Presentation:
Federal Income Taxation
Chapter 18 Assignment of Investment Income
Professor Wells
November 4, 2015
1 Chapter 18
Whose Income is It?
P.1057
Fundamental inquiries in this chapter:
Who is the taxpayer?
whose income?
whose deductions?
How take advantage of “multiple runs up the bracket
ladder”?
How can income or deductions be attributed to another
taxpayer?
2 Choices for Identifying the Taxpayer Unit
Choices for possible income/deduction shifting:
1) spouses;
2) children;
3) other family members;
4) family entities (trusts, corporations & partnerships)
Alternative: the entire family (how defined?)
Cf., perspective of other cultures
3 Comparing Income Tax Rates
Rate Brackets and Marginal Rates for individuals - Code
§§1(a)-(d) & (h)
Marginal rates - tax rate applicable to the last taxable dollar.
Cf., effective rate (or average rate).
Tax rates for corporations: Code §11.
4 Corliss v. Bowers
Property Income
p.1058
FACTS: Taxpayer transferred assets into a trust fund for children but
retained the right “to modify or alter in any manner, or revoke in whole
or in part, this indenture and the trusts then existing, and the estates and
interests in property hereby created.”
Holding: Grantor is taxable on the trust proceeds.
[T]axation is not so much concerned with the refinements of
title as it is with actual command over the property taxed—the
actual benefit for which the tax is paid. If a man directed his
bank to pay over income as received to a servant or friend, until
further orders, no one would doubt that he could be taxed upon
the amounts so paid. . . . . The same right existed here although
it is not called a title but is called a power.
5 Douglas v. Willcuts
Property Income
p.1060
Taxpayer transferred funds to a trust for benefit of wife in lieu of
alimony. IRS said that the trust income was taxable to the taxpayer and
that the taxpayer made alimony payments to his ex-wife.
Court held for IRS, stating:
“We have held that income was received by a taxpayer when,
pursuant to a contract, a debt or other obligation was discharged by
another for his benefit. The transaction was regarded as being the
same in substance as if the money had been paid to the taxpayer and
he had transmitted it to his creditor.…The creation of a trust by the
taxpayer as the channel for the application of the income to the
discharge of his obligation leaves the nature of the transaction
unaltered.”
Subsequent Event: §682(a) changes this result for alimony trusts.
6 Burnet v. Wells
Property Income
p.1063
FACTS: Taxpayer established trust that paid insurance premiums on
taxpayer’s life insurance.
Held: Grantor remains subject to taxation on income of the trust.
Trusts for the preservation of policies of insurance involve a
continuing exercise by the settlor of a power to direct the application
of the income along predetermined channels. . . . . He might have
created a blanket trust for the payment of all the items of his own
and family budget, classifying the proposed expenses by adequate
description. If the transaction had taken such a form, one can hardly
doubt the validity of a legislative declaration that income so applied
should be deemed to be devoted to his use. Instead of shaping the
transaction thus, he picked out of the total budget an item or class of
items, the cost of continuing his contracts of insurance, and created a
source of income to preserve them against lapse.
7 Blair v. Commissioner
p. 1069
Edward Blair as the owner of a life interest under trust, but
not the remainder interest (presumably for benefit of
children).
He transferred percentage interests in that life interest to his
children.
Assignments were valid under state law.
Held: Assignment was valid and income attributed to the
children and not to the assignor father.
8 Helvering v. Clifford
Property Income
p.1074
Grantor transferred funds into trust, the income of which would be for
the benefit of his wife. Trust was to terminate in five years and the
grantor was the remainderman. Grantor also was the trustee and had
broad discretionary powers
Held: Income of the trust was taxable to the grantor.
“If it be said that such control is the type of dominion exercised by
any trustee, the answer is simple. We have at best a temporary
reallocation of income within an intimate family group. Since the
income remains in the family and since the husband retains control
over the investment, he has rather complete assurance that the trust
will not effect any substantial change in his economic position. . . .
[W] hen the benefits flowing to him indirectly through the wife are
added to the legal rights he retained, the aggregate may be said to be
a fair equivalent of what he previously had.”
9 Helvering v. Horst
Property Income
p.1080
Assignment of bond interest coupons to child shortly before
interest due date.
“The power to dispose of income is equivalent to the
ownership of the income.”
The anticipatory assignment of income is not permitted for
income tax purposes.
Cf., registered bonds & coupon bonds.
10 Helvering v. Eubank
p.1085
Services Transformed into Property
Facts: Eubank, an insurance agent, assigned renewal commissions
(presumably as gifts).
Held: The commissions are taxable to Eubank, when paid, not to
the assignees.
11 Estate of Stranahan v. Commissioner
(Supp. pp. 84-86)
FACTS: Estate sold dividend strip to beneficiary for $150,000.
Estate reported the transaction as immediate income to estate. IRS
disagrees and claims this is an anticipatory assignment of income.
Question: Why does the IRS contest the estate’s increased taxable
income?
Question: What is the benefit to the heir in doing this transaction?
12 Code §1286
Stripped Bonds
p.577
Assign any tax basis from a bond to stripped interest
coupons? Code §1286 provides that original basis in the
instrument must be allocated between (i) the retained
stripped bond and (ii) the stripped coupon.
Allocation based on relative FMVs at the time of the
stripping transaction. OID to accrue on each instrument
(for both seller’s purchase and buyer’s retained interest).
1,000
100 100 100100 100 100 100 100100100
13 Income from (1) Property or (2) Services?
Supp. pp. 87-88
Heim v. Fitzpatrick
Assignment of patent license royalties to wife and children.
Were royalties received by wife & children taxable to
inventor/husband/parent?
Held: gifts of income producing property – and not merely
gifts of income.
14 Summary of Assignment of Income
Personal Services Income
þ  Assignment of Present (Lucas v. Earl) or Deferred Compensation (Helvering v.
Eubank)
Patents/copyrights/art produced from personal effort (Heim)
Gifts of Income Producing Property
þ  Donor retains underlying property and carves-out income (horizontal slice) or
retains right to get the income producing property back. See Helvering v. Horst.
But see §1286 for bonds
Donor gives the underlying property (vertical slice). Taft v. Bowers. Income
follows the property itself.
Donor gives all that Donor has (even if donor only has a life interest or “horizontal
slice”). Income follows the property itself. Blair v. Comm’r.
Sale of Carved-Out Interest in Income Producing Property.
Donor retains underlying property and sells a carved-out interest in income
(horizontal slice). See Estate of Stranahan.
15 Final Thoughts: Income From Property
Income from property is taxed to its owner.
Gift of the property itself shifts the income from the
property to the transferee.
Gift only of income from the property (while retaining a
remainder interest) will not shift the income to the recipient
of that income.
16 Identifying “Carved-Out” Interests
Examples:
1)
Gift of dividends stream (for several years?) from
corporate stock, but retaining the stock itself.
2)
Gift of rent from a “rent house,” but not a gift of a
remainder interest (or portion) in the house.
Extend Code §1286 to these situations?
17 Income from Gift and Bequest Property
§102(b)(1) - the income exclusion does not extend to the
income received from the gifted property.
Consider several trust interests:
1) the life tenant’s portion; and
2) the remainderman’s portion.
Trust income is entirely taxed to the life tenant. E.g., gift of
“income only” is not excluded from gross income; the entire
benefit of the §102 exclusion is for the remainderman (when
eventually receiving the remainder interest).
18 Trusts
p.1089
(i.e., “Simple” or “Complex” Trusts”)
Tax either to (1) trust or (2) beneficiary.
§§651-652 – simple trusts – merely a conduit (p. 593).
§§661-662 – complex trusts – taxation to the trust if income
retained by the trust; or, tax to beneficiaries to receive
income distributions.
Very steep income tax brackets for trust income taxation.
§1(e).
19 Trusts
Grantor vs. Nongrantor Trusts
p.1092
§671 provides for grantor trust (i.e., ownership) status,
where:
§673 – reversionary interest of grantor
§674 – certain beneficial powers
§675 – administrative powers
§676 – revocation power
§677 – subsequent distribution to grantor or spouse (or to
satisfy support obligation)
20 Interest-Free Loans
§7872
p.1098
1. A’s employer lends her $100,000 interest free to purchase a home.
2. B’s mother lends him $100,000 interest free to purchase a home.
3. What difference would it make in either of the above cases whether the loan were a demand
loan or a fixed-term loan? What if the employer loan, in particular, were a 15-year term loan, but
with a provision requiring payment sooner upon termination of employment?
4. Are there relationships other than those specified in §7872 in which an interest-free or belowmarket interest loan may represent a disguise for something else?
5 (a) Geraldine could simply make her parents a $40,000 interest-free loan to enable them to
purchase the condominium and then increase her annual contributions from $6,000 to $21,700 to
enable them to meet the resulting annual costs.
5 (b) Geraldine could seek to borrow $160,000 on her own credit and then lend her parents
$200,000 with no interest to enable them to buy the condominium without a mortgage.
(c) Geraldine might simply purchase the condominium herself and then let her parents live in it
rent free. She would pay all the expenses of ownership, including mortgage interest and principal,
directly.
(d) Geraldine could purchase the condominium herself and then let her parents live in it charging
them the existing ceiling rental of $6,000 ($500/month). In this case Geraldine would plan to treat
her investment in the condominium as an income-producing investment. She would in this case
also plan to give her parents about $6,000 a year in some other form to meet other expenses, so
that their total budget would not be upset by the necessity of paying rent.
21 Partnerships
Partnerships are conduit entities, not subject to federal
income taxation.
Each partner is allocated his share of each income and
deduction item.
Informational tax return to be filed, including K-1s (a W-2
or 1099 equivalent).
Tax basis in the partnership interest enables loss flow
through; tax basis includes debt (note the Tufts case) &
allocated income.
22 Family Partnerships
Can a parent make his children “partners” in a partnership
and deflect income to them through the partnership
arrangement?
Cf., a service partnership vs. a capital investment
partnership.
§704(e) permits recognition of those partners who have a
capital interest in the partnership where capital is a
“material income-producing factor.”
23