miums paid on any life insurance policy covering the life of any officer or employee, or of any person financially interested in any trade or business carried on by the taxpayer when the taxpayer is directly or indirectly a beneficiary under such policy.24 SPECIAL ASSESSMENTS AGAINST LOCAL BENEFITS. Although assessments against local benefits are frequently referred to as taxes, and are imposed by local governments, they are not deductible as taxes, if "of a kind tending to increase the value of the property assessed." 25 The quoted words were added by the Revenue Act of 1918. Under the 1916 Law, which did not contain this provision, such assessments as, for instance, for paving, curbing, installing sewage and water systems, etc., were held to be expenditures which add to the value of the property and should be capitalized, that is, added to the cost of the property for the purpose of determining the loss or gain in a subsequent sale of such property.2 26 Credits. The net income of the tax payer is ascertained by subtracting the deductions from gross income. The net income so ascertained is subject to surtax if the taxpayer is an individual or to war-profits and excess-profits tax if the taxpayer is a corporation. For the purpose of the normal tax of individuals and the income tax of corporations the net income may be further reduced by the credits specified in the statute. The credits are (a) such items of income as are included in gross income but are not subject to normal tax in the case of individuals or income tax in the case of corporations (i. e. dividends and interest on certain obligations of the United States) (b) the personal exemption in the case of individuals or the amount of the war-profits and excess-profits tax plus $2,000 in the case of corporations. 24 Revenue Act of 1918, §§ 215 (d), 235. See Chapter 27 on Deduction of Business Expenses. 25 Revenue Act of 1918, §§ 214 (a) 3, 234 (a) 3. 26 Letter from Treasury Department dated December 22, 1914; I. T. S, 1918, ¶¶ 521 and 1454. CHAPTER 27 DEDUCTION OF BUSINESS EXPENSES The Revenue Act of 1918 permits to corporations the deduction of all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered, and including rentals or other payments required. to be made as a condition to the continued use or possession of property to which the corporation has not taken or is not taking title, or in which it has no equity. The law permits to individuals the same deduction, except that the property with respect to which rentals, or other payments required to be made, may be deducted, must be used "for purposes of the trade or business" carried on by the individual. The deduction of business expenses is allowed in the case of non-resident aliens and non-resident foreign corporations if and to the extent that they are connected with income arising from a source within the United States; and the proper apportionment and allocation of their deduction with respect to sources of income within and without the United States is determined under the rules and regulations prescribed by the Commissioner with the approval of the Secretary. The special provisions applicable to each of 1 Revenue Act of 1918, § 234 (a). 2 Revenue Act of 1918, § 214 (a) 1. 3 Revenue Act of 1918, §§ 214 (b) and 234 (b). The 1916 Law permitted to individuals the deduction of the "necessary expenses actually paid in carrying on any business or trade," (Revenue Act of 1916, § 5 (a), and in the case of corporations all the ordinary and necessary expenses paid within the year in the maintenance and these four classes of taxpayers are discussed in the chapters on citizens and residents, non-resident aliens, corporations and foreign corporations, respectively. The discussion in this chapter is limited to the rules applying generally to all taxpayers. As a general rule, the expenses which may be deducted are those necessary for the creation of the income which is taxed. It should be noted, however, that the language of the law contains some express limitations, which are more fully discussed in the following paragraphs. Deductions Not to Be Duplicated. Where a deduction may, or should be, claimed as one of the items specifically stated in the law, such deduction should not also be included under the head of business expense. Thus, where a deduction is claimed for depreciation, or loss, the same amount should not also be deducted as expense, or if the cost of tools or small articles has been charged to expense, depreciation should not be claimed thereon, as it would result in allowing the same deduction twice. Interest paid by a corporation constitutes a separate deduction and should not be taken into account as a part of the cost of manufacture.4 Business Expenses. Business expenses include all items entering into what is ordinarily known as the cost of goods sold, together with selling and management expenses. Among the items to be treated as business expenses are material, labor, supplies and repairs in the case of a manufacturer, while a merchant would include his purchases of goods bought for resale. In either case the amount to be taken as a deduction in any year should be determined by taking into consideration the inventory at the beginning operation of the business and properties of the corporation, including rentals or other payments required to be made as a condition to the continued use or possession of property to which the corporation has not taken, or is not taking, title or in which it has no equity." (Revenue Act of 1916, § 12 (a).) In the case of non-resident aliens the deduction was limited to business conducted within the United States and in the case of foreign corporations to business and property within the United States. 4 T. D. 2137. and end of the year. Other items that may be included as business expenses are reasonable compensation for the services of officers and employees, advertising and other selling expenses, together with insurance premiums against fire, storm, theft, accident or other similar losses in the case of a business, and rental for the use of business property. A taxpayer is entitled to deduct the necessary expenses paid in carrying on his business from his gross income from whatever source.5 Expenses of Operation. Expenses of operation 6 were held under the 1916 Law to include all expenditures for material, labor, fuel, and other items entering into the cost of the goods sold or inventoried at the end of the year, and all other expenses incurred in the operation of the business, except such as were required by the act to be segregated in the return,7 or had been considered in determining the cost of purchases during the year. Payments for labor and materials which go into the actual operating of a railroad and its properties were deductible.8 Cost of Manufacturing Products. One engaged in manufacturing might, under the 1916 Law, include as an element of the cost of manufactured products, the cost of raw material, the cost of labor of the men who actually work on such products as well as the cost of supervisory labor such as that of foremen, inspectors, overseers, etc., provided such expenditures were not separately deducted from gross income in the return of annual net income. This 5 Reg. 45, Art. 101. * * # 6 The 1916 Law permitted the deduction by corporations of "all the ordinary and necessary expenses paid in the maintenance and operation of its business and properties.'' The 1918 Law permits the deduction by corporations of "all the ordinary and necessary expenses paid in carrying on any trade or business," which seems to be a broader phrase than that used in the 1916 Law. (Compare Revenue Act of 1916, § 12 (a) with Revenue Act of 1918, § 234 (a) 1.) 7 Reg. 33, Art. 114. * 8 Grand Rapids etc. Ry. Co. v. Doyle, 245 Fed. 792, T. D. 2210. 9 T. D. 2152. ruling permits certain items of wages and salaries to be included in the cost of the manufactured product, or to be separately listed as labor, wages, commissions, etc. Cost of Materials. Taxpayers carrying materials and supplies on hand should include in expenses the charges for materials and supplies only to the amount that they are actually consumed and used in operation during the year for which the return is made, provided that the cost of such material and supplies has not been taken into account in determining the net income for any previous year.10 If a taxpayer carries materials or supplies on hand for which no record of consumption is kept or of which physical inventories at the beginning and end of the year are not taken, it will be permissible for the taxpayer to include in his expenses and deduct from gross income the total cost of such supplies and materials as were purchased during the year for which the return is made, provided the net income is clearly reflected by this method.11 Commissions. Commissions paid to a real estate agent for collecting rents and managing property are allowed as a business expense to the owner. Commissions paid to salesmen as a part of the expense of conducting business are also allowed as deductions.12 Commissions paid in purchasing and selling securities are a part of the cost or selling price of the securities and not otherwise deductible. They do not constitute expense deductions in a return of income, 13 COMMISSIONS PAID IN STOCK. Commissions allowed to salesmen, paid in stock, are deductible as an expense, if so charged on the books, at the actual value of such stock.14 Entertainment Money. So-called spending or treating money actually advanced by business enterprises to their 10 Reg. 33 Rev., Art. 130. 11 Reg. 45, Art. 102. 12 T. D. 2090. 13 Reg. 33 Rev., Art. 8. 14 Reg. 33, Art. 117. |