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(b) If, for any taxable year, it appears upon the production of evidence satisfactory to the Commissioner that any taxpayer has sustained a net loss, the amount thereof shall be allowed as a deduction in computing the net income of the taxpayer for the succeeding taxable year (hereinafter in this section called "second year"), and if such net loss is in excess of such net income (computed without such deduction), the amount of such excess shall be allowed as a deduction in computing the net income for the next succeeding taxable year (hereinafter in this section called “third year"); the deduction in all cases to be made under regulations prescribed by the Commissioner with the approval of the Secretary.

(c) (1) If in the second year the taxpayer (other than a corporation) sustains a capital net loss, the deduction allowed by subdivision (b) of this section shall first be applied as a deduction in computing the ordinary net income for such year. If the deduction is in excess of the ordinary net income (computed without such deduction) then the amount of such excess shall be allowed as a deduction in computing net income for the third year.

(2) If the second year the taxpayer (other than a corporation) has a capital net gain, the deduction allowed by subdivision (b) of this section shall first be applied as a deduction in computing the ordinary net income for such year. If the deduction is in excess of the ordinary net income (computed without such deduction) the amount of such excess shall next be applied against the capital net gain for such year and if in excess of the capital net gain the amount of that excess shall be allowed as a deduction in computing net income for the third year.

(d) If any portion of a net loss is allowed as a deduction in computing net income for the third year, under the provisions of either subdivision (b) or (c), and the taxpayer (other than a corporation) has in such year a capital net gain or a capital net loss, then the method of allowing such deduction in such third year shall be the same as provided in subdivision (c).

(e) If for the taxable year 1922 a taxpayer sustained a net loss in excess of his net income for the taxable year 1923 (such net loss and net income being computed under the Revenue Act of 1921), the amount of such excess shall be allowed as a deduction in computing net income for the taxable year 1924 in accordance with the method provided in subdivisions (b) and (c) of this section.

(f) If for the taxable year 1923 a taxpayer sustained a net loss within the provisions of the revenue Act of 1921, the amount of such net loss shall be allowed as a deduction in computing net income for the two succeeding taxable years to the same extent and in the same manner as a net loss sustained for one taxable year is, under this Act, allowed as a deduction for the two succeeding taxable years.

(g) If a taxpayer makes return for a period beginning in one calendar year (hereinafter in this subdivision called first calendar year") and ending in the following calendar year (hereinafter in this subdivision called "second calendar year”) and the law applicable to the second calendar year is different from the law applicable to the first calendar year, then his net loss for the period ending during the second calendar year shall be the sum of: (1) the same proportion of a net loss for the entire period, determined under the law applicable to the first calendar year, which the portion of such period falling within such calendar year is of the entire period; and (2) the same proportion of a net loss for the entire period, determined under the law applicable to the second calendar year, which the portion of such period falling within such calendar year is of the entire period.

(h) The benefit of this section shall be allowed to the members of a partnership, to an estate or trust, and to insurance companies subject to the tax imposed by section 243 or 246, under regulations prescribed by the Commissioner with the approval of the Secretary.

(Section 200—1924 Act)

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Bad Debts. The Law provides that "debts ascertained to be worthless and charged off during the year or, at the discretion of the Commissioner, a reasonable addition to a reserve for bad debts, may be deducted". Under the 1918 Act only the debts ascertained to be worthless and actually charged off within the taxable year were deductible. From the viewpoint of good accounting, it is desirable that the estimated loss on account of bad debts, based on the experience of past years, be placed on the books at the end of each fiscal period. Both the 1921 and the 1924 Revenue Acts provided that, in the discretion of the Commissioner, a reasonable addition to a Reserve for Bad Debts may be treated as a deduction. This provision was advocated by accountants who were, no doubt, responsible for its enactment.

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There has been some confusion as to when a debt is ascertained to be worthless. The Treasury Department has ruled that in order to comply with this provision it must be ascertained without reasonable doubt that it is bad; however, the Department has held that in the case of a bankrupt corporation which has some assets, debts which it may owe cannot be regarded as ascertained to be worthless until the trustee in bankruptcy has settled the affairs of the estate and has been discharged by the court. In the case of a debt which has arisen from income due, it cannot be treated as a deduction when ascertained to be bad unless the income which it represents was reported at the time it accrued. For instance, if interest is due on money loaned and later it is found that the amount of the interest is uncollectible, it cannot be treated as a deduction unless it has been previously reported as income. In case of a dispute as to the amount due, if a compromise is made and a less amount is accepted in payment than was first claimed, the difference cannot be treated as a deduction; however, if there is no dispute as to the amount of the debt, and if the smaller amount is accepted in order to obtain immediate payment, the difference may be treated as a deduction.

If the endorser of a note has to pay it on the default of the payor its amount may be treated as a deduction. In case of a foreclosure of a mortgage held by a taxpayer and provided that the property is not purchased by the mortgagee the difference between the amount received as a result of foreclosure and the amount due on the mortgage may be treated as a deduction. If the property is purchased by the mortgagee no deduction can be claimed until the property is finally disposed of and the loss incurred actually ascertained.

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Depreciation. The Law provides that a reasonable allowance for exhaustion, wear and tear of property arising out of its employment in business or trade, may be treated as a deduction. No depreciation is allowed, however, upon the property used as a residence either in city or country. When the full value of the property has been deducted by means of depreciation, no further allowance is permitted. For instance, if the taxpayer estimates that an asset which cost $800.00 will last for ten years and claims as a deduction $80.00 each year, but finds that at the end of ten years the asset has still a value of $200.00, he is not permitted to claim any further deduction after the tenth year.

No allowance for depreciation is permissible upon items of personal property. For instance, depreciation cannot be claimed upon an automobile used only for personal purposes. Neither depreciation nor appreciation of land is to be considered. In case of renewals or replacements, which do not appreciably lengthen the life of the property and which are charged against depreciation reserves, no deduction can be claimed. In order that depreciation may be claimed as a deduction, it must be entered upon the books. It was formerly held it must be credited to the asset to which it related, but later rulings permit it to be expressed in a reserve account. The latter method is, of course, the one approved by good accounting practice and should be followed in every case.

At one time the Treasury Department held that the amount of the depreciation reserve must be set aside as a special fund and could not be used in the conduct of the business, but this has also been reversed and now the amount of the depreciation reserve can be represented by the general assets of the business and need not be shown separately. This is, of course, in accord with sound accounting practice. No depreciation on good will is permissible. A reasonable allowance for obsolescence may be considered in the calculation of depreciation.

Depletion. The distinction between depreciation and depletion should be clearly understood. Depreciation is à decrease in the yalue of the assets due to their use in the business while depletion refers to the decrease in the value of the asset because it enters into the making of the commodity sold. Depreciation occurs in connection with the machinery used in a coal mine, but depletion occurs in connection with the mine itself because the coal is actually being removed and sold.

In the case of mines, oil and gas wells, other natural deposits and timber, a reasonable allowance for depletion and depreciation of improvements will be allowed according to the peculiar conditions in each case, based upon cost, including cost of development not otherwise deducted. In case of property acquired prior to March 1, 1913, the fair market value on that date should be taken in lieu of cost.

In the case of the above properties (except timber) discovered by the taxpayer on or after March 1, 1913, where the fair market value of the property is materially disproportionate to the cost, depletion allowance may be based upon the fair market value of the property at the time of discovery or within 30 days thereafter. The depletion allowance based on discovery value is not to exceed the net income, computed with allowance for depletion, from the property on which discovery is made, except where such net income so computed is less than the depletion allowance based on cost or fair market value as of March 1, 1913.

Contributions or Gifts. Contributions* or gifts may be deducted by the taxpayer as provided by Law. To be deductible, such contributions or gifts must be made within the taxable year. They are deductible to an aggregate amount not in excess of 15% of the taxpayer's net income except in the event the contributions or gifts of the taxpayer in the past year and ten preceding taxable years exceeds 90% of his net income in which case the full amount may be deducted.

The following proposition will serve to illustrate the application of this provision to a return.

Proposition B Howard Nolan has a gross income of $3,800.00 derived from salary and commissions. His allowable deductions amount to $1,400.00 not including a contribution of $450.00 to the Community Chest.

Solution It is necessary to compute his net income before making any deduction on account of the contribution to the Community Chest. By subtracting the deductions of $1,400.00 from the gross income of $3,800.00, it will be found that his net income amounts to $2,400.00. In view of the fact that his contribution to the Community Chest exceeds 15% of his net income, he will be permitted to deduct on account of the contribution an aggregate amount not in excess of 15% of his net income. 15% of $2,400.00 is $360.00. Mr. Nolan is, therefore, entitled to make a deduction of $360.00 on account of his contribution to the Community Chest in addition to his other deductions, hence he will have a taxable income of $2,040.00.

Mr. Nolan would not be entitled to take advantage of the 90% clause even though he had, in the preceding ten years, been donating more than 90% of his income to charitable or other causes within the scope of this section of the Law, because the amount of his contribution for the present year does not exceed 90%.

*Such contributions or gifts have been construed to mean gifts of money or property. The value of services rendered to charitable institutions may not be allowed as a deduction under the Law.

In all cases where the total contribution is less than 15% of the taxpayer's net income, when computed without including the contribution in the deductions, the taxpayer may deduct the total amount of such contribution.

Contributions by Partnerships. The proportionate share of contributions made by a partnership may be claimed as a deduction in the personal returns of the partners. The reason for this is because the partnership itself is not entitled to deduct contributions in arriving at the distributive share of each partner's income.

Items Not Deductible. (a) In computing net income no deduction shall in any case be allowed in respect of,

(1) Personal, living, or family expenses;

(2) Any amount paid out for new buildings or for permanent improvements or betterments made to increase the value of any property or estate;

(3) Any amount expended in restoring property or in making good the exhaustion thereof for which an allowance is or has been made; or

(4) Premiums paid on any life insurance policy covering the life of of any officer or employee, or of any person financially interested in any trade or business carried on by the taxpayer, when the taxpayer is directly or indirectly a beneficiary under such policy.

(b). Amounts paid under the laws of any State, Territory, District of Columbia, possession of the United States, or foreign country as income to the holder of a life or terminable interest acquired by gift, bequest, or inheritance shall not be reduced or diminished by any deduction for shrinkage (by whatever name called) in the value of such interest due to the lapse of time, nor by any deduction allowed by this Act for the purpose of computing the net income of an estate or trust but not allowed under the laws of such State, Territory, District of Columbia, possession of the United States, or foreign country for the purpose of computing the income to which such holder is entitled.

(Section 215—1924 Act) This section of the Law is so clear that it needs no detailed discussion. The provisions of the 1924 Act regarding nondeductible items is the same as in the 1921 Act. In order to illustrate the application of Sections 214 and 215 of the Law, the following schedule has been prepared to show the proper classification of a number of ordinary expenditures.

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