C. Harry Kahn

English

Research Papers in Economics

This PDF is a selection from an out-of-print volume from the National Bureau
of Economic Research
Volume Title: Business and Professional Income Under the Personal Income
Tax
Volume Author/Editor: C. Harry Kahn
Volume Publisher: Princeton University Press
Volume ISBN: 0-691-04107-5
Volume URL: http://www.nber.org/books/kahn64-1
Publication Date: 1964
Chapter Title: Introductory pages to "Business and Professional Income
Under the Personal Income Tax"
Chapter Author: C. Harry Kahn
Chapter URL: http://www.nber.org/chapters/c0757
Chapter pages in book: (p. -15 - -1)Business
and Professional Income
Under the
Personal Income Tax
C. HARRY KAHN
NATIONAL BUREAU
A STUDY BY THE
OF ECONOMIC RESEARCH, NEW YORK
PUBLISHED BY
PRINCETON UNIVERSITY PRESS
1964
ACopyright ©1964by National Bureau of Economic Research
All Rights Reserved
L.C. Card62—21 104
Printedin the United States of America•BUSINESS AND PROFESSIONAL INCOME
UNDER THE PERSONAL INCOME TAXNATIONAL BUREAU OF ECONOMIC RESEARCH
Fiscal Studies
1. Fiscal Planning for Thtal War
William Leonard Crum, John F. Fennelly, and Lawrence H. Seltzer
2. Thxable and Business Income
Dan Throop Smith and J. Keith Butters
3.The Nature and Tax Treatment of Capital Gains and Losses
Lawrence H. Seltzer
4. Federal Grants and the Business Cycle
James A. Maxwell
5. The Income- Thx Burden on Stockholders
Daniel M. Holland
6. Personal Deductions in the Federal Income Thx
C. Harry Kahn
7. Dividends Under the Income Tax
Daniel M. Holland
8. Business and Professional Income Under the
Personal Income Thx
C. Harry KahnTo My Parents
/1NATIONAL BUREAU OF ECONOMIC RESEARCH
1964
OFFICERS
Albert J. Hettinger, Jr., Chairman
Arthur F. Bums, President
Frank W. Fetter, Vice-President
DonaldB. Woodward,Treasurer
Solomon Fabricant, Director of Research
Geoffrey H. Moore, Associate Director of Research
Hal B. Lary, Associate Director of Research
William J. Carson, Executive Director
DIRECTORS AT LARGE
Robert B. Anderson, New York City
WallaceJ. Campbell, Nationwide Insurance
Erwin D. Canham, Christian Science Monitor
Solomon Fabricant, New York University
Marion B. Folsom, Eastman Kodak Company
Crawford H. Greenewalt, E. I. du Pont de Nemours & Company
Gabriel Hauge, Manufacturers Hanover Trust Company
A. J. Hayes, International Association of Machinists
Albert J. Hettinger, Jr., Lazard Frères and Company
Nicholas Kelley, Kelley D!ye Newhall Maginnes & Warren
H. W. Laidler, League for Industrial Democracy
Charles G. Mortimer, General Foods Corporation
George B. Roberts, Larchmont, New York
Harry Scherman, Book-of-the-Month Club
Boris Shishkin, American Federation of Labor and
Congress of Industrial Organizations
George Soule, South Kent, Connecticut
Joseph H. Willits, Langhorne, Pennsylvania
Donald B. Woodward, A. W.Jones and Company
DIRECTORS BY UNIVERSITY APPOINTMENT
Harold M. Groves, Wisconsin
Gottfried Haberler, Harvard
Maurice W. Lee, North Carolina
Lloyd G. Reynolds, Yale
Paul A. Samuelson, Massachusetts
Institute of Technology
Theodore W. Schultz, Chicago
WillisJ. Winn, Pennsylvania
DIRECTORS BY APPOINTMENT OF OTHER ORGANIZATIONS
Percival F. Brundage, American Institute of Certified Public Accountants
Nathaniel Goldfinger, American Federation of Labor and Congress of Industrial OrganizatIons
Harold G. Halcrow, American Farm Economic Association
Murray Shields, American Managemmt Association
Willard L. Thorp, American Economic Association
W. Allen Wallis, American Statistical Association
Harold F. Williamson, Economic Histoiy Association
Theodore 0. Yntema, Committee for Economic Development
DIRECTORS EMERITI
Shepard Morgan, Norfolk, Connecticut
N. I. Stone, New York City
Jacob Viner, Princeton, New Jersey
RESEARCH STAFF
Moses Abramovitz Solomon Fabricant C. Harry Kahn G. Warren Nutter
Gary S. Becker Albert Fishlow Irving B. Kravis Richard T. Selden
William H. Brown, Jr. Milton Friedman Hal B. Lary Lawrence H. Seltzer
Gerhard Bry Victor R. Fuchs Robert E. Lipsey Robert P. Shay
Arthur F. Burns H. C. Georgiadis Ruth P. Mack George J. Stigler
Phillip Cagan Raymond W. Goldsmith Jacob Mincer Norman B. Ture
Joseph W. Conard Challis A. Hall, Jr. Ilse Mintz Herbert B. Woolley
Frank G. Dickinson Daniel M. Holland Geoffrey H. Moore Victor Zarnowitz
James S. Earley Thor Hultgren Roger F. Murray
Richard A. Easterlin F. Thomas Juster Ralph L. Nelson
V. W. Bladen, Toronto
Francis M. Boddy, Minnesota
Arthur F. Burns, Columbia
Lester V. Chandler, Princeton
Melvin G. de Chazeau, Cornell
Frank W. Fetter, Northwestern
R. A. Gordon, CallbrniaRELATION OF THE DIRECTORS TO THE WORK AND PUBLICATIONS
OF THE NATIONAL BUREAU OF ECONOMIC RESEARCH
1. The object of the National Bureau of Economic Research is to ascertain and to present
to the public important economic facts and their interpretation in a scientific and impartial
manner. The Board of Directors is charged with the responsibility of ensuring that the work
of the National Bureau is carried on in strict conformity with this object.
2. To this end the Board of Directors shall appoint one or more Directors of Research.
3. The Director or Directors of Research shall submit to the members of the Board, or to
its Executive Committee, for their formal adoption, all specific proposals concerning researches
to be instituted.
4. No report shall be published until the Director or Directors of Research shall have sub-
mitted to the Board a summary drawing attention to the character of the data and their
utilization in the report, the nature and treatment of the problems involved, the main con-
clusions, and such other information as in their opinion would serve to determine the suita-
bility of the report for publication in accordance with the principles of the National Bureau.
5. A copy of any manuscript proposed for publication shall also be submitted to each mem-
ber of the Board. For each manuscript to be so submitted a special committee shall be
appointed by the President, or at his designation by the Executive Director, consisting of three
Directors selected as nearly as may be one from each general division of the Board. The
names of the special manuscript committee shall be stated to each Director when the sum-
mary and report described in paragraph (4) are sent to him. It shall be the duty of each
member of the committee to read the manuscript. If each member of the special committee
signifies his approval within thirty days, the manuscript may be published. If each member
of the special committee has not signified his approval within thirty days of the transmittal
of the report and manuscript, the Director of Research shall then notify each member of the
Board, requesting approval or disapproval of publication, and thirty additional days shall be
granted for this purpose. The manuscript shall then not be published unless at least a
majority of the entire Board and a two-thirds majority of those members of the Board who
shall have voted on the proposal within the time fixed for the receipt of votes on the publi-
cation proposed shall have approved.
6. No manuscript may be published, though approved by each member of the special com-
mittee, until forty-five days have elapsed from the transnittal of the summary and report. The
interval is allowed for the receipt of any memorandum of dissent or reservation, together with
a brief statement of his reasons, that any member may wish to express; and such memoran-
dum of dissent or reservation shall be published with the manuscript if he so desires. Publi-
cation does not, however, imply that each member of the Board has read the manuscript, or
that either members of the Board in general, or of the special committee, have passed upon
its validity in every detail.
7. A copy of this resolution shall, unless otherwise determined by the Board, be printed in
each copy of every National Bureau book.
(Resolution adopted October 25, 1926, as revised February 6, 1933 and February 24, 1941)
viiCONTENTS
ACKNOWLEDGMENTS XVI1
FOREWORD by Solomon Fabricant xix
1.INTRODUCTION AND SUMMARY 3
Purpose of the Study 3
Profit and Loss Concept in Tax Statistics 4
Nature and Limitations of the Data 6
Summary of Findings 7
2.SOURCES AND COVERAGE OF BUSINESS AND PROFESSIONAL INCOME ON
TAX RETURNS 15
Sources of Sole Proprietor and Partnership Income 15
Relation to Total Income 17
Coverage on Tax Returns 25
Effect on Coverage of Income Below Filing Requirement 38
Comparisons with Other Studies 41
Coverage by Size of Income Reported 45
3.SIZE AND PATTERN OF INCOME ON RETURNS WITH PROFIT OR Loss
FROM BUSINESS AND PROFESSIONS 51
Distribution by Size of Profit or Loss 52
Relation of Income from Business and Profession to Total Income
of Proprietors 53
Conversion of Unincorporated Enterprise Profits into Other Income64
Effect on Business Organization of Tax Treatment of Pension Plan
Contributions 77
Pattern of Income on Returns with Profit or Loss from Business or
Profession 79
4. THE TREATMENT OF LOSSES 84
The Extent of Loss Offset 85
Provisions for Loss Carryover Deductions 90
The Conceptual Relation Between Loss Carryover Deductions and
Net Losses on Returns with Negative Income 95
5. TAX LIABILITY ON UNINCORPORATED BUSINESS AND PROFESSIONS 97
Effective Tax Rate on Business and Professional Income 98
Marginal Tax Rate by Sole Proprietor and Partnership Profit
and Loss 120
Significance of Annual Mean Tax Rates for Aggregate Net Profits
and Losses 124
xCONTENTS
APPENDIXES
A. Tabulation of Sole Proprietor and Partnership Income by Size of
Income and Type of Industry: Explanation of Difference 131
B. Derivation of the Estimates for Farm and Nonfarm Unincorporated
Enterprise Income 134
C. Derivation of Estimates of Total Wages and Salaries and AGI 149
D. Estimates Based on 1948 ACP Data 153
E. Patterns of Income on Returns Which Have Unincorporated Enter-
prise Income as Well as Income from Wages, Interest, Dividends, or
Rents and Royalties, 1955 and 1959 155
F. Derivation of Tables 43 Through 46 160
G. Amounts and Frequencies of Reported Net Profits and Net Losses;
Estimated Tax Liability Attributable to, and Estimated AGI on Re-
turns with, Net Profit and Net Loss, by Sole Proprietors and Partners,
Selected Years, 1939—60 166
H. Computation of Mean Effective and Marginal Tax Rates 179
I.Note on Estimate of Net Operating Loss Deduction 182
INDEX 187
xTABLES
1. Adjusted Gross Income and Its Components as Reported on Tax
Returns, 1960 15
2. Industrial Distribution of AGI from Unincorporated Business and
Professions Reported on Tax Returns, 1960 16
3. Unincorporated Business and Professional Income as a Component
of Total Personal Income and Adjusted Gross Income, 1929—60 18
4. Unincorporated Business and Professions, Wages and Salaries, and
Property as Sources of Income Reported on All Returns, 1918—60 20
5. Total Number of Tax Returns Related to Number with Sole
Proprietor and Partnership Income, 1937—60 24
6. Business and Professional Income Reported on Tax Returns Related
to Estimated Total, 1929—60 27
7. Total Wages and Salaries, Dividends, and Interest Receipts Reported
on Tax Returns Compared with Estimated Total, 1936—60 29
8. Income from Unincorporated Enterprise Reported on Tax Returns
as Percentage of Estimated Total, by Farm and Nonfarm, 1939—6030
9. Average Farm Income from Farm Enterprise as Reported on Tax
Returns and as Estimated, 1939—60 33
10. Number of Farm Businesses Accounted for on Individual Tax
Returns, 1939—60 34
11. Income from Wages and Salaries and Nonfarm Business and Pro-
fessions: Average Amount Per Recipient and Percentage Reported
on Tax Returns, 1939—60 37
12. Number of Persons with Business and Professional Income Less
Than $500, Less Than $1000, and Total: Tax-Return and Census
Data, 1954, 1956, and 1960 40
13. Estimated Increase in Gross Receipts and in Net Profit Less Loss
After Audit of 1949 Tax Returns for Sole Proprietors, by Farm and
Nonfarm Income 42
14. Number of Sole Proprietor Returns with Tax Error, by Income
Groups, 1948 46
15. Tax Change Disclosable by Audit on Returns of Sole Proprietors, by
Income Groups, 1948 47
16. Estimated Increase in Disposable AG! Due to Underreporting on
Returns of Sole Proprietors with Tax Error, by Income Groups, 194848
17. Cumulative Percentage Distribution of Net Profits and Net Losses
Reported by Sole Proprietors and Partners, by Size of Net Profit
and Loss, 1960 51
18. Distribution of Business and Professional Income and AGI of Pro-
prietors, by Income Groups, 1960 54
xiTABLES
19. Business and Professional Net Income and AGI Reported on Returns
with Business and Professional Income or Loss, 1939—60 55
20. Sole Proprietorship Net Income and Estimate of AG! Reported on
Returns of Sole Proprietors; by Income Groups, Selected Years,
1939—60 56
21. Partnership Net Income and Estimate of AGI Reported on Returns
of Partners, by Income Groups, Selected Years, 1939—60 58
22. Sole Proprietorship Income and Estimated AGI, by Returns with
Net Profit and Net Loss and by Income Groups, 1945 and 1960 61
23. Partnership Income and Estimated AGI, by Returns with Net
Profit and Net Loss and by Income Groups, 1945 and 1960 62
24. Total Reported Net Profit and Net Loss from Sole Proprietorship as
Percentage of Estimated AGI on Returns of Sole Proprietors,
Selected Years, 1939—60 63
25. Total Reported Net Profit and Net Loss from Partnership as Per-
centage of Estimated AGI on Returns of Partners, Selected Years,
1945—60 64
26. Number of Returns Reporting Net Profit or Net Loss from Sole
Proprietorship and Partnership, by Net Profit and Net Loss and by
Income Groups, 1955 and 1960 65
27. Business and Professional Net Profits and Losses and Realized Net
Gains and Losses from Sale of Capital Assets Reported on All
Returns, by Income Groups, 1960 66
28. Number of Corporations and Unincorporated Enterprises Electing
Optional Tax Treatment as Percentage of Total Number, 1957—6069
29. Number and Net Income of Corporations Electing to Be Taxed as
Partnerships, by Net Profit and Loss, 1958—60 70
30. Net Profit, Net Loss, and Depreciation of Real Estate Operators
and Lessors Reporting as Sole Proprietors and Partnerships, 1958—60 71
31. Mining Net Profit and Loss, Depreciation, and Depletion, Reported
for Sole Proprietors, Partnerships, and Corporations, 1953—60 74
32. Sole Proprietorship Net Income: Total and Four Selected Industries,
by Income Groups, 1960 77
33. Number of Returns with Unincorporated Enterprise Profit or Loss
as Percentage of All Returns Filed, 1955 and 1959 80
34. Relative Frequency of Returns with Unincorporated Enterprise
Profit or Loss and Income from Other Sources, 1955 and 1959 82
35. Net Operating Loss Carryforward Deductions and Estimated Net
Operating Losses from Unincorporated Enterprises on Returns with
Negative AG!, 1943—61 86
xiiTABLES
36. Number of Returns with Negative AGI and Net Loss from Either
Sole Proprietorship or Partnership, by Size of Net Loss, 1954 and
1960 93
37. Tax Liability Attributable to Unincorporated Business and Profes-
sional Income, Employment, and Property Income Under the
Personal Income Tax, 1918—60 99
38. Effective Tax Rate on Unincorporated Business and Professional
Income and All Other Income Reported on Tax Returns, 1929—60101
39. Estimated Mean Effective Tax Rate on Unincorporated Business and
Professional Income, Reported and Estimated Total, 1929—60 102
40. Effective Tax Rates on Unincorporated Business and Professional
Net Income Reported on Tax Returns, by Income Groups, Selected
Years, 1939—60 105
41. Effective Tax Rates on Unincorporated Enterprise Net Income
Reported on Tax Returns Adjusted for Income Reporting Errors,
by Income Groups, Selected Years, 1949—60 109
42. Mean Effective Tax Rate on Profits and Losses, by Sole Proprietor
and Partnership, 1952—60 110
43. Estimated Percentage of Returns on Which Reported Sole Proprie-
torship Net Profit Is Less Than, or Exceeds, Stated Percentage of
Income, by Income Groups, 1960 114
44. Estimated Net Profit Reported on Returns with Sole Proprietorship
Net Profit Less Than, or Exceeding, Stated Percentage of Income, by
Income Groups, 1960 116
45. Estimated Net Profit and AGI Reported on Returns for Which Net
Profit from Sole Proprietorship Was Over 50 Per Cent of AGI,
by Income Groups, 1960 117
46. Estimated Effective Profit Tax Rate of Returns with Sole Proprietor-
ship Profit Greater Than 10 Per Cent, and Greater Than 50 Per
Cent, of AGI, 1958 and 1960 118
47. Estimated Effective Tax Rate on Net Income from Sole Proprietor-
ship, by Farms, Professions, and Business, 1960 119
48. Mean Marginal Tax Rate on Profits and Losses, by Sole Proprietor
and Partnership, 1952—60 121
49. Amounts of Unincorporated Enterprise Net Profit and Net Loss
and Marginal Tax Rate, by Income Groups, 1957 and 1960 122
APPENDIX TABLES
A-i Unincorporated Enterprise Income Reported on Tax Returns, by
Income-Size and Industrial Tabulations, 1939—60 132
xliiTABLES
B-iNet Income and Net Loss from Sole Proprietorship and Partner-
ship, by Farm and Nonfarm Enterprises, as Reported on Business
Tax Returns, Selected Years, 1939—60 135
B-2Estimates of Farm Operators' Net Money Income (Agriculture
Department), Adjusted for Comparability with Tax Return Con-
cepts, Selected Years, 1939—60 140
B-3 Estimates of Nonfarm (Commerce Department) and Total Unin-
corporated Enterprise Income, Adjusted for Comparability with
Tax Return Concepts, 1939—60 144
C-i Adjustment of Wage and Salary Disbursements (Commerce Depart-
ment Estimates) for Comparability with Amounts Reported on
Tax Returns, Selected Years, 1939—60 149
C-2 Adjustment of Personal Income Estimate (Commerce Department)
to Obtain Estimate of Total Adjusted Gross Income, 1960 150
C-3 Estimated Adjusted Gross Income on Tax Returns, 1918—43 152
E- 1Number of Returns with Unincorporated Enterprise Profit or Loss
and Income from Wages and Salaries, Dividends, or Interest, 1955156
E-2 Number of Returns with Unincorporated Enterprise Profit or
Loss and Income from Wages and Salaries and/or Rents and
Royalties, 1959 158
F-iEstimated Number of Returns with Reported Net Profit from Sole
Proprietorship Less Than, or Exceeding, Stated Percentage of
Income, by Income Groups, 1960 160
F-2Estimated Net Profit on Returns with Net Profit from Sole Pro-
prietorship Less Than, or Exceeding, Stated Percentage of AGI, by
Income Groups, 1960 162
F-3Estimated Mean Effective Tax Rate on Net Profits for Returns
with Sole Proprietorship Net Profit Greater Than 10 Per Cent
and Greater Than 50 Per Cent of AGI, 1960 164
F-4Estimated Mean Effective Tax Rate Weighted by Frequencies on
All Returns with Sole Proprietorship Net Profit and on Returns
with Sole Proprietorship Net Profit Greater Than 10 Per Cent
and Greater Than 50 Per Cent of AGI, by Income Groups, 1960165
G- 1Amounts and Frequencies of Reported Net Profits and Net Losses;
Estimated Tax Liability Attributed to, and Estimated AOl on,
Returns with Net Profit and Net Loss, by Sole Proprietors and
Partners, Selected Years, 1939—60 167
I-iComputation of Net Operating Loss Estimate for 1952 and 1959183
1-2Distribution of Net Operating Loss Carryforward Deduction, by
Income Groups, Selected Years, 195 1—61 185
xivTABLES
CHARTS
1. Business and Professional Income, Wages and Salaries, and Prop-
erty Income Reported on All Tax Returns, 1918—60 23
2. Business and Professional Income and Wages and Salaries as
Percentage of Adjusted Gross Income, 1929—60 26
F—i Formulas for Estimating Frequencies for a Fraction of a Class
Interval 161
xv

Business and Professional Income Under the Personal Income Tax

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Research Papers in Economics