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Q. I use my automobile partly for recreation and partly in my business. Are any of the expenses of operating the car deductible?
A. The Treasury Department has ruled that actual expenses satisfactorily shown to have been incurred in the operation of the car for business purposes, plus a proper allowance to cover depreciation, are deductible from gross income.
Q. I do not maintain a reserve for bad debts, but charge of | each debt as it becomes worthless. To deduct these charge-offs in my tax return must I first bring legal action to determine definitely that they are worthless?
A. No. Where all the surrounding circumstances indicate that a debt is worthless and that legal action to enforce payment in all probability would not result in the satisfaction of execution on a judgment, you are warranted in claiming the charge-off as a deduction in your tax return. The Commissioner, when satisfied that a debt is recoverable only in part, also may permit the debt to be charged off in part.
Q. On what basis is depreciation of property figured?
A. The basis of deduction for depreciation is the cost of the property or, if acquired before March 1, 1913, its fair market value on that date plus the cost of improvements, additions and betterments since then.
Q. May a net loss incurred in one year be deducted from the profits of a succeeding year?
A. Yes. To the extent that a net loss is incurred in trade or business during a taxable year beginning after December 31, 1920, permission is given to deduct the loss from the income for the next succeeding year. If the loss exceeds this income, the excess may be deducted from the income for the second succeeding taxable year.
Q. My principal source of income is an automobile accessory business. My tax return for the calendar year 1921 showed a deficit of $45,000, due to the deductions allowed being greater by that amount than my taxable income. Am I permitted to deduct this loss from my 1922 income?
A. The amount of net loss that you may claim as a deduction from your 1922 net income must first be computed according to Section 204 (a) of the Act (see page 61). Analyzing your records for 1921, we find the following facts:
(a) Gross taxable income from business..
$50,000 b) Non-taxable interest on municipal bonds.
10,000 (c) Taxable gain from an isolated real estate trans
action not connected with your business... 5,000 (d) Allowable deductions for tax purposes, including
$10,000 for loss by fire of your residence, $500
100,000 (e) Interest paid upon money borrowed to carry
municipal bonds but not allowed as a deduc-
8,000 The computation follows: Total deductions (d). ...
$100,000 Deduct: Loss by fire (d)..
$10,000 Loss on securities (d)...
Statutory Net Loss.
$34,000 This figure, and not the $45,000 deficit as shown by your tax return for 1921, may be applied to reduce your taxable net income for 1922. If the loss is greater than your net income for 1922, the balance may be used to reduce your taxable income for 1923.
ITEMS Not DEDUCTIBLE
A. The law expressly disallows the deduction of personal, living or family expenses, such as rent paid for a home, wages of lomestic servants, cost of food, clothing, etc., for the family, :ducation of the children, upkeep of an automobile for recreaion and similar items involved in the maintenance, well-being or pleasure of the taxpayer or his dependents.
Deductions may not include investments of a permanent nature; expenditures for the erection of buildings, grading of lawns and other permanent improvement of property; or the cost of installing machinery or buying books, tools or implements having a permanent value, or similar inconsumable property, since they constitute merely a change in form of capital, not a reduction of wealth. The test is whether a capital asset a is acquired.
Q. On November 1, 1922, I sold a bond for $950 which cost me $1,000 in 1920. On November 15, 1922, I repurchased and still hold a bond of the same issue. Is my loss deductible?
A. The law provides that a loss resulting from the sale of securities outside the taxpayer's trade or business is not deductible where the same or substantially identical property is acquired within thirty days before or after the date of sale and held "for any period after such sale." (See Section 214 (a) 5, page 69.)
Q. In 1920, Fred Smith purchased 300 shares of A & W stock for $110 a share. He sold these shares on October 2, 1922, for $60 a share. A week later, on October 9, 1922, he purchased and still holds 200 shares of the same stock for $75 a share. What is Mr. Smith's loss?
A. Since Mr. Smith purchased 200 shares of A & W stock within thirty days of the sale by him of 300 shares of the same stock, only one-third of the loss resulting from the sale of the 300 shares is deductible. (See Section 214, (a) 5, page 69.) The computation of the allowable loss is as follows:
300 shares bought in 1920..
Part of loss disallowed:
x $15,000 (loss on sale)
$5,000 Q. Referring to the preceding question, how will Mr. Smith compute profit or loss from the subsequent sale of the whole or any part of the 200 shares purchased on October 9, 1922?
A. These shares are regarded as taking the place of an equal number of shares sold October 2, 1922, and hence are considered to have cost him $110 a share. Any difference between this cost and what he receives will be his gain or loss for tax purposes.
Q. A, who is employed in a city, has his home in a nearby town. He pays railroad fare to and from his place of employment and takes his mid-day lunch in the city. May the money spent for carfare and food be claimed as a business expense?
A. No. The Treasury Department has ruled that such amounts are items of personal expense.
INVENTORIES Q. How should inventories be valued?
A. The regulations of the Commissioner provide two tests to which inventories must conform: (I) They must comply as nearly as may be to the best accounting practice in the trade or business, and (2) they must clearly retlect the income. The basis of valuation most commonly used by business concerns and which meets the requirements of the Revenue Act is (a) cost or (b) cost or market, whichever is lower. To reflect income clearly, the inventory practice of a taxpayer should be consistent from year to year. A basis once established may be changed only by permission of the Commissioner.
Q. What does “ cost ” mean?
A. When merchandise is on hand at the beginning of the year, “cost” means the inventory price of the goods. The cost of merchandise purchased after the beginning of the taxable year generally means the invoice price less trade or other discounts. To this should be added transportation and other necessary charges incurred in acquiring possession of the goods. To illustrate: Invoice price.
$1,850 Less trade discount.
250 Net price...
$1,600 Add: freight.
30 Cost of goods..
Strictly cash discounts, approximating a fair interest rate, may or may not be deducted at the option of the taxpayer, provided a consistent course is followed.
The cost of merchandise produced by the taxpayer since the beginning of the taxable year is made up of these factors: (a) the cost of raw materials and supplies used in making the product; (b) expenditures for direct labor; (c) indirect expenses involved in production of the particular article, including a reasonable proportion of management expenses, but not any part of the cost of selling or any return on capital, whether in the form of interest or profit.
In an industry where the usual rules for computing production costs do not apply, the costs may be approximated upon any basis that is reasonable and in conformity with established trade practice in that industry.
Q. What is meant by “ cost or market, whichever is lower” basis?
A. In using this basis each item of the inventory must be valued at cost, if the cost is lower than the market value when the inventory is taken, or at the market value if the market is lower than the cost. To illustrate:
Value 10,000 lbs. grade C wool
$ 9,000 $ 9,750 $ 9,000 7,500 B
9,800 8,900 8,900 18,000 N cotton 7,200
19,200 18,000 18,000
$45,200 $44,650 $43,100 Q. What does market mean?
A. Under ordinary circumstances, and for normal goods in an inventory, “market” means the current bid price at the date of the inventory for the particular merchandise in the volume in which it usually is purchased by the taxpayer.
Q. What should the inventory include?
A. The inventory should include raw materials and supplies on hand that have been acquired for sale, consumption or use in production processes, together with all finished or partly finished goods. Goods out on consignment, goods which have been bought and shipped but not yet received and goods sold but not included in sales because still on hand, are to be included. In all cases title to the merchandise included in the inventory must be vested in the taxpayer; goods ordered for future delivery, title to which has not been transferred, should be excluded.