that is, within ten days after the notice and demand, is a 5% increase on the amount of the tax and interest at the rate of 1% per month until paid. The interest and the 5% penalty may be collected in the same manner as the tax.

XI. ILLUSTRATIVE CASES.

229. Grocery Partners. Walter Hinman and John Rogers were partners in the grocery business, conducting "The Busy Bee Grocery. During 1917, each partner took out of the business $100 a month in cash and the groceries for his family. At the end of the year they had placed $1,000 to the partnership surplus account, and also had on the books of the company an additional $2,000 outstanding, owing by customers for groceries purchased during the year over and above the amount of the unpaid bills owing by the partners. With respect to these items how must the partners determine their income schedules? Answer: See paragraphs 42, 44, 59, 69, 85. Each of the partners must determine the value of the groceries consumed and include the amount as income. Each partner must also include one-half of the surplus account, being $500, and onehalf of the accounts receivable, being $1,000, as gross income, in addition to the $1,200 drawn out during the year.

230. Farmer. Henry Woodhouse, a farmer, had the following transaction, among others, during 1917: In the month of May he purchased for $400 a breeding sow with a litter of five young pigs. He sold the five pigs in December for a total sum of $200 cash and kept the sow. How must he figure this item in his Return? Answer: See paragraphs 49; 55, 131. Woodhouse must determine the cost of the sow as apart from the pigs at the time of purchase. The cost of the sow must be included in the permanent investment account and not as a deduction from gross income. The profit on the pigs must be included in the gross income. The expense of keeping and feeding the pigs may be added to the original cost in determining profit, or they may be omitted here, and included as part of the general expense of the farm on the page in the Income Tax Return covering "Deductions."

231. Dry Goods Store. Abel Wise conducted a dry goods store. In December, 1916, he inventoried his stock in trade at $21,000, being the cost. During 1917 he purchased $63,000 worth of goods and sold a total of $81,000 in retail trade. In December, 1917, his goods inventoried at $27,000 at cost price, although he had no more on hand than at the time of the previous inventory. How must Wise show these facts in his schedule? Answer: See paragraphs 49, 55, 58, 59, 69. Abel Wise will total the stock on hand with the stock purchased, being $84,000. He will total the amount sold at retail with the inventory taken in December, 1917. If $27,000 did not represent the cost inventory, but was something more or less, he should take the inventory at cost and ignore the increased or adjusted value. This sum totaled with $81,000 equals $108,000. Deducting $84,000 from $108,000, this leaves $24,000 as gross income. Of course, Wise will deduct from this his general expenses, losses, bad debts, etc., to determine his net income.

232. Landlord. Christopher Hansen owned an apartment house containing three apartments, all of which were heated by one furnace in the

basement. Hansen lived in the first floor apartment with his family and rented the two upper apartments for $45 a month each. The lease contracts with his tenants required that he furnish the heat, light for the halls, and the running water. Hansen employed a janitor to care for the furnace and the halls, and to maintain the building in good condition. How should the apartment figure in Hansen's income schedule? Answer: See paragraphs 75, 125, 132. Hansen must determine how much of the cost of the heat, light, running water and janitor service is attributable to his own apartment, and the balance of such cost he may deduct from his gross income as expense. The entire amount received as rent, but not the rental value of his own apartment, must be included in the gross income. 233. Wage Earner. Henry Johnson is an accountant, working on a monthly salary of $250, for the Federal Harvester Corporation. Johnson is married, and with his wife, lives in Oakhaven, a suburb 20 miles out from the city in which he works. He spends 30c a day traveling to and from the city and Oakhaven. He is a member of the Harvester Athletic Club, which costs him $100 per year. His lunch expense is 50c daily. Outside of these, he has no business expenses. How do these items figure in his income tax schedule? Answer: See paragraph 125. Johnson will deduct the traveling expense as a business expense. The club dues are a personal expense, or a permanent investment, and are not deductible. The lunch expense is personal living expense and is not deductible.

234. Banker-Farmer. George Bowman, president of the First National Bank, owned a two hundred acre farm located about seven miles out from the city in which he lived. Bowman managed the farm himself through a foreman. Bowman estimated his net earning for the farm, for 1917, at $1,600; but this included the worth of 600 bushels of corn which he still had in his farm bin and valued at $1.50 per bushel. How does the farm figure in Bowman's income? Answer: See paragraphs 50, 72, 125, 131. Since the corn has not been a gain realized in cash, it will not figure in this year's income. This will leave a net income of only $700 to be added to his other income. If the farm is run as a source of profit, it is part of the business of Bowman and his Return must include in Gross Income the gross receipts of the farm, not the net earnings, and should include all expenses and losses in the Deductions. If the farm is primarily a country home or a pleasure enterprise, only the net income need be included in the Return.

235. Real Estate Values. Harry Edwards owns New York City vacant property, the estimated value of which, in 1910, at the time he inherited the land, was $200,000. The property is in an attractive part of the city where real estate experts figure that the land is increasing in value 7% yearly. Edwards intends to hold his property indefinitely, doing nothing with it. How should he consider this property in his Income Tax Return? Answer: See paragraphs 50, 51. The increasing value of the property is not income and does not need to be shown in the Return. When the property is sold, Mr. Edwards will be required to return, as profit, the amount by which the selling price exceeds the fair market value as of March 1, 1913, together with the expenses of the sale and the "carrying charges,' such as taxes.

236. Business Man. Walter Bower, supporting a wife and mother, is in the brick manufacturing business. His bookkeeping system is very

crude, and he estimates his profits by the annual increase in his bank bal ance and investments. On January 1, 1917, he estimated that his plant was worth $16,000, with brick on hand worth $5,000. He had $1,000 in the bank, and $4,000 drawing interest at 7% in a building and loan association. On December 31, 1917, his plant had depreciated somewhat in value; his brick on hand was worth $3,500; his bank balance was $1,000; his building and loan association deposits were $6,000; he had a touring automobile purchased for $800 in May of the same year. He estimated his personal and home expenses at $200 a month. How shall he determine his income tax? Answer: See paragraphs 58, 59, 60, 125, 188. Since Bower has not kept an account, his income must be estimated. He has spent during the year, $2,400 for living expenses, $800 for the automobile, and $2,000 added to his building and loan investment, or $5,200, which he must have received. On the other hand, his stock of brick is reduced $1,500, so that, as his bank balance is the same, his gross income was probably $3,700, and should be so returned. He is entitled to deduct from this gross income the depreciation of his brick plant, which would be, at 3%, $480, leaving his net income $3,220. Deducting his exemptions of $2,000 and $4,000, he must pay 2% on $1,220, or $24.40.

237. Limited Partnership. Brown & Potts is a limited partnership engaged in the tannery business. In 1917 it cleared $15,000. The firm consists of three men. What must the firm do with reference to the Income Tax? Answer: See paragraph 7. The firm, being a limited partnership, is treated as a corporation, and must make a Return and pay an income tax of $900.

238. Retired Business Man. Elam Stratford, retired, living with his wife, has an income of $8,000 a year, derived as follows: $1,000 from Pennsylvania Railroad Stock, $1,000 from Middle East Utilities Corporation 6% gold bonds (guaranteed tax free), $800 from Anglo-American Steamship Company bonds (not tax free), $200 from Yucatan Gum Corporation stock (a Mexican corporation doing no business in the United States and not subject to the Income Tax Laws), $2,000 from a stock farm which is under the management of a foreman, and $3,000 a year from a partnership engaged in the leather business, from which he retired, but retains a direct interest. How must he figure his income tax? Answer: See paragraphs 50, 125, 131, 208. Mr. Stratford's Return of gross income would be as follows: from business, etc., $2,000 (from the stock farm); partnership profit, $3,000; interest, $1,000, (from the Middle East Utilities Corporation bonds) to be entered as paid at the source, and $800 (from the steamship company bonds) not paid at the source; dividends from foreign corporations, subject to normal tax, $200, (from the gum corporation); dividends from domestic corporations, $1,000, (from the Pennsylvania Railroad stock). The totals will be: Gross Income and Net Income, $8,000; dividends, $1,000, exemption $2,000, and income subject to normal tax, $5,000 at 2% tax, $100; exemption, $4,000, and 2% normal tax on $3,000, $60; credit amount of normal tax paid at source, $20; balance of normal tax due, $140. There will also be an additional tax of 1% on $2,500 and 2% on $500, or $35, making the total tax due, $175.

239. Corporation Promotion. The Hamilton Equipment Corporation was organized in July, 1917, to exploit a newly patented device for making iron castings. The company was capitalized at $100,000. In order to

make the stock fully paid and non-assessable, and at the same time sell it at less than par, without a stock liability, an arrangement was made with the patent owner whereby his device was assigned to the company for all of the stock of the corporation. Thereupon, in accordance with the contract, the inventor turned back into the treasury of the company, 51% per cent of the stock as "treasury stock,' to be sold for the benefit of the company in creating working capital. How must this transaction be scheduled in the Return? Answer: See paragraphs 67, 68. The stock is a gift to the corporation, and therefore neither its value nor the proceeds upon its sale need be included in the Return. If there is an increase in its value, so that it is sold for more than its value when received, such increase should be accounted for as profit.

240. Buying Leasehold. The Fidelity Shoe Stores issued $50,000 of its capital stock to pay for a leasehold having twenty-five years to run. How shall this be scheduled in the Return? Answer: See paragraph 132. 4% of the actual value of the stock when issued may be charged off the books each year as an expense of doing business.

241. Installment Business. The following is typical of considerable business on the books of the Bell Phonograph Corporation. In July, 1916, it sold a phonograph to Simon Hoyle for the price of $45 on the installment payment plan, taking notes for $3 a month. The manufacturer's cost of the machine was $15; the selling cost and office overhead was fixed at $15, leaving a net profit of $15. Hoyle was never prompt with his payments. During 1916 he paid only four notes, in 1917 he paid only four more, and in October of that year the company compelled Hoyle to return the machine and did not refund any money to him. This was in accordance with the contract. How should the company have reported this transaction in its Return for 1916 and how must it report for 1917? Answer: See paragraphs 56, 57, 58, 59, 60. There was a gross profit of $30 which should be shown in the Return for 1916. The $12 collected does not appear in the gross income. The expenses actually incurred in 1916 for the entire business will, of course, be deducted. In 1917 the $12 collected is not included in income and there is a loss to be deducted of $21 for the uncollectable notes, but the Return must also show that the company has received back its $15 phonograph. The value of the machine when recovered, with due allowance for the use it has had, should be included in profit in 1917, and should also be treated as the cost to determine the profit when the phonograph is sold again. Any expenditures for refinishing or renewing should properly be charged to expense in the year in which it is made, but may be added to the cost to determine profit upon

a resale.

242. Stock Assessments. Owing to its inability to secure raw products, the Western Soap Corporation showed a deficit at the close of the year 1916. The stock of the corporation was fully paid and non-assessable, so that the stockholders could not be compelled to make up the deficit. At the annual stockholders' meeting, however, all agreed to an assessment of 3% on the par value of the stock, which was paid by all the stockholders in February, 1917. How should this transaction be reported by the corporation and by the stockholders in their respective Returns? Answer: See paragraph 143. The item is not mentioned in stockholders' Returns, nor in the corporation's Return.

243. Employment Benefits. John Moore, vice-president of the Great Western Milling Corporation, had the exclusive use of an automobile and chauffeur furnished by the corporation. He used the car to ride to and from business and home and on business trips during the day, and it was at the disposal of his daughter, Katherine, after six in the evening. The daughter drove her own electric during the day. What consideration, if any, must Moore give this item of the motor car in preparing his Return? Answer: See paragraph 44. The reasonable value to Mr. Moore of the use of the automobile must be accounted for as salary received.

244. Bonus Payments. In January, 1916, Crane Pipe Corporation established a policy of giving 30% of the profits over 8% on its capitalization of $225,000 to its employees, paying each of them a pro rata share, depending upon the total wage each received during the previous year. The company stated that this policy would be permanent, but it reserved the right to withdraw it on or before the first of June of any year. How shall the company figure this amount in its income tax schedule, its excess profits schedule and its capital stock tax? How shall the employees figure their income? Answer: See paragraphs 43, 145. The payments are made as additional compensation and should be deducted from the gross income as part of the expenses of operation. As the Return for Excess Profits Tax is based upon the net income subject to Income Tax, the corporation has the benefit of the deduction as to Excess Profits Tax. So, also, the value of the stock, when based upon earning power, should be based upon earnings from which such payments have been deducted. The employees must account for the sums received as salary.

245. Physician's Income. George Lee is a physician, supporting a family. He owns an automobile driven by a chauffeur, used both in his professional work and sometimes for pleasure. He employs an assistant in his work, paying him $80 a month; one-fourth of the assistant's time is spent in the St. Joseph hospital on charitable work, which the doctor charges up on his expense account to "good will promotion.' He pays $400 a year to club dues, etc., which he charges up to the same account. He appropriates $200 a year to medical magazines and books. His office expenses are $100 a month. He gives $200 a year to the local charity organization and spends $500 a year attending medical conventions and clinics. His income from professional work averages $20,000 a year. How shall these items be noted in his tax schedule? Is he subject to the Excess Profits Tax? Answer: See paragraphs 125, 130, 213. Expenses of business includes (1) estimated cost of operating automobile, including chauffeur's salary, for the time in which automobile is subject to use in the business; (2) assistant's salary; (3) cost of professional magazines and books; (4) office expenses. Other expenses are not incurred in carrying on business, but, in so far as they are not merely personal expenses, they are investments for which an immediate or anticipated return is received. The gift of $200 may be deducted, if the local charity organization is organized and operated exclusively for charitable purposes, and if no part of its net income inures to the benefit of any private stockholder or individual. George Lee's net income (disregarding the cost of running the automobile) is therefore $17,640. As the capital invested in his profession is no more than nominal, he deducts $6,000 and pays an excess profits tax of 8% on the balance, or $931.20, in addition to his income tax. The amount