ness, agricultural and personal service partnerships,1 and income derived from the business of life, health, and accident insurance combined in one policy issued on the weekly premium payment plan. But the act will be remembered principally for the introduction of the idea of invested capital; i.e., that a fair return should be allowed on the stockholders' equity and that only the excess of the yearly income over such fair return should be subjected to a supertax. This act was repealed by the act of October 3, 1917, which substituted a "war excess profits tax," effective from January 1, 1917. The new act was designed to apply to enterprises making large war profits, as the title indicates. It applied to all trades and businesses, including professions and occupations, except officers and employees of the United States or a political subdivision, corporations exempt from the income tax, and insurance businesses of the type exempt under the act of March 3, 1917, as explained above. ACTS FROM 1918 TO 1926 On February 24, 1919, the 1918 law was signed by the President. This law was effective from January 1, 1918, and repealed the 1916 and 1917 laws. Invested capital, as in the case of the 1917 act, was again given a prominent place in the computation of the tax but its application was limited to the corporate form of enterprise.2 A general demand for the reduction of taxes following the war brought the 1921 act, approved by the President November 25, 1921. The schedule of taxes applicable to corporations and individuals was retained for the year 1921, but commencing with 1922 the rates were scaled down considerably through the abandonment of the excess profits tax and a decrease in the individual surtaxes. Many doubtful 1 Personal service organizations, including corporations, were quite consistently regarded by Congress as not subject to the tax imposed on ordinary business enterprises. They were enterprises whose invested capital is a minor factor in the production of income. See Chapter XXVII. 2 See Chapters XXI-XXIV for details. points relating to the computation of income were made plain and the number of possible tax-free exchanges was increased. The act of 1924, approved June 2, 1924, continued the same tax on corporations and again lowered individual taxes, while the act of 1926, approved February 26, 1926, increased the corporate tax for 1925 and 1926 but made another substantial reduction in individual taxes. SOME DEFECTS OF EARLIER ACTS Acts that are retroactive in their application do not give the individual or corporation time to adjust his or its affairs to the tax imposition, with the result that they work great hardship on the taxpayer. All of the acts which have become effective have been retroactive. The enactment of seven radically different laws in thirteen years has contributed much uncertainty to business conditions. Many thousands of amended returns and claims for refund have been due to lack of time in which the laws and regulations could be studied. Former acts did not provide for making returns on the basis of income and expenses accrued rather than paid and for that reason caused the taxpayer endless trouble in arriving at his income for tax purposes. At present there seems to be a distinct trend toward the elimination of arbitrary limitations on deductions, the acceptance of established business customs and institutions, and the recognition of the accountant's definition of profits.1 The 1909 law was brief and general in character and left to the administration much latitude in interpretation. The 1913 law contained restrictions on deductions which caused frequent complications, one being that deduction of losses could cover only those incurred "in trade." Corporations had to pay on dividends received from other corporations regardless of whether or not the other corporations were 1 That is, all earnings accrued within the period less all accrued and probable expenses and losses. subject to income tax. Collection at the source in the 1913 law was a cause of trouble but much more so than the necessity of having to give information at the source under the 1916 act. The 1909 law allowed nothing for depletion, and the 1913 law limited the allowance for depletion in the case of mines to 5% of the gross value of the product at the mine. Later laws permitted the allowance to be based on discovery value. Prior to the 1918 law no recognition was given to obsolescence until the year in which it was finally sustained. The 1916 law and also the 1917 law and amendments established a limitation on the deduction for interest. Unlike the 1918 act, which provided for averaging, the 1917 law offset all borrowed money against inadmissible assets in computing invested capital.1 The 1917 law did not permit the deduction of a premium paid on life insurance of an employee as an expense even if the corporation was not the beneficiary. Many other differences, of more or less importance in individual cases, are discussed at length in subsequent chapters. SIGNIFICANCE OF MARCH 1, 1913, AND OTHER DATES From time to time certain dates relating to the tax laws, regulations and ruling will be referred to, each of which has a definite significance. 1. January 1, 1909: Effective date of the excise tax law of 1909; values on this date were used in lieu of cost where property was purchased prior to 1909 and sold between 1909 and 1913 (Great Northern Ry. Co. v. Lynch, 292 Fed., 903). 2. August 5, 1909: Date of passage of the excise tax law of 1909; this act was applicable to the period commencing January 1, 1909, and ending February 28, 1913. 1 See page 261. 3. March 1, 1913: Effective date of the 1913 act and (by subsequent legislation) of the Sixteenth Amendment permitting Congress to tax incomes. The effective date of the amendment was February 25, 1913. 4. October 3, 1913: Date of passage of the 1913 act. 5. January 1, 1916: Effective date of the 1916 act. 6. September 8, 1916: Date of passage of the 1916 act. 7. January 1, 1917: Effective date of the 1917 act. 8. March 3, 1917: Date of passage of an excess profits tax act which was repealed later in the year without having been put into effect. This date continued to mark the division, however, in later acts between the period in which invested capital had not been thought of as a factor in the computation of the tax liability and the period in which corporations might tend to inflate invested capital values (through the good-will account or by means of a reorganization) and thus lower the excess profits tax payable. 9. April 6, 1917: Date of declaration of war. This date is the beginning of the war period, and assets purchased during that period, contributing to the production of war facilities, could be "amortized," commencing with January 1, 1918. 10. August 6, 1917: Effective date of rule in the 1917 act taxing dividends according to rates prevailing in years earned by corporations. The rule held until the 1918 act became effective; i. e., January 1, 1918. II. October 3, 1917: Date of passage of the 1917 act. 12. January 1, 1918: Effective date of the 1918 act. In the 1924 and 1926 acts, this is the effective date of a rule which prohibits the enhancement in value of assets acquired by a corporation through reorganization. 13. February 24, 1919: Date of passage of the 1918 act. 14. January 1, 1921: Effective date of the 1921 act, marking the beginning of the period during which gifts, certain transfers in trust, and property acquired in tax free exchanges must be valued at cost to the transferor. 15. March 3, 1921: Date of resolution of Congress declaring the war with Germany at an end. According to the 1918 act the amortization period was to end with the cessation of the production of war facilities and not later than three years from this date (i. e., March 3, 1924). 16. July 2, 1921: Date fixed by proclamation of the President ending war with Germany. This date, rather than the preceding, governs in connection with Liberty bond interest. 17. November 23, 1921: Date of passage of the 1921 act, with which commences the limitation on the deduction of "wash" sales. 18. January 1, 1923: Effective date of certain amendments of the 1921 act. 19. March 4, 1923: Date of passage of certain amendments of the 1921 act. 20. July 2, 1923: Date of change of exemptions of Liberty bond interest from a principal of $125,000 to a principal of $50,000. 21. January 1, 1924: Effective date of the 1924 act. 22. June 2, 1924: Date of passage of the 1924 act. 23. January 1, 1925: Effective date of the 1926 act. 24. February 26, 1926: Date of passage of the 1926 act. 25. July 2, 1926: Date on which $50,000 Liberty bond exemption ended. These dates are given here for later reference purposes only. ADMINISTRATION OF THE LAW The interpretation and application of the various income tax laws have been vested in the Commissioner of Internal Revenue, whose Bureau is a part of the Treasury Department. The Income Tax Unit makes up the largest part of the Bureau, its personnel, including the staff at the offices |