distributed, when the dividend is a distribution of profits earned since March 1, 1913, and are taxable at the rate in effect when the profits being distributed were earned. 115. Stock Dividends. Stock dividends constitute income, subject to the additional tax, but not the normal tax. The value of a stock dividend is the amount of earnings, profits or surplus distributed, and the valuation at which the stock is distributed in payment of the dividend. In practice, this generally means par value, even though the stock, after it is issued, may have a market value much greater or less than par. 116. To illustrate: A corporation with ten stockholders, each owning 100 shares of the par value of $100 per share, has tangible property valued at $200,000 and a good will or profit making opportunity valued at $200,000. Each of the shares will therefore be worth about $400, and we will assume that it has that market value. The books of the corporation will show assets, $400,000; liabilities, capital $100,000, surplus $300,000. Now suppose it is decided to "distribute" part of the surplus by declaring a stock dividend of 100%, that is, one share at $100 to every share outstanding. Each shareholder will then receive 10 additional shares; but now the property of the company must be divided among 2,000 shares instead of among 1,000 as formerly, so that each share will represent only $200 of the assets of $400,000, and the stock, both new and old, will have a market value of $200. The shareholders have gained nothing, but will be required to pay the additional tax upon the so-called dividend of $100 per share. If later these same shares are sold at a greater price than par value, the excess must be returned as profit, subject to both the normal and additional tax in the year when realized. Of course, there may now be a loss in value on the original stock, since its intrinsic worth is less. This loss will not be reflected in the Return until the original stock is sold for a price less than its original cost. This is discussed under "Deductions for Losses.'' 117. Stock in a reorganized or consolidated company, received in exchange for stock of the former company, is income if its par value exceeds that of the old stock. Upon the analogy to a stock dividend, it has been held by the Treasury Department that a stockholder who turns in one share, at $100, of stock in the old company, receiving two or more shares of stock in a new company, which is taking over the business and property of the old company, is liable to the additional tax upon the par value of such new stock, even though the entire market value may be no greater than the original stock. If the exchange is for stock of an equal face or par value, there is held to be no income, and if for stock of a less face value, there is held to be a loss. V. PARTICULAR PERSONS AND CORPORATIONS. Fiduciaries. 118. Return of Fiduciaries. "Guardians, trustees, executors, administrators, receivers, conservators, and all persons, corporations, or associations acting in any fiduciary capacity, shall make and render a Return of the income of the person, trust, or estate for whom or which they act." This applies to all persons who receive income in which another person has the beneficial interest. Any one of joint fiduciaries may execute the Return. If any one beneficiary receives income in excess of $1,000, or $2,000, if the head of a family, the fiduciary is required to make a Return (on Form 1041) showing the entire income of the estate or trust and the amounts distributable to each beneficiary, including those who receive less than $1,000. But, if no one beneficiary receives an income in excess of $1,000 or $2,000, no Return is required, no matter how large the total income of the estate. This, of course, does not apply to the cases where the estate is treated as an entity. If any beneficiary is a minor, insane person, or non-resident alien, an additional Return (on Form 1040) should be made for such beneficiary individually. A fiduciary who makes the individual Return on Form 1040, in addition to his fiduciary Return, acts as agent and is required to pay the normal and the additional tax in the same manner as would the ward if he were acting for himself. However, when the beneficiary files his own Return, the fiduciary as such, is required to file Form 1041 only. 119. While an estate is held as an entirety, with accumulation of income for unknown or undetermined beneficiaries, rather than with a regular distribution of income to known beneficiaries, a Return (on Form 1040) must be made as though the estate were a person and the income is subject to the normal and the additional tax. Where any part of the income is held for unknown beneficiaries, the estate itself is regarded as the beneficiary to that extent, and if the income so held exceeds $1,000 the Return is required. The estate is allowed a single exemption of $3,000 as to the 1916 law normal tax and $1,000 as to the 1917 law normal tax, and also the General Deductions. The income of the estate upon which the tax has been paid then becomes a part of the estate and when later distributed is not subject to tax. Where the income of the estate is being regularly distributed, or is held for known beneficiaries without distribution, no income tax is required except that paid by each individual upon receiving a share of the income. 120. Executors and Administrators. A Return on behalf of a person dying within the year is required of the executor or administrator. Where a person who has died during the tax year has received an income in excess of $1,000 (or $2,000 if the head of a family) between the first of January and the date of his death, his executor or administrator is required to make a Return on Form 1040, as the agent of the deceased. The entire exemption is allowed without regard to the length of the period covered. This Return is distinct from and in addition to the Return which the executor or administrator is required to make to cover the income of the estate, received subsequent to the death and before the end of the year. The fiduciary may again claim the full exemptions of $1,000 and $3,000 when he makes a Return for the estate for the remaining portion of the year. Corporations Exempt from the Tax. 121. It has already been explained that every corporation must pay a tax of 6% annually upon the net income received from all sources. This includes joint stock companies, associations, and insurance companies, but not ordinary partnerships. 122. Certain corporations are exempt from payment of the tax. These are as follows: (1) labor, agricultural, or horticultural organization; (2) mutual savings bank not having a capital stock represented by shares; (3) fraternal beneficiary society, order, or association operating under the lodge system, or for the exclusive benefit of the members of a fraternity itself operating under the lodge system, and providing for the payment of life, sick, accident or other benefits to the members of such society, order or association or their dependents; (4) domestic building and loan association and co-operative bank without capital stock, organized and operated for mutual purposes and without profit; (5) cemetery company owned and operated exclusively for the benefit of its members; (6) corporation or association organized and operated exclusively for religious, charitable, scientific, or educational purposes, no part of the net income of which inures to the benefit of any private stockholder or individual; (7) business league, chamber of commerce or board of trade, not organized for profit and no part of the net income of which inures to the benefit of any private stockholder or individual; (8) civic league or organization not organized for profit but operated exclusively for the promotion of social welfare; (9) club organized and operated exclusively for pleasure, recreation, and other nonprofitable purposes, no part of the net income of which inures to the benefit of any private stockholder or member; (10) farmers' or other mutual hail, cyclone, or fire insurance company, mutual ditch or irrigation company, mutual or co-operative telephone company, or like organization of a purely local character the income of which consists solely of assessments, dues and fees collected from members for the sole purpose of meeting its expenses; (11) farmers', fruit growers' or like association, organized and operated as sales agent for the purpose of marketing the products of its members and turning back to them the proceeds of sales, less the necessary selling expenses, on the basis of the quantity of produce furnished by them; (12) corporation or association organized for the exclusive purpose of holding title to property, collecting income therefrom, and turning over the entire amount thereof, less expenses, to an organization which itself is exempt from the tax imposed by this title; or (13) federal land banks and national farm-loan associations as provided in section twenty-six of the Act provided July seven-teenth, nineteen hundred and sixteen, entitled "An Act to provide capital for agricultural development, to create standard forms of investment based upon farm mortgage, to equalize rates of interest upon farm loans, to furnish a market for United States bonds, to create Government depositaries and financial agents for the United States, and for other purposes''; (14) joint stock land banks as to income derived from bonds or debentures of other joint stock land banks or any federal land bank belonging to such joint stock land bank. 123. An exempt corporation must establish its right to be exempt by filing with the collector of internal revenue, affidavits showing the purpose and nature of the organization, the source of its income, the disposition of the same, and whether or not any of its net income will inure to the benefit of any private stockholder or individual. 124. Not Within the Exempt Classes. If a corporation does not come within one of the classes described, it is not exempt merely because it is organized not for profit. A corporation formed as a family affair to hold property together is not exempt. Subsidiary corporations are regarded as distinct entities, and are not exempt because they are owned by a holding corporation which pays income tax when it receives the earnings of the subsidiary. Nor is a corporation exempt because it is owned by and is a subsidiary of a corporation within one of the exempted classes, but the subsidiary must also come within one of the described classes. The exemption for "agricultural or horticultural organization' does not include a corporation engaged in agricultural pursuits, such as the ownership and operation of sugar plantations, for profit. Cemetery companies are not exempt if operated for profit. Co-operative dairy associations are not exempt. VI. GENERAL DEDUCTIONS. Expenses of Carrying on Business. 125. Operating Expense. The first item of general deductions is the amount of necessary expense actually paid within the year in carrying on a business. There is no provision for deducting from gross income any expenses incurred otherwise than in business, and the Return points out that the item of expense should not include personal expenses or family expenses. A man may spend a great deal of money for his clothes, for the upkeep of his pleasure automobile, for the care of his house and grounds, or to educate his children, but these are not allowable deductions from gross income. Thus, wages paid to domestics, or those who produce articles consumed in the family, as for instance dressmakers, are not deductible. But wages of all employees incident to the producing of income in the trade or business of the taxpayer are deductible. The item of "Expenses in Business" should not include expenses of a business which is carried on by a partnership, since those expenses should be deducted before determining the net profits of the firm. These net profits are all that the members should include in their Gross Income. 126. The corporation Return calls for a more particular showing of the expense of the business and in that way indicates the nature of the deductions. For example, there is indicated the following: Labor, wages, commissions, etc.; fuel, light, power, etc.; rentals (ordinary) and payments in lieu of rent (royalties, etc.); repairs, ordinary and incidental; salaries of officers. 127. One result of limiting the deduction to business expenses and excluding personal expenses, while income does not include the rental value of property occupied by the owner or the value of farm produce used by the farmer, is that a person paying money for these living expenses is taxed on the money earned while the farmer and house owner have this living free of tax, as it never enters into their incomes. 128. Permanent Improvements. Investments of a permanent nature are not expenses. Money spent for the permanent improvement of property, as in the erection of buildings, grading of lawns, installation of permanent machinery, or other additions to capital investment may not be deducted from gross income. Such expenditures do not reduce the capital of the spender but are merely a change in form. 129. Permanent improvements must be distinguished from incidental repairs and replacements. A company equips its general offices with a new set of office furniture or enlarges and improves its office premises; a hotel entirely refurnishes its parlors and dining rooms and replaces its |