the insured, his estate and other beneficiaries. Any damages recovered by suit or agreement on account of such injuries or sickness are similarly excluded from the gross income of the individual injured or sick, if living, or of his estate or other beneficiaries entitled to receive such damages, if dead. . . . . Since June 25, 1918, no assessment of any federal tax may be made on any allotments, family allowances, compensation, or death or disability insurance payable under the War Risk Insurance Act of September 2, 1917, as amended, even though the benefit accrued before that date. (Art. 72.)

The above regulation explains the provisions of the statute which includes in the exemption amounts paid either to the insured (or his estate), together with allotments, allowances and war risk insurance and compensation.2

See pages 39, 285.

22

CHAPTER XIII

INCOME FROM BUSINESS

The line between the profits resulting from business, dealt with in this chapter, and the profits resulting from appreciation of property, discussed in Chapter XIV, must be somewhat arbitrarily drawn. Most business, of course, consists of dealing in property, while all dealings in property are usually thought of as "business" transactions.

An attempt is made to distinguish between income from the purchase and sale of merchandise, securities and other property by dealers, and income or profits realized by investors and others who are not dealers. General principles regarding the nature and taxation of appreciation of fixed assets and securities, real estate, etc., are discussed in Chapter XIV. Sales and exchanges of property (not forming part of a dealer's stock-in-trade) are discussed in Chapter XV. The discussion of inventories and other "current" assets is, consequently, retained in this chapter.

LAW. Section 213. . . . . the term "gross income"(a)

Includes gains, profits, and income derived from . trades, businesses, commerce, or sales, or dealings in property, whether real or personal, growing out of the ownership or use of or interest in such property; also from . . . . securities, or the transaction of any business carried on for gain or profit, . . .

Section 202. (a) That for the purpose of ascertaining the gain derived or loss sustained from the sale or other disposition of property, real, personal, or mixed, the basis shall be

(1) In the case of property acquired before March 1, 1913, the fair market price or value of such property as of that date; and

(2) In the case of property acquired on or after that date, the cost thereof; or the inventory value, if the inventory is made in accordance with section 203.1

'For section 203, see page 295.

[Former Procedure] The specification of March 1, 1913, as the date from which to measure gains or losses was first included in the law in 1916, sections 2 (c) and 10. Before 1916 the Treasury utilized a prorating plan for determining taxable profit or deductible loss in

Gross income from business defined.

REGULATION. In the case of a manufacturing, merchandising or mining business "gross income" means the total sales, less the cost of goods sold, plus any income from investments and from incidental or outside operations or sources. In determining the gross income subtractions should not be made for depreciation, depletion, selling expenses or losses, or for items not ordinarily used in computing the cost of goods sold. Gross income includes all amounts received by the taxpayer as allowances for amortization, from whatever source and by whatever name called. . . . . (Art. 35.)

Business need not be lawful.-The law of 1913 (section II B) provided that the tax was levied on the gains from "any lawful business carried on for gain or profit." In the law of 1916, the word "lawful" is omitted and it does not reappear in the 1918 law. This would seem to indicate a direct intention on the part of Congress to make "stealings" and "winnings" taxable as well as "earnings." Income from gambling would, of course, come under this head.

In this country there is not a large class of professional gamblers or others transacting an unlawful business, but such as can be reached should be taxed. Occasional betting, however, is frequent, millions of dollars being wagered on the results of political campaigns, athletic contests, etc. The winnings are subject to tax. What they win cannot be termed a gift or any other item specifically exempt from taxation, and "gains derived from any source whatever" are taxable. One should, therefore, include all receipts from bets in his income tax return.

BRITISH PRACTICE.-In England it has been held that a professional bookmaker is liable to assessment under the income tax law. The court decided that:

Under

case of a sale of property purchased before March 1, 1913. the above quoted provision the prorating method is superseded in all cases where it is possible to establish the value of the property on March 1, 1913, more exactly by some other method.

"This statement of course does not modify those sections of the law and regulations which permit the use of recognized accounting practices. A taxpayer will not be required to change his method of accounting merely to ascertain items of "gross income."

DECISION. Persons receiving profits from betting systematically carried on by them throughout the year are chargeable with income tax on such profits as derived from a "vocation." [Partridge v. Mallandine, L. R. 18 Q. B. Div. 276 (1886).]

SPECULATION IN "FUTURES," ETC.-The purchase and sale of "futures," which chiefly concerns those who deal in cotton and other commodities on exchanges, is often called gambling and those who indulge in such transactions do not always consider that their gains are taxable income. It is immaterial whether the transactions are called business dealings, speculation or gambling. If they result in net gain, the profit must be returned as taxable income.3

Accounting Procedure

Fiscal year for individuals.-The 1918 law, by providing that an individual may compute his net income on the basis of his "annual accounting period (fiscal year or calendar year, as the case may be)" makes it possible to avoid the difficulties which previously beset the person whose business accounting was on the basis of a fiscal year. An individual business man or a partner may now simply make his personal tax year coincident with his business fiscal year or, if he desires to make his personal return on the basis of the calendar year, he may report his income from a business to the end of its fiscal year only, without attempting to restate the accounts as of December 31.

It is, however, difficult and annoying to make tax returns for a period other than the accounting period adopted by an individual. The end of December is a very inconvenient time

For discussion of deductibility of losses, see Chapter XXVII. 'Section 212 (b), see page 70.

[Former Procedure] Before 1918, the individual was denied the privilege of reporting on the basis of a fiscal year.

If an individual had a fiscal year for business other than December 31, he nevertheless had to report as of December 31, and do the best he could to reconcile the results shown by his books for the fiscal year with the figures required for a calendar year basis. The adjustments were not easily made and were annoying and expensive in time and labor.

Under the pres

for many taxpayers to state their accounts. ent law it is possible to select and report for a year ending on the last day of any month most convenient for the taxpayer.

Comments on receipt or accrual basis and the proper accounting procedure are fully discussed in Chapters XI and XII.

Computation of business income of contractors.-The business of contracting offers some peculiar difficulties in the calculation of income. The regulations deal with them as follows:

REGULATION. Persons engaged in contracting operations, who have uncompleted contracts, in some cases perhaps running for periods of several years, will be allowed to prepare their returns so that the gross income will be arrived at on the basis of completed work; that is, on jobs which have been finally completed any and all moneys received in payment will be returned as income for the year in which the work was completed. If the gross income is arrived at by this method, the deduction from gross income should be limited to the expenditures made on account of such completed contracts. Or the percentage of profit from the contract may be estimated on the basis of percentage of completion, in which case the income to be returned each year during the performance of the contract will be computed upon the basis of the expenses incurred on such contract during the year; that is to say, if one-half of the estimated expenses necessary to the full performance of the contract are incurred during one year, one-half of the gross contract price should be returned as income for that year. Upon the completion of a contract if it is found that as a result of such estimate or apportionment the income of any year or years has been overstated or understated, the taxpayer should file amended returns for such year or years. . . . .7 (Art. 36.)

Contractors should be able to prepare their accounts on the accrual basis. Their difficulties are by no means insurmountable.

[Former Procedure] Under the old regulations this special provision for contractors applied only to corporations (Reg. 33, 1918, Art. 121). The term "person" includes individuals and corporations. [Former Procedure] Regulations 33 and T. D. 2161 (February 19, 1915) did not provide for the adjustment of income of any year which had been overstated or understated, by the filing of amended returns for such period.