or accrued during the taxable year to a foreign country upon income derived from sources therein, or to any possession of the United States, subject to the limitations of section 222 of the statute. . . . . (Art. 323.) The procedure regarding exemption for dividends, interest and taxes is fully outlined in the respective chapters dealing with those subjects and in the chapters on returns. INTEREST ON TAX-EXEMPT BONDS ΤΟ BE ENTIRELY OMITTED FROM THE CALCULATION OF NET INCOME. The basis prescribed for the calculation of net income in section 218 (d), quoted on page 502, plainly excludes entirely interest upon tax-exempt securities." '[Former Procedure] CREDIT for 1917 excess PROFITS TAX RESTRICTED TO 1917 INCOME. LAW. Section 218. "(c) In the case of an individual member of a partnership which makes return for a fiscal year beginning in 1917 and ending in 1918, his proportionate share of any excess-profits tax imposed upon the partnership under the Revenue Act of 1917 with respect to that part of such fiscal year falling in 1917, shall for the purpose of determining the tax imposed by this title, be credited against that portion of the net income embraced in his personal return for the taxable year 1918 to which the rates for 1917 apply." This provision is equitable. The partner's tax on 1917 profits, not reported until 1918, should be based on 1917 rates; therefore the credit for the 1917 excess profits tax was applicable against the 1917 income, not against 1918 income. [Former Procedure] The 1916 and 1917 laws were also specific on this point [section 8 (e)], but the procedure was somewhat different, the interest being apportioned among the partners for deduction by each rather than excluded from the net income of the partnership altogether. Under the 1913 law the Treasury ruled on April 22, 1915, that interest on tax-exempt bonds might be deducted by partnerships in ascertaining the distributable interest of partnership members. On February 3, 1916, this position was reaffirmed. However, there was a complete reversal a few months later by T. D. 2337 (June 1, 1916), which it should be borne in mind was issued under the 1913 law. There seems to have been no justification for the reversal. The deduction was specifically corrected in the law of 1916, and a court decision under the 1913 law has declared the position assumed to have been a mistaken one. Unfortunately a large amount of tax was paid under the ruling which has been reversed. Partners who paid these taxes may secure a refund whether or not they paid the taxes under protest. For full discussion of the foregoing, see Income Tax Procedure, 1919, pages 372-373. IDENTITY OF INCOME OF PARTNERSHIP-HOW FAR TRACEABLE. In the gross earnings or expenses of a partnership there may be items other than the specified dividends or interest which would be favorably treated in the returns of individuals if segregated from the partnership profits. If there are such items partners may confidently report them separately unless and until partnerships are taxed as entities. In United States v. Coulby' the court said: 6 DECISION. The Congress (in the 1913 law), consequently, it would seem, ignored for taxing purposes, a partnership's existence, and placed the individual partner's share in its gains or profits on the same footing as if his income had been received directly by him without the intervention of a partnership name. It follows from these considerations that legally the defendant's share of the gains and profits of Pickands, Mather & Co., derived from corporations taxable on their net incomes, is to be treated as if the same had been received by him directly from the tax-paying corporations. Regarding the argument that the insertion of the specific clause permitting deduction of dividends in the 1916 law evidenced a belief of Congress that the 1913 law provided otherwise, the court said: DECISION. I do not agree with this contention. In my opinion this provision was inserted in the 1916 act to put at rest the present controversy rather than to change the law, and is to be regarded only as a legislative recognition of the scope and intent of the prior law. '[Former Procedure] A ruling under the old law held as follows: REGULATION. "The character of partnership profits divisible between persons has no reference (except as otherwise specially provided for in section 8 (e), act of September 8, 1916, as amended) to any character which as income accruing to the partnership it may have borne prior to the receipt by the partnership, and hence, with the exception noted, income received from a partnership can not be traced to its source behind the partnership for the purpose of claiming individual exemption." (Reg. 33, 1918, Art. 30.) This regulation was subject to criticism. It happens that under both the 1916 law and the new 1918 law the kinds of partnership income which it is an advantage to "identify" are "specially provided for." Therefore taxpayers are not concerned at present about the restriction. 'District Court, N. D. Ohio E. D., 251 Fed. 982 (June 26, 1918); affirmed by Circuit Court, 258 Fęd. 27. INFORMATION NEEDED TO TAKE ADVANTAGE OF CREDITS AND DEDUCTIONS.-In view of the credits and deductions set forth in the preceding paragraphs, the partner should, before preparing his personal return, request specific information regarding the following points in addition to the mere statement of net profit or net loss:8 I. 2. (b) When taxable at 1918 or prior year rates.1o Interest upon "obligations of the United States and bonds issued by the War Finance Corporation which is included in gross income under section 213" of the law.12 3. Gifts.13 DEDUCTION FOR PARTNERSHIP LOSSES.-Partnership losses are, of course, deductible in the returns of the individual partners. The following regulation explains the basis of division among partners: REGULATION. Losses sustained during the taxable year are fully deductible . . . . if (a) incurred in the taxpayer's trade or business, . . . . (Art. 141.) Even though the distributive share on the firm's books is a net profit, if the aggregate of dividends and interest described on page 503 is greater than the net profit the difference is an allowable deduction as a loss to the partner. If the books of a partnership show a net profit of $40,000 with two equal partners, each is subject to surtax on his dis "Which it is assumed would be drawn up in accordance with the law and the regulations. See page 87. "See pages 452, 455. 10 See page 482. "See page 459. 12See page 419. Particular care should be exercised to make sure that interest entirely exempt, including that received on farm loan bonds, is reported but not included in the statement of net income. 13See page 559. [Former Procedure] When fiscal years ended in 1918, other than at December 31, 1918, it was necessary to know the amount of partnership income subject to the 1917 income and excess profits tax rates. tributive share, irrespective of the character of the income. If the firm received $50,000 in dividends each partner should return $25,000 from that source and claim credit for a loss of $5,000. The amounts entered as dividends will be free of normal tax, and the difference between $25,000 and $5,000 ($20,000 each) will automatically be subject to the surtax, which commences at $5,000. The accounting period. The partner is taxable on his distributive share of the net income "for any accounting period of the partnership ending within the fiscal or calendar year upon the basis of which the partner's net income is computed" [section 218 (a)]. The 1918 law, it will be recalled, permits an individual, for the first time, to report on the basis of his fiscal year. The phrase just quoted makes it clear that a partnership having a fiscal or closing period different from that of the individual partner need not attempt to make an additional closing of the books or ascertainment of profits. or losses in order that the partner may return his share of the net profits or losses of the partnership for his full, personal fiscal year. Different partners may, indeed, have fiscal years ending at various dates and to insist upon a closing of the books in each instance would be out of the question. What the government wants from an individual who is a partner in one or more firms is a full and accurate return of his share of the partnership profits for the twelve months ending at some date during his personal fiscal year. The acceptance of this as sufficient obviates the necessity of guessing or roughly calculating the partner's income when the fiscal year of the partnership does not agree with that of the partner. It is convenient and accurate to report the amount shown by the partnership records, and, as the income tax has come to stay, individuals should change their own fiscal periods to the regular closing date of their partnerships. It should be borne in mind that so-called salaries paid to partners are in effect a distribution of anticipated profits (Chapter XXIV). They may, however, have been deducted on the partnership books in determining the net annual profits distributable at the end of the fiscal year. If so deducted such salaries should be included as taxable income, for the year in which received, in each partner's individual return, in addition to his remaining share of the partnership profits for the fiscal year mentioned above. ESTABLISHMENT OF FISCAL YEARS.- -Section 226 of the 1918 law makes it possible for a partnership to change from a calendar year to a fiscal year, a fiscal year to a calendar year or one fiscal year to another." The procedure is fully outlined in the chapters on returns." 15 PROCEDURE WHEN FISCAL YEAR INCLUDES PERIODS WITH DIFFERENT RATES.-The law provides a method of computation for a partner who in his return for his fiscal or calendar year includes partnership profits for a preceding period that are taxable at a different rate.18 LAW. Section 218. (b) If a fiscal year of a partnership ends during a calendar year for which the rates of tax differ from those for the preceding calendar year, then (1) the rates for such preceding calendar year shall apply to an amount of each partner's share of such partnership net income equal to the proportion which the part of such fiscal year falling within such calendar year bears to the full fiscal year, and (2) the rates for the calendar year during which such fiscal year ends shall apply to the remainder.17 Most of the problems regarding the computation. of the tax when the rates for different years must be applied were in 1918. In 1919 returns the only difference in rates is the reduced normal tax.18 "[Former Procedure] In the past it was customary to require a partnership to give notice of the establishment of a fiscal year thirty days prior to March 1. (Reg. 33, 1918, Art. 31.) See page 70. 16For criticism of method, see page 156. "For the rates of previous years, see pages 139, 140. For specimen return showing correct computation of tax, see Appendix. "For discussion of procedure in 1918, see Încome Tax Procedure, 1919, pages 378-379, 1044-1046 (Supp.). |