the taxpayer for personal services rendered | sections 21-24 is first reduced by the by him to a corporation which represents a sum of the allowable credits. These distribution of earnings or profits rather than a reasonable allowance as compensation include interest exempt from normal tax for the personal services actually rendered. only (and hence included in gross inIn the case of a taxpayer engaged in a trade come) received upon (1) obligations of or business in which both personal services the United States and (2) obligations and capital are material income-producing factors, a reasonable allowance as compen- of corporations organized under Act of sation for the personal services actually Congress which are instrumentalities of rendered by the taxpayer, not in excess of 20 the United States; an earned income per centum of his share of the net profits of such trade or business, shall be consid- credit; a personal exemption; and a credit for dependents. (See section 22 (b) (4).) For the purpose of computing the surtax the taxpayer's net income is entitled to none of these credits, except the credit for personal exemption and credit for dependents.*†

ered as earned income.

(B) "Earned income deductions" means such deductions as are allowed by section 23 for the purpose of computing net income, and are properly allocable to or chargeable against earned income.

(C) "Earned net income" means the excess of the amount of the earned income over the sum of the earned income deductions. If the taxpayer's net income is not more than $3,000, his entire net income shall be considered to be earned net income, and earned net income shall not be considered to be less than $3,000. In no case shall the earned net income be considered to be more than $14,000.

if his net income is more than $3,000, his

§ 9.25-2 Earned income credit. Under section 25 (a) (3) the earned income credit allowable for the purpose of computing the normal tax is 10 percent of the amount of the earned net income, but not in excess of 10 percent of the amount of the entire net income.

The entire amount received as pro(b) Credits for both normal tax and surtax. There shall be allowed for the pur- fessional fees may be treated as earned poses of the normal tax and the surtax income if the taxpayer is engaged in a the following credits against net income: professional occupation, such as a doctor (1) Personal exemption.—In the case of a or a lawyer, even though he employs assingle person or a married person not liv-sistants to perform part or all of the ing with husband or wife, a personal exemption of $1,000; or in the case of the head of a family or a married person living with husband or wife, a personal exemption of $2,500. A husband and wife living together shall receive but one personal exemption. The amount of such personal exemption shall be $2,500. If such husband and wife make separate returns, the personal exemption may be taken by either or divided

between them.

(2) Credit for dependents.-$400 for each person (other than husband or wife) dependent upon and receiving his chief support from the taxpayer if such dependent person is under eighteen years of age or is incapable of self-support because mentally or physically defective.

services, provided the clients or patients are those of the taxpayer and look to the taxpayer as the person responsible for the services performed. In the case of a husband and wife domiciled in a so-called community property State and rendering separate income tax returns on the community income basis, one-half of the income derived from personal services rendered by one spouse may be treated as earned income in the separate return of the other spouse.

In the case of a taxpayer engaged in a trade or business in which both per

(3) Change of status.-If the status of the taxpayer, insofar as it affects the per-sonal services and capital are material sonal exemption or credit for dependents, income-producing factors, a reasonable changes during the taxable year, the per- allowance as compensation for the personal exemption and credit shall be appor- sonal services actually rendered by the tioned, under rules and regulations prescribed by the Commissioner with the ap- taxpayer shall be considered earned inproval of the Secretary, in accordance with come, but the total amount which shall the number of months before and after be treated as the earned income of the such change. For the purpose of such ap- taxpayer from such a trade or business portionment a fractional part of a month shall be disregarded unless it amounts to shall, in no case, exceed 20 percent of more than half a month in which case it his share of the net profits of such trade shall be considered as a month. or business. No general rule can be prescribed defining the trades or businesses in which personal services and capital are material income-producing factors, but this question must be de

§ 9.25-1 Credits of individual against net income. For the purpose of computing the normal tax the taxpayer's net income as determined pursuant to

termined with respect to the facts of the | Earned income before applying limiindividual cases.

The provisions of sections 25 (a) (3) and 25 (a) (4) may be illustrated generally by the following examples:

Example (1). An individual received income from interest on bonds during the calendar year 1938 amounting to $6,000. His allowable deductions under section 23 for that year amounted to $2,000. He is entitled to an earned income credit of $300, computed as follows:

Gross income

Allowable deductions

Entire net income..

Earned net income allowable under
section 25 (a) (4) (C) ----
Earned income credit allowable (10
percent of $3,000) –.

tation in section 25 (a) (4) (A)- $10,000
Earned income as limited by section
25 (a) (4) (A) (20 percent of
$35,000) --

Earned income credit allowable (10
percent of $7,000) –

*†

7,000

700

§ 9.25-3 Amount of personal exemption allowable. A single person or a married person not living with husband or wife is entitled to a personal exemption of $1,000 and the head of a family or a married person living with husband $6,000 or wife to $2,500, regardless of the 2,000 amount of the net income. A husband and wife living together have but one personal exemption, which is $2,500. If they make separate returns, each may claim one-half of the personal exemption, or such exemption may, in accordance with an agreement entered into by them, be taken by either or divided between them in any proportion.*†

4,000
3,000

300

Example (2). An individual received a salary of $20,000 as a traveling salesman for the calendar year 1938. His allowable deductions under section 23 for that year amounted to $12,000, of which $2,000 was for traveling expenses in the course of his business and $10,000 was for a loss of his home from fire. His net income is $20,000 minus $12,000, or $8,000. He is entitled to an earned income credit of $800, computed as follows:

18,000

14,000

1,400

800

§ 9.25-4 Personal exemption of head individual who actually supports and of family. A head of a family is an maintains in one household one or more with him by blood relationship, relaindividuals who are closely connected and whose right to exercise family contionship by marriage, or by adoption, trol and provide for these dependent individuals is based upon some moral or legal obligation. In the absence of continuous actual residence together, whether or not a person with dependent relatives is a head of a family within the meaning of the Act must depend on the character of the separation. If a father is absent on business, or a child or other dependent is away at school or on a visit, the common home being still maintained, the additional exemption applies. moreover,

If,

Earned net income before applying limitation in section 25 (a) (4) (C)----. Earned net income as limited to maximum amount prescribed by section 25 (a) (4) (C)-. Earned income credit before applying limitation in section 25 (a) (3) (10 percent of $14.000) –. Earned income credit allowable as limited by section 25 (a) (3) (10 percent of $8,000, net income)___ Example 3. During the calendar year through force of circumstances a parent 1938 an individual was engaged in a is obliged to maintain his dependent business in which both personal services children with relatives or in a boarding and capital were income-producing fac-house while he lives elsewhere, the additors. A reasonable allowance as com- tional exemption may still apply. If, pensation for the personal services actually rendered by the taxpayer in the conduct of the business for that year was $10,000. The net profits of the business were $35,000, which constituted his net income for the year. He is entitled to an earned income credit of $700, computed as follows:

however, without necessity the dependent continuously makes his home elsewhere, his benefactor is not the head of a family, irrespective of the question of support. A resident alien with children abroad is not thereby entitled to credit as the head of a family. As to the amount of the exemption, see § 9.25-3.*†

§ 9.25-5 Personal exemption of mar- | 25 (b) (2) will be apportioned accordried person. In the case of a married ing to the number of months during man or married woman the joint ex- which the taxpayer occupied each status. emption replaces the individual exemp- A taxpayer not having the status of a tion only if the man lives with his wife head of a family or the status of a maror the woman lives with her husband. ried person living with husband or wife In the absence of continuous actual resi- shall be considered as having the status dence together, whether or not a man of a single person. For the purpose of or woman has a wife or husband living the apportionment of the personal exwith him or her within the meaning of emption and credit for dependents a the Act must depend on the character of fractional part of a month shall be disthe separation. If merely occasionally regarded unless it amounts to more than and temporarily a wife is away on a half a month, in which case it shall be visit or a husband is away on business, considered as a month. In general, the the joint home being maintained, the personal exemption and credit for deadditional exemption applies. The un-pendents allowable to any taxpayer will avoidable absence of a wife or husband be the sum of the amounts apportioned at a sanatorium or asylum on account to the several periods of the taxable year of illness does not preclude claiming the exemption. If, however, the husband voluntarily and continuously makes his home at one place and the wife hers at another, they are not living together within the meaning of the Act, irrespective of their personal relations. A resident alien with a wife residing abroad is not entitled to the joint exemption.*+

A

§ 9.25-6 Credit for dependents. taxpayer, other than a nonresident alien who is not a resident of Canada or Mexico (see section 214), receives a credit of $400 for each person (other than husband or wife), whether related to him or not and whether living with him or not, dependent upon and receiving his chief support from the taxpayer, provided the dependent is either (a) under 18, or (b) incapable of self-support because defective.

The credit is based upon actual financial dependency and not mere legal dependency. It may accrue to a taxpayer who is not the head of a family. But a

father whose children receive half or

more of their support from a trust fund or other separate source is not entitled

to the credit.*†

§ 9.25-7 Personal exemption and credit for dependents where status changes. If the status of the taxpayer changes during the taxable year, the personal exemption allowed by section 25 (b) (1) to a single person, a married person not living with husband or wife, a head of a family, or a married person living with husband or wife, and the credit for dependents allowed by section

during which each status was occupied.

Example (1). A, who had been single during the preceding months of 1938, married B on July 20 and lived with her during the remainder of the year. If a joint return is made by A and B on the calendar year basis for 1938, the personal exemption will be $2,208.33; that is, 7/12 of $1,000 for A while single, plus 12 of $1,000 for B while single, plus 512 of $2,500 for the period during which they were married. If separate returns are made by A and B on the calendar year basis for 1938, each may claim a personal exemption of $1,104.17; that is, 742 of $1,000, plus 2 of 12 of $2,500. In the latter case, however, the joint exemption of 12 of $2,500 may by agreement be taken either by A or B or divided between them in any proportion.

Example (2). A and B, who were heads of families during the first 6 months of 1938, were married on July 1, 1938, and lived together during the remainder of the year. If a joint return is made by A and B on the calendar year basis for 1938, the personal exemption while the head of a family, plus 2 of will be $3,750; that is, 1⁄2 of $2,500 for A $2,500 for B while the head of a family, plus 1⁄2 of $2,500 for the period during which they were married and living together. If separate returns are made by A and B on the calendar year basis for 1938, each may claim a personal exemption of $1,875; that is, 1⁄2 of $2,500, plus 2 of 2 of $2,500. In the latter case, however, the joint exemption of 1⁄2 of $2,500 may by agreement be taken either by A or B or divided between them in any proportion.

(b) Dividends received.-85 per centum of the amount received as dividends from a domestic corporation which is subject to taxation under this title, but not in excess of 85 per centum of the adjusted net income. The credit allowed by this subsection shall not be allowed in respect of dividends received from a corporation organized under the China Trade Act, 1922, or from a corporation which under section 251 is taxable only on its gross income from sources within the United States by reason of its receiving a large percentage of its gross income from sources within a possession of the United States.

Example (3). A and B were married | allowed to an individual as a credit for purand living together until November 30, poses of normal tax by section 25 (a) (1) or (2). 1938, when B, the wife, died. They had no dependents. The executor or administrator in making a return for B may claim a personal exemption of $1,229.16; that is, 1⁄2 of 112 of $2,500, or $1,145.83, for the period from the beginning of the taxable year to the date of the decedent's death, plus 12 of $1,000, or $83.33, for the period from the date of the decedent's death to the close of the taxable year. If A, the surviving spouse, makes a return for 1938 on the calendar year basis, he may claim a personal exemption of $1,229.16; that is, 2 of 112 of $2,500, or $1,145.83, plus 12 of $1,000, or $83.33. However, the combined personal exemption of A and B for the period. during which they were married and living together, that is, 1112 of $2,500, or $2,291.67, may by agreement be taken either by A, or by B's executor or administrator in behalf of B, or divided between them in any proportion.

Example (4). A furnished the chief support of a child under 18 years of age until the death of the child on June 20, 1938. If A makes a return on the calendar year basis for 1938, he is entitled, in addition to the personal exemption allowed under section 25 (b) (1), to a credit for dependents in the amount of $200; that is, 12 of $400.

Example (5). A and B were married and living together until June 30, 1938, when A, the husband, died. Prior to the date of death, A was the chief support of a child 10 years of age. B, the surviving spouse, was the chief support of the child during the remainder of the year. If B makes a return for 1938 on the calendar year basis, she is entitled, in addition to a personal exemption, to a credit for dependents in the amount of $200; that is, 12 of $400. The executor or administrator in making a return for A is entitled, in addition to a personal exemption, to a credit for dependents in the amount of $200; that is, 12 of $400.*+

SEC. 26. Credits of corporations. In the case of a corporation the following credits shall be allowed to the extent provided in the various sections imposing tax

(c) Net operating loss of preceding year.— (1) Amount of credit.-The amount of the net operating loss (as defined in paragraph (2)) of the corporation for the preceding taxable year, but not in excess of the adjusted net income for the taxable year.

(2) Definition.-As used in this title the term "net operating loss" means the excess of the deductions allowed by this title over the gross income, with the following exceptions and limitations

(A) The deduction for depletion shall not exceed the amount which would be allow

able if computed without reference to discovery value or to percentage depletion under section 114 (b) (2), (3), or (4);

(B) There shall be included in computing gross income the amount of interest received which is wholly exempt from the the amount of interest paid or accrued taxes imposed by this title, decreased by which is not allowed as a deduction by section 23 (b), relating to interest on indebtedness incurred or continued to purchase or carry certain tax-exempt obligations.

(d) Bank affiliates.-In the case of a holding company affiliate (as defined in section 2 of the Banking Act of 1933), the amount of the earnings or profits which the Board of Governors of the Federal Reserve System certifies to the Commissioner has been devoted by such affiliate during the taxable year to the acquisition of readily marketable assets other than bank stock in compliance with section 5144 of the Revised Statutes. The aggregate of the credits allowable under this subsection for all taxable years beginning after December 31, 1935, shall not exceed the amount required to be devoted under such section 5144 to such purposes, and the amount of the credit for any taxable year shall not exceed the adjusted net income for such year.

tion dividends paid credit, see section 27.
(e) Dividends paid credit. For corpora→

(1) Consent dividends credit.-For corporation consent dividends credit, see section 28.

§ 9.26-1 Credit of corporation for (a) Interest on obligations of the United interest on obligations of the United States and its instrumentalities.-The States and its instrumentalities. The amount received as interest upon obligations

of the United States or of corporations credit allowed by section 26 (a) is an organized under Act of Congress which is amount equal to the interest received

upon obligations of the United States or | 000. Included in such deductions was of a corporation organized under Act of Congress (if such corporation is an instrumentality of the United States and under the Act authorizing the issue of such obligations, as amended and supplemented, such interest is in the case of individuals exempt from normal tax) which is included in gross income under section 22.*†