corporation have been closed within the six months and earnings of the current year have been credited to surplus or undivided profits. The difference between the amount of net income reported by the corporation in its return of annual net income and the amount thereof distributed by the corporation at any time before the expiration of six months after the end of its fiscal or calendar year, constitutes the undistributed net income which this provision of the law seeks to tax. From such amount of undistributed net income may be deducted (a) the amount of any income taxes paid by the corporation within the taxable year imposed by authority of the United States; (b) that portion of such undistributed net income which is actually invested and employed in the business or; (c) is retained for employment in the reasonable requirements of the business, or (d) is invested in obligations of the United States issued after September 1st, 1917.4

INCOME TAXES PAID WITHIN THE YEAR. For the purpose of determining the net income subject to the income tax a corporation is not permitted to deduct the amount of the Federal income taxes paid within the year, but such amounts may be deducted for the purpose of this tax. Excess profits taxes paid during the year are not deductible for the purpose of this tax since the net income subject to this tax is the same as that determined for the purpose of the tax imposed by Subdivision 10a of the 1916 Law, which is the income remaining after the Commissioner of Internal Revenue has deducted the amount of excess profits taxes assessed against the cor

4 Act of September 8, 1916, § 10 (b) added by Act of October 3, 1917.

poration in the same year. As an illustration, if a corporation has a net income of $100,000 for the year 1917 and the war excess profits tax assessed against it, on such income, is $20,000, the income tax for 1917 will be assessed upon the remainder of the net income after deducting the amount of $20,000, that is, on $80,000. From the sum of $80,000 the corporation may further deduct the amount of Federal income taxes assessed against it for the year 1916, and paid by it in the year 1917, (not the income tax assessed against it for the year 1917, since such tax is not paid until the year 1918). From the net amount so obtained, it may deduct the amount of undistributed net income employed or invested as indicated in the three following paragraphs.

NET INCOME ACTUALLY INVESTED AND EMPLOYED IN THE BUSINESS. The amount of undistributed net income for the taxable year which is actually invested or employed in the business is not taxable. Under this head should be included only such earnings as have been actually and permanently invested or employed within the taxable year or within six months after the end of such year.

NET INCOME RETAINED FOR EMPLOYMENT IN THE REASONABLE REQUIREMENTS OF THE BUSINESS. This deduction differs materially from the one referred to in the preceding paragraph. It is not required that the undistributed net income shall be actually used or employed in the business before the expiration of six months after the end of the taxable year, but it is sufficient if such income has been retained for employment in the reasonable requirements of the business. The "reasonable requirements of the business" will be for

practical purposes what the Treasury Department construes the phrase to mean. It is not unlikely that the term' will be given a very narrow construction in the first and general rulings, leaving a more liberal construction to be worked out as specific instances are ruled upon. It seems that even under the strictest construction an amount retained for employment in the business during the following year is reasonable, so long as it is not in excess of such percentage of the earnings as the officers of the corporation have found by experience in previous years to be necessary to take care of the normal growth and expansion of the business. Sums which may be retained for the purpose of making up losses in "lean" years will probably be held not to be "reasonable" since the advent of a lean year is a contingency which cannot be anticipated with any reasonable certainty. Amounts retained for the purpose of equalizing dividends in the future would seem to be retained rather as a matter of advisability or expediency, than for the reasonable requirements of the business. Income retained by a corporation for the purpose of meeting any definite obligation coming due at a certain time in the future is retained for the reasonable requirements of the business. Amounts set aside in sinking funds to pay off mortgages would come within this class, unless the amount set aside in any year is clearly much greater than reasonably necessary, considering the amount of the mortgage debt, the amount previously set aside in the sinking fund, and the length of time to elapse before the due date of the mortgage. The earnings of a corporation used to purchase preferred stock for cancellation are held to be retained for employment in the reasonable requirements of the business and therefore not taxable." 5 T. D. 2570.

NET INCOME INVESTED IN OBLIGATIONS OF THE UNITED STATES. In order to avoid any question as to whether or not the undistributed net income for the year has been retained for the reasonable requirements of the business, such income may be invested in obligations of the United States issued after September 1, 1917. Any amount so invested may be deducted, for the purpose of this tax, whether or not it is necessary, or merely advisable, to retain such amount for employment in the business at some future time. Such part of the net income for the current year as may be invested in the first issue of Liberty Loan bonds will be subject to the tax unless, by such investment, the amount is employed in the business or the amount is retained for employment in the reasonable requirements of the business. The exemption as to investment in obligations of the United States applies only to such obligations as are issued after September 1, 1917.

Rate of Tax. On the amount of net income remaining undistributed six months after the end of each calendar or fiscal year, after deducting the several deductions described above, a tax of 10% is levied. The law does not contain any provision as to when the tax is due and payable or to whom it shall be paid. Such administrative details are left to be covered by regulations.7

6 T. D. 2570.

7 As first proposed this provision of the law gave only a period of two months in which to distribute the earnings for the preceding calendar or fiscal year, and it was apparently the intention of Congress that the amount remaining undistributed should be reported upon the form of return of annual net income, and that the tax should be paid at the same time and in the same manner as the income tax. The present period of six months in which to

Penalty Tax. If a corporation has reported its net income for a calendar or fiscal year as being employed in the business, and the Secretary of the Treasury ascertains and finds that any portion of such amount is not so employed, or, if the corporation has reported an amount to be retained for employment in the reasonable requirements of the business, and the Secretary of the Treasury ascertains that the amount is not reasonably required in the business, a tax at the rate of 15%, instead of 10%, is imposed upon such amount. It should be noted that this provision practically makes the Secretary of the Treasury judge as to when the earnings are employed in the business, or what the reasonable requirements of the business may be. The provision is intended as a means of deterring officers of corporations from making too liberal allowances for the reasonable requirements of the business. In effect, the provision imposes a penalty of 50% of the amount of the tax for understatement of the taxable undistributed earnings.

Returns. The law does not indicate when or with whom the returns on which this tax is to be assessed should be filed. The matter is left entirely to the Treasury Department, which has issued no regulations at the time of this writing.

make distribution of the earnings eliminates this method of reporting and paying the tax.