No deduction shall be allowed in the case of a life or terminable interest acquired by gift, bequest, or inheritance, if the estate or trust is entitled to a deduction under the Act but there is no reduction of the income of the life or terminable interest. For example, an estate or a trust in a certain State sells securities at a loss; if, under the laws of that State, the beneficiary suffers no actual loss, then even though the estate or trust is permitted to deduct such loss in making its return, the beneficiary whose income has not been diminished thereby is not entitled to a deduction on account of such loss, but must include in his return the full amount distributed or distributable. (See section 162.) However, in the case of property held by one person for life with remainder to another person and in the case of property held in trust, see section 23 (1) as to depreciation and section 23 (m) as to depletion. CHAPTER V CREDITS AGAINST NET INCOME SEC. 25. CREDITS OF INDIVIDUAL AGAINST NET INCOME. (a) Credits for normal tax only. There shall be allowed for the purpose of the normal tax, but not for the surtax, the following credits against the net income: (1) DIVIDENDS.-The amount received as dividends from a domestic corporation which is subject to taxation under this title. The credit allowed by this paragraph shall not be allowed in respect of dividends received from a corporation organized under the China Trade Act, 1922, or from a corporation which under section 251 is taxable only on its gross income from sources within the United States by reason of its receiving a large percentage of its gross income from sources within a possession of the United States. (2) INTEREST ON UNITED STATES OBLIGATIONS.-The amount received as interest upon obligations of the United States which is included in gross income under section 22. (3) INTEREST ON OBLIGATIONS OF INSTRUMENTALITIES OF THE UNITED STATES.-The amount received as interest on obligations of a corporation organized under Act of Congress, if (A) such corporation is an instrumentality of the United States; and (B) such interest is included in gross income under section 22; and (C) under the Act authorizing the issue thereof, as amended and supplemented, such interest is exempt from normal tax. (4) EARNED INCOME CREDIT.-10 per centum of the amount of the earned net income, but not in excess of 10 per centum of the amount of the net income. (5) EARNED INCOME DEFINITIONS.-For the purposes of this section (A) "Earned income means wages, salaries, professional fees, and other amounts received as compensation for personal services actually rendered, but does not include any amount not included in gross income, nor that part of the compensation derived by the taxpayer for personal services rendered by him to a corporation which represents a distribution of earnings or profits rather than a reasonable allowance as compensation for the personal services actually rendered. In the case of a taxpayer engaged in a trade or business in which both personal services and capital are material income producing factors, a reasonable allowance as compensation for the personal services actually rendered by the taxpayer, not in excess of 20 per centum of his share of the net profits of such trade or business, shall be considered as earned income. (B) "Earned income deductions means such deductions as are allowed by section 23 for the purpose of computing net 94759°-35-9 (99) income, and are properly allocable to or chargeable against earned income. (C) "Earned net income' means the excess of the amount of the earned income over the sum of the earned income deductions. If the taxpayer's net income is not more than $3,000, his entire net income shall be considered to be earned net income, and if his net income is more than $3,000, his earned net income shall not be considered to be less than $3,000. In no case shall the earned net income be considered to be more than $14,000. (b) Credits for both normal tax and surtax.-There shall be allowed for the purposes of the normal tax and the surtax the following credits against net income: (1) PERSONAL EXEMPTION.-In the case of a single person, a personal exemption of $1,000; or in the case of the head of a family or a married person living with husband or wife, a personal exemption of $2,500. A husband and wife living together shall receive but one personal exemption. The amount of such personal exemption shall be $2,500. If such husband and wife make separate returns, the personal exemption may be taken by either or divided between them. (2) CREDIT FOR DEPENDENTS.-$400 for each person (other than husband or wife) dependent upon and receiving his chief support from the taxpayer if such dependent person is under eighteen years of age or is incapable of self-support because mentally or physically defective. (3) CHANGE OF STATUS.-If the status of the taxpayer, insofar as it affects the personal exemption or credit for dependents, changes during the taxable year, the personal exemption and credit shall be apportioned, under rules and regulations prescribed by the Commissioner with the approval of the Secretary, in accordance with the number of months before and after such change. For the purpose of such apportionment a fractional part of a month shall be disregarded unless it amounts to more than half a month in which case it shall be considered as a month. ART. 25-1. Credits of individual against net income.-For the purpose of computing the normal tax the taxpayer's net income as determined pursuant to sections 21-24 is first reduced by the sum of the allowable credits. These include dividends (as defined in section 115) received from a domestic corporation which is subject to taxation under Title I of the Act (other than a corporation entitled to the benefits of section 251, or other than a corporation organized under the China Trade Act, 1922); interest exempt from normal tax only (and hence included in gross income) received upon (1) obligations of the United States and (2) obligations of corporations organized under Act of Congress which are instrumentalities of the United States; an earned income credit; a personal exemption; and a credit for dependents. (See section 22 (b) (4).) For the purpose of computing the surtax the taxpayer's net income is entitled to none of these credits, except the credit for personal exemption and credit for dependents. ART. 25-2. Earned income credit.-Under section 25 (a) (4) the earned income credit allowable for the purpose of computing the normal tax is 10 per cent of the amount of the earned net income, but not in excess of 10 per cent of the amount of the entire net income. The entire amount received as professional fees may be treated as earned income if the taxpayer is engaged in a professional occupation, such as a doctor or a lawyer, even though he employs assistants to perform part or all of the services, provided the clients or patients are those of the taxpayer and look to the taxpayer as the person responsible for the services performed. In the case of a husband and wife domiciled in a so-called community property State and rendering separate income tax returns on the community income basis, one-half of the income derived from personal services rendered by one spouse may be treated as earned income in the separate return of the other spouse. In the case of a taxpayer engaged in a trade or business in which both personal services and capital are material income-producing factors, a reasonable allowance as compensation for the personal services actually rendered by the taxpayer shall be considered earned income, but the total amount which shall be treated as the earned income of the taxpayer from such a trade or business shall, in no case, exceed 20 per cent of his share of the net profits of such trade or business. No general rule can be prescribed defining the trades or businesses in which personal services and capital are material incomeproducing factors, but this question must be determined with respect to the facts of the individual cases. The provisions of sections 25 (a) (4) and 25 (a) (5) may be illustrated generally by the following examples: Example 1: An individual received income from interest on bonds during the calendar year 1934 amounting to $6,000. His allowable deductions under section 23 for that year amounted to $2,000. He is entitled to an earned income credit of $300, computed as follows: Gross income___ Allowable deductions__ Entire net income__ Earned net income allowable under section 25 (a) (5) (C). $6,000 2,000 4,000 3,000 300 Example 2: An individual received a salary of $20,000 as a traveling salesman for the calendar year 1934. His allowable deductions under section 23 for that year amounted to $12,000, of which $2,000 was for traveling expenses in the course of his business and $10,000 was for a loss of his home from fire. His net income is $20,000 minus $12,000, or $8,000. He is entitled to an earned income credit of $800, computed as follows: Earned income---. $20,000 Earned income deductions___ 2,000 Earned net income before applying limitation in section 18, 000 Earned net income as limited to maximum amount prescribed by section 25 (a) (5) (C). 14,000 Earned income credit before applying limitation in section 25 (a) (4) (10 per cent of $14,000)‒‒‒‒‒ 1,400 Earned income credit allowable as limited by section 25 (a) (4) (10 per cent of $8,000, net income). 800 Example 3: During the calendar year 1934 an individual was engaged in a business in which both personal services and capital were income-producing factors. A reasonable allowance as compensation for the personal services actually rendered by the taxpayer in the conduct of the business for that year was $10,000. The net profits of the business were $35,000, which constituted his net income for the year. He is entitled to an earned income credit of $700, computed as follows: Earned income before applying limitation in section 25 (a) (5) (A)-- $10,000 Earned income as limited by section 25 (a) (5) (A) (20 per cent of 35,000) -- Earned income credit allowable (10 per cent of $7,000) – 7,000 700 ART. 25-3. Amount of personal exemption allowable.-A single person is entitled to a personal exemption of $1,000 and the head of a family or a married person living with husband or wife to $2,500, regardless of the amount of the net income. A husband and wife living together have but one personal exemption, which is $2,500. If they make separate returns, each may claim one-half of the personal exemption, or such exemption may, in accordance with an agreement entered into by them, be taken by either or divided between them in any proportion. ART. 25-4. Personal exemption of head of family.-A head of a family is an individual who actually supports and maintains in one household one or more individuals who are closely connected with him by blood relationship, relationship by marriage, or by adoption, and whose right to exercise family control and provide for these dependent individuals is based upon some moral or legal obligation. In the absence of continuous actual residence together, whether or not a person with dependent relatives is a head of a family within the meaning of the Act must depend on the character of the separation. If a father is absent on business, or a child or other dependent is away at school or on a visit, the common home being still main |