36

of the United States, and a domestic corporation in the United States, is primarily liable to pay a tax in Porto Rico or the Philippines on income derived therefrom and also a tax to the United States on the same income, but is entitled to deduct the amount of income tax paid to those possessions from the amount due on the entire net income to the United States.3 Under the 1916 Law Porto Rico and the Philippines were treated as a part of the United States and only one tax was imposed on the income of taxpayers residing therein and deriving income from the states and territories, or vice versa.37 Under the 1916 Law and also under the present law the Porto Rican or Philippine Legislature has power by due enactment to amend, alter, modify or repeal the income tax laws in force in its jurisdiction.38

Gross Income. Gross income is defined in the law to include income, gains or profits of all kinds except those enumerated as exempt from taxation. A more complete definition will be found in a subsequent chapter.39

Net Income. Net income is defined as gross income less the deductions allowed by the law, as is more fully stated in a subsequent chapter.40 The Revenue Act of 1918 for the first time requires net income to be computed on the basis of the taxpayer's annual accounting period (fiscal year or calendar year as the case may be) in accordance with the method of accounting employed in keeping the books of such taxpayer. If no method of accounting has been employed or if the method employed does not clearly reflect the income, the computation is to be made upon

one of the districts of the continental United States was not taxable in Porto Rico or the Philippines, although a portion of the income received might be derived from business carried on in one or both of those jurisdictions. Although the law provided that income collected in those jurisdictions "shall accrue intact to the general governments thereof," this was held to refer only to the tax legally assessable therein, and not to alter the general rule that all of the tax should be paid in the district in which the taxpayer resided or had his or its principal place of business.

36 Revenue Act of 1918, § 238. Reg. 45, Arts. 1132 and 1133.

37 Letter from Treasury Department dated April 4, 1917.

38 Revenue Act of 1918, § 260. See also Revenue Act of 1917, § 5. Since this power exists, it is not safe to assume that the income tax laws in Porto Rico and the Philippines are identical with the Revenue Act of 1916.

39 See Chapter 14.

40 See Chapter 14.

such basis and in such manner as in the opinion of the Commissioner does clearly reflect the income.11

Deductions and Credits. The law specifies that certain deductions may be made from gross income in ascertaining the net income of the taxpayer. "Deductions" reduce income for all purposes. "Credits" do not reduce net income for all purposes, but reduce the net income of an individual for the purpose of the normal tax and not the surtax, or, in the case of a corporation, reduce net income for the purpose of the income tax and not the excess-profits tax. Another form of credit provided by the law may be applied directly against the tax and not against the net income. These distinctions are more fully stated and explained in subsequent chapters.

Reporting Net Income. Taxpayers are required to file annually a return showing the amount of gross income received, the deductions, credits and exemptions claimed and the net income upon which the tax is to be imposed. This return is filed in the collection district in which the taxpayer resides or has his principal place of business. Non-residents having no place of business in this country file their returns with the Collector of Internal Revenue at Baltimore, Maryland. The returns are required to be filed on or before March 15, if the report is made for the preceding calendar year. If made for a fiscal year, the returns are required to be filed on or before the 15th day of the third month following the close of the fiscal year. The Commissioner may grant a reasonable extension of time for filing returns whenever in his judgment good cause exists.43 Under the 1918 Law both individuals and corporations are required to file their returns for their fiscal years instead of for the calendar year if they keep books of account which are regularly closed each year at the end of some month other than December. One important change made by the 1918 Law is that partnerships are required to file annual returns showing their net income although they are not subject to tax as partnerships.

41 Revenue Act of 1918, § 212.

Revenue Act of 1918, § 227 and § 241. This dictrict is the one in which Washington, the national capital, is located.

43 Revenue Act of 1918, § 227 and § 241.

44 Revenue Act of 1918, § 224. See Chapter 8.

Record to Be Kept. Every individual, partnership or corporation liable to any tax imposed by the internal revenue laws of the United States, or for the collection thereof, is required to keep such records, to render such statements and returns under oath, and to comply with such regulations as shall be prescribed by the Commissioner. The Commissioner may also examine any books, papers, records or memoranda of a taxpayer.

Individuals. Ordinarily, no person whose net income is less than $1,000 in any calendar year is required to file a return for that year, but the Commissioner may require any person, whether liable to tax or not, to file returns of income or such statements as he may deem sufficient to show whether or not such person is liable to tax.46 Unmarried persons and married persons not living with husband or wife and receiving $1,000 or more net income during the calendar year, and married persons living with husband or wife and receiving $2,000 or more net income during the same period, are required to file annual returns. Minors are now required to file returns if they have received the mininum amount of income specified in the law. Prior to 1918 returns were required only of persons of lawful age.47

PERSONAL EXEMPTION. The personal exemption or credit is an arbitrary amount of net income on which residents and citizens (in some cases non-resident aliens) are not taxed.48 It may be said to be an amount allowed for personal or family expenses, the actual amount of such expenses not being deductible in ascertaining net income. The amount of the personal exemption allowed to an individual depends upon his status. Married persons living together and heads of families, whether married or not, are entitled to an exemption of $2,000. Others are entitled to $1,000. An additional exemption of $200 is allowed to any taxpayer, whether single or married or head of family, 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.49 A non-resident alien

45 Revenue Act of 1918, § 1305; Reg. 45, Art. 1711; Reg. 33 Rev., Art. 50. 46 Revenue Act of 1918, § 1305.

47 See Chapter 34 for further discussion of this subject.

48 Revenue Act of 1918, § 216 and § 217.

49 Revenue Act of 1918, § 216. The exemption of $200 was formerly limited

is entitled to claim these exemptions to the same extent as a citizen or resident unless he is a citizen or subject of a country which imposes an income tax and does not allow a similar exemption or credit to citizens of the United States not residing in such country. The personal exemption may be deducted only in computing the normal tax.50 The 1918 Law provides that all corporations shall be entitled to an exemption of $2,000.51

Normal Tax. The normal tax is a tax imposed upon all the net income of an individual in excess of (a) dividends received from taxable corporations; (b) interest upon bonds and other obligations of the United States issued after September 1, 1917; (c) interest upon bonds issued by the War Finance Corporation; (d) the personal exemption and (e) the exemption for dependent persons.52 For the year 1919 and subsequent years the rate of normal tax in the case of citizens and residents of the United States is 4% on the first $4,000 of income subject to normal tax and 8% on the remainder; and in the case of non-resident aliens 8% on all net income from sources within the United States subject to normal tax.53

to cases of children dependent upon the taxpayer, and is now extended to cases where other persons are dependent, as stated in the text.

50 For a further discussion of the personal exemption, see Chapter 31. 51 Prior to the 1918 law corporations have not been allowed an exemption similar to the personal exemption allowed to individuals.

52 Revenue Act of 1918, § 216. The distinction made between incomes subject to normal tax and incomes subject to surtax is artificial and necessary only for the purpose of granting certain partial exemptions or taxing various kinds of income at different rates. The distinction between normal taxes and surtax seems to have originated in England where the income tax was first imposed at a proportional rate on all income and later graduated rates were applied to incomes over a minimum limit. One reason for distinguishing between normal taxes and surtaxes under our 1913 Law lay in the fact that the statute provided for withholding at the source of the normal tax, as does the English Law. Under the 1913 Law and the 1916 Law the normal tax was the rate which applied to corporations and individuals alike but under the present law this characteristic is destroyed since the normal tax is also a graduated tax. The law will no doubt always retain the distinction between normal and surtaxes since bonds of the United States are issued exempt from "normal tax,'' an exemption which, by the way is uncertain and precarious since it is within the power of Congress to reduce the normal tax at any time to a minimum and thereby practically destroy the tax exemption or raise the normal tax as is done by the present law in order to increase the exemption.

53 Revenue Act of 1918, § 210. For the year 1918 the rate of normal tax

Surtax. A surtax (sometimes called "supertax" or "additional tax") is imposed upon the entire net income of individuals in excess of $5,000 without deducting the personal exemption and including dividends and interest on United States obligations, issued after September 1, 1917, and bonds of the War Finance Corporation. The surtaxes are at a series of graduated rates the first of which is imposed on that part of the net income which exceeds $5,000 and does not exceed $6,000. Each additional $2,000 of net income is subject to a higher rate of tax than the preceding one up to and including $100,000, and thereafter the surtax is increased at less frequent intervals on income up to $1,000,000, the final rate being 65% on the amount by which the net income exceeds $1,000,000.54

Corporation Tax. The income tax imposed on corporations is at the rate of 10%.55 This rate might be said to measure the normal tax imposed on corporations in contradistinction to the graduated excess-profits tax which is also imposed on corporations. For the purpose of the income tax the net income which is subject to the excess-profits taxes is reduced by deducting therefrom certain credits consisting of (a) interest on the bonds and obligations of the United States issued after September 1, 1917, and bonds issued by the War Finance Corporation; (b) the amount of any excess-profits tax imposed on the net income for the same taxable year; and (c) in the case of a domestic corporation the sum of $2,000.56 Certain kinds of corporations not organized for profit, both domestic and foreign, are exempt from this tax.57

Personal Service Corporations. The 1918 Law recognizes a new class of corporations-those whose income is due primarily to the activities of the principal owners or stockholders who are

in the case of citizens and residents of the United States was 6% on the first $4,000 of income subject to normal tax and 12% on the remainder. Nonresident aliens were subject to a normal tax at the rate of 12% on all of the net income subject to normal tax received from all sources in the United States. 54 Revenue Act of 1918, § 211. See Chapter 2 for a schedule of rates of this tax.

55 This rate was 12% for the year 1918.

56 Revenue Act of 1918, § 230 and § 236. This subject is more fully discussed in Chapter 10.

57 See Chapter 13 for list of exempt corporations.