public highways, the provision of sewage, gas and light and the reclamation, drainage, or irrigation of land are districts for public use, and consequently political subdivisions of the state, within the meaning of the law.21 Road, water, school, levee, harbor and port improvement districts lawfully created and authorized by the State to levy a tax to meet the obligations of such district are also held to be political subdivisions of the state. 22 However, a district without power to exercise any governmental function, created for the purpose of making some improvement, primarily beneficial to the property located in and comprising the district, is not, within the meaning of these acts, a political subdivision of the State. Obligations issued in payment for such improvement, although guaranteed by a county, municipality, or other political subdivision of the State, are not the obligations of the State or of any political subdivision thereof; but are rather the obligations of the benefited property upon which they constitute a lien. Hence, the income derived from obligations which are a direct charge against or lien upon benefited property is not exempt and must be returned as income of the recipient.23

Although inter

MORTGAGE ASSUMED BY MUNICIPALITY. est on municipal bonds is exempt from the tax, yet where a municipality has purchased a public utility subject to a mortgage, and the mortgage retains its original charac

*

*

*

21 Opinion of Attorney General dated January 30, 1914. In the course of his opinion the Attorney General said: “ ́* where the power to levy a tax is given a district by the state, presumptively that district is created for a public use, and is exercising a public function. * Nor does it make any difference that the tax is measured by the benefit conferred." But he refrained from expressing any opinion whether assessment districts might not be created for a purely private purpose so as to bring them within the principles laid down in the South Carolina Dispensary case, 199 U. S. 437, rather than within those which governed U. S. v. B. & O. Railroad Company, 17 Wall. 322.

22 T. D. 1946; Reg. 45, Art. 73.

23 Reg. 33 Rev., Art. 84.

ter, even though the municipality assumes the mortgage indebtedness and pays the interest thereon, the mortgage does not become an obligation of the municipality within the meaning of the law and the interest thereon is not exempt.24

Excluding Exempt Interest from Gross Income. It is provided in the respective acts authorizing the issue of Second, Third and Fourth Liberty Bonds, and the War Finance Corporation Bonds, all of which were issued after September 1, 1917, that interest upon such bonds shall be exempt from the normal tax.25 As indicated in the foregoing paragraphs, the extent of exemption of the interest upon such bonds from surtax and war-profits and excess-profits taxes depends upon the amount of principal of such bonds owned by the taxpayer. The Revenue Act of 1918 provides 26 that in the case of obligations of the United States issued after September 1, 1917, and in the case of bonds issued by the War Finance Corporation the interest shall be exempt only if and to the extent provided in the respective acts authorizing the issue, thereof as amended and supplemented, and shall be excluded from gross income only if and to the extent it is wholly exempt from taxation to the taxpayer both under the income and war excess-profits taxes. Conversely, only interest from Second, Third and Fourth Liberty Bonds and Bonds issued by the War Finance Corporation which is not wholly exempt from normal tax, surtax and profits taxes need be included in gross income. Income from United States obligations issued prior to September 1, 1917, interest on bonds of states, territories, possessions of the United States (and political subdivisions thereof) and the District of Columbia, need not be included in gross

24 T. D. 2090.

25 Act of September 24, 1917 (Public No. 43); Act of April 4, 1918 (Public No. 192); Act of April 5, 1918 (Public No. 121); Act of July 9, 1918 (Public No. 192); Act of September 24, 1918 (Public No. 217).

26 Revenue Act of 1918, § 213 (a) 4.

income, but the amount of such securities owned by the taxpayer and the income therefrom must be stated in his return.27

Interest on Bonds of Exempt Organizations. Although a corporation may be exempt 28 from a tax on its income, yet interest on the bonds of such an organization is taxable income to the bondholder.29

Accrued Interest on Obligations at Time of Purchase. Where a purchaser pays the price of the security purchased and an additional sum representing accrued interest, the amount of interest received on the next interest date should not be reported in full. The amount of accrued interest at the time of purchase represents the return of capital to the purchaser and he should deduct such amount from the interest received, and report the remainder only. The seller of the security should account in his return for the accrued interest received at the time of sale, since to him that amount is income.30

Interest on Bank Deposits. Interest on bank deposits or on certificates of deposit, credited to the account of the depositor by the bank, is income for the year in which the credit is made.31

Interest Received and Paid by Brokers. Where the customers of a brokerage house buy securities, paying only a part of the purchase price and paying interest on the balance, and the brokerage house buys such securities

27 Revenue Act of 1918, § 213 (a) 4.

28 Revenue Act of 1918, § 231.

29 Letter from Treasury Department dated July 30, 1914; I. T. S. 1918, ¶ 1319.

30 Reg. 33 Rev., Art. 4; Letter from Treasury Department dated February 5, 1915; I. T. S. 1918, ¶ 360. In a later ruling the Treasury Department declined to permit the taxpayer in such a case to report all of the interest received as income and to deduct the amount of accrued interest paid at the time of purchase as an expense or as interest paid by the purchaser. Letter dated March 8, 1915, I. T. S. 1917, ¶ 237.

31 Reg. 33, Art. 67; Letter from Treasury Department dated February 18, 1915; I. T. S. 1918, ¶ 363.

from others, paying only a part of the purchase price and paying interest on the balance, the brokerage house must include in its return as gross income the interest received from the customers and may deduct as interest the amount of interest it pays on such purchases.32

Interest Accruing Prior to March 1, 1913. Where interest became due prior to March 1, 1913, and funds have been on hand to pay the same since the due date the amount is not taxable, since it represents income that was due and payable and could have been reduced to possession on demand prior to the incidence of the income. tax. Even where interest has been in default since a time prior to March 1, 1913, and funds to pay the same have accrued since that date, it has been held that the interest represents income accrued to the owners of the bonds prior to the incidence of the tax, and hence does not constitute taxable income when received thereafter.33

32 Altheimer Rawlings Investment Co. v. Allen, 248 Fed. 688, petition for writ of certiorari to United States Supreme Court denied November 11, 1918; see T. D. 2686 and T. D. 2441. This case was decided under the 1909 Law, but the principle seems to apply to the language of the present law. Interest would be deducted in full if paid on collateral the subject of sale in the ordinary course of business. The amount of such interest deductible in the case of corporations was limited under the 1916 Law. See Chapter 12 on corporations.

33 Letter from Collector at Cincinnati dated March 16, 1915, embodying decision of the Treasury Department; I. T. S. 1918, ¶¶ 463 and 823.

CHAPTER 23

INCOME FROM DIVIDENDS

The law expressly states that the gross income of a taxpayer shall include gains, profits and income derived from dividends.1

Definition. The term "dividend," as used in the Revenue Act of 1918 (with one exception where it is used in connection with dividends paid by insurance companies on policy and annuity contracts) is defined therein to mean (1) any distribution made by a corporation, other than a personal-service corporation, to its shareholders or members, whether in cash or in other property or in stock of the corporation, out of its earnings or profits accumulated since February 28, 1913, or (2) any such distribution. made by a personal-service corporation out of its earnings or profits accumulated since February 28, 1913, and prior to January 1, 1918.2 Amounts distributed in the liquidation of a corporation are expressly required to be treated as payments in exchange for stock or shares, and any gain or profits realized thereby will be taxed to the distributee

1 Revenue Act of 1918, §§ 213 (a) and 234 (a) 10. The Revenue Act of 1916 provided that subject only to such exemptions and deductions as were thereinafter allowed, the net income of a taxpayer should include gains, profits and income derived from dividends (Revenue Act of 1916, § 2 (a).).

2 Revenue Act of 1918, § 201 (a). It will be noted that the new definition, aside from its provision for personal-service corporation distributions, omits the words "or ordered to be made'; substitutes the word "accumulated" for "accrued"; and also expressly includes distributions made "in other property." See Revenue Act of 1916, § 31 (a), Reg. 33 Rev., Art. 106.