XXIII

WITHHOLDING AND INFORMATION AT THE

SOURCE-CREDITS ALLOWED

General significance of withholding at source. Credits allowed: Individual normal tax, individual surtax, corporation normal tax, corporation excess profits tax.

THE 1918 Revenue Act eliminated most of the withholding,' in cases of "determinable gain or income," required under previous tax laws. Withholding is now required under the 1921 act in the following cases (Sec. 221 and 237):

(a) Eight per cent of income payable to a non-resident alien individual or partnership, except dividends allowed as a credit,2 interest on bank deposits and interest on bonds containing a tax-free covenant.

(b) Twelve and one-half per cent (10% from 191821) of income payable to a foreign corporation having no business or place of business within the United States, with same exemptions as in (a).

(c) Two per cent of interest payable to an individual or partnership, or to a foreign corporation as described in (b), in connection with bonds containing a tax-free clause (Art. 361; 601).

In (a) and (b), taxable income on which the 8% to 10% has been withheld must be reported in full; credit against the tax payable is allowed for the amount withheld. In

1 "Withholding" refers to the payment of tax by the giver of income rather than the receiver, and is much more extensively applied in the income tax laws of other countries.

See page 213.

(c) the 2% paid by the corporation is not deductible in its return but is credit against the tax payable of the individual. Following are points that should be noted in connection with withholding:

(a) Withholding at the highest applicable rate is required in the case of interest payable to unknown owners: this has been held to mean 2% in the case of tax-free bonds and 8% in the case of other income.

(b) Since the 2% is in effect a portion of the normal tax paid by a corporation for an individual, the latter may claim exemption from having tax paid at source to the extent of his personal exemption and claim for dependents by filing the proper ownership certificate (Form 1001, revised).

(c) Withholding described in (c) above is not required in the case of securities issued by an individual or partnership with a tax-free covenant clause.

Articles 361-375 should be carefully studied by persons responsible as withholding agents.

Informational returns are required when asked for from corporations, as to dividends (Art. 1060) and from brokers, as to payments, and so forth, to customers (Art. 1065). Yearly informational returns, using Forms 1096 and 1099, are required of all persons, corporations, and other organizations making payments of fixed and determinable gains or income of $1,000 or more to any other person (Art. 107180). Ordinary purchases are thus eliminated, because the gain is not determinable, as well as all payments to corporations, rents to a real estate agent, payments for professional services, and so forth (Art. 1073). Informational returns of the kind described in this paragraph are due on March 15 of each year, and cover the preceding calendar year.

Four per cent received from an individual mortgagor, and the additional 2% from a corporation, in the case of a bond with a

4% tax-free covenant, should be reported by a taxpayer as gross income under the 1921 act (I. T. 1762).

CREDITS ALLOWED

As already indicated,1 "credits" are the portions of net income not subject to a normal tax or supertax. Their first purpose is to grant exemption from tax to those individuals and corporations whose income is small; and this is necessary not merely because of injustice or hardship imposed on the individual or business with a small income but also because of the administrative expense in handling small items. Other reasons for credits have arisen in recent laws. Dividends are exempted from the individual normal tax in order that double taxation may be avoided. Policy exempts from normal tax all Government securities, and so forth.

A. Individual Normal Tax. Individuals are subject to a "normal tax" and "surtax," each being computed independently of the other. The "credits" or portions of taxable net income on which the individual normal tax is not levied are (Art. 301-5 and Sec. 216):

(a) Dividends from domestic corporations or from foreign corporations more than 50% of whose gross income for the three years preceding the declaration of the dividend years arises from sources within the United States. In 1918 the rule was that the earning of any income from sources within the United States put the dividends of foreign corporations on the same footing as the domestic corporation (T. B. M. 21). It should be recalled at this point that ordinarily dividends received are taxed to individuals at surtax rates only and are not taxable at all when received by corporations. Dividends from foreign corporations other than those just described are subject to both normal and surtaxes, for the reason that the foreign corpora1 See Chapter II.

tion pays no normal tax, and there is, therefore, no double taxation.

(b) Interest on United States obligations and War Finance Corporation bonds. On page 89 it was stated that a portion of such interest was entirely exempt. The remainder which is not exempt is taxable at surtax rates only and hence is a credit for normal tax purposes.

(c) Personal exemption of $1,000, $2,000, or $2,500. Unmarried individuals, not heads of families, can claim an exemption of but $1,000, while heads of families or married persons living together may claim a $2,500 exemption unless the aggregate net income exceeds $5,000, in which case only $2,000 can be claimed. A provision in the new law states that the reduction of the personal exemption from $2,500 to $2,000 (i. e., in cases where the net income is less than $5,020) is not to increase the tax computed on the $2,500 basis by more than the amount of the net income in excess of $5,000. The exemption of $2,000 or $2,500 may be split by husband and wife in any way. Under the 1918 law only the two credits of $1,000 and $2,000 prevailed. Blood or marriage relationship must exist in order to claim the exemption. However, in the case of husband and wife living apart voluntarily, the $2,000 exemption cannot be claimed. The status of the taxpayer on the last day of his taxable year determines the exemption to which he is entitled.

(d) Credit of $400 for each dependent. The 1917 and the 1918 laws provided a credit of only $200. Dependents must be under 18 years of age or must be mentally or physically incapable of self-support. Blood relationship need not exist, but the dependent must receive his chief support from the taxpayer, and this has been defined to be at least one-half his (the dependent's) income. The credit for dependents cannot be