chapter 7 p. 551 tax progressivity · 12/5/2013 (c) william p. streng 2 moderating the progressive...

12/5/2013 (c) William P. Streng 1

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)?


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.”


Tax “Common Law”

Lucas vs. Earl p.554

Services income. (Before availability of joint

return filing) could he contract with 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?


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?


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 other tort actions).


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.


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.


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?


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.


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.


Windsor decision

US Sup. Ct. 2013

Invalidation of DOMA (violation of equal

protection clause).

Same-sex marriages recognized for FTI

purposes.

Rev. Rul. 2013-17 permitting joint returns 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.


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 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?


Married Filing Separate

Returns p.569

Situations where useful for married persons to

file separately:

- Separate but not divorced.

- To avoid joint & several liability on the federal

income tax return. One spouse has undisclosed

income (but “innocent spouse” provisions).

- To enable one spouse to use deductions above

the floor for medical expenses (7½% or 10%) or

casualty losses (10%).


Transfers of Property

Income p.569

Income from property is taxed to the owner.

- A gift of property itself will shift the post-

transfer 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.


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?

(c) William P. Streng 16

Blair Trust Structure

1) Grandfather – Last Will

2) Life Interest –

to Taxpayer- Father

3) Remainder interest –

to grandchildren


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?


Stripped Bonds - §1286

p.577

Separation of (1) the bond and (2) the

right to the interest payment.

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.


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 already performed;

permitted assignment of property interest.


Olmsted Life Agency

p.581

Agent surrenders renewal commission rights for

a 15 year annuity (spreading the income

forward).

Held: not a taxable disposition of rights under

the commission agreement.

Accepted that taxpayer could extend the time

for the receipt of taxable income by the

taxpayer (& not by others).


Heim v. Fitzpatrick

P. 579

Assignment of ownership interest in invention &

patents (applications) to spouse and children.

Prior patent assignment/royalty agreement with

inventor’s closely held company. Transfer of

property interests/substantial rights to spouse &

children (subject to snap-back provisions).

Held: transfer of income-producing property

for income tax purposes.

Similarity to Horst (interest payments) case?


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 re attorney assigned portion of interest

in a patent for services provided and the

attorney then transfers the royalty interest to

child. Income inclusion by the assignor?

Copyright on book, and then assigning interest

in the copyright to child. See the copyright on

the FIT casebook.


TRUSTS

p.582

What is a “trust”? A property law concept

where legal and equitable ownership are

separated (between the owner and the trustee),

with distributions (income and/or corpus)

payable to one or more beneficiaries.

Tax question (considering the “assignment of

income” principles) 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).


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. Subchapter J, §§641-668.

Cf., trusts where the grantor has retained

certain significant power, i.e., “grantor trusts.”

If so, taxation of the income of the trust is to the

grantor/owner. §§671-677.


Simple Trusts – True

Conduit Treatment p.583

Assume: Trust is required to distribute all

income currently, and no corpus distributions.

See §§651-652 specifying that all income is taxed

to the beneficiary. No income is taxed to the

trust (or to the trust grantor).

A conduit analysis applies to determine the

attribution of trust income to the beneficiary.

Also: Pass-through of tax character (e.g., capital

gains or tax-exempt) of distributed income.


Complex Trusts

p.584

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).

Throwback rules (p.585). Note, the functional

repeal of throwback rules in §665(c).


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 amalgamation of trusts

where (1) 2 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.


Grantor Trusts

p.586

Under what circumstances is the 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.”

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.


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.



5) Certain unusual “administrative powers”

can cause grantor trust treatment. §675.

E.g., power of grantor to buy property from the

trust or borrow from trust, subject to

exceptions.



6) §677. Income for the benefit of grantor.

§677(a) – distribution to grantor or spouse –

presently or delayed;

Or, the payment of insurance premiums on life

of the grantor.

§677(b). Satisfaction of a support obligation.

What is a support obligation? College tuition?

The definition of “support” is a state law

matter.


§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., be

a “support” trust.


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.”

2) S corporation – modified conduit treatment.

3) Qualified retirement plans.

4) Other techniques? E.g., gift-leaseback or

sale-leaseback.


Family Partnerships

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 a

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”?


Gift & Leaseback

(Non-trust) p.593

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 the father’s income).


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.


Basye Structure

Partners Retirement Plan

Trust

1) Compensation

2) Plan Contributions

Permanente Kaiser Foundation

Medical Group Health Plan

(Ltd. Partnership)


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chapter 7 p. 551 tax progressivity · 12/5/2013 (c) william p. streng 2 moderating the progressive...

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