Assignment of Income - Who

General Concepts

1. Income is generally taxed to the TP who earns it, or to the TP who owns property which produces income.

2. The liability to pay tax on an item of income generally may not be avoided merely by assigning the right to the item of income to another TP either directly or through an entity.

All of this section is common law and has no related code §§.

Four Ways to Analyze Assignment of Income

1. Fruit and Tree Principal

2. Control Principal

3. Timing Principal

4. Relationship Principal

Fruit and Tree Principal

If you assign the tree (income producing property or service), the fruit (income) will taxed to the assignee.

If you only assign the fruit (income) and retain the tree, the income will be taxed to the assignor.

(SERVICES) Lucas:

i. Tree is the work preformed, or person who preforms the service

ii. Mr. Earl was the tree, and the fruits of his labor could not be assigned to his wife - at least, he still had to pay the tax on the amount

iii. The fruit was the salary, or commissions or whatever you are earning

(PROPERTY) Horst:

i. Tree is the thing - realty or personalty - which creates the income

ii. Fruit is the income it generates - who ever owns the tree, pays the tax on the income

iii. Example: TP assigns part of his herd of cattle to another which includes not only the cattle themselves, but the calves born in the future. Calves constitute future income generated from the property if they are later sold

Overall Takeaway: You can't convert of give away fruit w/o paying tax on it, but if its a tree, you can give it away or split it.

TP's Control Principle

Principle:

i. The more the TP controls disposition, the more likely it will be TPs income. (Giannini)

ii. "The power to dispose of income is equivalent of ownership of it" (Helvering)

Example:

If the TP controls the disposition, it is income, even if TP never sees the income

i. President of Corp. tells the Corp. to stop paying him and to "do something worthwhile" w/ the money.

ii. Actual receipt of the money is irrelevant to who gets taxed on it

iii. The less control a TP has over the disposition of an asset or the use of income, the less likely the TP is responsible for the tax liability

THERE IS A RELATED IDEA

a. Old Colony Trust: if the disposition benefits the TP, it is income

b. Rev. Rule 69-102 -> control of the income = Tax of the Income

Timing Principle

Principle:

i. If the future income give away BEFORE earned, then less likely to be taxed to TP

ii. This is related to motive as well

IF FRUIT AND TREE ANALYSIS POINTS IN ONE DIRECTION, BUT THE TIMING PRINCIPLE TRUMPS THE FRUIT AND TREE ANALYSIS (Salvatore)

Anticipatory Assignment

i. The assignment of income generally requires a TP to include in his GI an item of income, which has been gratuitously assigned to another TP

ii. If such a right to future income is sold or exchanged for its present value, however, there is not gratuitous assignment and the trasnfereor must include theproecceds in his GI inthe year of the sale or exchange

Relationship Principle

Principle:

i. If TP and Assignee are closely related, then TP more likely to be taxed b/c it's more likely to be an invalid assignment of income

ii. If Tp and Assignee engage in arm's length transaction, then less likely to be taxed

Three Cases Which Illustrate this:

i. Personal relationship. Mom was making sure the kids got theirs, and the kids were going to make sure they supported mom (Salvatore)

ii. Dad sells to sons, dividends are fruit, but the dad gave away the RIGHT to receive the dividends, not the actual dividends. (Stranhan)

iii. But, if the assignment is an arms length transaction, then it is less likely to be taxed (Stranhan)

THE KEY difference between Horst was that there was no consideration in Horst, but in Stranhan, the son paid FMV for the right to receive the dividends and took the risk that the dividends might not be paid so this negated the problem of the relationship.

Assignment Rev Rule. 66-167 & 74-581 (Executors and Law Clinics)

Rev. Rul. 66-167 (Executors) - Which is the principal principle

i. Timing - intention would be manifest if done w/16 months

ii. Control: The powers to dispose of income is the equivalent of ownership of it.

Rev. Rul. 74-581 (Law Clinics) - Which is the principal principle

i. Relationship

Variations of Relationships: Chattel

Tatum/Campbell

In Tatum, the donor was the landlord, who had tenant farmers. The tenant farmers pay their rent in crops not cash. Landlored wanted to give the crops to charity, so when teh charity sold the crops the court said it was tatum's income. The court said this was fruit, not hte tree, b/c it was a subsitute for rent, which is fruit

Variations of Relationships: Copyright

Creator v. Transferee

i. If you have a work of music, and you create a copyright on that, then you have a right to receive royalties when other people play that music

ii. The ideais, there are royalites that are fruit of the tree that you created

iii. SO what if you assign your royalty contract, is that tree or fruit?

->In the hands of the creator, the copyright might be fruit of their labor, but if they transfer that copyright to a third party, teh copyright is now a tree in the hands of the third party

Ripe Fruit

Rev. Rul. 69-102

i. Ripe Fruit: That which accrues over time

ii. If at the time you assign the tree, there is ripe fruit on it that you haven't picked, then that is income

iii. "Where the taxpayer does not receive payment of income in money or property realization may occur when the last step is taken by which he obtain the fruition of hte economic gain which has already accured to him"

Compare Horst with Salvatore:

What was being assigned in each case?

Horst - coupons of corporate bond.

Salvatore - portion of contract of sale of gas station.

What was "fruit" and what was "tree"?

Horst - bond is tree; coupon is fruit.

Salvatore - gas station is tree; proceeds from sale is fruit.

Compare Estate of Stranahan with Blair

What was being assigned in each case?

Stranahan - Right to anticipated dividends from his shares of stock, not just a gratuitous purchase b/c there was risk of not getting paid involved.

Blair - Income interest for life in a trust.

What was "fruit" and what was "tree"?

Stranahan - right to dividends (and risk involved) are tree; dividends are fruit

Blair - claim to income is tree; income is fruit; gave away his LE to stream of income which is the same as giving away the tree.

Compare Campbell with Tatum

Chattel: Cf. Campbell with Tatum Campbell: Calves are trees - can divide it (not a tree, it is a forest).

Tatum: Crops are fruit.

Copyrights: Creator v. Transferee Creator is the tree; cartoon which is created is also a tree; income generated from the cartoon is the fruit.

After transferred - Rights are tree.

Partners: Entities Used for Assignment of Income

Partnerships: Created by Agreement

Partnerships are taxed called pass through

Partnerships do not pay tax as they are not recognized as TP under Federal Law

Partnerships calculates taxable income

Partnerships pay tax on distributive share

How partnerships splits income

Will look to partnership agreement (Partnership of capital or services)

KEY: PARTNERS ARE A SINGLE ECONOMIC UNIT (look at division ie. 40% partner or 20% partner)

How are Trusts Created

Three Key Requirements:

1. Settlor/Grantor

i. Puts $$ into trust to be held.

2. Trustee (Trust Never fails for want of a trustee, if others are lacking it will fail)

3. Beneficiaries

Types of Trusts

Simple 651 v. Complex 661

Simple: Provision requires distribution in year received. All in, all out

Complex: Allowed to accumulate income to further the business/investment the trusts are involved in.

Regular (641) v. Grantor (671)

Regular: Considered separate taxable entity

Grantor Trusts: Complex; granto trust taxed on all trust income

1. If it looks like grantor has too much control of the trust

How Trusts are Taxed

Steep Rate Curve (1)(j)(2)(E)

Simple: taxable Inc. - Distributed Inc.

Complex - Distributive Net INc. 37%

Grantor: Trust ignored; Grantor Taxed

How Trusts Split Income

Grantor (Property) -> Trust --- ($) -> Beneficiary

i. Grantor puts income producing property in trust

ii. Trust pays money to beficiary

Grantor Trust Rules (671)

a. Trustee administerss to the trust ot the beneficiaries pursuant to the Grantor's wishes

i. Grantor transfers the property (Tree) to the Trust

ii. Note that Grantor cannot have too much control in the trust, or he will be liable for the taxes.

b. Trust transfers the income (Fruit) to the beneficiaries.

c. Basic: Grantor is taxed

d. Irrevocable v. Revocable:

i. Irrevocable - trust is taxed

ii. Revocable - Grantor is taxed

f. Who earns income? Beneficiariy or grantor?

Corporation Characteristics

Johnson & Borge

a. Limited Liability to Owners under State Charter

b. Board of Directors (Management)

c. Stockholders who can sell, buy shares

d. Perpetual Life: assumed to exist into perpetuity

Corporation: How Taxed

a. Sub C, 301 vs. Sub S, (1361)

i. Sub C: C Corp. taxed as separate entity. Reports & pays tax on its own incomce: If distribute dividents, shareholders also pay tax on those distributions

ii. Sub S: taxing small corps. S Corp. is a pass through for taxation purposes.

Certain types of corporate owners can elect for the orp. to not be taxed and owners are taxed as a passed through entity

How do Corporations Split Income

TP creates Personal Service Corp.

i. TP creator is key employee

ii. TP provides services to Corp.

iii. Corp. makes contracts with 3rd parties to provide those services through its employees

iv. 3rd party was receiving servics from corp. not the TP and paid corp a fee

v. PSC pays shareholders.

i. If shareholders are passive, it makes it look more like assignment of income.

Other ways to Split Income

TP --- (sale or gift of property) → Corp. or Trust.

Corp. or Trust ---(lease-back) → TP ---(rent$) → Corp. or Trust.

Corp. or Trust ---(distributions) → Shareholder or Beneficiary.

Ex. TP owns property and has a law office and purchases an office building.

>TP wants to assign income → create corp. or trust.

>Contribute property to corp. or trust as gift or sale → lease back property from corp. or trust.

>Corp. or trust. Takes the $ and distributes to shareholder or beneficiary.

Cf. May v. CIR, 723 F.2d 1434 (9th Cir. 1984) with Van Zandt v. CIR, 341 F.2d 440 (5th Cir. 1965). May: perfectly fine transaction. Nothing wrong with how trust is set up.

Van Zandt: doesn't work. This is not two transactions. It's one transaction b/c substance over form. Grantor effectively still has control of property.

Assuming trust is valid, court must look at purpose of lease-back and look to purpose of the whole scheme of the transaction.

Statutes that Discourage Assignment

a. Kiddie Tax (1)(g), (1)(j)(4)

i. Makes Jr. pay trust rate on unearned income

ii. Used to be that kids paid at parent's rate, but now pay trust rate.

iii. If kid in school ends at age 24.

b. Trusts: Grantor trust rules 671

i. Force TP to assume all tax implications

c. Personal Service Corps: (Evil 269A)

i. Allows Income to be allocated b/w PSCs and EE-owners

ii. IRS can recharacterize transactions to clearly reflect tax liability

d. Regular Corps: 21% rate; bizzarro 199A

i. 199A lowerd C corp tax rate to 21%> now you wantincome to be at corp. rate and not assigned

e. Partnerships Eco. Substance doctring 7701(0)

i. DONT NEEd TO KNOW 7701(0)