themselves regularly engaged in the active conduct of the affairs of the corporation and in which the capital invested is not a material income-producing factor. Such corporations are recognized as being taxable in the same manner as partnerships; that is, the corporation is required to pay no tax but the stockholders are required to include in their personal returns their distributive shares of all the profits of such corporations whether distributed or not. Personal service corporations are composed, for instance, of professional men or agents who have adopted the corporate form merely as an incidental convenience. The law expressly provides that no foreign corporation shall be considered to be a personal service corporation, nor shall any corporation be so considered if 50% of its gross income consists either of gains, profits or income derived from trading as a principal or of gains, profits, commissions or other income, derived from Government contracts made between April 6, 1917, and November 11, 1918, both dates inclusive.58

Partnerships. A partnership itself is not taxable, but the members of the partnership are required to report their distributive shares of the partnership income, whether such income is actually distributed or not. The present law expressly states that where the fiscal year of a partnership ends within a calendar year the partner shall be taxed at the rates for the preceding calendar year on that proportion of his share of the partnership's net income equal to the proportion which the part of the fiscal year falling within such calendar year bears to the full fiscal year; and the rates for the calendar year during which such fiscal year ends shall apply to the remainder. For instance, if the partnership fiscal year ends June 30, 1919, the partner will be taxed at the 1918 rates on one half of his net income from the partnership and at the 1919 rates on the other half.59 Thus, if his share of partnership profits were $40,000, the first $20,000 would be taxable at the 1919 normal tax rates and the second $20,000 at the 1918 normal tax rate applying to incomes over $20,000.60 The surtax rates will be applied to the entire $40,000, without distinc

58 Revenue Act of 1918, § 200. For further discussion of this subject see Chapter 9 and as to the excess-profits tax see Chapter 43.

59 Revenue Act of 1918, § 205 and § 218.

60 Id. § 206.

tion, since those rates are the same in 1918 and 1919. All partnerships are required to file annual returns of income for the purpose of showing the amount of net income distributable to each partner.61

Collection of the Tax at the Source. Collection at the source, deduction at the source, withholding at the source and stoppage at the source, are synonymous terms meaning that the one paying income to another deducts or withholds an amount equal to the tax on the sum so paid and turns it over to the Government to the credit of the one against whom it is withheld. This method is used in order to facilitate the collection and to prevent evasion of the tax. Under the 1913 Law, and the 1916 Law during the year 1916, the normal tax was withheld on payments to individuals, whether citizens, residents or non-resident aliens. Under the 1916 Law, as amended by the 1917 Law, the tax was not withheld on payments of income to citizens and residents (except in the case of bonds containing tax-free covenants).62 Collection at the source applies at the present time only to (1) payments of fixed and determinable annual or periodical income to non-resident aliens in which case the tax is to be withheld at the rate of 8% (and if the Commissioner so rules the non-resident alien may claim exemption from withholding to the extent of his personal exemption); (2) payments of the same kind of income to nonresident foreign corporations not engaged in trade or business within the United States and not having an office or place of business therein, in which case the tax is to be withheld at the rate of 10%; and (3) the Commissioner may authorize deduction 63 at the source in the case of payments of any interest upon any securities the owners of which are not known to the withholding agent; (4) in the case of payments of interest on bonds and similar obligations of domestic corporations which contain a so-called "tax-free covenant," the tax to be withheld in all such cases to be limited to 2%, whether the owner be a citizen or resident or a non-resident alien or a foreign corporation or a domestic or foreign partnership. The only bondholders to which

61 Id. § 224.

62 Revenue Act of 1916, § 9 (c) as amended by Revenue Act of 1917.

63 The law is not clear whether the Commissioner may authorize deduction at the rate of 8% or 10% in the case of bonds not having "tax-free covenants'' and it seems to be within his discretion.

the last mentioned provision does not apply are domestic and resident corporations. The Commissioner may authorize the tax of 2% to be withheld on interest on "tax-free covenant” bonds where the owner is not known.64 It is to be noted that the only case in which withholding against citizens or residents of this country takes place is (4) above. In such cases the law is made to operate in order that the debtor corporation issuing such "tax-free covenant" bonds may be compelled to assume a part of the tax of the bondholder, since withholding does not actually take place.65

Information at the Source. For the purpose of checking up the returns of taxpayers the law provides for a system of information at the source, whereby every corporation may be required to report to the Commissioner the names and addresses of its stockholders and the amount of dividends paid to each; 66 brokers may also be required, when called upon, to report the names and addresses of customers and furnish information as to the profits and losses of each;67 and all persons, corporations or partnerships may be required to report the names and addresses of any persons to whom they pay fixed or determinable gains, profits or income of $1,000 or more in any taxable year. In the case of payments of interest to the bondholders of corporations the names and addresses of such bondholders are required to be reported regardless of the amount paid during the year, as is also the rule in the case of the collection of foreign items of interest and dividends.68

Payment of the Tax. The income tax is due and payable in four installments, each consisting of one-fourth of the total tax. The first installment is payable at the time when the return is due to be filed, unless an extension of time for filing the return is granted, in which case the first installment is due at the expiration of such extended period with interest at the rate of one half of one per cent. per month from the date on which the return was originally due to be filed. The return is required to be filed on the 15th day of March (or the 15th day of the third month fol

64 Revenue Act of 1918, § 221 and § 237.

65 For a further discussion of this subject see Chapter 40. 66 Revenue Act of 1918, § 254.

67 Id. § 255.

68 Id. § 256.

F. T.-2

lowing the close of the fiscal year), and the second, third and fourth installments are due on the 15th day of the sixth, ninth and twelfth months respectively after the close of the taxable year. 69 In the case of a taxpayer filing a return for the calendar year the first installment will de due on March 15, the second on June 15, the third on September 15 and the last on December 15. In the event of default in the payment of any installment the whole amount of tax still unpaid becomes due and payable upon notice and demand by the collector. The above provisions do not apply to taxes collected at the source. The tax may be paid in a single payment instead of in installments. It is then due or payable, when the return is filed, either at the date set by law or to which time to file the return has been extended. No discount is allowed where such an advance payment is made. Receipts are no longer given for taxes paid, except upon the request of the taxpayer."1

Abatement and Refund. The collection of the income tax cannot be restrained by injunction, but the Commissioner is authorized to remit and pay back to the taxpayer any taxes which have been erroneously or illegally collected. The importance of collecting revenue is so great that the law permits no taxpayer to interpose a hindrance to the orderly assessment of the tax. He must allow the tax to be assessed and may thereafter claim abatement or refund.72

69 Id. § 250.

70 Id. § 250 (a).·

71 Id. § 251.

72 See Chapter 38 for procedure as to abatement and refund.

CHAPTER 2

THE INCOME TAX RATES

As indicated in the foregoing chapter, the income tax is imposed generally at two rates (called the normal tax) on a part of the net income, and at a series of progressive rates (called the surtax) on all the net income over $5,000. In the case of corporations no surtax is imposed, the income tax rate being uniform on all amounts of net income.

Normal Tax. Under the Revenue Act of 1918 a normal tax of 4% is imposed upon the first $4,000 of taxable net income of citizens and residents for the calendar year 1919, and a normal tax of 8% upon the remainder of such taxable net income. In the case of non-resident alien individuals the rate is 8% 5 on the .taxable net income. In assessing the normal tax of citizens or residents the following items are deducted from net income to determine taxable net income: (a) the amount received as dividends from a corporation which is taxable for income tax purposes on its net income and from a personal service corporation out of earnings or profits subject to income tax; (b) the amount received as interest upon obligations of the United States issued after September 1, 1917, and bonds issued by the War Finance

1 In 1917 the income tax was assessed and collected under two laws (the Revenue Act of 1916 and the Revenue Act of 1917); but it is now assessed and collected under one law-The Revenue Act of 1918.

2 This rate was 6% for the calendar year 1918.

3 This rate was 12% for the calendar year 1918.

4 Revenue Act of 1918, § 210 (b); Reg. 45, Art. 2. The subject of income is treated fully in Chapter 14 et seq.

5 This rate was 12% for the calendar year 1918.

6 In the case of non-resident alien individuals only income from sources within the United States, including interest on bonds, notes or other interestbearing obligations of residents, corporate or otherwise, dividends from resident corporations, and including all amounts received (although paid under a contract for the sale of goods or otherwise) representing profits on the manufacture and disposition of goods within the United States, is taxable (Revenue Act of 1918, § 213 (c)). But as to dividends, see p. 45.