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As provided in Section 221 of the Revenue Act of 1924, it becomes necessary, under certain conditions, for persons to deduct and withhold an amount equal to 6% of the annual or periodical gains, profits, and income. This is known as a Tax at the Source. The individual affected by this withholding of income at the source must report such income in his return but is entitled to credit the amount so withheld against the amount of tax computed in his return. Space will not permit a detailed discussion of this provision of the Law. The application of it is not of sufficient scope to justify a more extensive treatment. However, further information may be obtained by those interested by reference to Sections 221 and 222 of the Revenue Act of 1924 and to the Regulations issued by the Treasury Department.

Earned Income. Individuals are permitted to deduct certain credits for taxes imposed by foreign countries or by possessions of the United States. (See Section 222 of the Act.) These credits are not deducted in computing the normal tax, as are the credits for dependents, but are treated as a deduction from the total tax. In addition to the credits provided for in this section of the Act, individuals are entitled to a credit of 25% of the amount of tax which would be payable if the earned net income constituted the entire net income. (See Sec. 209 of the Act.) In no case, however, shall the amount of this credit exceed 25% of the normal tax computed in accord with Section 210 of the Law.

Earned income is the income derived from wages, salaries, professional fees and other amounts received as compensation for personal services. Earned income deductions are such allowable deductions as are directly chargeable against earned income. Earned net income is the difference between earned income and earned income deductions,

In the case of individuals whose net income does not exceed $5,000.00, the entire net income shall be considered to be earned net income. In the case of individuals whose net income exceeds $5,000.00, the earned net income shall be considered to be not less than $5,000.00. In the case of individuals whose net income exceeds $10,000.00, the earned net income shall never be considered to be more than $10,000.00.

In the case of a taxpayer who is engaged in a trade or business in which both his personal services and capital are material income-producing factors, a reasonable compensation will be allowed for personal service actually rendered by the taxpayer and this shall be considered as earned income. However, the total amount of such earned income shall in no case exceed 20% of the taxpayer's share of the net profits of such trade or business.

The following proposition will serve as a basis for illustrating the application of the above provisions to the return of an individual and also serve as a basis for further discussion.

S. O. Bernhart's income for the current taxable year consists of:

Capital gain derived from the sale of residential property, $6,000.00; earned income derived from salary received for services, $3,600.00; and other income amounting to $1,800.00. His allowable deductions include a capital deduction consisting of commission paid real estate agent, $200.00 and other allowable deductions amounting to $1,400.00.

Mr. Bernhart is a married man with one minor child. Compute his income tax in the most advantageous manner.

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Computation of Tax Net Income.

$4,000.00 Less Credits: Personal Exemption..

$2,500.00 Dependent..

400.00 2,900.00

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Referring to the preceding solution, it will be noted that it is first neces. sary to compute the normal tax, proceeding in the usual manner, but omitting from net income the capital gains and omitting from the deductions the capital deductions. In this proposition, there is no surtax to be assessed because the net income does not exceed $10,000.00. After computing the normal tax, the tax on the capital net gain is computed at the rate of 1272% and added to the normal tax. After computing the total tax, it is necessary to determine the amount of credit to be allowed on account of the earned income. The earned income in this proposition amounts to $3,600.00.

However, under the Law, when a taxpayer has a net income of more than $5,000.00, the amount of his earned income shall not be considered to be less than $5,000.00. In this proposition, the net income of the taxpayer including the capital net gain amounts to $9,800.00. Therefore, the taxpayer's earned income should be considered to be not less than $5,000.00. This amount should, therefore, be considered to be earned income of the taxpayer in this proposition.

Before the amount of credit can be computed, it is necessary to determine the amount of tax which would be payable if the earned net income constituted the entire net income. After ascertaining that this tax would amount to $42.00, it is a simple matter to compute the amount of the credit which is 25% of $42.00. This credit is applied on the total tax previously computed. The difference is the amount of the actual tax to be paid.

The proposition states that the tax is to be computed in the most advantageous manner. Therefore, it becomes necessary to compute the tax in the usual manner as provided in Sections 210 and 211 of the Act before we can determine which plan will be most advantageous to the taxpayer.

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Deductions Commission paid Real Estate Agent. $ 200.00 Other Allowable Deductions...



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It will be seen that it will be most advantageous to the taxpayer in this case to compute his tax in the usual manner as provided in Sections 210 and 211 of the Act for in this case his total tax will amount to only $185.50 whereas in the former case his total tax would amount to $736.50. The reason it is more advantageous to compute the tax in the usual manner is because the normal tax rate is much lower than the capital gain tax rate.

How Tax may be paid. The tax should be paid, if possible, by sending or bringing with the return a check or money order drawn to the order of the “Collector of Internal Revenue." The total tax may be paid at the time of filing the return or the tax may be paid in four equal installments.

If the taxpayer elects to pay the tax on an installment basis, the first installment shall be paid at the time fixed by Law for filing the return, the second installment shall be paid on the fifteenth day of the third month, the third installment on the fifteenth day of the sixth month, and the fourth installment on the fifteenth day of the ninth month, after the time fixed by Law for filing the return.

The balance due at any time may be paid in full on or before the date when the next installment is due. One installment must be paid and the balance may be paid in installments, or in full, on or prior to any subsequent installment date referred to above. Failure to pay any installment on or before the date fixed by Law makes the taxpayer liable for the payment of the balance of tax upon notice and demand by the Collector.


Accounting for Income Tax Returns. When an accountant is engaged to prepare an Income Tax Return, it is usually advisable for him to make at least a partial audit to verify the information given him and to ascertain that all of the taxable income and allowable deductions are included in the return. After making the necessary audit and obtaining the information needed in the preparation of the return, it is advantageous to compile and classify this information in the form of a Working Sheet.

The purpose of the Income Tax Working Sheet is to gather all the information together for reference in making up the return and in computing the tax. After the return is made up the Working Sheet, together with all the working papers of the accountant, should be kept on file under the name of the client for future reference in the event the Treasury Department asks for additional information in regard to any of the items on the return. It is not infrequent that the taxpayer is asked to furnish additional information. Of course, the taxpayer expects the accountant whom he employs to make the return, to take care of any subsequent matters which may come up in connection with the return. The accountant will frequently find himself called upon to furnish information many months and even years after the return is filed.

It is felt that an illustration of the accounting procedure will be more helpful and more illuminating than a further discussion.

Proposition E As an accountant, you are consulted by P. S. Spangler, 444 Liberty St., Pittsburgh, Pa., who wishes you to prepare his Income Tax Return for the current year ending December 31. You undertake the engagement and proceed to prepare the necessary working papers for his return. An analysis of his personal account taken from his books reveals the following information:


Analysis of Personal Account

Calendar Year Ending Dec. 31, 19—
Balance, Jan. 1 (beginning of year).

$ 922,738.05 Household Expenses...

$ 15,824-59
Withdrawals by Wife.

School Expenses, James.
School Expenses— Virginia.

Salary—Private Secretary.

1,400.00 Salary-Chauffeur...

750.00 Automobile Expenses..

Personal Withdrawals and Expenses.

Contributions to Educational and Chari-
table Corporations.

Gifts to Persons...

725.00 Local Benefit Taxes..

Personal Property and Real Estate Taxes..

Federal Income Tax (applicable to preced-
ing year).

Interest on Personal Loans.

Interest on Loans to carry tax-free Munic-
ipal Bonds...

Bad Debts Written off.

Loss from Sales of Bonds.

Compensation as Trustee for G. L. Spangler

500.00 Salary (Spangler and Bowman)

5,250.00 Trading Profits..

1,067.56 Profits from Sales of Stock..

11,237.66 Income from Estate of G. L. Spangler..

7,163.25 Stock Dividends..

1,100.00 Cash Dividends.

41,733.75 Municipal Bond Interest (principal $39,250.00)...

1,687.13 Corporation Bond Interest.

13,773.41 Directors' Fees...

65.00 Distributive Share of Profits (Spangler and Bowman)

68,945.73 Rentals..

2,442.09 Interest on Liberty Bonds..

1,862.50 Balance, Dec. 31 (end of year).

965,593.34 $1,079,566.13 $1,079,566.13

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