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The law permits to individuals the deduction of the necessary expenses actually paid in carrying on any business or trade (limited in the case of non-resident aliens to business conducted within the United States) and in the case of corporations all the ordinary and necessary expenses paid within the year in the maintenance and 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 (limited in the case of foreign corporations to business and property within the United States). The special provisions applicable to each of 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.1

Expenses Incurred in Earning Exempt Income. Expenses incurred in earning income which is not subject to tax do not constitute allowable deductions in computing net income from other sources which are taxable.2

Expenses of Operation. Expenses of operation 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 are required by the act to be segregated in the return, or have 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 are deductible.4

Cost of Manufacturing Products. One engaged in manufacturing may 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 are not separately deducted from gross income in the return of annual net income. This 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. The items however, should not be listed under both heads, as this would constitute double deduction of the amounts.

1 T. D. 2137. 2 T. D. 2137. 3 Reg. 33, Art. 114. 4 Grand Rapids & Indiana Ry. Co. v. Doyle, T. D. 2210.

F.I. Tax.-20

Sums Expended for Materials Used and on Hand. Where a business carries materials and supplies on hand for use, the cost thereof, to be included as an expense for the year, should be only the amount paid for the materials which are actually disbursed and used in operation during the year.6 Amounts expended for materials to be used in subsequent years are proper deductions in the year in which the materials are used.

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.?

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.8

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Entertainment Money. So-called spending or treating money actually advanced by business enterprises to their traveling salesmen, as a part of the selling expense of their product, is a proper deduction. There must, however, be some showing that all of the allowance claimed as a deduction was actually expended for the purpose for which the allowance was made, namely, the selling of the product in question.'

Contributions for Campaign Expenses. Such contributions, and sums of money expended for lobbying purposes, are held not to be ordinary and necessary expenses of corporations and are therefore not deductible.10

Customs Duties. Customs duties may be either deducted as taxes or may be included as a part of the cost price of the goods, if the taxpayer is engaged in the importation of goods and merchandise.11 Such duties of course should not be both included as cost of the goods and deducted as taxes.

Discounts. Discounts, other than bank discounts on notes executed by a corporation, were required, under the 1909 Law, to be segregated from the interest item on the return and to be included under expenses.12

Accounts Payable. Accounts payable actually charged into the expense account and so entered on the books as to constitute a liability against the assets of

9 T. D. 2090. 10 T. D. 2137.

11 Letter from Treasury Department dated December 22, 1914; I. T. S. 1917, 1358.

12 T. D. 1675.

the company, and so treated in the preparation of the return of annual net income that they will not be included in the deductions of the year in which they are actually paid, may be deducted from the gross income of the year in which the expenses were incurred. This ruling applies only to accounts payable representing ordinary and necessary expenses of maintaining and operating the business, that is, such expenses as are incurred in producing the gross income which it is required to return. 18

Expenses of Maintenance. Maintenance means the upkeep or preserving of the condition of the property to be operated and does not mean additions to the equipment, additions to the property or improvements of former condition of the property.14 Expenses of maintenance are deductible.

Improvements. In the case of a railroad where old rails are replaced with new and heavier rails, wooden bridges and culverts with concrete and steel bridges and culverts, the rule is that the cost of renewals with like kind and quality is allowable, but excess cost is not allowable as a deduction. 15

Repairs. Incidental repairs made to the business property of a taxpayer which neither add to the value of the property nor appreciably prolong its life, but keep it in an operating condition, are expense. 16 Incidental

13 Letter from Treasury Department dated March 2, 1915; I. T. S. 1917, (1267.

14 Grand Rapids & Indiana Ry. Co. v. Doyle, T. D. 2210. 15 Grand Rapids & Indiana Ry. Co. v. Doyle, T. D. 2210. 16 Reg. 33, Art. 131.

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