linen, china and table service; it may be contended in each of these cases that there is a new investment, but the life of such new property is so short and its value disappears so quickly with the use that it should properly be accounted as expense of maintenance. There could of course be no question if there were merely a few chairs purchased in place of broken ones or enough sheets and towels bought to make good the loss of worn out ones. As with repairs of buildings, the test is whether there is an addition to value or capital, which is not deductible, or a maintenance of value or capital, which is expense. Repairs of machinery and build'ings may either add to the value and prolong the life of the property, or the repairs may merely keep the machinery and buildings in operating condition; the former are not deductible, the latter are. 130. Wage Earners' Expenses. A person who works for a wage or salary may deduct as expenses all amounts which are incidental to his business or occupation. For example, transportation to and from the place of business is an expense of the business, but clothes and food are personal and can not be deducted, even though the employment necessitates expenditures somewhat larger than would otherwise be required. But, if clothes must be purchased to be used in the business, as, for example, a uniform not adapted to ordinary use, the cost is a business expense. 131. Expenses of Farmers. Farmers may deduct as the expense of carrying on their business the cost of tools and implements, but not the cost of farm machinery; the cost of stock purchased for resale, but not if purchased for breeding purposes; the price paid for stock which had died from disease or injury, less depreciation which has previously been deducted; money paid for labor, seeds, freight, or expense of marketing, and other current expenses. 132. Expenses of Landlords and Tenants. A person who owns rented property may deduct the cost of securing tenants, expense of maintenance, such as ordinary repairs, light and fuel, janitor service, elevator service, and insurance. These items may not be first deducted in arriving at the Gross Income, which must include the gross receipts of rent. A tenant who rents for business purposes, and a corporation which rents its business premises, may deduct the rent paid during the year as an expense. Where taxes or interest charges are required by the lease to be paid by the tenant in addition to the rent, such taxes or interest charges are deductible in the rent item. Frequently, part of the consideration for a lease is that the tenant will erect a building or make permanent improvements for the benefit of the landlord. Such expenditures are considered as rent and the cost should be prorated over the term of the lease, and a proportionate part deducted in each year during the tenancy. Where a tenant is obliged to make the incidental and ordinary repairs, such expenses should be deducted in the year when made. A lump sum, paid by a tenant for an assignment of a leasehold, should be prorated over the life of the lease and a deduction made in each year as additional rent. A premium paid to secure a lease may be prorated in the same way. 133. Rental Value. The rental value of property occupied by the owner is not expense. Where a corporation owns its factories or where an individual owns the property he occupies for his business, there is saved the amount of the rental value which it would be necessary to lay out if such property was not owned. If it were actually paid out it would be deductible, but where it is possible to save it, the result is that the income is greater and the deduction is properly disallowed. 134. Expenses Charged. Expenses actually charged may be deducted even though the cash is not paid until later. No particular method of bookkeeping is required, so long as the actual facts are represented. Therefore, if the books of the business show an actual charge for an expense of the class which may be deducted, that amount may be used in the Return even though the cash has not been paid. It is desirable to have the Return correspond with the books of the business so far as possible. The expenses not actually paid must be so entered as to constitute a liability against the assets of the corporation or person, and must be so treated that they will not again enter into the deductions when paid. 135. Accounts Payable. As in the case of accounts receivable, the rule of business practice is followed in the administration of the law, and the amounts actually charged on the books of a business as payable may be deducted even though they have not been paid. They should of course not be deducted in the next year when the payment is actually made. 136. Cost of Merchandise and Raw Materials. The individual Return expressly directs that the cost of merchandise should not be included in expense of business, but it is expected that the cost of merchandise and of raw materials will be deducted in arriving at profit on the basis of inventories and net sales, which has already been discussed under the item of Gross Income. The corporation Return, however, states that such expenses are deductible as expense if they have not been included in the determination of profit. This rule would also apply to individuals. 137. Other expenses of manufacturing which may be deducted are labor, cost of superintendence and overhead charges. Interest paid should not be included in expense. This is considered later. Rental value of property owned and occupied is not expense, nor should there be deducted any amounts not actually paid which are saved by reason of the ownership or use of capital or property. 138. Expenses of an Estate During the Period of Administration. Where an estate is held as an entity and is subject to the income tax as such, the same deductions are allowed as in the case of an individual. This has been the settled practice, although the law seems to state that such deductions, in the case of an estate, shall be included in the fixed exemption allowed. The expenses of an estate are of two classes, those which are incidental to the administration and reduce the income of the estate and those which are charged against the estate and reduce the principal of the estate. The former are deductible, the latter are not. Examples of the expenses which are not allowed as deductions are court costs, attorneys' fees and executors' commissions. Where an executor or trustee is authorized to conduct a business, the expenses of the business may be deducted. 139. Claims and Judgments Paid. Alimony is a personal expense and is not deductible. A payment in settlement of damage claims, either in a law suit or settlement, may be deducted only if the liability was incurred in trade or business. 140. Fidelity and Surety Bonds. Where a person is required to furnish a fidelity or surety bond as a necessary incident of his employment or in his business, the premiums paid for such bond may be deducted as part of the expense of the business. 141. Insurance Premiums Paid. The premiums paid by an individual on his own life or accident insurance, or on the insurance of the life of one of his family are personal expenses and, therefore, may not be deducted as expenses of business. Where a corporation or partnership, as a business measure, insures the lives of officers or members, the premiums are not deductible as expenses, but are to be deducted from the amount ultimately received on the policy, the net gain only being included in gross income. 142. The cost of fire insurance for the dwelling of the owner is not a business expense, but the premiums paid by a corporation or individual to insure property used in business or rented or leased to secure an income are allowed as deductions. 143. Assessments on Stock. Where the holders of stock in a corporation are called upon to make additional payments upon their stock, such payments are not deductible expenses but are regarded as additional investments of capital, and for the same reason are not considered income of the corporation. Voluntary assessments are in the same class. 144. Salaries. In the ordinary case, salaries paid will constitute business expense. Where salaries are based upon stock ownership or depend upon the profits rather than upon the value of the service, they are not expense, but a division of the profit and can not be deducted. For example, a corporation consisted of two stockholders who agreed that they should each receive as salaries one-half of all the profits of the corporation. This was held to be the equivalent of a dividend and not an expense which the corporation could deduct from its taxable income. If the salary paid to one of the owners of a corporation is a fair and reasonable compensation for services rendered, it may be deducted. Bonuses and profit sharing payments to employees are deductible wherever they are proper compensation for services, but not if they are gifts or donations. Salaries paid to the members of a partnership may not be deducted as an expense of the firm unless they are separately returned as salaries by the partners, in addition to the profits received. 145. Gratuities and Pensions. Gratuities or bonuses which are more than a mere compensation or which are not paid pursuant to a contract or established practice are not deductible. We have already discussed such payments from the standpoint of the person receiving them under the title of Gross Income. In general, if the payment is a gratuity so that the person receiving it is not required to include it in his income, it is not allowable as a deduction to the person paying it. It has been held that salaries paid to employees who are absent because on duty in the federal service with the National Guard are necessary expenses. But, where a salary of a deceased employee is paid for a limited period after his death to his widow, such payment is not a necessary expense but is a gratuity and may not be deducted. Where there is an established practice and plan, pensions paid to injured or aged employees, or their dependents, may be deducted. Christmas presents to employees, even when made as an established practice, may not be included in expense because they are purely voluntary. 146. Miscellaneous Payments. Entertainment money spent by salesmen is expense. Money actually spent for treating or entertaining buyers for the purpose of selling goods may be deducted as a necessary expense. Commissions allowed salesmen paid in stock may be deducted as expense if so charged on the books at the actual value of such stock. 147. Lobbying expenses and campaign contributions are not deductible. It has been held that contributing to campaign funds or spending money for the purpose of securing or influencing legislation is not an ordinary or necessary expense and therefore may not be deducted from the gross income. 148. Donations by corporations are not deductible as expenses, nor under the item of charitable contributions allowed to individuals, and explained later Many corporations feel compelled to donate to fairs or hospitals, or to contribute to funds or to assist other enterprises of the people from whom they must secure their business. Although made to obtain or preserve the good will of customers, such donations are merely gratuitous and are not expenses. Where the benefit of the corporation is more direct, as where a donation is made to a hospital on condition that a ward is reserved for the use of employees, the donation is an expense. This applies to donations to schools for the benefit of the employees of the donor, or charitable institutions for their dependents, or any other institution which performs a function connected with the business. 149. Organization Expenses. Expense of organization may not be deducted. When a corporation is formed it must pay a fee to the state which issues its charter, filing and recording fees, lawyers' fees, charges for publication of notices, and other expenses incidental to organization. These are regarded as the cost of the franchise or charter, which is a permanent asset of the corporation, and not as expenses of “maintenance and operation"; such expenses should therefore not be included in the deductions from the income of the first year. As the franchise is not physical property and cannot be subject to exhaustion by wear and tear, no claim for depreciation may be made. Where a franchise has a limited duration or is of value for only a limited period, a deduction is allowable on the same principles as the amortization of a patent; or when the corporation is finally liquidated and dissolved, the cost of the franchise may be charged off as a loss, since there is an actual disappearance of property. Interest Paid. 150. Interest on Personal Indebtedness. An individual may deduct interest paid upon his own indebtedness without any restrictions as to amount, but may not deduct interest upon indebtedness incurred for the purchase of securities, the interest upon which is exempt from income tax. In other words, a man may not borrow money to buy state or municipal bonds, use the exempt income from such bonds to pay the interest on the loan, and then deduct from the remainder of his taxable income an amount equal to the interest so paid. This applies also to corporations. Interest is deducted when paid, and it is not material when it accrued; for example, the interest for five years on a promissory note which has been that long over-due must nevertheless be deducted when paid. The interest must be upon personal indebtedness; interest paid upon the debt of another, for example, pursuant to a guaranty, is not deductible. |