The reorganization sections of the law illustrate the need for clarification mentioned some pages above and also the difficulties connected with the administration of the law and their relation to the handling of appeals. While real progress has been made in clarifying the definition of reorganization, the decision of the Circuit Court of Appeals for the second circuit in Helvering v. Gregory, (69 F. (2d) p. 809) for the review of which a petition for certiorari is now pending before the Supreme Court, shows how far the stature as now drawn falls short of setting the matter at rest. A literal interpretation of the present law permits the reorganization device to be used, as Judge Learned Hand pointed out in that case, for no apparent purpose other than to avoid tax. Did Congress so intend? The court though not. But the decision threw the whole matter open once more to the uncertainties of judicial interpretation.

Far worse is the present state of the law as to the proper basis to be applied in many situations. So great are the uncertainty and differences of opinion as to the intent of the law that the Bureau is at present deciding each case strictly in favor of the revenue without regard to consistency. Such a situation is intolerable and ought not long to continue. This whole problem is in a sense sui generis. It is a long-range problem and should be treated as such. One difficulty, of course, is political. The choice is between the transferor's basis and the cost to the transferee. Under the conditions prevailing prior to 1930, the use of the transferor's basis was more favorable to the revenues; since the great deflation of prices took place, transferee's cost. The Bureau has felt it essential to protect the revenues against whatever rule might finally emerge from the court decisions. The Bureau's difficulty would be solved by excepting these reorganization cases from the statute of limitations, and there is so much to be said for such an exception that this suggestion should receive serious consideration.

Partnerships And Associations. -- Some effort should be made also to clarify in the statute the distinction between partnerships on the one hand and associations that are to be treated as corporations on the other. There is enough case authority available now to be helpful. As it is, it is often difficult to identify the taxpayer, and this is bad both from the Government's and the taxpayer's point of view. See Section 801, Revenue Act of 1934 for the present definitions.

Insurance And Annuities. -- Still other illustrations of the need for clarification are found in Sections 22(b) (1) and 22 (b) (2) dealing with insurance and annuities. Congress has never made it perfectly clear whether it intends to exclude from gross income increments over and above the lump sum value of life insurance policies at death, which are paid under one or the other of the optional deferred payment clauses found in the standard forms of policies.

Penalties. -- A layman reading the penalty provision of the law might think the penalties somewhat severe, but he would assume that they are administered with some degree of justice. It is said, however, that it is better from a pecuniary standpoint to be charged with fraud, which carries a 50 per cent penalty than to be charged with failure to file on time, which carries a 25 per cent penalty. It is almost impossible to secure a finding of fraud, but the Attorney General's ruling in the case of the Great American Indemnity Company (Opinions Vol. 36, p. 40, 1929) is interpreted to mean that any failure to file by due date subjects the taxpayer to a fine of 25 percent if he legally and technically owes the fine and if he is financially able to pay -- this penalty applies whether the delinquency is for one year, for 20 years, or merely for one day because his stenographer forgot to mail the return.

An opinion of October 24, 1933, not yet published, further limits the Secretary by holding penalty, or interest and penalty, not subject to compromise separate and apart from the taxes in connection with which such penalties or interest had been incurred. The total of tax, interest, and penalties is said to constitute the "case" that, under Section 3229 of the Revised Statutes, the Secretary is given authority to compromise, but there can be no splitting of such case. Hence the Secretary cannot, in order to avoid injustice or great hardship, compromise the penalty alone.

Some unnecessary irritation and even hardship might be avoided by giving the Commissioner more discretion and/or by providing a graduated penalty. For example, 2 per cent a month for the first six months or a year, with a minimum of $5.00, would not outrage a taxpayer who had failed to pay on account of some minor negligence and still would tend to prevent undue negligence. Even better provisions might be suggested, this one is merely illustrative.

Other instances of sections that need revision for the sake of clarification or for the sake of equity or for other reasons might be cited, but it may be well not to distract attention from the main point of this section, namely, the importance of improving the personnel and organization of the whole administrative set-up, not because it has deteriorated on the whole but because it has so much greater possibilities than it has yet attained.

As a matter of fact, the greatest opportunity for the real improvement of the income tax and one that would result in appreciable increases in revenue and also in greater equity between taxpayers lies in the field of administration, and, what is more, most of what is needed lies within the power of the administration without any further legislative authority, though revision of a few minor features of the law would be helpful.

Appended are some data kindly supplies by the Bureau at the request of the writer upon the question of a more adequate administrative staff.



Treasury Department

September 5, 1934.

Office of
Commissioner of Internal Revenue

Address reply to
Commissioner of Internal Revenue
and refer to

Dr. R. G. Blakey,
Room 318 1/2.
Treasury Building.

Dear Dr. Blakey:

You have indicated an interest in the yield in additional tax obtained per revenue agent engaged, and in response to your request. I am outlining below some detail of our studies in that exact regard:

It is probably necessary first to visualize the project as a whole, and to start with an impression of an undertaking embracing the management of approximately 2,500,000 potential tax cases per year. About 2,000,000 of these are returns of individuals, while about 500,000 are returns of corporations.

The limited number of agents available necessitates a plan of selection, and it is the endeavor of the Bureau to, at the earliest practicable date, segregate and send to the field forces the number of returns that it is considered should be handled -- a job of a size that will enable orderly management. We know that if we take on too much, the resulting confusion might endanger our objective. Unless the undertaking is kept within manageable proportions, it will not be possible to obtain the best results.

Production data have been maintained over a period of years and through analysis of such data it is possible to obtain an estimate with respect to the probable profit to be derived from the conduct of additional investigations. And let it be understood that the Bureau does not pretend that as many examinations as should be made, in justice to the job, are actually undertaken. We know from past experience that the number of reports possible number of dollars, and this is the measure employed upon which to base estimates of an additional yield, if more examinations could be undertaken and more reports prepared.

In past years, we have been successful in producing yields in additional or back taxes of very substantial sums. Without these efforts, this money, which under the taxing statutes is due to the Government, would not be collected into the Treasury. Without our efforts, it is true, too, that we should expect more of a certain type of citizen to fail to make proper returns. So, in addition to enabling actual collections of more than $200,000,000 back taxes annually, the organization stands as a sentinel to compel obedience to the law. If the Bureau discovers understatements of income during a year that produce $200,000,000 in back taxes, it is not unreasonable to assume that were it known that investigations would not be conducted, understatements would be greatly increased.

The following data is of exact interest to our inquiry:

[Table 21]

         Number of Returns   Number of Examination       Amount
Year      Sent to Field           Conducted           Recommended

1930        472,226                328,289          $207,220,446.39
1931        508,363                321,870           295,338,223.99
1932        433,891                300,271           275,942,496.80
1933        493,626                305,723           209,560,777.83
1934        617,964                299,984           203,510,465.96

Total     2,516,070              1,556,137        $1,191,572,410.97

Average     503,214                311,227          $238,314,482.19
per year

The returns that are sent to the field (revenue agents) for examination include all 1040 ($5000 or more) returns reporting a gross income of $25,000 or more, all taxable corporation returns reporting a gross income of $75,000 or more, and all non-taxable corporation returns reporting a gross income of $125,000 or more, as well as such other individual returns on Form 1040 ($5000 or more) or corporation returns as in the judgment of the forces of the Income Tax Unit might justify examination.

We have seem that the average number of returns referred to the field per year was (over the five-year period) in excess of 500,000, while but approximately 311,000 examinations are conducted each year. That does not mean, however, that the cases represented by 311,000 of the 500,000 returns forwarded to the field were examined. During the year many cases develop upon the basis of information -- sometimes furnished anonymously, sometimes obtained in consequence of private litigation which becomes a matter of public discussion, sometimes upon the basis of request by Washington offices for further data upon pending cases. The number of reports necessary in cases developed from these several sources each year will average between 50,000 and 100,000.

The first interest of Agents in Charge upon the receipt of returns for a given year us to inspect them for the purpose of eliminating those which in their judgment (considering their limited forces) are within the capacity of the men available and to eliminate those which may be with more safety accepted as filed. This process is called a "survey" and its purpose is to bring the job into manageable proportions. Of course, there can be no "carry-over" since the job is one recurring annually. The force will have just as large a task with respect to the next year's work.

After this culling-out process, the field office has left that work which in the judgment of its most efficient men should be undertaken, and at this point it is necessary to examine the following table which shows for each of the five years the number of cases selected by Washington and retained after survey by the field offices that are returned to washington without examination because a sufficient field force is not available:

                   1930                     121,495
                   1931                      93,395
                   1932                     125,949
                   1933                     135,346
                   1934                     203,147

How consider our problem from the standpoint of the yield per agent employed per year over the five years. The average number of agents employed per year over the period 1930 to 1934 is shown to have been as follows:

                    1930                       2,543
                   1931                       2,521
                   1932                       2,473
                   1933                       2,432
                   1934                       2,350

Average                                       2,464

To obtain the result per agent employed, we may first consider the average tax recommended per agent. The average total tax recommended by the field forces for the five-year period was, as shown above, $238,314,482.19. The average number of agents employed over the period of years is shown to have been 2,464, and dividing the average total amount per year of recommended tax by the total agents employed, we have an average recommended additional tax yield of $96,719.00.

However, the total amount recommended is, of course, not sustained. So, we examine data compiled to determine a percentage that should be representative of the amount that will be sustained and assessed to the amount recommended.

A study of 190,081 cases in which assessment of a total of $261,169,126.00 was recommended shown that $189,663,152.00 was sustained and assessed. Many of the cases producing this total were closed by agreement with taxpayers while others were decided by the Board of Tax Appeals or courts of appellate jurisdiction. The percentage sustained to that proposed or recommended was 72.6%. The study is believed to be complete enough to be reasonably representative of what can be expected in cases now being developed. If anything, our basis for estimate of the probably future percentage yield may be considered to be conservative, since many of the cases settled by Board of Tax Appeals and court decisions and included in our study will represent final action in cases developed in the early years of our operations when the basis in support of our recommendations may not have been so sound as are the recommendations of our more experienced force of recent years, equipped as it is with precedents established throughout the years by Board and court decisions, Department rulings, etc.

Applying this known percentage factor to our average in recommended tax for the five-year period, we obtain an annual figure of back income taxes assessed of $173,016,314.00, an annual average yield per agent of $70,218.00. The interest rate on deficiency taxes is not less than 15%. Add 15% or $70,218.00 and we find $80,751.00 is the value per year of the average revenue agent.

It has been shown that over the five-year period we averaged 311,227 examinations per year. We were unable because of lack of force to examine an average of 135,866 taxpayers each year. We did not have sufficient personnel to examine that number of cases which should have been examined. We selected the work we wanted to do but were compelled, because of lack of men, to neglect each year many thousands of examinations.

We do not suggest that if we examined all selected cases before "survey" we could or would produce an average yield per examination equal to the average established by dividing the total amount of sustained recommended tax by the total number of examinations conducted, but we believe that if we could handle the selected cases that are not examined solely because of inability physically to do the work, we could maintain the rate.

As an aid to an appreciation of the problem in a particular locality and more especially to permit an opportunity to understand the relation of available personnel to the undertaking, it will be helpful to examine conditions in a typical section of the country. There is a branch of the St. Louis Division located at Kansas City. There are 11 agents attached to that Kansas City office. The territory assigned to these men comprises the western half of the State of Missouri, and within that territory are Kansas City, St. Joseph and Joplin, all industrial cities. In addition, there are many smaller towns and cities. Approximately 200 public accountants in this territory are engaged upon work similar to that of the revenue agents, i.e., the conduct of audits, and who prepare income tax returns, and in addition there are probably at least 25 men in the Kansas City district who specialize and engage exclusively in income tax practice. As stated above, we can assign to that part of the St. Louis Division only 22 agents, and the conditions there are considered representative of those throughout the United States.

Over a five-year period, we prove a yield per agent of an annual average of $80,751.00, we show that many examinations are not made because lack of personnel, and we advocate a limited number of additional competent agents. We believe we can obtain an average yield per agent that will equal the average yield in prior years.

The business of the Income Tax Unit requires competent and loyal employees and, by reason of its complexity, necessitates a period of training before real value may be anticipated. It is not an undertaking into which a "new" man can be fitted without training. If it is limited in its recruitment program to an opportunity alone to fill vacancies, it will not be possible to meet its responsibilities as adequately as is desirable.

(Signed) Chas. T. Russell
Deputy Commissioner

September 7, 1934.

Dear Mr. Russell:

Thank you very much for the very interesting data in your letter of September 5th. I would like to raise one point about the average of additional tax collections per revenue agent if you should secure more agents. I note that you say that you could not maintain the average with an increased staff it you examined all selected cases before "survey". One would think that the cases actually selected and audited would represent the cream and that you would be unable to maintain as high an average for each member of the additional number added to your present staff.

As I recall, Mr. Sherwood informed me that the average costs for additional revenue agents would be about $3500 each per year including expenses. If this is correct, it would seem an extremely profitable investment for the Government to spend that much in order to secure $80,000 or even a third of that amount in taxes justly and legally due. It would probably be even more profitable to secure superior men at a higher rate of compensation.

Again thanking you for your kindness in supplying me with these data, I am

Very truly yours,

(Signed) Roy C. Blakey.

Mr. Charles T. Russell,
Deputy Commissioner,
Bureau of Internal Revenue,
Washington, D. C.

Attention: Mr. W. F. Sherwood.


Treasury Department
September 7, 1934

Office of Commissioner of Internal Revenue

Dr. R. G, Blakey,
Room 318 1/2,
Treasury Building.

Dear Dr. Blakey:

In your letter of September 7th you indicate that it might be desirable to submit further comment upon the suggestion that, if a field force large enough to conduct more examinations were available, we would expect to maintain the yield per additional agent indicated upon a study of results for five years, presented and discussed in my letter of September 5, 1934. You apprehend that it is not illogical to presume that to produce the annual average of $80,751.00 of additional tax per agent, the field forces have selected for examination those cases most likely to produce additional taxes.

Of course, it is true that the Bureau personnel have exercised their best judgment to select cases for examination that would be most productive of results favorable to the Government. However, during the close of a limitations period, the field forces are compelled by necessity because the field employees are totally inadequate to the performance of the complete selected task, to return to Washington without examination many cases originally selected. It must be understood that the examining officers are inadequate to the task even as it has been narrowed by the survey in the field described in letter of September 5th.

The rules that govern selection are based largely upon taxpayer's statements contained in returns filed. Other rules of equal strength could be employed, and many experienced men interested in the project believe that the case of every taxpayer should be examined at least once during a period of years.

Returns presenting the most innocent aspect upon the inspection for selection may in fact be return deliberately intended to mislead. The Bureau is engaged upon a task involving great hazards. One of the most apparent risks is evident immediately when the necessity occurs to select a job a manageable proportions. A most exact hazard develops upon the necessity to abandon a part of the selected task.

The letter of September 5th in analysis of our program show than an average of 135,000 selected returns per year were not examined over the five-year period solely because men were not available to do the work. It is to be appreciated that these were returns of the selected group which in the judgment of the field forces should be examined and which were likely, upon examination, to produce additional revenues.

To have an intelligent appreciation of the real problem, it is essential that it be understood that the magnitude of the job is for such proportion and the force so completely inadequate to the field work necessary that the Bureau has been forced to operate under the rules described in the communication of September 5th as those most adapted under the circumstances to protecting Federal revenues. It is not possible to state positively that the production per individual employed, if more agents are made available, will equal an average additional tax in excess of $80,000 per annum, but it is the decided view of this office that the ratio can be maintained at least to the extent of the number of additional agents the Bureau would be willing to recommend.

It is true that the cost per additional revenue agent, including compensation and travel expenses, would average about $3500 per annum, and its is certainly profitable to secure superior men at rates of compensation higher than the average for all agents. It has been one of our handicaps that in more recent years we have been unable to reward with increased salary men who have demonstrated unusual proficiency and who have produced more than the average in additional taxes. This has resulted quite naturally in the loss of many very valuable agents who might have been increases in their compensation. As in any other business, the outstanding men, if they are not rewarded upon the basis of their production, will look for more profitable fields and the market for their services is ample even in the most difficult times. Perhaps it would help one to an appreciation of the importance of maintaining an adequate force if it is kept in mind, as stated in my previous communication, that no part of this money that is collected in deficiency taxes would be made available except for the services of the revenue agents.

Of course, the Bureau is always interested to secure by appointment men whose experience indicated the best preparation to undertake the difficult task assigned to the revenue agent. Even were it concluded -- and that is, of course, far from the fact -- there is every reason why we should continue to recruit the force in order that we can at least maintain a production program equal to that permitted by the limited force heretofore available.

Sincerely yours,

Deputy Commissioner.