Chapter 7 p. 551 Tax Progressivity Why seek income splitting : To moderate the impact of the progressive income tax rate structure. What is tax rate progressivity? See Code 1. What is the marginal rate? Average rate? Tax policy: Does progressive tax rate structure facilitate distributive tax justice? Is this appropriate (e.g., to implement egalitarianism)? Fiscal policy: relevance of USG spending? Redistribution downwards (or upwards)? 11/25/2014 (c) William P. Streng 1
Moderating the Progressive Tax Rate Can be achieved by income splitting. How is an assignment of income to another taxpayer accomplished to moderate the impact of the marginal rate? Shifting of gross income for FIT purposes can occur: (1) within a family unit (i.e., individuals), or (2) among controlled entities and owners. Note (p.553), e.g., 1(g) providing for unearned income of minor children to be taxed at parents marginal income tax rate. The kiddie tax. 11/25/2014 (c) William P. Streng 2
Tax Common Law Lucas vs. Earl p.554 Services income. Before availability of joint tax return filing - could he contract with his wife for her to receive 1/2 of his income and, therefore, each spouse would separately report 1/2 of his total gross income from salary/fees? Held: Income is taxable to that person earning the wages (and not the legal owner for local property law purposes). No anticipatory assignment of income was permitted. Was this a U.S. constitutional law case? Why? 11/25/2014 (c) William P. Streng 3
Gratuitous Performance of Services p.556 Should the providing of gratuitous services to another produce imputed income to the donor? E.g., parent provides investment assistance to child? And, also bookkeeping/computer record keeping assistance? And, prepares the child s/parent s federal income tax return? What if free (entertainment) services directly provided by a famous entertainer at a charity event? Or, at a political event? 11/25/2014 (c) William P. Streng 4
Employment p.556 Discrimination Damages Plaintiff in employment discrimination case must include all damages received in gross income, including amount paid to contingent fee lawyer. Deduction is available to taxpayer for legal fees paid; inclusion in the lawyer s income. What impact of this treatment for (1) 2% floor, (2) itemized deduction phase-out, and (3) AMT? See Code 62(a)(20) providing above the line treatment for costs in discrimination lawsuits (but not for other tort actions). 11/25/2014 (c) William P. Streng 5
Community Property & Income Splitting p.557 Poe v. Seaborn: spouses in community property state made separate income tax returns with each reporting one-half of their total income. IRS says all income is his for tax reporting. Conclusion: income allocation here is governed by state (community) property law & wife has a vested right in ½ of the community property. IRS asserts husband s power of management. Here: husband s earnings were community property income from the inception. 11/25/2014 (c) William P. Streng 6
After Poe v. Seaborn p.560 Advantage provided to community property jurisdictions - since splitting of the income enabled two runs up the bracket ladder for federal income tax purposes. Seaborn was a statutory case, not a constitutional case, but should it have been rejected by Congress? Eventual result (1948): Joint income tax return for spouses enabling equal splitting of income and two runs up the income tax bracket ladder. 11/25/2014 (c) William P. Streng 7
Income Diversions Mandated by Law P.560 Commr. v. First Security Bank bank deflected insurance business to a related company which received entire premium income with no reduction for commission. Bank s receipt of the sales commission violated Federal banking laws. IRS says applicability of 482 the (economic) income allocation & transfer pricing rule. Sup. Ct. says no income to the bank since prohibited from receiving. Can Sup. Ct. declare laws of economics (or the market) invalid? 11/25/2014 (c) William P. Streng 8
Domestic Partners & CCA 200608038 Domestic partners in California: include (1) all of individual s earned income, or (2) one-half of total earned income of individual & domestic partner. For California income tax reporting purposes then to use FIT filing status (but could enter into a property allocation agreement). IRS held: Report only one s own income in this situation for FIT purposes. Poe vs. Seaborn is not applicable in registered domestic partnership not married under Cal. law. 11/25/2014 (c) William P. Streng 9
CCA 201021050 p.564 2007 change in Cal. law re registered domestic partners that earned income is to be treated as community property for state income tax purposes, and also for Cal. property law purposes. IRS decision: Federal tax law respects state property law characterizations. Therefore, FIT treatment of community property law applies to registered domestic partners in California. Each must report ½ of total community income. 11/25/2014 (c) William P. Streng 10
Windsor decision US Sup. Ct. 2013 Invalidation of DOMA (violation of the equal protection clause in U.S. Constitution). Same-sex marriages are recognized for Federal tax (estate tax) purposes. Rev. Rul. 2013-17 permits joint income tax return filing for same-sex couples if validly married under state law even if domiciled elsewhere. Optional retroactivity of this status permitted. See Notice 2013-61 re over-collected FICA taxes, etc., & refund procedures. 11/25/2014 (c) William P. Streng 11
Marriage Penalty (& Bonus) p.566 1948 enactment of joint return opportunity. Twice the tax on one-half of the income. But, then a marriage penalty for couples where each spouse had a similar amount of income when compared to non-married filing. Does this provide an incentive to two high income earners to live in sin for tax planning reasons? Is this also a benefit for (unmarried) same sex couples where income levels are equalized? 11/25/2014 (c) William P. Streng 12
Married Filing Separate Returns p.569 Situations where useful for married persons to file separately: - Separated but not divorced. - To avoid joint & several liability on the federal income tax return. One spouse has undisclosed income - but does the innocent spouse provision apply? See 6015. - To enable one spouse to use deductions above the floor for medical expenses (7½% or 10%) or casualty losses (10%). 11/25/2014 (c) William P. Streng 13
Transfers of Property Income p.569 Income from property is taxed to the owner. - A gift of property itself will shift the posttransfer income received from the property to the transferee. How define property? - A gift of only income from the property (while the transferor retains a remainder interest in the property) will not shift (for FIT purposes) the income to the recipient of that income. The transfer can be, however, a completed gift for contract/property purposes. 11/25/2014 (c) William P. Streng 14
Blair v. Commissioner p.570 Blair was the owner of a life interest under a testamentary trust, but not the remainder interest (for the benefit of his children). Blair transferred percentage interests in his trust life interest to his children. These assignments were valid under state law (rejecting earlier spendthrift trust treatment). Held: Assignment was valid and the income was attributable to the children/donees & not to the donor/assignor father. Vertical slice transferred? 11/25/2014 (c) William P. Streng 15
Blair Trust Structure 1) Grandfather Last Will 2) Life Interest to Taxpayer- Father 3) Remainder interest to grandchildren (c) William P. Streng 16
Helvering v. Horst Fruit & Tree p.572 Delivery (by gift) of bond interest coupons to child shortly before an interest income due date. What is a coupon bond? Or, a detached interest coupon? Sup. Ct: The power to dispose of income is equivalent to the ownership of the income. This anticipatory assignment of (this) income is not permitted for income tax purposes. Cf., registered bonds vs. coupon bonds. How mechanically accomplish reg. bond transfer? 11/25/2014 (c) William P. Streng 17
Stripped Bonds - 1286 p.577 Separation of (1) the bond and (2) the right to the interest payment. How? Each instrument (bond & interest payments) is treated as a separate OID bond, i.e., discounted at the then applicable discount rate. In Horst was tax basis allocable to all the components, i.e., the interest coupons and the principal amount? No. 11/25/2014 (c) William P. Streng 18
Services Transformed into Property p.577 Helvering v. Eubank, p. 578 Life insurance agent terminated status as an agent; but, was entitled to renewal commissions in the future from previously written contracts. Taxpayer made assignments of all these future payments (to a trust for children). Holding: income to assignor of commissions. Separate opinion: can not be income from services if the services are already performed; would permit assignment of property interest. 11/25/2014 (c) William P. Streng 19
Olmsted Life Agency p.581 Income postponement (not deflection). Agent surrenders renewal commission rights in exchange for a 15 year annuity (spreading the income forward) paid to the agent. Held: not a taxable disposition of rights under the commission agreement. Accepted that the taxpayer could extend the time for the receipt of taxable income by the taxpayer (& not by others). 11/25/2014 (c) William P. Streng 20
Heim v. Fitzpatrick P. 579 Prior patent assignment & royalty agreement with inventor & his closely held company. Then, a transfer by the inventor of his property interests/substantial rights under the royalty agreement to the spouse & children (subject to snap-back provisions). Held: transfer of income-producing property for income tax purposes. What similarity (if any) to Horst (interest payments/coupons, p.572) case or Blair case? 11/25/2014 (c) William P. Streng 21
Examples re Assignments of Intellectual Property P. 581. Examples re creation or purchase of patent and then the transfer of an interest to a family member. Example: Attorney was assigned a portion of interest in a patent for services provided and then the attorney transfers the royalty interest to child. Income inclusion by the assignor? Cf., copyright on a book, and then assigning the interest in the copyright to child. P. 582. See the copyright notice on the FIT casebook. 11/25/2014 (c) William P. Streng 22
TRUSTS p.582 What is a trust? A property law concept where (1) legal and (2) equitable ownership are separated (between the equitable owner(s)/beneficiaries and the trustee). Distributions (income and/or corpus) are payable to one or more beneficiaries. The tax question (considering the assignment of income principle) is: Who is deemed in receipt of the trust income for FIT purposes - (1) trust grantor? (2) the trust itself? or, (3) one or more beneficiaries? Not trustee (an agent). 11/25/2014 (c) William P. Streng 23
Irrevocable Trusts and Income Taxation p.583 Assume (1) an irrevocable or true trust with (2) no retention of controls by the trust grantor (including, e.g., at the time of death). Then: Subject to tax rules for dividing income (for income tax purposes) between (1) the trust and (2) beneficiaries. See Subchapter J, 641-668 (Subpart A-D). I.e., Statutory rules re assignment of income. Cf., trust income allocation rules for local/trust law purposes 11/25/2014 (c) William P. Streng 24
Cf., Grantor Trust Rules Income to the Grantor Cf., trusts where the grantor has retained certain significant powers, i.e., grantor trusts. The grantor is treated as the owner for federal income tax purposes. I.e., an assignment of income has not been completed. Taxation of the income of the trust is to the grantor/owner. 671-677 (Subpart E). 11/25/2014 (c) William P. Streng 25
Simple Trusts True Conduit Treatment p.583 Assume: Trust is required to distribute all its income currently, and no corpus distributions. See 651-652 specifying that all income is taxed to the beneficiary & deduction to the trust. No income is taxed to (1) the trust (i.e., flowthrough treatment) or (2) the trust grantor). A conduit analysis determines the attribution of trust income to beneficiary. 652(b): Pass-through of the tax character (e.g., capital gains or tax-exempt) of trust income. 11/25/2014 (c) William P. Streng 26
Complex Trusts p.584 A trust may be subject to income tax (at a steeply progressive rate) on its taxable income. Deduction is permitted to the trust for current income distributions to the beneficiaries. The beneficiaries are subject to income tax on the distributed amount, as limited to the distributable net income or DNI. 643(a). See, throwback rules (p.585); but, note, the functional repeal of throwback rules in 665(c) & tax rate structures. 11/25/2014 (c) William P. Streng 27
Multiple Trusts Rule p.586 Note: Tax planning attempts to use multiple trusts for the same beneficiaries to enable several runs up the bracket ladder. Also, to benefit from $100 or $300 exemption per trust. But, consider 643(f) re the possible amalgamation of trusts where (1) two or more trusts have substantially the same grantors and same primary beneficiaries, and (2) the principal purpose of such trusts is the avoidance of federal income tax. 11/25/2014 (c) William P. Streng 28
Grantor Trusts p.586 Under what circumstances is income of a trust allocable to the trust grantor (and not the trust or trust beneficiaries)? I.e., the trust is treated as the equivalent of an agency. See 671. 1) Trust is revocable. 676 requires income attribution of a revocable trust to the grantor. 2) For the benefit of the grantor. 677(a) attributes income to grantor where income can be used for grantor (or spouse). 677(b) also when income used to fund a support obligation. 11/25/2014 (c) William P. Streng 29
Grantor Trusts, cont. 3) Reversions income attribution to the grantor where grantor s reversionary interest is greater than 5 percent of the value of the trust. 673. (see casebook, p. 39). Exceptions when a reversion after the death of minor descendant. 4) Powers of control grantor as owner where holding a power of disposition. 674. Certain exceptions for retained powers, 674(b), (c) & (d) &, also, dependent upon who is the trustee. E.g., 674(c) permits a spray or sprinkle power granted to an independent trustee. 11/25/2014 (c) William P. Streng 30
Grantor Trusts, cont. 5) Certain unusual administrative powers can cause grantor trust treatment. 675. E.g., power of grantor (a) to buy property from the trust, 675(1); (b) to borrow from trust without adequate security, 675(2); (c) certain borrowing by the grantor and no repayment at year-end, 675(2); or, (d) significant voting powers re stock held by the trust, 675(4). Cf., trustee s tilting trust investment policy to (1) bonds or (2) stock. 11/25/2014 (c) William P. Streng 31
Grantor Trusts, cont. 6) 677 (considered further). Income for the benefit of grantor. 677(a) distribution to grantor or spouse presently or delayed; Or, 677(a)(3) - the payment of insurance premiums on the life of the grantor. 677(b). Satisfaction of a support obligation. What is a support obligation? College tuition? Definition of support is a state law matter. 11/25/2014 (c) William P. Streng 32
678 Power to Demand Trust Distribution p.591 678 provides that a person other than the grantor can be treated as owner if holding the authority to demand income or corpus from a trust. Must have the power to vest the income or corpus in oneself. Power can not be subject to a limitation, e.g., can not be a support trust. 11/25/2014 (c) William P. Streng 33
What Other Choices for an Investment Entity? 1) Partnership (including an LLC ) conduit treatment for FIT purposes, including a family partnership or family limited partnership or an FLP. 2) S corporation modified conduit treatment. See 1366 re reasonable compensation required. 3) Qualified retirement plans. 4) Other techniques? E.g., gift-leaseback or sale-leaseback. 11/25/2014 (c) William P. Streng 34
Family Partnerships Culbertson case p.592 1) Can a partnership be used to deflect earned income to a family member? 2) What about where partnership income is derived from capital investment? See 704(e) about making family members part of the partnership where capital is a material income-producing factor for the partnership. Can income be deflected to another person through a partnership if the income is derived from investment property? When is capital a material-producing factor? 11/25/2014 (c) William P. Streng 35
Gift & Leaseback p.593 Brooke case (Non-trust) Father/donor transferred real property to children, including where parent had a business (medical practice) office. Father was appointed as guardian of children. Father paid rent for use of his medical offices in transferred property. Held: Sufficient property interest passed by gift to the children to enable a 162(a)(3) business expense deduction to Father. Payments to children were not for support obligations, i.e., not father s income; cf. 677(b). 11/25/2014 (c) William P. Streng 36
Deferred Comp. Trust Basye case p.599 Physicians in Permanente limited partnership and partner/physicians contribute to a medical care plan. Beneficiaries of the trust were physician partners and other non-partner doctors. Possible payment after retirement, but forfeiture of interest if employment at Permanent is terminated before retirement. Permanent provided services to Kaiser Foundation insured and Kaiser contributed to a separate trust. Compensation currently to the partners? Held: yes. 11/25/2014 (c) William P. Streng 37
Basye Structure Partners Retirement Plan & Trust Payments by Kaiser: 1) Compensation 2) Plan Contributions Permanente Kaiser Foundation Medical Group Health Plan (Ltd. Partnership) 11/25/2014 (c) William P. Streng 38
Bayse case holding P.599 Gross income of the partnership includes payments to the retirement trust. Result even though payments not made to the partnership income is taxed to the earner. Deflection of income to retirement fund covered by Lucas v. Earl analysis. Inclusion in income of the individual partners pursuant to sharing ratio in the partnership agreement. 11/25/2014 (c) William P. Streng 39
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