or Porto Rico or the government of any political subdivision of those possessions is also exempt. Where a state, territory or the District of Columbia, or any political subdivision of a state or territory, has prior to September 8, 1916, entered into a contract with any person or corporation to acquire, construct, operate or maintain a public utility no tax is levied upon the income derived from the operation of such public utility so far as the payment thereof will impose a loss or burden upon such state, territory or district or political subdivision, but this provision is not intended to confer upon such person or corporation any financial gain or exemption or to relieve such person or corporation from tax on the part or portion of such income to which such person or corporation is entitled under such contract.44 Federal Reserve Banks. The income of Federal Reserve Banks is exempt from income tax 45 by express provision in the Federal Reserve Act.46 The dividends on the stock of such banks are exempt from tax in the hands of member banks.47 Dividends paid by member banks are treated like dividends of ordinary corporations and are not exempt from tax.48 44 Revenue Act of 1918, § 213 (b), 7. 45 Also from war-profits or excess-profits tax. 48 Reg. 45, Art. 75. Federal Reserve Bulletin, April 1, 1916. CHAPTER 16 INCOME IN GENERAL A discussion of the various conceptions of income would be interesting but is out of place in a work of this character. For all practical purposes it is sufficient to state that the income taxable under the present laws is defined in the statute. One conception of income excludes gains or increment in the value of capital assets, but this conception was not that of Congress, since the tax is not only upon income conceived as a production of capital, but also upon gains and profits derived from sales or dealings in property, growing out of the ownership or use of or interest in such property, whether real or personal, or from gains or profits from any source whatever.2 For the purpose of discussion in this and the following chapters, the general rules and principles applicable to income from all sources will first be described, and thereafter, the special rules applicable to income from (1) personal services, (2) business, trade or commerce; (3) farming, (4) sales or dealings in property, (5) rent, (6) interest, (7) dividends, (8) royalties, (9) miscellaneous sources. The special rules relating to income from partnerships and fiduciaries are treated in the chapters on those respective subjects.3 What Constitutes Income. Income may be defined as the gain derived from capital, from labor, or from both 1 Revenue Act of 1918, § 213. 2 Revenue Act of 1918, § 213 (a). 3 See Chapters 10 on Partnerships and 8 on Fiduciaries. combined. The meaning of the word is not to be found in its bare etymological derivation. Its meaning is rather to be gathered from the implicit assumptions of its use in common speech. Of course the term is not limited to earnings from economic capital, i. e. wealth industrially employed in permanent form.5 The courts have uniformly construed the word "income" to include only the receipt of actual cash as opposed to contemplated revenue due but unpaid, unless a contrary purpose is manifest from the language of the statute. What was taxed by the 1909 Law was "net income received," not income, accruing or accrued, which had not been received and portions of which might never be received. While the phrases "income received" and "income accrued" are frequently used in the same statute, the courts have not departed, unless it expressly appears otherwise, from a construction of the law. in accord with an intention to reach the actual and not the potential income. In the 1913 Law the two preceding phrases were employed. Doubtless it was the intention of Congress to employ terms of sufficient comprehension to reach the actual income by foreclosing any possible avenue of escape, but it can hardly be said that in so doing an intention prevailed to tax that which did not actually exist, except on paper, as income accrued during the taxing period. One cannot be said to receive an income of defined proportions until he balances receipts and deductions at the end of a stated period and ascertains, not what is due, but what has been actually received. The assets and liabilities may be measured by a different rule 4 Stratton's Independence v. Howbert, 231 U. S. 399; Doyle v. Mitchell Brothers, 247 U. S. 179. 5 U. S. v. Oregon-Washington etc. Co., 251 Fed. 211. 6 Act of August 5, 1909, § 38 (36 Stats. 112). The language of the 1909 Law was held to indicate that the net income, which was the measure of taxation, meant what had actually been received and not that which, although due, had not been received, its payment for any reason having been deferred or postponed. (Mutual Benefit Life Ins. v. Herold, 198 Fed. 199, affirmed 201 Fed. 918). 7 U. S. v. Schillinger, 14 Blatch. 71, Fed. Cas., No. 16,228. of accounting, but income as defined by the courts means, as said in one case, "in the absence of any special law to the contrary, income must be taken to mean money, and not the expectation of receiving it or the right to receive it at a future time." In the 1916 Law the phrase "income received" was used with respect to both individuals and corporations. Under the Revenue Act of 1918 with the exception of stock dividends 10 all items of gross income shall be reported in the year in which they are received by the taxpayer 11 unless in order clearly to reflect income such amounts are to be accounted for as of a different period.12 Actual Receipts. The Revenue Act of 1918 intends primarily to tax individuals and corporations upon income received, and not income which has arisen or accrued, but has not been received.13 This basis of actual receipts is not exclusively prescribed; for the statute recognizes as income-determining factors other items, among which are inventories, accounts receivable, property exhaustion and accounts payable for expenses incurred. Net income is computed in accordance with the method of accounting regularly employed in keeping the books of the taxpayer unless no such method of accounting has been 8 Maryland Casualty Co. v. U. S., 52 Ct. Cls. 201, T. D. 2451. This ease is now No. 395 on the docket of the United States Supreme Court. 9 Revenue Act of 1916, §§ 1 (a) and 10 (a). 10 Judge Mayer held in a decision (U. S. Dist. Ct. So. Dist. of N. Y.) handed down January 23, 1919, following Towne v. Eisner, 245 U. S. 518, among other cases that stock dividends are essentially not income and cannot be taxed as such. This decision was rendered under the 1916 Law. (See Chapter 23 on Income from Dividends). 11 The term "taxpayer" as used in this chapter includes any person, trust or estate subject to income tax. The term "person" includes individuals, partnerships and corporations. The term "corporation" includes associations, joint-stock companies and insurance companies. 12 Revenue Act of 1918, § 213 (a); Reg. 45, Art. 23. 13 Revenue Act of 1918, §§ 213 (a) and 233 (a). This was also true under the 1916 Law (Revenue Act of 1916, §§ 1 and 10). F. T.-19 employed or the method employed does not clearly reflect the income in which case the computation is made on such basis and in such manner as in the opinion of the Commissioner does clearly reflect the income.14 Thus, individuals and corporations may report their income upon the basis of accruals instead of actual receipts. This provision is more fully discussed in subsequent paragraphs of this chapter.15 If a taxpayer does not keep his accounts on such basis, the tax must be computed on the basis of actual receipts. An early ruling of the Treasury Department, under the 1913 Law, holding that a person receiving fees or emoluments for professional services must include all actual receipts for services rendered in the year for which the return was made, together with all unpaid accounts, charges for services or contingent income due for that year, was discussed in a case 16 in which the court said: "No such construction of the Treasury Department can enlarge the scope of the statute so as to impose the tax upon unpaid charges for professional services rendered, which for aught anyone can tell may never be paid. The statute alone determines what is income to be taxed. It taxes only income derived from many specified sources, and one does not derive income by rendering services and charging for them." Accrued but unpaid interest on investments has been held not to be income.1 17 Under the broader language of the 1909 Law it was held that income was taxable only to the extent that it was actually received during the year, and did not include items which had been earned, or become due, but had not been collected.18 It was also held under that law that items of "non-ledger assets" shown in the annual report of a life insurance company, made in pursuance to a state statute as "uncollected and deferred premiums" and "interest due and accrued,” 14 Revenue Act of 1918, §§ 212 (b) and 232. 15 See page 320. 16 Edwards v. Keith, 231 Fed. 110. 17 Ins. Co. of North America v. McCoach, 218 Fed. 905. 18 Connecticut Mut. Life Ins. Co. v. Eaton, 218 Fed. 206. |