We have already ex 168. Taxes Paid on "Tax Free Bonds."' plained that income taxes paid by a corporation on the interest on its bonds, pursuant to a "Tax Free Covenant," may not be deducted by the corporation. The owner of such bonds is not entitled to any deduction from net income on account of the payment of federal income taxes paid on such bonds, but he may deduct state income taxes paid. 169. Losses. Losses Incurred in Business or Trade. Henry Bergman, a dealer, sells a lot of chairs of an unpopular style at less than he paid for them. Bergman may deduct the loss as one incurred in his business. He also sells, at a loss, an automobile which he bought for his personal use, but found unsatisfactory. That loss was not incurred in his business or trade, and is not deducted. As a corporation has no affairs apart from its business, this qualification does not apply to the losses which may be deducted by corporations. 170. A person may be engaged in more than one business or trade. A single transaction engaged in for profit does not constitute the business of an individual. That in which a person has invested money and to which he devotes part of his time and attention, for the purpose of a livelihood or profit, and not consisting of merely isolated transactions, is his trade or business. A man in the coal business who speculates in stocks and bonds is not in the business of dealing in stocks and bonds. A steel manufacturer who runs a large farm at his country home is not in the business of farming. 171. Losses Incurred Other Than in Business or Trade. Losses sustained in transactions entered into for profit, but not connected with the business or trade, may be deducted to the amount of the profits arising from such transactions, but not otherwise. If the coal dealer makes a profit on the stock market in some of his deals and loses on others he must include in his income all of the profits made and he may deduct the losses, if they do not exceed such profits. But, if his losses are greater than his profits, he can deduct only that amount equalling the profits, and if all his dealings were at a loss and there were no profits, he can not make any deduction. Losses in transactions of this sort are separately shown on the Return, and are not to be included in the item of losses in business or trade. 172. Casualty and Theft Losses. Losses by fire, theft, or other casualty may be deducted by an individual, even though not incurred in his business. Suppose a man does not have his own dwelling insured and it burns down; the loss sustained must be deducted from the income received during the same year. Of course, to the extent that such a loss is covered by insurance, there is no loss to the owner. Losses may be deducted only in the year in which they are incurred. If the value of the destroyed house is more than a year's income of the owner, he is not entitled, because of that fact, to deduct part of the loss in one year and part in the next; it must all be deducted in the year in which it occurs; the next year's income is subject to tax, regardless of this excess loss. 173. Actual Losses. Losses are deductible only when they are actual. They must be deducted in the year in which they are actually sustained. A person may feel certain that real estate which he owns is worth much less than when he bought it, or that some of the stock in his store will never be sold until he marks it below cost, and it would ordinarily be said that he had lost money in both cases. But the losses which may be deducted from income must have finally been determined, as by a sale of the real estate or the stock, and must arise from a completed and closed transaction. A transaction is closed when property is disposed of at a fixed valuation. Mere shrinking in value, not finally determined and closed, can not be deducted as a loss. This rule applies alike to corporations and individuals. 174. The loss incurred in the sale of property is the difference between the cost and selling prices. On property owned prior to March 1, 1913, the value of that date is used instead of the cost. To determine the amount of loss, cost and selling price should be ascertained in the same manner as was explained with reference to profit. Cost includes the price paid and the expenses incident to acquiring, keeping, improving and selling the property. Any such expenses which have already been deducted in the Return should not be added to the cost. Where the expenses are of such a nature that they may allowably be deducted from the annual income under the first item of deduction as expense, they should be so treated, instead of being included in the cost of the property. 175. Value of Original Stock Reduced By Stock Dividends. Suppose in the case stated showing the income from stock dividends, paragraph 116, the ten stockholders all owned their stock prior to March 1, 1913. At that time, we will say, this stock was worth only $250 a share, since the surplus was not so large as when the stock dividend was declared. The declaration of the stock dividend now has reduced this to $200 a share. Obviously, there has been a loss with respect to this particular stock originally held. But still, so long as it remains a book loss and not a realized one, it cannot be deducted. Suppose, however, Walter Reynolds, one of the holders, now sells his shares at $200 per share. He has already returned the par value of the stock dividend for the purpose of his additional tax income from dividends. He must now make a Return of the other $100 per share on the dividend stock as realized profits, for both the normal and additional tax. He has, however, suffered a loss of $50 a share on the original stock held on March 1, 1913. If Reynolds deals in stocks as his business, he may deduct this loss as one incurred in his business or trade. If he is not a member of the stock exchange or a licensed or recognized broker, and buying and selling securities is not a part of his recognized business, he may nevertheless deduct it, to the extent that it does not exceed the amount of gain or profits derived from similar transactions, that is, from sales of securities, in the same year. The income from the stock dividend is not income from a similar transaction, but the profit upon the sale of the dividend stock is. 176. Corporation Losses. All losses sustained by a corporation may be deducted. A corporation may deduct from its income, "all losses actually sustained and charged off within the year and not compensated by insurance or otherwise." This includes the loss sustained by reason of the sale of property at a loss and the destruction of property, such as the wreck of a railroad train. 177. The basis for determining the loss upon property acquired prior to March 1, 1913, is its fair market price or value as of that date. As in the case of profit, the loss incurred by an individual or corporation upon the sale of property acquired prior to March 1, 1913, is not the price paid, but the fair market price as of that date. The rules applicable to determination of such price or value were fully discussed in connection with profit. 178. Bonds Issued at Discount. A corporation may deduct the loss incurred in selling its own bonds below par. Suppose the Fidelity Corporation issues bonds for $960 each, which it must pay in ten years at $1,000 each, there is obviously a loss of $40 on each bond. On principle, this loss is not actually sustained until the bonds are paid, but the liability accrues at once and the corporation is allowed to pro-rate the loss over the life of the bonds; it may deduct in each year one-tenth of this loss. 179. Bonds Redeemed at Premium. The redemption of bonds at a premium is deductible loss. The bond issue of corporations frequently involves an obligation on the part of the corporation to redeem, or retire some of the bonds before they are due, and this may require the corporation to pay more than the par value. It has been held that the corpora tion may deduct as a loss all that it must pay, in excess of what it receives. For example, if the ten year bords of the Fidelity Corpora tion which, in our previous illustration, sold at 96, are redeemed after five years at par, the corporation has deducted only one-half of the loss, under the pro-rating plan described; therefore, it may now deduct the other one-half. If the bonds are redeemed at 102, the loss is 2 points (or $20 on a $1,000 bond) greater. 180. Suppose now that the bonds were issued at 102 and the corporation included the $20 premium in its taxable income. It may subsequently deduct the $20 when it redeems the bonds at 102. If the whole amount received was treated as capital and not as income, then there is no loss when the same amount of capital is repaid. 181. Redemption of capital stock at a premium may not be deducted. The preferred stock of a corporation is in some cases redeemable at a premium, say 105. In case such stock has been issued at par, its redemption would be an expense to the corporation, but, because the transaction is entirely a return of capital, the loss incurred may not be deducted. 182. Reserves. Reserves set aside to meet expected expenses or losses are not allowable deductions. Corporations frequently carry reserve accounts to provide for anticipated fire losses, depreciation, or reduced value of merchandise, equipment, or real estate. The amounts appropriated to such funds out of the year's profits is not lost to the corporation, but is still there and may be drawn down for any purpose. The addition to such a reserve may not, therefore, be deducted, except that the amount allowed as a deduction for the physical depreciation of property may be held in a depreciation reserve fund. When actual expenditures are made from reserve funds for which no deduction has been made, the amounts paid should be deducted from the income received in the year in which the payment is made. But an expenditure to replace property upon which an allowance for depreciation equal to the cost has been made is not allowed as a deduction. 183. Losses of Insurance Companies. Insurance companies may deduct the losses to which all form of business are subject in common, such as the sale of property at a loss, the destruction of property, accounts charged off as worthless, and theft, fire, and other casualty. In addition, insurance companies are allowed a deduction for the amounts paid to policy holders, which are to be specifically set forth in the Return. This includes the liability upon death, disability, fidelity, fire or accident policies, matured endowments, annuities, policies surrendered for cash, and other contractual obligations. The so-called dividends, or return of unused premiums, having been excluded from income, are not deductible as losses. The reserve set aside for anticipated losses may not be deducted, except that, where the law specifically requires the maintenance of a reserve, the amount added to the reserve during the year pursuant to law may be deducted. If a reserve of this kind is reduced during the year, the amounts taken from it must be included in income. Mutual insurance companies, which did not include in their income the amounts received as premiums to cover anticipated losses, are not allowed to deduct the losses. 184. Removal of Building. The voluntary removal of a building is not a loss. Where an old building is torn down to make room for a new one being erected, the value of the old building may not be deducted from income as a loss. but it may be included in the cost of the new building being erected, for purposes of computing depreciation or profit and loss. Worthless Debts. 185. Bad debts, which have been actually ascertained to be worthless and have been charged off during the year, may be deducted. The Return must show some evidence of the manner in which the worthlessness was ascertained, that is, it should state, for instance, that the debtor was discharged in bankruptcy, or disappeared leaving no property, or that the ordinary methods of collection have been exhausted. The form of Return for individuals has a particular item for bad debts. On the Return for corporations, the item of Losses includes this deduction. 186. If the bad debt represents taxable income, the deduction will be allowed, only if the sum has been included in a Return of Income. A man takes a promissory note for two months' salary in 1916, but does not include it in the Return as income. In 1917, he actually ascertains that the note is worthless and attempts to deduct it from his income for that year. The deduction will not be allowed because the debt, if collected, would be taxable income, and the fact that some expected income is not received does not reduce the income. But the rule is otherwise, if the note has been taken for a loan; then the payment would not be income when received and the failure to collect results in a diminution of capital. 187. Securities. Bonds are debts, and when they are ascertained to be worthless, and charged off, the face amount may be deducted. Stocks are not debts and when they become worthless there can be no deduction except for the loss realized if they are sold. Exhaustion, Wear and Tear of Property. 188. Physical depreciation of property may be deducted. Depreciation is the popular name for the charge described as "a reasonable allowance for exhaustion, wear, and tear of property." Such an allowance may |