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CHAPTER 30

DEDUCTION OF TAXES

In the case of individuals and domestic corporations the provisions for the deduction of taxes are the same. In the case of non-resident aliens and foreign corporations the taxes which may be deducted are limited to those assessed by the United States or its territories or possessions or under the authority of any state, county, school district or municipality or other taxing subdivision of any state, paid within the United States, within the year, except such taxes as are not deductible by any class of taxpayers. For the special rulings applicable to nonresident aliens and foreign corporations see the respective chapters on those subjects.

Taxes Paid Within the Year. Under the 1913 Law and the 1916 Law the provisions for deducting taxes expressly limited deductions to taxes paid within the year. It was held by the Treasury Department that reserves for taxes could not be established as only such sums as were actually paid within the year could be deducted, that is, the aggregate of the amounts actually paid as shown by the cash book. The provision of the 1916 Law allowing individuals and corporations to report on a basis other than that of actual receipts and disbursements, and the rulings by the Treasury Department there

1 Reg. 33, Arts. 156, 158.

under, would seem to permit, in the case of individuals or corporations reporting on an accrual basis, the deduction of the amount of taxes accrued on their books or the amounts reserved for the payment of taxes providing such amounts did not exceed the actual liability incurred during the year.?

Taxes Not Deductible. The law expressly provides that the taxpayer shall not deduct the amount of income taxes paid within the year under the 1916 or 1917 Laws and the amount of excess profits taxes paid to the Federal Government. It is provided, however, that in assessing the tax for any year the Commissioner of Internal Revenue shall deduct the amount of the excess profits tax assessed for the year from the net income of that year before assessing the income tax.4 The Act also provides that taxes assessed against local benefits shall not be deductible and that taxes paid by a corporation pursuant to a "tax-free” contract in its mortgages or bonds, shall not be deducted. In addition the Treasury Department holds that inheritance taxes are not deductible and taxes paid by a corporation for its stockholders have been held by the courts to be not deductible.

INCOME AND EXCESS PROFITS TAXES. Prior to the amendment of October 3, 1917, it was held that the income tax paid on income of one year, whether paid by the taxpayer or withheld at the source by the withholding agent, was properly deductible from the net income of

2 T. D. 2433.

3 Act of September 8, 1916, 88 5, 6, 12 (a) and 12 (b), as amended by Act of October 3, 1917.

4 Act of September 8, 1916, $ 29, added by Act of October 3,

the following year. The 1917 Amendment however, expressly provides that the Federal income taxes and the Federal excess profits taxes shall not be allowed as a deduction. Income taxes, or other taxes, levied by any state or government, other than the Federal Government, are proper deductions, In assessing the income tax, however, the net income embraced in the return is credited by the Commissioner of Internal Revenue with the amount of any excess profits tax imposed by Act of Congress and assessed for the same calendar or fiscal year upon the taxpayer, and, in the case of a member of a partnership with his proportionate share of such excess profits tax imposed upon the partnership.

TAXES ASSESSED AGAINST LOCAL BENEFITS. Taxes paid pursuant to assessments levied by special districts, such as irrigation, reclamation, and drainage districts, for sidewalks in cities, street extension, grading, paving, etc., are held to be taxes assessed against local benefits and not allowed as deductions. The taxes contemplated by the law as deductible are those which are paid to defray the expense of running the government. Where the taxpayer pays an assessment for something which will directly benefit him or his property it is not considered to be a tax in the true sense but rather in the nature of an investment in property.

TAXES PAID UNDER “Tax-FREE" COVENANTS. Where a corporation pays taxes for its bondholders under stipulations in bonds agreeing to pay the interest in full, regardless of any tax which it may be required to withhold or deduct, the amount of taxes so paid on behalf of such bondholders is not a proper deduction by the corporation. The rulings on this point are contained in the chapter on corporations. The bondholder may, however, treat the amount so paid for him as his tax and deduct the same, if it is a tax levied by a state; if levied by the federal government he cannot deduct the amount as the law expressly prohibits deduction of the federal income tax. On the other hand, the bondholder should report as additional income the amount of tax so paid for him by the corporation.

5 T. D. 2135.

6 Act of September 8, 1916, $ 29, added by Act of October 3,

7T. D. 2090; Reg. 33, Art. 153.

INHERITANCE TAXES. A collateral inheritance tax, such as that levied under the laws of the State of New York, being a charge against the corpus of the estate is not considered to be such a tax as is allowed to be deducted under this provision of the law, either in computing the net income of the estate or the net income of the beneficiary. Whether or not under any conditions an inheritance tax may be deducted has not been decided, but it seems that the theory adopted by the Treasury Department is that an inheritance tax is not in a true sense a tax which operates to reduce the income of the taxpayer for the year, and is rather the taking of a part of the corpus of the estate.

TAXES PAID BY CORPORATION FOR STOCKHOLDERS. Under the statutes of many of the states taxes are assessed against the stockholders of banks, the bank being required to pay the tax on behalf of its stockholders. In such cases it was held, under the 1909 Law, that the bank was not entitled to deduct the amount of taxes so paid as the tax was not a tax upon the bank or upon its property.10 This rule was continued under the 1913 Law and the present laws, such taxes being held to be against the property of the private stockholders and not against either the corporation or its property.11 The requirements of a state law that a bank shall pay for the stockholder cannot be construed as authority under which the bank may deduct the tax.12 Where a statute requires the bank to pay the tax and gives it a lien upon the shares, the bank is not entitled to deduct the tax.13 Where the statute gives the bank the option either to pay the tax out of its general funds or to collect the same from its stockholders, that fact does not change the character of the tax as a tax against the property of the individual stockholders, and the bank cannot deduct.14 Even though the state statute makes no provision for recovery from the several shareholders of their proportional part of the amount so paid, the bank cannot deduct.15 The absence of an express provision in the statute does not show that there is no such right of recovery, or that the intention was for the tax to fall ultimately upon the bank and not upon the stockholders. 16 As a general rule the

8 T. D. 1948.

9 Letter from Treasury Department dated February 10, 1916; I. T. S. 1917, 11 352 and 661.

10 T. D. 1763.

11 The Northern Trust Company v. McCoach, 215 Fed. 991; T. D. 2135.

12 T. D. 2161.

13 Eliot National Bank v. Gill, 210 Fed. 833; aff'd 218 Fed. 600; National Bank of Commerce v. Allen, 211 Fed. 743; aff'd 223 Fed. 472; petition to the United States Supreme Court for writ of certiorari denied October 25, 1915.

14 Northern Trust Company v. McCoach, 215 Fed. 991. 15 First Nat. Bank of Jackson, Miss. v. McNeel, 238 Fed. 559. 16 Home Savings Bank v. Des Moines, 205 U. S. 503.

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