation of $500.00 to the Red Cross. This was claimed as a deduction.

(7) He claimed depletion amounting to $1,000.00 of which $250.00 is based upon the value of the mineral in a mine as of March 1, 1913, and $750.00 is attributable to increase in valuation on account of discovery subsequent to February 28, 1913.

(8) He received interest from municipal bonds amounting to $5,000.00 which, under the Law, were exempt from taxation. (9) He paid interest amounting to $4,000.00 upon money borrowed to carry municipal bonds which amount was not treated as a deduction.

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The Law provides that the net loss computed as above may be offset against the net income of succeeding years under the following conditions:

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