nerships it follows that since the partners are subject to tax on the distributive shares of the profits, the net income should be ascertained in general under the same rules as apply to individuals.11

In the

Deductions. The deductions to which a partnership is entitled are not stated in the law, but it would seem that deductions of expenses, interest, taxes, losses, depreciation and depletion should be made by general partnerships under rules applicable to individuals. case of limited partnerships reporting as corporations, the deductions should be made under the rules applicable to corporations. Such special rulings as have been made with respect to deductions of partnerships are given below.

PROFIT SHARING. Where a partnership agreed with an expert to take charge of one of its departments upon a participation of profits basis by which the expert served without salary and received his compensation in the form of 20% of the net profits of the department at the end of the year, it was held that this arrangement established the relation of employer and employee, not that of partner, and that the amount of compensation paid to the expert constituted a proper item of business expense to be deducted in computing the taxable income accruing to the partnership members.12

INSURANCE PREMIUMS. Premiums paid on life insurance policies covering the lives of partners or employees

11 This manner of determining net income is expressly required of partnerships in making the special returns which the law authorizes the Commissioner of Internal Revenue to demand at any time. Act of September 8, 1916, § 8 (e).

12 Letter from the Treasury Department dated June 30, 1916; I. T. S. 1917, ¶ 512.

are not permitted to be deducted in computing the profits of a partnership for the purpose of determining the distributive shares of the partners.13 On the maturity of such policies the amounts of premiums so paid (if not deducted from the net income of the years in which paid) will be a proper deduction from the amount of the policy, the remainder constituting the taxable portion of the amount received.

INTEREST. Partnerships may deduct interest paid during the year to the same extent as individuals, and subject to the same limitation in the case of interest paid on money borrowed for the purchase of bonds the . interest on which is exempt as income.14

Distribution of Partnership Profits. The law has not been construed at any time to require the collection of the tax at the source on the distribution and payment of profits of a partnership to the partners. No ruling has yet appeared requiring such deduction on payments to non-resident alien partners.15

Profits to Be Reported by Partners. The annual net profits of a partnership when divided and paid to the

13 Act of September 8, 1916, as amended by Act of October 3, 1917, § 32. Under the 1916 Law prior to this amendment the Treasury Department permitted such premiums on life insurance to be deducted from year to year as paid and required the amount of the policy to be included in gross income in the year in which the policy matured and such amount was received. (T. D. 2090.) 14 See Chapter 29.

15 If a non-resident alien partner fails to pay the tax on his share of the profits, the partnership might be held liable as a resident agent having custody and control of such income, but the Treasury Department does not seem so far to have required any

members should be included by each individual partner receiving the same in his annual return and the tax paid thereon as required by law. Both normal and supertaxes must be paid, except as noted below. When the annual profits are not distributed and paid to the partners, the respective interests of each partner in the undistributed profits for the year should be ascertained and the partners entitled thereto should include the amount of their respective interests in their annual returns as if the profits had been distributed and paid to them.16 Such undivided annual profits of partnerships having been reported by the individual members thereof and the tax having been paid thereon, are not again taxable to the partners when actually distributed at a later date.17 The distributive interests of the partners in the firm's net income should be the amount shown by the books when closed and not their distributive interests in the amount of income of the partnership represented by actual cash receipts, unless the partnership keeps its books on the basis of cash receipts and disbursements. Where accounts receivable, for instance, are entered on the books of the partnership as income and the amounts thereof are treated as debts due from customers or clients, the partners' returns are required to be based on the total sum of such accounts receivable and not on the amount thereof that has actually been paid.18

action to be taken to withhold the tax at the time of payment. See I. T. S. 1917, ¶ 2282.

16 Reg. 33, Art. 13. 17 Reg. 33, Art. 14.

18 Letter from Treasury Department dated February 28, 1916; I. T. S. 1917, ¶ 521.

INTEREST ON NATIONAL BONDS. A partner may deduct from his net distributive interest in the partnership a proportionate amount of the income received by the partnership on the obligations of the United States, if and to the extent that it is provided in the act authorizing the issue of such obligations that they are exempt from taxation. This provision is no doubt intended to grant the same exemption to partners as is granted to individuals under the provision of Section 4 of the 1916 Law as amended. That section, however, permits the deduction of interest on the obligations of the United States whether or not the act creating the obligation provides that the obligation shall be exempt from tax, except in the case of obligations issued after September 1st, 1917. Congress undoubtedly had in mind that partners should be allowed to deduct the interest on obligations of the United States issued prior to September 1st, 1917, whether or not the act authorizing such issue specified that the obligations would be exempt, although a strict construction of the provision applying to partnerships would seem to. prohibit the deduction in all cases unless the authorizing act contained a clause exempting the interest.19

INTEREST ON BONDS OF THE STATES, POSSESSIONS AND POLITICAL SUBDIVISIONS. The interest received by the partnership on the obligations of a state or any political or taxing subdivision thereof and upon the obligations of the possessions of the United States may be deducted by a partner in proportion to his share of the total partnership profits. This is undoubtedly intended to give the partner the benefit of the same exemption as

19 Act of September 8, 1916, as amended by Act of October 3, 1917, 88, Subdivision (e).

is accorded to individuals or corporations under Section 4 of the 1916 Law, although that section refers only to "political subdivisions while the provision relating to partnerships refers to "political and taxing subdivisions." However, political subdivision has been construed to mean any subdivision of a state having the power to levy taxes so that the inclusion of the phrase "taxing subdivision" does not seem to extend any greater exemption to partners than to others.20

DIVIDENDS. For the purpose of computing the normal tax a partner is allowed a credit for his proportionate share of the income derived by the partnership from dividends.21 Although this provision of the law seems to permit a credit of all dividends, it is undoubtedly intended to be limited to dividends on the stock of corporations subject to this tax, since the credit to be allowed is that provided by section 5, subdivision (b), of the same act which is specifically limited to such. dividends. The rate of supertax on dividends depends on the year in which the profits were earned by the corporations.22

Fiscal Year. A partnership has the same privilege of fixing and making returns upon the basis of its own fiscal year as is accorded to corporations. If a fiscal year ended during 1916 or ends during a subsequent calendar year for which there is a rate of tax different from the rate of the preceding calendar year, the rate for the preceding calendar year applies or shall apply

20 See Chapter 29 on Deduction of Interest.

21 Act of September 8, 1916, § 8, Subdivision (9), as amended by Act of October 3, 1917.

22 See Chapter 23.

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