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The Columbia University Libraries reserve the right to refuse to accept a copying order if, in its judgement, fulfillment of the order would involve violation of the copyright law. Author: Giblin, James Vincent Title: Practical federal income tax procedure, 1922 Place: Boston Date: 1922 cn-^XiuS- H MASTER NEGATIVE * COLUMBIA UNIVERSITY LIBRARIES PRESERVATION DIVISION BIBLIOGRAPHIC MICROFORM TARGET ORIGINAL MATERIAL AS FILMED - EXISTING BIBLIOGRAPHIC RECORD ' Boftnrsf 491 G35 Giblin, James V Practical federal income tax procedure 1922. A condensation of existing tax regulations and important decisions, by James V. Giblin... With acknowledgment of thankn for valuable suggestions from J. T. Drury... ^and^ I. B. Baruch...- 4th ed... rev., Feb. 1, 19J32... Boston, Hickey, C1922. 115 1. 27^ cm. In order to presppt to the reader a con- (Continued on next card) y^" I. i. Giblin, James V. Practical federal income tax procedure 1922. ol922, (Card 2) densed summary statement of the law and at the same time explain fully the more difficult sec- tions and articles, these lectures, given at several of the schools in and about Boston, have been arranged in printed form. "-foreword. o RESTRICTIONS ON USE: TECHNICAL MICROFORM DATA FILM SIZE: ?)f^w^ DATE RLMED: REDUCTION RATIO: \3>^ \HU-<\H IMAGE PLACEMENT =(S) HA IB IIB INITIALS: ?2L TRACKING # : AfS^ ^'T.Ttf I FILMED BY PRESERVATION RESOURCES. BETHLEHEM. PA. Oi> ^ ^T^ CJ1 Ol ^ 3 ^ 3 > 09 03 ABC bcdef 0,0 o m ^o o.'jy -m n> O (» X 3x 3 r" Is S3S a>3 2 i o -vi o o Is 00^ ^ IS ^ RST stuv 3 o;^ $ cz (T>X X < oorM o X M »v> > ^^^ V V o o 3 3 ^o ..^-'X^y f^ Is 3i 3 ^ s| ^^ o»x ^;5 S fcp 1— • r>o CJl o = z ^^J^ *' ^^. Q) O > 05.0 IS 5C |o *< JO •-*— I o>x ^< 00 Nl O '^. L'b ^%. ^j^^. ^ € ■^ '4^ tl . J'^^M^^ ^l:g:^i>^^^ :^'-:^ .^^::'#^tn^t;-|;:^.*i^:v., IWA *Kl& ^ Mm - ^ ST *f?'*..i^J £ tm « < •■..»•■ ■ , .^'r' 43 i^;v u r. ^ "ill A1!1\! '1 ii^ i ii ft' .k . r "' • \ tjf I'' ?•■''('] 4/,V. '^S'-^ I / 1 \ \ Columbta ^Hmberittp inttjeCttpof^togorii LIBRARY School of Business V ^ Practical Federal Income Tax Procedure 1922 A Condensation of Existing Tax Regulations and Important Decisions £y JAMES V. GIBLIN, A.B., A.M, CERTIFIED PUBLIC ACCOUNTANT (MASS.) Special Lecturer on Income Tax Procedure at Boston University, College of Business Adminis- tration; Boston University, School of Law; Head ^James V, Giblin Company, Accountants Boston New York Washington With Acknowledgment of Thanks for Valuable Suggestions from J. T. DRURY, B.Sc, A.M., LL.B. I. B. BARUCH, Ph. B., A.M., LL.B. CERTIFIED PUBLIC ACCOUNTANT (MASS.) ATTORNEY-AT-LAW Formerly Lecturer, Massachusetts University Extension Course at Harvard ATTOR NE Y- AT-LA W PUBLIC ACCOUNTANT Formerly of Department of Mathematics Princeton FOURTH EDITION SECOND IMPRINT Revised, February /, 1922 Price ^3.75 \ n COPYRIGHT, I9ai, BY E.J. ^IC^^EY, Publisher 755 BOYLSTON STREET, BOSTON ; 4 FOREWORD At the present time there is an over-abundance of Income Tax literature and refer- ence books being offered to the public. However, in practically all cases, these works are a reprint of the Law, together with quotations from numerous Supreme Court de- cisions and Treasury Department regulations. Such publications, excellent in themselves, are invaluable for reference and other purposes, but are often confusing and incompre- hensive to the reader who wishes to obtain an introduction to the subject of Income Tax Law and a clearer understanding of the more difficult sections. In order to present to the reader a condensed summary statement of the Law and at the same time explain fully the more difficult sections and articles, these Lectures — given at several of the Schools in and about Boston — have been arranged in printed form. They do not represent in themselves a complete text book, but, if fully mastered by the reader who desires to obtain a thorough understanding of the fundamentals, they should make the reading of the actual Law a much easier task. To illustrate the purpose of the work. Lecture I takes up the personal exemptions allowed an individual. In the Law nothing more than the general requirements for an individual obtaining exemption are given. In the average text book these are recopied and decisions inserted. In these Lectures numerous practical illustrations are given which should enable the reader to grasp the points involved more readily. The Lectures have also been used as a means of transferring the theoretical legal phraseology of the regulations to the actual practical Income Tax Returns, with their multiplicity of figures, schedules and computations, so that a mastery of the Lectures should enable the reader to write the majority of Income Tax Returns with only an occasional reference to the Law and decisions. Throughout, cross-references have been avoided, topics rarely met with in practice omitted, and the series so arranged as to make the Lectures valuable to the business man, student, or reader desirous of mastering the important fundamentals in the briefest possi- ble time. THE PUBLISHER Boston, Mass. February i, 1922 CONTENTS FIRST SECTION - INDIVIDUALS LECTURE I Individual Income Tax Procedure Kind of Taxes Rates of Taxes Computation of Tauces Persons Taxable auid Exempt Income Taxable. Page . 1 LECTURE II Exclusions from Gross Income Items Excluded by Law Other Items Excluded Liberty Bond Interest Excluded. 8 LECTURE III Gross Income Items Generally Included Items Subject to Special Rules Effect of March 1, 1913, Value 19 LECTURE IV Allowable Deductions 28 LECTURE V Preparation of Form 1040A Income Tax Return of Individual With Net Income Less Than $5,000. 38 LECTURE VI Preparation of Form 1040 Income Tax Return of Individual With Net iQcome of More Than $5,000 47 SECOND SECTION - CORPORATIONS LECTURE VII Page Corporation Income TEixable 59 Kinds of Taxes Rates of Taxes Corporations Exempt Corporation Income Taxable and Exempt LECTURE VIII Invested Capital 71 LECTURE IX Invested Capital (continued) 80 LECTURE X Computation of Corporation Taxes in Special Cases 85 LECTURE XI Preparation of Form 1120 91 Corporation Income and Excess Profits Tax Returns LECTURE XII Miscellaneous Topics 109 LIST OF PHOTOGRAPHIC REPRODUCTIONS OF RETURNS Page PLATE I Form 1125. Taxable Interest on Liberty Bonds 15 " II 1040A. Page 1. Individual Income Tax Return, Income Less than $5, 000 41 " III 1040A. Page 2. Individual Income Tax Return, Income Less Than $5 , 000 42 " IV 1040. Page 1. Individual Income Tax Return, Income in Excess of $5,000 50 " V 1040. Page 2. Individual Income Tax Return, Income in Excess of $5,000 51 " VI 1065. Partnership Income Tax Information Return 52 " VII 1120. Page 1. Corporation Income and Profits Tax Return 95 " VIII 1120. Page 2. Corporation Return 96 " IX 1120. Page 3. Corporation Return 97 " X 1120. Page 4. Corporation Return 98 -1- LECTURE 1. INDIVIDUAL INCOME TAX PROCEDURE Kinds of Taxes. Rates of Taxes Computation of Taxes. Persons Taxable and Exempt. Income Taxable. KINDS OF TAXES: There are two taxes levied against the incomes of individuals, the NORMAL TAX and the SURTAX. RATES OF TAXES: The Normal Tax is at the rate of 4% on the first $4,000 of taxable income, and 8% on all taxable income above that amount. "Taxable Income," for Normal Tax purposes, begins after an allowable exemption or credit has been subtracted from an individual's net income. Thus "A" earns $7,000 per year. He is single and allowed an exemption of $1,000. Therefore, of the $7,000 received" by "A" the first $1,000 is not taxable; the amount earned from $1,000 to $5,000. represents the first $4,000 taxable, and is assessed at the rate of 4%; the balance earned, from $5,000 to $7,000 is taxed at the rate of. 8%. Non-resident aliens are subject to an 8% tax on all their net income, after an exemption of $1,000. RATES OF TAXES: The Surtax-or additional tax-is levied against net incomes above $5,000, at the following rates: 1% for income from " $5,000 to $6,000, 2% for income from $6,000 to $8,000, and 1% addi- tional tax for each $2,000 of additional income up to $100,000, after which the rate increases in steps from 48% to 65% (See Surtax Tables, Regulations 45, pages 21-24). Thus a person receiving $10,000 salary would pay a Surtax of $110, computed as follows: The amount earned from $5,000 to $6,000 would be taxed at the rate of 1%, or $10; from $6,000 to $8,000 (or the next $2,000) at 2%, giving $40; and from $8,000 to $10,000 (or the next $2,000) at 3%, giving $60. The total Surtax would be $10 plus $40 plus $60, or $110. This same income is also subject to the Normal Tax. For taxable income earned in 1922, the Surtax begins at $6,000 instead of at $5,000, and is at the rate of 1% for income from $6,000 to $10,000; 2% for income from $10,000 to $12,000, etc., up to 50% for income in excess of $200,000 (See Sec. 211 -New 1921 Revenue Act). COMPUTATION OF TAXES: "B," single, has an income of $12,200. His total tax would be $936, computed as follows: NORMAL TAX SURTAX Total Taxable Income $12,200 1% from $5,000 to $6,000 $10 Exemption for single person. .1,000 2% " 6,000 to 8,000 40 3% " 8,000 to 10,000 60 Taxable Income (Normal Tax). 11, 200 4% " 10,000 to 12,000 80 4% on first $4,000 taxable. . .4,000 5% " 12,000 to 12,200 ...10 8% on balance tstxable 7,200 4% on $4,000. .$160 Surtax $200 8% on $7,200. . 576 Normal Tax ..736 Normal Tax $736 Total Tax ."|§36 -2- Note the Surtax Computation for the income from $12,000 to $12,200. In the Government Regulations and the Income Tax Forms, the Surtax Tables give the tax for $12,000, it being necessary only to add 5% of $200 to that figure. In computing the Surtax, it is necessary to remember that it begins at $5,000. Thus while a single man earning over $5,000 may be allowed am exemption of $1,000 and a married man one of $2,000, before either is subject to the Normal Tajc, each pays the same Surtax. PERSONS TAXABLE: All citizens of the United States, whether residents of this country or not, and all foreigners residing in this country and not merely transients, are taxable. Non-resident aliens, that is, persons living in foreign countries, atnd not citi- zens of the United States, are taxed only on income derived from sources within this country. Thus, an Americgui residing in Mexico and earning his living there is taxable, as citizens of the United States are taxable where- ever resident. So also, an Italian, residing here and receiving all his income from abroad, is tawcable, as residents of the United States are taxable, regardless of source of income. A Canadian, living in Canada, suid deriving his total income from investments in corporations in the United States, is taxable, as a non-resident alien is taxed on income derived from sources within the United States. But, a Brazilian, residing in Brazil, and representing an American concern, -e. g. , the U. S. Standard Oil Co., -and being paid from the United States, is not tameable, as the income was earned outside the United States, and therefore is not considered income derived from sources within the United States. So also, a non- resident alien, receiving dividends from an American corporation which earned its income entirely in foreign countries, would not be taxed. American seeunen and alien -resident seamen engaged in foreign trade are taxable, but non-resident alien seamen whether on American or foreign vessels are not taxable, although their ves- sels may stop at American ports and part of the income be earned within the United States. Persons bom here, still subject to American jurisdiction, and not naturalized elsewhere, auid foreigners naturalized here, are citizens of the United States. Naturalized citizens lose their citizenship if they return to their own country for a period of two years or any other foreign country for a period of five years. Foreigners who have merely taken out their first papers are not considered naturalized. PERSONS EXEMPT: The law allows an exemption of $1,000 in the case of a single person, and either $2,000 or $2,500 in the case of a married person or head of a family, before the Normal Tax is levied. A further exemption of $400 is granted for dependents under certain circumstances. MARRIED PERSONS: For the taxable year 1921, a married person, living with husband or wife, is allowed an exemption of $2,500, ex- cept that when the combined income of both is in excess of $5,000, an exemption of only $2,000 is allowed even though each submits a re- turn with separate income of less than $5,000. Only one personal exemption is allowed husband and wife. This exemption, however, may be taken in any proportion desired. Thus, if both are employed, their combined income may be reported and one exemption of $2,500 taken; or they may report separately, one claiming an exemption* of $1,500 anci the other of $1,000; or each may claim $1,250 exemption. Husband and wife must be living together, actually or construct- ively, in order that the $2,500 or $2,000 exemption may be allowed. If the husband is a traveling man and occasionally visits home, or if the wife is absent unavoidably through illness or otherwise for a long period, the law considers the two (constructively) as living together. But if the husband or wife is continually and voluntarily absent from home, or each makes his or her home at a different place, then neither one is entitled to the exemption for married persons. HEAD OF A FAMILY: of a family is allowed family is a person who one or more members* of marriage, or adoption, financial support, and As in the case of a married person, the head a $2,500 or $2,000 exemption. The head of a (1) maintains a home, (2) in which he supports a household related to him through blood, (3) to whom he gives substantially all (4) who is also under some legal or moral ob- ligation to act as head. To claim exemption as head of a family, a person must actually assume the responsibility of the household and the dependent must look to him for support. If two persons are sup- porting a household on an approximately equal basis, neither can claim exemption as head of the family. However, if one contributes substantially all the support, and the dependents receive incidental incomes, such as bank interest, or interest on bonds, etc., he is nevertheless entitled to the $2,500 or $2,000 exemption. If a father places his widowed child with relatives temporarily, he will still be considered head of a family, but not if he does so continually and without good reason. DEPENDENTS: An additional $400 exemption is allowed a taxpayer (1) who gives chief support to a dependent other than husband or wife, (2) which dependent must be under 18 years of age or mentally or physically incapacitated for self-support. No special relation- ship is required. No home need be maintained by the taxpayer. Thus, a philanthropist supporting a needy person under 18 may claim $400 additional exemption. A son forwarding money to an incapacitated mother, although not living with her and not head of a family, may claim the dependency exemption. If the dependent to whom support is given has sufficient other income, or is over 18 and capable of working, exemption is not allowed. "Giving chief support" to a per- son means furnishing over 50% of his support. EXEMPTION DATE: The status of the taxpayer on the last day of his taxable year determines his exemption. The number of dependents he has at the end of his taxable year- not throughout the year- furnishes the basis for determining exemption. Thus, "A", married, and earning $4,800, is supporting four children during the year. In December, two die. He is allowed $3,300 exemption at the end of the year, because at that time he was supporting a wife and two children. Also, a person married December 30 is allowed $2,500 exemption for the year. A person divorced December 1, if not remarried within the year, may claim only $1,000 at the end of the year. Under this same rule, if a person dies during the year, his status at the time of death determines his exemption. "B", married, and supporting two children under 18, dies April 1, his income up to that time being $4,000. His wife continues to support the same two children for the remainder of the year and earns $3,500. "B"'s administrator, in making out "B"'s tax return, is entitled to take $3,300 exemption for "B" at the time of his death, April 1, which is the end of his taxable year. "B"'s wife would also be allowed $3,300 exemption December 31, as she was at that time head of a faimily and supporting two dependents, despite the fact that previous exemptions were claimed for the children. The wife supported two dependents, the husband three, yet each received the same exemption, because the $400 dependency exemption is allowed only for dependents other than husband or wife. If, moreover, "B"'s estate is still in the process of administration on December 31, an exemption of $1,000 may be claimed for it the same as for an individual taxpayer. EXEMPTIONS: Illustrative examples. A husband earning $3,000 is supporting a wife and a child under 18 and is entitled to $2,900 exemption. If the wife should die, what would the husband's exemp- tion be? Still $2,900, as he would be head of a family, and sup- porting a dependent other than husband or wife. A brother earning $4,000 lives with and supports his sister, age 22, 2tnd able to work. He is entitled to $2,500 exemption as head of a family, but no dependency exemption for the sister. If the sister receives $40 in bank interest and $50 in dividends during the year, will the exemption be destroyed? No, as such amounts are considered "incidental income". If the sister is incapacitated for self-support, the brother is entitled to $2,900 exemption, as he is head of a family auid supporting a dependent. « If a brother mails home the entire support of an aged father and a sister over 18, what is his exemption? Nothing as head of a family, nothing for the sister, $1,000 for himself and $400 for the father; total exemption, $1,400. Two brothers, earning $2,000 each, contribute respectively $1,500 and $1,600 to a home in which they live and are the sole support of a mother and a sister, age 15. What are the exemptions allowed? The brother contributing $1,500 is entitled to a $1,000 exemption only; the brother giving $1,600 gets an exemption of $1,400, -$1,000 for himself, $400 for his minor sister, nothing for his mother. Neither is head of a family and furnishing substantially all support to the members; neither can claim exemption for the mother, as it does not appear that she is incapacitated for self-support, and only the one con- tributing over 50% of the sister's support can claim the $400 additional exemption. Three brothers send home to their mother $200, $300, and $500 annually. What additional exemptions arise? None, as no one of the three brothers is giving over 50% support to the mother. If a person earning less than $5,000 marries December 30, and is still looking for a house at the end of the year, is he entitled to $2,500 exemption? Yes, the fact that he is married and not voluntarily separated from his wife will entitle him to the full $2,500. A father makes $2,100 a year and his minor son, age 17, makes $500 a year. How should the amounts be reported? If the minor son is living at home and apparently under the guidance and control of his parents, his father should include the $500 with his own income and take a dependency exemption of $400 for the son. A minor making over $1,000, and single, must pay a tax. QUALIFICATION OF $2,000. EXEMPTION: For the years 1918 to 1920 inclusive, a $2,000. exemption was allowed a married person or head of a family; for 1921 and subsequent years this exemption is $2,500. against net incomes up to and including $5,000., and $2,000. against net incomes in excess of $5,000.; except that for incomes from $5,000. to $5,020. the tax is the amount it would have been if only $5,000. were earned, plus the amount of the income in excess of $5,000. Thus, if an individual earned $4,900. he would be entitled, if married, to $2,500. exemption, but if earning $5,010., he would be entitled to only $2,000. Under the above ruling, an individual making $5,010. would first compute the tax for $5,000. and apply against the $5,000. his $2,500. (or other exemption,- such as $2,900. or $3,300. exemption), leaving $2,500. on which to pay a 4% tax, or $100. He would then add to this $100. the $10. made in excess of $5,000., giving him a tax of $110. This special rule is used for income from $5,000. to $5,020., but after the latter amount has been reached, then only the $2,000. exemption applies. Thus, if an individual makes $5,021., and is married, he will have to take an exemption of $2,000. and pay a 4% tax on the balance. The Surteix is computed the same as ever, whether the taxpayer is entitled to Normal Tax relief or not. Resident aliens, living in this country, and mailing money else- where, are entitled only to the personal and dependency exemptions. Thus, an Italian forwarding $2,600 a year to Italy to his wife and three children under 18, is entitled to $2,200 in credits, $1,000 for himself, and $400 for each child, but nothing for the wife, as he is voluntarily separated from her. Returns must be filed by all married persons having a net in- come in excess of $2,000, and by all single persons with net incomes in excess of $1,000; also by all persons with gross incomes in ex- cess of $5,000. If the combined gross income of husband and wife is in excess of $5,000. a return must be filed. Gross income means gross profit on Sales in a business, plus income from other taxable sources. Exemptions must be proved. Thus, a married man making $2,600, and supporting a wife and two children under 18 years of age, is entitled to $3,300 exemption, but must file a return, claiming and proving his exemption. INCOME TAXABLE: The taxes are levied against net income, 'which is gross income less allowable deductions. GROSS INCOME includes items of income from all sources whatsoever, except those specifi- cally enumerated under exclusions. EXCLUSIONS are income items which of their nature are excluded for tax purposes, such as salaries received from the State. DEDUCTIONS are those items in- cluded in gross income, which are deducted to obtain net income, such as general business expenses. NET INCOME therefore equals gross income (omitting specific exclusions) less allowable deduc- tions. CREDITS are items deducted from net income to obtain tax- able income for purposes of the Normal Tax, such as the $2,500 exemption for a married man. The NORMAL TAX is levied against NET INCOME LESS CREDITS, the SURTAX against NET INCOME. To illustrate: "A" receives a salary of $3,000 as Attorney for the State. As a practicing lawyer he receives fees for the year amounting to $8,600, but his office and other business ex- penses are $2,400. He is married. His total income is $11,600, but his gross income is only $8,600, as the State salary is grouped under exclusions for purposes of the tax and not reported in the gross income. From his $8,600 gross income he may subtract $2,400, as this item represents allowable deductions, giving him $6,200 as net income. The Surtax is levied against his net income, $6,200. He is now allowed a credit or exemption of $2,000 as a married man, which is subtracted from the net income of $6,200, giving $4,200- or net income less credits— and the Normal Tax is applied against the $4,200. Thus: Total Income ^-''i'oSS State Salary deducted as it comes under exclusions 5,000 Gross Income ^o ' 5nn Allowable deductions subtracted ^^'^QQ Net Income, which is gross income less deductions 6,200 Credits or exemptions-married man ^>00Q Net Income less credits ^^' 200 The Surtax is now levied against the $6,200 and the Normal Tax against $4,200. -7- LECTURE 1. Questions to be answered. 1. (a) Name the two taxes levied against individuals. (b) State the exemption allowed a single person, an estate in process of administration, a married person, and the head of a family. (c) Name the conditions under which an additional exemp- tion for supporting a dependent is allowed a taxpayer. 2. (a) Distinguish between gross income, exclusions from gross income, allowable deductions, net income and exemptions. Tax Laws: (b) State which of the following are subject to the Income (1) United States citizen living in Canada, earning his living there. (2) Canadian citizen working in the United States. (3) English citizen, living in England, with income from investments in this country. (4) Italian citizen, naturalized here, who returned to Italy last year, and who is now earning his living there. 3. (a) An individual with income of $4,800 supports in his own home his mother, wife, and child, age 12, also an adopted child, age 10, and his own brother, age 20, temporarily unem- ployed. State his exemption. (b) A taxpayer, divorced, earning $6,000, forwards $50 a week to his former wife and two children under 18. State his exemption. (c) A taxpayer, widow, with income of $3,000, is living with relatives, while her only daughter, age 19, is completing finishing school, following which the mother contemplates keeping a home of her own. State her exemption. 4. Compute the tax of a married person living with wife, in each of the following cases: (a) Income of $4,990. (b) Income of $5,010. (c) Income of $5,025. (d) Income of $10,000. -8- LECTURE 2 . EXCLUSIONS FROM GROSS INCOME. Items Excluded by Law. Other Income Items Excluded. Liberty Bond Interest Excluded. ITEMS EXCLUDED BY LAW: The following twelve groups of items are specifically excluded from Gross Income by the new 1921 Revenue Act : 1. Proceeds of life insurance policies paid to beneficiaries or estates upon the death of the insured. 2. Amounts received by the insured himself as a RETURN or premiums paid out. „,,^«„ 3. The value of property acquired by GIFT, BEQUEST, DEVISE, or DESCENT. 4 . Interest upon State obligations and certain obligations of the Federal Government and its Agencies. 5. Incomes received by foreign governments from investments in bonds, stocks, domestic securities, etc., in this country. 6. Amounts received through health and accident insurance, workmen's compensation acts, etc., because of injury or sickness. 7. Incomes of States and subdivisions thereof from public utilities. 8. Income received by non-resident aliens or foreign corpo- rations from operating ships. ,^ . . _ 9. Amounts received under the War Risk Insurance or Vocational Rehabilitation Acts. ^ , x- r. -i^ 10. The first $300 received by a member from a domestic buila- ing and loan association for the period December 31, 1921, to Jan- uary 1, 1927. ^ . ^ o . 4. « 11. The rental value of dwelling property furnished ministers of the Gospel. _ ^ . . x 12. Receipts of ship owners' mutual protective and indemnity associations. EXPLANATION OF ITEMS EXCLUDED BY LAW: The foregoing groups in detail cover the following exclusions: -xu x GROUP 1. Proceeds of life insurance policies going either to the insured's individual beneficiaries, an estate, in trust, or to a partnership, are not taxable, whether received in annual install- ments or a single payment. . Illustrations: (a) "A" dies, his wife receiving $10,000 insur- ance; the amount is not taxable, (b) "C" dies; "B", his wife was given 3% of the principal of his policy annually with interest; D a son, receiving the balance upon "B"'s death. Neither "B" nor "D" is taxable on the proceeds, (c) "E" is a beneficiary in a policy which provides for annual installment payments and dividends during the beneficiary's life; "E" is not taxable, the amounts being "pro- ceeds of a life insurance policy", (d) Where, however, "F" had the option of receiving the face value of a policy, or leaving the -9- amount with an insurance company to draw interest annually and elected the latter course, it was held (Gov. Decision) that the interest was taxable, as it was not the "Proceeds of a life insur- ance policy", but a return from the proceeds re -invested. GROUP 2. Amounts received by the insured during the term of a policy, at maturity, or upon surrender, which can be construed as a return of premiums paid by him, are not taxable. Illustrations: Dividends upon unmatured life insurance or endowment policies, or from annuity contracts, are not taxable, whether received in cash or used to reduce future premium pay- ments. Dividends from paid-up policies are taxable. The former ^^^^^P^^^ return of premiums paid by the insured; the latter a profit, leaving the principal, created through premiums, still intact and returnable. Amounts received, representing interest are taxable. GROUP 3. Money or personal or real property received as a gift, under a will, or through statutes of descent, is not taxa- ble income. The income derived therefrom is. A gift should not contain the element of compensation. e.n ^Jll^st rations: (a) "A", through a will, is left a house worth »10,000, the annual rent income from which is $2,000. The rent only is taxable. "A" sells the house at a profit of $3,000. The $3 000 is taxable income, (b) "B" owes "C" $500. "C" cancels the debt; this IS a gift to "B" and not taxable income. If "B" did some work for ' C" then the cancellation would be compensation for services rendered and taxable. Pensions as awards from former employers are taxable, other- wise not. The Federal Government gives pensions to its aged em- ployees, the Carnegie Foundation to certain retired teachers; the former are taxable, the latter not, being considered gifts. Like- wise, a so-called Christmas gift or annual bonus received from a corporation by an employee or officer is taxable, even if the re- cipient IS no longer employed. An amount paid under a marriage settlement is a gift. Alimony is not taxed, nor allowances received based on a legal separation. GROUP 4: Interest upon bonds of a State, county, city, town or any political subdivision of a State, such as road, water, gas' drainage, irrigation, school or harbor district, is exempt, also ' interest from bonds of Federal Farm Loan Associations and Federal Land Banks. Dividends of Federal Land Banks and Federal Reserve Banks are exempt. Dividends of member banks of the Federal Re- serve System are taxable. All these banks may be taxed for real property owned. If a corporation issues bonds secured by proper- ty, and the State purchases the property, the bonds do not be- come State bonds. Interest upon bonds of the Federal Government or its possess- ions, also the District of Columbia, is exempt ordinarily, except that interest on Federal obligations issued after Sept. 1, 1917 -10- is exempt only as specified in the respective loan acts. There- fore, exemptions on Liberty Bonds issued after Sept. 1, 1917, War Saving Certificates, Treasury Certificates of Indebtedness, and bonds of the War Finance Corporation are exempt only as speci- fied in the respective loan acts, as changed and approved by Congress from time to time. (See part 2 of this lecture for Liberty Bond Exemptions for 1920 and 1921). Interest from Postal Savings Deposits made prior to September 1, 1917 is exempt. GROUP 5. Income received by foreign governments, or indepen- dent subdivisions thereof, from investments in this country, is exempt. Income received by foreign ambassadors from stock and bond investments here or from bank deposits is exempt, but not profits from a business carried on by such ambassadors in the United States. American ambassadors to foreign countries are taxable on all their income, also Americans employed by foreign ambassadors. If foreign governments receive money from individuals and reinvest it in this country, the income therefrom is taxable. GROUP 6. Amounts received through accident and health in- surance, from workmen's compensation acts, and from law suits and agreements on account of injuries or sickness, are not taxable, whether received by the individual injured, or his beneficiaries or estate. Illustrations: (a) "A" is injured, and by State Law, his em- ployers pay him one -half his former income for a period of six months. The amount thus received is exempt, (b) "B" is injured in an automobile accident, and disabled for four months. By legal agreement, "B" received $2,000 in lieu of trying the case in court. The amount is exempt. However, by Government Decisions, it has been held that an amount received through legal suit be- cause of alienation of affections, or because of breach of promise, would be taxable, as the income is not from personal injury or sickness, as defined by the law. GROUP 7. Incomes of States and political subdivisions there- of, from public utilities and other sources, are not taxable. If a contractor operates a public utility giving part of the profit to the State, he may deduct the amount as expense, the balance retained by himself being tameable. GROUP 8. Incomes of non-resident aliens or foreign corpora- tions earned exclusively from operating foreign ships will be exempt if the countries under the laws of which they are operating permit similar exemptions to American citizens and corporations operating vessels. GROUP 9. Any amounts received under the War Risk Insurance or Vocational Rehabilitation Acts, or as pensions from the Feder- al Government for active military services in time of war are not taxed. Previous to the passage of the 1921 Revenue Act amounts received under the War Risk Insurance Act were declared, under date -11- of June 25, 1918, not to be taxable; but by government decision amounts going to Vocational Rehabilitation students had formerly been declared taxable. Any pension received by a soldier or sailor from either the Federal or State Government has been declared exempt. GROUP 10. If Domestic Building and Loan Associations are operated exclusively for the purpose of making loans to members, then the first $300 received for the years 1922 to 1926 inclusive will not be taxed. GROUP 11. The rental value of dwelling property furnished ministers of *the gospel is not taxable income starting with the year 1921. Heretofore such individual reported as taxable income salary received and the cash equivalent value of board and room furnished. GROUP 12. Shipowners' Mutual Protective and Indemnity Asso- ciations do not pay any taxes on receipts if any profits arising do not inure to the benefit of individual stockholders. However, these Associations are taxed on income such as interest, dividends, and rents received. Heretofore military salaries up to $3500 received from the Federal Government by persons in active military service during the last war have been exempt. By act of Congress such salaries were exempt only up to March 3, 1921. Apparently from the new law they are taxable for the whole year 1921 as they are no longer grouped under exclusions from gross income. In addition to the foregoing twelve groups of exclusions, a few other items are not taxable. By Supreme Court decision, stock dividends received are ex- empt from taxation, although profit on the sale of them is not. Income earned or accrued before March 1, 1913, and realized or re- ceived thereafter is exempt. Thus, a person owning real estate which cost him $100,000 in 1910 and sold for $175,000 in 1920, might show that part of the increase in value occurred before March 1, 1913, in which case he pays a tax only on the profit ac- cruing from that time to date of sale. (Decisions on this point will be considered later). Amounts credited to a person's account without giving him unrestricted claim thereto, are not taxable. Thus, a corporation gives an officer ten shares of stock, provi- ded he will remain three more years with the company. As the officer has not full title to the stock it is not taxable income. Interest on Liberty Bonds, also cash dividends received, are sub- ject to the Surt2txes only, being exempt from Normal Taxes. No tax is levied on the profits from the sale of vessels built prior to Jan. 1, 1914, if the total money received there- from is reinvested in vessels approved by the U. S. Shipping Board. Partnerships, as such, pay no income taxes, but submit re- turns of information. The partners pay on their respective shares of partnership profits, whether received or not. -12- Compensation paid by States or subdivisions thereof is not specifically exempt by Law, but is nevertheless not taxable, be- cause the Federal Government, through constitutional limitations, may not interfere with the operations of the several States. Therefore, salaries and compensation received by employees of a State itself or city, county, town, or other subdivision of a State, are exempt. Salaries of State and city civil-service em- ployees, political appointees, etc., are not taxable on account of this limitation. However, if a person is employed only occasion- ally or temporarily by a State or city, as an attorney to fight a particular case, or a contractor to build a road, the amount re- ceived is tajcable. The test to determine taxability appears to be as follows: If the person receiving the income from the State is acting in the capacity of an independent contractor with the Gov- ernment, then the profit received is taxable. Thus, a person mak- ing a profit through erecting a public building is not exempt; he has contracted with the State the same as with any other client, suid the income is subject to the Federal Taxes. Notary public fees received are not taxable; fees of receivers appointed by State Courts are also exempt. College professors receiving salaries under the Smith-Lever Act are exempt. Through this Act, Federal funds are donated to States, for the purpose of defraying expenses of certain State colleges. As the funds are mixed with State monies, losing their identity, salaries received thereunder are considered income from States. Under the 1921 Act, when property is exchanged, it may be possible that there is no tameable gain resulting therefrom. The rule under the 1918 Act was as follows: Wherever property was ex- changed, the market value of the property was used as the basis for determining loss or gain. Thus, if stock was acquired in 1915 and was exchanged for real estate in 1920, and neither the stock nor real estate had any readily realizable value, each party to the transaction would have to obtain the market value as well as possible under the circumstances, and report any gain or loss from the transaction, based on the cost of the property to each party and the market value of each kind of property in 1920. The new Law states that no loss or gain is to be reported in exchange of prop- erty hereafter in the following cases: (1) where the property ex- changed has no readily realizable market, and (2) where it may possibly have a readily realizable market but the following facts exist: (a) where property held for investment purposes or for pro- duction is exchanged for property of like use and kind; (b) where stock held by an individual is exchanged for stock resulting from a merger, consolidation, reorganization, change in identity form, etc.; (c) where an individual or two or more persons exchange prop- erty for stock in a corporation and thereafter control 80% of the voting stock or ownership stock of the corporation. (See 1921 Act- Sec. 202). Lecture II, Part 2 INTEREST ON LIBERTY BONDS Interest received on Liberty Bonds is subject to different exemptions for the years 1920 and 1921. For those reporting on a fiscal-year basis, it will be necessary to understand the ex- emptions for both years; for those reporting on a calendar-year basis it will be necessary only to understand the exemptions for the year 1921. For the year 1921, interest on Liberty Bonds as previously explained is exempt from all Normal Taxes. Interest on the First issue of Liberty Bonds and on the 3f Fifth issue is ex- empt from Surtaxes. Interest received from the 4f Fifth issue of Liberty Bonds is subject to Surtaxes. Interest received on Second, Third and Fourth issues. Original or Converted, is exempt to the extent of the first $5000 of principal amounts owned. Also there is a general exemption of the Seconds, Thirds, and Fourths, Original or Converted,- called 4's and 4^'s,- to the extent of $125,000 of principal amounts owned. There is also an exemption of First Liberty Bonds originally converted into Fourth Liberty Bonds to the extent of $30,000. Summarized, these exemptions for 1921 are as follows: all five issues free from Normal Tax; First Issue, 3|, no Surtax; Fifth Issue, 3-1 , no Surtax; Fifth Issue, 4f, always a Surtax if the tax- payer is in the Surtax class, plus the following exemptions of Second 4's, Third 4:|-'s and Fourth 4^'s, original or converted, before the Surtax is effective; $5,000. in general (which exemp- tion may extend to include War Savings Certificate, U. S. Certifi- cates of Indebtedness, etc.). $125,000. in general; $30,000. First 3-|-'s transferred in Fourth 4:^'s (called First Second 4:|-'s). For the year 1920, the same total exemptions against the same issues exist, but they are arranged in more complicated form and are allowed in some cases only under certain circumstances. It is not advisable to study these, unless the reader wishes to know ac- curately the exact title of the bond issues, and finds it necessary to write fiscal year returns for 1920-1921. The information on the next four pages is placed here chiefly for reference and study purposes. For the year 1920 Liberty Bond exemptions are as follows: As previously explained. Interest on Federal obligations issued after Sept. 1, 1917, is exempt from taxes under the old law only as spec- ified in the respective loan acts. As there were five issues of Liberty Bonds, four after the above date, special attention must first be given to the various exemption clauses. The five original issues of Liberty Bonds are known by the following titles: First -14- Si's, Second 4's, Third 4i's, Fourth 4i's, Fifth 3f' s, and Fifth 4-|'s. Certain of the earlier issues were changed into later ones, as their special titles designate. Thus, a First 3^ transferred into a Second 4, is called First 4, a First 3^ transferred into a Third 4^ is called First 4^; also a Second 4, transferred into a Third 4^ is designated Second 4\, a First 3^ transferred into a Fourth 4^ is called First Second 4^, etc. For purpose of exemp- tion, the ultimate denomination governs. Thus, a First 3^ converted into a Third 4\, with a title - First 4^, is, for exemption purposes, considered a Third 4^, or a Third Liberty Loan Bond, instead of a First. With the foregoing as a basis. Liberty Bond Exemptions for 1920 may be summarized as follows: All five issues of Liberty Bonds are free from the Normal Tax. Interest on bonds of the First 3^ Issue and the Fifth 3f Issue is exempt from the Surtaxes also. Interest on bonds of the Fifth 4f Issue (Victory Notes) is always taxable under the Surtax, if the taxpayer is in the Surtax class. There remains the interest on Second, Third and Fourth Issues (Original or Converted) to consider, called 4 and 4\ bonds. The interest on the first $5,000 of any or all of these three issues is exempt, plus $30,000 additional, giving a total general exemption of $35,000 on principal amounts of Seconds, Thirds, and Fourths, owned. There is also a specific exemption of $30,000 worth of Fourths alone, and of $30,000 in principal of Firsts trans- ferred into Fourths (Called First Second 4^). In addition, there is an exemption of Seconds and Thirds not to exceed one and one- half times the Fourths originally subscribed for and still owned and not to exceed $45,000. Finally, there is an exemption of Seconds, Thirds, and Fourths, otherwise taxable, not to exceed three times the Fifths (both issues) originally subscribed for and still held emd not to exceed $20,000. Summarized in tabular form, these exemptions are as follows: All five issues free from Normal Tax. First Issue, 3i, No Surtax. Fifth Issue, 3|, No Surtax. Fifth Issue, 4f, Surtax, if Taxpayer is in Surtax Class. Plus the following maximum exemptions of Seconds, Thirds, and Fourths, Original or Converted, before the Surtax is effective. $5,000. In general. (Including War-Saving Certificates, Treasury Certificates of Indebtedness, etc.) $30,000. In general. $30,000. Fourths. $30,000. Firsts transferred into Fourths. (First Second 4^) . $45,000. Seconds and Thirds, not to exceed 1^ times Fourths originally subscribed for and still held. $20,000. Seconds, Thirds, and Fourths, not to exceed 3 times Fifths originally subscribed for and still owned. $160,000. Maximum exemption of Principal Amounts of Seconds, Thirds, and Fourths, under conditions specified. -15- For both the years 1920 and 1921, the $5,000 exemption applies also to obligations other than Liberty Bonds. The foregoing exemptions apply alike to individuals and corpo- rations for amounts owned, an individual paying a Surtax and a cor- poration an Excess Profits Tax on any taxable interest. As a cor- poration pays only an Excess Profits Tax on Liberty Bond Interest and there is no such tax for 1922, a corporation apparently will hold such bonds free of taxes after Dec. 31, 1921. For both the years 1920 and 1921, if a trustee holds Liberty Bonds, and the income therefrom is distributed periodically to bene- ficiaries, then each beneficiary is considered as owning a propor- tionate share of the bonds for purposes of exemption. If a trustee purchased Fourths and Fifths during the original drives, then the beneficiaries may also claim exemption under the last two groups above named ($45,000 and $20,000 groups). When a beneficiary is undetermined or unborn, a trustee may take the same exemptions as an individual against amounts owned. Individual members of a partnership or personal-service cor- poration are considered as owning proportionate shares of a firm's Liberty Bonds for purposes of exemption, so that, if a firm pur- chased Fourths and Fifths during the original drives, and the pres- ent individual partners or stockholders were then members, they are entitled to the exemptions in the last two groups above named ($45,000. and $20,000. groups), in addition to all other exemptions Interest on the first $5,000. of 5% War Finance Corporation Bonds is not taxable. Although income on Liberty Bonds may usually be exempt, yet complete information concerning Taxable and Non-Taxable Liberty Bond Interest is necessary on individual and corporation income tax reports. A special Liberty Bond Schedule appears on Page 1 of the Individual Income Tax Return for 1920, while a special form, called "Schedule of Taxable Interest on Liberty Bonds" is used with Corpo- ration Returns. A copy of the latter, together with an illustra- tive problem, appears on page 16 of this Lecture. Form lias.— UKITED STATES INTERNAL REVENUE SERVICE SCHEDULE OF TAXABLE INTEREST ON LIBERTY BONDS (To b* flUd vMi tlM Collwrter of latwaal lUvMUM with Form 1120 and Form 1121) For Calendar Year 1920 Of fbf p6iiod bcgmi Name of Corporation Address ^^ 19.^Q, and ended .lLe.afirol3_er...2L , i9.aQ, L&ttg-. Uanuf aatur Ing --CQirip.aiiy- 1.0bUg». («) $....AQD (6) Avcngt XxzMmoRS: (e) 15,000. id) $20,000. («) $30,000. (/) $45,000. (g) $30,000. (h) $30,000. (t) $5,000 . 0*) Priicipal ■ occss tf 2. First 4's, and 8ecaiMl4's. IQOQQ aUi Z X zz z z z z zz z z z z z 0.0$ JL9Q1. 00 3. Plrst 4J's, Steond 4i's, uid Third 4i's. Maoa 35 $148.7. 8.4350.0.0. MQQ 392 .M ZZ zz zz 24 .448.0a. .24 z z z X :: s s z z z zz z z z z z z z z z .3.3$ ZZ zz .Q 4. First SeooBd 4*8. Z X s z z =< 3OQ0O- z z z z z Z Z Z X z .sooo. .Q|$...212.. 50 00 8. Fourth 4^*8. ..9.0000 ZZ aa zr xz QQ 50 2.0000 __a.QQ0.O Z Z Z Z Z Z X Z Z Z Z Z X z soooa Z Z Z Z X X zf « % other Obligations issued since Sept. 1, 1917. 7. Victory 4J's. -Q.Qs 2-7d-Qds 9.8. .00 .JLQQ.0.0. .jQC .00 xz zx OC zz OC .6.QQ0 ..Q.Q. Lafi2 &O.Qtl.i)C X X X X Z X X Z Z X X Z X X Z Z Z Z X Z X Z Z Z X X X X z zzz z z z Z Z Z Z Z X X $ 485. ..0.0$. .10-00 xz XX XX XX XX XX X X X X X z z X Z X X X X X X X X X X X X X Z X X X X X Z X Z Z Z X z Z X Z Z Z X X Z X X X X z z 8. War Finance Corporation 5% Bonds. .45 $....400. ..7.-^ ...aODQ. DO .iafi2. .4^.00 $.. aa zx XX xz xz zz zz zz .0.0 Z X X X z Z Z X z z Z X z z z X z z z z Z Z Z X z Z X Z X z ...5.0.00 00 Mi $...150. XX xz zz zz xz zz .00 (D Total taxable interest aa computed on line (k) above (enter on Fonn 1120, page 1, in Schedule A. as Item 4) $1312 j31 INSTRUCTIONS ""^ ' ~" ObU^ations subject to taxation.— The interest ou the obliga- tiona roecified in the table above is subject to excew profits tax only to the extent that the holdings exceed the exemptions pro- vided by the act authorizing the issue and subsequent acts. The diort titles for the taxable obligations are used in thw table The official titles, dates of issue, and interest dates of the Liberty Bondsand Victory Notee are given at the foot of the page. Compiitation of interest— To determine the interest on any class of obligations received during the taxable period, where the books are kept on a cash receipts and disbursements basis, add to the amount of all coupons and registered bond inters^ falling due within the taxable period the amount of accrued interest received on salea of obligations between interest pay- ment dates, and deduct from this sum the accrued interest paid on purchasee of obligations between interest payment dates. This method will be followed where books are kept on a cash hasis. whether or not the coupons falling due within the taxable penod are actually c«dhed. If the books are kept on the accrual basis, report the actual amount oi interest accrued on the obligations held during the taxable year. Exemptions. — ^The exemptions specified above on lines (c) to (i), inclusive, are applicable to the obligations for which spaces have been provided, but the total amount entered in these spaces on any one line must not exceed the exemption specified. The exemption on lino (d^ (maximum |20,000) is limited to three timop ^e amount of Victory Liberty Loan 3|% and 4}^ Notes originally subscribed for and still owned at the date of filing the return. The exemption on line (/) (maximum $45,000) is limited to one and one-half times the amount of Fourth Liberty Bonds originalb' tnibscribed for and still owned at the time of filing the return. In case the Victory Notes or the Fourth Liberty Bonds originally subscribed for were disposed of before filing the return, or none were subscribed for, no exemption can be claJmcNd on lines (d) and (/). , J How to fill in table above. — Enter on line (a) in the proper columns the amounts of interest computed on the various obligations held during the taxable period. On line (6) enter the average principals which will produce these amounts of interest in one year, as the exemptions are deducted from these amounts. The average principal of any class of oblieiation is determined by dividing the amount of interest entered in any column by the rate of interest which the particular class of obligation bears. For example, if the amount of interest entered on line (a), column 2, is $1,200, the average principal would be this amount divided by .04, or $30,000. If $25,000 exemption was claimed in this column, the interest on the balance ($5,000 at 4%, or $^) would be the amount of taxable interest. It will be necessary to enter the rate of interest received at the top of column 6, provided for "Other Obligations. " If it is desired, the exemptions may be applied directly against the actual holdings for the period held. In which case the entries in the table above may be omitted, and in lieu thereof a schedule must be submitted which will show the following information with respect to each class of obligations held: To) Dates and amounts of purchases; (6) dates and amounts of sales- and (c) interest received or accrued. * Consolidated returns.— In the case of an aflUiated group of corporations, this form and answers to the following questions should be submitted for each of the corporations composimt the group which held during the taxable period any of ^ obligations shown in the table above, as each affiliated corpo- ration is entitled to the exemptions: VjOiat amount of Victory liberty Loan SfjS and 4i% Notes were onginaU v subscribed for and still owned at date of filine this return? $ .^ What amount of Fourth Liberty Loan 4{% Bonds wero ongin^y subscribed for and still owned at date of filinir thin return? $ * Offloial Title. Short Title. First Liberty Loan Converted 4 % Bonds of 1932-47 (col. 2) _ First 4 's First Liberty Loan Converted 4\fc Bonds of 1932-47 (col. 3)"* First 44.'s*~ Date of issue. Interest payable. November 15, 1817.. June 15, DecembCT 15. y 9, 1918 June 15, December 15. First Liberty Loan Second 0)nv. 4i% Bonds ol 1932-47 (coi~4r'"FirHt ^^^aH^ nlu oi inTo" r^ ^^» December 15. Second Lib^y Loan 4% Bonds of 1927-42 (col. 2)._._::r'-£^nd1^« ^ S^^Lf^'il^^fo^W?''® ^^' December 15. -I«44t1 -17- The problem assumes that the taxpayer, a corporation, owned the following Liberty Bonds during 1920: Title Amount Int. Reed, or Accrued Period Held 1st si's 1st 4|'s $20 , 000 . 00 $ 700.00 Entire Year 50 . 000 . 00 1903.15 Jan.23-Dec.l5 2nd 4's 10,000.00 400.00 Entire Year 1st 2nd 4i's 35 , 000 . 00 1487 . 50 It It 4th 4i's 90 . 000 . 00 3825 . 00 It It 4|- Cert. Indebtedn. 6,000.00 270 . 00 It It War Fin. Bonds 5% 8,000.00 400 . 00 ti It Victory Sf's 25 , 000 . 00 937 . 50 It It Victory 4f' s 20 , 000 . 00 91.08 Nov.27-Dec.31 $50,000. of Fourth 4i's and $25,000. of Victory 3f' s (Fifths) were originally subscribed for and are still owned. Regarding First 4:|-'s, these bonds were purchased for $48,000. plus accrued interest of $220.65 on Jan. 22, 1920. On June 15, the corporation cashed its 2H% coupon, receiving $1,062.50, semi- annual interest. Of this, $841.85 is income for the period Jan. 23 to June 15, inclusive. This figure may be obtained by taking 145/183 of $1,062.50, as the Government computes interest by the exact-day method, and on 181, 182, 183 and 184 day bases, depending on the half year periods. Special Actuarial Tables for computing Liberty Bond Interest are issued by the Treasury Department. For the period, June 16 to Dec. 15, the corporation received $1,062.50 additional interest, or a total income of $841.85 plus $1,062.50, giving $1,904.35. This amount, divided by 4\% gives $44,808.24, which is considered the Average Principal of 4^'s held for 1921, being the equivalent of $50,000. held from Jan. 23 to Dec. 15, inclusive, and is so entered on the schedule. Likewise, from Government Ta- bles, $20,000. in Victory 4f's from Nov. 27 to Dec. 15 will yield $46.72, and $41.76 from Dec. 16 to Dec. 31, or a total of $88.48. This eunount is divided by 4f%, giving $1862.74 (accurate to 4 places). $20,000. in bonds held from Nov. 27 to Dec. 31, therefore, is the same as $1,862.74 held for a year, properly averaged. The averages thus obtained, together with the other amounts given above, are entered in the proper columns and exemptions com- puted. Exemptions are applied against the larger interest bonds first. Thus, the 4^ U.S. Certificates of Indebtedness, euid the 4-5- interest bearing bonds, should be exempted first, whenever possible, leaving 8uiy balance to be used in exempting 4% bonds. When exemptions have been exhausted, the balance of the Prin- cipal of each issue is carried to column (j). Principal in Excess of Exemptions. The rate of interest for each separate group of bonds is then applied against the Principal not exempt, and the tajcable interest obtained. The taxable interest is totalled, and placed in line (1). It is then transferred to the Income Tax Re- turn and the proper tajc paid on it. Note: Purchase price of bonds below par does not alter exemption. -18- LECTURE 2. Questions to be Answered. 1. State which of the following items are excluded from income for tax purposes. Bonus received from employer in addition to salary at Christmas time. Weekly compensation from employer, during illness, under the (a (b (c (d (e (f (g (h (1 Workmen's Compensation Act. Weekly payments received from fraternal lodge during illness Monthly payments from labor union during a period of unem- ployment. Property left an individual through a will. Salary received as a school teacher for the City of Boston. Salary received as professor at Harvard University or Ohio State University. Military salary received as Lieutenant for the year 1921. Notary Public fees received by a New York State Notary and one appointed in the District of Columbia. 2. Mrs. "D" was divorced April 1, 1921, following which she re- ceived alimony of $50.00 per week for the remainder of the year. During May and June she was employed as Secretary to an Attorney engaged to represent the State in a special case and received $125.00 per month. In September, she invested $8,000 in a partner- ship in which she was entitled to 50% of the profits. Up to Dec. 31, the partnership made a profit of $13,500 of which she received $4,000. Compute, in detail, her taxable income. 3. (a) State the Liberty Bond exemptions for the year 1921 for each of the five issues of Liberty Bonds. (b) The Pastor of a certain church received during the year $1,800 in salary, and $300 in Christmas gifts. He was also provided with a home and board, the fair cash value of these being $500, and $600 respectively. State his taxable income. 4. A tax payer received the following income during the year 1921: Salary of $2400.00 as factory manager. Interest of $20.00 on bank deposits. Interest of $100.00 on City of New York Bonds. Interest of $47.50 on 4f Liberty Bonds. Interest of $250.00 on United Drug Bonds. Interest of $35.00 on 3i Liberty Bonds. Stock Dividend of $200.00 from the Standard Oil Co. He is married and living with his wife. Compute his tax. -19- LECTURE 3 GROSS INCOME Items Generally Included. Items Subject to Special Rules. Effect of March 1, 1913, Value. In general. Gross Income includes all items received not spe- cifically exempt by law. SERVICES RENDERED. Gross income includes compensation for personal or professional services in whatever form received, such as salaries, wages, commissions, fees, tips, bonuses, baptisnal offerings, percentages of profits, etc., whether received in cash or other value, also rent, living quarters, and board famished. Clergymen's income, also salaries of employees of charitable organi- zations and the Federal Government are taxable. Fees of law suit witnesses, in both State and Federal Trials, and of jurors in Fed- eral Cases are taxable. While fees of receivers appointed by State Courts are exempt, those of administrators of deceased persons' estates are not, nor are fees of guardians. Insurance paid by corpor- ations on officers or employees where the latter are beneficiaries is additional compensation and taxable. If * an individual is reporting on a cash basis, salaries and fees earned and available are income, whether collected or not. Under this same basis of reporting, an individual should exclude from taxable compensation only amounts due him but not definitely determined or definite amounts due him but not yet set aside so as to give him unrestricted claim thereto. If an individual is reporting on an accrual basis he should report any compensation earned whether or not received or set aside for him. The only exception is that if any income earned has not been exactly determined he should postpone reporting it as taxable income until the sunount due has been definitely determined. Thus, if a salesman has made and been credited with $20,000, in a year and has drawn out only $4,000, he is taxable on $20,000, even when reporting on a cash-receipt basis, because "crediting him" with the ajnount and giving him unrestricted right thereto, is con- sidered "constructive receipt". (Gov. Decision.) Also, where a receiver, (not appointed by a State) received $2,000 a month from a railroad company from 1913 to 1918, and then in 1918 it was final- ly determined that an additional $100,000 - properly prorated over the months from 1913 to 1918, - should be paid him, it was held that the $100,000 is taxable income for the year in which determined, najnely 1918. If, however, the receiver reported on a cash basis and the amount was merely determined in 1918, and not paid or credited to his account until 1919, it is income for the latter year. (Supreme Court Decision) . -20- OTHER ITEMS OF GROSS INCOME: Bank interest or interest re- ceived on loans is taxable; also income from foreign investments and interest on bonds of foreign governments. Interest on postal savings placed with the Government before September 1, 1917, even though received after that date, is exempt. Interest on postal savings deposited on and after September 1, 1917, is taxable. Here- tofore a 2% tax paid by corporations for bondholders, pursuant to a tax-free covenant clause, was included in an individual's taxable income. Under the 1921 law this amount is no longer reported by the individual. However, such ajmount is still deducted from a tax- payer's income tax payable. (See Lecture 5.) Employees who have room and board furnished should report the fair cash value of these as income together with wages re- ceived. (See Lecture 2 for exemptions for ministers of the Gospel.) Where, however, steamships furnish quarters or construction com- panies camps for workers, the additional value need not be reported. Pensions received by retired military officers are taxable, the same as pensions received by other federal employees. Military and naval compensation received for 1921 is taxable. Profits on the sale of capital assets such as land, buildings, etc., are taxable. However, such capital assets held for a period of two or more years, when sold, are subject to a limited tax in cer- tain cases. Beginning with the year 1922 the rule is, that if a taxpayer elects he may, instead of computing his tax for all income in the ordinary way, compute it first for ordinary gains and then at the rate of 12-§-% on his capital asset gains. If he elects this method of computation his tax shall in no case be less than 12-§-% of his taxable income. To illustrate: an individual receives a salary of $8,000 for the year 1922 and sells a piece of land at a profit of $100,000; his taxable income is $108,000. Assume he is married. Ordinarily the Surtax on $108,000 is $26,300 and the income tax $8,320, or a total of $34,620. If this amount appears excessive, the taxpayer may then compute the tax in the ordinary way against $8,000, and to the result add 12-|-% of the profit on the sale of the capital asset. Computed this way the Surtax for 1922 on $8,000 is $20.00 and the Normal Tax $320.00; the total tax $340.00. To this is added 12^% of $100,000, or $12,500, giving a total tax under the special relief clause of $12,840. However, if the taxpayer elects to use this latter method and it results in a tax less than 12-|-% of his entire income, - namely 12^% of $108,000, - or $13,500, then he shall pay the latter amount instead of $12,840. Among other items, a business reports net sales less cost of goods sold as gross income. Rents, royalties and income from leases should be reported. If tenants pay taxes directly to cities, owners of property should report such amounts as additional income. The value of property left to lessors by tenants after termination of leases is taxable income to lessors. (See new ruling. Lecture 6.) -21- Annuities received representing profits are taxable, and should be distinguished from annuities which are distributions of the corpus of an estate, emd not taxable. Dividends received from Americgui Corporations are subject to the Surtax only; but dividends received frOm foreign Corporations are subject to both the Normal tax and Surtax. However, if a foreign corporation from which a dividend has been received has derived over 50% of its gross income from sources within the United States for three years prior to the taxable year such dividends will be sub- ject to the SurtEix only, the same as in the case of American Cor- porations. (Act of 1921). PAYMENTS OTHER THAN CASH should be* included in gross income at their cash-equivalent value. If a corporation pays its employees in stock instead of cash, the cash value of the stock should be reported as income. Such stock paid is compensation and taxable, sold should be distinguished from stock dividends, which are distri- butions of profits. A note received as compensation for services rendered should be reported as income at its discounted value, and if collected in full in a later year, the disceunt should at that time be reported as income. Land received as income in one year, the title to which is disputed and not fully determined until another, is income for the first year. However, in a law suit, where the amount awarded will be income if actually obtained, it is income for the year in which received. Accounts Receivable, charged off as bad debts, and then recollected, are income when paid. If income is constructively in possession of an individual, then the amount earned or received should be included in gross in- come. Thus, if a Liberty Bond Coupon is due, whether cashed or not, it becomes income. Also, where ordinary bond interest is due, fail- ure to collect will not give the right to exclude it from income. If dividends have been forwarded to an individual and not cashed, they become income. If a savings bank credits interest to a person's account, euid does not allow withdrawal of it until 90 days after it is so credited, it becomes income as of the time it is first placed in his account. Ordinary bank interest is income when first credit- ed to a concern's account. However, items not fully reduced to possession, or to which an individual does not have unrestricted claim, need not be in- cluded in gross income. If a cooperative bank credits a person periodically with ten dollars and he does not obtain a full share until the amount has reached $100, when he may withdraw it, then the amount is not income until unrestricted title to it has been obtained . Under the 1921 law profits on the sale of a gift are treated somewhat differently than heretofore. The previous rule was that -22- when a gift was received its cash-equivalent market value at the time transferred to the donee was considered its cost; and this value was thereafter used as the basis of determining any gain in case of sale. The new rule is that the cost to the donor will be -considered the cost to the donee in case of gifts received after Dec. 31, 1920. Thus "A" bought a piece of land in 1916 for $20,000. He donated it to his son in Jan., 1920, at which time it had a market value of $25,000. The son sold it for $28,000 in Dec, 1921. He reports $8,000 as taxable income for the year 1921 instead of $3,000 as heretofore. (Act of 1921.) In the case of property acquired through a will or by statutes of descent the former rule exists, namely; that the market value at the time property is received will be the basis for determining gain or loss. OTHER ITEMS OF GROSS INCOME: Certain other items of gross income may be treated as follows: If a concern is employed on a long-term contract, such as the erection of a large factory or immense office building, the income from the contract need not be reported until the termination of the work. However, if a con- cern prefers to report the estimated profit on the contract an- nually it may do so. Thus, if a building will cost approximately $3,000,000 and the contract price is $3,600,000 a contractor may estimate in advance that his profit for the work will be $600,000. If at the end of the first year he has expended $1,000,000, then he may figure that the work is one-third completed ($1,000,000 cost over $3,000,000 cost), and regardless of amounts received as payments on the building, he may report $200,000 as the profit for the year, or one-third of the estimated final profit of $600,000. Installment sales may be handled as follows: If goods are sold for credit, the total amount to be paid may be considered income at the time of sale. This is usually done in the case of sales the collections on which will be received within a reason- ably short time. If goods are sold on the installment plan, with an initial payment of 25% or more, then the total sales price is returned as income in the year of the sale. If the initial payment is not substantial, then the following method may be employed in reporting income from installment payments: -23- four installments, the purchaser defaulted and the piano was re- turned, the company would then have to report the remaining $120 re- ceived, out of the first four payments of $50 each, as additional profit. In this way, the full $200 received would have been treated as income. When an inventory of merchandise is taken at the end of the year, the piano is included in such inventory at its deprecia- ted value, and thus any loss taken. When plots of real estate are divided into lots, and sold, profit on each lot should be reported, as a real estate concern is not permitted to wait until all of a certain plot is disposed of before reporting taxable income. Thus, a company buys a plot of land for $100,000. It is then divided into 30 or 40 lots, which sell at varying prices from $2,000 to $5,000. If at the end of the first year the company has sold about 10 lots, which have returned about $30,000 in cash, it is not permitted to claim that it has not yet recovered the original cost, but must pro- rate, as carefully as possible, the $100,000 original cost over the different lots in proportion to their value; compute the pro- fit on each piece of land sold, and include such total profit in gross income. Real estate sales on the installment plan are re- ported the same as personal property sales, described above. An individual whose taxable year ends December 31, and who receives income from a partnership reporting on a date other than Dec. 31, includes in his return profits made for the fiscal period ending within his taxable year. Thus, a partnership closes its books March 1, 1921, showing a profit of $20,000, "A's" share be- ing $10,000. "A" also makes a salary during the calendar year of $5,000. He reports as of Dec. 31, his $5,000 salary made during 1921, and the $10,000 allotted to him March 1, 1921, but earned from March 1, 1920, to March 1, 1921, regardless of when he is paid by the partnership. Sale of Stock: Several methods are used for computing the profit to be included in gross income when stock is sold. (1) An ordinary purchase and sale of a block of stock is re- ported the same as any other business transaction, except that a broker's fee is added to the cost of stock when purchased and deducted from the selling price when sold. (See Lecture 5). (2) If a bonus of preferred stock is given with the purchase of common stock, any additional cost attributable to such bonus may be used to determine the exact cost of each share of common and preferred stock. Thus, 10 shares of common stock are pur- chased for $1,100. ($110. a share), and a bonus of 5 shares of preferred stock given. The facts may show that the common stock if sold without the bonus would bring in only $90. per share or $900. Therefore, the remaining $200. divided by 5 shares, giving a cost of $40 per share, may be used to get a cost-value for the preferred stock. In case of sale later, $90. and $40. should then be used as the cost price of common stock and pre- ferred stock, respectively. -24- (3) If it is impractical or impossible to allocate any def- inite cost to each share of common and preferred stock in case (2) above, then no taxable profit need be reported until the total cost has first been recovered. Thus, 8 shares of common may be sold for $100. each and 2 shares of preferred for $75. each, the holder receiving $950. It is apparent that in all probability a profit is being made on the sale of each share, but as the original cost, $1,100., has not yet been recovered, no profit need be reported. (4) If a stock dividend is received, its value is not taxable, but for purposes of future sales, certain rules must be observed in computing the cost value of such stock. (a) If the stock received as a dividend is of the same class as the stock upon which it was declared, cost for purpose of computing profit in case of sale is obtained as follows: 10 shares of common were purchased for $100. each, total cost $1,000. Later a 40% stock dividend was received by the holder, of 4 shares additional. The 14 shares cost $1,000. or $71.43 each ($1,000. divided by 14) , and in case of future sale of either the original stock or the dividend stock, $71.43 is considered the cost. (b) If the stock received as a dividend is of a different class and price than the stock held, computation to obtain cost is as follows: 100 shares of common stock were purchased for $9,000. ($90. per share) in 1917. A 20% stock dividend, payable in pre- ferred stock, was declared in 1921, at which time the market value of the original common stock was $80. per share, and the dividend preferred stock $100. per share; total market value, 1921, common $8,000., preferred (20 shares) $2,000.; total combined, $10,000. At the time the dividend was declared, the preferred stock rep- resented 1/5 of the total worth of all the stock ($2,000. of $10,000). As the cost originally was $9,000., then the actual cost of the preferred stock is considered to be 1/5 of $9,000. - the original cost of the common stock, - or $1,800., and the common stock is re- duced to 4/5 of $9,000. or $7,200. For purposes of future sales of either group, the common stock cost $72. per share ($7,200. divided by 100 shares), and the preferred $90. per share ($1,800. divided by 20 shares). If a person sells his private residence on which he has not been allowed to take depreciation in prior tax returns he need not increase his profit by such depreciation in reporting gross in- come. Thus, a house was purchased in 1915 for $5,000. and sold for $6,000. in 1920. The owner's family were the sole occupants 2Uid hence he was not permitted to deduct depreciation in his returns from 1915 to 1920. He reports only $1,000. profit for the year 1920. If depreciation had been taken, he would report somewhat as fol- lows: Sale price $6,000. Cost $5,000. less $500. depreciation, or present value $4,500., profit for 1920-$1,500. -2^. If a corporation, in addition to paying an officer a salary, also gives a bonus, the latter is taixable. But if the bonus is not granted until the next year after it is earned, it is not income until that time. Thus, a corporation sets aside on Dec. 31, 1920, a sum, out of which its officers and employees are to receive a bonus. The bonus is not assigned to individuals until Jan. 2, 1921, and then paid. The amount is taxable for 1921 stnd not for 1920, guid the tax thereon not payable until 1922, because the officers and employees did not have unrestricted title to their respective share until the next year. This is true even though the company has deducted the amount as expense in 1920, and even though the individual recipients reported on a so-called accrual basis. (Gov. Decision.) Amounts paid as rewards for special meritorious work should be included in gross income. Thus, a person is rewarded for having stopped a bauik robbery; although apparently such reward is a gift, it is considered taixable income. (Gov. Decision.) Gross income should include only that actual profit which has accrued since March 1, 1913, when items have been owned prior to that date. Thus, a business was established in 1905, and when sold in 1921, the sum of $100,000. was paid for its Good Will. Ordinarily, the taixpayer would have to pay an income tax on $100,000. for the profit made on the sale of the business. He is permitted, however, to show that the Good Will may have been worth $60,000. or $70,000. on March 1, 1913, the day the tax law became effective, and if so, he pays a tax on only $30,000. or $40,000. In the case of fluctuating values, however, a different rule, in conformity with recent Supreme Court Decisions, must now be followed. In brief, only the ACTUAL LOSS OR GAIN on the sale of assets should be taken in tajc returns, and only that part of such actual loss or gain assignable to the period after March 1, 1913. This is best understood by means of illustrations. Illustrations: 1. Stock cost $10,000 in 1910, was worth $13,000 March 1, 1913, and sold for $21,000 in 1921. Actual profit $11,000, taxable profit, $8,000, being that part of the actual profit made since March 1, 1913. 2. Stock 1913, and sold tajcable profit, since March 1, only that part March 1, 1913, cost $10,000 in 1910, was worth $8,000 March 1, for $15,000 in 1921. Actual profit, $5,000, $5,000. A total profit of $7,000 has been made 1913, but the actual profit only may be taxed, and of the actual profit assignable to the period after so a maximum profit of $5,000 is reported. 3. Stock cost $10,000 in 1910, was worth $15,000 March 1, 1913, and sold for $13,000 in 1921. Actual gain $3,000, tax- able gain, nothing. While an actual profit of $3,000, was made, none of this actual profit is assignable to the period after -26- March 1, 1913, hence no gain is reported, for tax purposes. Al- so, no loss is taken. 4. Stock cost $10,000 in 1910, was worth $8,000 March 1, 1913, and sold for $4,500 in 1921. Actual loss $5,500, al- lowable loss for tax purposes $3,500. Although there was an act- ual loss of $5,500 only $3,500 of it is assignable to the period after March 1, 1913. ($8,000 less $4,500.) 5. Stock cost $10,000 in 1910, was worth $12,000 March 1, 1913, and sold for $7,000 in 1921. Actual loss $3,000, allow- able loss for tax purposes $3,000. A loss of $5,000 has been suffered since March 1, 1913, but only the actual loss may be taken and only that part of the actual loss assignable to the period after March 1, 1913. Therefore only $3,000 may be taken, and as this amount is assignable to the period after March 1, 1913, the $3,000 represent the allowable deduction for tetx purposes. 6. Stock cost $10,000 in 1920, was worth $7,000 March 1, 1913, and sold for $9,000 in 1921. Actual loss $1,000, allow- able loss, for tax purposes, nothing. While an actual loss of $1,000 was suffered, none of this actual loss can be assigned to the period after March 1, 1913, therefore no loss is report- ed. Also, no gain is included in gross income. Other phases of the subject relating to gross income, such as what is meeuit by reporting income on a cash basis and on an accrual basis, what is meant by fiscal year and calendar year, what steps are necessary to change from a fiscal year to cal- endar year basis, etc., will be considered under miscellaneous topics in Lecture 12, -27- LECTURE 3. Questions to be Answered. 1. A taxpayer received during the year, the following amounts in interest: $1,000 from mortgages on real estate, $500 from City of Boston Bonds owned, $50 from Bonds issued under the Federal Farm Loan Act of 1916, $45 in -bank interest, and $200 from so- called 2% tax-free covenant bonds. State the amount of tgixable income he would report from the above. 2. An individual bought stock as follows: United Steel: in 1914 ten shares at $90 per share, in 1915 five shares at $95 each, in 1918 ten shares at $120 each. He sold four shares for $112 each in 1917 and sold twelve more for $93 each in 1921. Com- pute the taxable profit or allowable loss for 1921. 3. An instructor is teaching in a state college, his salary be- ing paid by the State. Of the $3,000 received, 10% is paid by the Federal Government to the State, and then paid to the instruc- tor. This same individual received $1,400 during the year as administrator of an estate, and $300 as receiver appointed by State Court in dissolution of a partnership. State the amount which he should include in taxable income. 4. An employee of a manufacturing concern received $2,600 salary for the year, also $90 in dividends from the same company, as well as $200 in interest from bonds owned. He also received $95 in interest from 4f Victory Notes held throughout the entire year. The above is his total income from all sources for the year. He is single. Compute his tax. 5. A Chaplain with the A.E.F. during the war remained with the Army of Occupation, resigning Jan. 31, 1921, during which time he received compensation at the rate of $3,000 a year from the Government. He returned to his congregation May 1, receiving $1,000 salary for the remainder of the year. He also received $308 from May 1 to Dec. 31 on account of marriage fees, baptismal fees, special donations for special services, etc. The congrega- tion furnished him a home, the fair cash value of which was $50 a month, starting June 1. As congratulations for his military serv- ices the congregation gave him $500 in cash and a $50 watch Sept. 1 He is single. Compute his tax. -28- LECTURE 4. Allowable Deductions. The law classifies Allowable Deductions . from Gross Income under the following twelve captions: Business Expenses, Interest, Taxes, Losses (three groups). Bad Debts, Depreciation, Amortization, Deple- tion, Charitable Contributions and Property Seizures. BUSINESS EXPENSES: Under this heading, all ordinary and neces- sary expenses incurred in carrying on a business may be deducted, including expenditures on account of salaries, materials, supplies, incidentals, labor, insurance, rent, royalties, repairs, selling and administration. Cost of goods sold is usually deducted from sales, giving gross profit, from which the above business expenses and other allowable deductions are subtracted, resulting in taxable business income. Cost of goods sold should consist in general of inventories at the beginning of a year, plus purchases, less inventories at the end of a year. If inventories are not obtainable, then purchases may be used for cost of goods sold. If, however, inventories are nec- essary in any business to get correct profit, they must be used. If in prior tax returns a company has failed to use inventories where necessary for correct tax computations, the Government is insisting that correct returns be made with inventories estimated as accurately as possible. Salaries are allowable deductions only where they represent reasonable compensation for services rendered. Salaries are con- sidered unreasonable (1) when they are obviously given for pur- poses of evading taxes, and (2) when they increase suddenly and substantially, apparently because a concern has made a higher pro- fit than usual. In such cases, any excess above reasonable sal- aries received by chief stockholders is considered a distribution of profits, and taxed as dividends. Excessive compensation received by other than owners of substantial amounts of stock is subject to both the Normal Tax and Surtax, and is not deductible by a corpor- ation. By decision, the Government has declared that all agreements for large salaries made prior to but payable in the high tax years 1917, - 18, and - 19, will be allowed regardless of reasonableness of amounts paid. Occasionally, payments by corporations, ostensibly for salaries, may represent payments for a business purchased. Such a case may arise where a corporation purchases a partnership, and thereafter pays the former partnership owners an unreasonably large compensa- tion. Any excess payments will be considered part of the purchase price and not deductible expenses on account of salaries. Ordinary rent is an expense. If a lessee pays taxes directly to a city for a lessor, such taxes are additional rental payments etnd deductible. If a tenant erects property on land or perma- -29- nently attaches improvements to buildings, the expense of these should be prorated over the life of the tenant's lease, as they do not belong to him at the termination of the lease. Other deductions coming under business expenses are the fol- lowing: bonus paid as a reward for work performed or as a stim- ulus to further work, pensions paid to employees' families, com- pensation paid to helpers while injured or ill, salary paid to a widow for a limited period after a husband's death, and salaries paid to employees while absent in war service. Gifts, as previously explained, are not deductible, and are not income to the recipients. Professional men may claim as deductions, cost of supplies, ex- penses and repairs on autos used for business calls, dues and sub- scriptions to professional societies and journals, rent for office and rooms, and light, heat, phone, etc., for office. If a profes- sional maui has an office in his own home, only a proper proportion of his rent, light, heat and phone may be deducted out of his total home expenditures. If he has an established place of business in the business section of a community, and only incidentally received patients or clients at his home, he cannot deduct for home office expenses. If a professional man owns his own home, he may deduct nothing for rent on any part used as an office but may deduct for other business expenses. Farmers may deduct expenses for tools, small farm implements, food purchased for stock, farm help, auto up-keep, cost of seeds, etc. Land and orchard improvement costs, purchase of auto or truck, purchase of draft, dairy and breeding animals, cost of farm buildings, etc., may not be deducted as these are capital charges. If a person runs a farm for pleasure, any loss resulting is not an allowable expense, but any profit made thereon is taxable. If a farmer grows crops which take more than a year to mature, he may report on a crop basis. In no case should a farmer deduct food grown on a farm and fed to animals, as it has not been in- cluded in income. A special form, called 1040 F, is used in con- nection with reporting the tameable income from farms. Ordinarily all charges are deductible in the year in which they were incurred. Thus, a person had goods stolen from his store in 1918, but did not discover the theft until 1919. He must deduct the loss for the former year. However, amounts paid for personal in- jury are deductible when put in judgment and paid, not when the accident or injury occurred. (See Page 32 - Deduction of Unusual Losses. ) Incidental repairs, which do not materially prolong the life of an asset, but merely keep it in ordinary operating condition, are deductible. But repairs to the extent that they are actually replacements, or retard deterioration, are not expenses, and not deductible . Traveling expenses, incurred in connection with a trade or business, may be deducted in entirety, beginning with the year -30- 1921. Heretofore, railroad fare and other business expenses were deductible, but in the case of room and board, only the differ- ence between such expense while at home and while traveling was deductible. (Act of 1921.) INTEREST on indebtedness, whether paid on personal or busi- ness obligations, is deductible. Interest paid on a bank loan to a busine'ss is an expense, also interest paid on a mortgage on a house in which the taixpayer and his family are the sole occu- pants. Interest paid on mortgages and loans on which individ- uals are not liable, but in which they have an interest, is de- ductible. Thus, "A" has his house mortgaged by a bank, and "B" purchases the property from "A", agreeing to pay the interest on the mortgage to the bank although not legally liable. "B" may deduct the interest. On the other hand, interest paid on money borrowed to pur- chase securities the income from which is exempt may not be de- ducted. Thus, "C" borrows from a bank $10,000 to assist him in purchasing $15,000 worth of State Bonds, paying the bank $600 interest for the year. He may not deduct the interest thus paid, as any income from State Bonds is exempt. Interest gratuitously paid for a friend on his debts is not deductible; also interest charged on investment accounts in a partnership or corporation, as such interest is a means of distributing profits. Interest paid on scrip dividends is deductible. Previous to 1921, all interest paid on loans to purchase Liberty Bonds was deductible, whether the income from such bonds was taxable or exempt. For 1921, interest on loans to purchase Liberty Bonds is deductible only if such bonds were subscribed for during the original drives and were issued after Sept. 24, 1917. (Act of 1921.) TAXES: With few exceptions, all tsixes, both business and personal, are deductible. Among the tajces, for any and all pur- poses, which may be deducted are the following: state and city taxes on personal and real property, whether used in business or not, state income tax, poll tax, automobile license (tax), spe- cial liquor or oleomargarine license (tax), special consumers' war taxes, such as soda taxes and theatre amusement taxes, fed- eral capital stock tajc, and any special federal or state taxes. Import duties may be deducted as taxes if not included in cost of goods sold and thus deducted from sales. Luxury taxes, such as the taxes on automobiles, pianos, canoes, cameras, toilet articles, etc., levied against manufacturers and practically always collected from the consumer, are deductible by the manu- facturer but not by the consumer. The consumer may deduct the so-called war taxes on eunusements, etc., but not the excise and stamp taxes levied against manufacturers and usually collected from the public. States cannot levy taxes against national banks, but usually collect an amount from such banks which in reality represents an assessment against the individual stockholders. Beginning in 1921, banks and other corporations may deduct any such ajnounts paid for shareholders, as expense, provided reimbursement is not made by the individual shareholders. The latter may not deduct such taxes as expenses. In 1920, banks did not report such taxes as deductible, but considered them distributions of profits to the stockholders, who, in turn, reported them as dividends received and taxes paid out. Ordinary tsixes levied by foreign countries against American Citizens, are deductible with other expenses, but income taxes collected by foreign countries are deductible from the income tax itself. (See Lecture 6.) {Act of 1921.) Certain taxes may not be deducted: (1) Federal Corporation and Individual Income Taxes, including Excess Profits Taxes ajid Surtaxes, as these are a distribution of part of profits to the Government; (2) Income taxes paid foreign Governments, as these are usually deducted from the income taxes payable; (3) Improve- ment gind local benefit taxes, as these expenditures should be cap- italized; (4) Amounts paid by corporations to States for share- holders, as previously explained. To be a local benefit tax, and not deductible, the amount paid out by the taxpayer as tax should be expended for the benefit of the property assessed. Thus, prop- erty owners on a single street in a city, taxed to improve the sidewalks of the street, pay a local benefit tax, and should add such expenditure to the cost of their property. Inheritance taxes, under the 1921 law, are to be accrued when due. (Act of 1921.) LOSSES: Losses may be deducted if (1) incurred in a person's business, (2) incurred in a transaction entered into for profit, or (3) when resulting from fire, storm, casualty, theft, etc., and not connected with a person's business. When assets are sold their cost less depreciation usually gives the basis for deter- mining profit or loss. When destroyed or damaged, their cost less depreciation, whether ever taken or not, less salvage, less insur- ance received, gives the basis for determining the loss, or occa- sionally and rarely the gain. Thus "A" bought a house in 1915 for $6,000 and depreciated it $200 a year for four years, after which it was burned, gtnd he received $3,000 in insurance and $300 in salvage. He reports a loss of $1,900 computed as follows: Cost $6,000 less depreciation $800, less insurance $3,000, less salvage $300, total $4,100, total loss $1,900. If a building is voluntarily abandoned or removed, its cost less depreciation, less salvage, gives the basis for the loss. If property destroyed had been acquired prior to March 1, 1913, its fair market value as of that date should be used as the basis for determining any loss. (Act of 1921). If a person buys land and old buildings, and then razes the latter, leaving the land cleared, he cannot deduct the removal expense and cost of the building as a loss, but adds the cost of the Istnd, building and razing expense together to obtain the total cost of the land unencumbered as apparently desired when original pur- chase was made. After November 23, 1921, no loss is allowed on the sale of securities if substantially identical property is purchased thirty days before or after the sale stnd held for any period of time. Thus, an individual owns Steel Stock which cost $100,000, but is worth $70,000 on the market. If he sells the stock Dec. 27, just prior to the close of the taxable year, in order to take a $30,000 loss against his taxable income, and then purchases additional Steel Stock for about $70,000 some time in January, then the $30,000 loss may not be taken. So, also, if, about Dec. 1, the taxpayer pur- chased about $70,000 worth of Steel Stock, and then about December 27 sold the original $100,000 for $70,000, the loss may not be taken. If the taxpayer purchased only $35,000 worth of Steel Stock about December 1, then one-half of the $30,000 loss when the $100,000 worth was disposed of, might be taken. (Act of 1921.) Ordinarily, charges are deductible when incurred. Treasury De- cision 3262, Dec. 20, 1921, explains that under the new 1921 Act, unusual losses need not always be deducted when they occur. Such losses, however, may be taken in other than the year in which they occur, only in the discretion of the Commissioner of Internal Revenue and after the taxpayer has shown that otherwise there would be an injustice to himself and that the deduction at another date would more clearly reflect income. The taxpayer should submit his returns to the Government by deducting the losses in the year in which they occur and by asking permission to transfer them to a later period. This section refers to such losses as theft in one year discovered in the next, or loss of a vessel in one year not known of until the next. It does not refer to shrinkage in inventory values nor drop in the market value of stocks. Losses cannot be taken unless a transaction is completed. Thus stock purchased, costing $100 a share may be worth $50 at the end of a taxable period, but unless sold, no loss can be taken. If stock actually becomes worthless, and such fact can be proved, then a loss may be taken without attempting to sell. If banks, pursuant to state laws, value stock on their books at market prices, and thus show a loss, no deduction thereon is allowed. Brokers, however, in taking inventories of stocks on hand, may compute them at the market price, and if a loss results, it may be taken. If a person sells a house in which he has been living and which he has been holding as his private residence, no loss is allowed, unless he can show (Gov. Decision) that he originally purchased with the intention of making a sale later at a possible profit. Such loss is not incurred in business or as the result of theft, fire, cas- ualty, etc. If property, such as machinery, equipment, etc., loses its value through being replaced by inventions, or otherwise rendered useless, and such circumstance was in all probability practically impossible to foresee, a loss may be allowed. Gambling losses are not deductible, as illegal losses may not be taken. Wherever gambling is legal, losses may be taken. If farmers keep inventories of live stock owned euid crops, any losses through death of stock or shrinkage of crops ceuinot be taken, as such losses will be reflected in the reduced inventory values at the close of the taxable year. If no inventories are kept farm- ers may deduct losses on stock killed or crops destroyed which have been purchased, less any depreciation taken on the stock suid less 2Uiy insurance received on either group. Goods grown on farms, and never included in inventories, cajinot be considered a loss when de- stroyed, as they were never included in gross income. When animals die which have been fed for purposes of sale as food animals, any foods furnished them, the value of which is now lost, cannot be taken as a deduction, because if such items of food are grown on the farm they have not been included in income and if purchased may be deducted as such. If ordinary assets, such as buildings, autos, garages, etc., are destroyed on farms, their value may be taken as losses, subject to the conditions previously enumerated. BAD DEBTS: Bad debts may be taken as losses (1) when they have previously been included in income, and (2) when they have actually become bad debts and can be proved as such. If a company sets up a Reserve for Bad Debts on its books, thereby taking anticipated losses, the amount set up in the Reserve is not ordinarily an allow- able deduction. All the circumstances surrounding a bad debt should be taken into consideration in deciding whether a debt is actually worthless or not. Bankruptcy may or may not signify that a debt is worthless; disappearance of debtor may not; inability to collect may not; however, all these facts may assist materially in deciding whether or not a debt is uncollectible. However, a Reserve for Bad Debts may be used starting with the year 1921, as follows: If a taxpayer has been using a Reserve for Bad Debts and it appears on the books as of January 1, 1921, the taxpayer should charge against such Reserve during 1921 any actual bad debt losses and should then subtract as a tax deduction only the addition to the Bad Debt Reserve at the end of the year. If a concern has not previously used a Bad Debt Reserve it may now adjust its books as of January 1, 1921, by setting up a Bad Debt Reserve, but not deducting it in its tax return. Such taxpayer shall also then charge the actual bad debt losses against the newly established reserve during the year, and then deduct on his books and in the tax return the addition to the Bad Debt Reserve at the end of the year. If the taxpayer adopts the policy of using the Reserve he shall be required to continue the pol- icy in subsequent years. It will also be necessary to give a state- ment to the Commissioner showing the amount of sales, and the balances of receivable accounts at the beginning and end of the year, and other factors which the taxpayer is using as a means for computing his Bad Debt Reserve in his particular line of business. Hereafter, fractional bad debt losses may be taken. If so, any amount collected in excess of the balance not charged off shall be taxable income as of the time received. Thus, $800. of a $1000. bad debt loss is charged off; later $300. is collected, — $100. of which is considered taxable income, as the books contain a $200. balance on which an amount of $300. has been collected. (Act of 1921.) (Treas- ury Decision 3261 — Dec. 20, 1921.) A mortgage may be charged off as a bad debt if uncollectible. However, if a mortgagee buys property covered by a mortgage to him, no subsequent loss can be taken. Thus, "A" had a $3,000 mortgage on "B's" house, which the latter could not pay; foreclosure proceed- ings followed at which "A" purchased the house for $2,500, the -34- money being immediately turned over to himself as mortgagee. "A" cannot now deduct the $500 cash loss, as the $3,000 mortgage evi- dently was t£iken against a house worth at least $3,000 euid "A" now has the house. Any loss suffered by "A" upon sale to a third party may be taken. A company buying accounts receivable, some of which prove un- collectible, may charge off the cost price only against the losses, £uid not the face value of the accounts. Worthless securities charged off under bad debts should be proved valueless. DEPRECIATION, AMORTIZATION AND DEPLETION: Depreciation is defined by the Government as the lessening in value of an asset, through exhaustion, wear, tear, decay, decline, obsolescence through the normal progress of the art in any particular line, and inadequacy due to the growing and increasing needs of a busi- ness. Any depreciation should be spread as uniformly as possible over the life of sui asset, in accordance with good accounting practices. The depreciation should be based on the cost of the asset, less scrap value and the estimated life. In the case of property bought prior to the enactment of the Income Tax Law, and which contained exi appreciated value as of March 1, 1913, depre- ciation is to be applied against the newer value. Thus, if a house cost $10,000 in 1910 and was worth $12,000 on March 1, 1913, depreciation is to be applied against the $12,000 value. In the case of intangible assets depreciation is permitted only if such assets are limited in time. Thus, patents, copyrights, franchises and licenses, usually limited in time, are depreciable, although intangible. Purchased good will and similar intangible items may not be depreciated. The Government has given out no set rates of depreciation; a reasonable percentage, depending upon the facts in each case, being allowed. However, a few of the following rates have been approved by the Government. Depreciation on brick buildings - 2 per cent; Depreciation on wooden and freune buildings - 3 to 5 per cent; Depreciation on office furniture and fixtures - 10 to 15 per cent; Depreciation on auto trucks - 20 to 25 per cent; Depreciation on ships and vessels - 3 1/3 per cent A few special rates have been established by the Government for particular assets in certain lines of business, but even these may be altered by the facts in any case, if they are shown to be un- reasonable . Amortization is the writing off of value (almost the saune as depreciation) of assets acquired after April 6, 1917 and used to assist in the prosecution of the war. Such sunortization applies chiefly to vessels, buildings, machinery and the like, purchased after the war began, for the purpose of directly or indirectly assisting the Government. Amortization is permitted, starting with -35- January 1, 1918, and should consist of writing off the asset from the value as of that date up to the time the asset was sold, dis- carded or discontinued on war work. Thus, if a corporation erected a special building in 1917 and depreciated it a little for the rest of that year, and sold such an item in June 1919, or discarded it at that time, it should amortize the value of the asset as of January 1, 1918, down to its saleable or discarded value as of June 1919, over the period January 1, 1918 to June 1919. If, on the other hand, such factory, machinery, vessel or other asset, is used in ordinary business after completion of Government work, it should bs amortized down to its post-war value to the concern in its ordinary nonnal business. What constitutes "the post-war normal value" of war facilities used in ordinary business is often a difficult question to decide. Amortization written off for the years 1918 to 1921, inclusive, may be reviewed by the Government, or open to reconsid- eration by request of the taxpayer, up to March 3, 1924. Depletion is the lessening of value of an asset whose decreas- ing worth cannot be retarded by repairs and replacements a.id which, itself, cannot be renewed. Depletion is applied to timber lands. oil and gas wells, coal mines, etc. In the case of property ac- quired before March 1, 1913, the depletion rate may be applied against the property value as of that date. If an individual dis- covers a mine which cost him but a nominal figure, he is allowed to teike depletion against the fair market value, as of the time of discovery, but in no event shall such depletion exceed the pro- fits made in any one year. Both depletion and amortization open up special fields, which oftentimes require handling by special- ists only. Those interested in these two particular phases of deductions against income taxable should read Regulations 45, 1921 issue, pages 76 to 100, and the new Law, Section 214, Sab- divisions 9 and 10. CHARITABLE CONTRIBUTIONS: Charitable contributions or gifts are donations to corporations, associations, funds or foundations, operated for religious, charitable, scientific, literary and edu- cational purposes; to posts of the American Legion and Women's Auxiliary Units, to the Vocational Rehabilitation Fund, and the Federal and State Governments when used for exclusively public pur- poses. A taxpayer is allowed to deduct for such donations an amount not to exceed 15% of his taxable income as computed without the benefit of the above, and without first taking out his personal exemption. Thus, "A" received a salary of $12,000 and is married. During the year he donated to his Church $500, to the Y.M.C.A. $400, to Boston University $500, and to the Red Cross $500. He paid out in charitable contributions $1,900. However, 15% of $12,000, or $1,800, is the maximum deduction allowed for such con- tributions, and therefore only the latter amount should be subtrac- ted, leaving a taxable income of $10,200 which balance is subject to the Normal Tax, after deducting his personal exemption, and to the Surtax, the same as any other similar taxable anount. Donations to the American Legion, Women's Auxiliary Units, and Federal and State Governments are deductible beginning in 1921; -36- also donations to funds or foundations. Heretofore, the donations must have been made to corporations and associations operated for certain beneficial purposes or to the Vocational Rehabilitation Fund to be deductible. Corporations, associations, foundations, etc., receiving donations must not permit profits to inure to the benefit of any individual stockholders, or deductions of contribu- tions to them will not be allowed. cannot be deduc- to whom deduct- return an item- Partnerships contributions , but ion purposes, each on which he in- the partnership. Contributions to needy individuals or families ted, as they are not included in the organizations ible gifts may be given. In a person's income tax ized list of charitable contributions must be given or corporations, as such, cannot deduct charitable after a partnership reports its income for informat partner may then deduct from his distributive share tends to pay a tax, his share of donations made by claiming same as individual donations. By Government Decisions, all contributions to churches come within the 15% deduction, even where the money received is used for building a new church, or to form a social club within a church, or to finance foreign missions and foreign religious undertakings, as all such expenditures in general tend to promote religion. Con- tributions to religious and charitable organizations in foreign countries may be deducted. (Gov. Decision.) Donations to the Red Cross and similar military, charitable organizations may be deducted. For the year 1921 a new method of computing deductions in the case of property seizures has been devised, to the effect that the proportion which the amount expended bears to the receipts shall be applied against any gain and the result allowed as a deduction. Thus, if a house was worth $4,000 and was compulse rily taken from the taxpayer, through Right of Eminent Domain, destruction, or otherwise, and he was compensated to the extent of $5,000, it would be necessary for him to report $1,000 profit. However, if he then attempts to replace the property substantially in kind, he is allowed as a deduction, the ratio above defined. Thus, if it costs him $4,200 to replace the house worth $4,000 and for which he received $5,000, he is allowed as a deduction 42/50 of the $1,000 gain. For the year 1921, under the new Act, losses of one year may be used to offset gains of any subsequent year. Thus, a loss in 1921 may be used to offset a gain in 1922. For example, if a tax- payer has a loss of $20,000 in 1921 and a gain of $30,000 in 1922, he reports a taxable gain of only $10,000 for 1922. It must be carefully noted that such losses are effective only for subse- quent years and that the rule is effective beginning with the year 1921. For a fiscal year ending in 1921, that proportion of the loss assignable to the period after January 1st may be used to offset subsequent fiscal year gains. Thus, a concern loses $24,000 for the period April 1, 1920 to April 1, 1921. 3/12 of this loss may be assigned to the period after January 1, 1921, or $6,000. This $6,000 may be used to offset any gains for subsequent fiscal years. LECTURE 4. Questions to be Answered. 1. An individual, president of a corporation owning eight chain stores, uses his automobile every day in going from his home to Store No. 1. He then uses it the remainder of the day in driving from one store to another. He returns to his home in it each evening. He uses it Sundays, but not for business purposes. State in general what deductions, if any, you would allow for the up-keep of such automobile. (Question decided by recent Gov. Decision. ) 2. A dealer in fur coats paid $4,000 during the year as duties on imported furs, which amounts he did not deduct from cost of goods sold in his business. He paid $3,000 more as luxury tajces to the government for the same coats sold by his store to cus- tomers. He paid $30 import tax on a fur coat purchased in Eu- rope by his wife. He paid $50 tax to the manufacturer on a piano purchased for his own home. State what he may deduct as allowable expense. 3. An individual paid the following taxes during the year: $70 Federal Income Tax, $60 State Income Tax, $5 Poll Tax, $20 license fee for truck in his business, $15 license fee for auto- mobile for private use, $8 in soda taxes and amusement taxes, $28 in railroad taxes, and $70 for a license to sell certain drugs within a state. What amount may be deducted from his gross income? 4. A taxpayer owned two houses, each containing two tenements. In house No. 1, his own family occupied one of the tenements. His income from House No. 1 was $35 rent a month, from house No. 2, $80 rent a month. On house No. 1, during the year, he paid out the following. Taxes $60, Insurance $70, Interest on Mortgage $40, Repairs $25, Water Bills $8. On house No. 2, he paid out Taxes $65, Insurance $75, Interest on Mortgage $45, Repairs $80, and other costs $20. His salary, which is the only income from sources other than the rents received, is $4,000 a year. He is married and supporting a wife and one child. Compute his tax. 5. "A" donates the following amounts during the year: $500 to Boston College, $50 to Post 200-American Legion, $40 to a club to which he belongs for Promoting the Study of the Spanish Language, $50 to the University Club, $25 to the Boston Herald's coal Fund, $45 to a friend of his in need, and $100 to the Massachusetts Hospital for the Blind. Which amounts may he deduct from Gross Income? LECTURE 5. Preparation of Form 1040 A. Income Tax Return of Individual with Net Income of Less Than $5,000 « Under the 1921 Act, Form 1040 A is used in preparing the return of an individual with net taxable income of less than $5,000 and subject to the Normal Tax only. It consists of six printed sheets: Pages 1 and 2 of the Return, and pages 1 and 2 of the Instructions. The in- structions are a condensed, comprehensive summary of the tax law, and should be carefully reviewed. Page 1 of the tax return reports the income and deductions of the taxpayer. The income items are properly classified on the first page. Any of the items requiring supporting Schedules are so designated; that is, to the left of each line of income is either a blank space or a letter. Where a letter appears, such as A, B, C, D, this signifies that a supporting Schedule on page 2 of the Return is required in order to explain in detail the net income on any particular line. All income items are classified on lines 1 to 8 of the Return, and totalled on line 9. Lines 10 to 15 report allowable deductions. It should be noted that the deductions on these lines are the personal ones allowed individuals, such as personal interest, taxes, and con- tributions paid out. The use of each line can best be understood by the writing of an actual Return. Problem Illustrating Use of Form 1040 A Under the 1921 Act. The taxpayer, Mr, Harry J. Turner, 1400 Allston Ave., Brook- line, Mass., supporting a wife 2uid child - age ten years, submits the following information to your office and requests that you prepare his tax return for the year 1921. From Jan. 1 to March 31, 1921, he was in the active military service of the United States, receiving $150 a month. Upon leav- ing the service he received a bonus of $100 from the State of Massachusetts. During the first five months of the year his wife was stenographer for the City of Boston at $100 a month, and in November and December received the sajne rate of salary from the Morgan Memorial, a charitable organization, itself tax-exempt. Mr. Turner resumed his former business in April, 1921, at 500 Washington St., Boston, Mass., the business consisting of buying typewriter supplies, packing and stamping same in his own name and selling them as his own product. His profit and loss statement ap- pears as follows: Sales of typewriter supplies for 1921 (8 mos.) Cost of Sales: Materials Bought (8 mos.) $10,221.40 Goods on Hand, April 700.00 Labor, Packing 4,850.35 Packing Materials 1,201.50 Incidental Costs 45.00 $18,510.10 Total 17 ,018.25 Goods on Hand, Dec. 31 Sold Sales 3 ,510.00 13 , 508 . Cost of Goods i 13 ,508.25 .25 Gross Profits on ; $5,001. ,85 Less Expenses: Salaries $3 . 000 . 00 Rent 720 . 00 Interest 55.00 Taxes 105 . 00 Depreciation 100 . 00 Repairs 40.00 Bad Debts, Actual 119 . 00 Telephone 78.50 Electric Light 21.00 Advertising 115.00 Stationery 55.00 Postage 25.00 Office Expense 12.85 4.446. 4 ,446.35 ,35 Profit for 8 mos. $555 . 50 Books were kept on an accrual basis. Included in salaries are $1,500 paid to Mr. Turner himself, and a $50 bonus paid to him. Mr. Turner also had an interest in a partnership during 1921, called the Washington Manufacturing Co., in which he was entitled to one-fifth of the profits. In its return of information to the In- come Tax Unit, the partnership shows a profit of $6,174.50. Included in the total income is an item of $120, interest received at 6% on $2,000 worth of 'tax-free covenant" bonds, and income from a $1,000 4f% Victory Note, owned part of the year, amounting to $29.50. The corporation issuing the bonds paid a 2% tax on the interest be- fore sending the $120 to the partnership. Mr. Turner received only $1,000 in cash from the partnership, during 1921. Other business transactions reported by Mr. Turner were as follows: - At the beginning of the year he owned two houses, in one of which he lived with his wife euid 10 year old child. The other house cost him $3,800 in 1910, but he could prove satisfactorily that it was worth $4,000 on March 1, 1913, the date the Income Tax Law became effective. From March 1, 1913 to date of sale, he de- preciated the house at the rate of 2^% per year. He spent $200 on it in 1921 for additions and betterments. On Sept. 1, 1921, he sold the house for $4,110. Up to that time, the property had been rented for $45 a month, and the following amounts had been expended on it: - for repairs, $30;, for water bills, $20; and for taxes, $90. He bought ten shares of N. E. Telephone Stock in 1919 at 99, and sold them at 102 in 1921, paying a commission of $1.50 with each transaction. He built a garage in 1921, at a cost of $1,000, had rented it two months at $20 per month, and had paid out in taxes $25, when it was destroyed by fire. He estimated that de- preciation amounted to but $5 up to the time of the fire. The building was insured, and he received $895 from the insurance company . Concerning matters not connected with his business, Mr. Turner reported as follows: - He bought a new automobile in September for $1,200; it was later stolen, and he was allowed $1,000 insur- ance by the insurance company. He paid $60 in interest on personal loans, a $5 poll tax, a $20 State Income Tax, and a $40 Federal Income Tax, also $20 for a license for the stolen automobile, which was not at any time used for business purposes. He spent $40 for repairs, $60 for insurance, $30 for interest on mortgage, and $50 for taxes on the house occupied by himself, wife and child. He was able to submit satisfactory proof that taxes for baseball, theatre and other amusement tickets totalled $7.50 for the year. He gave out in charity during the year, $50 to the American Legion, Post 101, and $25 to the Women's Auxiliary, also $17.50 to the Tremont Temple Church and $20 to the Christmas Fund of the same church, and $30 to John Blake's needy family, located several streets from him. He loaned $38 to J. White while in the army, taking his note for same, but has recently learned that Mr. White was killed in the service. He owned stock on which he received $200 in stock dividends and $539.10 in cash dividends. Bank interest received for the year totalled $20.17. Mr. Turner's uncle died during December, and he received $3,000 insurance as beneficiary, also $5,000 in real estate. From the foregoing facts and figures, - Form 1040 A is written as follows: V'orm 1..1;412 ChccLt win be accepted if piTiUs at par al CoDector't Ofic*. v(|| 24.' Balance Due (Item 21 minus 22 and 23).. 2S. Tax Paid when Filing Return 56 56 .48 48 QO 9*«*«M«*«w**«|*««k^a9 »— lien SCHEDULE A.-EXPLANATION OF ITEM 4. (IUbU mt%d RoyaltlM.) LKindofproiMrty- 3. Cost, or March 1, 1913, value. 3. Amount received. 4. Repairs. 5. Depreciation and aepletioa. 0. other expenses. 7. N«t proat (or loss). House .ipoo. 1000 00 360 00 00 30 .0.0 ...0 .66, 6 .67 00 110 125 Oi Oi Ol Ol .....1.53 - 90 .3.3 Garage .00 .40. 00 State estimated iile at prop4rty and how yoa jjgured depreciati aCHBDULE B.-EXPLANATION OF ITEM «. (Buein— or onHou sej-40 ?r s _Rat e 2 'ViS of valugJJl^.L ^L-L?-j:g.^ ToU) InMOMtniB BialBMi or PntailMi ________«. . . ........................... Total BustaMM Ktimbiw (itsUtpMltoDx, mo Instiucttan U) Kr P>om(oaUM*) (UpnatblMitiianasu>l,ozpUa).. 8510 16404 2105 1.0 60 60 ! Laxea.lQ.5.>^jejtaAxftJL4Q...^bad-.del>.tfl..ll9-..>ato&r_.exPii2a7^S&^iCQtaL^ SCHEDULE C.-EXPLANATION OF ITEM «. (S«l« of RmI Estate.) • '« 1. Klndorprop«ty. 2. DaU ■oqulrtd. S. Amount reoeiTed. 4. Coft 5. March 1, 1013, Talue. t. Subsequent ImproTenMota. 7. Depredation. 8. Net profit { 1, 1«13, vnhu. S. Depredation pravioutly taken. 4. Salvafi Talue. 6. Insoranoe. 6. Net loss. loss of Automobile by theft -.12.00. -QQ. Q JSiQQ.m 200 ..0.Q ,, 1 1 1 1 II 1-1, .„. SCHEDULE F.~EXPLANATION OF DEDUCTIONS CLAIIMED IN ITEMS 1, U, 14, mM»A 18.) Item 15-Tremont Temple 37e50 Amer>Leglon 50e Women's Auxe 25» jLt.e.ii.l4r:ir.iL.jabit^..-....AJOTy...^ ^ciieluI§..£.-^iQje.ftojgLt...Qt.^^^^ Jj6ss Inv J4ater.ials.l201.,50^pux,102 1. Are vou a dtizen or * 2. If you filed n return for jeeldent of the United voo 1»», to what C«« lector's -d^ ,,j.^y, l.Toao StotesT XJSta... office was it sent? JuQ.vl tPn^^..X4a^^.f.. 4. Was a separate If so^ state: (b) Name and address 3. Is this a joint return of husband v a r« and wifer XM S. . . 5. Were yoa married and living with husband ^^ ^ 6. If not, were you on the last day of your taxable period supporting one or more persons ^ *• or wifeon the last day of your taxable period? XbB living in your household who are closely related Io you by blood, marrl^e, or adoption? 7t How many dependent persons (other than husband or wife) under 18 years of age or incapable of self-support beeausa f\^ ^ mentally or phyacaily defective were reoeivinf their chief support from you on the last day of your taxable period? lfJl.il. S. State amount of dividends received 9. State amount of from domestic corpomtions (induding interest received on dividends received through partner- fCCCQ I n Victory Liberty e qa ships, fiduciaries, etc.) .^ t-gy-j?Jijii.V-. Loon 4J% Notes ... %.Qj»SP.W... 10. State amount of Interest received on other oblinUons of the United SUtes (except Liberty Bonds) on a principal /\ in excess of S5.O0O $ U. I 8WKAB (or afllrm) that this retara, including the accompaQ ving schedules and statements (if any), has boon •zamined bv me, and, to the best of ray knowledge and belief. Is a true and co mple ta return, mado in good faith, for'lho taxable period as stated, pursuant to the Revenue Act of 1931 and the R^ulations issued imder authority tbereoL OlNtaniis by t. Mwt b* ststod oo «kto Hm.) ■ ^^^■■••■•»'i Sworn to tad tubaolbed bafora ma tlilf . .day of. .,1922.< •CiadhrldMlor .) Ml-* •C «C«ct ■•Im't'atrrriaa Oftih.) (TiUv.) rotum must bo plidolf martoad *9 tho cl ladividusl sr •ff tiM vattini.) >-4M The following items received by Mr. Turner are not taxable: Military bonus from the State, salary earned by the wife from the State or its subdivisions, stock dividends received, insurance re- ceived as beneficiary, and the value of property received as a gift or through inheritance. Therefore, Mr. Turner does not report as taxable income the following amounts: - $100 from the State, $100 a month for 5 months received by wife from the City of Boston, $200 in stock dividends, $3,000 in insurance, and $5,000 in real estate. The taxpayer's military salary received for the year 1921 is taxable under the new law. The wife's salary from the Morgan Me- morial, a charitable organization, is taxable, for although such organization itself may be exempt, earned salaries received there- from are taxable. Turning to page 1 of the Return, it is made out as follows: The taxpayer's military salary and the salary of the wife from the Morgan Memorial are placed in item 1. Bank interest received is entered in item 2. Partnership income is entered in item 3. The partnership shows a profit of $6,174.50. Included in this is $29.50 interest on a 4f% Victory Note, which amount is subject to the Surtax only; also included therein is $120 interest received on 2% tax-free covenant bonds. The partnership must first submit to the Government a Return of Information. In this Return of Information will be shown the fact that the total profit of the concern was $6,174.50. It represents several kinds of income as follows: $29.50 interest on 4f% Victory Notes, $120 income on 2% tax-free covenant bonds, and $6,025 ordinary income. The partnership information return also then shows that the taxpayer, Mr. Turner, has been assigned 1/5 of each kind of income, so that he should report $5.90 interest on 4-1% Victory Notes, $24.00 interest on tax-free covenant bonds, and $1,205 ordinary income. As the $5.90 is subject to the Surtax only, it is reported as a matter of information at the bottom of page 2 of the Return. The other items, $1,205 ordinary income plus $24 interest on 2% tax-free covenant bonds, are reported in item 3 of the Return, the total being $1,229. It is permissible for the taxpayer to report $1,205 in item 3 and the $24 in item 8 under other income. Item 4 records income from rents and royalties. The tax- payer received rent on the house sold by him Sept. 1, 1921, the amount being $360, or $45 per month for eight months. This amount is reported on page 2, Schedule A, along with any expenses which are deductible against the rent. In Schedule A, Bracket 4, the taxpayer reports the repairs on the house, and, in Bracket 5, the depreciation. In Bracket 6, he shows the $90 taxes and the $20 in water bills, or a total of $110. The repairs, depreciation, and other expenses are then subtracted from the rental income and the net gain from rent received, shown in the last column of Schedule A. As a matter of information, the cost of the house is entered in Bracket 2 of Schedule A. In the same Schedule, on the next line. the taxpayer shows the two months' rent of $40 received on the gar- age erected by him in 1921. He also reports the $5 depreciation in Bracket 5. In Bracket 6 are shown other expenses, which in this case include $25 in taxes and $100 loss through fire. This loss is obtained by taking the cost of the garage - $1,000, and subtracting the $5 depreciation, leaving a value of $995. Insurance to the ex- tent of $895 has been received, there being a final loss through fire of $100. The net loss on the garage is then shown in Bracket 7 of Schedule A. The rental income from the house less the loss on the garage, or $63.33, is then transferred to item 4, page 1 of the Return. Item 5 records income from a business or profession. Mr. Turner's typewriting business is reported in this item. A profit of $555.50 is shown in the problem. Mr. Turner has taken $1,500 salary and a $50 bonus out of the business. If these ajnounts are deducted as expense, they should be reported as salary income to Mr. Turner in item 1. Preferably, salary to a proprietor from his own business should not be deducted and then reported in item 1, but should be omitted from both items 5 and 1. If not deducted from the income, the profit is increased from $555.50 to $2,105.50 (after adding $1,550). Item 5 is so reported in the Return. Item 5 is supported by Schedule B of page 2. In this schedule the taxpayer merely shows the total sales less cost of goods sold and other expenses, giving him the net profit for the business. In the same Schedule, and if necessary in Schedule F, the various business expenses are then itemized. Item 6, page 1, reports income from the sale of real estate. In the problem, the taxpayer purchased a house for $3,800 in 1910, which was worth $4,000 in 1913. As explained in Lecture 3, the latter value is used as cost in determining profit in this case and also in computing depreciation. An amount of $200 for better- ments in 1921 increased the cost of the house. It was sold for $4,110 in 1921. Depreciation at date of sale amounted to $850, computed as follows: 2% on $4,000 for each year, or $100 a year; depreciation for 1913, ten months, $83.33; for 1914 to 1920 inclu- sive, $700; for 1921, eight months, Sept. 1, $66.67. Summarized, the figures show: Cost, $4,000 plus betterments $200, total cost, $4,200, less depreciatiofl $850 - value at date of sale $3,350 ($4,200 less $850), sale price $4,110, profit $760. This infor- mation is then shown in Schedule C in the following order: first, the date is given, then the sales price, then the March 1, 1913, value plus improvements, followed by a subtraction of the depre- ciation, giving the net profit of $760, which amount is then trans- ferred to item 6 of page 1. Stock sold by the taxpayer cost $990 (10 shares at $99 each), to which is added the brokerage commission of $1.50, giving a total cost of $991.50. He sold the stock for $1,020 (10 shares at $102 each), but before receiving payment, the broker again deducted $1.50, so that he received $1,018.50. He reports the purchase and sales prices in Schedule D, page 2, as shown, the profit being $27. This amount is then transferred to item 7, page 1. Items 1 to 7 are then added, giving the total income of $4,855. As previously explained, page 1 of the Return, lines 10 to 15, records personal deductions allowed by the Law. The taxpayer paid out in interest $60 on personal loans and $30 on a mortgage on his private residence. These are both deductible and reported in item 10, page 1. The taxpayer paid out in taxes, not already de- ducted in Schedules A and B, the following: $50 property tax on private residence, $5 poll tax, $20 State Income Tax, $40 Federal Income Tax, $20 license fee on stolen automobile not used for busi- ness, and $7.50 on amusement and soda taxes. All these are deduc- tible, except the $40 Federal Income Tax, or a total of $102.50 in all. The amount is placed in item 11, page 1. The taxpayer's automobile was stolen; cost new $1,200, in- surance received $1,000, loss $200. This is reported in item 12, page 1. Losses incurred in business are deductible, also other losses, provided they are the result of fire, storm, casualty, theft, etc. The taxpayer loaned $38 to J. White, in the army with him. If it can be shown that such a loan was a strictly business one which the taxpayer in the course of time expected to be repaid, then the amount may be deducted. Any of the deductions requiring supporting Schedules, such as items 12, 13, and 14, are then supported by Schedules E and F of page 2, as shown in writing the Return. The total deductions are then subtracted from the total income, giving the taxable net income, which appears in item 17. At the bottom of page 1 the tax is then computed. The tax- able net income is transferred from item 17 to item 18; from it are subtracted exemption credits allowed the taxpayer. The taxpayer is supporting a wife and child, and is, therefore, entitled to $2,900 exemption; $2,500 as a married man supporting a wife, and $400 for a child under 18. This amount is subtracted from the net income, giving the balance subject to the tax. As the taxpayer is getting less than $5,000, the amount is taxed at the rate of 4%, giving a tax of $54.48, the Normal Tax of the taxpayer. However, the amount paid for the taxpayer by the debtor cor- poration against which his partnership holds bonds, amounting to 48 cents (2% of $24 included in partnership income) is now de- ducted from the Normal Tax. That is, the corporation, as already forwarded to the Government, has advanced payment of income tax for the taxpayer, 2% of the amount of interest paid on its bonds. When the 48 cents is subtracted, a balance of $56 remains, which is the normal Federal Income Tax of the taxpayer. Certain minor information is requested at the bottom of page 2 and from the answers given, they are practically self-explanatory. As noted at the beginning of the problem, the stock dividend sheet of the taxpayer is not taxed. The cash dividend received by him, ampunt- ing to $539.10, is subject to the Surtax only. As the taxpayer is not in the Surtax class, this amount is entered as a matter of in- formation at the bottom of page 2. LECTURE 5. Questions to be Answered. Compute on Form 1040 A, the tax of Mr. J. J, Right, 240 Tenth Ave., Brooklyn, N. Y., who supports in his own home a wife, one daughter age 19, and another age 16. He reports on an Accrual Basis, submitted a return from the same address as above last year, and states that no separate income has been received by his wife. Mr. Right has a 50% interest in a partnership, which during the year made a profit of $5,280, of which he has received $2,000. Included in the $5,280 is income of $100 interest from $2,500 worth of Second 4% Liberty Bonds. Mr. Right received a salary of $1,200 from the partnership, which amount was deduc- ted from its profit before reporting $5,280 as its income. The taxpayer owned a garage from which he received $800 in rent during the year, and paid out $40 in taxes, $75 in repairs, and $25 in incidentals. He owned a $500 bond on which he received $35 in interest, and $500 in stock on which he received a dividend of $25 Dec. 24, but which he has not yet cashed. He received in baidt interest $15. He paid out the following during the year: New York State Income Tax, $22, Federal Income Tax $40, Interest on Personal Loan $15, Interest on loem to assist in purchasing Bonds owned $20, Donations to his Church $30, to the Red Cross $5, Salvation Army Christmas Fund $5, Fraternal Dues $20, Labor Union Contributions $10, Special Fund for Assistance of City Poor $12. He claims that about $8 represents war taxes paid by him on baseball tickets, soda tickets, theatre tickets, etc. He paid dues of $10.00 for the year to Post 200 of the American Legion, and also contributed $25 to the organization as a gift. -47- LECTURE 6. Preparation of Form 1040. Income Tax Return of Individual with Net Income of more than $5,000. Form 1040 is used in preparing the return of an individual with net taxable income in excess of $5,000, which is subject to both the Normal Tax and the Surtax. It consists of six sheets: pages 1 and 2 of the Return, 1 and 2 of the Worksheet, and 1 and 2 of the In- structions. The latter are important and shbuld be read. Form 1040 closely resembles Form 1040A, already explained in Lecture 5. Any differences appearing on it are due to the fact that a Surtax must be computed on income in excess of $5,000, and to the fact that a greater amount of information is demanded of those who are subject to both taxes. Page 1 of the Return closely resembles page 1 of Form 1040A. Instead of items 1 to 8, there are items 1 to 10, the difference being due to reporting dividends on stock and taxable liberty bond interest, which two amounts are subject to the surtax only. The deductions beginning with line 12 are the same as in form 1040A. The total tax is computed at the bottom of the first page, as in the case of 1040A, except that any dividend income or taxable Li- berty Bond interest are first subtracted from the net income before computing the Normal T€ix. Page 2 A to D cover detailed figu Schedule F of for reporting uling taxable porting misce same for both for reporting f the Return contains Schedules A to G. Schedules the same information in each Form, except that more res are required on these Schedules in Form 1040. Form 1040 is used in place of Schedule E of 1040A. losses. Schedule E of Form 1040 is used for sched- Liberty Bond interest. Schedule G is used for re- llaneous Schedules. Briefly, the Schedules are the except that Form 1040 has an additional Schedule Liberty Bond interest. Problem showing Use of Form 1040 and Containing Illustrations of the New 1921 Revenue Act. Mr. Louis J. Wright, Architect and Engineer, 125 Broadway, New York City, submits the following report to your office, and asks you to prepare his Return: Professional Fees received and accrued for 1921 - $27,500. Office Expenses: Salaries $14,410, Rent $4,000, Uncollectible Fees $300, Stationery, Drafting Supplies, Postage, etc., $1,200, Light, Telephone, etc., $125.04, and Traveling Expenses $597. Office Equipment cost $2,000 in 1917 and will last 10 years. A salary of $5,000 paid to the taxpayer is included in the $14,410. The taxpayer is an active partner in the partnership named Joslyn Construction Co., New York, Construction Engineers. He has a one -third interest, and has received a salary of $3,000 from the concern, which, after deducting partners' salaries, reports as follows: Profits for 1921 - $36,957; included in profits is $297 interest on 4-| Victory Notes purchased during the year, $303 in- terest on tax-free covenant bonds owned by the concern and $120 in cash dividends. The partnership books show that the profit for the year was obtained in the following manner: Contract Fees Less: Cost of Contracts Gross Profit on Contracts Plus: Other Income Interest on 4|% Victory Notes Interest from Bank Deposits Interest on tax-free Covenant Bonds Dividends on Stock Total Income $297.00 50.00 303 . 00 120 . 00 $275,670.00 200,000.00 75,670.00 770.00 $76,440.00 Less : Expenses Salaries to Officers Repairs on Equipment Taxes Bad Debts Depreciation on Equipment Miscellaneous Expenses Net Profit $9,000.00 500 . 00 3,000.00 2,500.00 4,000.00 20,483.00 39,483.00 $36,957.00 The taxpayer owned three pieces of land on January 1 1921 He sold one lot for $14,000, which had cost him $11,500 in January 1909, and was worth $10,500 on March 1, 1913. He owned a second tract located in Fcance, on which he paid a land tax to the French Government of $25. He owned a third plot, valued at $10,000 which was leased January 2, 1921, for ten years. The lessees immediately erected a building thereon during 1921 at a cost of $15,000, of such material as to depreciate about 2% a year. His rent income for the land was $1,000 a year, and his taxes thereon were $170 The taxpayer also received a salary of $3,000 as Consulting Engineer for the City of New York, and the following other income: Interest on $15,000 Liberty Bonds Z\% Interest on $15,000 Liberty Bonds 4th 4^ Interest on $15,000 Victory Notes 3f% Interest on $15,000 Victory Notes 4^% Interest on City of Boston Bonds, $10,000 Interest on Federal Farm Loan Bonds, $5,000 Interest on tax-free covenant bonds Interest on bonds Interest on bank deposits Dividends from European Products Co. of England Dividends from Michelin Tire Co. of France Stock Dividend, Cadillac Motor Co. Cash Dividend, United Steel Stock $525 . 00 637 . 50 562 . 50 712 . 50 600 . 00 200 . 00 200 . 00 37.00 250 . 06 225 . 00 400 . 00 200 . 00 100 . 00 His records on United Steel Stock were incomplete, but he vouched for the following transactions: Purchased United Steel Stock as follows: 1914 - 80 shares @ $100 per share; 1915 - 200 shares @ $90 each; and 1918 - 140 shares @ $180 per share; sold in 1919 - 60 shares @ $130 each and in 1921 - 120 more shares for $125 per share. Which particular purchases he sold, he could not ascertain. He received Standard Oil Stock as a gift in January, 1921, from a relative. The stock cost the donor $8,000, had a market value of $9,000 when received and the donee sold it for $8,000 in 1921. He also owned $60,000 worth of United Drug Bonds which he sold on December 20 for $54,000; the price of these re- mained unchanged and he bought $27,000 worth on January 10, 1922 - face value $30,000. He paid out the following: $18.43 income tax to France, $272 income tax to the State of New York, and $1,120 Federal Income Tax. He gave out the following donations: Colgate College, $1,000; Post 48 American Legion, $200; Various churches, $500; Land to the City of New York for a public playground, $2,000; the Carnegie Foundation, $300. He also paid $37.00 in sundry consumers' taxes, etc. He purchased an $8,000 automobile during the year, the li- cense costing $20. It was purchased on installments and the in- terest on deferred payments was $40. He exchanged the auto later in the year at a loss of $3,300. He is living at home, supporting a wife, a child age 10, and a dependent mother age 60. He operates on Long Island chiefly for pleasure a small farm, which cost him in expenses $1,000 for the year. At the race tracks during the year the books show that he won $11,000 and lost $10,900. He lost approximately $500 in base- ball bets. His tax for the year 1921 will be found computed on the next three pages, using Form 1040; explanations of the solution of the problem are on the pages following. 1*40 U. 9. ImrmMMAL Rir iwot IF RETURN IS FOR CALENDAR YEAR isa nu IT WITH THE COLLECTOR OF INTERNAL REVENUE FOR YOUR DISTRICT ON OR BEFORE MARCH IS. im IF FOR A PERIOD OTHER THAN A CALENDAR . YEAR THE RETURN MOULD BE RLED ON OR BEFORE THE 15TH DAY OP THE THIRD MONTH FOLLOWING THE CLOSE OF SUCH PERIOD -50- INDIVIDUAL INCOME TAX RETURN IM m INCOnS W Mil THAN SM 01 SEPAlin tnONS OF BDSUND A» WIFE IF COMB^ FOR CALENDAR YEAR 1921 Or for period iMgun ., It20, and •ndcd .»lttl MUNT NAME AND ADDRESS PLAINLY BELOW -XQUl8„J*-..frlght- _12SL.3rjoad«i|^ (> •rniml Ji JI|lf_YiQri^a..J3U- (O— Ky) DiMliRltoh«is FUSr PAYMENT on cm B.e. cin.''*''!S tnxm±rAA..aox£Lnajat^ t»)J&iYMfiMft_jcaL--ato.o]L.Al_iQrAl«n.Jlttr.px^^ («)jQ§fflLbliQg_Salafl . — fiooa .zoQa .287. -12079- 00- ..2500. -loaa JBIL .301. AQ.9... .1.0.0.. oa. 0£_. 00- .7a_ 00- OOl oo_ 50 00- 00- IL toux Ihooiis m Itvh 1 to 10 (lam loaaaa ahown tharoin, if any). DEDUCTIONS. IS. lataNit ^aid (not indndiac intareat daductad abora) IS. Taxaa Bud (not indoding taxes dedoeted above) _..____.__.._ 14. liomss by Ria^ Stem, ate 15. Ooatribntiona. - Ifi. Bid Dabta (not iaduding bad dcbu dedoctad ahora) . IT. Othar DadnctioBB Aathoiisad by Lav .4a ^5A. QQl. OOl .4000. POj 0. ...0. u. Total of Itkim 13 to 17 War IwcoMi (Item 11 minaa Item M) .40144. -42£4 It afiOfiD-i.5a -SSL QSL COMPUTATION OF TAX. ». Rat 21. 21 (Itaai If abora). Dividends (tUn 8 abova)._. Tkzable Intereatoa Liberty Bonda, etc. (Item 9 above). Personal Exemption and Credit lor Dependents I-„J3j&5.. 2800 .00. 50j 00 M. Total, or iTiMa 21, 23 and 23 . 25. Balaaee (Item 20 minns Item 94). 26. Amount taxable at *% (aot over 94,000) -i7. Dalanee taxable at 8^ (Item 25 minus Item 26). flfiOSO .5SL7.6L .3207.3. .....4000. A zmi^ Cheduand drafts will ba accepted only if payabU at par. 3a 5a_ 28. Normal tax (*% of Itam 2f) 29. Noraal tax (8^ of Itam 27) Ba_ 00- 99. Swtax on Itam 20 (saa Instructioa 6) 91. ToTAi. Tax ..._-_—._ 32. 33. Tax paid at aoureo Income and (rofita taxaa paid to foreign countriea orposseasiomsof tha U. 8. (attach Form 1116) ..ia.43. 34. Balance due (Item 31 minus Items 32 and 33) 35. AiBOOBt of tax paid when filing return ^60. .2245. 2718. 312A. JE14 .31QQ. -oa _9a .45. 45. ..oa -51- tagPOH A^-BXrOUUTIOIt or mU 4. ,yUnU aBd RoylU— .) ge»lMtn»rtleall Xand « T.ftftBfld. t.Oon.tm1itmm l.lMiV4L0B. ■E r o pft rt y -jp l a oftd on Lan d^Pre a^gottl J^iaoJJfejjd^yaltta AmnrtlMdml yniir JiAtal. RacnrsD. ..QUQ2..7.a ^02 .£14. 4. BlTAIH. iX.r il & DtrascuiHui AID DmCIMM. a_i uc •.OVBB SiO. .7.Q..0.Q. 7. NnVKMtr sza fi7QQ J1Q2. -J^352. XKX J2:4- J14. -7.8.. fiuie wtimatod life of propwtY md how yoa iiL SCHEDilLE Bw-EXPtANATION OF ITEM f.. (W iwInoM or LS^ lB(tnieUoal«w 1. ToUl inooiiM (roga hiwin— or ptofwriBB. CcwT 09 GooM Soto: 127500.. 3.1lat«udMdMppU«. 4. MoiclMiidlM bo«|^ for ak. >UMr coaU (Ikt peine bolow or 00 Mpukto i t. Othor coaU (Ikt priadnl itema and amouata ' labaat) t. PIm lavaatory H haginnh^ «l jtmt. 7. ^»»*«- t. Lap iBvankty it «d of jraar. t. NaT Gear ov Good* 8oldl._ Oimsa BonxiM DBocdnoiia: 10. Salaciaa tad wira not reported aa "Labor" OB line 2 (aaalnatniction 13) 11. Bant on bunneaa property in which t&xpayer haa no aquity IS. lataroatonboiinaaaindabtadnaMtootkaia^ t.U4in 4000 tS. Taxaa on bnajnaaa and burinaaa property 14. Repaiia, wear and tear, obaoleacence, deple- noo, and property loaea (explain beiuw) . 16. Bad debta ariiinc from aalea or aervieea, il already reported aa income 17. Other expenaaa (liat principal itema and IS. below or on aepaiato ahoct). TOrai. (Itank 10 to 17, induaive). JDOJ 00 .2QQ. 9.8S 1.-20832 _JQ 00. .0.4-.- -Q4- oo. \$2QQ2i2JjA^ It. Nte Coar, rtoa Total DioocnoNa (Item f plua Item 18) ao. Nt PaoFTT (on Loee) fwom BuaiMBee oa Paoraaaioif (Item 1 minua Item 19).. k-M&l ExplaaatJonoldadactJonaltflflB 17i Qthar ETTflnBflfl; StatlOTlflry jc Drafting -Suppl-ifta :pi>.nn,nn. l-tgh-t: ftn«^ Telephone $125eQ4; TrnYflllng KTpQnflefl..^a7.jaa Itflm„L4m.J>etzrfixilJa±loiL.JQ-;^ ot .<^gQQCLOjQ_ SCHEDULE C— EXPLANATION OF ITEM •. (Sale of lUal Ertato.) Bmhatnctica n. Land. ISitSl. xntm 1909 I 14Q00 I. AMooar joa oiaoa QQ_i_io5oa 4.0oat. JLi5jaQ_Qia ft. Kabci t, 1»U, VAtPt. JiO- JiJJiQfl.Qft 6. SOMCQVSMT iMraovKMuna. ^JX 7. DtrsacuTiox. t ZbQO.aQ^ a Nrr PBoriT (OK hOSf). 2500 00 Ifnotaeqn ■■■■■»-■■■ ■ .. .J 1 .. »..■.. . . ................... , SCHEDULE D.-EXPL4NATION OF ITEM 7. (Sale of Stocka. Bond*, etc.) Bm Instnictioa is. UKm.<»Tmmmf. Jt^Ata lOoai. 4. Uabch 1, UU, Vautk. •. AMOUNT Racitvco. a. HRPkorrr (obLom). St Oft V - TTnltftA ^-fcAAl 191 4-1 S l-llOOil 00 t - e 15000 OO s~40oa- iX)_ "Uty-n^t^ .- TTnl-fcA^ •nr^aflp 1920 -JjaOQQ -no.. •• . SlQflQ 00 - 9QQ0.. 00 Total 41000 jQa. , II ^, , ..JiZOQO 00 ..,,1000 00 If not acquired by purd>ai», atate how acqnited- SCHEDULE E.— EXPLANATION OF ITEM f . (Taaable Intereat on Uberty Bonde. etc.) Ba. lnstmcttai i». L OBUOAiwmofTinrmmBrATnlMutBSaKcSimmcal, 1*17. (WkoOy tttapt iromiMcnel tax, but MO^Kt t« airtax M to wHMi ovw •MmfKiflos lyMMM.) (a) lint Liberty Loan Second Converted Hfk Booda . .MOHB.. (») Fkat, and Second 4*4, and Fiiat, Second. Third, and Foiiith4i'8 (e) OthtrOblifftionaiawad Mace September l.M17(«wp«Vi»tey and T i iMai y lfaiw). (d) Victory liberty Loan 4|K Nolaa^ and T ^ eaa q ry Kot w («) ToTAi. Taxabm IwT«B««t (If you have boo^t or aold during the year attach atatement ahowing holdingi by poriods). Kxtamom. (Aap«sM« Prindpal Amooat.) .NONB_. .NOMI s.im,oaa. 15000.00 .JfONB. S. PBIMOrAI. Amouht m ExcEM or Ex- mmom SracmiD m Coivinna,t,AMD4. •. IirrucaroN Vuk- OTAL Amount IN Excua or ExEMnioMa. .JLIQM^aU .JBll L JSjl ..30. 30. SCHEDULE F.— EXPLANATION OF ITEM 14. (Loaaee by Fire, Storm, etc.) 8m lostmcUoo n LKl »etF««»r. lOoar.oaMAaca l,»li,VAi.oi. t. DKncaxTioN PasnooatT Takim. 4. Saltaob Valub. K. InvBAjtca. •.NatLo Hone p 1 ... t. 5. t-JSQX^ SCHEDULE C— EXPLANATION OF DEDUCTIONS CLAIMED IN ITEMS 1, 18. IC, AND 17. J&age._Iii» I te m .13».-Taxeg^. H. Ye Stat e Inoome -.2ax-^27.2^.QQ^ Land -T.ax-gxftnoe-$^5.>.QQ JLaLtomoMle..I«ljaenaa..(.Tax).-42a»QQ^...3ttndr.y-^oa8ttner-8..Ja3caa.-43-7.-Oa..«...TAtal...$3^ JagA. J.^ Itfim»15-Coatr.llmtlona ; cl.tyi..o:f ..|taw..:yor]t.-;;^i3tQ»O0.;-.Calgate.-Col-leg».4lQQQ*QQ • ■ Chttrohea $500 > 00; Carnegie goundatlon ^QO.QQf..iU) , ■■ DEDUCTIONS 13. Ordinary and neceeaary axpenaea (except amounta reported in Item 2 above or caOad for aaparately balov) (from Schedule 75-670- 00 -0 J2971|.-0a 353.!.00 Q ._.o i2a|.oo A13). 14. Gompensstion of members (including shareholden cf personal service corporation irti( commitaions, and other compensation in whatever form paid) (from Scnedule A14), m irtio drew salaries therefrom and aalariea, 15. Repairs (including labor, supplies, etc.) (from Schedule A15). le. Interest (from Schedule A16)„ 1?! Taxee 'except Federal income and profits taxes, and taxes which are a credit under Section 222 %Not«i oiim-a. Wer Fiiunre Corpontioo .■)% Bonds ol ItlO. DfCMDbsrlS. Maris. NoTtmbOTlS. JoMtL DsrcabwlS. Utrli. SvnmtmiS. U«rrhl&. Bapttmbsr It. JonalS. DfccBbcrlt. AorlK. OeUbmlS. June IS. April 1. Ocioberl. Amount of interest— i__ ._a.. 1 a 8 a-. 8 .0. 8 X^. 8 0- [..... 0„. 8 . ...a 8..297.»0a~ 8 Total iNTEREar ow All OBUOATiONa ab Showw Above (to be entered as Item 4, Schedule A, and distributed in column 5, Schedule C). Bute the amount of Victory Liberty Loan Si% and 4{^ Notes originally subscribed for and still owned st the date of filing this return... Bute the amount of Fourth Liberty Loan 4\% Bonds orupnally subscri b ed for and still owned at the date of filing this return.. f „297-..Q0 8- 8.. None SCHEDULE C-MEMBERS' SHARES OF INCOME, ETC. Enter below the share of net income (whether distributed or not) of each member of the partnership or shareholder of the peraonal service corporation, and each member's share at any income and profits taxes paid by the partnership or corporation to a foreign country or to a po«eesicA of the United Sutes. (See page 1 of instructions, paragraphs 10 to 14, inclusive. ) If the dwtribuuble intereats in the net incomo are datanBined on a haaia other than a percentage basis, attach an explanatory atatement. Membsrs of partnenhip or thsreholden o( penoasl (errtco corporttloa. I. NsoM and sddreee of each, u itaowa en tadlTtdnsI tax rttums. {«) (c) («0 .-.J"o»Iy3V.-BrQoklyn^...H*_Xo. _J*...iQil.teL,„Long.-I«lftnd^-JIw-:X^ .-J^_Erlght ».-l!fiB...3gbrk»...y^jy^. ••nklp at OOB- Wr«f iUfMkaM Vs- I— 151 — 50- • -1/3. 1. Intetert on Tss- Free Cofsaaat Boo* hieia4*. atmm *.-■ ■ A.) .so8._iaii«- ^0 OOl- 6. obisr 6039. -l2jQ7S._ba 5a 60- 7. Ineoms snd profits tazat paid to • lordcs ooantrrortos ■Ian olib»V. -I-- -1—0 (MfMturs •( emcsr sdalautariac oatt) Prtndent ofeorpontion. Membtr of partnenhip. (0»«is)sspasHy) Trmnmrqfcorfongm, As in Form 1040 A, the taxpayer's income from salaries is re- ported m Item 1, page 1, income from partnership in item 3. and income from his ovm business in item 5. As explained, both the proprietorship and partnership businesses have deducted the tax- payer s salary before reporting the net income. Consequently, in this case it will be necessary for the taxpayer to report the *= «^i®^ ^^°"' these two sources in item 1. Therefore, both the »5,000 income and the $3,000 income are reported at this stage. His salary as Engineer for the City of New York is not taxed. In item 3, the taxpayer's proportion of the ordinary partner- ship income IS reported. From the profit and loss statement in the problem, it appears that the partnership earned $36,957. However J^is income included $303 interest on tax-free covenant bonds $120 in cash dividends, and $297 in Victory Note interest. It is necessary for the partnership to submit a report of information, after which the taxpayer reports his distributive share of the various kinds of income received by the partnership. This report of information is shown as part of the Lecture. First of all part- 2II^S^S records his profit and loss statement, showing income 'of »36,957. At the bottom of the page of the partnership Return, this income is then broken up into its various parts, and each partner assigned his distributive share, regardless of the profits he mav have drawn out during the year. *u- J^^ taxpayer's share of the profits in the problem is one- third; assume that two other taxpayers are to receive one-half and one-sixth of the profits. The report would show that one-third of the interest on tax-free covenant bonds has been assigned to the taxpayer, Mr. Wright, and that one-half and one-sixth of this in- terest has been assigned to the other partners. Also, one-third of the dividends received and all the interest on Liberty Bonds would also be assigned to the taxpayer, while the other partners would receive their distributive shares. The balance of the income would then be divided among the partners according to their fractional interest in the partnership. Thus the total income of $36,957 would be broken up into $303 interest on tax-free covenant bonds, $120 dividends on stock, $297 interest on Liberty Bonds, and $36 237 or- dinary income, with each partner receiving his distributive share of each kind of income. This may be best understood by a careful study of Schedules A and C of the photographic partnership Return. The partnership having made out the above Return, the taxpaver then reports his one-third of the income in item 3, page 1 He reports his one-third of the dividends in item 8, with other divi- dends received directly by himself, and reports his share of the Liberty Bond interest in item 9, page 1, with any taxable Liberty Bond interest received on bonds owned by himself. Finally, he re- ports his share on tax-free covenant bonds in item 10, line A of page 1, with any other such interest received. Regarding the proprietorship business, the taxpayer reports the income from this in item 5, page 1. This item is supported in detail by Schedule B, page 2. This Schedule is self-explanatory. and is practically a transcript of the profit and loss account of the taxpayer. The foregoing completes the writing of items 1, 3, and 5, income from salary, partnership and proprietorship. Item 2 of the taxpayer's report shows income from interest. In the problem, interest has been received from various sources; however, certain amounts are not taxable. Among these will be interest on 3i% Liberty Bonds, 4^% Liberty Bonds, 3f% Victory Notes, City of Boston Bonds, and Federal Farm Loan Bonds. Interest received on bank deposits and interest received on bonds should be reported in item 2, the total being $287.06 ($250.06 plus $37). The taxpayer also received $200 interest on tax-free covenant bonds. This amount is entered in item 10, line A, together with the $101 interest on tax-free covenant bonds received from the partnership, the total being $301. Item 4 reports income from rents and royalties. In this case, the taxpayer leased a piece of land and received therefrom $1,000 rent. His taxes on the property amounted to $170. Both these sunounts are reported in Schedule E. Schedule E should also include amy income accruing to the lessor of property through the permanent attachment to his land of buildings, etc. In this case, the lessee of the taxpayer's land has erected thereon a building worth $15,000. The new rule for the handling of this item is, that the taxpayer reports as income in the year in which such permanent improvement was placed upon his land, the value of the new property as encumbered by the lease, or the difference between the value of the land without the building, and the value of the land with the building, the build- ing being subject to a lease. Ordinarily, this means that the lessor reports the value of the property in 1921 at its depreciated value in 1931 when he obtains possession as well as ownership of the property. In the particular instance under consideration, the building cost $15,000 and will depreciate at the rate of 2%, or $300 a year, for the next ten years, and will be worth $15,000 less $3,000, or $12,000, in 1931. The taxpayer therefore reports in 1921 the value of the building in its depreciated condition when returned to him with his land at the expiration of the lease. However, by special decision, the Government has permitted the taxpayer to report the discounted value in 1921 of $12,000 to be received in 1931, or permits him to report the present worth of $12,000 to be received 10 years hence. The Government has not set any special rate to be used in computing discounted value, but, assuming 6% as the normal rate, $12,000 received at the termina- tion of the lease 10 years hence, discounted annually at 6%, has a present worth of $6,700.74. This amount is therefore reported as income from the property erected on the taxpayer's land. No depreciation is allowed against the $6,700.74, and presumably, (although the law is silent on this point) the discount value should be amortized each year from 1921 to 1931, bringing the $6,700.74 finally up to the taxable value of the property - $12,000. Depending upon the facts and the exact dates in a particular case, part of such amortized discount might be re- reported income in the present year. One year's ajnortized dis- count has been taken in the problem on the assumption that the building was immediately placed upon the land. Six percent of $6,700.74 equals $402.04, and this amount has been added to the present worth of $12,000 and reported as income. See Schedule A, page 2, of the Return. The foregoing completes the writing of items 1 to 5 and the filling in of the supporting Schedules A and B, on page 2 of the Return. Item 6, page 1, reports profit or loss from the sale of Real Estate. In this case, the land sold in 1921 but purchased in 1909 is reported. In this case, the land cost $11,500, was worth $10,500 on March 1, 1913, and sold for $14,000 in 1921. The 1909 value is used for cost, because, in computing profit on items pur- chased before March 1, 1913, the taxable gain shall not exceed the actual gain, and only that part of the actual gain assignable to the period after March 1, 1913. The actual gain is $2,500, the gain since March 1, 1913, is $3,500, the former being used. The sales price of $14,000 and the 1909 cost price of $11,500 are reported in Schedule C. Item 7 reports profit or loss from the sale of stocks, bonds, etc. In the case of stocks, where the information relative to a certain kind is uncertain, any sale of stock is charged against the earliest purchases first. In this particular case, it appears that the taxpayer purchased 80 shares of United Steel Stock in 1914, 200 more in 1915, and 140 more in 1918. He sold 60 shares in 1919. It therefore appears, that of the total purchased (80 plus 200 plus 140, or 420 shares) he has sold 60 already, these properly having been charged against the first 80 purchased, and he now disposes of 120 more shares. These should be charged against the remaining 20 of the first 100 purchased in 1914 and not yet considered sold, and the remaining 100 shares should be charged against the 200 pur- chased in 1915. The 20 shares purchased in 1914 cost $2,000 ($100 per share) and the 100 in 1915, $9,000 ($90 per share). Therefore, the total cost of the stocks sold in 1921 was $11,000. The sales price is $15,000. (120 shares sold for $125 per share.) #The in- come of $15,000 less the $11,000 cost is reported in Schedule D. The taxpayer sold $60,000 in bonds for $54,000, suffering a $6,000 loss. However, he purchased similar bonds within 30 days of the sale, therefore the $6,000 loss may not be taken (Act of 1921). However, if the amount purchased is less than the amount sold, a fractional loss is allowed. He secured $30,000 worth of bonds for $27,000; hence one-half the loss may be taken. Therefore Schedule C shows the cost and sales price of that part of the $60,000 sold and not re-purchased, or $30,000 sold for $27,000 (Act of 1921). The net gain in Schedule C is then transferred to Item 7, page 1, Item 8 reports dividends on stocks of domestic corporations. The taxpayer reports in this item the $40 in dividends received through the partnership. He also received cash dividends from the European Products Co. of England, the Michelin Tire Co. of France, and the United Steel Co., while he received a stock dividend from Cadillac Motor Co. Assume that the European Products Co. made over 50% of its profits in this country during the years 1918 to 1920. The stock dividend from the Cadillac Motor Co. is not taxed, and not reported. Cash dividends from the United Steel Co. and Euro- pean Products Co. are subject to the Surtax only, and are reported in item 8. Item 8 should, therefore, show a total of $365, as follows: $40 in dividends from the partnership, $225 from the European Products Co., and $100 from the United Steel Co. The div- idend of $400 received from the Michelin Tire Co. of France should be reported in item 10, line B; as dividends from a foreign cor- poration, making less than 50% of its profits in this country, are subject to both the Normal Tax guid the Surtax. Item 9 reports taxable Liberty Bond interest. First, Liberty Bonds owned are reported in Schedule B, page 2. This Schedule will show that the interest received on the $15,000 4^% bonds is exempt, while the $712.50 received on 4f% Victory Notes plus the $99 received through the partnership of 4-|% Victory Notes will be tgixed. Therefore, $811.50 will give the taxable Liberty Bond in- terest. As a matter of information, the taxpayer may show the amount of Liberty Bonds held, averaged for the year, by dividing .0475 into $811.50, giving $17,084.21. The taxable Liberty Bond interest of $811.50 is transferred to item 9, page 1. Item 10 reports miscellaneous income. Already, there have been placed in this item the interest from tax-free covenant bonds and the dividends received from stock of foreign corporations. There needs to be added at this time only the income from gambling. Regarding gains and losses through gambling, betting, and similar transactions, the general rule is, that illegal losses are not deductible and illegal gains taxable. However, an ex- ception to the rule is, that losses of a similar nature as gains may be used to offset such gains, giving a net profit for gambling in any particular line. The taxpayer, as the records of the race tracks show, has made $11,000 in race-track gambling, and lost $10,900. Instead of reporting $11,000 profit and taking no loss, he may use the $10,900 loss to offset the $11,000 gain and report only the $100 net profit. If the loss had been $11,900 instead of $10,900, the net loss of $900 could not have been deducted. The loss through baseball bets is not an allowable deduction. The total of items 1 to 10 is placed in item 11. From this is subtracted personal deductions in lines 12 to 17. The taxpayer paid $40 in interest on deferred installments when buying his automobile, and may deduct the amount at this time. He paid out in taxes the following sums: New York State income tsix $272, sundry consumers' taxes $37, land tax to the Government of France $25, and automobile license $20; total $354. He gave out in deductible donations $2,000 to the City of New York, $1,000 to Colgate College, $500 to various churches, $300 to the American Legion, and $200 to the Carnegie -57- Foundation. The donations to the City of New York, the American Legion, and Carnegie Foundation are permitted starting with the year The total deductions for interest, taxes, and contributions is placed in item 18, subtracted from item 11, and the net income placed in item 19. The tax is then computed at the bottom of page 1. When the amount of income is transferred to item 20, Page 1, before the Normal Tax is paid, certain credits are allowed; these include the personal exemption, any cash dividends received, and any taxable Liberty Bond Interest. After these are subtracted, the first $4,000 of the taxable income is taxed at the rate of 4%, and the balance of the taxable income subject to the Normal Tax taxed at the rate of 8%. The two amounts are then entered on lines 28 and 29 of Page 1. The Surtax is then computed on the amount in Item 20, or $36,050.30. The Surtax on $36,000 is $2,710, according to the Surtax Rate Table contained in the Instruction Sheets. The amount in excess of $36,000, or $50.30, is then taxed at 17%, as per instructions in the Surtax Rate Table, giving $8.55, which amount is added to the Surtax on $36,000, giving $2,718.55 ($2,710 plus $8 . 55 ) . The two Normal Taxes plus the Surtax give the total indi- vidual income tax, or $5,124.45, from which are then subtracted the amounts paid at the source on tax-free covenant bonds, $6.02, and the income tax paid the Government of France, $18.43 - the the final tax therefore being $5,100. Any ordinary tax paid to a foreign government is deductible as expense, but an income tax paid to a foreign government is deductible from the final tax payable, reducing the amount of tax to be paid to the United States, In the problem, it has also been mentioned that the taxpayer received stock worth $9,000, but that it cost the donor $8,000, and that the donee later sold it for $8,000. The former rule was that the fair market value at the time the property was acquired was considered cost for the purposes of computing the gain or loss. The new rule is, that in the case of a gift the cost to the donor will be the basis for computing the gain or loss. As the stock cost the donor $8,000 and was sold for $8,000, there is neither a gain nor loss to be reported (Act of 1921). Under the old rule there would have been a loss. The Federal Income Tax for the prior year is not deductible, or the loss on the farm run for personal recreation. The loss on the exchange of the taxpayer's automobile may not be taken, as non-business losses are allowable only when they result from fire, storm, theft, casualty, etc. The loss on the sale of stock ac- quired as a gift is not allowed, as explained above. -58- LECTURE 6. Questions tc be Answered. Compute on Form 1040, the tax of Mr. J. L. Cross, 100 Commonwealth Ave., Boston Mass. He supports a wife and two daughters under 18, and his wife's sister, age 35, in the same household. He submitted a report last year on an Accrual Basis. The taxpayer is engaged in the real estate business, both as a real estate broker and owner of property. He reports the following transactions from his brokerage business: Commissions Received $52,450, Expenses: Salaries to Self $8,000, to Assistants $10,000, Office Supplies and Expenses $550, Adver- tising and Soliciting Expenses $2,200, Depreciation of Equip- ment $200, Rent $4,800, Losses on Bad Accounts $300. He sold two pieces of land owned by himself during the year. One piece was purchased in 1908 for $5,000, was worth $5,500. March 1, 1913, and was sold for $9,000 in 1921. Another was pur- chased in 1912 for $10,000, was worth $9,600 March 1, 1913, and sold for $12,000 in 1921. From property owned by himself and sub rented, he reports the following: Rents Received*$22,000, Expenses: Taxes $4,800, Depreci- ation $4,500, Repairs $2,100, Cost of Help $3,900, Incidentals $1,000, Interest $500, Insurance $600. On his own residence, not sub rented, he reports expenses as follows: Taxes $450, Interest $200, Insurance $400, Repairs $50. Income from corporation bonds amounted to $340, from Liberty Bonds - 4f Fifths - $475 and cash dividends from stock $510. He reports that he paid out a State Income Tax of $290, a Fed- eral Tax of $3,200, a Poll Tax of $5, Auto License $20, donations to Boston Athletic Association $100, Red Cross $100, Boston Uni- versity $500, and Y.M.C.A. $200. His wife gave $500 to Radcliffe College and $250 to the Boston Unit of the Women's Auxiliary of the American Legion. -59- LECTURE 7. Corporation Income Tax. Kinds of Taxes. Rates of Taxes. Corporations Exempt. Corporation Income Taxable and Exempt. KINDS OF TAXES: For the year 1921, two taxes are levied against the incomes of corporations - an Income Tax and an Excess Profits Tax; for the year 1922, there will be only an Income Tax. The Income Tax for 1921 is at the rate of 10%, and for 1922 at the rate of 12i%. An exemption of $2,000 is permitted corporations with incomes of |25,000 or less, while corporations with incomes between $25,000 and $25,200 are subject to a special exemption. An Excess Profits Tax is levied against income at the rate of 20% and 40%, after subtracting 8% of a corporation's Invested Capital plus an exemption of $3,000 from its profits. (For a detailed explanation of Invested Capital see Lectures 8 and 9) . RATES OF TAXES. COMPUTATION OF TAXES. For the year 1921, a corporation has an Invested Capital of $200,000 and a profit of $85,000. Its Income and Excess Profits Taxes would be computed as follows, first computing the Excess Profits Tax: Invested Capital $200,000 Income 85,000 8% of $200,000 $16,000 Specific Exemption... 3,000 Total Credit $19,000 Excess Profits Tax Income Credit 20% of Invested Capital $40,000 Over 20% of Inv. Capital 45,000 $19,000 Taxable Income $21,000 45,000 $85,000 $19,000 $66,000 The Excess Profits Tax is $22,200. Income Tax Rate Tax 20% $4,200 40% 18,000 $22,200 Income $85,000 Less Excess Profits Tax Credit 22,200 Income Tax, 10% $6,280 Excess Profits Tax 22,200 Am't taxed at 10% $62,800 Total Tax $28,480 EXPLANATION OF COMPUTATION: It is necessary to compute the Excess Profits Tax first, because the amount obtained is used as a credit against the income subject to the Income Tajc. In computing the Excess Profits Tax it is necessary first of -60- all to obtain the Excess Profits Credit, which consists of 8% of the Invested Capital, or $16,000, plus the $3,000 specific exemption, or a total of $19,000. The reason for this is that a corporation is allowed to make 8% on its Invested Capital plus $3,000 before it is subject to a tax due to making a profit in excess of a normal return from its investment. The corporation, therefore, is permitted to make $19,000 before being subject to the Excess Profits Tax. Next, 20% of the corporation's Invested Capital is found, amounting to $40,000. What a corporation makes above its Excess Profits Tax Credit and up to 20% of its Invested Capital is taxed at the rate of 20%. Therefore what the corporation made between $19,000 and $40,000 is taxed at 20%, giving a tax of $4,200. All that a corporation makes above a 20% return on its investment is taxed at 40%. In this case all above $40,000 and up to $85,000, or $45,000 additional income, is taxed at 40%, giving $18,000 more tax. The $4,200 plus $18,000 gives $22,200, the corporation's Excess Profits Tax. In order to compute the Income Tax, the income of $85,000 is used again. From this is subtracted the Excess Profits Tax of $22,200, leaving a balance of $62,800, which is taxed at 10%, giving $6,280. This is added to the $22,200, giving a total corporation tak of $28,480. (For additional illustrations of corporation tax computations, see Lecture 10). • Corporations Exempt. The following fourteen groups of corporations are exempt, each under the special conditions enumerated: 1. LABOR, HORTICULTURAL OR AGRICULTURAL ORGANIZATIONS, if educa- tive, instructive, and beneficent in character, if for the promo- tion and betterment of industrial and agricultural conditions, and if the net income does not inure to the benefit of any member. 2. MUTUAL SAVINGS BANKS, if having no capital stock represented by shares. A Massachusetts savings bank, otherwise exempt, with an insurance department, is still considered a mutual savings bank. 3. FRATERNAL BENEFICIARY SOCIETIES, ORDERS OR ASSOCIATIONS, if op- erated under the "lodge system" and paying sick, accident or other benefits to members or their dependents. 4. DOMESTIC BUILDING AND LOAN ASSOCIATIONS AND CO-OPERATIVE BANKS, if not run for a profit or if members share earnings on substan- tially the same footing. Where paid-up stock is guaranteed a fixed dividend, and the holders also share in the remaining pro- fits with the other shareholders, exemption is not allowed. 5. CEMETERY COMPANIES, if operated exclusively for the benefit of members. Where all lot owners are members and hold stock on which a dividend is paid and2;the stock itself is to be retired when the lots are sold, exemption is allowed. -61- 6. CORPORATIONS AND COMMUNITY CHESTS, FUNDS OR FOUNDATIONS ORGANIZED FOR RELIGIOUS, CHARITABLE, SCIENTIFIC, LITERARY, OR EDUCATIONAL PURPOSES, if (1) organized for one or more of the pur- poses specified, (2) exclusively for such, and (3) the net income does not inure to the benefit of any individual stockholder. The group includes societies assisting needy families, furnish- ing nurses, giving free instruction, offering lecture services, etc. It excludes societies publishing controversial propaganda, or engaged for part time in pursuits other than the above. 7. BUSINESS LEAGUES, CHAMBERS OF COMMERCE, AND BOARDS OF TRADE, if not run for a profit and if, in the case of a business league, the members have a common business interest. 8. CIVIC LEAGUES, if not organized for a profit and run exclu- sively for the promotion of social welfare. Where originally or- ganized for profit and now exclusively engaged in welfare work, exemption is not allowed. 9. RECREATIONAL AND PLEASURE CLUBS, if operated exclusively for recreation, etc., with no profits inuring to the benefit of in- dividual members. Where a hunting club continually sells timber for a profit on land it owns, exemption is not allowed. 10. MUTUAL CO-OPERATIVE AND PROTECTIVE ASSOCIATIONS, if not run for profit. Where incidental profit is received, as bank inter- est, exemption is allowed. This group includes mutual fire in- surance companies, co-operative telephone companies, mutual hail, cyclone, irrigation and similar societies, etc. 11. CO-OPERATIVE SALES AGENCIES, if the income, less necessary ex- penses, is distributed in proportion to the value and quantity of the goods supplied by the members. 12. HOLDING COMPANIES, if the income, less necessary expenses, is to be transferred to corporations in themselves exempt. 13. FEDERAL LAND BANKS AND NATIONAL FARM-LOAN ASSOCIATIONS if created by the Government Act of July, 1916. 14. PERSONAL-SERVICE CORPORATIONS, if proving themselves to be such, in which case the members report as individuals, for pur- poses of the tax. For 1922, personal-service corporations report the sajne as other corporations. To be entitled to exemption, any of the above corporations, except in group 14, must file an affidavit with the collector, showing (1) the character of the organization, (2) purposes for which organized, (3) receipt and disposition of income, (4) whether income is carried to surplus and distributed in part to members, (5) any other facts necessary to prove exemption, (6) copy of articles of organization or incorporation and by-laws. If approved by the collector, no further return of income is necessary. If any case is doubtful, the collector will obtain decision from the -62- commissioner. Once exempt, no further return of income is necessary, it being the business of the collector to investigate from time to time to see if the corporation is still entitled to exemption. All corporations, not specifically exempt, even though operated at a loss, must mai^e a return. Corporation Income Taxable and Exempt. Gross Income, Allowable Deductions and Net Income for Corporations. A corporation is taxed on its net income, which is its gross income less allowable deductions. Except in the case of insur- ance companies- and foreign corporations, gross income is practically the same. as for individuals. The following exceptions, covering gross income, may be noted: A corporation reports proceeds from life insurance policies, upon death of the insured, less any premiums paid out, as income for 1920, but not for 1921. Trustees holding property for a corporation must report profits from the sale of assets. Also, if a lessee pays interest or dividends directly to bondholders or stockholders through having leased a corporation's property, the amount so paid is income to a corporation although never handled by it. No income or loss results from the buying and selling of a corporation's own stock. Thus, if a corporation sells its stock at a premium or discount, no income or loss resulting is to be reported. So also, if a corporation receives Treasury Stock through purchase or as a gift, and sells it at a profit or loss, no taxable gain or allowable deduction results. If a corporation levies a voluntary assessment against stockholders, the amount received is not taxable income. If a corporation buys and sells investments in other companies, the gain or loss is to be reported for tax purposes. The buying and selling of a corporation's own stock is looked upon as a reduction or increase of the company's investment account, and is called a capital transaction, as dis- tinguished from the buying and selling of some other company's stock, which is called a revenue tretnsaction. Transactions relating to bonds of a corporation are classed as revenue, and resulting gains and losses are reported. Thus, if a corporation sells $100,000 in bonds for $110,000 the $10,000 is considered income to be prorated by the corporation over the life of the bonds. In the same way, if bonds are sold at a discount, the loss is to be prorated over the life of the bonds. If bonds are re-purchased before maturity date, then the differ- ence in purchase price over the remaining book value is loss or gain for the year of the cancellation of the obligations. Thus, a concern sold $10,000 in bonds for $11,000 under a ten-year is- sue agreement. At the end of the seventh year, the bonds were purchased by the company for $10,500. A loss of $200 results from the cancellation. The company treated the $1,000 premium as deferred income, and for each of seven successive years, reported $100 income in its returns. The bonds therefore had a book value of $11,000 less $700 at the end of seven years, or $10,300. They were cancelled for $10,500, giving a loss of $200. Deductions allowed corporations differ from those of indiv- iduals as follows: Only reasonable compensation may be paid offi- cers, and only for services actually rendered. What constitutes reasonable compensation depends upon all the facts in a particu- lar case. Rent may be deducted only if a corporation has no equity in the leased property. Interest may be deducted, except when paid on loans to purchase securities the income from which is exempt. A foreign corporation may deduct as interest only that proportion of all interest paid, which its income from the United States bears to all its income. All taxes paid, including special corporation taxes, are deductible, except local benefit taxes and income and excess profits taxes paid to the Federal Government. Ordinary foreign real property, privilege and other taxes are deductible as expenses, but income taxes paid foreign governments are deductible directly from the income and excess profits taxes due this country. A corporation reports as income, and then deducts as not tax- able, any dividends received from other American corporations, as defined. Dividends received by American corporations from foreign corporations which have made over 50% of their profits here for the last 3 years are not taxable. Amortization, depreciation, and depletion allowances are the same as for individuals. The 15% deduction for donations to charitable, religious, scientific and educational organizations, allowed individuals, is not allowed corporations. A corporation may deduct only those donations from which it receives a direct benefit, as, for ex- ample, where a corporation donates to a hospital or school for its own employees. Where a street railway company donated funds to a convention, anticipating increased business therefrom, it was held that the gift was deductible. No deduction may be made for dividends paid, but a deduction is allowed for interest paid on bonds. Interest paid on scrip dividends is deductible. If a corporation retains and pays to the Federal Government a 2% tax on so-called tax-free covenant bonds, the tax may not be deducted. If a similar tax is paid a State, it may be deducted. If banks or other corporations pay special stockholders' taxes to a State, the amounts are deductible by the banks or other corporations under the new law. If a State Law requires a bank to set aside annually an amount called a "Depositor's Guarantee Fund" and this is actually set aside and in the possession of the State, no longer a bank asset, the amount may be deducted. Corporations may not deduct the following: Strictly personal expenses incurred by officers and individuals, amounts paid for life insursmce of officers or employees, if the corporations are the benefici- aries, orggmization expenses (considered assets), and amounts paid by a guaranteeing corporation for a subsidiary compemy, in fulfilling its contract of guaranteeing dividend payments for the smaller concern. Corporation tetxable income, therefore, is the ssune as for individuals, except as noted. Computing Taxable Income of a Corporation. A corporation, organized Jan. 10, 1921, submits the follow- ing Profit and Loss Statement for the year, from which to compute its taxable income: Sales Cost of Manufactured Goods Sold Gross Profit on Sales Plus other gains: Interest on Liberty Bonds - 4th Issue Interest on Bonds, American Corporation Dividends on Stock, American Corporation Dividends on Stock, Foreign Corporation Interests on City of New York Bonds Land Donated to Corporation by City Profit on Sale of Capital Asset (Land) Rental Income Pension Fund, withheld from Payroll Assessment of Stockholders Profit from Employees' Restaurant Total Income Less Miscellaneous Expenses: Officers ' Salaries Bonus to Officers Expense against Rent Income Organization Expenses Fines and losses in law suits Discount on Stock Sold Commissions on Stock Sold Loss on Re-purchase of Own Stock Sold Bond Discount Written Off Dividends Paid Interest on Scrip Dividends Federal Income Tax for 1921 Estimated City Property Taxes Decrease in Market Value of Stocks Owned Bond Interest Paid Donations to Red Cross Donations to Y. M. C. A. for Benefit of Help Donations to School operated by Corporation Payments to State Compensation Insurance Fund 2% Paid to Government on Bond Interest Interest on Notes Payable Interest on Loan to Purchase Liberty Bonds Interest on Loan to Purchase Amer. Corp. Stock City Tax to Grade Land at Corporation's Factory Typewriters Purchased (12) Net Profit as per Books 600 700 1,000 1,100 100 4,000 2,000 5,000 9,000 20,000 1,500 100,000 25,000 1,000 16,920 11,000 80 , 000 50,000 20,000 10,000 70,000 700 240,000 9,900 300 60 , 000 500 3,000 9,000 8,000 1,200 4,500 600 700 990 1,200 $5,500,000 2,200,000 $3,300,000 45 , 000 $3,345,000 724,510 $2,620,490 Assume that the amount reported as Pension Fund comes from the corporation organizing a separate company, which deducted a certain amount from each employee's wages for the purpose of providing pensions at a later time. The full amount of wages, including the part withheld, has been deducted under Cost of Goods Sold. The following information in regard to other income items has been furnished. Land, valued at $4,000 was donated to the cor- poration by the city in which it located, as an inducement to manufacture there. The rent income is from property purchased near the factory, the upkeep of the property being $1,000, which amount has been deducted as expense. Employees' Restau- rant Profits arose through the company having a restaurant in the factory for the benefit of factory help. The assessment of stockholders came about through a voluntary levy by the corpora- tion against the stockholders who bought stock below par. Concerning certain expense items, the following is noted. The bonus to officers was paid at Christmas time. Organization expenses consisted of Incorporating Fees, attorney's fees, audi- tor's fees, and office salaries during the first few days of or- ganization. Fines were levied for violation of certain Child Labor Law Requirements, and losses were incurred through law suits for failure to fulfill certain contracts of sale. When stock was sold, it was disposed of at a discount. In addition, the underwriters withheld a commission. During the year, the company bought back and placed in the Treasury certain stock, having sold it originally for $90,000 and having paid $110,000 to retire it. When dividends were paid, part were dis- tributed in cash, and part in scrip, the company giving interest on the latter for deferment of payment, finally paying in cash both the scrip dividends and the interest on these dividends. The value of American Corporation Stock Owned had dropped on the Market $300 by Dec. 31, 1921. The payment of amounts to the State Compensation Insurance Fund is made monthly and required by law. The company agreed in its bond issue to pay 2% to the Government of the amount paid out in interest to bondholders. The bonds were sold by the company at a discount of one hundred thousand dollars, the bonds being due and payable in ten years. Regarding donations, the company permitted the Y. M. C. A. to erect a building on its land, so that its own help, with others, might receive more direct benefits, and, to assist its own em- ployees, the company made a donation to the Y. M. C. A. The do- nation to the school operated by the corporation was occasioned by the fact that employees under a certain age are required by State Law to attend school evenings. To assist its employees the corporation financed its own school, Prom the foregoing, the correct taxable income of the corpo- ration is $3,080,200, computed as follows: Net Profit as per Books Items deducted on books, not allowed as expense, and which, when not subtracted, increase income: Interest on Loan to Purchase Liberty Bonds Organization Expenses Discount on Stock Sold Commissions on Stock Sold Loss on Re-purchase of Corporation's Own Stock Dividends Paid Federal Income Tax for 1921 Decrease in Market Value of Stock Owned Donations to Red Cross Donations to Y. M. C. A. for Benefit of Help 2% Paid to Government on Bond Interest Interest on Loans to Purchase American Corp. Stock City Tax to Grade Land at Corporation's Factory Typewriters Purchased Income adjusted by adding Unallowable Deductions: Less Items included in income but not taxable: Interest on Liberty Bonds - 4th Issue $600 Dividends on Stock, American Corporation 1000 Interest on City of New York Bonds 100 Land Donated to Corporation by City 4000 Assessment of Stockholders 20000 $2,620,490 600 16,920 80 , 000 50,000 20,000 70,000 240 , 000 300 500 3,000 1,200 700 990 1,200 $3,105,900 25,700 Taxable Income $3,080,200 The items of expense which cannot be deducted are given above. The reasons for their disallowance are various. Organization Expenses are not deductible, nor 'depreciable', but represent capital charges. Organization Expenses should appear in the Balance Sheet capitalized; such expenses may not be deducted later or prorated over several years as expense. They are not permitted as allowable income-tE« deductions. Discount on Stock is not an allowable deduction because it rep- resents a valuation account showing the correct amount invested through the Capital Stock Account. Thus, if the corporation sold stock, par value $800,000, at 90%, receiving $720,000, its usual entry would be: Cash Discount on Stock Capital Stock 4720 , 000 80,000 $800,000 The Government considers this transaction as an investment of $720,000. The discount gives thefcorrect value to the Capital Stock Account. It is, therefore,|not|an:iallowable deduction. Commissions on Stock are not allowable deductions, but for a dif- -67- ferent reason, which will be more apparent in studying a corpora- tion's Invested Capital. In the case of commissions paid for the sale of stock, the amount expended is practically an organ- ization expense, and for that reason not deductible. However, the Government considers that (constructively) the corporation has received the ajnounts paid out as commissions, and then compen- sated the underwriting company for its selling services, whether the underwriters withheld the commissions, or received them after first giving the gross receipts from sale of stock to the corpora- tion. Therefore, Commissions on Stock Sold are capitalized and placed in the Balance Sheet, whereas, a debit account, called Discount on Stock, is not considered an asset, but a reduction of the Capital Stock Account. Loss on Purchase of Treasury Stock is not an allowable deduc- tion. In the particular case, the corporation sold certain stock for $90,000, or $10,000, below par. It retired this stock by paying $110,000 and a cash loss of $20,000 resulted. This is not an allowable deduction, as it is considered a capital trans- action; that is, the corporation increased its capital stock in- vestment account $90,000 originally and reduced its investment account $110,000 when the stock was retired. A corporation real- izes no gain or loss from the buying and selling of its own stock. Dividends Paid and Federal Income Tax Payable may not be deduct- ed, as each is considered a distribution of a corporation's prof- its, the former to stockholders, the latter to the Government. Decrease in the Market Value of Stock is not permitted as a deduction, because such loss is not realized until actual sale. Usually only realized losses may be deducted. Donations to the Red Cross may not be deducted, as corpora- tions are not permitted to deduct donations. Donations to the Y.M.C.A., under the facts stated, may not be deducted. The rule is, that corporations may deduct for donations which directly . benefit them, and which, accordingly, may be classified as "or- dinary and necessary expenses." In this case, the company has donated $3,000 to the Y.M.C.A., located on the corporation's land, and for the benefit of any employees of the corporation using the Y.M.C.A. Despite the fact that there is apparently a benefit to the corporation from such a donation, the Government has ruled, through decision, August 1921, that such donation to the Y.M.C.A. is not sufficiently a necessary business expense to be considered deductible, but is a donation and not deduct- ible. This is practically contrary to previous rulings, but represents the present attitude of the Government in regard to such donations, the benefit from which ultimately reverts to the corporation. The 2% of the $60,000 Bond Interest Paid, or $1,200, which the corporation has forwarded to the Federal Government, is not de- ductible. This is a voluntary payment of an individual's income teix, and not considered either a necessary tax payment of the business or an ordinary and necessary business expense. It is in the nature of a gift to a bondholder. Interest paid on loans, the money from which is used to pur- chase tax-exempt securities, is not deductible. Therefore, the $700 interest paid on money to buy Stock in an American Corpora- tion may not be deducted. However, an exception to the rule is, that interest paid on money used to purchase Liberty Bonds may be deducted as a corporation expense provided the bonds were purchased after Sept. 24, 1917, and during the several drives. Therefore, in this problem, the $700 paid on loans to buy stock in an American Corporation, the dividends from which are exempt, is not deducti- ble, also the interest paid on money used to buy Liberty Bonds is not deductible, as the corporation is new and must have purchased the bonds recently. The City Tax to grade the company's land is not deductible, as it is called in the Law - a local benefit tax, and should be capitalized, increasing the cost of the land to the corporation. The typewriters purchased may not be deducted, as they are as- sets, and should be capitalized. The foregoing items may not be deducted, for the reasons stated. Several items that have been deducted require comment. The Bonus to officers has been deducted. Although this was paid at Christmas time, the usual conclusion is to consider such a bonus as additional compensation, unless the evidence is very strongly to the contrary. Fines for violation of the law and losses in law suits are usually deductible. There is an occasion- al exception to this rule. Interest on scrip dividends is allow- able as a deduction, it being considered an ordinary interest charge payable by the company because it did not have sufficient cash to pay dividends when declared. Interest on bonds and notes payable is deductible. Compulsory annual, monthly or other periodic payments to State Workmens Compensation Act Funds are deductible. (Gov. Decision). Donations to a school operated by the corporation to assist in fulfilling certain legal requirements regarding employees are allowable as deductions. (Gov. Decision.) Regarding income, certain items in the corporation's profit and loss statement are not taxable. Interest on Liberty Bonds, 4th issue, are exempt, as $130,000 of such bonds may be owned before the interest received on them is taxable. Interest from Bonds of an American Corporation is taxable, also Dividends on Stock of a Foreign Corporation making no profit here, but Dividends from Stock of an American Corporation are not taxable, and have therefore been eliminated from the taxable income. The corporation which paid the dividends has already been subject to the corporation Income and Excess Profits Taxes, and it does not appear equitable to tgtx a second corporation receiving profits in the form of dividends, since these profits have already been tajced once. Interest on City of New York Bonds is not taxable, as explained previously. Profit on the sale of land, or any other capital as- set, is taxable. (Supreme Court Decision.) A distinction must be drawn between the profit and loss on the sale of a corporation's capital stock, and the sale of so-called capital assets. The former when bought and sold by a corporation merely alters a com- pany's investment; the latter, however, represents the buying and selling of assets, the same as in the case of merchandise, and when sold at a profit or loss, the gain or loss is taxable or deductible, as the case may be. Land donated to the corporation is not taxable as income, proper entry when such land is received is the following: The Land $4,000 Donated Surplus $4,000 The gift thus received is considered an additional investment in the company, almost the same as premium on stock, except that, preferably, it is credited or placed in a separate Donated Sur- plus Investment Account. Usually gifts to a corporation are so treated, although there occasionally are exceptions. A pension fund, withheld from payrolls, where the latter have been deducted in full, is income and taxable. (Gov. Decision.) The Assessment of Stockholders, whereby the company received $20,000, is looked upon as asking the stockholders to increase the price they paid for their stock, and should be credited either against any Dis- count on Stock Account in the Balance Sheet or to a Special Surplus or Premium on Stock Account. It represents additional investment 2uid not income. Profits from an employees' restaurant within the factory are taxable, likewise any loss resulting from its operation would be deductible . The foregoing explains the obtaining of a corporation's cor- rect taxable income. However, in writing a corporation tax return, it is necessary to list any differences between book income and taxable income in a special schedule, and properly reconcile such changes with the Surplus Account. This will be explained fully when a corporation return is written in Lecture II. All corporations, except those specifically exempt, are sub- ject to the taxes. The word "corporation", as used in the law, includes joint-stock companies, associations and insurance com- panies, as well as incorporated concerns. Domestic corporations are tajced on all income, no matter where earned, whereas foreign corporations are talced only on income derived from sources within the United States. -70- LECTURE 7. Questions to be Answered. 1. (a) Name the two federal taxes levied against corporation income (b) Are other organizations than corporations subject to these taxes? 2. (a) A grain elevator corporation is formed, to which all stock- holders ship wheat grown by themselves, the profits therefrom be- ing distributed according to the quantity and quality of wheat furnished by stockholders. Is such a corporation taxable? (b) A fruit growers organization is formed which receives fruit on consignment from growers, paying for it when sold. Only stock- holders can forward goods to the organization, which distributes profits to stockholders in proportion to their stock holdings. Is the corporation taxable? (c) A hunting and gun club, not organized for profit, has been cutting timber from its lands for the last five years and dispos- ing of it at profit. Is the organization taxable as a corporation? 3. A corporation sold $100,000 in bonds, - payable in ten years, - for $90,000, to pay 6% interest annually. It also sold $100,000 in stock, for $90,000 or at a 10% discount. Is there any dif- ference in reporting these transactions for tax purposes? 4. What general group of deductions allowed individuals is not allowed corporations? 5. A corporation received the following income items: Dividends . on stock of a Foreign Corporation which makes 25% of its profits in the United States, Interest on Bonds of the same corporation. Stock Dividends, Cash Dividend from an American Corporation and In- terest on Scrip Dividends. Which are taxable? 6. A corporation reports the following expenses: Donations to Red Cross, K. of C, and Y.M.C.A. War Drives, Donations to Repub- lican Convention, Pensions to former employees, 5% Gift to offi- cers and employees above regular compensation received. Dues to manufacturers association and local chamber of commerce. Incor- poration Fees, and Commission for selling stock. Which are allowable income-tajc deductions? 7. A corporation has a Capital Stock Account of $500,000 and a Bond Payable Account of $300,000. A second corporation leases its entire factory by agreeing to pay 6% dividends to the stock- holders directly and 5% to the bondholders. The first corporation does not operate, therefore, during the year, but its bondholders BXid stockholders were paid by the lessee corporation as agreed. Does such a corporation have to file a return or pay a t2uc? r -71- LECTURE 8. INVESTED CAPITAL Part 1. Invested Capital, in general, consists of the net assets and property, properly valued, invested in a company at time of incorporation, plus additional investments thereafter and plus any Earned Surplus left in the corporation. To compute Invested Capital it is necessary first of all to analyze the original investment made at the beginning of a corpora- tion's existence. When corporation stock is sold, naturally it is exchanged, either for money or for property, the latter being tangible or intangible. After a Corporation operates a year, it has either made a profit or suffered a deficit. Invested Capital upon incorporation, therefore, represents the following: (1) The actual cash paid in for stock, regardless of the par value of the stock; (2) the cash value of any tangible property given in exchange for stock; (3) the cash value of any intangible pro- perty given in exchange for stock (but not to exceed a defined limit) and (4) any Paid-in Surplus (explained later). To illus- trate, a Corporation begins business by selling stock of a par value of $100,000, as follows: 300 shares at $100 each for $30,000 in cash; 500 shares valued at $100 par each for plant and equipment worth $50,000 and 200 shares of stock at $100 par each for $20,000 in Good Will. It also borrowed $10,000 from a bank. At the beginning its Balance Sheet would read somewhat as follows: Assets Cash $40,000 Plant and Equipment 50,000 Good Will 20,000 Liabilities Capital Stock ..$100,000 Loans Payable 10,000 $110,000 $110,000 The Invested Capital in the above case would be $100,000, not because the Capital Stock reads $100,000, but because $100,000 in cash and property values was given in exchange for the Capital Stock. The $10,000 Loans Payable Account is not part of the in- vestment, for borrowed money is not Invested Capital. The same thing is true when Bonds Payable and similar accounts appear on a Balance Sheet; they represent borrowed capital and should not be in- cluded in Invested Capital. To illustrate further, suppose this same Corporation had sold its stock as follows: 150 shares, par value $15,000, at 90%, re- ceiving $13,500; the next 150 shares, par value $15,000, at 120%, receiving $18,000; the next 500 shares, par value $50,000 for plant and equipment worth $51,000; and 200 shares, par value $20,000, for Good Will worth $18,000; and, further, suppose the same loan of $10,000 was made. The balance sheet from the fore- going would read somewhat as follows: -72- Assets Cash $41,500 Plant & Equip 50,000 Good Will 20,000 Stock Discount 1,500 Liabilities Capital Stock $100,000 Stock Premium 3,000 Loans Payable 10,000 $113,000 $113,000 The Invested Capital, from the foregoing facts and above Balance Sheet, would be $100,500; that is, the Capital Stock alone does not represent the capital invested in a corporation unless it was exchanged for property worth exactly the par value of the Capital Stock issued. In the above case cash sumounting to $13,500 and $18,000 was received for stock and a building and equipment worth $51,000, plus Good Will valued at $18,000. The total of these is $100,500, which is the Invested Capital, being the amount invested in a corporation in exchange for its Capital Stock. Reverting to the definition of Invested Capital it consists of the cash paid for the stock, the value of tangible property paid for it, the value of intangible property paid for it and the Paid-in Surplus, and computing Invested Capital accord- ing to the above facts and in conformity with the rules, it is readily seen that $100,500 represents the correct ajnount invested. The excess of plant value over the par value of stock exchanged therefor, or $1,000, is called Paid-in Surplus. In the course of the year, assume that the Corporation made a $25,000 profit, and paid out $10,000 in dividends, its balance at the beginning of the next year would then read somewhat as follows: Assets Cash $20,000 Plant & Equipment... 50,000 Good Will 20,000 Inventory 30,000 Accts. Receivable... 11,500 Stock Discount 1 , 500 $133,000 Liabilities Capital Stock $100,000 Stock "Premium 3,000 Loans Payable 10, 000 Surplus 15,000 Plant Reserve 5,000 $133,000 The Invested Capital in the above problem is $115,500 obtained as follows: Use all the figures in the old problem, where the investment was $100,500 and add to the amount, the Earned Surplus left in the business. Invested Capital is comput- ed as of the beginning of the year. It has been assumed that the Corporation made $25,000 but left only $15,000 of it in the business as "Surplus" as of the beginning of the next year. The next item, therefore, that makes up Invested Capital is the Earned Surplus, which is added to the Invested Capital. There- fore, in general. Invested Capital represents the four items given, ordinarily making up the corporation's original investment, gmd to this original investment is annually added any Earned -73- Surplus left in the business, the five together in general giving the Invested Capital. In the foregoing problem, the Invested Capital, as of the beginning of the second year might be obtained in a detailed manner as follows: Capital Stock $100,000 Surplus 15,000 Invested Capital as per books $115,000 Add Premium on Stock 3,000 Add Paid-in Surplus on Plant & Equipment 1^000 $119,000 Deduct Stock Discount $1,500 Good Will Reduction 2,000 $3,500 3,500 Invested Capital $115 , 500 With the above as a general starting point, the various rules covering Invested Capital will be considered: Several terms require explanation. BORROWED CAPITAL means Capital received which must at some time be returned and which, consequently, is a Liability and not part of Invested Capital. INTANGIBLE ASSETS are defined by law to include only such items as Patents, Copyrights, Good Will, Secret Formulae, Trade Marks, Trade Brands, Secret Processes, and the like. TANGIBLE PROPERTY includes all assets not coming under the heading of Intangible Property and has been defined to include such accounts as Lease- holds, Notes Receivable, Accounts Receivable, etc. INADMISSIBLE ASSETS are those assets the income from which is ordinarily not taxable, such as the income from State bonds owned or stock owned by one corporation in another. These assets are not admitted to the Balance Sheet at their full value for purposes of computing Invested Capital and hence are called Inadmissible Assets. To illustrate the above terms the following Balance Sheet is given. Assets Liabilities Cash Accounts Payable Plant Notes Payable Patent Rights Capital Stock Good Will Surplus Accounts Receivable Loans Payable Inventories State Bonds Owned Corporation Stocks Owned In the foregoing group Capital Stock and Surplus, as of the beginning of the year, ordinarily represent Invested Capital. Loans Payable and Notes Payable are classified as Borrowed Capital and not -74- part of Invested Capital. Accounts Payable are considered ordinary Liabilities and not part of the corporation's investment. Among the Assets given above, the following, for purposes of Invested Capital, are called Tangible Assets; Cash, Plant, Accounts Receivable, Inventories, State Bonds Owned, Corporation Stocks Owned; Intangible Assets consist of Patent Rights and Good Will; Inadmissible Assets consist of State Bonds Owned and Corporation Stocks Owned. Both Intangible Assets and Inadmissible Assets are subject to special valuations for purposes of Invested Capital and hence must first be classified as above. BORROWED CAPITAL: Wherever the Corporation borrows money, giving in exchange notes, debentures, etc., the amount may not be added to the Invested Capital. However, even so-called preferred stock may be considered Borrowed Capital instead of Invested Capital. If either the payment of the interest on the stock or the payment back of the money given therefor ranks ahead of or with that of the claims of general creditors, then the stock is considered a loan, in fact a bond issue, with merely the title of stock, and not allowed as part of Invested Capital. If salaries are owed to officers and appear on the corporation's books, but are left in the business by consent, these amounts are usually considered Borrowed Capital. If interest is payable on such accounts, or if the rights to claim the amounts rank ahead of those of the general creditors, then they are considered Borrowed Capital; but if no inter- est is paid on them and they rank after general creditors in case of liquidation, they form part of Invested Capital. INTANGIBLE ASSETS when purchased for cash are permitted to be valued at their cash value; when purchased for stock they may not exceed (1) their actual cash value, (2) the par value of the stock given therefor, (3) 25% of the outstanding stock as of March 3, 1917, or (4) 25% of the outstanding stock as of the beginning of the taxable year, whichever of the four values is lowest. As previously ex- plained. Invested Capital, - other things being equal,- would ordi- narily consist of Capital Stock and Surplus; conversely, the Invested Capital would consist of Assets less Liabilities, or the Net Asset value of a corporation. Consequently, any reduction in the asset value of Intangibles results in the reduction of Invested Capital. To illustrate the computation of Intangible Asset values, assume the following Balance Sheet existed as of January 1, 1921: Liabilities Capital Stock $100,000 Surplus 20 , 000 ' Accounts Payable 23,000 Assets Cash $35 . 000 Accounts Receivable 18.000 Inventory 20 , 000 Plant 20,000 Patents 20 , 000 Good Will 30 . 000 $143,000 $143 . 000 -75- Assume, further, that the Patents were purchased for cash, that the Good Will was purchased for stock and worth about $35,000 at the time it was acquired and that the company had outstanding Capital Stock of $110,000 as of March 3, 1917. As the Balance Sheet now reads, the Invested Capital for 1921 would be $120,000 or the Capital Stock plus Surplus. From the facts, however, it may be necessary to adjust the Invested Capital because of the purchase of Intangible Assets. The Patents (Intan- gibles) were purchased for cash and, therefore, no reduction in value is required. The Good Will, however, was purchased for stock euid is subject to the limitations just outlined. It appears that the Good Will was worth $35,000 when acquired, that it was ex- changed for $30,000 worth of stock - par value,- that 25% of the outstanding stock March 3, 1917, was $27,250 and that 25% of the outstanding stock January 1, 1921, was $25,000. The Good Will, or any Intangible Asset purchased for stock, may not exceed the lowest of the four above figures; therefore. Good Will may not exceed in value $25,000 for purposes of Invested Capital. Conse- quently, the Invested Capital of $120,000 is reduced $5,000, leav- ing it at $115,000. This rule will be further explained in the writing of the corporation return in Lecture 11. INADMISSIBLE ASSETS: Even though no interest is received on such assets during a year, they are still classified as Inadmissible and even though the taxpayer is willing to report any income received through them, the assets will still be considered Inadmissible. Only in two cases may Inadmissible Assets be considered Admissible. (1) If part of the profit from a so-called Inadmissi- ble Asset is due to the sale of it, then the ratio of the profit on the sale to the total income from the Inadmissible gives the ratio which may be used in computing that fractional part of the Inadmissi- ble allowed as Admissible. (2) Secondly, if interest is being paid out on loans to purchase Inadmissible Assets it may be possible to consider a fractional part of the Inadmissibles as Admissibles. To illustrate case (1) above, suppose a corporation owns $50,000 worth of Standard Oil Stock and $60,000 worth of Bethlehem Steel Stock; dividends received from both of these are non-taxable. Suppose on April 1st the corporation sells $40,000 worth of the Steel Stock for $42,000, making a profit of $2,000; also suppose that during the same year the corporation received $3,000 and $2,500 respectively in dividends from Oil Stock and Steel Stock, then the company made a profit of $7,500 on the two Inadmissible Assets for the year. Under the special rule here explained, each group of Inadmis- sibles must be treated separately; hence, the $3,000 of income from Oil Stock is not taxable and the asset remains Inadmissible. However, of the $4,500 profit on Steel Stock $2,500 is non-taxable and $2,000 taxable. Therefore, $2,000 over $4,500, or 4/9 of the total Steel Stock owned; Is considered admissible. However, it is Admissible only while held 2uid up to the date of sale. Therefore, of the total Steel Stock owned, - $60,000, - 4/9 of it, or $26,667, is considered Admissible from January 1st to April 1st, and the \ -76- balance, $33,333, is considered Inadmissible from January 1st to April 1st, while from April 1st to the end of the year the remain- ing unsold $20,000 balance of Steel Stock is considered Inadmissi- ble. Properly averaged, the Steel Stock, which read $60,000 January 1st and $20,000 December 31st on the Balance Sheet, is Inadmissible to the extent of $33,333 for the first three months of the year and to the extent of $20,000 for the rest of the year, or $23,333. (This is equivalent to $20,000 Inadmissible for twelve successive months and $13,333 inadmissible for three suc- cessive months, or $3,333 for the year. The $3,333 plus the $20,000 total $23,333, giving the Inadmissible Asset Value). To illustrate rule (2) above, assume that a corporation owns $10,000 worth of State Bonds on which it is receiving $700 annual interest; also that the corporation borrowed $10,000 with which to purchase these Bonds and pays $600 interest annually on the loan. The $700 is not taxable income and the $600 not an allowable expense; which is equivalent to reporting $600 of the $700 as income and then deducting the $600 interest paid on the loan. This being the case, that fraction which is the ratio between the unallowable deduction and the non-taxable income is applied against the asset to determine the part that will be considered Admissible. Therefore, of the $10,000 Asset Account,- State Bonds Owned, - 6/7 of it ($600 over $700) is considered Admissible and only 1/6 Inadmissible for the year. The above two examples illustrate the only cases in which Inadmissible Assets may be treated as partly Admissible. However, by special rule, obligations of the United States, although tax exempt, are allowed as Admissible Assets. Therefore, any Liberty Bonds owned, whether tameable or exempt, are Admissible Assets. Obligations of the District of Columbia, United States possessions and the Federal Farm Loan Boards are not considered obligations of the United States for purposes of this special rule. With the above outline of what constitutes Inadmissible Assets, the following illustration is given to show exactly how they are computed in a practical problem: BALANCE SHEET Assets Jan. 1, , 1921 Liabilities Cash Accounts X Stock Y Stock Plant Invento I i Receivable Owned Owned $15 , 000 25 . 000 60 . 000 30 , 000 100.000 20 , 000 Capital Stock Surplus Accounts Payable Plemt Reserve * $150 . 000 25 . 000 40 , 000 35.000 $250,000 $250 . 000 -77- December 31. 1921 Assets Liabilities Cash $20 , 000 Capital Stock $150,000 Accounts Receivable 60 . 000 Surplus 40,000 X Stock Owned 20 . 000 Accounts Payable 27,000 Y Stock Owned 30 , 000 Plant Reserve- 39.000 Plant 100 , 000 Inventory 26.000 t $256,000 $256,000 X Stock Owned and Y Stock Owned represent investments in other corporations, the income from which is not tameable. Ordinarily Inadmissible Assets are computed for purpose of re- ducing Invested Capital as follows: The Inadmissibles at the be- ginning of the year, in this case $90,000, and at the end of the year, in this case $50,000, are totalled together and divided by 2, giving the average of the Inadmissibles held during the year,- in this case $70,000. ($90,000 plus $50,000 divided by 2). Then the total assets at the beginning of the year, in this case $250,000, and the total at the end of the year, in this case $256,000, are added together and divided by 2, giving an average of $253,000 for the year for Total Assets. Then the fraction 70,000 over 253,000 or 70/253, (being the ratio of Inadmissible Assets over Total Assets) is applied against the Invested Capital as of the beginning of the year,- in this case $175,000. (Capital Stock $150,000 and Surplus $25,000). The result of 70/253 times $175,000 is the amount by which the Invested Capital is reduced on account of a corporation owning Inadmissible Assets. However, there are always additonal factors to be considered in computing Inadmissible Asset reductions. In the first place, the date on which Inadmissibles held at the beginning of the year were sold may have a bearing on the fractional percentage, as already explained, while also the Total Asset value may not be the correct Asset Value, this depending upon the facts in each case. For purpose of illustration assume that $40,000 of X Stock in the foregoing Balance Sheet was sold April 1, 1921; assume, further, that there was a profit on the sale of X Stock to the amount of $1600, and that during the year there were received dividends on X Stock of $2400 and dividends on Y Stock of $2500. The latter amount does not alter the Inadmissible value of Y Stock. Of the $4000 income on X Stock, however, the $1600 or 2/5 of it, received through sale April 1st is taxable; therefore 2/5 of X Stock, - total $60,000, - is Admissible from January 1st to April 1st, and the remaining $20,000 worth unsold is Inadmissible from April 1st to December 31st. Therefore 3/5 of the $60,000 in X Stock, or $36,000, is Inadmissible for the first three months of the year, which is the same as $9,000 Inadmissible for the entire year, while $20,000 in X Stock is Inadmissible for nine months, which is the same as $15,000 Inadmissible for the entire year. The $15,000 added to the $9,000, gives a total average of $24,000 Inad- missible value for the entire year for X Stock Owned. Therefore, -76- $54,000 is the average Inadmissible value of X and Y Stock Hot the year, in this particular case, or $24,000 in X Stock and $30,000 in Y Stock Owned Inadmissible. Therefore, instead of $70,000 being the Inadmissible Asset value, $54,000 is the figure used, with a consequent net saving to the taxpayer. Concerning the Total Asset Value, it reads $250,000 at the beginning of the year, but the Plsint Reserve Account, listed under the Liabilities, is a valuation account and, when subtracted from the Plant Account, gives the correct value of the latter asset. Therefore, the Total Assets at the beginning of the year, correctly valued, amount to $250,000 less $35,000 reserve, or $215,000. Likewise, at the end of the year, the Total Assets of $256,000 are reduced by the Plant Reserve of $39,000, leaving the Total Asset values at $217,000. These two totals, properly averaged, amount to $216,000 (that is, $215,000 at the beginning and $217,000 at the end of the year). Therefore, $54,000 over $216,000 or 54/216 or 1/4 gives the ratio of Inadmissibles to the total of Admissible and Inadmissible Assets. This ratio, namely 1/4 - or 25% - is multiplied against the $175,000 of Invested Capital, resulting in $43,750, which amount is then subtracted from the $175,000, leaving $131,250 as the Invested Capital in this problem. Stated otherwise, the Inadmissible Assets, aver- aging $54,000 for the year, are not admitted to the Balance Sheet for $43,750 of their value. NOTE CAREFULLY that the assets were averaged for the year, but the percentage reduction was applied against the Invested Capital at the beginning of the year. NOTE CAREFULLY also that, in the case of Inadmissible Assets, the percentage reduction was applied against the Invested Capital, while the limitation on account of Intangibles purchased for stock is always calculated as against the par value of the outstanding Capital Stock only. When bonus stock is issued with bonds, any excess in sales price of the bonds, due to the bonus, gives the figure at which the stock may be added to Invested Capital. Thus, a corporation was selling bonds at $950 each, but, by giving bonus stock free with bonds, the latter sold for $980. The $30 difference in each bond sold should be placed in a Capital Stock Account and consid- ered part of Invested Capital. Also $50 (the difference between $1000 and $950) and not $20 represents the bond discount to be amortized, assuming the face value of the bonds to be $1000. If a note is given in exchange for stock such note is a Taui- gible Asset to the extent of its cash value and the stock given therefor is part of Invested Capital. This is permitted if any note given may be legally used to purchase stock under the laws of the domicile of the corporation, and if such note is legally enforceable against the individual. Inadmissible Assets are computed in the same meuiner, regard- less of whether they are purchased for stocks, bonds or cash, except that in guiy event, they should be listed at their cash -79- value when acquired, and should not be reduced or increased on the books because of changes in their market value after acquisition. When Tangible and Intangible Assets are purchased for bonds and stock, it will be presumed by the Government that the former were given for the purchase of the Tangibles and the stock for the balance of the Tangibles and for the Intangibles, the purpose of this being to apply the limitation on the purchase of Intangibles for stock in the particular case. Also if Tangibles and Intangi- bles are purchased for stock and liabilities assumed at the same time, the latter are presumed to apply as a reduction against the assumed value of the Tangibles, again causing the application of the rule concerning Intangibles purchased for stock. Evidence proving the contrary may be introduced in either of the foregoing cases. Intangible property may not be valued above the par value of the stock given therefor. Tangible property, however, may be,- any excess of value over the stock given therefor being called "Paid- in Surplus". That is, if a company gives $100,000 in stock-par value, and receives in exchange a building worth $110,000, the $10,000 is called Paid-in Surplus. Substantial proof to establish a Paid-in Surplus to be used for purposes of Invested Capital is required. Among other things, an appraisal at the time of the acquisition of the building or figures covering the assessed value over a period of years may be introduced to show value in excess of the par value of the stock. Also evidence may be received to show that the stock was selling above par at the time the building was purchased. In every case the evidence of Paid-in Surplus must be AS OF THE TIME THE ASSET WAS ACQUIRED. That is, an appraisal at the present time to show the value several years prior Ac the pre- sent year is not considered proper evidence. By decision, an appraisal approximately a year before or after such asset is acquired has been allowed as sufficient evidence of Paid-in Surplus. If the additional value is ascertained or developed after date of acquisition, no Paid-in Surplus is allowed. -80- LECTURE 9. INVESTED CAPITAL (Continued). So far it has been pointed out that Invested Capital consists of the investment of a company at the time of incorporation, plus the Earned Surplus. It has also been shown that Borrowed Capital is not part of Invested Capital, and that Intangible Assets and Inadmissible Assets, when properly valued, may result in altering Invested Capital. Next it is necessary to consider the Invested Capital as it appears on the books to see whether or not the Surplus Account represents true Earned Surplus. Wherever the facts show that Earned Surplus does not represent true Earned Surplus, then additions and deductions should be made as of the beginning of the year. There are several instances in which such adjustments need to be made. If depreciation, obsolescence or depletion has been deducted from Surplus in too great amounts in previous years, and such can be satisfactorily proved, the excess may be added to Surplus and be made a part of Invested Capital as of the beginnning of any year. Thus, a concern has depreciated its plant and equipment at the rate of 10% up to January 1, 1917, the date upon which Invested Capital became a factor in computing the Income Tax. At the beginning of 1917 its Balance Sheet may read somewhat as follows: Plant and Equipment Other Assets $200,000 Capital Stock 100,000 Surplus PlEint Reserve Liabilities $300,000 $175,000 50 , 000 60 , 000 15,000 $300 , 000 From the foregoing Balance Sheet, apparently $20,000 depre- ciation has been taken for three successive years. If the facts show that only 5% depreciation, or $10,000, should have been taken each year, then the excess may be restored to Surplus. Therefore, in the above Balance Sheet, which now contains a Plant Reserve Account on the credit or right hand side, $30,000 of the amount in this account may be added to Surplus. In this way. Invested Capital would consist of Capital Stock $175,000, Surplus $50,000 and Addition to Surplus $30,000, or a total of $255,000. This adjustment is permitted, of course, only when amended returns for previous years are made out and the errors on excessive deprecia- tion corrected. Likewise, if depreciation taken has proved too small, the Government may insist upon amended returns and the trans- ferring back of part of Surplus into the Reserve Account, thereby reducing Invested Capital. By decision, however, the Treasury Department, during the last few months, has permitted companies which apparently under-depreciated in prior years to use the book value of the assets, if, in general, it can be shown that they represent a substantially correct Invested Capital value as of the year in which their asset value is used for Invested Capital purposes Amounts expended prior to January 1, 1917, for equipment and assets which have a useful life extending beyond a year and which have been charged to expense, may be added to Invested Capital. If, however, such expenditures were recovered through having the assets added to Cost of Goods Sold, they cannot now be restored to Invested Capital. If such equipment and assets are used only occasionally, their Invested Capital value should be based on their earning capacity. If Intangible Assets have been purchased and either written off the books or excessively depreciated, they may be readjusted and a proper amount added to Invested Capital. Thus, if Good Will was purchased, and then written down to the value of one dollar, it may be restored to Invested Capital at its cash value when pur- chased. There is one exception to the rule that items excessively depreciated or written off may be restored to Invested Capital. This occurs in cases where money has been expended for experimental expenses, patent development expense and advertising to create Good Will. In these cases, at the time the money was expended the corporation had the option of charging part of the amount as asset and part as expense and the law on this point reads, that a corporation exercises a binding option at the time such ex- penditures are made. Thus, if a corporation spent $1,000,000 in advertising in 1910 and charged all this off to expense except $10,000, which it called Good Will, it is not now permitted to show that more than $10,000 in Good Will was acquired through the advertising. So, also, if a corporation expends several hundred thousand dollars in developing certain patents in its own labor- atories and charges these ajnounts off as expense, and now wishes to increase the value of its patents by amounts expended in exper- imentation, this also is not permitted. Concerning the value of patents, legally patents have a life of seventeen years and, therefore, ordinarily may be depreciated 1/17 annually. However, their value depends chiefly upon their earning power and the monopoly which a business concern may have over certain inventions. Consequently, if it appears that a patent will outlive its legal life of seventeen years, then it may be depreciated at a less rate thgtn 1/17 a year. Also, if it appears that a patent in all probability may be superseded by another in the course of two or three years, it may be depreciated 30 or 40 per cent a year. As far as Invested Capital is concerned, if a corporation depreciated patents 1/17 per year and the patent rights themselves had not depreciated that rapidly, the corporation may not now restore the difference to Invested Capital. If, however, a corporation merely reduced the book value of patents 1/17 and took a smaller deduction against its taxable income, then the difference may be restored to Invested Capital. When assets are appreciated as of March 1, 1913, there is no effect upon Invested Capital. Thus, if a corporation has buildings valued at $100,000 on its books as of March 1, 1913, and through appraisal finds that the buildings had a market value as of that date of $125,000, the increase may be placed on the corporation books but should be debited to the Asset Account and credited to £Ui account called Surplus From Appreciation. Thereafter the cor- poration may depreciate against $125,000 in asset value instead of $100,000, but the appreciated value is not permitted as part of Invested Capital. If the corporation should sell such asset and the appreciated value thereby become realized, it is then allowed as Invested Capital from date of sale. (See Lecture 11 for proper recording of Appreciated Surplus.) So far in this Lecture it has been shown that Invested Capital consists first, 'of the amounts invested in a corporation and second, of the Earned Surplus. Next it has been shown that excessive depreciation written off and assets charged off may be restored to the books, thus increasing the Earned Surplus. Also that appreciated value is not part of true Earned Surplus. In addition to the foregoing, there are in general a group of Reserves which usually may be added to Invested Capital. These are known as Unallowable Reserves. An unallowable reserve is one, the additions to which are not permitted as offsetting allowable Income Tax deductions. Thus, a concern deducts a certain amount annually from Surplus and places it in an Income Tax Reserve. As pointed out previously. Income Taxes may not be deducted as expenses. Therefore, if an Income Tax Reserve appears in a Balance Sheet as of the beginning of any year, it should be con- sidered part of the Invested Capital and added to the Capital Stock and Surplus. Assume that a Balance Sheet read as follows: Cash $150 , 000 Capital Stock $200,000 Building 100 . 000 Surplus 120,000 Patents 20 , 000 Inventory Reserve 40,000 Good Will 30 . 000 Bad Debt Reserve 25.000 Inventory 110,000 Sales Discount Reserve 5,000 Accounts Receivable 60 . 000 Income Tax Reserve 9,000 Sinking Fund Reserve 71,000 $470 . 000 $470 , 000 The Invested Capital in the above Balance Sheet reads $320,- 000, that is, the Capital Stock Account plus the Surplus Account. However, the correct Invested Capital value is $470,000. It will be noted that the right heuid side of the Balance Sheet consists of five Reserves. Each one of these Reserves is known as an Unallowable Reserve; that is, no deduction is usually allowed for fluctuation of inventory values, for anticipated bad debt losses, for sales discounts taken in advance, for any Income Tax to be paid or for sinking fund amounts reserved. As these are not allowed as expenses, the effect is the same as if the deductions resulting in these five Reserves had never been made. If they were not made, the Surplus would be cor- respondingly larger. Hence they are added at this time to the Capital Stock euid Surplus Accounts. Beginning with the year 1921 a Bad Debt Reserve may represent an allowable expense, if per- mission to use it is given by the Commissioner. For purposes of Invested Capital insurance paid on officers of a corporation is usually carried at its cash surrender value in the Balance Sheet. The foregoing rules, as outlined in Lectures 8 and 9, are intended to show how InVfested Capital is arrived at as of the beginning of the taxable year. Certain changes may occur during the year which also affect Invested Capital. Among the changes during a year which affect Invested Capital are the payment of a corporation's Income Tax, the payment of dividends, the sale of additional stock and the retirement of corporation stock. All these items are carefully explained and their computations worked out in Lecture II. LECTURE 9. Questions to be Answered. 1. Define Invested Capital Borrowed Capital Inadmissible Assets Intangible Assets 2. (a) Which of the following are Intangible Assets: Organization Expenses, Commissions on Stock, Notes Receivable, Accounts Receiv- able, Good Will, Trade Marks and Patent Rights. (b) Which of the following are Inadmissible Assets: Liberty Bonds -First Issue, Liberty Bonds -Fifth Issue 4f, State Bonds Owned, Stock Owned in American Corporation, Stock Owned in Foreign Corpor- ation making no profit here. Stock Owned in Foreign Corporation making 70% of its profits here for the last four years. 3. For purposes of computing the tax, which of the following items are part of a corporation's Invested Capital: Capital Stock, Pre- ferred Stock, Bonds Payable, Loans Payable, Earned Surplus, Surplus from Appreciation of Assets, Sinking Fund Reserve, Reserve for Building New Plant, Depreciation Reserve, Taxes Accrued, and Reserve for Federal Income Taxes. 4. State the allowable value for Patent Rights for 1921 in the fol- lowing cases: Patent Rights worth $50,000 were purchased for $45,000 in stock - par value - Dec. 1, 1915. The company had stock outstanding of $70,000 on March 3, 1917, and $100,000 in stock outstanding on Jsin. 1, 1921. 5. State in your own language the general rule for computing the reduction of Inadmissible Assets for purposes of Invested Capital. LECTURE 10 COMPUTATION OF CORPORATION TAXES IN SPECIAL CASES. Problem 1: As explained in Lecture 8, the ordinary computation for a corporation's Income and Excess Profits Taxes for 1921 is as follows: Invested Capital $500,000 8% of $500,000 $40,000 Income 125,000 Specific Exemption 3,000 Excess Profits Credit. . .$43,000 Excess Profits Tax Income Credit Bal. Taxed 20% of Invest. Cap. $100,000 43,000 57,000 Over 20% 25,000 25,000 Rate 20% 40% 125 , 000 43,000 Income Tax Income $125,000 Profits Tax 21,400 82,000 Income lax 10%. Tax 11,400 10 , 000 $21,400 ..10,360 103 , 600 Total Tax $31,760 Problem 2: If a corporation has income of less than $25,000, it is entitled to a $2,000 exemption. If taxable Liberty Bond Interest is included it is subject to the Excess Profits Tax only. If a tax has been paid to a foreign country, it is deductible from the tax payable. * Invested Capital $75 , 000 8% of $75 , 000 $6 , 000 Ir^come 21,000 Specific Exemption 3,000 Income includes Lib. Bond Int. $100 Excess Profits Credit $9,000 20% of Invest. Cap. Over 20% Excess Profit Tax Income Credit Bal. Taxed $15,000 9,000 6,000 6,000 6,000 Rate 20% 40% 21 , 000 Income Less: Liberty Bond Int. Profits Tax Exemption 9,000 Income Tax $21 , 000 $100 3,600 2,000 5,700 12,000 Income Tax Total Tax Less: Foreign Tax Paid (Assumed) $15,300 Final Tax Teix 1,200 2,400 $3,600 1,530 5,130 200 $4,930 Problem 3: Computation where Excess Profits Credit exceds 20% of Invested Capital. Invested Capital $15,000 Income 6,500 8% of-$15,000 $1,200 Specific Exemption 3,000 Excess Profits Credit $4,200 Excess Profits Tax Income Credit Bal. Tax Rate 20% of Invest. Cap... $3, 000 3,000 20% Over 20% 3,500 1,200 2,300 40% Tax $920 The Excess Profits Credit of $4,200 exceeds 20% of the Invested Capital - or $3,000. In such case that part of it needed to eliminate any income subject to the 20% tax is used, thereby eliminating the tax at the 20% rate. The balance of the Credit, in this case $1,200, is used against the Income in excess of 20% of the Invested Capital, thereby reducing it before the 40% tax is levied. In the above case the $1,200 balance of the Credit is subtracted from $3,500, - the in- come ordinarily subject to a 40% tax, - and only the balance, $2,300 is taxed at 40%. The Income Tax is computed the sajne as before with Credits of $920 and $2,000. Problem 4. Section 302 of the New 1921 Act (also the 1918 Act) provides special relief for a small corporation subject to a high Excess Profits Tax. This Section states that in no case shall the Excess Profits Tax exceed 20% of the income above $3,000 and not in excess of $20,000 and 40% of the income in excess of $20,000. . To illustrate, the same Invested Capital and Income figures as in Problem 3 above may be used. The amount of income in excess of $3,000 is $3,500 (i.e. $6,500 less $3,000). The Excess Profits Tax may not exceed 20% of $3,500 or $700. Therefore, in Problem 3, the corporation does not pay an Excess Profits Tax of $920, but $700 only. Problem 5: Section 302 gives relief for income in excess of $20,000 as follows: Invested Capital Income $50,000 8% of 50,000 $4,000 22,000 Specific Exemption 3,000 $7,000 20% of Invest. Cap. Over 20% Excess Profits Tax Income Credit Bal. Taxed Rate $10,000 7,000 3,000 20% 12,000 12,000 40% Tax 600 4,800 22,000 7,000 15,000 $5,400 (Problem 5 continued) Computed in the ordinary way, the Excess Profits Tax is $5,400. Applying the relief section, the tax may not exceed 20% of the income in excess of $3,000 and not in excess of $20,000 or 20% of $17,000 and 40% of the amount in excess of $20,000 or 40% of the $2,000 of income above $20,000. Therefore the tax shall not exceed 20% of $17,000 plus 40% of $2,000 or $3,400 plus $800 or a total of $4,200. The maximum Excess Profits Tax on $22,000 therefore is $4,200. This amount is used as a credit against the income and the Income Tax computed in the ordinary way. Problem 6: If a corporation operates for a fractional part of a year, then only fractional credits or exemptions may be used. Thus a corporation begins business April 1 with an Invested Capi- tal of $100,000. Invested Capital $100,000 8% of $100,000 $8,000 Profit 9 months 21,000 Specific Exemption 3,000 3/4 of 11,000 - Total 11,000 $8,250 3/4 of 20% of Inv. Over 20% Excess Profits Tax Income Credit Bal. Tax Cap. $15,000 8,250 6,750 6,000 6,000 $21,000 8,250 12,750 Rate 20% 40% Income Less: Profits Tax Exemption (3/4) Income Tax $21,000 Income Tax-10% $3,750 1,500 5,250 15,750 Total Tax Tax 1,350 2,400 $3,750 $1,575 $5,325 Note that only 3/4 of the Excess Profit Credit is subtracted in computing the tax (nine months over 12 months), also that only 3/4 of the $2,000 exemption is used in computing the Income Tax. In the case of individual income taxes, the taxpayer's status the last day of the taxable year was the basis for determining exemption, and if a person married December 29 he was allowed sxi exemption as a married person. In the case of a corporation, the time it operates, and not its status December 31, determines the exemption. Problem 7: A corporation with a fiscal year from April 1, 1920, to April 1, 1921, would compute its tax as follows: Invested Capital $200,000 Invested Capital $200,000 Profit - 1918 Act 60,500 Profit-1921 Act 60,000 A difference in profit is shown above, because under the 1918 Act, in effect for 1918, 1919 and 1920, a slightly different profit may result than under the new 1921 Act for the fiscal year 1920-1921. For a corporation reporting on a fiscal year basis, it is necessary to compute the tax under the 1918 Act first and then apply against it that fraction which represents the number of months in 1920 over the total number of months. 1918 Act. Fiscal Year Income from April 1, 1920 to April 1, 1921. Invested Capital $200,000 8% of 200,000 $16,000 Profit 60,500 Specific Exemption 3,000 Excess Profits Credit $19,000 Excess Profits Tax Income Credit Bal. Tax 20% of Invested Capital $40,000 19,000 21,000 Over 20% 20,500 20,500 Rate Tax 20% $ 4,200 40% 8,200 60,500 19,000 41 , 500 Income Less : Profits Tax Exemption Income Tax $60,500 Income Tax at 10% $12,400 4,610 12,400 2,000 14,400 Total Tax (1918 Act) 17,010. 9/12 or 3/4 of 17,500 $12,757.50 46,100 1921 Act. Fiscal Year Income from April 1, 1920, to April 1, 1921. Excess Profits Tax ^^^ ^ ^ Income Credit Bal. Tax Rate Tax 20% of Invested Capital $40,000 19,000 21,000 20% 4 200 Over 20% 20,000 20,000 40% 8^000 Income Less : Profits Credit 60,000 19,000 41,000 Income Tax $60,000 Tax at 10% 12,200 Total Tax (1921 Act) $47,800 1/4 of 16,980 - Answer. Tax (Act 1918) $12,757.50 Tax (Act 1921) 4,245.00 $12,200 4,780 16,980 $4,245 $17,002.50 Problem 7 (Continued) . As will be observed by the reader, the iS^n^^ computed under the 1918 Act (used in 1918, 1919 and 1920) and then 3/4 of the answer is used as the tax,- the company operating in 1920 for 3/4 of the fiscal year, or 9 months. The tax is then recomputed under the 1921 Act, in which case the income may vary slightly because of the new rules, and in which case also the $2,000 exemption is not w! in obtaining the Income Tax. In this computation, iboi° mv ^^^2*^^ gives the tax for the three months of x? : . "® **° fractional amounts are then added, giving the total t£ix payable. For a fiscal beginning in 1921 and ending in 1922, the *P IS first computed, as above, under the 1921 Act, and then the ratio applied against the answer, based on the number of months in 1921 to the whole year. The tax is then recomputed under the 1921 Act for the year 1922. in **i^?oiw^®^® ^^ ^° Excess Profits Tax, but an Income Tax of 12^%. A ratio based on the number of months of the fiscal year falling in 1922 is used against the tax as first obtained. The two fractional amounts are then to- talled, giving the tax for the fiscal year 1921-1922. ^^°''^*S:.^A««"'^^®^ *^® ^^21 Act, corporations with income of »25,000 or less are allowed a $2,000 exemption, and those with income in excess of that amount, no exemption. For •oc nL° corporations with income slightly in excess of $25,000 the tax is computed (1) with the exemption and then any excess of income above $25,000 added to the answer, and (2) without the exemption; whichever of the two results in the lesser amount gives the tax to pay. Invested Capital Income $75 , 000 25,100 S% of 75,000 Specific Exemption Excess Profits Credit 20% of Inv. Cap. Over 20% Excess Profits Tax Income Credit Bal . $15,000 9,000 6,000 10,100 10,100 Teix Rate 20% 40% 25,100 9,000 16,100 $6,000 3,000 $9,000 tax $1 , 200 4,040 $5,240 Income Less: Profits Tax 5,240 Exemption 2,000 Income Tax With Exemption $25,100 Income Tax 10% 7.240 Total Excess above $25,000 $17,860 Total Tax 1,786 7,026 100 $7,126 -90- Income Less : Profits tax Income Tax Without Exemption. $25,100 5,240 $19,860 Income Tax 10% Plus Profits Tax $1,986 5,240 $7,226 The above is the interpretation placed upon the relief section of the New Act by the Internal Revenue Department, Boston, Mass. A final explanation of the meaning of the Relief Claim had not been made from Washing-^on up to February 1, 1922. -91- LECTURE 11 Preparation of Form 1120, Corporation Income and Excess Profits Tax Returns - For 1921 The following is the Profit and Loss Statement of the Boston Furniture Co. for the year 1921 - as per books. Sales Less Cost of Goods Sold: Inventories - Jan. 1, 1921 Majiufacturing Costs Total Costs Less: Inventories Dec. 31, ).921 Gross Profit on Sales Income from Liberty Bonds Interest on State Bonds Dividends on Lumber Stock Owned Total Income Less Expenses: Selling Expense Office Expenses Administrative Expense Insurance, etc. Officers ' salaries Repairs Notes and Bonds Pay. Property State Income 1920 Federal Income 1920 Federal Income 1921 Bad Debts - Actual Inventory Reserve Increase Depreciation of Machinery Depreciation of Building Obsolescence of Patents Sinking Fund Donations Bond Discount Written off Organization Expense" Discount on Stock Commission on Stock $345,750 1,456,100 $2 , 151 , 800 1 . 801 , 850 395 . 480 1 , 406 . 370 745 . 430 1,675 4,000 5,095 $756,200 Int . on Tsixes - Taxes - Taxes - Teixes - II II II II II $65 , 630 26.910 7.090 4,000 125.000 13,000 38,000 20 . 000 30 , 000 100,000 60 , 000 10 , 000 4,500 51 . 000 5.000 17,000 50 , 000 3,000 5,000 2,000 5,000 5.000 Net Profit per books 647,130 $109,070 -92- Surplus Account Shows: Dividend declared Jan. 10, payable Jan. 25, 1921 Dividend payable March 5 Dividend payable Dec. 1 Total Withdrawals Balance of Book-Profit Left in Surplus Total Book-Profit Accounted for $18,300 9,400 60,000 87,700 21,370 $109,070 Balance Sheets As per Book Assets Liabilities Jan. 1. '21 Dec. 31. '21 Jan. 1.1921 Dec. 31. 1921 Cash $45 , 500 $71 . 650 Bonds Pay. $500 , 000 $500,000 Notes Rec. 10.000 15.000 Accts. Pay. 138 , 000 84,270 Accts. Rec. 170 , 500 231.200 Mort. Pay. 100 . 000 100.000 Invent . 345.750 395 . 480 Notes Pay. 13 , 300 13 . 650 Lib. Bonds 40 . 000 40 . 000 Bldg. Res. 39,000 44.000 State Bonds 75 . 000 75 . 000 Mach. Res. 159.400 210 , 400 Stock Owned 100,000 110.000 Sink. Fund 100 . 000 150 . 000 Machinery 510.000 555 . 000 Invent . Res . 28,000 32.500 Buildings 250 , 000 250 . 000 Cap. Stock C 425 , 000 500,000 Furniture 10 10 Pref. St. - 1 250 . 000 200.000 Patents 170 . 000 153.000 Pref. St. - 2 250 . 000 250 . 000 Good WiU 275 . 000 275 . 000 Surplus 122 . 360 143.730 Def. Chgs. 500 410 Pd.-in Surplus 20 . 000 20 , 000 Stock Disc. 20 . 000 15.000 Donated Surplus 10 . 000 10,000 Stock Com. 15.000 10.000 Tax Res. 60 , 000 Bond Dis. 40 . 000 35 . 000 App. Surplus 42 . 200 41 , 200 Organ. Exp. 20 . 000 18 . 000 . Tr. Stock 10,000 10 . 000 Land 100 . 000 100 . 000 $2,197,260 $2,359,750 $2,197,260 $2,359,750 The company incorporated December, 1912, paying $280,000 in stock - par value - for Land and Buildings and $250,000 in stock - par value - for the Good Will, as the plant was previously owned by an active manufacturing partnership. It appeared from substan- tial facts that the Buildings were worth $200,000 and Land $100,000 and the Good Will $275,000. They were so entered on the books, the excess of Building value over par value of the stock being placed in Paid-in Surplus, and the excess of Good Will over stock given therefore carried to Surplus. The balance of the stock was sold through a commission brokerage concern as follows: balance sold,- $395,000 par value,- sold for $350,000 in cash, after which the commission brokerage concern deducted a commission of $55,000. Ex- penses of organization amounted to $36,000. The Balance Sheet shortly after incorporation read as follows: -§3- Balance Sheet Dec. 1912. Assets Cash Organization Expense Discount on Stock Commission on Stock Plant & Buildings Lsind Good Will $259,000 36,000 45,000 55,000 200 , 000 100,000 275,000 $970,000 Liabilities Capital Stock $925,000 Paid-in Surplus (Bldgs). 20,000 Surplus from Good Will 25,000 $970,000 It appears that the Buildings were appraised March 1, 1913, and because of changes in business conditions, their market value was $250,000. The $50,000 increase was charged to Building Account and the offset credited to Surplus from Appreciation. A review of the books shows that the company charged off Organization Expense at the rate of $2,000 a year from 1913 to 1920 inclusive, leaving a balance in the Account of $20,000 on Jan. 1, 1921. The Company charged off $5,000 a year against the Commission on Stock Account from 1913 to 1920, inclusive reducing it from $55,000 to $15,000. Beginning December 31, 1916, it charged off $5,000 per year of the Discount on Stock Account, reducing it from $45,000 to $20,000 as of Jan. 1, 1921. Depreciation is at the rate of 10% per annum on Machinery on hand at the beginning of any one year. For the period prior to 1921 the Government has disallowed $18,400 excessive depreciation, which has not been restored to Surplus. An analysis of the Building Reserve Account shows that, from 1913 to 1920 depreciation was taken as follows: 1913 (10 months) $4,000, 1914 to 1920 inclusive $5,000 a year; total up to January 1, 1921 - $39,000. Depreciation was taken on the original value, $200,000, and on the appreciated value of $50,000 at the rate of 2% per year. In each year when depreciation was taken against the building, 4/5 of it was charged against the Earned Surplus and 1/5 against the Surplus from Appreciation. For the present year when appreciation of $5,000 was taken, $4,000 was charged against the Earned Surplus, and $1,000 against Surplus from Appreciation. An analysis of the Furniture and Fixtures Account shows that furniture was purchased in January, 1915, for $10,000 and that the company took depreciation of $5,000 in 1915 against the account and $4,990 additional in 1916, leaving $10 in the account as a nominal value. An analysis of the facts in the case shows that Furniture and Fixtures should have been depreciated onlv $1,000 per year. other facts of importance and bearing on the tax are as follows: Patents were purchased in December 1920 for $170,000 in cash and depreciation of 1/10 of the value has been charged directly against the Patent Account for the year 1921. Two deduc- tions have been made for payments of Federal Income taxes, one for the cash pajnnents made during 1921 on account of 1920 income, the second for payment of the 1921 Income Tax in the year 1922; this latter amount has been placed in a Tax Reserve Account. Deductions have also been made for Reserve for Sinking Fund to take care of cancellation of the Bonds Payable Account at a later date, while an additional amount has been set aside in Inventory Reserve for possible fluctuation in the price of the inventories. Donations have been made as follows: $500 to the Y. H. C. A. and Red Cross and $2,000 in similar donations to local charitable organizations. Bond Discount Written Off is the result of having sold $500,000 worth of Bonds at 90% in 1919, the company having received $450,000 in cash, and having already charged off $5,000 in 1919 and 1920 as Bond Discount. A similar amount is being charged for this year, as the Bonds will nin ten years from date of issue. Treasury Stock was received in December 1920 as a gift, the offsetting entry being a credit to Donated Surplus. During the year the company sold on April 1, 1921, $75,000 worth of Capital Stock, Common, and on December 10th retired $50,000 worth of First Preferred Stock. Stock Owned Account represents ownership of $100,000 worth of stock in an American lumber corporation; $10,000 additional stock of this concern was purchased June 25th. Concerning Liberty Bond interest, it appears that the company owned $30,000 worth of Second 4's on which it received $1,200, and $10,000 in Fifth 4f' s on which it received $475, giving a total of $40,000 in Bonds Owned and interest received to the extent of $1,675. The Manufacturing Costs Account shows that the amount therein was expended as follows: For Labor $685,600, Materials $625,840, Supplies $48,000, Fuel $49,100, Overhead and other costs $47,560. The Officers' Salary Account shows that J. Doe, President, received $50,000 for 1921 and $40,000 for the three years prior thereto, J. Roe, Treasurer, the same compensation for the four years and J. Hoe, Secretary one-half the salary of the others for the last four years. Form 1120 properly written from the foregoing figures appears as follows: IP RETUItN IS FOR CALENDAR TEAR 1920 FILE IT WITH THE COtlECTOR OF INTERNAL REVENUE FOR TOUR DISTRia ON OR BEFORE MARCH IS. ISZl IF FOR A PERIOD OTHER THAN A CALENDAR TEAR THE RETURN SHOULD BE FILED ON OR BEFORE THE, ISTH DAT OF THE THIRD MONTH FOLLOWn^ THE CLOSE OF SUCH PERIOD Vb^ 1 of B«tum iiM-mrmD states internal revenue service corporahon income and profhs tax return FOR CALENDAR YEAR 1921 Or for p«riod iMgun Jfcn. X<, 19.21, and •nded. .„JDao, H l9J^i C«IU«t*val ii»r •■4 «■ til* (PRINT PLAINLY CORPORATION'S NAME AND BUSINESS ADDRESS) Boston Parnitor* CoDpany Washington Streat, lorth Boston, Mass. CASH H.«L CEtT. •riMDi (M NOT WUn M TMt »ACt> AditoJbjr nUST PAYMETiT $ .- Cashtor's Stamp KIND OF BUSINESS.....fBLgnltnrflL.JUuMLfflLatiLrlng. IS THIS A CONSOUDATED RETURN rJIS. SCHEDULE Ar-TAXABLE NET INCOME. I. OnMiMlM,lMiNtanisaadaIlow*DCM t. Laa coH of goods mM, oxclwivo ot bdov (from SclMduk At) CROSS INCOME. itfin, Mid othor items cmllod for Mpsimtoly JEIQQ m h-Gnmiaeaum from opwstioM o^thaa tiwUM or mmrafftctoriiw. km alloiraaeM (torn SdMdnlo A3) ^yf *>>• iP>tmt.oa obligstk— ol tho Unitad «atM sod Ww flmuK* Oorpoatkn Bomk (from Form 1125, toe Schedulo A4). S. TkzsblofiMHHt ftamaUoCteoooRM (from SclMdnlo AS). %. Rntih -^., T. Ro>^ttm > ^ ^^<*'>>^*i><»^«rn>^l>y.P«»Ml'wvie*mrpor»tk»diifi]i|ritsM^ t. OivklMMk OQ Mock of (a) lof«%n coipontiofM (from SchodnW A9), I ; wd (6) domestic corpomtions. SKcapt psBBoosl sarvk* oocpoiBtioas from ssnii^ socumubtsd on sad aftar Jsauary 1, 1918, « ' Total. 10. GsHS inoomo from sU othsr IL Tocjll or Itam 1 «o tM.Otihatjaad\ All) (not inchtdiac uqr uwmat ropoctod in Itsm IS. bslov) (from Schsdulo AlO). 7M 4d0 475 096 00 00 00 DEDUCnOML tti MportMl ia IlHt t abovs or caOsd for sqpuatalx bskw) (ftam Schadnls IS. flmap M i— tinn nt iMrmm ( JwuAnAh^ .^l^gLfi M. Bai«if»(iiifcliidia( labor, sappttoa, sic.) (ftam Sc^sdvk A14) Uk Ialmt(sssp^SolIartractioii%p«Hn|>b9) U. Tnmifnm SchsdolsAll) : ^ ir. D«b«ia«»«aiiwl«ob«imrtU«Baodchaifsd«C«itkiBttetaxabtopsriod(taM8ch«latoAin IS. T i b a th m , wmr and tsar (ladadlac obwlss c sm ^ ) (from Scbsdnto AH) '. IS. Pagkliim (iwm Schsdoto Alt) , 9l Total o» Itbxs U to '• . iaiiAatmw form paid) (from SdMdulsAlS) 102 .42 .6.0 ..X.Q 6Ja£L 000 00 000 1 00 -0-QQ.lD.Q] .QQ0J.Q.Q J?.QftlQa L.a BBTwam I of capital 11AMDS9. *r- . Md miKsllaiMouB invsstments, iodiidiag Uqoidatinc dividendsCfrom Scbodule A22). I. dttnag tbo tazabis psrjbd aad boC compeomted for hy insmaiica or o&nnso. (nam Schsdols A2S.) (BK«swltolastcofauBasamo(ordillsrsao« bsCirs«i ItonMnaadB) -fi. M. Nstiii(»m«lortaxaMspsriod«zchiaiv«ofd«dtkctk>iisfordivid«fKksiidamortasatkm(sumofordi^^ WL Dividnds oa stock of(«) ionifB corporatioas taxabU by tbo United States oa tbsir net incomss, and (b) p wa tioa^sacspipsmbiialsmvfca corporations from eandngiacaimiilstedoa and after January 1, 1911.. of or difference between Items 21 and 23, tbe lattsr as eztsnded). * ' cor- 096 ol«iriMililias(lrom8cbadaUA»)(sKteadtotalo(IISM»and») Mar laooMB loaTAxaMB Phhod (difimaM* bstwosa Itsma M and 98. tbe latter as extended-4o be enttred as Item 5, Scbedule D). Lamdsdaetiaa pwvUodialka imt paiHnpk of Seetioa SS, ICsrtAant Marine Act of l»20(see page 1 of Instructions, paragnph 4) Wi* Jneeasa ol a earpsftfoa ssrafan sMps ennged in fareltn trade (Msonnt to be osed only in computing profits to» in Schedule D) OQ. 4.ia ^■aaaBBHt -Ja 3K afc» 337 327 000 6.50 a7?roQ Z33I 09§. 875 00 esL m .Q(L OfiL SCHEDULE B-INVESTED CAPITAL. I. Q ipi t a 1 .siaplBs^andandhrMedpwflmatbetinnfa^of«ajmbUpsrfadsashoaabybook»(lwmSAsdiito^ 11). S.Plasa4iiistsMniBbyaajflfadditiaM(tea8chediikP,I«M4)_— ^ ■. 4.I^ *ITnrfii hy^^ynlAJiiSi— fh«>aA>i.Un, TS^t ) Sb RaMAonHB ~— ——___«— ______________«««_____«__«_______..__ S. PiMcrminoscfaaaBSS in tn iM t a d capital doriactanblopmlod (Wet Twcw mw or P s ct SMSIrom Scbedule H) T. Torsi (oa n»M*nm— ) 8. LsmdedaetkmooaoooantefinadmMbMamsm(from8chedaleJ) >. InTirtsdcapitalfartaabla period. (li retain is loc a period Ism thas a ftiM year, sse page 2 of iMtractions. paragtapb 11) Amovmt. k-lj5.73 63 19.§. 78 IE iot; TJ9T 360 396" QSL 750 00 5C OQ.. OUQ_(iCL .;.3. 87- 650 7iy SCHEDULE C-EXCESS PROFITS CREDIT. 5.4_ 53" l.Bi|bt per coat of inTostodcaptel lor tnnbia period (Item 9 of 8cbsdateB).___ t. BInavtimi (18,000) (ssospt lor forsicn corponrtiMa) '. 8.E»semProfts(beditatemlplaiItsmD. (IfrstBmistorapsriodlemtbanafoUymr.seepaKeSof Inetnictione. pamumphll). 31. .3. 977_Sll. QQQ..^ SCHEDULE D-COMPUTATION OF TAXES. 1. Hs8inoeaBe.noCin 2. Balance of net of 80^ of invested c^itaL 8. TMals computed under Section 801(b) 4. Ezcem Profits Ttt, if OMBpntsd 1. Aaoonos N rr IMOMB (Inifs £12. 10.7. SL42. 32diU* A).. ponilaa 7. BsMMproSta tas'(l^ S,a;bMlal« D)«r •. Bifiwi prolta wd war (iMa le. Pona lUW, OoT — — * eMtractt) - -. ^ Eic«pUaaa,«Mptiorltni|B canons Uoofl. t3,a0» nba ratvra to lorlMi tban a yaar Aa* pac*3«(lHtrBrtlnB, .fifi ilZ& 18&JI& Inl X9giL „ QQ. 00 10. Balance salqect to income tax (Item &.l«mItems«.77siiT 9. or Item 6. lem Items 8, 8. and 9) „.l. j 3^7 875 69 258 .801 00 05 073 95 AMENDED RETURNS. .^n amended rotura must be plainly marked " Aamnded ' thefaceofthorHaia. 11. Tu of 10% on Item 10 12. Total tax (Item 8, 4, or 8 plus Item 11). u. !«. jd pnata taxM paid t« (enlSB rooBtriM or paMiMiaa* of tha UaitadSteUa. (flaaaacUoasasaad S«(c) a( K*rmm Act of MU) tax withlMld at tha towea te ttm af a foraini oanontthm not as- ltiS«d ie a trada or tnHswi wfUda tba Ualud Statai, aed aot harli« any -^ odNOtaMttawaia..... 15. Balance of tax (Item 12 minus Items 13 and 14) . d. Amookt ov Tax. .S£. .4.8. Za2L13_ affi&.9.8- 25 33: 807 40 94_&5.^|4&.. iL CHECKS AND DRAFTS. CWAs and dmite will be accepted only if payable at par at your Collector's oftee. Pace ft of Betnm liT-CAnTAL. SURPtUS. AND UNIMVIDCO PROFITS AS SHOWN BY HTORC ANY ADJUSTMENTS ARE MADE THEREIN. ■4. Staek MtittDj outsUndlng »t t!)* end or tlM pr«c«din« UnUa p«M tbauM IwaalMd in thb ■eteM* •ifta*«it«ttk«titUp«idup. I(st(wtptr*ahMUM«aMa *nU nflKt Um utounU on th« books In nitpact thanof ;il tb« eUis* of Uw pnotdinc Uaabi* p«tod. BO. This Itamtkould tnciudo paid-in surplus OS iiboaro tjr books It thooad of tbopncadtng tezmlil* portsd. lliBywii>iinriiBlrtm«(lMrtwBwtti«3a»(»)(?)ottl»oR>v>mMActo(m»oruod»Artfcl>«WotR«KulllnM l^thoMDonnf riiteid ihiwM l»in«w«attwlif Itea i, Schadulo F. and not In thhidwdnlfc. B7. "■ -II -M-*- rnrnnl iJirtnllTiii tT mqitiM Ml t w i r" nrmmiitrifl ttinnii|> (kAmtkim — ii tewpotttB»tineow»MW>wBidt«pw«1— y>f>w>ay.lfp>opwty«plato*J.b>ilMiaMH—T. Sodi WWthouldboldilMliiMiMBMi— |iiBiinllid»nht»l.ino»«b>rtttiirrw. Bia IttteoorponttaatadMlMadMMirtlB*4iiflii|tthaU>aU*p«ladaB7toMni7itBek.Mpl««(th« IwwMl miIiIm nil I w Iih till iiiiiiinl 1 1 iiiin i 1 1 | iii wiliiii tiiil ini iii ) »w|iiiiii ii Ul Mfiii l ii ml j lii rmrtilii d. TuMutiiHnt lKliiil««n«locfcriicstiiwdbytboc*»yw»lla«Md»«tci«cri«d.iipwW«ioCtUwMB«l»rtl» Item. ■ikiiir ftyltil lluli iwld iip—d nctunnyoutslindtmat thot lo»oof thopwrodiat ytar L t. a. «■ meetmit tt tiinwiiy stock- Cipltnlwid wrplns at hwtnn tn t of t»«»bl» parted m Atmn by fcooitt .9JE^5QQ0^0a lOQQQJX). 3CHCOUU P.K-ADIUSTMCIfTS BY WAY OF ADOmONB. n. V u addltUm to Invcstad capital U cUlsied In tttm I, Bdiadula T, nitailt « i (a) tba kind of property, (») tha yaar tn which it was paid In, (r) tnm wbon acquirad, tsplainlaf hliralihaa Alp to tba oorpsratloo, (4) tba actoalcasb vakia o( surb proparty at tha data wbM paid la, (O tba par vslnaaC •tack or sbana lauad tbwafor and tba aaMont at which such property waa «itarad in tba MBMBla, (/) tba bailt upon which tba actual cash valna ot tba property was datamiaad and tba data whan tudh daterwlnatlna wm iaade,aad(f) the amount ofdapraeiatka niitaimd aiUDdt proparty »«■ tba data oCac^Jittloa to th a h ag lw l i n altbatasafcia period. n. U aa addition to tuTastad capital ta datanwl In Item 1, a*a«rfa F, ankBtt a itiliwt abowtaf (a) tba kind o( property , (6) the year in which It waa acquired, (e) lU eaat, (d) tba aaMoat a( dipraaiattai aoa- k property from the date of acqoiiltiaa to the beciiiiii&( of tha tanblapatod. lata aim wbaHi» titamaeoiht to bareatored was actually naaJar amble at tba hetinnlic of tba tanbia parted. Warathan a«paadltuwa, when made, written off in lien oldipwriatleB? , .. Uae,«iplaiB«hatadiai*mm«i hara ban made to provida for depredation in Ttaaraf tha patpomdraatoratkntaiBptai. AddtttanilitMi I ara camulatlve to tba beclnnlnc of the tasaMa parted. Par all addlttaaa I wiwiiii lat proflili wait ba (fcrJaprariattew ta tba baflnntof of tba taiabte period. n. U any additlao to laraatad oapttal te ciaimad la Item I. SdMdola P, itila vaattetBy tha iMial s i cmdWparcsntafthan>in> at tha tasaMa parted. l«oiB.-» tha stack of tha earporatlen was lasnad at a asalaal enhm or wtthont par eahM, Br tha I af tha cempotatka mdar Item 1, tba par vakw shall ba deaaasd to bo tha tatr market vataa M of tha data or datas aflmoa. Tha agpa^tavataa so datersBtaMd of stock ontstaaMacea March S,l«17, oral thai tasaMa petted, than hatha baste lor tha eampntat tea. ot. Is say lantfMe property, paid la Br stock. 'irtir"^ Use. te tt «tmd on the books at a TShia la •asam a( tha par Taloa of tha stock paid tharsBrt II tha aas^sr to stthar ot tha Isat two qnsitteM is "ysig'' SBbarit a (») whsa aoqoirad, (c) par TahM of the stock paid thsrste, (d) aetoal M IB MM* BX tM OOVporattOB? SJOL Mat shswli« (a) ktatd of prapatty, Tshw at the property whan paid ia, (r) tba baste on whlA that Tataa was dolemlnsd, (0 valDS at which tha proparty Is antarad ea tha eorparatlan's haoks, and (I) amoont by whli^ audh TshM oaesads tha aOewaMa ealaa aider Saottea mca) 0) «( tha Baeanna Actafins. Enter thtoamoont as Itaa 3, adMdoloO, Br tha taiabte ported. OS. Wmtha biahiam lejaeorporatad, roerisidsod, or aobaaca la owaarshlpot property after March S,ltl7T ^ « waslto«wasidripehaB(sd or waathara ~ If so, answer tha BB i all (himWiii (•) ^-'--■-*— *-'"'j- ' '-*^-*— TVTirirT'ii*hi | ir n i n t j rtilrh rh sato d ii wa on Mi rsmain la the control of t b a mm o peraops, cerparatlana, om of lo tl i a s , ar partnenhipe, or of any of thamT ..JSyji— _ (>) Ware any of tha aaaato enterad on tha boohs o< tha eorpontloa isaktac thto rstom ct a hifbar vahw thaia aa tha books of Its pradeeassor7 _:r:=>___ (e) II soch proTteos owBsr was act a ooipantioa, attadh a otataaamt *owii« (1) the cost of aeqnMtioa to thaprevioaaownorafaByaosotsotraBSfBn«derroeahrad,0)asp«dttnrmonbaeqaenttoth*tdatafarbettenMnt or deratopaaHit not dedoetod as oxpanm or otbsrwlsaBaea March 1, IMS, by axh prerioua owBV, (3) thaaltow. aea lor dapradation, depletkm, or Impalnacnt slace tba data of acqatettien by such prerioua owner. (O If all, or substantially all, of tbo property wae aeqolnd taaa a osrporatiea dnriaf tha tasaMa parfod, «**«^'>— «"*^'»"'"*"*'"*«~'»'l"< "1 "" '■— **'^*-t'"'''^"f**^ *ttM tirfTMairiMattlia ^t»i».«^i.t^l»i.»»/.n.^t>....«^»ftiM.|»iy»*Yt..tv».i.| IT .^t^^tt^^ — . 'Til slrn a balsnna shsat or statement of tha corporation maklaf thto rstoB Aaorlai tha vahM at 1 or traaslarfad were antacod on the books. Vbr tha pnrpoM of dotermlafaic iaeastad cafMaleaA aaa than vanid haea bean allowed to tha prerioos awBV, U a iswh ptavlana awnar, wtth prapor adtoatmarts Bt taaaiMti i|M«l ahaO set ba aDovad a or,llaela Ui( Ot. b any praparty (ImBKHin phyateal property, aocurlUas. and lntan(lbte property) paid fcr with ea* or with othar tucibte proparty antmd on the books ot tha estporatioo at a rahja Inu^ of the amoont of caA paid thiisfcr ar tha actnal cmh Tahm of tha tai^ia pwiporty peid thwefcyT ... JLU Ifw.nbmlta statanwat^aali^ (a) Mai at p roperty, (ft)ameaBtotcaahpald therefor, (c) actual cash tsIuo of other tangiblo pceparty pnU thaasBr, (d) haw that Tshia was dstsflai rt, (r) rahie at which the property is entered on tha books of the corporatten, and (/)•«*•* of «) over (») or (c). ThUexcmmiKtbaentcredatltemf.ScfaedutoO, BrthetviabteprTted. GA.HW adaqnato iiiiihiBa haaa aaal^tn tha aoooonts of the compel' fcr (s) losses of aeatr Uadr Yftg (») depreciathnT _..Iflfl„.... (c) ob«)leaccncer XAB , (i) depMten af niaml deposits, timber sopvllr*, and tbr ItkoT ..^^ n rlriin** charts hm not betn made for deprodaUon, depletion, obsolssesnoe, and othar loases, and (ha TShss ot tha prsparty hss not been maiotaJDed by replaoemenU that haifa baaa charfsd to expense, proper addittenal Amim thanfcr asut bo computed for aU years in which thsj VMS ast BBda oa the books, and tha total sms— tat snA c i h m is s m n i r haaBamd aa Item fc M e h sd ate O. ^ OC Did thaoarporatlen aeer rseoiva a stock dirldoad on ttoA ownad In aaothor oorporaUonT .. JL w ... If tha aoawer U "ysa," state in detaU for each stock dividend rMseived, (e) data leooired, (6) from whom NSiivod, (c) number of shsies rsceiTtd, (O por rahie of shares reoelTOd, (r) Tshia at which entered on its hookscfaoooust,(/) whether or not surphis was increased by this tsIuol Ifanswer is "yea," enter t b a a mon a t by which surphis was lacraaaad •• Item 6, Schedule Q. U answerls"no,''ststathe aoooant in whkdilt was todndsd, (f) data of sate at aay of tba shares of stock rscolTed as a stock dtridaid, (t) anabar of ahaias sou, (0 aammt reeolTed tberolar. NOTX.— If answers to the tore(o abh ported or pertods In which this error occurred. Itam. I. Valuation of patents, copvTirbts, Sf>cret prorcaarx. or (ormnte, rood will, trade-marks, trade Brmods, fraorhises. or other lntaia(ible propnty 1 Vataattoa of taadbto property paid in lor stock k. S. Vahmttea of ssssta arqolrod la reorcanlratinrw .,—» «. Aivmclattoa_3.tL0.Qk_ J Iw PopwlaHsn, <^iatfaa, aad othw losses : CMsckdiTMsaaaaslsokheldlnaaotbrrcorpacatlen t; TtwAt Panmiwa-.— .———»...-.— ■—.-..— 43760.00 JSiQQQQM .6S.7.5.0.a.O.O aCHCDULB H.-CHANCES IN INVESTED CAPITAL DURING TAXABLE PERIOD. 1. Chanpa in laimted safltal dadnf the taxaUe period ordiaaifly srlm la oaTor more of tba fcOowlac sntsr tba aombor of days remaining I n t he taxabto pwtod Qnohsd lag the data of diaagt). act roportod in Schednie L, if not in aocordsnoe with tba inoraasm or < ahaaU, abenld U fully raoaodted tborswith. L Kstaraofaddlttaas aaddadaotloasL dL. S. Number ofiharM sold or re- aeqidrsd. 4. If lor caah.fltata price per ohare. S. Amount of cadi orcaahTahia or paid out. Number of days aOechva. 7.Adla*tadanraca. /Ori»oSXCMMat\ fiomaatoQk ^ 750 U.00e 1.76000 a -£16_ r66606 a8& ? . - 4.x . ., i:M ^OOBM taj 100000, ' -42860.27 f 1, , 1/8J jjaaoae^. iDiTidftnd a_ L SAIL. ^UQlLJll t. Nat iMcaSAsa ea DacnBASB _ .-r^MM^.-Xl aCHEOUUE J.— INADMISSIBLE ASSETS. Haa tha eorpontloa any Inadmtaribte aaseU (L a., stocks, bo^ and othar oblifslkaB, of the United Btatoa, tbo income from which u not taxabto)T ksM. U M, atlaefc barato a statemant showing fcr tha taxsMa period the facte caOad hr In (■}to(A«faii If tba tacessa tnm sooh aassta oonslsta in part of gala or profit from tha aate or othar dlspositton thorseC ar IfallorpartofthetotereotdsriTedftomsnehassstotelnofloctlwchidodlatheiMtlnenmabecaueeofthellmitatloa on tbo dodnsttea of Interest ondar Section 23tcforad«duetlngrM*rT«ilDr (lelMdaMttaf). Raw Work In rtnlthMl SuppliM. ■•aaaaa: Dead*— U. 8. DaaosaadoonfMlooa(MchiSSoatoM SttMd MpwMtiT). BxMBpt (munidiial. StSMk «*a.X Otha. All corpotationa enj^aged in an inWm efi.'^er, may suhnil in heu of aho\-o Fona T»«AewtiBd4 TsMlHn. (tobadMsOia). Und. Bolldl^ Dinvary soulpsMt. Owafarnitiire. Otbw (MSM charaottr). Total. br dspfMlaMnn wy bo dodurtod fla*d« La« r— rm for ilMwrlotlMi (Aow oiBafMaiy amsnet •ppUeabto to «eh flxad ■«•()> «d wB, aei ilhac Inaasnil* aasoto: Paid for Id eaih or «th«r uiifibi* propwtr. I>ald for la nock (otbar than Mock divldwds) Cnatsd bf ttoek dlvidwd or otbcrwiia. Ool Oo stock. LIABIUTIBS. ■mMo: To'omovs uid stockboldan. To otben (uidudiiig book loaaa). Acaoaal* v«|«bte: Trade Otb«r. A u n n d *i e — s ua tad l osor no . tho wblch aro aUowabla doductioos from ho dotal lod). crtotlnc KaaorvM. tbo dMnas craoting wtaldi are not aUow^ thmifroBi ' fk«a tbo roipaeUT* Toru. aeeoonU or iloaalaod «i tbo labUitr iide o( tbo bobneo tboot sbio dodncthmi froBi Inoomo: Boamras lor tossot oo notta rwrivablo. Otbar roaarrm (to bo dotaOad). Costtal aodi outatwdbis (to bo daariflad). SaifhM and aadMdad TOTAU and aeeeoota intrastate trade or business and reporting to the Interstate Commerce Commission and to any national, State, municipal, or other public of thiir balance sheets prescribed by said Conwaiaaoa or State and muukipal authorities, aa at tho begioniog and end of the taxable period. 1— ie«7t -98- PlB^ 4 of Btftiim* SCHEDULE I — RECONCILIATION OF NET INCOME AND ANALYSIS OF CHANGES IN SURPLUS. 1. NM hMDOM from Scbadolt A, Itm 27 l> MtalKabi* income: («) IttUrest on obUsktlons at Um CnUcd 6tmt« and iU whofly uempt (I) iBterwt on ob4l*Uaiu <4 SUtes, larrltorlas, and poUtkal wb- (e) IntaKMt «■ rwa Lain Boiiii'ia'MAiaiiii'fiai^Tirm'Loui Act (^) Dividends oa Mode of dowitUo eorporaUao* and from fortun coriftRlL.-C>n...St.9.ck (3)...0r^anlaAl;lQtt..&Lpaji3.e.a 13. Tetalafltamll _ 14. DiTideods paid durlns the taxable period (sute whether paid in '^•h. stock of this company, or other property): (a) Dau pald.jj.9AA...^.^ awracter_„Q.ft8h (l)I)aU|»ald„lfcMr.ia...6._ Character ....0.89.1^1 (e) Date paid .JiajCL. U, OthardeblUtosari4tta(tobadataUed): Character. Charaeiar. .C&Qh. 0)- (0- 10. Total of Items Head IS. „...a 100 .50 .60 fi. 5 .000. 000 5.00. 1.......?.. 18 9 .;4o :sT. QQQ- 000 00. oo_ 00. ao. 00 oo. 000 00. 00 300 400 OOO. 00 OQl 00. IM. OCT SCHEDULES SUPPORTING SCHEDULE A. TT>»fenMied,Midtho«>pw^H^ Ent«rittineaod»dd««of capaation on ewhiheet RxuaiTK or MsrmsMa, bxpaim. amd othsk a CHSD OlK At: COOT OV GOODS SOtD, . rmis CALUO) pos sspasatslt. mur a.Camacala el InvMlaii.TMm im,aBd (») SUln the faUowinc sebedttle.entstinc oa liaea 3 and*, immedl- •taiy betora the amoant eolnmn, tJba httrns "C,'' or "C or M," to Indloau that InvtnLidaiaM Tahiadat Mthar watioreost or market, whldieverUleww. ~»iM»«™T«ww«t«uiw O) MvchaMlise bought tor aala (D Coat of manu^aoturlnc or otharwlae j aat of ma nua e turlnt or otherwise niodueini toeda. (SabMltaaMMa - ^jssi,v-^^-^^^.^i^s^si^^^,ss^ _i45.6iaa..ao .g.457.e;o.ao t_-Aaoid&Q..ao. fl) Tlaal a f ia ry at tmhwilii^ of yaar- H) Tatal .a9£4flQ.>.QO ■CBK^U Al: OKOM IXC<»CB PBOM OPKBATIOin OTRBt THAR TSADma OX MASTU- (<) Tm i lnv m ij at «d of yaar. (•) omoiwaiwU Sabmlt a sebedule sbowinc t)ie nature i Mat frouped In one amooat. (For S t of tba priadpal Itaau taeindad herala, the miner Items n asa pace 3d Iaatraetioaa,paraciBpba 3 and 3.) M intsraatwaa derived durliur the taxable perfod from liberty Bonds or oOmt ebUMdona of the Uoitad •mm issued daee SMpMnbwlTnn (axeapt vlnory Liberty Loan »»% Hatm), or WwTlnanoa Cmotm^ Jg^l^mntnn tbaCoUsetor and idaMapart of thUtetura 8dMi£ttof T^^ ■MM thaamoaat •( VlMmy Ub«7 Loaa 31% aad 4|K MoModtfidlr aAndbad te Md Mfll owasd MtbadataorflaBct)ilai«na,«X000O«.0O fltata Iba amoiiBt of ftoitk Ubwty Loaa 41% IkadMdilad^ adMdbad IV Ml Min «*w« at te 4aM 0^ ttblsiatnni,! v "^ Oorporadoa Bonds, aa eash aflhatad oorporfion U entltlad M WusavdaM.^^ ^^ UIM AS: TAXABLK nrmtlST FROM AIX OTHBX SOOXCMk tabmita8cbedu]asbowinctbaaeaioa»iiatai«,aDdamsiiato) kind of w... aatlanal, W a f a. wimW pal, or eerparaU), (e) amooat of pr&dpal, and (Oaa^t ifiSwaL wcfiwnmM A9t nvroxHDs or stock or forxigr cokpokatiors. tebmlt a acbadnlashowlaitn) with respect to aaishtorelgBcoipaiatka taxable by tbaVUtadSMatM Its nK inconie. (a) name d corporation, (t) eountry in which orcaaijad. (O total par vdna of stork Mmad^S (rf),ainMiit d'dliMsnda: (2) same fnrirmatkn «ith remct tTSSMm^onoiSiM aMUi^^ I'itSaJo^lZJSui^^ir'''*'''''*^ ^^'^ "^' *•' aadi fchle. «p«altai ii* uiibtoW15 SCHXDCIB AlO: GROSS IHCOta FROM AIX OTHXX SODXCXS (ad ibadt asehadolashowlnc tbaaouna. nature, and unoui betnf grouped In ORDIRAXr ARD ^TJ^SLI PKUOD^ ASCRRTAIRRD TO BS WORTHLBSS ARD CHAROSD OFT WITBIR <») t a schadula tram other souroae other than thoaa spadiled ■ tha uaoimt (a) arWnjf from tales, or aerricca pravfoosiy reported u totwest rent, wa tice, etc.) prevkusiy reported as income: (O arid id above (to bo ItvaUmi). (Baa Article ISl, RecuUtions 4S.) tneoma; arisincfraai SCHIOOU AU! EZHACSnOR. WKAK ARD TKA« (laehidlai ebaeleecanee). ,_.M* i?'*!P«i*t?*<'* on aooomit of depreciation, the followinc schedule must be flilad In, Hid tha tatal !!??fi!f'SS'.*''*r!'°J^^ oemspood with the n«ures reflected in the bdance sheet. LaiMl^Jnes mSt aMbatootadadlatbUKtedula. (See page 3 of Instroetlons, parasraph 10, and ArtSas Wlto inrBe^ Kind of property. (UbuOdingsrsuta themateiidof wMckoonsuueted.) Uaoh.!.;.. Bullllnga Pa.tenta 19.20 Fiiiu&..PJjdiai£L Tetd.. Data mn wh«a acquired. naw. JIB.W. Coat, or if aequired prior toller. i.lSU.tbe tairinvkecvdue on that data. 610Q0O. 250000, L7QO'o6.. ■10000. QAQOQO^ Probable tile after acquire- ment. 10. 60 id. 10. Amount of depredation charted oft. ThUyear. 5.51000,.. ...-.6OQ0.e.... .17000.... ZTwmz. rrevloas yaais. il5.9.4Qa..*. -.-.3.9..0QQ.^. .0.._. .e..OQo^.. ,204400^ NOTt.-If ddmed tor th»ii^hiri^£S^ftliS^S^^^ ""^ ' »t«em«,t d>owin( tha amount 8CHSD0U Altt XOtPLKTIOR. • ♦18400. disallowed FWm F(i complete UadadwtlaBtoddmedonacnMmtord«BlHln.nearerrom theoollector Form D (mlncr»b). Form E feed>. !S^.^i??^*ii^i/JS^ CT (cUand fas), or Form T (Umber), fill in and file with return, lif S. .- !»."* * '"I^PP'^JS*'^ oueetkmnaire In previous rears, then file with this return intorma. niiiiaaaiTWiinaciijmr dipMUia sdieduleup to date, settijic forth in full statement of all transactions baaiw mdadiMdeat ar aMiloaa to vdoe of physical assets with explanation of how depledtw ded^ntontor (£^ p«tiedkaabe«dat«miBad. In case of timber thUsbouM be done by filling in FMmT(tlmte). ■Hr^iJ?WR*.iV«?.'*^!F 9? }P^ S?J*i¥ ^ CAPITAL ASSETS ARD IdSCSUARBOUS UIVBSTMSNTS (Including Uquldatlug divldcods). m^immmmtim). tabmlt asehadolasbowlnf tbaaourse, nature, and amount of tha prtodpd items Induded herdn, tba mlaar TlM tetd ol the schedule shouldbeewsfedaaltM 10, ScheduiaA.^^ T RX P KR81 S (a loaDadtor •CRXDULX A12 ScbadaiaA). tabmlt a atatannt showing ctaanetar and aMMmt of tba priadpd itams iadoded betala. tha befaggraapad^onaaaMoat. (For srhadalM ta baaabmltiad^lMnmnea campaaJM aeapaga tkiB8.pan«rapha4to7.) ' * *^^ BCaiDQU AlSt C0MPKRSAT10R OV OFfldBS. BobmitaaebaiMashowing far each officer (1) itock o«Ded or controUcd: (eTpretaned, (») eon^ amount of, and raaaon tor iacraasa. if any, over prMading period. BttbaJtasctwdtte*p«te«lorM^ampl^^ li at the ratad 33,000 or an p«aHnm,facUdmllar to thosa called tor iaiaspairt tooOo^ 3d ^ CT) MiM, (3) ttBa«r«B«a« toaseh dntt«a.(4) diarnd : (S) total eom p e nrnttoi far the taxable period, and (6) 8CHSDUU AMI XXPAII8 Aibmit a sebodule showing the nature and amoant of tha prindBd Itama ladnded harain, tba » Bdag grouped in one amount. (yorclaii!H>narinnofrepalt«aaapie«flriiMtnMHnne,p«»« jT»p jff J SCHXDOLB AUi TAXI& Botait a scheduleshowtaig separudy tor sadi daM of taxea dadoeted. (a) cbaraetar. and (») Mmltoeomudprollutaiaa, taxes which are a credit oadar Section 33S, taxee asaaeaed bcMfta of a ^ taadtag to iaereasa tha vahja of tha property arsaaaad, and States oouatT, and m pdd by bank»Mjd other coraera d e n ebeaad en tha vilneeflhdrcapltd stock w net dfcwabia oomputlng tanhia Inoomeof nob caQMHlna. (See AMdaiW, Regulations 4«^SiaeltaR inlast munidpd BevaaneAetdnu. . dedjctlsnsta nK»)(S)a(the la eaw.pf aspoad.of prepmy, rmulting la a profit or 1 a MpasaiaUaa tor aeon aaaet. loas, the fdk>wiBg schedule moK U fined la, odBc !• Badelpnptity. 3. Date acquired. 3. Ace when aequired. 4. Cost, or if acquired prior to Uar. 1.1913, the ialr market value 6. Cost of subsequent improve- mD ARD ROT COM. PBRSATXD FOR BY lltSURARCB OR OTHERWISE. ***~*» rmiuuu Anw wax <30M. A schedule Similar to the one requested above should be submitted With rcspeet to leases d pnpertT «^ ■K from flrae, storms, stiipwreck, or other cejonity, or from theft, and not oompensated for by inmMaa »tiont iiwwd woder withority th^wof ■ '-w «^ kwu muu, rar we Sirani to and mbaaibed belon m* thia . .diqrol. PMMdmti The Schedules below should accompany the return and are part of the answer. SCHEDULE A 2. MANUFACTURING COSTS. Labor Materials Supplies Fuel Overhead Expense $685 , 600 625 . 840 48,000 49,100 47,560 $1,456,100 Issue Second 4's Fifth 4i's SCHEDULE A 4 Taxable Liberty Bond Interest Principal Interest Rec'd $30 , 000 $1 , 200 10 , 000 475 Interest Taxable 475 $1 , 675 $475 SCHEDULE A 12 Ordinary and Necessary Expenses Office Expense $26,910 General Adm. Expense 7,090 Selling Expense 65,630 Insurauice, etc. 4,000 $103,630 SCHEDULE A 13 Compensation of Officers Name Duties Time Shares Compensation Compensation Reason for Owned 1921 1918-20 Increase J. Doe Pres. All 1,000 $50 , 000 $40 , 000 J. Roe Treas . All 1,000 50 , 000 40,000 Increased J. Hoe Sec. All 800 25,000 20 , 000 Responsibil- ities SCHEDULE A 14 Repairs This amount, $13,000, was spent for minor parts, labor, etc., which did not materially prolong the life of the assets nor appre- ciably retard depreciation. SCHEDULE A 15 Interest Interest on Bonds Payable ($500,000) 6% Interest on Mortgage Payable ($100,000) 6% Interest through writing off Bond Discount Interest on Notes Payable Total Interest $30 , 000 6,000 5,000 2,000 $43,000 -100- SCHEDULE A 16 Taixes Property Taxes, etc. State Income (Excise) teix Total $20 , 000 30,000 $50 , 000 SCHEDULE A 18 Depreciation - See page 4 of Return SCHEDULE E 7 Unallowable Reserves Sinking Fund Reserve Inventory Reserve Total for Invested Capital $100,000 28,000 $128,000 SCHEDULE F 2 Additions to Surplus Organization Expense Commission on Stock Jan. 1, 1921 Original Value Value $20 , 000 $36,000 15.000 55 . 000 $35,000 $91 , 000 Difference Restored $16,000 40,000 $56,000 Cash Value Good Will $275,000 SCHEDULE G Intangibles Purchased for Stock Par Value Stock 25% Stock 1-3-17 $250,000 $231,250 25% Stock 1-1-21 $228,750* ♦Value 1-1-21 not allowed because Treasury Stock not deductible from Outstanding Stock for purposes of computing 25% limitation. There- fore, correct value 1-1-21 is also $231,250. Book Value $275,000. Value Allowed $231,250. Deducted $43,750. SCHEDULE I Inadmissible Assets (c) Inadmissibles Jan. 1, 1921 (d) Inadmissibles Dec. 31, 1921 (e) Average Inadmissibles 1921 (f) Admissibles Jan. 1, 1921 (g) Admissibles Dec. 31, 1921 (h) Average Admissibles 1921 (i) Sum of (e) and (h) ( j ) Percentage which (e) is to (i) *See Explanation in Answers. $175,000. 185,000. 180,000. 1,786.300.* 1,894,790.* 1,840,545. 2,020,545. .089 SCHEDULE K Balance Sheets. These are required as part of the Return to the Government, but are given in this Lecture as part of the problem. They need not be repeated here. -101- LECTURE II, PART 2, EXPLANATION OF ANSWERS. When the corporation return is prepared, it is advisable first of all to write the Profit and Loss Statement in Schedule A, page 1, showing the Taxable Net Income. The Profit and Loss Statement in the problem shows a profit of $109,070. The Statement contains non-tax- able income and unallowable deductions. Non-taxable income includes interest on State Bonds of $4,000, dividends on Lumber Stock Owned of $5,095 and $1,200 of the $1,675 interest on Liberty Bonds. The com- pany owned $30,000 worth of Second Liberty Bonds and the $1,200 re- ceived on these is not taxable. It owned $10,000 of Fifth 4f Victory Notes and the $475 received on these is taxable. Therefore, the three above items just listed, being non-tajcable, are not included in the taxable income of Schedule A on page 1 of the Return. The following unallowable deductions appear in the company's Profit and Loss Statement: First, the deduction for Federal Income Tax for 1920 and also for 1921 may not be taken. Secondly, the amount deducted for Inventory Reserve is unallowable, and thirdly, the amount transferred to the Sinking Fund Reserve. The taxes are a distribution of profits and the Sinking Fund and Inventory Reserves are known as unallowable reserves and additions to them are not allowable deduc- tions. Donations of $3,000 are not deductible by the corporation. Commissions on Stock, Discount on Stock and Organization Expense written off may not be deducted, as fully explained in Lecture 7. The remaining expense items in the Profit and Loss Statement, have been placed on the proper lines in Schedule A. The only thing to note is that line 13 of deductions includes all expenses not specifically called for on other lines. It may be well to note that dividends from other corporations have been included in income and then later de- ducted as expense (lines 9 and 25), the effect being the same as if such dividends were not included in income at all. The book income, as given, was $109,070, while the taxable income is $327,275, the difference being due to the non-taxable income items 2Uid unallowable deductions described above. Having written Schedule A, page 1, the writer should then turn to Schedule L at the top of page 4 of the Return. This schedule lists the difference between book income and tsixable income. It be- gins by placing the taxable income in the upper left hand corner. To it are then added non-taxable income items, because these have been included in book income, which will be correspondingly larger because of this fact. This raises the taxable income of $327,275 up to $338,570. On the right hand side of the same schedule a list of un- allowable deductions is placed. These total $229,500. Such amount is then subtracted from the $338,570, giving $109,070 book income. This schedule, therefore, reconciles, as its title implies, the book income with the tsixable income. -102- Next the taxpayer reconciles his Surplus Account in Schedule L, page 4, of the return. This account read $122,360 when the year began and to it has been added the book profit of $109,070, giving a total of $231,430 in surplus for the year. From this amount have been sub- tracted the three dividend payments of $87,700, leaving a balance of $143,730. These figures show, therefore, the totals of the Surplus Account for the year. The Surplus Account in Schedule L, page 4, should reconcile with the Surplus Account in he tBalance Sheets of the problem at both the beginning and end of the taxable year. One item in Schedule L may require comment. The company took $1,000 additional depreciation for Furniture and Fixtures in its tax return but not on its books. For purposes of reconciliation, this item is treated the same as a non-taxable income item, because, having omitted it, the books are $1,000 in excess of the Taxable Income. Having completed Schedule A of page 1 and Schedule L of page A, the writer should then compute Invested Capital on page 2 of the Return. The schedules on page 2 are numbered E, F, G, H and J. At first these may seem somewhat confusing, but a brief study will show that they are arranged in a useful order. Schedule E contains the Invested Capital as it appears in the Balance Sheets and on the books at the beginning of the year. Schedule F contains any additions which are to be made to the book values as of the beginning of the year, and Schedule G any subtractions to be made from the values as of the beginning of the year. Therefore, E, F and G together give the Invested Capital as of January 1, 1921, in the problem. Schedule H records any changes in Invested Capital during the year and Schedule J covers deductions on account of Inadmissible Assets. In the problem the Invested Capital, as it appears in the Balance Sheet, consists of the following accounts at the beginning of the year: First Preferred Stock, Second Preferred Stock, Common Stock, Paid-in Surplus and Earned Surplus. These are all placed in Schedule E. To these are added Unallowable Re- serves, properly defined in Lecture 9. They consist of Sinking Fund Reserve and Inventory Reserve. Also to the foregoing is added Donated Surplus. These amounts are then totalled in Schedule E, giving the Invested Capital as per the Balance Sheets and books. From this amount is then subtracted in Schedule E any Treasury Stock. By consulting page 2 of the Corporation Return figures, the handling of Schedule E, as described above, will be easily understood. Schedule F records any additions to Invested Capital above the book value. For practical purposes this becomes an im- portant schedule. In the particular problem the following items may be added to Invested Capital. First of all. Furniture and Fixtures are on the books at but $10, while it appears that such assets were purchased for $10,000 in 1915, and should have been depreciated $1,000 per year from 1915 to 1920 inclusive, or y -103- $6,000, leaving a balance at this time of $4,000. Therefore, the difference between the $10 book value and the $4,000 corrected value is added to Invested Capital in Schedule F. Also it appears that Commission on Stock Account and Organization Expense Account read respectively $55,000 and $36,000 in 1912 when the concern was incorporated, while these accounts now read $15,000 and $20,000 each. The differences of $40,000 and $16,000 should now be added in Schedule F, because the writing off of these accounts or the talking of allowable income tax deductions on account thereof is not permitted. Therefore, a total of $56,000 has been restored in Schedule F. Thirdly, the Government has disallowed $18,400 excessive depreciation. The correct entry to restore this item to the books would be to debit Depreciation Reserve for Machinery and credit Surplus. Whether this is done or not, the amount should now be added to Invested Capital through Schedule F. The total for this schedule may be obtained by inspecting page 2 of the Corporation Return. Schedule G records any reductions against book values as they appear in the Balance Sheets. It appears here that Good Will was purchased in 1912. Its cash value then was $275,000, the par value of the stock given for it was $250,000, and it also appears that 25% of the outstanding stock March 3, 1917 was $231,750, or 25% of $925,000, and 25% of the outstanding stock at the beginning of the year was $228,750 or 25% of $915,000. This last change is the result of Treasury Stock having been donated to the concern in December 1920. The law is that any intangible purchased for stock shall not exceed whichever of the four above figures is lowest. Therefore, ordinarily it may not exceed $228,750. However, by special rule. Treasury Stock once actually sold and then returned to a concern need not be deducted from outstanding stock for purposes of computing the limitation on Intangible Assets. Therefore, in the above case, $925,000 in stock is used for applying the 25% limitation, both as of March 3, 1917 and as of January 1, 1921. Therefore Good Will may not exceed $231,250. It is carried on the books at $275,000. It is therefore reduced by the difference of $43,750 through Schedule G. Any other item that may result in an over-inflated value of accounts on the Balance Sheet is then subtracted. As pointed out in Lecture 7, Stock Discount is not an asset account, but a valuation account, giving the correct value to Capital Stock. It is therefore deducted in Schedule G at this time, the amount being $20,000. Schedules E, F and G, therefore, record Invested Capital as of the beginning of the year, properly adjusted. Schedule H now records changes in Invested Capital during the year. These usually consist of additional Stock sold or retired and any dividend or income-tax payments. In the particular problem 750 shares of Common Stock were sold for $75,000 April 1, 1921, which means that the Company increased its investment $75,000 from April 1st to December 31st inclusive, and that, so far, this amount has not been included in Invested Capital, as Schedule E recorded the Capital Stock as of January -104- 1, 1921. $75,000 in stock from April 1st to December 31st inclusive is the same as $56,506.85 invested for the whole year. This is obtained by counting the number of days from April 1st to December 31st inclusive, or a total of 275 days and multiplying $75,000 by 275/365. Note that the day the stock is sold, April 1st, is included. Secondly, the concern retired $50,000 in Preferred Stock December 10th. Therefore, ordinarily from December 10th to December 31st the corporation's Capital Stock is considered reduced to that extent and a subtraction computation similar to that in the case of the Common Stock sold should be made. However, by special rule, if a concern has made sufficient profit during the year to retire its stock, then no deduction is made for purchase of its own stock. In the particular problem the company has made over $300,000 and has evidently made sufficient to cancel $50,000 in Preferred Stock. Therefore, no deduction is made at this time. This is not in con- formity with good accounting rules, in that the retirement of stock, an investment account, does not require the making of a profit for its cancellation. In Schedule H is also deducted any income-tax payments, for the reason that the aunount paid out as Income Tax has been included in Earned Surplus in Schedule E, as of the beginning of the year, and does not remain in there for the entire period. For a leap year, 42.14% is applied against the income tax payment and the deduction placed in Schedule H; for any other year 42.26% is applied against the income taix paid during the year. In the particular case 42.26% is multiplied against the $100,000 in Income Tax paid during 1921 on account of 1920 income and the result, $42,260.27 (carried to 7 places) has been placed in Schedule H. The reason for the above percentage is the following: The income tetx payments are due in quarterly installments on March 15th, June 15th, September 15th and December 15th. As in the case of dividends, the quarterly installments are considered as coming out of Surplus from the date paid to the end of the year, inclusive. When the first $25,000 has been paid by the concern on March 15, 1921, it is out of Invested Capital from March 15th to the end of the year, or 292 days. Therefore, 292/365 of $25,000 gives the deduction to be made on account of the first tax payment. Summarized, the deductions would ordinarily be as follows: 292/365 x $25,000 200/365 X 25,000 108/365 X 25,000 17/365 X 25,000 The above may be more readily obtained by totalling the frac- tions and multiplying as follows: 617/365 X $25,000 or, further, 1/4 of 617/365 may be used or 154^/365 and this figure used against the full tax payable, namely, $100,000; that is, 617/365 X $25,000, will give the same result as 154^/365 x $100,000. -105- As the latter amount is readily known, it is better to use the computation, saving the trouble of dividing the tax payable into four amounts and then multiplying. However, 154^/365 equals the fraction 42.26%, so that the tax payable may be multiplied by 42.26%, as was done in this case, and the answer immediately obtained For a leap year this percentage is 42.14, as will be observed in the 1920 Corporation Tax Form used in the problem. It has also been necessary to describe the obtaining of the above percentage, for the reason that a concern with a fiscal year will not be able, in the average case, to use either of the above percentages, but will have to maike deductions by counting the number of days and mul- tiplying the fractional results against the quarterly tax instal- ments . Schedule H also records axiy deductions on account of dividends paid. The rule is that if dividends are paid in the first sixty days, they are presumed to come from profits of prior years, which profits have been included in the Surplus in Schedule E and, con- sequently, when paid within this period they should be deducted in Schedule H. If paid after the first sixty days no deduction is made, as it is presumed that they are being paid out of current profits. However, if a concern has not made a sufficiently large profit to pay a dividend after the first sixty days, then such divi- dend also comes out of Invested Capital through Schedule H. In the problem given a dividend of $18,300 was declared January 10th and paid January 25th. The date that the dividend is payable and not the date it is declared is the effective date. Therefore the $18,300 is considered out of Invested Capital from January 25th to December 31st inclusive, or 341 days. Therefore, 341/365 of $18,300, or $17,096.71, is deducted from Invested Capital, through Schedule H. During the year other dividends were paid amounting to $9,400 and $60,000, on March 5th and December 1st, respectively. However, these gunounts were paid after the first sixty days and it appears in each case that the company had made sufficient profit so that the dividends could be paid out of income of the current year. Therefore, no reduction of Invested Capital is made on account of them. Schedule H is then summarized, the deductions for dividend and income-tajc payments slightly exceeding the increase on account of Common Stock sold, with a net result of $2,849.31 subtracted from Invested Caipital. It should be carefully noted at this stage that the income earned during the current year does not become part of Invested Capital for that year, but is added to the Surplus and Undivided Profits, as of January 1st of the next year. At this stage, the totals of Schedule E, F, G and H are transferred to the proper lines of Schedule B, page 1, and added or subtracted, as the case may be, thereby obtaining Invested Capital, which result should appear on line 7 of Schedule B, page 1. From this result is then deducted ajiy reduction in Invested Capital on account of Inadmissible Assets. -106- Conceming Inadmissible Assets, the ratio of the Inadmissibles to all the assets is then applied against the Invested Capital obtained through using the four above schedules and the amount sub- tracted. In the problem .089 is multiplied against line 7 of Schedule B, page 1, and the result subtracted, giving the Invested Capital for the problem. In obtaining the ratio of Inadmissibles to total assets the following should be noted. It is necessary to reduce all assets to their proper Invested Capital value. Thus, Discount on Stock and Treasury Stock appearing with the other assets in the Balance Sheet are not assets at all but give the correct value of the Cap- ital Stock Accounts. On the other hand. Furniture and Fixtures Account appears in the Balance Sheet at but $10, whereas, the correct value, for purposes of Invested Capital, is $4,000. There- fore, it is necessary to revise the figures as they appear in the Bal£uice Sheets before computing the reduction on account of Inad- missibles. The schedules showing how the correct values were obtained are as follows: Jan. 1, 1921 Dec. 31, 1921 Balance Sheet Asset Totals $2,197,260 $2,359,750 Plus additions Furniture and Fixtures - Excess above Book Value 3,990 Orggtnization Expense - Written Off - Now Restored 16,000 Commission on Stock - Written Off - Now Restored 40,000 2,990 18,000 45,000 Total $2,257,250 $2 , 425 , 740 Less Reduction of Asset Values Jem. 1, 1921 Dec. 31, 1921 Treasury Stock $10,000 $10,000 - Discount on Stock 20 . 000 15 . 000 Good Will Reduced 43,750 43,750 Appreciated Value in Bldgs. 42.200 41.200 Building Reserve 39.000 44,000 Machinery Reserve reduced 141,000 192,000 Inadmissibles 175,000 185,000 470 , 950 470,950 530.950 530 , 950 Admissible Baletnces used in Schedule J. »1, 786, 300 $1,894,790 In the foregoing, attention is called to the fact that assets may not always appear in the Balstnce Sheet at their true value. Furniture and Fixtures Account, Organization Expense Account and Commission on Stock Account have been restored to their original Invested Capital Value. On the other hand. Treasury Stock and Discount on Stock have been deducted, as they do not represent asset accounts; Good Will has been reduced to its Invested Capital value, while Building ajid Machinery Asset Accounts have been reduced by the offsetting reserves, leaving the net asset value in them. On the other hand, Inadmissibles have been deducted. Appreciated Value of Buildings has been deducted from the Building Account, so -107- that the extra $50,000 placed in the Building Account, through ap- praisal March 1, 1913, will not be used as part of Invested Capital. Of the $50,000 appreciated value only the amounts given on the previous page, namely, $42,200 and $41,200, remain undepreciated in the building value for Jan. 1921 and Dec. 1921. Regarding property value resulting from appraisal, the proper way to handle this is to charge the asset directly with the in- creased amount, as was done in this case. The offsetting balance should be placed in an account called Surplus from Appreciation. Each year that part of the depreciation due to appreciated value should be charged against the Surplus from Appreciation Account. In this way none of the appreciation will appear in the Earned Surplus Account and the balance due to appreciation will be known as of any one time by inspecting the Surplus from Appreciation Ac- count. In the list of Admissible Asset figures, it appears that the net asset value of the buildings is $250,000, less $39,000 in the Reserve and less $42,200 in the Appreciated Surplus, as at the beginning of the year. Therefore, both these amounts have been subtracted from the asset total. In the case of Machinery, the Reserve read $159,400 at the beginning of the year, and this has been reduced to $141,000, because $18,400 of the depreciation taken has been disallowed by the Government, leaving only $141,000 actual depreciation to be deducted from the Machinery Account, to bring it down to its net Invested Capital value. Attention should be called to the fact that, for purpose of Inadmissible Asset computation. Bond Discount is considered an Admissible Asset. The Government has taken the view point that this account is a deferred charge. Having deducted the unallowable value of the Inadmissibles in Schedule B, line 8, the result in line 9 gives the Invested Capital for the corporation. Then the taxpayer takes the two figures, first, the net taxable income in line 27 of Schedule A, and secondly, the Invested Capital in line 9 of Schedule B. With these two figures as a basis, the Excess Profits and Income Taxes are computed in Schedules C and D on page 1 of the Return, exactly as described in Lecture 10. First, an Excess Profit Credit is obtained which is used as a reduction of the income, subject to the 20% rate. Then the 20% and 40% rates are applied against the proper balances. In computing the Income Tax any taxable Liberty Bond interest and the Excess Profits tax are both deducted first. For the year 1921 the exemption of $2,000 is not used against the tatxable income, the concern having made more than $25,000 in tax- able income. Pages 3 and 4 of the Corporation Return call for certain mis- cellaneous information, most of which is readily understood without any special instruction. An inspection of these two pages of the Corporation Return will show what is required as additional inform- ation. -108- LECTURE 11 Question to be Answered. Prepare on Form 1120, the Tax Return of the Smith Sales Cor- poration, Tenth Ave., New York City, which reports as follows: Sales - year 1921 Cost of Sales Gross Profit on Sales Less: Selling Expenses General Expenses Repai rs Teixes - State Tajces - Federal Income Bad Debts - Actual Depreciation Donations Interest on Notes Payable Income Interest on Notes Receivable Interest on Victory Notes 3f Miscellaneous Income Net Book Profit 1921 2.000,000 1 , 650 . 000 $350,000 50 . 000 60 . 000 5,000 3,000 18,000 3,000 10,000 4,000 3,975 $156,975 $193,025 600 375 6,000 6,975 $200,000 Balance Sheet Assets Cash Accounts Receivable Notes Receivable Victory Notes 3f Merchandise Building $50 , 000 100 , 000 40,000 10 . 000 125 . 000 225 , 000 Jan. 1, 1921. Liabilities Notes & Accts. Payable Reserve - for Depreciation Reserve - Bldg. Extension Reserve - Merchandise Surplus Capital Stock >b. 5 -1921- $5,000 ily 5 -1921- 25,000 Income 18,000 $140 . 000 40 , 000 20 , 000 5,000 245 , 000 100,000 Dividend Paid Dividend Paid Federal Tax Paid 550 , 000 Fe Jv for 1920 $550,000 -109- LECTURE 12 MISCELLANEOUS TOPICS CONSOLIDATED RETURNS: In two cases the Government insists upon Consolidated Returns. These are, first, where a parent company or holding company controls practically all the stock of subsidiary companies or, secondly, where the stock of separate companies is owned in almost equal proportions by the same individ- uals. When returns are consolidated the usual Inter-Obligation Accounts and Inter-Investment Accounts are eliminated and any Inter-Compajiy profits taken out. This is more a matter of account- ing than Income Tax law. To illustrate briefly the handling of Consolidated Balance Sheets, the following problem, given by the American Institute of Accountants in the C. P. A. examinations of November 15th and 16th, 1921, is worked out below with proper solu- tion. The dates have been changed in the problem so as to illus- trate its handling under the Act of 1921. Companies A, B, and C were all organized during the year 1918, A and B being engaged in manufacturing, while C acted as selling agent for B at a distant point. The capital stock of C is owned entirely by B, having been acquired at the organization of C and paid for in cash at par. The capital stock of A and B is owned entirely by John Doe, Richard Roe and Mary Roe in equal proportions (one-third in each company). No dividends were paid by either of the three companies during 1921. It may be assumed that the miscel- lEineous investments shown on the balance-sheet of the one company and the gross assets of all three corporations remained the same during the year 1921. Below are shown the balance-sheets of the three companies as at December 31, 1920: Balance Sheet-Company A-December 31, 1920. Liabilities Capital Stock Notes and Accts. Pay. Surplus Assets Equipment $100,000 Inventories 50 , 000 Accts. Receivable 15,000 Cash 10 , 000 Liberty Bonds (4r-4\s) 50 , 000 Prepd. Ins. zuid taxes 5.000 $230,000 $150,000 50 , 000 30 , 000 $230 , 000 -no- Balance Sheet-Company B-December 31, 1920. Assets Liabilities Equipment $200 , 000 Capital stock $250,000 Inventories 75,000 Notes Payable 50,000 Accts. Receivable 15,000 Accts. Payable 10,000 Cash 5,000 Surplus 65,000 Investments : (In Company C (at cost] I 25,000 Miscellaneous stocks (domestic) 50 , 000 Prepd. Ins. and taxes 5,000 $375,000 $375,000 Balance Sheet-Company C-December 31, 1920. Assets Inventory Cash Prepd. teixes $35,000 9,500 500 $45,000 Liabilities Capital stock $25,000 Accts. payable 10,000 Miscellaneous 5 , 000 Surplus 5,000 $45,000 The net income for the year 1921, carried to surplus (per books), was as follows: Company A " B " C $20,000 25,000 5,000 $50,000 The following items appear in the respective profit-and-loss accounts for the year 1921: Income and profits taxes paid for 1920 Int. Accrued on Liberty Bonds Int. paid on indebtedness incurred to carry Liberty Bonds Capital additions charged to profit and loss Dividends received from miscel?.aneous investments Compainy A Company B Company C $1,500 $2,000 2,125 3,000 1 , 000 750 3,000 Prepare balance-sheet as at December 31, 1920 for tax purposes, and also statements showing (1) the determination of the net tax- able income of the group, (2) calculation of invested capital and (3) calculation of income and profits taxes payable by the group for the year 1921. (Problem Adapted from the A. I. A. Examination of Nov. 16, 1921.) -Ill- Solution Under 1921 Act Consolidated Balance Sheet Assets A B Equipment $100,000 $200,000 Inventories 50, ,000 75, ,000 Accts. Receivable 15, ,000 5, ,000 Cash 10, ,000 5, ,000 Liberty Bonds 50, ,000 Investment in C 25, ,000 Domestic Corp. Stocks 50, ,000 Prepd. Items 5, ,000 5, ,000 Accts. Rec. C 10, ,000 Combined Consolidated 35 , 000 9,500 500 $300 , 000 $300 . 000 160 , 000 160 . 000 20 , 000 20,000 24.500 24.500 50 , 000 50 , 000 25.000 50 , 000 50 . 000 10.500 10 , 500 10 , 000 Totals 230,000 375,000 45,000 650,000 615,000 Liabilities Capital Stock Notes & Accts. Payable Accts. Pay. B. Surplus Totals 150 , 000 250 , 000 25 , 000 425 , 000 50,000 60,000 5,000 115,000 10,000 10,000 30,000 65,000 5,000 100,000 400,000 115,000 100 , 000 230,000 375,000 45,000 650,000 615,000 There have been eliminated the Capital Stock Account of Company C owned by Company B and the amount owed by C to B. Invested Capital: Capital Stock $400,000.00 Surplus 100,000.00 Total Deduct : Income Tax 42.26% Total Deduct: Inadmissibles 50/615 500 , 000 . 00 1,479.10 498,520.90 40,530.09 Taixable Income Schedule: Book Profit $50,000 Add: Income Tax 3,500 Capital Charges 1,750 Total Deduct : Lib. Bond Int. Dividends TAXABLE INCOME 55 , 250 2,125 3,000 $50,125 INVESTED CAPITAL 457,990.81 Invested Capital Income Computation of Tax 457,990.81 50,125.00 8% Invested Capital Specific Exemption Profits Credit 36,639.26 3,000.00 $39,639.26 -112- 20% of Invest. Cap. Income Less: Profits credit Excess Profits Tax Income Credit Bal. Ta^ed $50 , 125 .00 39 , 639 .26 10 , 485 . 74 Income Tax 50,125.00 Income tax at 10% Rate Tax 20% $2,097.15 4,802.79 2,097.15 $48,027.85 Total tax $6,899.94 The foregoing is merely an outline of the way in which Consol- idated Returns should be handled. The topic, like many others, is a special one, and those desiring to go further into it should read the Laws in detail. The lectures, so far, have endeavored to cover the more practi- cal and more difficult phases of the subject of Federal Income Tax Law. There are many more topics which might be taken up at this time but which, after the reader has fully mastered the lectures, may be readily understood by reading the Law. On the other hand, there are several topics which are of such difficulty that they do not warrant being given in an introductory course of this nature. A few of these are briefly commented upon in the remaining para- graphs below. REORGANIZATIONS: Special rules are applied in cases where corporations reorgauiize or where there is a merger of several cor- porations. (See Reg. 45, Section 330.) INSURANCE COMPANIES: There are special rules for the handling of Returns of insurance companies. No special sections are allotted to the treatment of them in the Law but each section has some spe- cial mention of the treatment of Returns of these companies. PERSONAL SERVICE CORPORATIONS: These companies consist of incorporated concerns whose income is derived chiefly from the activities of the stockholders and whose Invested Capital is merely nominal. If inventories are required by such companies they are not considered personal service corporations; also if payrolls are required to any extent for other than the stockholders they lose their identity as personal service companies. If a corporation does prove itself to be a personal service one, it submits a Return of Information and each stockholder pays on his distributive share of profits the same as in the case of a partnership. (See Reg. 45, Section 18.) (1921 Act, Sections 242 to 247.) FIDUCIARIES:- if the income is not being accumulated fiduciaries report in the same manner as partnerships and personal service cor- porations, submitting Returns of Information and assigning the annuities to the several beneficiaries who pay a tax on their dis- tributive shares. Estates and Trusts in which it appears that the income is being accumulated submit a Return, take an exemption the same as a single person and pay a tax on the income. (See Reg. 45, Sec. 219.) (1921 Act, Sec. 225.) -113- NON-RESIDENT ALIENS: These taxpayers pay an 8% tax on all their taxable income. They are allowed an exemption $1,000. under the new law. Usually, in the case of non-resident aliens, the compeuiies forwarding etny income to such individuals are expected, under all the facts, to withhold any tstx due to the Government at the source, in order to be certain that it is finally collected. (See Reg. 45, Sec. 221.) EXCHANGE OF PROPERTY: Where property is exchanged, having no ready realizable market value, starting with the year 1921, no gain or loss is to be reported. Heretofore, any exchange of property was considered a completed tax transaction and each tax- payer reported as the sales price for the article exchanged the market value of the article received at that time. (See Act of 1921, Sec. 202, Para. E.) RELIEF FOR CORPORATIONS: All corporations which submitted Returns for 1917 to 1921 inclusive and paid excessive taxes may ask for a reduction of these under the Relief Sections of Regulations 45, Sections 327 and 328. This relief is granted for the Excess Profits Tax only. In order to be entitled to it a corporation must show that unusual factors exist through which the corporation is maJc- ing a profit, but which it may not include in its Invested Capital. Thus, a corporation may have a certain amount of Good Will created through advertising which, under the Laws, it may not capitalize; or it may possess valuable patents on which a profit is being made, but which have been developed by the company itself and which may not be capitalized at more than a nominal figure; or, in the extreme cases the Borrowed Capital of a concern may be very large and at the saune time not included in its investment. If a com- pany proves that such factors exist, the Government will then com- pare its Excess Profits Tax with the average percentage of Excess Profits Taxes paid in its particular line of industry and reduce the tax accordingly. This Section has recently become of great im- portance. In submitting returns compeuiies may report on what is called a cash receipt euid disbursement basis or an accrual basis. The former refers to reporting sales only when the cash is received for them and reporting expenses only when the cash is actually paid out; the latter reports sales and income when the sales are made or the income earned, regardless of receipt and deducts expenses when they occur or accrue, not when they are paid. A corporation or individual may also report on a fiscal or calendar year. A fiscal year is any taxable year ending on the last day of any month other them December. If an individual or corporation keeps books on a fiscal year, then it is necessary to report on a fiscal year basis. A corporation reporting on a fiscal year basis pays a tax for the fiscal period, whereas a partnership operating on a fiscal year basis, submits a Return of Information for the period and the in- dividual owners include the fiscal year profits in their calendar year Returns ending after the close of euiy fiscal year. -114- As explained in a previous lecture, inventories should be taken whenever necessary to obtain correct profit. Inventories should be priced at "cost" or "cost or market whichever is lower." This means that a concern may take its inventories at cost every year or may use a second method, namely, to take inventories at cost or at cost or market whichever is lower, for each group of items. Having elected one of the above two methods, that is, for example, having elected to take inventories on a cost basis, a company must use this same basis every year. Likewise, if a company has elected to use cost or market whichever is lower, as a basis, this method must be used every year. An exception was made at the end of the year 1920, in that concerns using cost as the basis of inventory were permitted to take the market value as of the end of that year. After Returns have been submitted, errors may have been dis- covered by the taxpayer. If so, three different forms of Claims may be submitted. The first one of these is a Claim for Refund. If the taxpayer has overpaid he may submit a Claim for Refund which, as the term implies, is a claim for the recovery of the taxes paid to the Government. Secondly, he may submit a Claim for Credit. In this case, any over-payment of one year discovered by a tajcpayer may be used in this claim as a credit against a tax payment for the next year. Finally, there is a Claim for Abatement, which is used in case the taxpayer wishes to abate any special tax payment. In the latter case, if an individual computes his tax as $2,000, paying the first three instalments, he may discover that he has overpaid $500; therefore against his last installment he may sub- mit a Claim for Abatement. Having studied these Lectures, the reader should be sufficiently familiar with the subject to use the direct sources of the Law to gather a further knowledge of the Tax. The pamphlets to obtain are the following: First, a copy of Regulations 41, covering the 1917 Act; second, a copy of Regulations 45, covering the 1918 Act in effect from 1918 to 1920 inclusive; thirdly, a copy of the Revenue Act of 1921, in effect November 23, 1921, unless otherwise specified. Having obtained these, the reader should then make use of the weekly Bulletins issued by the Government. Throughout the Lectures occas- ional reference has been made to Government Decisions. These Decis- ions are issued in the weekly Bulletins and often explain and alter the existing Tax Regulations. They may be obtained from the Govern- ment Printing Office at a nominal charge and are mailed directly to the taxpayer each week. The Regulations for 1917, 1918 and 1921 may be obtained from the Government Printing Office without charge, or from the local Collector of Internal Revenue. Th"^se Regulations and weekly Bulletins are the official source of the Law. There are several valuable practical Income Tax Services on the mar- ket, which also should prove of great value after these Lectures have been thoroughly understood, as they contain reprints of the Law, copies of Decisions and Regulations and, to some extent, explanations of the various Sections and Articles. -115- LECTURE 12 Questions to be Answered. 1. Under what two conditions is it necessary for corporations to submit consolidated returns. 2. In what manner do partnerships and personal-service corpora- tions report, as distinguished from the manner in which indi- viduals and corporations report. * 3. Distinguish between Claim for Abatement, Claim for Credit and Claim for Refund. 4. What is meant by withholding of tax at the source? 5. Do the rates of taxes levied against non-residents differ from those levied against resident-aliens and American citizens? 6. What are the official sources from which to obtain information relative to the Income Tax Laws? 7. In what manner do Fiduciaries report? ^ 8. Under what conditions are corporations entitled to relief \inder Sections 327 and 328 of the 1918 Act? 9. What is meant by reporting on a cash receipt and disbursement basis and on an accrual basis? 10. What is meant by pricing inventories at "cost" or "cost or market whichever is lower?" INDEX Abatement, claim for, 114 Accident insurance, 10 Accrual basis, 113 Aliens, nonresident, 2, 113 Alimony, 9 g,* Amortization, 34ja Annuities, 21 *4i| Anticipated losses Appraisals, 107 Appreciation, 107 Army and Navy salary, 11 Associations, as corporations, 69 Bad debts, actual, 33 Reserve, 1921, 33 Mortgage debts, 33 Banks, assessments paid, 31 Federal Land Banks, 9 Federal Reserve Banks, 9 Funds deductible, 63 Baptismal offerings, 19 Bequests, exemption, 8, 9 Bonds, interest, deductible, 62 Discount on, 62 Farm Loan Bonds, 9 Liberty Bonds, 13-17 Tax-free covenant, 43 Bondholders, credit deductible from tax, 43 Bonus, common stock, 23 Military bonus, 43 Salary bonus, 9, 19 Borrowed capital, 73, 74 Business expenses, 28 Capital assets, sale of, 20 Changes in ownership, 12 Charitable contributions, 35 Charitable corporations, 61 Children, exemption for, 3, 4 Citizens, taxable, 2 Claims for abatement, 114 for credit, 114 for refund, 114 Commission on stock, 66, 67 Compensation, 19 Federal, 19 Personal service, 19 State, 12 Computations of t8« Corporation, 59, 85-90 Individual , 1 Consolidated returns, 109-112 Constructive receipt, 19, 21 Cooperative associations, 11, 60-61 Copyrights, 34 Corporations, 59-114 Return, form 1120, 95, 98 Taxes on, 59 Credits Corporations, 59 Individual, 1, 6 Deductions , allowable Corporations, 63 Individuals, 28-36 Dependents, credits for, 2, 3 Defined, 3 Depletion, 34 Deposits, interest on, 20, 21 Depreciation, deductions, 34 Depreciation, excessive, 81 Devises, exempt, 8, 9 Dividends, cash, 21 Dividends, stock, 11 Received by corporation, 63 individual , 21 partnership, 53 Donations, 35 Earned surplus, 72 Excess-profits tax, 59, 71-90 Special computations, 85-90 Exchange of property, 12 Exclusions, 8-17 Exemptions Corporation, 59 Individual, 2-5 Income exempt, 8-17 INDEX - Continued Expenses, business, 28 Experimental charges, 81 Fair market value, 25, 26 Farm income and expense, 29 Fiduciaries, 112 Fines, 68 Fiscal year, 113 Gifts, exemption of, 9 Sale of, 1921 rule, 21, 57 Good will, 74, 113 Gross income, 6, 19-26 Obsolescence, 34 Partnership return, form 1065, 52 Patents, depreciation, 34 Invested capital, 74, 81 Payments at source, 113 Pensions, 9, 29 Personal exemptions, 2, 3 Personal service corporations, 112 Postal savings, interest, 20 Preferred stock, 23, 24, 74 Professional income and expense, 29 Head of family, 3 Husband and wife, returns by, 3 Inadmissible assets, 75-78 Income, definitions of, 6 Information return, 11, 112 Insurance, accident, health, life. War Risk, 8-10 Installment sales, 22 Intangibles, depreciation, 34 Invested capital, 74 Interest, bank, bond. Postal Savings , 20 Inventories, pricing of, 114 Invested capital, 71-83 Computations, 59, 85-90 Rates of taxes Corporation, 1 Individual, 59, 85-90 Real estate, lot sales, 23 Receipt, constructive, 19, 21 Receivers, fees of, 19 Refunds, claims for, 114 Regulations, Federal, 114 Relief from High Taxes, 113 Removal of buildings, 31 Rent, deductible, 28 Office at home, 29 Repairs, deductible, 29 Reserves, bad debts, 33 Unallowable, 82 Resident, defined, 2 Returns, writing of, 38-57, 91- 107 Liberty Bonds, 13-17 Live stock, 29, 32 Living quarters, 20 Long-term contracts, 22 Losses, business and personal, 31-33 Exchange of property, 12 Military compensation, 11 Ministers, room rent, 8, 11 Municipal bonds, 9 Net income, defined, 6 Normal tax, 1 Notary Public fees, 12 Sales of corporate stocks and bonds, 62 Capital assets, 20 Gifts, 21, 57 Scrip dividends, 68 Seapen, taxable, 2 Seizare of property, 36 Shipping companies, 11 Smith-Lever Act, 12 Soldiers auid sailors, income of, 11 State Bonds, 9 Contract profits, 12 Salaries, 12 Securities exempt, 9 ii i\ INDEX - Continued Stock Exchange of, 12 Given as Compensation, 21 Invested capital, 71 Sale of, 62 Stock dividends, 11 Stockholders, taxes paid for, 31 Surplus, earned, 71 Paid-in, 71 Surtsuc, computation of, 1 Tangible property, definition, 73 Taxes, deductible, 30 Nondeductible, 31 Tax-free covenant bonds, 43 Traveling expenses, 29 Treasury stock, 62, 103 Trusts. See Fiduciaries United States obligations, 8, 9 Vessels, depreciation of, 36 Sale of, no tax, 11 Victory Notes, 13-17 Vocational Rehabilitation Act Income from, 8-10 War Finance Bonds, 15, 16 War Risk insurance, 8-10 Withholding tax at source, 113 Workmen's Compensation Insurance, not taxable, 10 I "*^/? 6 19^2 NEH AUG101991 *'«* IS^)Wf«'^-^#f.'*i*!",J ^^^^J "'*^ •*iS^#;^*fc**i i'^*-.->-v -"- Wv\^}\ ^^ VAVm! i' ''rM J: ; hi :U ''•i r 1' '■" ^M1 \M . "^ ki ^4^f; p' fc* *is^ j| «■> f -5 Jl 'l-i I i'i !' ^ii ^• iii i Ijl i: Iv- <■ ^lai V ? ^^ ^< ^ NV*.* , - "' - -K . 1"" t.« '■■i '/■i -,t ■ iSr- If. '■'■iiT-iJ. END OF TITLE