and a proportionate part of the principal," and "where the entire annuity is composed of an interest return upon the principal sum paid therefor, the entire annuity is income." 34 The matter quoted, however, was afterward stricken out of the ruling.35 The present ruling is as follows: Annuities paid by religious, charitable and educational corporations under an annuity contract are subject to tax to the extent that the aggregate amount of the payments to the annuitant exceeds any amounts paid by him as consideration for the contract. An annuity charged upon devised land is income taxable to the annuitant, whether paid by the devisee out of the rents of the land or from other sources. The devisee is not required to return as taxable income the amount of rent paid to the annuitant, and he is not entitled to deduct from his taxable income any sums paid to the annuitant. Where an insured receives under life insurance, endowment or annuity contracts, sums in excess of the premiums paid therefor, such excess is income for the year of its receipt.36

Matured Shares in Building and Loan Association. Where the amount paid back to a depositor by a building or loan association, at the maturity of the series, exceeds the aggregate deposits made to that series, only the difference between the total amount received for the surrender of the matured certificate and the aggregate of the deposits made by the certificate holder, is to be returned as income.37

Compensation by Insurance. Insurance money is clearly a substitute for the assets lost or destroyed. If the insurance money is in excess of the cost of the property it may be used to restore the property or be placed in a fund for that purpose for a reasonable time until restoration can be made, final accounting for tax on the excess over the

34 T. D. 2090.

35 T. D. 2152.

36 Reg. 45, Art. 44.

37 Letter from Treasury Department dated February 8, 1917; I. T. S. 1918, ¶ 310.

amount expended to replace or restore the property substantially in kind, being deferred until the restoration or replacement has taken place. The rulings on this point are stated above.

CHAPTER 26

DEDUCTIONS-IN GENERAL

In computing the net income of an individual or a corporation certain deductions are specified in the law.1 While the deductions allowed both corporations and individuals are based upon the same principles, they vary in some particulars, due to differences in the status of the two classes of taxpayers. Thus, an individual may deduct charitable contributions or gifts made within the taxable year, while no corresponding deduction is allowed to corporations. The separate provisions made in the case of individuals for the deduction of losses sustained in any transaction entered into for profit though not connected with trade or business, and losses of property not connected with trade or business, if arising from fires, storms, etc., have no counterparts in regard to corporations, since all losses of a corporation may be deducted. Certain special deductions are allowed in the case of insurance companies which are not necessary in the case of individuals and other kinds of corporations.2 Dividends from a corporation which is taxable upon its net income, and from a personal service corporation out of earnings or profits upon which income tax has been imposed are allowed as a deduction to corporations and to individuals only as a credit for the purpose of the normal tax. The general effect of the Revenue Act of 1918, as compared with the 1916 Law is to place individuals and corporations more nearly upon

1 Revenue Act of 1918, §§ 214 and 234.

2 These deductions are specially treated in Chapter 13 on Insurance Companies.

the same footing in regard to deductions. The Revenue Act of 1918 also expressly provides that certain items shall not be deductible in the case of both individuals and corporations. In the case of non-resident aliens and foreign corporations the deductions are intended to be limited to such expenses, losses, etc., as are incurred in the creation of the income which is taxed by this Government. The special provisions applicable to individuals, corporations, non-resident aliens and foreign corporations are set forth in the chapters dealing respectively with those subjects. The general provisions applicable to all taxpayers are discussed in this and the following chapters.

Time for Deduction of Charges. Each year's return, so far as practicable, both as to gross income and deductions therefrom, should be complete in itself, and taxpayers are expected to make every reasonable effort to ascertain the facts necessary to make a correct return. The expenses, liabilities, or deficit of one year can not be used to reduce the income of a subsequent year. A person making returns on an accrued basis has the right to deduct all authorized allowances, whether paid in cash or set up as a liability, and it follows that if he does not within any year pay or accrue certain of his expenses, interest, taxes, or other charges, and makes no deduction therefor, he can not deduct from the income of the next or any subsequent year any amounts then paid in liquidation of the previous year's liabilities. A loss from theft or embezzlement occurring in one year and discovered in another is deductible only for the year of its occurrence. Any amount paid pursuant to a judgment or otherwise on account of damages for personal injuries, patent infringement, or otherwise, is deductible from gross income when the claim is liquidated or put in judgment or actually paid, less any amount of such damages as may have been compensated for by insurance or otherwise. If subsequently thereto, however, a

3 Revenue Act of 1918, §§ 215 and 235. 4 Revenue Act of 1918, §§ 216 and 236.

taxpayer has for the first time ascertained the amount of a loss sustained during a prior taxable year and not deducted from the gross income therefor, he may render an amended return for such preceding taxable year, including such amount of loss in the deductions from gross income, and may file a claim for refund of the excess tax paid by reason of the failure to deduct such loss in the original return.5

Only the Deductions Specified in the Statute Are Allowed. It must be borne in mind that although the tax is imposed on the net income of a taxpayer, yet the net income so taxed is that which is defined in the statute,6 and not that which may be generally termed net income in accounting practice or recognized as such by custom. There may be, for instance, many deductions dictated by prudence and good business management which are not recognized or countenanced by the law. Only those deductions which are expressly specified in the statute may be taken for income tax purposes. But the present law, to a greater degree than any preceding law, follows the lines of commercial usage in defining net income.

Deductions Must Be Actual. The deductions specified in the statute can be deducted by the taxpayer only in case they represent actual payments or actual liabilities. It is not permissible, for instance, for a taxpayer owning the property used and occupied for his or its own business purposes to include as a deduction the rental value of the property so owned. Neither is it permissible to deduct an amount representing the interest which might be earned on the capital employed in the business, if such capital were invested or employed otherwise, or so placed as to earn a given rate of interest. The deductions claimed in any year must ordinarily be those represented by actual cash disbursements unless the taxpayer keeps his books on

5 Reg. 45, Art. 111.

6 Revenue Act of 1918, § 212.

7 T. D. 2137.