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Federal Income Taxation

History of Taxation-Deductions:
Internal Revenue Code
Section 162
By: Earl Lofland
The United States financed the government with revenues from the customs revenues
until
1861. Yet on Aug 5, 1861 the U.S. Congress
enacted “The First Civil War Tax Act”, in order that the Civil War efforts would be
financed. In
this statute there was only one deduction, it was for
all national , state, or local taxes assessed upon the property from which the income is
derived, this bill expressly allowed deductions only of
taxes assessed on property generating income. The bills floor manager, due to
concerns
expressed in the Senate, that the Treasury
Department might interpret income to mean gross rather than net income replied, that
the
meaning of income would mean net profits, and the
Treasury Department would provide the ways and means to ascertain it. This was so
that it
would encourage landlords to deduct repairs, and
other amounts in order to reduce that taxable amount to zero, and that it would be
preferable
to let the Treasury Department prescribe rules to
prevent tax evasion. This act was superseded in 1862 . “The Second Civil War Income
Tax
Act” was enacted, and contained allowed deductions for taxes for property that
produced
income, certain income derived from military, and congressional salaries. Interest and
dividends
on certain stock and capital, and for certain amounts of rent paid for the taxpayer’s
dwelling
house. It also included deductions for a portion of
the rental value of the taxpayer’s homestead, for losses on the sale or real estate
purchased
in that year and certain business expenses in the
nature of interest, repairs and salaries. this was amended March 2,1867 expanding
certain
taxes, limited casualty losses, losses incurred in
the taxpayers trade, bad debt losses, rent paid for the premises occupied as a
residence by
a taxpayer, and his or her family. In 1870 the
“Income Tax Act” was reenacted to allow deductions for national , state county and
municipal
taxes paid by the taxpayer, for business and
casualty losses for bad debts, interest, for rent and services for to cultivate land, or
conduct
business. For the first time a specific deduction
limitation was enacted to prohibit the taxpayer from deducting any amount paid for new
buildings, permanent improvements, and betterment’s
made to increase the value of property, and continued to function until 1872. In 1874 the
federal government reinstated deductions , which
allowed for business expenses , certain interest certain taxes, certain casualty losses,
and
bad debts the prohibition of capital expenditure was
continued, and lasted until 1895 when Congress passed a “ Joint Resolution” to the
effect
that the cost of fire insurance premiums, and
ordinary repairs was at that time allowable deductions on the Federal Taxes. Yet in
1895 a
case , Pollock v. Farmers’ Loan & Trust Co. , The
Supreme Court determined that the 1894 Act was deemed unconstitutional, and on
rehearings, the Court reaffirmed, and declared the entire Act
unconstitutional. For fifteen years there were no actions to amended the Act of 1894,
but in
1909 Congress enacted a corporate excise tax
that was measured by income. In computing net income, ordinary and necessary
expenses
for the maintenance and operation of business and
properties , losses deprecations, interest, taxes and dividends received were permitted
to be
deducted from a corporations gross income.
This was continued until 1913.At that time Congress passed the Sixteenth Amendment.
It
granted Congress the power “ To lay and collect
taxes on incomes, from what ever source derived without apportionment among the
several
States, and without regard to any census or
enumeration” though it did not define income , If gross, net or both could be taxed, and
deductions also were not mentioned.
In Oct of 1913, Congress enacted the Revenue Act of 1913, allowing deductions on
necessary business expenses, interest, certain taxes
losses, bad debts, depreciation, depletion, and certain dividends received from
corporations
subject to the tax. Also in 1913 a specific
denominated personal deduction for insurance companies, and foreign corporations
doing
business in the United States was added.
Through the years, as Congress reenacted the “Revenue Act”, additional deductions
were
added. Some of the provisions, allowing a deduction
for losses from transactions entered into for profit that were not business. But only to the
extent of profits from transactions entered into for profit
in 1916.In 1917, charitable deductions were added and a deduction for federal income
taxes
was eliminated. In 1918 predecessors of Section
172 ( net operating loss deduction) Sec 265 ( limitations on deduction of interest paid or
incurred to purchase or carry tax-exempt obligations),
and Sec 264 ( a limitation on the deductions of life insurance premiums). Section 404,
(deductions allowed for contributions to qualified
employee retirement plans ) was enacted in the Revenue Act of 1928.
In 1939, The Internal Revenue Code ( I.R.C.) was issued, codifying income tax law as it
then
existed. But in 1942 Congress enacted the first
Section 212, Allowing deductions on expenses paid or incurred in carrying on profit
seeking
activities. That Act also contained the first medical
expense deduction of capital losses.
Deductions represent the most significant concepts of the federal income tax system.
Deductions are the only step in computing income tax
liability . They generated revenue losses , one of several tax expenditure items. They
also
include deferral tax liability, preferential rates, credits,
exemptions, and exclusions. Deductions generate decreases in tax liability, and
amounts
disallowed as deductions generate increases in tax
liability.
A deduction for compensation, and that is reasonable for personal services actually
rendered
in connection with the carrying on of a trade or
business is specifically allowed by Section 162.
For a compensation deduction to be permitted under Section 162, there must be proof
with a
written contract to render services, the actual
services, the actual performance, and a reasonable probability that payment was
intended
when the contract was made. The Employee must
have a genuine legal obligation to render the services, and the employer must have a
genuine
legal obligation to pay . Another allowable
deduction under Section 162, is rental expenses. Under section162, the rental or other
payment must be made as a condition to the continued
use or possession, for the purpose of the trade or business, of property to which the
taxpayer
has not taken or is not taking title, or in which he
has no equity. they also include rental payments not only to this, but also to rents paid in
kind by paying for improvements that are made to the
lessor’s property and that are intended to be credited against rents otherwise due and
also
with the respect that lessee is obligated under the
lease terms to make payments for improvements . The cost of making improvements on
the
rented property including construction costs of
buildings must be capitalized and is not deductible under Section 162, or section 212,
as long
as the repairs do not increase the fair market
value, or extend the useful life of the property, they are able to be deducted, under
Section
162.
Deciding points on the qualification for a deductions under Sections 162, or 212,
depends on
whether they are part of a plan of activity that
materially adds to the value of the property, or prolongs the life of the property in
question.
An example that is given in the the Bureau of National
Affairs Inc. #505 is the cost of replacing a broken electric switch. Usually under Section
212,
or 162 it constitutes a repair deduction but the cost
of repairing or replacing all the electrical switches as part of a major rehabilitation must
be
capitalized. in example some of the deductions that
have been permitted under the section 162 are as follows, ( if capitalization was not
required):
Brick pointing.... Thurner v. Comr, 11 T.C.M. 42,46 (1952)
Brush clearing to negate overgrowth clamping gas pipes to stop leaks.. Niagara
Mohawk
Power Co. .v. U.S. 558 F.2d 1379 ( Ct Cl. 1977)
Cleaning after a fire...Ticket Office Equipment Co., Inc. v. Comr. 20 T.C. 272, 279
(1953)
affirmed per curium 213 F. 2d 318 (2d Cir 1954)
Cleaning the exterior wall of a building...City Nat’l Bank v. Comr. 11 T.C.M. 411,413
(1952)
Cleaning the interior of rundown building...Jacobson v. Comr., 47 T.C.M. 499,502
(1983)
Cleaning mud from barge that sank in storm...Zimmern v. Comr., 28 F.2d 769 (5th Cir
1928,
Rev’g 9 B.T.A. 1382 (1928)
Cleaning pipes... Plainfeild- Union Water Co. v. Comr., 39 T.C. 333,341 (1962)
Cleaning well... Haynes v. Comr., 6 B.T.A.1166,1167(1927)
Clearing river channel after dock collapsed into it...Buffalo Union Furnace Co v.
Helvering,
72 F2d 399,403 (2d Cir 1934), rev’g 23 B.T.A. 439,457 ( 1931)
Converting appliances from using manufactured gas to using natural Conn. Light &
Power
Co. v. U.S. 299F.2d 259,266 ( Ct. Cl. (1962)
Cost of installing replacement for damaged boiler... Collieries v. Comr., 12 B.T.A.
500,508
(1928) rev’d in part on other issues, 50 F2d 777 ( 6th Cir 1931)
Cost of installing replacement from heating system required to be remodel by war
regulations...Beaven v. Comr., 6 T.C.M. 1344, 1345 (1947)
cutting out concrete cracks...Universal Mills v. Comr., 7 T.C.M. 886, 890 (1948)
Decorating... Squier v. Comr., 13 B.T.A. 1152 (1928)
Dismantling unsafe partition...Schmid v. Comr., 10 B.T.A. 1152 (1928)
Dredging fill washed into property by storms...Tampa Electric Co v. Comr., 12 B.T.A.
1002,
1008 (1928)
Drilling and grouting subsoil to prevent collapse of building threatened by sudden
shifting of
subsoil and resulting cave- in of factory
Floor...American Bemberg Corp. v. Comr., 10 T.C. 361,378 (1948) aff’d per curium
177
F.2d 200 ( 6th Cir. 1949)
Driving poles into railway roadbed... Kansas City Southern Railway Co. v U.S. , 112 F
Supp. 164, 165 ( Ct. Cl. 1953) Rev. Rul. 54-356, 1954-2 C.B. 82 , Supersedded by
Rev.
Rul. 77-478, 1977-2 C.B. 81
Eliminating hump in driveway entrance... Almacs Inc. v. Comr. , 20 T.C.M. 56, 59 (
1961)
Emergency activities to restore operations after fire...Ticket Office Equipment Co. Inc.
v.
Comr., 20 T.C. 272, 279 (1953), affirmed, 213 f.2D 318 ( 2nd Cir 1954)
Filling and grading property to alleviate water seepage caused by construction on
adjacent
property...Southern Ford Tractor Corp. v. Comr., 29 T.C. 833,845 (1958)
Filling Concrete cracks...Universal Mills v. Comr., 7 T.C.M. 886,890 (1948)
Installations of steel columns and cross members to support sagging floor...Regenstein
v.
Edwards121 F.Supp.. 952 , 954 ( M.D. Ga. 1954)
Insulating above a roof... Munroe Land Co. v. Comr., 25 T.C.M. 3,7 (1966)
Insulating house...Rice v. U.S., 75-1 USTC Paragraph 9207 ( D. Mont. 1975)
Lining tar- painted cast iron pipes with concrete Plainfield- Union Water Co v. Comr.,
39
T.C. 333, 341 (1962)
Make shift repair of floor... Standard Fruit Product Co. v. Comr., 8 T.C.M. 733, 739
(1949)
Maintenance of golf course... Berglund v. U.S., 81-1 USTC PAR. 9192 ( d. Minn.
1981)
Maintenance of septic tank system... Copper v. Comr., 42 T.C.M. 418, 423 (1981)
Mortar pointing... Thurner v. Comr., 11 T.C.M. 42, 45 (1952)
Moving and rearranging partitions...Neuberger v. Comr., 2 B.T.A. 911, 912 (1925)
Moving bookcases ... Squier v. Comr., 13 B.T.A. 1223, 1225 ( 1928)
Overhauling machinery annually...Peoples Ice & Cold Storage Co. v. Comr., 10
B.T.A.
16,17 (1928)
Overhauling tractor parts... Nottingham v. Comr., 12 T.C.M. 503, 505 (1953)
Painting a barge after recovering it from the bottom of a river... Zimmern v. Comr., 28
F.2d
769, 769 (5th Cir 1928) rev’g 9 B.T.A. 1382 (1928)
Painting and interior room.... Luce Furniture Co v. Comr., 9 B.T.A. 1413, 1418 (1928)
Painting the exterior of a building....O’Madigan v. Comr., 19 T.C.M. 1178, 1186 (1960)
aff’d
on other issues, 300 F 2d 154 ( 6th Cir. 1926)
Painting the interior of a building...Rose v. Haverty Furniture Co., 15 F. 2d 345, 346
(5th Cir
(1926)
Painting roof...Patter v Comr., 20 B.T.A. 252, 254 (1930)
Painting window sash... Buckland v. U.S. , 66 F. Supp. 681, 683 ( D. Conn. 1946)
Patching floors... Patter v. Comr., 20 B.T.A. 252, 254 (1930)
Plastic finish on building canopy...Gilles Frozen Custard, Inc. v. Comr., 29 T.C.M.
311,317
(1970)
Plastering a room...Standard Fruit Product Co. v. Comr., 8 T.C.M. 733, 739 (1949)
Pouring concrete over existing floor to restore its use... Hudlow v. Comr., 30 T.C.M.
894
923 (1971)
Pressure grouting railway roadbeds... Kansas City Southern Railway Co. v. U.S. , 112
f.
supp. 164,165 ( Ct Cl. 1953): rev Rul 54-356, 1954-2 C.B. 82, superseded by
Rev.Rul.
77-478, 1977-2 C.B.81
Recoveing ore that fell into river when ore dock collapsed... Buffalo Union Furnace
Co. v.
Helvering, 72 F. 2d 399, 402 ( 2d Cir.1934) aff’g 23 B.T.A. 439 (1931)
Recovering and repairing equipment buried by a flood... R.R. Hensler, Inc. v. Comr.,
73 T.C.
168, 182 (1979)
Recovering and repairing steam shovel that fell into creek... Jefferson Gas Coal Co. v.
Comr., 16 B.T.A. 1135, 1141 (1929) rev’d in part and aff’d in part on other issues
52 F.2d
120 ( 3d Cir. 1931)
Recrowning road...Pennock Plantation, Inc. v. Comr., 10 T.C.M. 1077, 1080 (1951)
Reflashing a roof...Fidelity Storage Corp. v. Burnet, 58 F.2d 526, 528 ( D.C. Cir 1932)
rev’g 18 B.T.A. 517 (1929)
Relining firebox... Wood Preserving Corp of Baltimore v. U.S., 233 F Supp. 600 , 601
(D
Md. 1964) aff’d on other issues, 347 F.2d 117(4th Cir. 1965)
Relining furnace used in enameling process...John Hollow Ware Co. v. Comr., 12
B.T.A.
48, 48 ( 1928)
Relining wall and floor of basement with concrete to prevent oil seepage from
neighboring
refinery...
Midland empire Packing Co. v. Comr., 14 T.C. 635, 642 (1950)
Removal of damaged building cornice ...Commodore. Inc. v. Comr., 46 B.T.A. 718,
724
(1942) , aff’d, 135 F.2d 89 (6th Cir. 1943)
Removal of damaged windows...Buckland v. U.S. , 66 F. Supp 681, 683 ( D Conn.
1946)
Removal of fire debris... Ticket Office Equipment Co., Inc. v. Comr., 20 T.C. 272, 279
(1953), af’d per curiam, 213 F.2d 318 ( 2d Cir 1954)
Repaving parking lot... Coors v. Comr., 60 T.C. 368, 404 (1973), aff’d on other issues
sub
nom., Adolph Coors Co. v. Comr., 519 F.2d 1280 ( 10th Cir 1975) cert. denied, 423
U.S.
1087 (1976)
Repainting the exerior of a building... Potter v. Comr., 20 B.T.A. 252, 254 (1930):
Watts v.
Comr., 34 T.C.M. 613,615 (1975): Cohen v. Comr., 7 T.C.M., 681, 684 (1948)
Repairing automobile damage caused by storm... Tampa Electric Co. v. Comr., 12
B.T.A.
1002,1008 (1928)
Repairing barge... L&L Marine Service v. Comr., 54 T.C.M. 312, 316 (1987)
Repairing bins... Mogg Coal & Coke Co. v. Comr.,10 B.T.A. 588,590 (1928)
Repairing boat...Standard Motors Inc. v. U.S., 61-2 USTC par.9639 ( E.D. La. 1961)
Repairing bookcases...13 B.T.A., 1223, 1225 (1928)
Repairing building damaged by storm...Tampa Electric Co. v. Comr., 12 B.T.A., 1002,
1008
(1928)
Repairing building damage caused by watter seepage Farmers Creamery Co. of
Fredericksburg Va. v. Comr., 14 T.C. 879, 883 (1950), nonacq., 1954-1 c.b. 8
Repairing ceilings ...Mason cotton Mill Co. v. Comr., 1 B.T.A. 449, 450 (1925)
Repairing counters... Schmid v. Comr., 10 B.T.A. 1152 (1928)
Repairing dam to stop leaks... Evans v. Comr., 557 F.2d 1095, 1101 ( 5th Cir. 1977),
Revg
33 T.C.M. 1192 ( 1974), SUPP., 34 T.C.M. 783 ( 1975)
Repairing doors... Marcell v. U.S., 61-2USTC PAR. 9628 ( D.Vt. 1961)
Repairing drill rig... Nottingham v. Comr., 12 T.C.M. 503,505 ( 1953)
Repairing drive belt...Mills v. Comr., 7 B.T.A. 1290, 1292 (1927)
(Copies of listings from The Bureau of National Affairs Inc. )
Tax court, and the Third Circuit has also affirmed that a deduction is allowed under S.
162
for ordinary, and necessary expenses paid or
incurred to protect the income of a trade, or business.
However no deduction was allowed in the sme case for expenses incurred or paid to
protect
the goodwill reputation of a trade or business.
This was in regards to a case that was presented to the Tax Court , General Pencil Co.
v.
Comr .. The Tax Court permitted legal fees incurred
in purchasing stock from one of its shareholders, because the corporations primary
purpose
was to
protect its business, and income, and not to acquier the stock solely for the purpose to
increase the value Included is a brief of the case ,
General Pencil Co. v. Comr. 3 T.C.M. 603 (1944), and the case memorandum in Tax
Code
Memorandums, Book 3 Page 603. Year of the case
,1944.
General Pencil Co. v. Commissioner
3. T.C.M. 603
Entered June 17, 1944
Decision entered under Rule 50
Majority Author: Arundell, Judge
PROCEDURAL POSTURE:
Tax Court
FACTS:
General Pencil Co. sought the allowance for a deduction for legal expenses incurred in
purchase of corporations own stock. Fees paid to
counsel employed by General Pencil Co., to protect taxpayers business interests
against the
threat of a takeover settlement by one of General
Pencil Co.’s shareholders which resulted in taxpayer purchasing its own stock, and this
as
being ordinary, and necessary expenses incurred in
the eyes of the Tax Court.
ISSUE QUESTION PRESENTED:
Is a corporation permitted to deduct legal fees, and fees paid for counsel to protect
taxpayers business, Is the issue at hand deemed as
necessary, and ordinary business expenses?
HOLDING RULE:
This is allowable as a deduction, under Sec. 162 of the I.R.C.
RATIONALE:
Judge Arundell felt that the fees paid by General Pencil Co. in 1941, are deductible as
ordinary and necessary expenses of carrying on
petitioners trade, or business. He felt that it was necessary to employ counsel to protect
petitioners business interests from the threat of a
possible takeover from on of General Pencil Co’s Stockholders.