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XI

COMPENSATION FOR SERVICES-CANCELATION

OF INDEBTEDNESS

Compensation for services. When compensation is included as taxable income. Receipts representing additional compensation. Distinction between compensation for services and other forms of receipt. Military exemptions. Non-taxable compensation. Forgiveness of indebtedness. Accounts payable as taxable income.

SALARIES, wages, pensions from prior employers, commissions, tips, fees, and rewards are examples of sums that have been included in compensation for personal services. They must be included in returns in the year in which they are made available to the taxpayer, whether or not the books are kept on a cash basis. When the compensation cannot be definitely determined for any one year or if its payment is dependent on some contingency, the amount need not be returned until the year of its determination unless the individual keeps his books on an accrual basis. Where living quarters are furnished in addition to a cash compensation, a fair rental for such accommodations must be included in the return unless these accommodations are regarded as furnished "for the convenience of the employer.” An exception is made in the case of officers, non-commissioned officers, and enlisted men of the Army and Navy, members of the Coast Guard, Coast and Geodetic Survey, and Public Health officers, the exemption applying to quarters furnished and to actual money allowances often referred to as "commutation of quarters."1 Premiums paid on insurance policies in favor of an employee or persons he may designate are taxable income to the employee as additional compensation unless they represent 1 Jones v. U. S., 60 Ct. Cl., 552; Mim. 3413; I. T. 2219, 2232.

payments on group life insurance with beneficiaries designated by employees; in the latter case the premiums are not taxable to the employee because of the impossibility of accurate allocation (Art. 32-3).

Compensation other than cash is taxable at its fair market value at the time of receipt; notes may be taken at their discounted value, provided the discount is included as income when the notes are paid (Art. 34). Traveling allowances over and above actual traveling expenses are taxable as additional compensation (Art. 102). In the 1921 and 1924 acts all compensation received from the United States as a war pension and amounts received by veterans under the War Risk Insurance or Vocational Rehabilitation Acts are exempted from tax (Sec. 213(b) (9)). It had been previously held that such amounts except from War Risk Insurance were taxable (Sol. Op. 97). Under the 1918 act, there was a $3,500 exemption (above personal credits) to those in the Army or Navy service.

Bonuses and pensions are generally business expenses and therefore taxable income to the recipient (Art. 108-9). Amounts received as compensation may, however, actually be dividends (Art. 106) or gifts (Art. 32).

Excessive salaries paid by a corporation to the extent not allowed as a deduction are to be regarded as dividends and subject only to surtax when bearing a close relationship to stockholdings. They may represent payments for property, in which case the recipient must treat the amount received as part of the sales price (Art. 107).

Compensation from a state or political subdivision thereof is exempt (Art. 88); this rule was not contained in the 1918 Revenue Act, but resulted from a ruling of the AttorneyGeneral (T. D. 2843). Compensation from non-governmental functions operated by government is taxable, however, commencing with January 1, 1925 (Sec. 1211; Art. 88; Mim. 3397).

Salaries of Federal judges have been held to be exempt by Evans v. Gore (253 U. S., 245), and Graham v. Miles

(268 U. S., 501), but this exemption does not apply to salaries of territorial court judges (O. D. 899; I. T. 2226). The reason for this rule lies in the third article of the Federal Constitution: "the judges, both of the Supreme and inferior courts. . . . shall . receive for their services a compensation which shall not be diminished during their continuance in office." A similar limitation applies to the salary of the President (Art. II of the Federal Constitution).

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Compensation from foreign sources of a citizen who is a bona fide non-resident for more than six months of any taxable year, provided such compensation answers the definition of earned income in Sec. 209, is exempt from tax (Sec. 213 (b) (14)). This provision has been held to apply to members of the U. S. foreign service, and to officers and men of the Army, Navy and Marine Corps (S. M. 5446; I. T. 2293), to employees of domestic corporations (I. T. 2274), and to citizens residing in Porto Rico and the Philippines (I. T. 2285), but not to citizens residing in Alaska and Hawaii (Sec. 2 (a) (5)).

When compensation is included as taxable income. Bonuses awarded in 1919 for services rendered in 1916 constituted income to the recipient for 1919 (O. D. 497). Bonuses of 1916 received by check dated January 2, 1917, were taxable income of 1917 (A. R. R. 182). A railway employee was discharged and later reinstated with salary for the intervening two years; the amount was taxable in the year in which received (O. D. 512). Additional salaries paid at the end of a term of years upon the condition that officers make the business pay were taxable to the officers and a deductible expense to the corporation in the year payment was made (A. R. R. 232). A lump sum awarded to a receiver without being previously fixed was income for the year received, even though allocated by the court to certain years of service (T. D. 3159 and 2960; see also T. B. R. 12) and even if offset by overdrafts made in anticipation of the award of additional salary (T. D. 3161). A, keeping his books on a cash basis, received in 1919 for services beginning in 1909 compensation which was actually determined in 1919 when the business was liquidated. It was held to be taxable for 1919 to the extent it exceeded the March 1, 1913, value of the claim (O. D. 717, superseding O. D. 460). A fee allowed in 1919 to an attorney

for an estate, by court order, for services from 1908 to 1919 was taxable in full in 1919 because there was no determinable claim as of March 1, 1913 (O. D. 1116). An award is taxable income when received (O. D. 602). Where a Federal officer's salary was held up for a number of years awaiting outcome of a contested election, the amount was held to be taxable income in the year received (O. D. 432). A bonus, equal to a year's pay in advance, was taxable when received by a retiring army officer (I. T. 1963). Commissions paid into court and held pending a decision as to ownership were not required to be returned as income until settlement (O. D. 980). Commissions were taxable income when credited to the account of and placed under the control of the taxpayer (A. R. R. 366). Commissions paid in advance were taxable in the year advanced. Any portion paid back was deductible in the year returned (O. D. 19). Where an individual was employed as an agent for a firm and under his contract was to receive as compensation 50% of the profits of the agency which might be appropriated by him monthly as earned, the amount actually appropriated constituted income to the agent for the year in which appropriated because the balance was the property of the principal as long as it remained undrawn (S. 1312).

But where the recipient follows the cash basis, salary credited to him but under an agreement not withdrawn until the cash was readily available was not income; and no income resulted when it was finally paid in stock having no par or market value (1 B. T. A. 760). But if the stock has a market value the compensation must be reported (1 B. T. A. 472), measured in one case by the fair value of the stock as determined from a general consideration of book values and earnings over a period of five years, there being no sales of stock (4 B. T. A. 509). Restriction on the sale of the stock does not eliminate fair market value (I. T. 2309). Compensation paid in Liberty bonds is taxable, the money value and not the bonds being the thing taxed (Hitner v. Lederer, 14 Fed. (2nd) 991). Compensation, having been accrued on the books of the employer, is not taxable when no funds are available (2 B. T. A. 1221). Advances to an executor who gave his personal note therefor until the court had awarded him his compensation were taxable income of the year of award (S. M. 1929). The unpaid portion of the salary of an officer was not constructively received when the officer had remitted it before the end of the year in order to improve the financial condition of the company (1 B. T. A. 103).

Receipts representing additional compensation. Where a cler

gyman was given free use of a parsonage, a fair rental value was required under the 1918 act to be reported as additional income (O. D. 862), but if he received only enough to live on and turned the remainder back to the order he was not required to make a return (O. D. 1197). From January 1, 1921, no income on account of quarters furnished need be reported (Sec. 213(b) (11)). A cash allowance to cover the cost of a parsonage, less expenses attributable to the portion thereof devoted to professional uses, is taxable income (I. T. 1694). The term minister of the gospel applies only to ordained ministers (I. T. 1306). The pension of a retired clergyman, paid from a fund obtained by assessments against the churches of the denomination, is taxable income (I. T. 1157). Where hospital employees were subject to call at any time, meals, quarters, and so forth, furnished them while at the hospital were not income, but furnished "for the convenience of the employer" (O. D. 915). The same rule was applied to employees of a fishing company where quarters and meals were furnished near their work (O. D. 814), to seamen while on board ship (O. D. 265), to employees who were furnished with "supper money" (O. D. 514) and to house servants (I. T. 2253). But the rental value of quarters furnished employees in the Indian Service was taxable, for such quarters were charged to the appropriation from which services were paid (O. D. 914, I. T. 2051). Business traveling expenses allowed in excess of those incurred were considered income (O. D. 1015). Amounts received in excess of actual expenses should have been reported by a Red Cross worker (O. D. 11). Where the corporation paid premiums on life insurance policies taken out on employees and the employees are permitted to designate the beneficiary, such premiums are additional compensation to the employees and must be reported as income (O. D. 627). The cost of books and tuition paid out by a corporation for the benefit of its employees who were required by the corporation to go to school was held to be taxable income to the employees (I. T. 1304). An officer of a corporation who performed services for the corporation outside of his required duties was required to report the "gratuity" received therefor as taxable income (I. T. 1262). Property acquired from a corporation or employer by a shareholder or employee for less than its fair market value gives rise, at the time received, to taxable income for the difference (T. D. 3435). Amounts withheld from the salary of Government employees for retirement annuities should be reported as income as well as the amount finally received in excess of the actual withholdings (T. D. 3112).

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