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DEFINITION. Christmas presents, gratuities, voluntary contributions and donations are considered as gifts and should not be reported as income by the recipient. An exception, however, is made in the case of clergymen; Easter offerings, and fees received by them for funerals, masses, marriages, baptisms, etc., while in the form of gifts, are in fact payment for services and should be reported as income.13 Special payments made by an employer as extra compensation to employees are sometimes called bonuses or gifts, but if made as compensation for services rendered, and paid in pursuance of a contract, express or implied, they are in fact not gifts but income from services, and taxable to the recipient.14 Where the salary of an employee is paid for a limited period after his death to a relative or dependent, in recognition of the services rendered by the employee, no services being rendered by the recipient, the payments are gifts and exempt from taxation.15 Of course, any amount paid by one person out of his income to another, as a gift, is not deductible from the net income of the

giver.16

SALE OF PROPERTY ACQUIRED BY GIFT. When property acquired by gift is thereafter sold, the value of the property at the time the gift was made is deducted from the amount received on the sale thereof and the remainder is taxable as income of the seller.

Recoveries on Bad Debts. Where a bad account has been charged off to profit and loss and subsequently the money is recovered, the sum so recovered must be treated as income whether or not the bad debt was charged off prior to the incidence of the tax or subsequent thereto. The fact that a bad debt has been charged off prior to the incidence of the tax does not make it any the less income for the year in which it is recovered.17

13 T. D. 2090. 14 T. D. 2152. See Chapter 17. 15 T. D. 2090, Reg. 33, Art. 6. 16 See Chapter 27 on Deductions.

Rights to Subscribe to Stock. Where a stockholder acquires the right to subscribe to new stock of the corporation and sells that right, the amount received is considered as income.18 If he exercises the right, no income accrues until the stock subscribed for is sold.

17 Letter from Treasury Department dated February 11, 1916; I. T. S. 1917, 11163. The term "incidence of the tax” means the time when the tax first applied to the taxpayer. Generally it is used to indicate March 1, 1913.

18 Letter from Treasury Department dated February 27, 1915; I. T. S. 1917, 1287.

CHAPTER 26

RECEIPTS WHICH ARE IN PART RETURN OF CAPITAL

Income is not synonymous with receipts. The tax is on income, gains and profits. The true function of the words "gains' and 'profits" is to limit the meaning of the word “income” and to show its use only in a sense of receipts which constitute “gains” and “profits.” The increased value of capital as such constitutes, in one sense, a gain or profit, but does not constitute income until the property has been sold or disposed of for cash or its equivalent. When so sold, the entire income is not gain or profit, but only so much thereof, according to the rulings of the Treasury Department, as the selling price exceeds the cost of such property. In an early case it was said that "income is that which capital earns remaining itself intact. Often receipts represent a change of capital investment or a distribution of capital assets. In that case there is no gain or profit. If such receipts were regarded as income the taxpayer's capital would be depleted. The law does not attempt to tax such receipts, as is evidenced by the language of the section (under the somewhat misleading head of exempt income) which provides, among other things, that the

1

People v. Davenport, 30 Hun. 177. This definition was adopted in Mitchell v. Doyle, 225 Fed. 437, and is in substance what the court held in Southern Pacific Company v. Lowe, 238 Fed. 847, and in the cases cited in that opinion.

2 Lynch v. Hornby, 236 Fed. 661; Lynch v. Turrish, 236 Fed. 653.

amount received by the insured, as a return of premium or premiums paid by him under life insurance, endowment, or annuity contracts, either during the term or at the maturity of the term mentioned in the contract, or upon the surrender of the contract, is exempt.3 The further provisions of the law holding that gain derived from the sale or other disposition of property acquired before March 1st, 1913, shall be taxed only to the extent that it is measured by the difference between the fair market price or value of such property as of March 1st, 1913, and the selling price, indicate that Congress did not intend to tax any income, gain or profit, or growth of capital, which took place prior to March 1st, 1913. Whatever growth took place in the capital of the taxpayer up to that date, and whatever amounts such capital had earned prior to that date, became capital on that date, so far as the income tax law is concerned. Another provision evidencing this intent is that which expressly provides that dividends from earnings or profits accrued to a corporation prior to March 1st, 1913, shall not be taxable on distribution to the shareholders. The Treasury Department, in the main, follows this principle, but deviates from it in some respects as, for instance, in the case of depreciation, where it requires the annual depreciation allowance to be based upon the original cost of the property whether acquired before or after March 1st, thus denying to the taxpayer a return of the full value of his capital on March 1st, 1913, in cases where the value of his property increased between the time it was originally purchased and that date. In most cases it is a comparatively simple matter to divide receipts into two parts, one representing return of capital (which is not taxable) and the other representing income

3 Act of September 8, 1916, $ 4.

(which is taxable) as the following rules will indicate. Difficulty sometimes arises in segregating capital and income in the case of instalment payments for goods sold in the course of business. The rulings which have been issued by the Treasury Department indicate, however, a method which might be adopted in handling such payments, as more fully appears in a later part of this chapter.

Dividends on Life Insurance Policies. Dividends paid on life insurance policies that have not matured, whether or not such dividends are drawn in cash by the insured or applied to the reduction of the annual premium due, are not considered items of taxable income. Dividends from paid-up policies, however, are considered income. The former represent merely a return of a part of the premium theretofore paid by the insured, while the latter represent a distribution of income earned by the insurance companies on the premiums paid by the insured, and, when paid to the insured, should be treated the same as dividends from corporations.4

Surrender Value of Insurance Policies. When an insured person discontinues insurance prior to the maturity of his policy, he is entitled to a certain surrender value, which is paid to him by the insurance company. The amount so received represents the return to the insured of a part of the premiums he has paid in the past, and is therefore not income. If the amount should exceed the aggregate of premiums paid, the excess would be taxable income.5

4 T. D. 2137.

5 T. D. 2090, as amended by T. D. 2152. Letter from Treasury Department dated February 8, 1917; 1. T. S. 1917, 1 2002.

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