the term mentioned in the contract or upon surrender of the contract, (b) the value of property acquired by gift, bequest, devise or descent (but the income from such property is taxable), (c) interest upon: (1) the obligations of a State, territory, or any political subdivision thereof, possessions of the United States, or the District of Columbia, (2) securities issued under the provisions of the Federal Farm Loan Act, (3) the obligations of the United States, issued prior to September 1, 1917, and if issued after such date, if and to the extent the acts authorizing the issue thereof, or acts supplementary thereto, exempt the interest from taxation to the taxpayer, both under the income and the war-profits and excess-profits taxes, (4) bonds issued by the War Finance Corporation if and to the extent stated in (3) above: (d) amounts received through accident or health insurance, or under Workmen's Compensation acts as compensation for personal injuries or sickness plus the amount of any damages received, whether by suit or agreement on account of such injuries or sickness, (e) income of any person derived from the operation of a public utility to be acquired, constructed, operated or maintained by such person, pursuant to a contract made with a State, territory or the District of Columbia, or any political subdivision of a State or territory prior to September 8, 1916, in excess of the part thereof to which such person is entitled under such contract.48 A more complete discussion of exemptions of income is contained in the several chapters dealing with the respective kinds of income enumerated. FEDERAL RESERVE BANKS. The income of Federal Reserve Bank is exempt from income tax 49 by express provision in the Federal Reserve Act.50 The dividends on the stock of such banks are exempt from tax in the hands of member banks.51 Divi 48 Revenue Act of 1918, §§ 213 and 233. Such tax-free income should not be included in the return of income and need not be mentioned in the return, unless information regarding it is specifically called for, as in the case, for example, of interest on municipal bonds. (Reg. 45, Art. 71.) Every person owning obligations, securities or bonds, the interest upon which is exempt, must submit a statement in his return showing the amount of such obligations, securities and bonds owned by him and the income received therefrom. 49 Also from the excess-profits tax. 50 Federal Reserve Act, 38 Stat. 251, Ch. 6, § 7. 51 Reg. 45, Art. 75. Federal Reserve Bulletin, April 1, 1916. dends paid by member banks are treated like dividends of ordinary corporations and are not exempt from tax.52 Net Income. "Net income" is defined by the Revenue Act of 1918 to be gross income as defined by the law less the statutory deductions.58 Thus, taxable net income is wholly a statutory conception, although it follows, subject to certain modifications as to exemptions and as to some of the deductions, the lines of commercial usage. Statutory net income is, subject to these modifications, commercial "net income." This appears from the fact that ordinarily it is to be computed in accordance with the method regularly employed in keeping the books of a taxpayer.54 Net income must be computed with respect to a fixed period. Usually that period is twelve months and is known as the taxable year.55 Net Income Subject to Normal Tax. Net income, as defined in the preceding paragraph, is subject only to the surtax in the case of individuals and the excess-profits tax in the case of corporations. For the purpose of the normal tax in the case of individuals and the income tax in the case of corporations, certain additional deductions called "credits" are allowed.56 These credits in the case of individuals are, (a) amounts received as dividends from a corporation which is taxable upon its net income or from a personal service corporation out of earnings or profits upon which income tax has been imposed; (b) the amount received as interest upon obligations of the United States and bonds issued by the War Finance Corporation, which is included in gross income; (c) the personal exemption; (d) the credit for dependents.57 In the case of corporations the credits allowed are, (a) the amount received as interest upon obligations of the United States and bonds issued by the War Finance Corporation, which is included in gross income; (b) the amount of any excess profits tax imposed for the taxable year; (c) in the case of a domestic corporation, $2,000.58 52 Reg. 45, Art. 75; Reg. 33 Rev., Art. 86. 53 Revenue Act of 1918, §§ 212 (a) and 232 (a); Reg. 45, Art. 21. 54 Reg. 45, Art. 21. 55 Reg. 45, Art. 22. 56 Revenue Act of 1918, § 211 (b); Reg. 45, Art. 21. 57 Revenue Act of 1918, § 216 (a). Dividends are a deduction in the case of corporations. (Revenue Act of 1918, § 234 (a) 6.) 58 Revenue Act of 1916, § 236. CHAPTER 15 INCOME FROM PERSONAL SERVICES The law expressly provides that the gross income of a taxable person shall include gains, profits, and income derived from salaries, wages, or compensation for personal services of whatever kind and in whatever form paid, or from professions or vocations. It is to be noted that salaries, wages, or compensation for personal services are taxable income "in whatever form paid." Where services are paid for in something other than money, the fair market value of the thing taken in payment is income.2 This is one of the three cases in which the law expressly specifies that the tax shall be based upon payments other than in cash, the others being the provision relating to dividends and the provision relating to exchanges of property. Salaries. Salaries are ordinarily income of the year in which they are actually received and not necessarily in the year in which earned. They will be income of the year in which actually earned if the recipient keeps his accounts upon an accrued basis and reports accordingly. A salary paid by a corporation which is itself exempt from the income tax is nevertheless subject to tax in the hands of the employee.5 In the case of corporations, so-called "salaries" of stockholders, if they are unreasonable in amount and if they bear a close relationship to the amount of stock held, are treated as a distribution of the net profits of the corporation, are not deductible as a business expense of the corporation, and are, therefore, not subject to the normal tax in the hands of the recipient. So-called salaries representing an appropriation of assets of the corporation by officers who control it and fix their compensation in violation of the 1 Revenue Act of 1918, § 213 (a). 2 Reg. 45, Art. 33. 3 Revenue Act of 1918, §§ 213 (a) and 201. 4 Revenue Act of 1918, § 202 (b). 5 T. D. 2135; T. D. 2090. rights of the corporation are not deductible by the corporation insofar as they exceed a reasonable amount; such excessive payments are to be treated by their recipients, however, as compensation subject to the normal tax, since compensation illegally secured is none the less subject to tax in all respects. So-called salaries constituting in part payment for property, should, insofar as they exceed a reasonable amount, be treated by the corporation as a capital expenditure and by the recipient as part of the purchase price. In the case of excessive payments by individuals or partnerships, the amounts of ostensible salaries disallowed as deductions should ordinarily be treated as shares of the profits of a partnership, except that a payment for property should be treated by the paying individual or partnership as a capital expenditure and by the recipient as part of the purchase price. Bonuses and Profit Sharing. Where employees receive bonuses, or are entitled to a share of the profits of the employer the amount so received should be included as income, provided (a) it is clearly made as compensation for services rendered and (b) it is paid under a contract, express or implied, or a long-time practice (practically an implied contract) regularly employed, which constitutes a condition, if not a contract, under which the employees may reasonably expect additional pay for the greater or better services which they render, or (c) the total amount of salary and bonus is not greater than a reasonable compensation for the services rendered by the employee. Such payments are income to the employee if they are of such character that the employer is entitled to deduct them as an expense of doing business. If a bonus is a mere gift, the employee should not treat it as income, since gifts or gratuities are not taxable, and the employer is not entitled to deduct it from his income as an expense of doing business. The rules governing the deduction of bonuses and profit sharing payments are more fully treated. elsewhere in this book.8 The rule to be followed by the employee is that if the employer is entitled to deduct the payments in question as an expense of doing business, the employee should 6 Reg. 45, Art. 106; T. D. 2696. See Chapter 22. 7 Reg. 45, Art. 107; T. D. 2696. See Chapter 22. 8 See Chapter 22. return them as income, and vice versa, if the employer is not entitled to deduct the payments in question as an expense the employee should not return them as income, otherwise the same sum of income would be taxed twice. If so-called bonuses or profit sharing paid to officers or stockholders of corporations, are in fact distributions of net profits bearing a close relationship to stock holding, or a waste or appropriation of the corporation's assets, or in part payment for property, they will be treated as indicated in the preceding paragraph. The same considerations apply when excessive bonuses are paid by individuals or partnerships.9 Commissions. Commissions paid salesmen, compensation for services on the basis of a percentage of profits, and commissions on insurance premiums are income to the recipients.10 Voluntary Offerings Received by Clergymen. Although as a general rule gifts and gratuities are not income, yet Easter offerings, and fees received by clergymen for funerals, masses, marriages, baptisms, and sums paid for saying masses for the dead, are considered income, because, though in the form of gifts, they are in fact payment to the clergymen, evangelists, and religious workers for services rendered.11 Christmas gifts to clergymen do not come within this category.12 The question is whether or not the money is actually a gift or merely in the form of a gift. Tips. Tips, though in the form of gifts, are in fact payment for services rendered and constitute income to the recipient.13 Compensation Paid Other Than in Cash. Salaries, wages, or compensation for personal services are income "in whatever form paid." Where services are paid for with something other than money, the fair market value of the thing taken in payment is the amount to be included as income. If the services were rendered at a stipulated price, in the absence of evidence to the contrary such price will be presumed to be the fair value of the compensation received.14 Where there is no stipulation as 9 Reg. 45, Art. 106; T. D. 2696. 10 Beg. 45, Art. 32; T. D. 2090; Letter from Treasury Department dated April 30, 1918; I. T. S. 1919, ¶ 858. 11 Reg. 45, Art. 32. 12 T. D. 2090. 13 Reg. 45, Art. 32. 14 Reg. 45, Art. 33. |