Federal Income TaxationHistory of Taxation-Deductions:Internal Revenue CodeSection 162By: Earl Lofland

The United States financed the government with revenues from the customs revenuesuntil1861. Yet on Aug 5, 1861 the U.S. Congressenacted

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The First Civil War Tax Act

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, in order that the Civil War efforts would befinanced. Inthis statute there was only one deduction, it was forall national , state, or local taxes assessed upon the property from which the income isderived, this bill expressly allowed deductions only oftaxes assessed on property generating income. The bills floor manager, due toconcernsexpressed in the Senate, that the TreasuryDepartment might interpret income to mean gross rather than net income replied, thatthemeaning of income would mean net profits, and theTreasury Department would provide the ways and means to ascertain it. This was sothat itwould encourage landlords to deduct repairs, andother amounts in order to reduce that taxable amount to zero, and that it would bepreferableto let the Treasury Department prescribe rules toprevent tax evasion. This act was superseded in 1862 .

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The Second Civil War IncomeTaxAct

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was enacted, and contained allowed deductions for taxes for property thatproducedincome, certain income derived from military, and congressional salaries. Interest anddividendson certain stock and capital, and for certain amounts of rent paid for the taxpayer

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sdwellinghouse. It also included deductions for a portion ofthe rental value of the taxpayer

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s homestead, for losses on the sale or real estatepurchasedin that year and certain business expenses in thenature of interest, repairs and salaries. this was amended March 2,1867 expandingcertaintaxes, limited casualty losses, losses incurred inthe taxpayers trade, bad debt losses, rent paid for the premises occupied as aresidence bya taxpayer, and his or her family. In 1870 the

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Income Tax Act

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was reenacted to allow deductions for national , state county andmunicipal

taxes paid by the taxpayer, for business andcasualty losses for bad debts, interest, for rent and services for to cultivate land, orconductbusiness. For the first time a specific deductionlimitation was enacted to prohibit the taxpayer from deducting any amount paid for newbuildings, permanent improvements, and betterment

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smade to increase the value of property, and continued to function until 1872. In 1874 thefederal government reinstated deductions , whichallowed for business expenses , certain interest certain taxes, certain casualty losses,andbad debts the prohibition of capital expenditure wascontinued, and lasted until 1895 when Congress passed a

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Joint Resolution

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to theeffectthat the cost of fire insurance premiums, andordinary repairs was at that time allowable deductions on the Federal Taxes. Yet in1895 acase , Pollock v. Farmers

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Loan & Trust Co. , TheSupreme Court determined that the 1894 Act was deemed unconstitutional, and onrehearings, the Court reaffirmed, and declared the entire Actunconstitutional. For fifteen years there were no actions to amended the Act of 1894,but in1909 Congress enacted a corporate excise taxthat was measured by income. In computing net income, ordinary and necessaryexpensesfor the maintenance and operation of business andproperties , losses deprecations, interest, taxes and dividends received were permittedto bededucted from a corporations gross income.This was continued until 1913.At that time Congress passed the Sixteenth Amendment.Itgranted Congress the power

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To lay and collecttaxes on incomes, from what ever source derived without apportionment among theseveralStates, and without regard to any census orenumeration

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though it did not define income , If gross, net or both could be taxed, anddeductions also were not mentioned.In Oct of 1913, Congress enacted the Revenue Act of 1913, allowing deductions onnecessary business expenses, interest, certain taxeslosses, bad debts, depreciation, depletion, and certain dividends received fromcorporationssubject to the tax. Also in 1913 a specificdenominated personal deduction for insurance companies, and foreign corporationsdoingbusiness in the United States was added.Through the years, as Congress reenacted the

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Revenue Act

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, additional deductionswere

added. Some of the provisions, allowing a deductionfor losses from transactions entered into for profit that were not business. But only to theextent of profits from transactions entered into for profitin 1916.In 1917, charitable deductions were added and a deduction for federal incometaxeswas eliminated. In 1918 predecessors of Section172 ( net operating loss deduction) Sec 265 ( limitations on deduction of interest paid orincurred 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 qualifiedemployee 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 itthenexisted. But in 1942 Congress enacted the firstSection 212, Allowing deductions on expenses paid or incurred in carrying on profitseekingactivities. That Act also contained the first medicalexpense deduction of capital losses.Deductions represent the most significant concepts of the federal income tax system.Deductions are the only step in computing income taxliability . They generated revenue losses , one of several tax expenditure items. Theyalsoinclude deferral tax liability, preferential rates, credits,exemptions, and exclusions. Deductions generate decreases in tax liability, andamountsdisallowed as deductions generate increases in taxliability.A deduction for compensation, and that is reasonable for personal services actuallyrenderedin connection with the carrying on of a trade orbusiness is specifically allowed by Section 162.For a compensation deduction to be permitted under Section 162, there must be proofwith awritten contract to render services, the actualservices, the actual performance, and a reasonable probability that payment wasintendedwhen the contract was made. The Employee musthave a genuine legal obligation to render the services, and the employer must have agenuinelegal obligation to pay . Another allowablededuction under Section 162, is rental expenses. Under section162, the rental or otherpayment must be made as a condition to the continueduse or possession, for the purpose of the trade or business, of property to which thetaxpayerhas not taken or is not taking title, or in which hehas no equity. they also include rental payments not only to this, but also to rents paid in