Income of Contractors. Persons engaged in contracting operations, who have uncompleted contracts, in some cases perhaps running for periods of several years, will be allowed to prepare their returns so that the gross income will be arrived at on the basis of completed work; that is, on jobs which have been finally completed any and all moneys received in payment will be returned as income for the year in which the work was completed. If the gross income is arrived at by this method, the deduction from gross income should be limited to the expenditures made on account of such completed contracts. Or the percentage of profit from the contract may be estimated on the basis of percentage of completion, in which case the income to be returned each year during the performance of the contract will be computed upon the basis of the expenses incurred on such contract during the year; that is to say, if onehalf of the estimated expenses necessary to the full performance of the contract are incurred during one year, onehalf of the gross contract price should be returned as income for that year. Upon the completion of a contract if it is found that as a result of such estimate or apportionment the income of any year or years has been overstated or understated, the taxpayer should file amended returns for such year or years.5

Income from Export Business. Under the 1916 Law income from the business of exporting goods was held to be taxable by the Treasury Department. It has also been held that a tax on such income is not a tax on the articles exported, and therefore not unconstitutional in that regard, since if Congress has power to lay a tax up to the time when articles are put in course of exportation, the conclusion is unavoidable that the net income arising from exportation when it has been completed or after the exportation and sale are fully consummated, is likewise subject to taxation under general laws.6

5 Reg. 45, Art. 33; Reg. 33 Rev., Art. 121; T. D. 2161.

6 Peck v. Lowe, 247 U. S. 165.

Discounts. The discount allowed to a corporation purchasing new equipment need not be reported as income, but the cost of the equipment as charged to capital must represent only the net cost after making allowance for the discount in question.6a

Bank Discounts. In cases wherein banks or other corporations loan money by discounting bills or notes, one of two methods shall be used in determining the amount of discount that is to be reported as income, namely (1) if the bank or corporation makes a practice of crediting such discount directly to a "discount account" or to profit and loss, and total amount thus credited during the year shall be considered income and shall be so reported, regardless of the fact that a portion of this amount may represent discount paid in advance and not then earned; (2) if the bank or corporation follows the practice of crediting such discount to an "unearned discount account," and later, as the discount becomes earned, debits the unearned account and credits an "earned discount account" with the amount so earned, the total amount credited to the "earned discount account" during the year shall be considered income and shall be so returned. The corporation having income of this character should state in a memorandum attached to its return which of the two methods was used in determining the amount of discount returned as income.7

Payment by Installment. If payments for goods sold are made in installments by the buyer, a proportionate part of each installment represents the profit on the sale of the goods and the rest represents a return of capital to the seller. The manner of treating the income arising on the payment on such installments is described in a later chapter.8

Income from Business of Certain Public Utilities May Be Exempt. The Revenue Act of 1918 expressly exempts

6a Letter from Treasury Department dated November 26, 1918; I. T. S. 1918, ¶ 3698.

7 Reg. 33 Rev., Art. 114.

8 See Chapter 20.

F. T.-22

from tax any income derived from any public utility or from the exercise of any essential governmental function and accruing to any State, Territory or the District of Columbia or any political subdivision of a State or Territory, or income accruing to the government of any possession of the United States, or any political subdivision thereof. It further provides that whenever any State, Territory or the District of Columbia or any political subdivision of a State or Territory has, prior to September 8, 1916, entered in good faith into a contract with any person the object and purpose of which is to acquire, construct, operate or maintain a public utility, no tax shall be 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, District of Columbia or political subdivision; but this provision does not confer upon such person any financial gain or exemption or relieve any such person or corporation from the payment of a tax as provided for in the law upon the part or portion of such income to which such person or corporation is entitled under the contract.9

9 Revenue Act of 1918, § 213 (b) 7.

CHAPTER 19

INCOME FROM FARMING

Special rules have been made with respect to farming and farmers.1 In connection therewith the term "farming" is defined as embracing the farm in the ordinary accepted sense and includes plantations, ranches, stock farms, dairy farms, poultry farms, fruit farms, truck farms and all land used for similar purposes; and the term "farmer" is defined as all corporations, partnerships or individuals who cultivate, operate, or manage such farms for gain or profit, either as owners or tenants.

"Gentlemen Farmers." A person cultivating or operating a farm for recreation or pleasure, on a basis other than the recognized principles of commercial farming, the usual result of which is a loss from year to year, is not regarded as a farmer. In such cases, if the operation of a farm results in a net gain for the year, such gain must be included. If, however, the expenses and losses incurred in connection with the farm are in excess of the receipts the entire receipts from the sale of products may be omitted from the return of income; and the expenses, being regarded as personal expenses, will not be allowed as a deduction from income derived from other sources.2

Farmers Keeping Books and Taking Inventories. Farmers who keep books according to approved methods of accounting, which clearly show net income, and take annual inventories may, if the same method is consistently followed from year to year, prepare their returns in ac

1 Reg. 45, Arts. 35, 110, 145, 172; T. D. 2665, amending T. D. 2153. Reg. 33 Rev., Arts. 4 and 123.

2 Reg. 45, Art. 35; Reg. 33 Rev., Art. 4.

cordance with the showing made by their books and inventories.3

Inventories. If the inventory method is adopted, the farmer should, in order to ascertain gross income, add to the amount received from sales made during the year, the inventory of the live stock and products on hand at the close of the year and from this sum deduct the amount expended in purchasing live stock and products plus the inventory of the live stock and products at the beginning of the year. The inventory at the begnining of the year must be the same figure as at the close of the next preceding year and (a) it must include the cost of live stock or products purchased for resale, (b) it may include live stock and products produced on the farm and still on hand. Where gross income is ascertained by inventory, no deduction can be made for live stock or products lost during the year, whether purchased for resale or produced on the farm, as such losses will be reflected in the inventory by reducing the amount of live stock or products on hand at the close of the year. Live stock purchased for draft, breeding, or dairy purposes, or for any purpose other than resale, may be included in the inventory for each year at a figure which will reflect the reduction in value estimated to have occurred during the year through increase of age or other causes. Such reduction in value should be based on the cost and estimated life of the live stock. In the case of loss of such live stock no deduction can be made, as the loss will be reflected in the inventory at the close of the year. When the inventory method is used, the cost price of the article sold must not be taken as an additional deduction, as it is reflected in the inventory.4

3 Reg. 45, Art. 35; T. D. 2665. See Chapter 16 on Income-In General for the rules in regard to inventories generally.

4 Reg. 45, Art. 35; T. D. 2665. This Treasury decision uses the expression "stock purchased for draft, breeding or dairy purposes or for any purpose other than resale" for the first time. The intention is apparently to extend the expression "stock used for breeding purposes" used in former rulings to all stock not purchased for resale.