1942: Income Taxation

Taxes on income are the most important source of Federal tax revenue. In the fiscal year 1942, income taxes — the individual income tax, the corporation income tax and the corporation excess profits tax — yielded $8,000,000,000, or 60 per cent of total Federal internal revenue and customs. The individual income tax accounted for $3,300,000,000 and the corporation income and excess profits taxes for $4,700,000,000. In 1941, collections aggregated $3,400,000,000, or 47 per cent of total Federal internal revenue and customs; the individual income tax produced $1,400,000,000 and the corporation income and excess profits taxes, $2,000,000,000.

The importance of the income tax in the Federal revenue system was further increased by the Revenue Act of 1942. Budget estimates indicate that changes made in the 1942 Act, together with increases in the level of income, will raise the yield of the individual income tax and the new Victory tax (net of post-war credit claimed for current use) to $7,800,000,000 in the fiscal year 1943 and $13,100,000,000 in the fiscal year 1944, the first full year of operation of the Act. Corresponding figures for corporation income and excess profits taxes (net of post-war credit claimed for current use) are $9,800,000,000 for 1943 and $14,600,000,000 for 1944. Estimated total income taxes of $17,600,000,000 in 1943 and $27,700,000,000 in 1944 will be approximately 74 per cent and 79 per cent, respectively, of total internal revenue and customs.

In response to wartime needs, income taxes are contributing a growing proportion of total Federal revenue.

During the fiscal year 1942, income taxes contributed $529,000,000, or 14 per cent, to estimated total State tax revenue (exclusive of unemployment compensation taxes). In the fiscal year 1941 collections were about $420,000,000.

Massachusetts, Mississippi, and New York made minor revisions in individual income tax rates during 1942. No significant developments occurred in the state corporation income tax field.

Individual Income Tax.

The Revenue Act of 1942 reduced personal exemptions (for taxable years beginning in 1942) from $750 to $500 for single persons and from $1,500 to $1,200 for married persons and heads of families. The credit for dependents was reduced from $400 to $350. Members of the armed forces below the grade of commissioned officer were granted additional allowances in the form of an exclusion from gross income of the first $250 received for active service in the case of a single person and the first $300 received for active service in the case of a married person or head of family.

For the Victory tax, a new element in the income tax system, the exemption for each individual receiving income is $624 regardless of his marital and family status. The exclusions of income for members of the armed forces apply to the Victory tax.

The normal tax rate of the regular income tax was increased from 4 per cent to 6 per cent. The surtax rates, which previously ranged from 6 per cent on the first $2,000 of surtax net income to 77 per cent on the excess over $5,000,000, were increased by the 1942 Act to range from 13 per cent on the first $2,000 to 82 per cent on the excess over $200,000.

The Victory tax became effective Jan. 1, 1943. It is a tax of 5 per cent on the 'Victory tax net income' of every individual after allowance of the fixed exemption of $624. 'Victory tax net income' is gross income in the case of wages, salaries, interest and dividends and net income in the case of rent and business, professional and farm income. A credit may be taken either currently or after the war for part of the Victory tax: for married persons, 40 per cent of the tax, or $1,000, whichever is less; for single persons, 25 per cent, or $500; and for each dependent, 2 per cent, or $100. To the extent that the taxpayer has paid premiums on life insurance, made net repayments of debt, and purchased eligible United States obligations the credit may be taken as a current tax reduction at the time the return is filed.

On wages and salaries collection at source under the Victory tax was begun Jan. 1, 1943. Taxpayers will file their first Victory tax returns as part of their income tax returns due in March 1944. At that time they will receive credit for amounts withheld at source, and if these exceed both the Victory tax and income tax liability, they will receive refunds from the Government.

A ceiling of 90 per cent was placed on the total effective rate of the individual income tax and the Victory tax, by limiting the Victory tax liability to the difference between 90 per cent of net income and the net income tax liability.

Many changes were made by the 1942 Act to achieve greater equity and to improve the administration of the income tax. An allowance for medical and dental expenses is one of the significant features of the Act. The allowance, a deduction in computing net income, is limited to expenses in excess of 5 per cent of the taxpayer's net income but may not exceed $2,500 where a joint return or head-of-family return is filed, or $1,250 in other cases.

Several important measures suggested by the Treasury were not included in the 1942 Act. One of these was that a part of the regular individual income tax be collected at source on wages, salaries, and dividends. The Act as passed restricted such collection at source to wages and salaries under the Victory tax. Three special privileges which the Treasury urged Congress to remove — the tax-exemption of interest from state and local securities, the use of separate returns by husband and wife, and the option of percentage depletion on mines and oil wells — were not eliminated.

To supplement the income tax the Treasury proposed that a tax be levied at progressive rates on consumer spending for goods and services. The spendings tax would have provided personal exemptions of fixed amounts to cover a minimum of necessities and comfort and would not have taxed personal savings. The Congress did not act favorably on the Treasury proposal.

It is estimated that more than 27,000,000 persons will pay a net income tax on 1942 incomes and that, at 1942 income levels, approximately 43,000,000 will be subject to the net income tax or the Victory tax on 1943 incomes. Final figures reveal that 14,710,771 individual income tax returns, including 7,437,307 taxable returns were filed for 1940. Returns with net income showed aggregate net income of $36,300,000,000 and income tax liability of $1,400,000,000. Returns with net income of $5,000 and over accounted for 6 per cent of all returns, 24.5 per cent of the reported net income, and 92.8 per cent of the income tax liability.

Corporation Income and Excess Profits Taxes.

The Revenue Act of 1942 left corporation normal tax rates unchanged but revised surtax rates upward. Corporations with normal tax net income of $25,000 or less are taxed at rates graduated from 15 to 19 per cent. Corporations with normal tax net income over $50,000 are subject to a normal tax of 24 per cent. Corporations in the intermediate bracket — normal tax net income over $25,000 but not over $50,000 — pay a normal tax equal to the sum of $4,250 and 31 per cent of the excess of the corporate normal tax net income over $25,000. Surtax rates were raised to 10 per cent for corporations with surtax net income of $25,000 or less and to 16 per cent for corporations with surtax net income over $50,000. Corporations in the intermediate bracket pay a surtax equal to the sum of $2,500 and 22 per cent of the excess of the corporate surtax net income over $25,000. The surtax rates prior to the passage of the 1942 Act were 6 per cent on the first $25,000 and 7 per cent on the balance of surtax net income.

The excess profits tax has been revised to substitute a flat rate of 90 per cent for the previous rates, which were graduated from 35 per cent to 60 per cent. The invested capital credit allowed in computing excess profits was reduced to 8 per cent on the first $5,000,000, 7 per cent on the next $5,000,000, 6 per cent on the next $190,000,000, and 5 per cent on the balance.

The effect of the higher tax rates is partially offset by other changes in the corporation income and excess profits tax structure. Profits which are subject to the excess profits tax are no longer subject to the income tax. The excess profits tax is limited to an amount which when combined with the income tax (both normal and surtax) is not in excess of 80 per cent of surtax net income prior to deduction of the profits subject to excess profits tax. Provision is made for a post-war refund of 10 per cent of the excess profits tax. Corporations making net repayments of debt may obtain a current excess profits tax reduction not to exceed 40 per cent of the net debt repayment or 10 per cent of excess profits taxes imposed in the year of repayment. The post-war refund for such year is diminished to the extent of the current tax reduction. In addition to the two-year carry-forward of losses and unused excess profits credit previously allowed, a two-year carry-back of losses and unused credit is provided. Full or partial exemption from excess profits taxes is granted under certain circumstances for income from certain mining and timber operations. Taxpayers with abnormally low earnings in one of the base-period years are granted automatic relief under the excess-profits tax. Taxpayers with abnormally low average base-period earnings may apply for special relief in the form of a constructive earnings base to a new division of the Tax Court of the United States.

The privilege of making consolidated income tax returns was granted to closely affiliated corporations, such corporations being subject, however, to an additional tax of 2 per cent on surtax net income. The interrelated capital stock and declared value excess profits taxes were retained, but an amendment permits annual redeclaration of capital stock value.

Further changes were made in the treatment of capital gains and losses (of both individuals and corporations) as well as in the provision imposing income taxes on insurance companies, investment companies, public utilities, and American corporations trading in the Western Hemisphere.

Preliminary statistics of income tax returns for 1940 show that 511,741 corporate returns were filed. Of these, 43,741 were for inactive corporations. The income tax liability was $2,000,000,000 and was levied on the $11,200,000,000 of net income reported on 220,980 taxable returns.

1941: Income Taxation

During the fiscal year ended June 30, 1941, the income tax continued as the single most important source of revenue in the Federal tax structure. Collections amounted to more than $3,400,000,000 and were surpassed only in 1920 when war-time rates under the Revenue Act of 1918 were in effect. The yield of the income tax during each of the last five years exceeded $2,000,000,000. In this 5-year period (July 1, 1936-June 30, 1941) income tax collections were more than double those of the preceding 5-year period (July 1, 1931 to June 30, 1936) and were greater than income tax collections for the eight fiscal years 1929-36. In the fiscal year 1941, the Federal individual income tax produced $1,417,655,000; the corporation income and excess profits tax, $2,044,373,000; a total of $3,462,028,000. This constituted 47 per cent of total Federal internal revenue and customs.

State income tax collections for 1941 amounted to an estimated $420,000,000. This represented 12 per cent of estimated total 1941 state tax revenues (exclusive of unemployment compensation taxes).

Individual Income Tax.

The Revenue Act of 1941 made important changes in the Federal income tax for taxable years beginning after Dec. 31, 1940. The changes included lower personal exemptions and filing requirements, revision of the dependent credit, higher surtax rates, a simplified income tax for small taxpayers, and a change in the treatment of income from noninterest-bearing securities sold at a discount.

Under the Revenue Act of 1940, the personal exemptions were $800 for single persons and $2,000 for married persons. These have been reduced to $750 and $1,500, respectively. Filing requirements were lowered to accord with the exemption levels. Prior to the Revenue Act of 1941, a person, though unmarried, who supported in one household one or more persons actually dependent upon him for their chief support, was deemed to be the head of a family and was allowed an exemption as such, plus $400 for each person dependent upon him who was less than 18 years of age or incapable of self-support. The present law provides that a dependent counted to constitute an individual as the head of a family cannot be counted again for purposes of the dependent credit.

The surtax rates have been increased, the 10 per cent defense tax has been made permanent and an integrated surtax schedule which includes the defense tax on the total individual income tax has been provided. Under the Revenue Act of 1940, the first $4,000 of net income in excess of the personal exemption and dependent credit was exempt from surtax; under the present law, surtax is imposed on the entire surtax net income. Surtax rates under present law range from 6 per cent on the first $2,000 of surtax net income to 77 per cent on amounts in excess of $5,000,000. Formerly, the rates ranged from 4 per cent on surtax net incomes in excess of $4,000 but not over $6,000 to 75 per cent on amounts in excess of $5,000,000. The normal tax rate of 4 per cent has not been changed. Under prior law, however, both the normal tax and surtax were increased by a 10 per cent defense tax, with the limitation that such defense tax was not to exceed 10 per cent of net income remaining after normal tax and surtax.

A simplified tax schedule has been provided for individuals with gross incomes of $3,000 or less derived solely from salaries, wages, compensation for personal services, dividends, interest, rent, annuities and royalties. Such individuals may elect to forego the reporting of deductions and the computation of tax and pay the tax shown on the tax return. Nonresident alien individuals, estates and trusts are not allowed to use the simplified method.

The tax on nonresident alien individuals not engaged in business or not having an office within the United States has been increased generally from 16 per cent to 27 per cent on interest, dividends and other fixed or determinable annual or periodical income from sources within the United States. The rate of withholding at source has been increased accordingly. The rates generally applicable to nonresident aliens do not apply where they would infringe upon a treaty obligation. Under prior law, these rates could be reduced to not less than 5 per cent as applied to residents of a contiguous country if so provided by treaty. The present law authorizes a similar reduction in the case of residents of any country in North, Central, or South America, the West Indies or Newfoundland.

Under prior law, income from noninterest-bearing securities sold at a discount was, for taxpayers reporting on a cash basis, taxable in full upon redemption of the bond. Taxpayers on the accrual basis could report and pay tax on the income as it accrued. The present law extends to taxpayers on the cash basis the privilege of electing to report income from these securities as it accrues.

There were no additions in 1941 to the list of states which have individual income taxes. At present, 31 states and the District of Columbia have general income taxes. Four other states tax income from intangibles only. Aside from the District of Columbia law which was enacted in 1939, all of the state income tax laws were enacted in 1937 or prior years. The states made numerous revisions in income taxes during 1941. Maryland lowered its rates and South Dakota both lowered the rates and increased the exemptions. West Virginia increased the rates on incomes of $4,000 and over. New York dropped its emergency 1 per cent tax but Massachusetts and Wisconsin extended their temporary surtaxes. Massachusetts also enacted an additional 3 per cent surtax, the proceeds of which are to be used for old-age assistance.

During the calendar year 1940, 7,715,660 Federal individual and taxable fiduciary income tax returns were filed, more than half of which were taxable. Data on taxable returns filed in 1940 show that net income of individuals and fiduciaries exceeded $15,000,000,000, and tax liability was $928,394,000. The average effective tax rate on the net income of taxable returns was 5.87 per cent. Forty-five returns showed net income of $1,000,000 and over. These reported a total net income of $81,370,000, and indicated a total tax liability of $53,181,000.

Tax Anticipation Notes.

See NATIONAL DEBT.

Corporation Income and Excess Profits Taxes.

The Revenue Act of 1941 imposes a surtax applicable to all corporations, and increases the rate of tax on foreign corporations. Also, the defense income tax is made permanent and integrated with the basic rates.

A surtax of 6 per cent on the first $25,000 of surtax net income and 7 per cent on the balance has been imposed upon corporations. The normal corporation income tax rates have not been changed except to round the rates to the nearest whole per cent, including the defense tax.

The rate of tax on foreign corporations not engaged in trade or business within the United States and not having an office or place of business therein has been increased from 16 per cent to 27 per cent. The rate for withholding at source has been increased accordingly. Treatment similar to that accorded nonresident alien individuals who are residents of the Western Hemisphere has been accorded foreign corporations organized under the laws of any country in North, Central, or South America, the West Indies, or Newfoundland.

The declared value excess profits tax has been continued without change except that the 10 per cent defense tax has been made permanent.

The excess profits tax imposed by the Second Revenue Act of 1940 has been amended by the Excess Profits Tax Amendments of 1941 and the Revenue Act of 1941. The changes made by the Excess Profits Tax Amendments of 1941 are applicable for taxable years beginning after Dec. 31, 1939. These changes consist of a series of relief provisions concerning: (1) The carry-over of unused excess profits tax credit to succeeding years; (2) the restoration to base period income of abnormal deductions; (3) relief for corporations that experienced rapid growth during the base period; (4) relief in cases of abnormal conditions during the base period; and (5) the use of a predecessor's earning experience by corporations resulting from tax-free exchanges or reorganizations.

The amendments to the excess profits tax made by the Revenue Act of 1941 are applicable for taxable years beginning after Dec. 31, 1940. The chief changes include increases in rates, reduction in the invested capital credit, reversal of the deduction for income and excess profits taxes, more liberal allowance for additions to capital and elimination of the exemption for income from mining strategic materials.

Excess profits tax rates have been increased by ten percentage points in each bracket. Under prior law, the rates ranged from 25 per cent on the first $20,000 of adjusted excess profits net income to 50 per cent on the portion in excess of $500,000. Present rates range from 35 per cent to 60 per cent.

The invested capital credit, which, under prior law, was 8 per cent of invested capital, has been left 8 per cent on the first $5,000,000 of invested capital but is reduced to 7 per cent on the balance.

Under prior law, the income tax was allowed as a deduction in the computation of the excess profits tax. In order that the part of the income tax which is computed on income which is not subject to the excess profits tax should not reduce the excess profits net income, the deduction has been reversed. As a result, the excess profits tax is allowed as a deduction in computing both the normal tax and the surtax but the normal tax and the surtax are not allowed as a deduction in computing the excess profits tax.

In order to encourage new capital in corporate enterprise, it was deemed desirable to offer a special inducement in the form of a more liberal credit where new capital is present. To achieve this result, new capital in the form of money or property paid in for stock during taxable years beginning after Dec. 31, 1940, and taxable stock dividends made during the same period, is counted at 125 per cent of its value.

Under prior law, that portion of the adjusted excess profits tax net income of a domestic corporation which was attributable to mining within the United States of tungsten, quicksilver, manganese, platinum, antimony, chromite, or tin, was exempt from excess profits tax. The Revenue Act of 1941 eliminates this exemption.

There were no additions during 1941 to the list of 32 states and the District of Columbia which had general corporate income taxes. During 1941, rates were reduced in South Dakota and changed in Arkansas from a flat 2 per cent rate to a rate graduated from 1 per cent on the first $3,000 of net income to 5 per cent on all income in excess of $25,000. Massachusetts and New York extended the temporary additional taxes on corporations and Massachusetts enacted an additional surtax of 3 per cent for the purpose of financing old-age assistance.

Federal corporation income tax returns for 1939 indicate that approximately 516,000 returns were filed in 1940, of which 200,000 showed net income, and 270,000 showed no net income, while 46,000 corporations were inactive. The active corporations reported a gross income of $132,000,000,000, deficit corporations accounting for $27,000,000,000. Net income corporations reported a total net income of $8,800,000,000 and those with no net income reported deficits aggregating $2,100,000,000. The returns with net income indicated a total tax liability on 1939 income of $1,232,000,000 including $1,216,000,000 income tax and $16,000,000 declared value excess profits tax. See also TAXATION.

1940: Income Taxation

During the fiscal year ended June 30, 1940, the income tax continued as the single most important source of revenue in the Federal tax structure. Collections exceeded $2,000,000,000 for the fourth consecutive fiscal period. For this four-year period (July 1, 1936- June 30, 1940) income tax collections were more than double those of the preceding four-year period (July 1, 1932 to June 30, 1936) and approximately equalled income tax collections of the seven fiscal years 1930-1936. In the fiscal year 1940, the Federal individual income tax produced $982,017,000; the corporation income and excess profits tax, $1,139,056,000; a total of $2,121,073,000. This constituted 37.3 per cent of total Federal internal revenue and customs.

State income tax collections for 1940 amounted to an estimated $345,916,000. This represented 8.5 per cent of estimated total 1940 state tax revenues.

Individual Income Tax.

The Revenue Act of 1940 made important changes in the Federal individual income tax for taxable years beginning after Dec. 31, 1939. Among the changes effected, were the lowering of personal exemptions and filing requirements, increasing the surtax rates in the middle brackets and imposing a temporary additional tax for defense purposes.

Personal exemptions were lowered from $2,500 to $2,000 in the case of married persons and heads of families, and from $1,000 to $800 in the case of single persons. No change was made in the $400 credit allowed for dependents.

The requirements as to filing income tax returns have also been changed. Under prior law, an individual was required to file a return if his net income amounted to $1,000 or more in the case of a single person, or $2,500 or more in the case of a married person, and, in either case, if his gross income was $5,000 or more. The Revenue Act of 1940 requires a return from a single person if his gross income is $800 or more, and from married persons if either their separate or aggregate gross income is $2,000 or more.

The surtax rates were increased on amounts of surtax net incomes in excess of $6,000 and the increases continue up to amounts of surtax net incomes not in excess of $100,000. From that point onward, the rates of prior law are retained.

The tax on nonresident alien individuals not engaged in business or having an office within the United States has been increased generally from 10 per cent to 15 per cent on dividends, interest, or other fixed or determinable annual or periodical income derived within the United States.

A temporary increase in the income tax for purposes of national defense for taxable years beginning after Dec. 31, 1939, and before Jan. 1, 1945, was also imposed. This defense income tax applicable to residents and nonresidents is equal to 10 per cent of the total income tax, with the provision that such increase shall not be greater than 10 per cent of the net income remaining after the income tax as determined without regard to the defense tax.

There were no additions in 1940 to states which have individual income taxes. At present, 31 states and the District of Columbia have general income taxes. Four other states tax income from intangibles only. Aside from the District of Columbia law which was enacted in 1939, all state income tax laws were enacted in 1937 or prior years. For the year 1940, revisions included rate increases in Louisiana and Mississippi, extension of the New York State emergency tax of 1 per cent through 1941 and repeal of the surtax on interest and dividends in South Carolina.

An innovation in individual income taxation occurred in December, 1939, when an income tax was imposed by the City of Philadelphia, the only city to impose a tax of this type. The rate is 1½ per cent on wages, salaries and other compensation, and on net profits of unincorporated business, professions and other activities. No personal exemptions or credits are allowed. In the case of residents of Philadelphia, the tax applies to all taxable income regardless of the place derived, and, in the case of nonresidents, to taxable income derived within the city.

During the calendar year of 1939, 6,303,890 Federal individual income tax returns were filed, approximately half of which were taxable. The net income shown on taxable returns filed in 1939 exceeded $12,000,000,000, and the tax liability was $765,887,000, indicating a 6.04 per cent average effective tax rate on the net income of taxable returns. 57 returns showed net incomes of $1,000,000,000 and over. These reported a total net income of $110,103,000, and indicated a total tax liability of $48,035,000.

Corporation Income Tax.

The Federal corporation income tax rates applicable to taxable years beginning after Dec. 31, 1939, were revised by both the Revenue Act of 1940 and the Second Revenue Act of 1940. The Revenue Act of 1940 increased corporation income tax rates and imposed a temporary additional tax for defense purposes. The main provisions of the Second Revenue Act of 1940 were the further increase in the rate of income tax on corporations with normal-tax net income of more than $25,000, the imposition of an excess profits tax on corporations and liberalized amortization on emergency facilities for defense purposes.

The Revenue Act of 1940 increased the corporation income tax rates 1 per cent, thus the general rate on corporations was increased from 18 to 19 per cent. A similar increase was effected in the rate of tax on foreign corporations having an office or place of business in the United States. Foreign corporations not engaged in trade or business in the United States and not having an office or place of business therein, are taxed at a uniform rate of 15 per cent upon dividends, interest, or other fixed or determinable periodical or annual income derived in the United States. Formerly, the general rate was 15 per cent except on dividends which were taxed at the rate of 10 per cent. A defense income tax applicable to taxable years beginning after Dec. 31, 1939 and before January 1, 1945, was also imposed upon corporations, equal to 10 per cent of the corporation income tax as determined without regard to the defense tax.

Under the Second Revenue Act of 1940, the income tax rate for corporations with normal-tax net income in excess of $25,000 was increased by 3.1 per cent. The total tax rate, including the defense tax, is, therefore, 24 per cent for taxable years beginning after Dec. 31, 1939. For corporations with normal-tax net incomes only slightly in excess of $25,000, an alternative tax is provided. For corporations with net income of not more than $25,000, the graduated rates of tax ranging from 14.85 to 18.70 per cent (including the defense tax) imposed by the Revenue Act of 1940 continue.

The excess profits tax provides for taxes ranging from 25 to 50 per cent of excess profits net income which exceed the excess profits credit plus a specific exemption of $5,000. Excess profits net income consists of net income subject to the income tax with certain adjustments, among which are the exclusion of long-term gains and losses, and the deduction of the amount of the income tax and dividends received. The excess profits credit under the excess profits tax law, is, according to the selection of the taxpayer, equal to 8 per cent of invested capital (equity invested capital plus 50 per cent of borrowed invested capital) or 95 per cent of excess profits net income for the base period 1936-39. Provision is made for the exemption of certain types of income and corporations, and the Commissioner of Internal Revenue is given authority to make such adjustments of abnormalities in income and capital of the taxpayer as are necessary to determine accurately excess profits tax liability.

Special amortization allowances, in lieu of the depreciation provisions under the Internal Revenue Code, have been made for emergency facilities necessary for national defense. Upon certification of the Advisory Commission to the Council for National Defense and either the Secretary of War or the Secretary of the Navy, the cost of certain facilities may be written off over a period of 60 months (or less if the emergency period ends in less than 60 months). See also AVIATION: Financing the Expansion Program.

The Second Revenue Act of 1940 also suspended the profit-limiting provisions of the Vinson-Trammell Act and certain provisions of the Merchant Marine Act of 1936.

There were no additions during 1940 to the list of 32 states and the District of Columbia which had corporate income taxes. Revisions, increasing the rates, were effected during the year in Louisiana and Mississippi.

Federal corporation income tax returns for 1938 indicate that approximately 521,000 returns were filed in 1939, of which 170,000 showed net income, and 301,000 showed no net income, while 50,000 corporations were inactive. The active corporations reported a gross income of $120,000,000,000, deficit corporations accounting for $40,000,000,000. Net income corporations reported a total net income of $6,500,000,000, and those with no net income reported deficits aggregating $2,900,000,000. The returns with net income indicated a total tax liability on 1938 income of $860,000,000, including $854,000,000 income tax, and $6,000,000 excess profits tax. See also TAXATION.

1939: Income Taxation

During the fiscal year ended June 30, 1939, Federal income tax collections for the third consecutive fiscal period exceeded $2,000,000,000. Total collections for the past three fiscal years approximately equal those of the preceding six fiscal years (July 1, 1930-June 30, 1936) and slightly exceed the combined collections of the three years 1928-1930. In fiscal year 1939 the individual income tax produced $1,928,834,000; the corporate income and excess-profits tax $1,149,597,000. Collectively they accounted for 39.6 per cent of total Federal internal revenue and customs.

State income tax collections for 1938, the last year for which data are available, amounted to an estimated $249,000,000 from the individual income tax and $188,000,000 from the corporation income tax. Together they represented 11.3 per cent of total 1938 state tax revenues.

Public Salaries Tax Act.

The most striking feature of 1939 Federal individual income tax legislation was the enactment of the Public Salaries Tax Act of 1939. It subjects to the Federal income tax the wages and compensation of all state and local officers and employees, regardless of the nature of their office or employment. In addition, it enables state and local governments to impose non-discriminatory taxes on the compensation of all Federal officers and employees. This legislation applies to compensation received after Dec. 31, 1938.

Hitherto, because of what were thought to be constitutional prohibitions, the Federal income tax did not apply to the compensation of most state and local employees, although it applied to the compensation of all Federal officers and employees. For the same reason state income taxes generally applied to the compensation of state and local officers and employees, but not to salaries of Federal officers and employees.

It is estimated that as of Dec. 31, 1937, active state and local government employees numbered 2,622,000 and received an annual compensation of $3,648,000,000. However, since approximately 40 per cent of all state and local employees receive a compensation of $1,000 or less and approximately 90 per cent receive a compensation of $2,500 or less, only a portion of state and local employees will actually be subject to Federal income taxation under the present deductions, personal exemptions, and credits for dependents. This legislation is expected to add $16,000,000 to annual Federal income tax collections.

Taking advantage of the Public Salaries Tax Act, 16 states and the District of Columbia passed legislation in 1939 providing for state taxation of the compensation of Federal officers and employees. A number of additional states can tax the salaries of Federal employees without special legislation. However, individual income is at present taxed in only 31 states and the District of Columbia. Therefore, not all of the 1,167,000 active Federal civilian and military personnel which (as of 1937-1938) received an annual compensation of $1,859,000,000, will now become subject to state income taxation. (See also UNITED STATES: Taxation.)

Other Changes.

During 1939 numerous other changes were made in individual income taxation. Congress enacted a local income tax for the District of Columbia, with rates ranging from 1 to 3 per cent. This represents the only addition to the list of income taxes during the year. In North Carolina and Oregon the tax rates were increased, and in New York and Wisconsin temporary rate increases scheduled to expire were extended. In Pennsylvania a constitutional amendment was proposed to permit the taxation of individual income at progressive rates, while in Nevada a constitutional amendment was proposed to prohibit income taxation. A number of other states made structural revisions in their income taxes providing, among other things, for the taxation of interest derived from Federal securities when such interest becomes taxable by state governments. Finally, mention may be made of the adoption of community property by the State of Oklahoma, as a result of which (subject to certain limitations) the combined income of two spouses is considered to belong one-half to the husband and one-half to the wife and may be taxable half to each, the husband and the wife.

Individual Income Tax Returns.

During the calendar year 1938 approximately 6,350,000 Federal individual income tax returns were filed, 53 per cent of which were taxable. This represented an increase of 17.3 per cent over the total number of returns filed during the preceding year. The net income shown on taxable returns filed in 1938 exceeded $15,000,000,000 and represented a tax liability of $1,142,000,000, indicating a 7.5 per cent average effective tax rate on the net income of taxable returns. The 49 returns with net incomes of $1,000,000 and over, reported a total net income of $85,000,000 and indicated a total tax liability of $61,000,000.

The Revenue Act of 1939.

The Revenue Act of 1939 revised the Federal income tax rates applicable to corporations by imposing a flat rate tax of 18 per cent on corporations with normal-tax net income of more than $25,000. This rate replaced the combination of a 19 per cent rate and a 2½ per cent dividends paid credit provided by the Revenue Act of 1938. The rates on small corporations — those having normal-tax net incomes of not more than $25,000 — which comprise about 90 per cent of all corporations filing taxable returns, were left undisturbed by the new act. Such corporations are subject to rates ranging from 12½ per cent to 16 per cent. Banks and insurance companies previously were subject to a flat rate of 16½ per cent, regardless of the size of their income. Under the new act they are taxed at the rates applicable to other corporations.

The Revenue Act of 1939 also altered the provisions respecting corporate capital losses. Under the Revenue Acts of 1934 to 1938 the deduction for capital losses of corporations was limited to $2,000 plus capital gains. The Revenue Act of 1939 repealed this limitation except with respect to personal holding companies. It permits corporations, which have sustained capital losses on assets held for more than 18 months, to apply such capital losses in full against their ordinary income for the taxable year in which the loss was realized. In the case of capital losses on assets held for not more than 18 months, the corporations are permitted to offset such losses only against gains from assets held not more than 18 months, but are permitted to carry over the excess loss into the next year to be applied against the short-term gains of such year.

Another significant provision of the Revenue Act of 1939 applies to individuals and corporations. It allows net operating business losses sustained in 1939 and thereafter to be carried forward for a period of two years. The taxpayer sustaining a net operating loss in 1939, is permitted to carry over such operating loss and reduce his income for 1940, and if such net loss is in excess of his net income for 1940 he can carry over such excess and reduce his income for 1941.

The Revenue Act of 1939 included several additional changes of a more restricted scope than those described, comprising largely revisions and refinements in the computation of taxable net income.

Corporation Income Tax Returns.

Federal corporation income tax returns for 1937 indicate that 529,000 returns were filed in 1938, of which 192,000 showed net income and 286,000 showed no net income, while 51,000 corporations were inactive. The active corporations reported a gross income of $142,000,000,000, deficit corporations accounting for $33,000,000,000. Net income corporations reported a total net income of $9,635,000,000 and those with no net income reported deficits aggregating $2,281,000,000. These returns indicated a total tax liability on 1937 income of $1,276,000,000 including $1,057,000,000 normal tax, $176,000,000 surtax on undistributed profits, and $43,000,000 excess-profits tax.

State governments also made revisions in their corporate income taxes. However, the only addition to the list of taxes is the 5 per cent District of Columbia tax on the income of corporations. At the close of 1939 corporate income was taxable in 32 states and the District of Columbia. See also BUSINESS.

1938: Income Taxation

Federal Taxation.

Legislative Changes.

Federal income tax revisions involving the undistributed profits tax on corporations, and the manner of computing taxable gain or loss from the sale of capital assets made by individuals were the outstanding features of the Revenue Act of 1938 which became law, without the President's signature, on May 28, 1938. This constituted the only time in the twenty-five years since the adoption of the Sixteenth Amendment that a President has refused to sign a revenue measure. The two major revisions, so far as Congressional intent can be discerned, were enacted to eliminate some of the alleged tax impediments to business recovery.

The undistributed profits tax has been retained in principle with operation limited to two years. For corporations with net incomes over $25,000, exclusive of personal holding companies and other special types, a tax of 19 per cent of adjusted net income is imposed if no dividends are distributed. This may be reduced to a minimum of 16 per cent if the entire net income is distributed. Thus the maximum rate of the undistributed profits tax is 2 per cent, while under the 1936 Act it was 27 per cent.

Corporations with net incomes of $25,000 or less are taxed at graduated rates as follows: 12 per cent on the first $5,000, 14 per cent on the next $15,000 and 16 per cent on the balance. Special classes of corporations, such as banks, insurance companies, and mutual investment companies, are taxed at a flat rate of 16 per cent. Foreign corporations engaged in trade or business in the United States are subject to a 19 per cent rate on their income from sources within the United States.

Determination of corporate undistributed profits tax liability is predicated upon an allowance against the 19 per cent tax of an offset equal to 2 per cent of the dividends paid credit. This credit consists of dividends paid during the year and several other items, the main ones being the amount of 'consent dividends' and amount of preceding year net operating loss carryover. 'Consent dividends,' a new concept in revenue legislation, consists of that amount of undistributed earnings which the shareholders agree to account for ratably in their tax returns on the same basis as if such amount actually were distributed.

The new law alters the definition of capital assets by excluding depreciable property used in trade or business. A distinction is made between 'short-term' capital gains and losses derived from sales of capital assets held eighteen months or less, and 'long-term' capital gains and losses derived from sales of capital assets held over eighteen months. The percentages of gain or loss taken into account in computing net income are 100 per cent if the asset was held eighteen months or less, 66 per cent if held over eighteen but not over twenty-four months, and 50 per cent if held over twenty-four months. Net short-term gains are included in full with ordinary income. Short-term losses are allowable to the extent of gains on such transactions, with the provision that the excess of loss may be carried forward to offset the short-term gains in the next succeeding taxable year, but only to the extent of the net income of such year.

Net long-term gains are included with other income or, as an alternative, are segregated and taxed at 30 per cent, whichever method results in the lesser tax. Similarly, net long-term losses are deducted from net income, or 30 per cent of such losses are credited against the tax, whichever method produces the greater tax.

Significant administrative changes involved (1) enlarging the scope of closing agreements to permit closing agreements to cover income tax liabilities relating to transactions in the current and future tax years, as well as years in which returns have been filed, and (2) mitigating the effect of the statute of limitations to permit, generally speaking, the correction of errors, and a recomputation of tax in cases involving allocation of items of gross income and deductions to their proper years, although such years have been barred by the statute of limitations.

Tax Collections.

The income tax is a more important element of the Federal tax structure than it is of the respective state tax structures. For the fiscal year 1938 Federal collections amounted to $2,586,000,000 or 45.7 per cent of total internal revenue. Of this total, approximately $1,300,000,000 was from corporations, and $1,286,000,000 from individuals.

State Taxation.

State income tax collections for 1937, the latest available, were estimated at approximately $361,000,000 or 13.1 per cent of state tax receipts.

In the field of state personal income taxation there were no additions during the year to the thirty-four states which levied income taxes in 1937. Mississippi slightly increased the range of rates; New York continued the emergency 1 per cent tax for a year and halved the applicable rates on capital gains; Massachusetts continued the additional levy equal to 10 per cent of the computed tax; and Georgia deleted the minimum tax provisions. The thirty-three states which levied general corporation taxes in 1937 continued such taxes in 1938. New York ratified the proposal of the Constitutional Convention to prohibit the taxation of undistributed profits.

Analysis of Federal Tax Returns.

For 1936 there were filed 5,413,499 Federal individual income tax returns, 530,779 corporation tax returns, and 237,367 partnership returns. While 87,5 per cent of the individual returns filed were by individuals reporting income under $5,000, this group accounted for approximately 54 per cent of the net income, but only 4.98 per cent of the tax. On the other hand, the class reporting over $50,000 constituted only .34 of 1 per cent of the individual returns filed, but reported 9.82 per cent of the net income and 58.25 per cent of the tax.

The composition of net income for 1936 reported by the net income class under $5,000 consisted of 70.2 per cent from salaries, 5 per cent from dividends, 3.6 per cent from rents and royalties, and 1.4 per cent from capital gains. In the net income classes of $100,000 and over, a maximum of 15 per cent was from salaries, 45 to 62 per cent from dividends, 9 to 13 per cent from capital gains, and approximately 1 per cent or less from rents and royalties.

Senate Investigations.

During 1938 the United States Senate authorized a Senate Finance Subcommittee to investigate profit-sharing systems and also to investigate the 'grant of compensatory tax exemptions and tax rewards when profit sharing is voluntarily established.' Another special Senate Finance Subcommittee was authorized to investigate tax exemptions now accorded Governmental securities and salaries.