CHAPTER V

THE INCOME TAX

INCOME EXEMPT FROM TAX

Under the specific mandate of the statute certain income is exempt from the provisions of the law. Such income is clearly defined and is exempt not only from tax but also from any other provision of the law. In other words, with respect to income which comes within the exemptions named in the statute, the recipient has no duty to perform to the Government. He is not even required to report any such income and no amount, thus received, need be considered by him in determining his liability to make a return.

62.-DEFINITION OF EXEMPT INCOME.

Section 4 of the Income Tax Law, Act of Sept. 8, 1916, reads as follows:

The following income shall be exempt from the provisions of this title:

The proceeds of life insurance policies paid to individual beneficiaries upon the death of the insured;

The amount received by the insured, as a return of premium or premiums paid by him under life insurance, endowment or annuity contracts, either during the term or at the maturity of the term mentioned in the contract or upon surrender of the contract;

The value of property acquired by gift, bequest, devise or descent (but the income from such property shall be included as income);

Interest upon the obligations of a State or any political subdivision thereof or upon the obligations of the United States (but, in the case of obligations of the United States

issued after September 1, 1917, only if and to the extent provided in connection with the issue thereof) or its possessions or securities issued under the provisions of the Federal Farm Loan Act of July 17, 1916;

The compensation of the present President of the United States during the term for which he has been elected and the judges of the supreme and inferior courts of the United States now in office,

And the compensation of all officers and employees of a State, or any political subdivision thereof, except when such. compensation is paid by the United States Government. 63.—PROCEEDS OF INSURANCE POLICIES.

In making up his return of income the taxpayer can ignore income derived from insurance policies or contracts as such income comes within the meaning of the law. He should not include any amount thus received in his statement of gross income. He can be guided by the following general definitions of exempt insurance in

come:

(a) Proceeds of life insurance policies paid upon the death of the person insured to an individual beneficiary.

(b) Amount paid under a life insurance, endowment, or annuity contract to the person making the contract (the insured) either upon the maturity or surrender of the contract; provided, such payment does not exceed the sum paid on the contract by the insured. When there is such an excess, the amount of it becomes taxable income in the hands of its recipient, the insured.

(c) Dividends paid on life insurance policies that have not matured, whether such dividends are drawn in cash by the insured or applied to the reduction of the annual premium due. (Dividends from paid-up policies are, however, considered taxable income.)

(d) Amount paid on life insurance policy to beneficiary in annuities or installments.

64.-GIFTS, BEQUEST, ETC.

The law provides that the value of property acquired by gift, bequest, devise, or descent does not represent taxable income to the recipient, but it does definitely provide that any income from such property, after the property has come into the hands of the recipient, is taxable and must be returned by him.

Distinction must therefore, be drawn between the value of the property at the time it comes into the possession of the person who benefits by the gift or bequest, and the subsequent income from the property.

A bonus received by an employee, as additional compensation for services rendered, is not a gift, if paid by the employer pursuant to a contract, express or implied, or pursuant to a fixed policy or practice. In such circumstances, the amount of the bonus is regarded as a part of the wage of the employee. Payment of the bonus in a case of this kind, however, would have to be conditioned upon the services rendered by the employee and not upon the earnings of the employer.

Where the salary of an employee is paid for a limited period after his death to his widow, or other dependents, in recognition of the services rendered by the deceased employee, no services being rendered by the widow or other dependents, the payment is regarded as a gift and is not subject to tax.

65.-INTEREST ON U. S. AND STATE BONDS.

Income in the form of interest on bonds or obligations of the following general classifications is exempt and need not be included in a return:

(a) Bonds or obligations of the United States or its possessions (except as to the limitation with respect to obligations issued after September 1, 1917, as hereinafter explained).

(b) Federal Farm Loan bonds, issued under authority of the Federal Farm Loan Act of July 17, 1916.

(c) Bonds of any State.

(d) Bonds of any political subdivision of a State.

[Note-important:

The exception noted above in (a), with respect to interest on bonds or obligations of the United States issued after September 1, 1917, has reference to a provision in the Act of September 24, 1917 to the effect that if the aggregate principal of the bonds and certificates issued by its authority and owned by one individual, partnership, corporation or association, does not exceed $5,000, the interest on them is exempt from income tax. If the aggregate principal of a single holding does exceed $5,000, then the interest on the principal in excess of $5,000 is subject to the graduated additional income tax. But only an individual is liable to the graduated additional income tax; hence only an individual is concerned with the amount of investment in such

securities when income tax liability with respect to the interest is incurred. The Liberty Loan Bonds of the Second Series were issued subject to this provision. The Liberty Loan Bonds of the First Series are not subject to the provision, they having been issued prior to September 1, 1917. All interest on the bonds of the First Series is exempt from income tax.]

66.—WHAT "POLITICAL SUBDIVISION” COVERS.

Referring to sub-paragraph (d) of the preceding general paragraph, the full scope of the meaning of the phrase "political subdivision of a state" should be understood. The Treasury Department has ruled, upon the advice of the Attorney-General of the United States, that it comprehends the bonds issued by

(a) Municipalities

(b) Counties

(c) School Districts

(d) Irrigation Districts

(e) Reclamation Districts

(f) Levee Districts

(g) Street Assessment Districts.

Interest on all such bonds is not to be considered for income-tax

purposes.

However, a mortgage assumed by a municipality in the purchase of a public utility, at the time of purchase subject to mortgage, does not become an obligation of the municipality within the meaning of the exempting provisions of the law with respect to interest.

67.-STATE, COUNTY, MUNICIPAL EMPLOYEES.

The exemption with respect to the compensation of officers and employees of a State, or political subdivison of a State is applicable to the salaries not only of all elected and appointed officers and employees of a State, county or municipality but also to the salaries of public-school teachers, members of the faculty and employees of a State University or other institution of learning, managers, superintendents and employees of all State, county and municipal institutions, and even special compensation paid by a State, or any political subdivision of a State, for professional services, whether such payment be denominated salary or special fee.

However, a payment made by a State or political subdivision of a State to a contractor engaged in the construction of a public work pursuant to the terms of a contract is not exempt.

CHAPTER VI

THE INCOME TAX

DEDUCTIONS ALLOWED INDIVIDUALS

[The deductions explained in this chapter are those allowed citizens or residents. For deductions allowed non-resident aliens read chapter on "Non-Resident Aliens."]

Unless the individual, on the one hand, knows his rights of deduction and, on the other, understands the technical limitations established by the Treasury Department, he is sure to be in trouble all the time, both before and after the filing of his return. He may, in the first place, overestimate his rights, upon the meager information available to him, and decide, without consulting authority, not to file a return. Then comes a day of reckoning. The field officers of the Internal Revenue Service, following leads from their innumerable sources of information, check him up and call for an explanation.

Or, the individual may, in an excess of caution, neglect to charge. against his gross income for the year deductions to which he is legitimately entitled. He may be wary of insisting upon the credits the law allows him lest he make a mistake. Government officers do not, as a rule, call him in and advise him that he has overstated his taxable income. In haphazard fashion he makes up his return and submits thousands of dollars to assessment that the law does not contemplate taxing. He pays dearly for his failure to assert his rights.

It, therefore, behooves every individual to look closely into his rights of deduction before filing his return. In this chapter such rights of deduction will be outlined. It will be necessary, however, to supplement the information given in this chapter by consulting that given elsewhere in the book under headings applicable to the questions involved.