fiscal year begins shall apply to an amount of each partner's share of such partnership net income (determined under the law applicable to such year) equal to the proportion which the part of such fiscal year falling within such calendar year bears to the full fiscal year. . . FACTS: PROBLEM 172 Illustrating Taxation of Income of Estates John Jones is the executor of an estate holding domestic corporate stocks and bonds. The will contains a direction that A and B shall be paid during their lives annually the dividends from certain of the securities. In 1921 these dividends totaled $5,000. Of the remainder of the income $5,000 is to be distributed annually to specified legatees, and in 1921 $25,000 was to be donated (which was actually done) to the Red Cross. The gross income in 1921 including all the above amounts was $100,000, and the expense of operating the properties, $20,000. QUESTION: What is the taxable net income of the estate and by whom is it to be reported? ANSWER: The executor will make a return including the income of the estate which is not periodically distributable to or credited during the taxable year to beneficiaries or legatees. The net income is computed as follows: Gross income Ordinary expenses for operating Interest and dividends paid to bene $100,000 $20,000 ficiaries and legatees under will 10,000 Donation to Red Cross in accord ance with will ... Net income 25,000 55,000 $45,000 It will be noted that any part of the gross income paid or permanently set aside under the terms of the will may be deducted from taxable income. It is also to be noted that the donations are not subject to the 15% limitation imposed by Sec. 214 (a) (11). REFERENCE: .. Sec. 219 (a): "That the tax imposed by sections 210 and 211 shall apply to the income of estates or of any kind of property held in trust, including (1) Income received by estates of deceased persons during the period of administration or settlement of the estate; (4) Income which is to be distributed to the beneficiaries periodically, whether or not at regular intervals. . . (b) The fiduciary shall be responsible for making the return of income for the estate or trust for which he acts. The net income of the estate or trust shall be computed in the same manner and on the same basis as provided in section 212, except that (in lieu of the deduction authorized by paragraph (11) of subdivision (a) of section 214) there shall also be allowed as a deduction, without limitation, any part of the gross income which, pursuant to the terms of the will or deed creating the trust, is during the taxable year paid or permanently set aside for the purposes and in the manner specified in paragraph (11) of subdivision (a) of section 214. In cases in which there is any income of the class described in paragraph (4) of subdivision (a) of this section the fiduciary shall include in the return a statement of the income of the estate, or trust which, pursuant to the instrument or order governing the distribution, is distributable to each beneficiary, whether or not distributed before the close of the taxable year for which the return is made." Sec. 225 (a): "That every fiduciary (except a receiver appointed by authority of law in possession of part only of the property of an individual) shall make under oath a return for . ... (4) Every estate or trust the net income of which for the taxable year is $1,000 or over." FACTS: PROBLEM 173 Illustrating Tax on Income of Trusts The directors of the Sunshine Corporation voted to put in the hands of a trustee for the employees of the Company under a plan of distribution certain shares of the capital stock of the company. The trust indenture provided that the employees were to pay par for the stock in small installments and that the dividends on the stock were to be paid to the trustee, the latter being required to credit the several employees with their respective proportions of the dividend as part payment for the stock. QUESTION: Is the trustee required to pay a tax on the income received by him? ANSWER: REFERENCE: Sec. 219 (f): "A trust created by an employer as a part of a stock bonus or profit-sharing plan for the exclusive benefit of some or all of his employees, to which contributions are made by such employer, or employees, or both, for the purpose of distributing to such employees the earnings and principal of the fund accumulated by the trust in accordance with such plan, shall not be taxable under this section." FACTS: PROBLEM 174 Illustrating Evasion of Surtaxes by Incorporation Henry Smith was the father of twin boys five years old. In order to provide a fund for them at 30 years of age, he conceived the idea of forming a corporation with a perpetual life which would not distribute any earnings during the first 25 years, but would accumulate these earnings and reinvest them in securities, thereby compounding the earnings. Accordingly he caused the Smith Investment Corporation to be organized in 1921. Its capital stock of $1,000,000 was issued in the names of his two sons, for securities of the value of $1,000,000 turned in to the corporation by Mr. Smith. QUESTION I: Since by the charter of the corporation it cannot distribute any dividends for 25 years after organization, how would such a corporation be likely to be considered by the Bureau of Internal Revenue? ANSWER: The corporation would probably be considered one formed and availed of for the purpose of preventing the imposition of the surtax on its stockholders or members, by permitting its gains and profits to accumulate instead of being distributed among its members or stockholders. QUESTION II: What would be the procedure of the Bureau in such a case? ANSWER: Before the tax can be assessed under section 220 in addition to that imposed by section 230, the Commisioner must certify that in his opinion such accumulation is unreasonable for the purposes of the business. Upon request of the Commissioner or any collector, the corporation is required to file a statement of its income, the names and addresses of each stockholder and the amounts that would be payable to them if such income were distributed. There are two methods of taxing such a corporation: (1) A tax of 25% of the net income of the corporation may be assessed in addition to the income tax imposed by section 230; (2) if all the stockholders agree, the Commissioner may assess each stockholder on his distributive share in the same manner as members of a partnership are taxed, in lieu of all income, war-profits and excess-profits taxes. REFERENCE: Sec. 220: "That if any corporation, however created or organized, is formed or availed of for the purpose of preventing the imposition of the surtax upon its stockholders or members through the medium of permitting its gains and profits to accumulate instead of being divided or distributed, there shall be levied, collected, and paid for each taxable year upon the net income of such corporation a tax equal to 25 per centum of the amount thereof, which shall be in addition to the tax imposed by section 230 of this title and shall be computed, collected and paid upon the same basis and in the same manner and subject to the same provisions of law, including penalties, as that tax: Provided, That if all the stockholders or members of such corporation agree thereto, the Commissioner may, in lieu of all income, war-profits and excess-profits taxes imposed upon the corporation for the taxable year, tax the stockholders or members of such corporation upon their distributive shares in the net income of the corporation for the taxable year in the same manner as provided in subdivision (a) of section 218 in the case of members of a partnership. The fact that any corporation is a mere holding company, or that the gains and profits are permitted to accumulate beyond the reasonable needs of the business, shall be prima facie evidence of a purpose to escape the surtax; but the fact that gains and profits are in any case permitted to accumulate and become surplus shall not be construed as evidence of a purpose to escape the tax in such case unless the Commissioner certifies that in his opinion such accumulation is unreasonable for the purposes of the business. When requested by the Commissioner, or any collector, every corporation shall forward to him a correct statement of such gains and profits and the names and addresses of the individuals or shareholders who would be entitled to the same if divided or distributed, and of the amounts that would be payable to each." PROBLEM 175 Illustrating Withholding of Tax-Income of Nonresident Aliens on Which Tax is to be Withheld at Source. FACTS: The Artemis Corporation, located at Baltimore, Maryland, acts as financial agent for various foreign individuals and interests. This company collects income accruing within the United States to the foreign principals, which have no residence here nor agents other than the Artemis Corporation. QUESTION: Must the Artemis Corporation withhold, for Federal Tax purposes, any of the income collected for the foreign principals? If so, what amount must be withheld? ANSWER: To the extent that such nonresident foreign principals consist of individuals or of partnerships composed in whole or in part |