closed and showed undivided profits or surplus for the current year. The language used in the law is that the dividends "shall be deemed to have been declared from the most recently accumulated undivided profits or surplus," regardless of what the actual facts may be. Thus, the corporation may actually intend to make a distribution in the form of dividends out of some fund other than the most recently accumulated profits or surplus, but, nevertheless, the law deems such payment to have been made from the most recently accumulated profits and surplus and the dividend will be taxable on that basis. This provision does not apply, however, to any distribution made prior to August 6, 1917, out of earnings or profits accrued prior to March 1, 1913.14

Dividends from Earnings or Profits Accrued Prior to March 1st, 1913. When a dividend is declared from earnings or profits accrued prior to March 1st, 1913, the recipient, whether individual or corporation, is liable for no tax thereon. Such earnings or profits, however, can be distributed only after all of the earnings and profits of the corporation accrued since March 1st, 1913, have first been distributed.15

14 Under the 1916 Law, the Treasury Department ruled that dividends could be declared from any specified fund, that is, a dividend could be declared from surplus accumulated prior to March 1, 1913, and consequently be free from tax in the hands of the stockholders, although the corporation had surplus and undivided profits accumulated since that date sufficient to pay the dividend. This ruling is annulled by the amendment of October 3, 1917, except as indicated in the text.

15 Act of September 8, 1916, § 31 added by Act of October 3, 1917. There is conflict in the cases under the 1913 Law as to the taxability of dividends distributed subsequent to the incidence of

SUCH DIVIDENDS EXEMPT ONLY TO STOCKHOLDERS OF FIRST CORPORATION. Where dividends are declared from surplus accrued prior to March 1, 1913, they are free from tax in the hands of the stockholder, but if such stockholder is in turn another corporation, upon the distribution to its stockholders of the sum so received as dividends, the fund becomes taxable to the stockholders of the second corporation as, to the holding company, such sum did not represent earnings or profits accrued prior to March 1, 1913. While the law provides for the exemption of dividends from corporate

In a

the tax from earnings which accrued prior thereto, the law being silent on that point. The Circuit Court of Appeals declared in the case of Lynch v. Turrish, 236 Fed. 653, that a sum received by a stockholder in excess of the par value of his stock, exclusively from the increase in value of his stock prior to March 1st, 1913, on account of the gradual advance in the value of the property of the corporation prior to that date, was not income when distributed by the corporation after the incidence of the tax. case decided at the same time, Lynch v. Hornby, 236 Fed. 661, the same court held that dividends received by a stockholder from the conversion of property into money and a distribution after the incidence of the tax was not taxable where the dividend represented the value of property owned by the corporation on March 1st, 1913, including the increase of the value of its timber lands and surplus from its business operations, the court announcing as its opinion that no property held by the corporation or the stockholder, whether original capital or previously earned surplus income, gains or profits, was intended to be made, or was made, taxable as income by the 1913 law, so far as it represented the value of such property on March 1st, 1913. In a later case, Southern Pacific Company v. Lowe, 238 Fed. 847, the District Court, for the southern district of New York, held that dividends from surplus accumulated prior to March 1st, 1913, were not taxable, if the surplus represented an increase in the value of the assets of the corporation, but were taxable, if the surplus was accumulated from earnings or profits of the corporation prior to the incidence of the tax. The question is now before the United States Supreme Court for final decision.

funds earned prior to March 1, 1913, it does not provide for tracing the identity or character of such dividends after the receipt thereof by the stockholders of the corporation which earned the fund prior to the incidence of the tax.16

DIVIDENDS RECEIVED BY AN ESTATE. Dividends re ceived by an estate are not exempt because paid from surplus accrued prior to the creation of the estate, but are taxable as are dividends received by other taxpayers, that is, either to the beneficiaries if the income is distributed, or to the estate if it is not distributed,17 unless the dividends were declared from earnings or profits which accrued to the corporation prior to March 1, 1913.

Dividends from Reserves for Depreciation or Depletion. It is the practice of some corporations to declare dividends out of reserves set aside to meet depreciation and depletion. Such dividends are held taxable to the stockholders if declared out of reserves accumulated since March 1, 1913.18

Cash Dividends. Where a dividend is paid in cash, or by check, which is the equivalent of cash, the dividend becomes taxable to the recipient in the year in which it is received, not necessarily in the year in which it is declared. In such cases it should be reported

16 Letter from Treasury Department dated July 23, 1917; I. T. S. 1917, ¶ 2277.

17 Letter from Treasury Department dated October 19, 1915; I. T. S. 1917, ¶ 669. The principle of the decision in Matter of Osborne, 209 A. D. 450 (N. Y.) was referred to in this letter and held to have no application to the income tax law.

18 T. D. 2540.

as income for the year in which the cash or check is received.19

Scrip Dividends. When a dividend is paid in scrip it is held to be equivalent to a payment in cash and an investment of the cash in the scrip. The dividend, therefore, must be included in the return at the face value of the scrip.20 If at a later date the face value of the scrip is not realized in cash a loss may be claimed in the year in which the stockholder parts with the scrip.

Dividends Paid in Equivalent of Cash. Very few rulings have been made on the subject of distribution of the net earnings in property other than cash or stock of the corporation. When distribution is made in property which has no fixed money value, it would be difficult to determine the amount, if any, of earnings or surplus in such distribution. Although the law, in its definition of the term "dividends," expressly states that a dividend shall be a payment in cash or in stock of the corporation, it does not seem to be the intent thereof that no tax shall accrue if the payment is made in the equivalent of cash. Where, for instance, the corporation uses its surplus and undivided profits in purchasing securities and thereafter distributes such securities among its stockholders as a dividend, it would

19 Letter from Treasury Department dated February 18, 1915; I. T. S. 1917, ¶ 178. This rule is not changed by the amendment of October 3, 1917, which expressly provides that in the case of distribution in 1917 or subsequent years the amount distributed shall be considered as a part of the annual income of the distributee for the year in which it is received.

20 Letter from Treasury Department dated January 19, 1915; I. T. S. 1917, ¶ 168. Scrip dividends were held taxable under the Act of June 30, 1864.

Bailey v. Railroad Company, 106 U. S. 109.

seem clear that the value of the securities, either at the time of purchase or at the time of the distribution, would measure the money value of the dividend. The time at which the corporation acquired the securities would seem to be the proper time at which to determine the money value of such a dividend, since any increase in the value above the cost of such securities, at the time of distribution, had not been realized as earning or profit of the corporation, and, it must be borne in mind, a dividend is taxable only to the extent that it represents earnings or profits of the corporation.

DIVIDENDS PAID IN LIBERTY BONDS. The fact that dividends are paid in Liberty Bonds does not make that income exempt from tax. The tax is upon the income itself as an entirety and not upon the specific articles into which this income is finally transmuted. When Liberty Bonds are used as a medium of payment, whether in discharge of a private debt or a corporate dividend, profit or gain to the recipient is nevertheless subject to income tax.21

TAXES PAID FOR SHAREHOLDERS TO BE CONSIDERED AS DIVIDENDS. Where a corporation, such as a bank, pays taxes assessed upon the respective interests of its shareholders, under laws which require the corporation to pay such taxes on behalf of its shareholders, the pro rata amount so paid on his shares should be reported

21 Letters from Treasury Department dated June 30, 1917, and June 22, 1917; I. T. S. 1917, ¶¶ 2257 and 2258. The second of these letters is based upon an opinion on the subject obtained from the Attorney General by the Treasury Department. The question was raised by reason of the language of the Act authorizing the first issue of Liberty Bonds, which exempted the principal and income from taxation.

F. I. Tax.-18