corporation designated under the 1918 law as a personal service corporation, will have been subjected to the normal income taxes imposed between March 1, 1913, and December 31, 1917. The status of the surplus follows any transfers of shares of capital stock-that is, dividends declared before or after the transfer were free from the normal tax whether paid to a new or to an old stockholder. In 1919 the purchaser of shares of stock of a personal service corporation would certainly be free from the normal tax on dividends declared out of surplus accumulated prior to January 1, 1918, and would be free from the surtax as well on dividends declared from earnings accumulated during 1918. Because of the fact that all earnings after January 1, 1918, are subjected not only to normal tax but also to personai surtax, regardless of whether distributed or not, whereas only normal tax has been paid on the undistributed earnings accumulated prior to that date, it is important that the corporation's books show a clear line of demarcation between the surplus or undistributed profits accumulated respectively prior to and subsequent to January 1, 1918. A partner may demand that his account be segregated from his other partners' and usually has full power to withdraw all or part of the earnings of a previous year. Certainly he can withdraw enough to pay his taxes. The stockholder of a personal service corporation has no right (as a stockholder) to insist that a dividend be paid, and may find himself liable to a very large surtax with no power to reach the fund, a part of which is supposed to be available for taxes. Thus a minority stockholder in a very profitable personal service corporation might be assessed for a surtax on net income of $100,000 based on his proportionate share of the earnings for 1919. The corporation might pay no dividends. This would be a good method for freezing out minority stockholders. The remedy would be to require a personal service corporation to pay the tax assessed on its stockholders. The corporation could then adjust its dividend policy accordingly. DEDUCTIONS AND CREDITS GENERAL Method of treatment.-The statute specifies the particular deductions and credits which may be subtracted from gross income to determine taxable net income or from the tax as ascertained under certain sections to determine the net tax to be paid. These deductions and credits are listed separately in the law and differ somewhat with the character of the taxpayer-whether a corporation, a personal service corporation or an individual, or whether a resident or a non-resident. In this book all the peculiarities relating to non-resident aliens, including deductions, are relegated to a special chapter (XXXIII). The deductions and credits allowed to others than non-resident aliens, whether individuals or corporations, are consolidated and are treated topically in the series of chapters which follows. This method of treatment is convenient because most of the deductions apply with equal force to individuals and corporations. Often the wording is exactly the same and in such cases repetition is avoided, for only one construction can be placed upon it. Where there is any variance in the deductions the fact is noted and the comments separated within the chapter, care being taken to make clear the limited application of the statements which relate only to corporations or only to individuals. Since the law is printed in full in the appendix and since all the provisions relating to deductions are quoted verbatim under the various individual topics in the succeeding chapters, it is not necessary to give here the various lists of allowable deductions. For these the reader is referred to sections 214 (a) and 234 (a) of the statute. Deductions limited to those specified in the statute.-While the tax is levied on "net income received," that term is not the usual "net income" of the accountant's vocabulary. It is a resultant obtained by subtracting from gross income, as determined in the particular manner described in the preceding chapters, certain specified deductions which are discussed in the chapters which follow. In the language of the regulations: REGULATION. Net income is that portion of the gross income which remains after all proper deductions have been taken into account. The net income of corporations is determined in general in the same manner as the net income of individuals, but the deductions allowed corporations are not precisely the same as those allowed individuals. . . . . (Art. 531.) The law expressly excludes certain items usually regarded as legitimate deductions from income, and the Treasury has held that some other items of ordinary expenses are not allowable. Some of these restrictions apply both to individuals and to corporations. Others apply merely to one or the other. Neither individuals nor corporations, for example, may deduct special assessments of certain types or interest on money borrowed to purchase certain tax-exempt securities. On the other hand, an individual may deduct charitable contributions to a limited extent, while a corporation may not. Again, an individual may not deduct personal expenses, which makes it necessary to define personal expenses very carefully, while a corporation, of course, is presumed to have no "personal" expenses. Taxes imposed on an individual's residence and interest on money borrowed for personal use are not considered personal expenses. Moreover, under the 1918 law an individual can deduct the net loss sustained by any "casualty" which happens to his automobile or other property (such as a stock of liquors), a loss which is nothing more than a personal or living expense. Inconsistencies such as these give rise to most of the complications encountered in drawing up returns. Those charged with the preparation of returns should carefully study the provisions of the law bearing on deductions and be prepared to pass on the propriety of including or ex |