tion for services, on the other, may be said to lie in the existence or non-existence of services as the legal consid cration for the payment, and in using the term "legal consideration," it is intended that past consideration or moral consideration be excluded in accordance with the general rule of the law of contracts. It is, of course, immaterial whether compensation for services is received in money or in other property, for the statute refers to compensation "in whatever form paid." In accordance with this provision Article 33, of the Treasury Department, Regulations 65, provides that "where services are paid for with something other than money, the fair market value of the thing taken in payment is the amount to be included as income." Thus, where a corporation issues its own capital stock to an employee in part consideration for his services, the amount thereof is taxable as income on the basis of the fair market value of the stock. It has also been held that the receipt of promissory notes, or other evidences of indebtedness, in payment for services constitute income to the extent of their fair market value. So also it has been held by Treasury ruling that where a taxpayer renders services in consideration of the cancellation of a debt, the amount of the indebtedness so cancelled is taxable income." One provision of Section 213 (a), which we are now considering, may now be considered as definitely invalidated by ruling of the Supreme Court, and this, despite the fact that Congress has reenacted this same provision since the Supreme Court has held it to be unconstitutional. This provision provides that gross income shall include compensation for personal services "including in the case of the President of the United States, the judges of the Supreme and inferior courts of the United States the compensation received as such" which was declared by the Supreme Court to be unconstitutional even though the Federal judge was appointed after enactment of the Revenue Act prescribing such tax. Such unconstitutionality results 6 Appeal of Conlen, 1 B. T. A. 177. Article 34, Regulations 65. I. T. 2043, III-2 Cumulative Bulletin, Page 94. from the fact that Article 3, Section 1, of the Constitution, provides that: "The judges, both of the Supreme and inferior courts, shall hold their offices during good behavior, and shall, at stated times, receive for their services, a compensation, which shall not be diminished during their term of office." In the case of Evans v. Gore, 253 U. S. 245, the Supreme Court considered the taxation of the salary of a Federal judge appointed prior to the enactment of the Revenue Act under which the tax was levied. It was there held that the tax was in effect a diminution of the salary provided by law and was, therefore, unconstitutional. The Government then attempted to tax the salaries only of those judges who were appointed after the passage of the various Revenue Acts under the theory that such appointees took office subject to the tax prescribed and their salaries were not diminished thereby. This theory has now been definitely overruled with the result that it appears that the salaries of none of the Federal justices, nor of the President, for that matter, are subject to dimunition by taxation. Income from any profession, business, vocation or trade: Income which falls under this heading may be said to come within two principal classes. It is either in the nature of 'Miles v. Graham, U. S. Sup. Ct. October Term, 1924. Not yet reported. The historical development of this question was rather fully discussed in the preceding article of this series (VI. 1 National University Law Review, 83) wherein it was shown that the Supreme Court had first held unconstitutional the taxation of salaries of judges appointed before the enactment of the taxing statute. The Government then attempted to tax the salaries of those judges appointed after the passage of the Revenue Act on the theory that they took cffice subject to the tax and its collection did not effect a diminution thereof. This theory has now, however, been definitely overruled with the above decision to the effect that the salaries fixed by statutes could not be diminished in any case by a federal income tax. Unfortunately, the writer, in the above article, supported the theory which has been overruled by the decision in Miles v. Graham, but this is, perhaps, pardonable, when it is considered that Congress itself re-enacted as late as February, 1926, the same provision which was held unconstitutional several months prior to that date. gains or profits from personal services rendered, and is, therefore, very similar to the compensation considered in the preceding section, or, it is in the nature of profits from the sale or other dealings in property of some form or other. Thus, the income of the professional man, such as the physician or the lawyer, is virtually compensation for services rendered, the principal distinction between it and the usual salary or wage being that it is not for regular employment nor is it paid at stated intervals. This being the case, the gross receipts for such professional services constitute the gross income of the taxpayer, and this rule would apply to any taxpayer who receives money or property in return for services, of whatever kind performed. The second class of income arising from business or trade concerns the profits realized from the sale or other disposition of property, which constitutes, perhaps, the largest class of income derived by taxpayers engaged in business. Thus, every merchant, or manufacturer, derives his principal income from the purchase, production and sale of merchandise. In considering this type of income we are confronted with the question; "Does the entire sales price constitute income such as would be subject to an unapportioned tax?" The answer is obviously in the negative because all of the sales price does not usually represent profit, and, as we have seen, "income" means "profits"." For example, if A purchases merchandise for $100 and sells it for $150, only $50 can be considered as taxable income for that is all the profits that results from the sale. The balance of $100 is merely a conversion of his capital from property of one form into cash, that is, the return of the capital invested by him in the merchandise. As simple as this rule may be, however, it is not an easy matter to determine the cost of the goods sold and the profit resulting from the sales of merchandise in the case of manufacturers or traders, who buy and sell large quantities of various commodities. In such cases the approximate cost only can be determined, and that only by the use of inventories. With this purpose in view, Section 10 Eisner v. Macomber, 252 U. S. 189, 40 Sup. Ct. 189; Southern Pacific Company v. Lowe, 247 U. S. 330, 38 Sup. Ct. 540. 205 of the Revenue Act of 1926, in language similar to that used in the previous acts, provides as follows: "Whenever in the opinion of the Commissioner the use of inventories is necessary in order to clearly determine the income of any taxpayer, inventories shall be taken by such taxpayer upon such basis as the Commissioner, with the approval of the Secretary, may prescribe as conforming as nearly as may be to the best accounting practice in the trade or business and most clearly reflecting income." Acting in pursuance of the authority thereby vested in him, the Commissioner issued regulations providing that "in every case, in which the production, purchase or sale of merchandise, is an income producing factor" inventories at the beginning and end of the taxable year should be used. Therefore, in all cases where merchandise is produced, purchased or sold, the cost of the merchandise so sold must be determined by the use of inventories." The method of applying inventories to determine the cost of the goods sold is best illustrated by example. Suppose, for instance, that A, a storekeeper, commences business at the beginning of the year with an inventory of goods which cost $15,000, which he intends to sell during the year. This amount is, of course, the cost of the goods, included in the inventory, which he intends to sell. During the year he purchases additional goods at a cost of $75,000, which also becomes a part of the cost of the goods which he intends to sell. The addition of these two sums results in the total cost of the goods purchased, that is, $90,000. A then sells the greater portion of these goods for $100,000, which leaves him an inventory at the end of the year which he finds by actual count had cost him $20,000. Our problem is, of course, to determine the cost of the goods which he sold for $100,000. We have already found that the total cost of all goods both on hand at the beginning of the year and purchased during the year amounts to $90,000. However, there is left on hand a balance of $20,000 which obviously has not been sold and, therefore, should not be included in the cost of the goods so sold. We shall, therefore, deduct the amount of this inventory on hand at the end of the year from the total figure to find that cost. This elimination discloses the fact that the goods actually sold had cost $70,000, computed as follows: Inventory on hand at beginning of the year.. $15,000 75,000 .$90,000 Total cost of all goods purchased... Less: Cost of goods not yet sold (inventory at close of year).. 20,000 Net cost of goods actually sold... .$70,000 Deducting the amount so obtained from the sales price of $100,000 produces a gross profit, or "income," from the sale of the merchandise, amounting to $30,000. The theory underlying the determination of the cost of goods sold in the case of a taxpayer who engages only in the purchase and sale of a finished commodity is, therefore, comparatively simple. Such is not the case, however, where the taxpayer applies some process of manufacture to the purchased raw materials and sells a finished product. In such cases there must be taken into consideration not only the cost of purchases of raw materials, as adjusted by the inventories, but also the cost of the manufacturing which has become attached, so to speak, to the materials. Suppose, for instance, that B, another taxpayer, purchases unpainted tables, paints them, and then sells the finished tables. Obviously, the cost of painting would be a part of the cost of the goods sold. The application of this cost is accomplished in much the same manner as the application of the cost of materials shown above. That is, the total cost of all manufacturing processes, which in this case would be the cost of the painting, is added to the purchases and then offset by cost of the inventory on hand at the end of the year—including, of course, a proportionate share of the manufacturing cost applicable thereto. We will assume, by way of illustration, that B purchased one hundred unpainted tables for $100 and pays his employee $50 for painting them. He then sells 75 of the finished tables, leaving a closing inventory of 25 tables. The cost of the goods sold would be determined as follows: |