I. Meals and lodging (sec. 119)

Under present law meals and lodging have been held to be taxable to the employee unless they were furnished for the convenience of the employer. Even in such cases, however, they are not excluded from the gross income of the employee if there is any indication that they are intended to be compensatory.

Under the bill these meals and lodging are to be excluded from the employee's income if they are furnished at the place of employment and the employee is required to accept them at the place of employment as a condition of his employment.

J. Subsistence payments to State police officers (sec. 120)

The bill provides an exclusion from gross income, not to exceed $5 a day, for subsistence allowances paid to members of a police department of a State, Territory, the District of Columbia, or a possession. There is no comparable exclusion under existing law.

VII. PERSONAL EXEMPTIONS

A. Earnings test for dependent (sec. 151)

Present law provides a $600 exemption for a dependent if the dependent has gross income of less than $600. The bill continues this earnings test for all dependents as defined under present law except that a son, stepson, daughter or stepdaughter of the taxpayer may have income in excess of $600 provided they are under 19 years of age or are full-time students at an educational institution.

The estimated revenue loss from this provision is $75 million in the fiscal year 1955.

B. Definition of dependent (sec. 152)

Under existing law a dependent is defined as an individual over half of whose support is received from the taxpayer and one who bears 1 of 8 specified relationships to the taxpayer.

The bill modifies the support test in two respects. It provides that in the case of children of the taxpayer who are students, any scholarships they receive for study at an educational institution are to be ignored in applying the support test.

The second change in the support test relates to cases where two or more persons supply the support of another individual but no one can claim the dependency exemption because of the failure of anyone to supply more than one-half of the support. Under the bill a group of contributors may annually designate one of their number to claim the dependency exemption where no one in the group contributed more than half of the dependent's support if all of the tests with respect to the dependency exemption (except the support test) are met by each member of the group; the person designated to receive the dependency exemption has contributed more than 10 percent of the dependent's support; and all other members of the group who have contributed more than 10 percent of the support have agreed in a written statement that they will not claim the exemption for that year.

The bill also modifies the "relationship" test of existing law. The bill provides that a taxpayer may claim as a dependent an individual over half of whose support he supplies, irrespective of the relationship of such individual to the taxpayer, if the individual has as his principal place of abode the home of the taxpayer and is a member of the tax

payer's household. The bill also provides a dependency exemption for cousins of the taxpayer, whom he supports, who are receiving institutional care (required by reason of a physical or mental disability) but prior to being placed in the institution were members of the same household as the taxpayer.

At present individuals may not be claimed as dependents if they are not citizens or residents of the continental United States (including Alaska and Hawaii) unless they are residents of a contiguous foreign country. The bill expands this exception for contiguous countries to permit taxpayers to claim as dependents individuals who are residents of the Canal Zone, Panama, and in certain cases the Philippines. For a resident of the Philippines to qualify he must be a child born to or adopted by the taxpayer in the Philippines before July 5, 1946, and the taxpayer must have been a member of the United States Armed Forces at the time the child was born or adopted.

It is estimated that this provision will decrease revenues by $10 million in the fiscal year 1955.

VIII. ITEMIZED DEDUCTIONS FOR INDIVIDUALS AND CORPORATIONS A. Business expenses not to include charitable gifts above limitation (sec. 162)

At the present time corporations are allowed a deduction for charitable contributions up to a limit of 5 percent of their income otherwise subject to tax. In addition, they are allowed to take as businessexpense deductions contributions to charitable and other organizations where the institution is to render a service commensurate to the contribution. However, where no service is rendered, a business-expense deduction may not be taken for amounts not allowable as charitable contributions only because they are in excess of the 5-percent limita

tion.

The bill makes it clear that the rule presently applicable to corporations is also to be applicable in the case of individuals.

B. Interest (sec. 163)

Although interest payments are deductible under present law, administration practice has denied any deduction for carrying charges on installment purchases unless the interest element is stated separately. Where carrying charges, but not interest, are stated separately, the bill permits the deduction as interest of an amount equal to 6 percent of the average unpaid balance (computed as of the 1st of each month) under the installment contract during the taxable year.

It is estimated that this amendment will decrease revenues by $10 million in the fiscal year 1955.

C. Apportionment of taxes on real property between buyer and seller (sec. 164)

Under present law, a taxpayer who buys real estate may be denied a deduction for the local property taxes which he assumes and pays if under local law the seller of the property has become liable for the tax prior to the date of sale. This occurs because the Supreme Court has held that the deduction for taxes depends upon the time when the tax becomes a lien upon the property. If, for example, the tax lien attached to the property before the date of sale, only the seller would be allowed to deduct the tax for income-tax purposes, regardless

of the manner in which the sales contract allocated the tax between buyer and seller. The purchaser would be allowed no deduction but would include the portion of the tax he paid in the basis of the property.

The bill provides that the purchaser and seller of real property are to each claim a deduction for that part of the real property tax which is proportionate to the number of months in the property tax year during which he held the property. This provision applies whether or not the parties to the sale actually apportion the tax. A special rule extends the benefit of this provision to cash basis taxpayers. D. Theft losses (sec. 165 (e))

The regulations under present law indicate that generally ordinary losses can be taken only in the year in which they are sustained.

The House adopted a provision which provides that theft losses can be deducted in the year in which the taxpayer discovers the loss, and only in that year.

E. Losses on securities in affiliated corporation (sec. 165 (g))

Present law provides that if the stock or securities of a subsidiary corporation become worthless the parent corporation may deduct an ordinary loss (rather than a capital loss) if it owned 95 percent of the stock of the subsidiary, and if 90 percent of the gross income for all years was derived from sources other than investment-type encome.

"Gross income" means gross receipts from sales or services less the cost of goods sold. Thus, even though the subsidiary may have been primarily engaged in commercial or industrial operations, a decline in the gross profit margin (or a loss) from such operations may have reduced the non-investment-type income to less than 90 percent of the whole.

For this reason the provision has been changed to permit an ordinary loss deduction if 90 percent of the subsidiary's "gross receipts" had been derived from non-investment-type income.

The bill also reduces the 95 percent ownership requirement to 80 percent. This conforms this provision with the change made in the general affiliation requirement for consolidated returns.

F. Bad debts (sec. 166)

Under existing law, business bad debts may be deducted in full. Nonbusiness bad debts of an individual, however, are treated as shortterm capital losses.

If a debt at the time it becomes worthless is not directly related to the taxpayer's trade or business, under present law it is treated as a nonbusiness bad debt. This rule is applied whether or not the debt was related to the taxpayer's trade or business at the time it was created.

The House bill permits the taxpayer to deduct as a business bad debt an obligation which becomes worthless, whether or not it is directly related to the trade or business at that time, if it was a bona fide business asset at the time it was created or acquired.

G. Depreciation (sec. 167)

Present law allows as a depreciation deduction a reasonable allowance for the exhaustion, wear and tear of property used in the trade or business, including a reasonable allowance for obsolescence. The annual deduction is computed by spreading the cost of the property over its estimated useful life. Most taxpayers use the straight-line

method which spreads the cost evenly over the years, although other methods are available, including the declining-balance method subject to a limitation of the rate to 150 percent of the corresponding straightline rate. Moreover, the declining balance method presently must be applied to old as well as new assets and thus much of the advantage of this method is lost.

The bill provides for a liberalization of depreciation with respect to both the estimate of useful life of property and the method of allocating the depreciable cost over the years of service.

The provision specifies that depreciation allowances computed under any one of the following methods are to be considered reasonable for new property acquired or constructed after December 31, 1953:

(1) The straight-line method allowable under present law.

(2) The declining-balance method, using a rate not in excess of twice the straight-line rate. Under this method a uniform percentage is applied to the unrecovered basis of the property. Since the basis of a particular property is constantly reduced by prior depreciation, the percentage is applied to a constantly declining balance. The depreciation allowances under this method, therefore, are considerably larger in the early years of the life of a property than those resulting from the straight-line method. The declining-balance method at twice the appropriate straight-line rate will write off approximately 40 percent of the cost of an asset in the first quarter of its service life and two-thirds of the cost in the first half of its life.

(3) Any other method consistently applied so long as the accumulated depreciation allowances for a property at the end of each year do not exceed the allowances which would have resulted from the use of the declining-balance method described above. Alternative methods which would be considered reasonable would include those based on units of production or a combination of straight-line rates.

The depreciation methods provided in the bill apply to all types of tangible depreciable assets. They are limited, however, to property new in use and therefore never before subject to depreciation allowances. In the case of property constructed by the taxpayer, the methods apply to construction completed after December 31, 1953, but only to that portion of cost incurred subsequent to that date. In the case of property acquired by the taxpayer after December 31, the proposed depreciation methods apply only to new property.

The bill also provides that where the taxpayer and the Internal Revenue Service have agreed in writing to a rate of depreciation to be applied to a particular property or to a group account, that rate will continue to be appropriate for tax purposes until such time as evidence is produced which was not taken into consideration when the agreement was made. The burden of proving the evidence rests with the party initiating the change to a different rate. When the necessity for a change has been established it will be made only prospectively. The bill further provides that the Internal Revenue Service may not disturb a depreciation rate used by a taxpayer so long as the useful life determined by the Internal Revenue Service to be correct does not differ by more than 10 percent from the useful life used by the taxpayer. The differing effects of straight-line and declining balance depreciation (at twice the straight-line rate) for single new assets are shown in the following table.

TABLE 13.-Annual charges for and accumulated depreciation of an asset costing $100,000 with estimated life as shown, under both straight-line and the 200-percent declining-balance method provided by H. R. 8300

Annual Cumu- Annual Cumu- Annual Cumu- Annual Cumu- Annual Cumu- Annual Cumucharge lative charge lative charge lative charge lative charge lative charge lative

Ignoring any stimulus to investment and assuming all eligible taxpayers adopt the declining balance, the loss in the fiscal year 1955 would be about $375 million. In the second and immediately subsequent years there would be greater losses, again ignoring any effect on investment.

H. Charitable and similar contributions (sec. 170)

The House bill raises the charitable contribution limit for individuals from 20 percent to 30 percent of adjusted gross income, but this extra 10 percent is to be allowable only with respect to contributions to religious orders, educational institutions, hospitals, churches, and conventions of churches. This extra 10 percent deduction for charitable contributions is to be available with respect to any contributions to the specified types of organizations, even though contributions to to other organizations account for the full amount allowable under the regular 20 percent limitation.

The House also made three other changes in the charitable contribution deduction.

At present a taxpayer (either corporate or individual) who has made the maximum allowable charitable contribution, if he subsequently carries back a net operating loss to that year, finds his allowable charitable contributions have been reduced by this downward adjustment in his income. The House bill ignores the net operating loss carryback in applying the percentage limitations.

At present the 20-percent limitation on charitable contributions does not apply where the combination of the taxpayer's charitable contributions and income tax in the current year and in each of the