Wayne State University Professor Alan Schenk
Law School Fall, 2016
BASIC INCOME TAXATION
Whose Income is it?
Key statutory provisions:
71 and 215=- alimony
However, a lot of this section is judge made law. We have a progressive tax system, which attempts to minimize tax w/in family.
How do we minimize tax?
Try to shift some of the income of the higher income members to the lower income members of the family
Typically from parents to children—problem in this area in connection w/ trust—parents might want to shift income into their child’s tax returns, more advantageous before than it is now, while they want to shift the income they aren’t that altruistic that they actually want to shift the wealth as well. And we will see that that’s what causes the problem.
So who’s the TP, who is assigned the income?
Overarching background: In the area of “who is the TP” or “assignment of income” we look at income from:
1) services, 2) income producing property and 3) disposition of income producing property the rules w/ respect to each of those is different.
If you look at section 1 for married individuals over 400,000 you’re up to 35% bracket, 466950= 39.6% bracket but unmarried individuals the first 9 thousand is taxed at 10%. So if you can shift income from a TP, or a joint return, husband and wife, you can shift income form 35% -39.6% down to 10% or down to zero. That’s quite a savings for the family! The incentive is there. So how do we deal with it?
We have categories—income from services—classic case was actually back before we ever had an income tax. TP decided he wanted to share his income from his income source w/ his wife, and therefore gave her and undivided half interest in any of the income that he had. Wellà
A) Services: Lucas vs. earl was decided in 1930, it was an agreement that was entered into in 1901. And the court in 1930 in Lucas vs. Earn said oh no! You cannot shift income from services that the income belongs to the person who rendered the services. That’s the basic principal.
Illustration: You can’t go up to dean Gables office and say “do me a favor instead of paying me on Wednesday could you just make that payment to my grandson, he’s getting ready for college next year, and I’d like him to have that check.”
What would that do our tax system if you can do it for services you can do it for anything. What would happen w/ our tax system if everyone had an opportunity to take income from services and direct it to anyone that they wanted and reduce their tax burden. Within every family group. The progressive income tax system wouldn’t be as progressive as it is now, they would just allocate income among members of the family and divide it up, if you had 5 kids, 10 kids, you’d spread it around so that everyone is taxed at a very low rate.
That’s why we have the
B) Income from income producing property: Income from income producing property is different. That is, if I owned some real-estate and derived rent from that real estate, that rent belongs to me I’m the owner of the property that’s producing the income, so I should be taxed on it.
So the principle is again the same! That is,
Illustration: and wouldn’t it be nice if I could keep my asset and just give the rent to other members of the family. I owned the significant property (the property that’s producing this income) I own an oil well, that’s extracting oil 24 hours a day.
However, if you do want to shift the benefit of ownership if you want to shift the real estate itself (land and rental building) to your child that’s ok and we’ve already seen at the beginning of the coursethat you can make gifts and if you make a gift of property that has appreciated, so long as you give away that income producing property, )
Illustration: so if I have some Microsoft stock that I bought for $10 a share, and its now $60 while I can’t just notify the registered agent to pay the dividends to my grandson, I can give the stock to my grandson, and if he sells it, he is the one that’s taxed on the $50 of appreciation as well as on all the future dividends.
We’ll look at the issues that arise when the owner of the property tries to shift the income of that property from the owner of the property
Key points so far:
Services Income is taxed from he who earns it
Income producing property-tree and fruit doctrine b/c the owner of the tree is taxed on the fruit, you can’t just give away the fruit and keep the tree, and transfer tax consequences
C. Disposition of income producing property:
: and the case we will look at is the Salvatori case where the TP’s husband owned a service station and he died, and she and a couple of the older kids ran the gas station, younger kids in the family as well. The oil company that was providing the gas to the station decides they would like to own that station. They negotiate w/ salvatori to buy the station. Station consists of land, structure, some pumps a few other things w/in the building where they’re selling gas, novelties, etc. easy to find in that case that the property that’s being sold= income producing. Piece of real estate, and some personal property as well which is what’s earning the income. so she negotiates w/ oil company to sell this business, and they pretty well agree on the terms, they’re about ready to close the deal and 5 minutes to 12 the tax advisor comes in and says “wait a minute” you know if you transfer the interest in this property, among you and the kids then each of you is going to report part of the gain on this sale, and in terms of the total tax consequences you’ll have to pay less tax. Sounds like a good deal!—so they transfer undivided interest in this piece of property, this business, to the kids and then sign on the dotted line and sell to oil company.
Issue: Who’s the TP? Who is the seller? I
son. So what was happen is that high income tax payers, that had assets to do this, would put 100,000 into a trust, the trust would invest in stocks and other investments. The income of the trusts went to the kids, and so effectively the income from that 100,000, rather than being taxed to the parent, now was taxed to the children. b/c of income tax rules we had at the time, the kids could get quite a big, several thousand a year that was not taxed at all, then they were taxed at a very low rate à like now 10% and it was wonderful for us tax advisors b/c we could give this wonderful advise and families could save tax, but the gov’t wasn’t too happy about it b/c more and more TP started doing it—upper and middle income tax payers started doing it. so IRS started losing revenue.
Congress puts an end to it: Congress said we aren’t going to do that anymore. If you’re going to do this and kids are under 19, basically the income of the kids is taxed at the parents highest marginal rate. If parents are taxed at 35% rate, then the kids income= 35% rate. That took care of all of the abuse. Usually when there’s an abuse congress uses a sludge hammer to fix it and we’ll see this in other cases as well. They really shut it down, special rules on the kids being entitled to standard deduction, no standard deduction, there’s still a little you can benefit from, but very little not enough say for college education that will cost several 100 thousand dollars.
You can see that in the material, while there was a substantial penalty on getting married if the two members of the couple each earned income especially if they earned about the same amount of income. if husband and wife each earn 50/70 thousand dollars, their combined tax is going to be higher than if they were unmarried. Congress tried to ameliorate it! There are a lot of tax features that try to take that into account: standard deduction on small roman 12. The standard deduction to file a joint return 12,600. If you’re unmarried its exactly half of it. So a lot of the cases that we have are cases that occurred during the time when it was even more valuable to be unmarried by these two job couples.
One of them is described in . A and B = married filed joint return in 1975—state court later annulled marriage, April 1976 the marriage was annulled. What happened in 1975 before that court decree. How do they change?