prove to be greater than the amount which would ordinarily be paid. Reasonableness is ordinarily the controlling test of the deductibility in the case of bonuses and special compensation for services, as in the case of salaries. Summarizing the latest ruling 50 the following rules may be stated as a basis for the determination of the question whether special payments made as extra compensation to officers and employees of an enterprise are deductible under the heading of business expenses: (a) the fundamental test is whether or not such payments are made as compensation for services rendered; (b) if payments of compensation for services rendered are made in pursuance of a contract express or implied (which need not be in writing) 50a or a long-time practice (practically an implied contract), regularly employed, of paying to employees certain sums in addition to their stipulated salaries, constituting a condition, if not a contract, whereby the employees may reasonably expect for greater or better service rendered, additional pay, they are deductible; (c) if payments are made as compensation for services rendered, but not in pursuance of a contract expressed or implied or a long-time practice as above stated, the total amount of salary and extra compensation may not exceed a reasonable compensation for the services rendered. The early condition that payments of bonuses or extra compensation could not be dependent upon the earnings of the paying corporation no longer obtains except in so far as may throw light upon the question of whether or not the payments in question are made as compensation for services rendered.51 50 Reg. 45, Art. 107; T. D. 2696. 50a A written contract is, of course, better evidence in case any question arises. 51 The early rulings held in effect that payments made by a corporation as extra compensation to officers and employees might be deducted: (a) if it was clearly shown that they were made as compensation for services rendered; (b) if they were paid in pursuance of a contract express or implied; (1) the contract need not have been in writing, (2) a long time practice (practically an implied contract), regularly employed, of paying to employees certain sums in addi GIFTS OR GRATUITIES TO EMPLOYEES. Gifts or gratuities made by an enterprise to its employees are not proper deductions under the heading of expense. Even where such payments are called extra compensation, if they are in fact gratuitous or voluntary payments for which no services are rendered, their character as gifts is not changed. The custom of paying bonuses or Christmas gifts to employees, even though it has been the practice of the enterprise for a long time to make such gifts, does not render the amount so paid a proper deduction as expense if the gift is purely voluntary and gratuitous.52 On the other hand, it would seem that so-called Christmas gifts may be deductible if they fulfill the requirements stated in the preceding paragraph. PENSIONS. Amounts paid as pensions to retired employees, or their families, or others dependent upon them, or paid on account of injuries received by employees, are ordinary and necessary expenses, but where the salary of an employee is paid for a limited period after his death to a relative or dependent, in recognition of the services rendered by the employee, no service being rendered by the recipient, the payment is a gratuity and not an expense of the business.53 This deduction was allowed or disallowed upon the basis of the general provisions 54 of the 1916 Law permitting the deduction of the necessary expenses of individuals in carrying on any business or trade tion to their stipulated salaries constituted a condition if not a contract, whereby the employees might reasonably expect, for greater or better services rendered, additional pay and was equivalent to a contract within this heading; (c) if the total amount of salary and extra compensation was not greater than a reasonable compensation for the services rendered, (d) if they were not conditional upon the earnings of the corporation but were conditional or dependent upon the services rendered. (See note 47a.) These tests were later modified, as indicated in the text above. 52 See T. D. 2090; T. D. 2152; Mimeograph letter to Collectors, No. 1314; I. T. S. 1918, ¶ 1407. See Reg. 45, Art. 107. 53 T. D. 2090. 54 Revenue Act of 1916, §§ 5 (a), 12 (a). and the ordinary and necessary expenses of corporations paid in the management and operation of its business and properties. The Revenue Act of 1918 expressly provides 55 that these expenses include "a reasonable allowance for salaries or other compensation for personal services actually rendered." But the intent is probably not to exclude pensions paid by reason of services which have been rendered. No deduction can be made for contributions to a pension fund the resources of which are held by the corporation, the amount deductible in such case being the amount actually paid to the employees.56 Donations. Donations by business concerns may or may not be held to be proper deductions as expense. There. must be a consideration in some form to take the donation out of the class of gratuities. When a donation legitimately represents a consideration for a benefit flowing, directly or indirectly, to the donor, as an incident of its business, it is an allowable deduction. It has been held that a corporation engaged in the agricultural business cannot be allowed to make deductions on account of donations to fairs, churches, and associations; such donations, although made for the purpose of obtaining and preserving the good will of the farmers, being mere gratuities. Where a street railway company donates a sum of money to an organization intending to hold a convention in the city in which the company operates, with the expectation that the holding of such convention will augment its income because a greater number of people will use its street cars, the donation has been held to be deductible. A donation to a hospital, under agreement that employees of the donor are to have a ward for their use in case of accident or illness, is a proper deduction. Donations made for purposes connected with the operation of the business, when limited to charitable institutions, hospitals or educational institutions, conducted for the benefit of employees 55 Revenue Act of 1918, §§ 214 (a) 1, 234 (a) 1. 56 Reg. 33 Rev., Art. 136. or their dependents, are within this class, but such donations should be reduced by any amount repaid to the corporation by the employees. Red Cross donations are not within the class.57 Farmers. The business expenses allowable as deductions in the case of farmers are fully discussed in another chapter 58 Public Utility Under Contract with a State. In the case of a public utility acquired, constructed, operated or maintained under any contract with any city, state or territory or the District of Columbia, where a portion of the net earnings of such public utility is payable, under the contract, to the state, territory, etc., the amount so paid may be deducted by the public utility operating under such a contract as an expense of its business.59 This deduction is allowed under an express provision of the statute.60 57 Reg. 33 Rev., Art. 134; letter from Treasury Department dated May 23, 1918; I. T. S. 1918, 3437; telegram from Treasury Department dated May 23, 1918; I. T. S. 1918, 3436. 58 See Chapter 19 on Farms and Farming. 59 T. D. 2090. 60 Revenue Act of 1918, § 213 (b) 7. See Revenue Act of 1916, § 11 (b). CHAPTER 28 DEDUCTION OF INTEREST The Revenue Act of 1918 provides that citizens and residents and domestic corporations may deduct all interest paid or accrued within the taxable year on indebtedness incurred or continued to purchase or carry obligations or securities (other than obligations of the United States issued after September 24, 1917), the interest upon which is wholly exempt from taxation as income to the taxpayer. Non-resident aliens and foreign corporations may deduct that proportion of such interest which the amount of his or its gross income from sources within the United States bears to the amount of his or its gross income from all sources within and without the United States.1 But this deduction is allowed to a nonresident alien only if he files a true and accurate return of his total income from all sources, corporate or otherwise, in the manner prescribed 2 by the law. The special rules applicable to each of the four classes of taxpayers enumerated above and the extensive changes made by the Revenue Act of 1918 are discussed in the chapters relating to each. In all cases interest upon indebtedness incurred or continued to purchase or carry obligations or securities (other than obligations of the United States issued after September 24, 1917), the interest upon which is wholly exempt from the income tax to the taxpayer, may not be deducted. 1 Revenue Act of 1918, §§ 214 (a) 2, 234 (a) 2. 2 Revenue Act of 1918, § 217. 3 See Chapters 4, 5, 12, and 14 on Citizens and Residents, Nonresident Aliens, Corporations, and Foreign Corporations respectively. |