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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 This act was superseded in 1862 .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 Actwas 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 taxpayers dwelling house. It also included deductions for a portion of the rental value of the taxpayers 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 Actwas 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 betterments 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 Resolutionto 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. FarmersLoan & 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 enumerationthough 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


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 lessors 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


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


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

Brush clearing to negate overgrowth clamping gas pipes to stop leaks Mohawk

Power Co.

Cleaning after a fire


affirmed per curium 213 F. 2d 318 (2d Cir 1954)

Cleaning the exterior wall of a building


Cleaning the interior of rundown building


Cleaning mud from barge that sank in storm

Thurner v. Comr, 11 T.C.M. 42,46 (1952)


.v. U.S. 558 F.2d 1379 ( Ct Cl. 1977)


Office Equipment Co., Inc. v. Comr. 20 T.C. 272, 279


Natl Bank v. Comr. 11 T.C.M. 411,413


v. Comr., 47 T.C.M. 499,502


v. Comr., 28 F.2d 769 (5th Cir


Revg 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

Helvering, 72 F2d 399,403 (2d Cir 1934), revg 23 B.T.A. 439,457 ( 1931)


Union Furnace Co v.

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


(1928) revd in part on other issues, 50 F2d 777 ( 6th Cir 1931)

Cost of installing replacement from heating system required to be remodel by war


cutting out concrete cracks


Dismantling unsafe partition

Dredging fill washed into property by storms

Collieries v. Comr., 12 B.T.A.


v. Comr., 6 T.C.M. 1344, 1345 (1947)


Mills v. Comr., 7 T.C.M. 886, 890 (1948)

Squier v. Comr., 13 B.T.A. 1152 (1928)


v. Comr., 10 B.T.A. 1152 (1928)


Electric Co v. Comr., 12 B.T.A.


1008 (1928) Drilling and grouting subsoil to prevent collapse of building threatened by sudden shifting of subsoil and resulting cave- in of factory



Bemberg Corp. v. Comr., 10 T.C. 361,378 (1948) affd per curium


F.2d 200 ( 6th Cir. 1949) Driving poles into railway roadbed

Supp. 164, 165 ( Ct. Cl. 1953) Rev. Rul. 54-356, 1954-2 C.B. 82 , Supersedded by


Rul. 77-478, 1977-2 C.B. 81 Eliminating hump in driveway entrance

Kansas City Southern Railway Co. v U.S. , 112 F

Almacs Inc. v. Comr. , 20 T.C.M. 56, 59 (


Emergency activities to restore operations after fire



Office Equipment Co. Inc.

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


Filling Concrete cracks

Installations of steel columns and cross members to support sagging floor


Ford Tractor Corp. v. Comr., 29 T.C. 833,845 (1958)


Mills v. Comr., 7 T.C.M. 886,890 (1948)



Edwards121 F.Supp

Insulating above a roof

Insulating house

Lining tar- painted cast iron pipes with concrete Plainfield- Union Water Co v. Comr.,


T.C. 333, 341 (1962) Make shift repair of floor


Maintenance of golf course

952 , 954 ( M.D. Ga. 1954) Munroe Land Co. v. Comr., 25 T.C.M. 3,7 (1966) v. U.S., 75-1 USTC Paragraph 9207 ( D. Mont. 1975)


Standard Fruit Product Co. v. Comr., 8 T.C.M. 733, 739

Berglund v. U.S., 81-1 USTC PAR. 9192 ( d. Minn.


Maintenance of septic tank system

Copper v. Comr., 42 T.C.M. 418, 423 (1981)

Mortar pointing

Moving and rearranging partitions

Moving bookcases

Overhauling machinery annually B.T.A. 16,17 (1928)

Overhauling tractor parts

Painting a barge after recovering it from the bottom of a river


Thurner v. Comr., 11 T.C.M. 42, 45 (1952)


v. Comr., 2 B.T.A. 911, 912 (1925)

Squier v. Comr., 13 B.T.A. 1223, 1225 ( 1928)


Ice & Cold Storage Co. v. Comr., 10

Nottingham v. Comr., 12 T.C.M. 503, 505 (1953)

Zimmern v. Comr., 28

769, 769 (5th Cir 1928) revg 9 B.T.A. 1382 (1928)

Painting and interior room

Painting the exterior of a building


on other issues, 300 F 2d 154 ( 6th Cir. 1926)

Painting the interior of a building (5th Cir

Luce Furniture Co v. Comr., 9 B.T.A. 1413, 1418 (1928)


v. Comr., 19 T.C.M. 1178, 1186 (1960)


v. Haverty Furniture Co., 15 F. 2d 345, 346


Painting roof


v Comr., 20 B.T.A. 252, 254 (1930)

Painting window sash

Patching floors

Plastic finish on building canopy



Plastering a room

Pouring concrete over existing floor to restore its use

Buckland v. U.S. , 66 F. Supp. 681, 683 ( D. Conn. 1946)

Frozen Custard, Inc. v. Comr., 29 T.C.M.

Fruit Product Co. v. Comr., 8 T.C.M. 733, 739 (1949)

Hudlow v. Comr., 30 T.C.M.

Patter v. Comr., 20 B.T.A. 252, 254 (1930)






Pressure grouting railway roadbeds


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

Co. v. Helvering, 72 F. 2d 399, 402 ( 2d Cir.1934) affg 23 B.T.A. 439 (1931)

Recovering and repairing equipment buried by a flood

73 T.C.

168, 182 (1979) Recovering and repairing steam shovel that fell into creek

Comr., 16 B.T.A. 1135, 1141 (1929) revd in part and affd in part on other issues

52 F.2d

R.R. Hensler, Inc. v. Comr.,

Kansas City Southern Railway Co. v. U.S. , 112

Buffalo Union Furnace

Jefferson Gas Coal Co. v.

120 ( 3d Cir. 1931)

Recrowning road Reflashing a roof

revg 18 B.T.A. 517 (1929)



Plantation, Inc. v. Comr., 10 T.C.M. 1077, 1080 (1951)

Storage Corp. v. Burnet, 58 F.2d 526, 528 ( D.C. Cir 1932)

Relining firebox ( D

Md. 1964) affd on other issues, 347 F.2d 117(4th Cir. 1965)

Relining furnace used in enameling process 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


(1942) , affd, 135 F.2d 89 (6th Cir. 1943)

Removal of damaged windows

Wood Preserving Corp of Baltimore v. U.S., 233 F Supp. 600 , 601


Hollow Ware Co. v. Comr., 12


Inc. v. Comr., 46 B.T.A. 718,


v. U.S. , 66 F. Supp 681, 683 ( D Conn.


Removal of fire debris

(1953), afd per curiam, 213 F.2d 318 ( 2d Cir 1954)

Repaving parking lot

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 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 B.T.A. 1002,1008 (1928)

Repairing barge Repairing bins Repairing boat

Repairing bookcases

Repairing building damaged by storm

Ticket Office Equipment Co., Inc. v. Comr., 20 T.C. 272, 279

Coors v. Comr., 60 T.C. 368, 404 (1973), affd on other issues

Potter v. Comr., 20 B.T.A. 252, 254 (1930):

Tampa Electric Co. v. Comr., 12

L&L Marine Service v. Comr., 54 T.C.M. 312, 316 (1987) Mogg Coal & Coke Co. v. Comr.,10 B.T.A. 588,590 (1928)



Motors Inc. v. U.S., 61-2 USTC par.9639 ( E.D. La. 1961) B.T.A., 1223, 1225 (1928)


Electric Co. v. Comr., 12 B.T.A., 1002,



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 Repairing counters

Repairing dam to stop leaks


33 T.C.M. 1192 ( 1974), SUPP., 34 T.C.M. 783 ( 1975)

Repairing doors Repairing drill rig Repairing drive belt


cotton Mill Co. v. Comr., 1 B.T.A. 449, 450 (1925)

Schmid v. Comr., 10 B.T.A. 1152 (1928)

Evans v. Comr., 557 F.2d 1095, 1101 ( 5th Cir. 1977),

Marcell v. U.S., 61-2USTC PAR. 9628 ( D.Vt. 1961) Nottingham v. Comr., 12 T.C.M. 503,505 ( 1953)


v. Comr., 7 B.T.A. 1290, 1292 (1927)

Tax court, and the Third Circuit has also affirmed that a deduction is allowed under S.


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.



The Tax Court permitted legal fees incurred

in purchasing stock from one of its shareholders, because the corporations primary


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


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 Cos Stockholders.