Taxation Schenk Winter 2017
1. Taxation of the Family
Druker v. Commissioner, 1983 (pg. 448)
Facts: Druker, an assistant U.S. Attorney, challenged the constitutionality of the tax burden on a married couple (“the marriage penalty”). Because we have a progressive tax system, a person filing individually who earns $25,000 pays a lower tax rate than if that same person files jointly and combined with his/her spouse has $50,000 in income.
Holding: the burden on marriage is not unconstitutional under any standard of scrutiny.
The disparity between filing individually and filing jointly used to be worse, but Congress has changed some of the laws to reduce this disparity.
While the right to marry is fundamental, reasonable regulations that do not significantly interfere with the decision to marry may be imposed.
For tax rates, see the rate tables on p. _______ of the Code book.
Historical argument: Marriage is an equal partnership in which couples pool their assets.
Current argument: administrative difficulties
Rev. Rul 2013-17: Rules for married couples filing separately (handout)
The Kiddie Tax (§ 1(g)) page 456
Children under 18 (sometimes under 25) will be taxed at their parents’ top marginal rate.
The purpose of this section is to prevent parents from avoiding tax consequences by transferring income to their children thereby reducing their own income and putting them in a lower tax bracket.
Children with some income were taxed at a very low rate. They also got the standard deduction, personal exemptions, etc. thereby sheltering thousands of dollars in taxes.
2. Dissolution of the Family- separation and divorce
One cannot, by any private arrangement, shift tax consequences from one individual to another. The only exception to this rule is upon separation or divorce. Separated or divorced couples may negotiate tax consequences.
Rev. Rul. 76-255, page 459
Facts: What if a married couple gets a divorce on December 28th and remarries on January 2nd so that on December 31st, the day that the taxpayer’s status is recognized, the two are unmarried?
§ 143(a)(1) the determination of whether one is married is determined on Dec. 31st.
Holding: for tax purposes, such a sham divorce/marriage is not recognized.
Reg. § 1.143-1(a) and Reg. § 1.6013-4(a) An individual shall be considered married even if living apart from the spouse unless they are legally separated under a decree of divorce or separate maintenance.
Estate of Borax v. Commissioner, 1965 (pg 461)
Facts: Husband and Wife, married in New York separated and entered a separation agreement. H and W2 went to Mexico where they got and ex parte divorce. H then married W2 in Mexico, then came back and had another ceremony in Connecticut. W1 filed a lawsuit for an injunction declaring that she and H were still legally married.
Holding: the Second Circuit ruled that the payments were deductible even though the court said that the divorce was invalid.
Superseded by Rev. Rul. 67-442: When the court recognizes a marriage, the IRS will respect that declaration.
For tax purposes, since they didn’t have a valid divorce, H could not deduct the alimony payments under § 215.
a. Alimony or Support Payments
The payment of alimony (federally defined) constitutes a deduction to the payer and is includable in the gross income of the recipient.
§ 71(a) gross income includes amounts received as alimony or separate maintenance payments.
(b)(1)(A) This refers to payments made under a divorce or separation instrument.
(b)(1)(B) The instrument must not state that the payment is not income to the recipient for tax purposes, and it must not be allowable as a deduction under § 215.
§ 215 there shall be allowed as a deduction an amount equal to the alimony or separate maintenance payments paid during such individual’s taxable year.
Historically, the paying spouse only got this deduction if he/she itemized. Now, § 62(a)(10) allows the § 215 deduction to be deducted in arriving at AGI.
If the two live under the same roof, § 71 and § 215 don’t apply.
The payment of child support generates no deduction to the payor and no income to the recipient.
The parent receiving those funds has an obligation to use that money to support the child.
§ 71(c) states that subsection (a) does not apply to funds that are designated child support.
Lester (not in book)- § 71(c) calls for a “fixed” payment for child support. If the payment is not explicitly “fixed,” then it will not be considered child support.
Why treat child support differently? Payor has a legal obligation to pay it, so payments are just discharge of that obligation.
B. Assignments of Income in General
Income from services is taxed to the person who earns it.
Income from income producing property is taxed to the owner of the property.
G/L from disposition of income producing property is taxed to whoever is the owner at the time of the sale.
1. Income from Services
Whether income (and tax conseq.) can be shifted depends on whether the TP directed the disposition.
If there’s no agreement to pay and services are rendered without consideration. Question: is a benefit received in the future really consideration for services rendered?
Lucas v. Earl, 1930 (pg 470)
Facts: Husband and Wife entered a contract, which said that income earned by either spouse would be treated as belonging equally to both. In 1920 and 1921 he paid half of his salary to his wife, then tried to only pay taxes on his part, arguing that the other half contractually belonged to his wife.
Earned income is taxable to the person who earns it.
You can’t make an anticipatory assignment of income to another individual to avoid to tax liability
The only time individuals can contract around tax consequences is in the case of alimony or child support payments.
2. Income from Property
Is what is being transferred a right to income or a right to income producing property?
Only a transfer of the latter will effectively transfer the tax consequences.
For example, Schenk can transfer his stock to his grandson, and the grandson will pay taxes on the dividends from that stock (as well as on any gain/loss if he sells). Schenk cannot, however, keep the stock and transfer the right to receive the dividends to his grandson and have his grandson pay taxes on those dividends. The dividends will be Schenk’s income.
Helvering v. Horst, 1940 page 476
Income from property is taxed to the owner of the property
Facts: Taxpayer detached interest coupons from bonds and gave them to his son as a gift.
Holding: the father must include the income from the coupons in his own income- the gift did not effectively transfer the income.
Because of the progressive tax structure, there is strict adherence to principles preventing shifting of income from income producing property.
The Horst decision is no longer effective with respect to bonds.
§ 1286 allows taxpayers to split the interest on bonds from the principal.
Blair v. Commissioner, 1937 page 474
Facts: TP is a life income beneficiary of a trust. He transferred part of his rights as life income beneficiary to his children.
Issue: whether or not that transfer was effective so that the kids would be taxable on the income that is distributed from the trust.
Holding: transfer of INCOME PRODUCING PROPERTY will shift the tax burden of income from property.
First, figure out if what was owned was more than just the right to receive income.
If he has something more than the right to receive income, then his interest is in income producing property and his transfer is effective.
A beneficiary of a trust has a right to enforce fiduciary duties against the trustee, therefore he has more than just a right to receive income. MUST HAVE MORE THAN JUST A RIGHT TO RECEIVE INCOME.
Ex. Trustee decides that beneficiary doesn’t need that much income; therefore
The beneficiary giving away part of his rights is like Schenk giving away the actual stock, not just the dividends.
Question in assignment of income; whether or not Blair owned income producing property
Riebe v. Commissioner, 1962 page 480
Facts: After the taxpayer’s sweepstakes ticket was selected as the winner, but before he received the money, he assigned 2/3 of the ticket to members of his family.
Holding: the taxpayer was liable for the taxes on the entire sweepstakes.
At the time he made the assignment, all he had was a right to receive income.
Braunstein v. Commissioner, 1940 page 481
Facts: taxpayers had a ticket for the Irish Sweepstakes. Two days before the drawing, they transferred their interest to a trust for their children.
Holding: the taxpayers were only taxable on the guaranteed value of the ticket, but not on the rest of the prize.
At the time of the transfer, the ticket was income producing property.
Salvatore v. Commissioner, 29 TCM 89 (1970) (NIB)
Facts: taxpayer inherited land w/ a gas station on it from her husband. The gas company wanted to buy the land, so she negotiated the terms of the sale. Right before they were about to seal the deal, she transferred part of her interest in the property to her kids so that they would receive part of the income from the sale.
The owner of property is the owner at the time of the sale.
Holding: the taxpayer was the owner at the time of the sale because she alone negotiated it.
Look at how much negotiation has taken place – this is fact specific.
TCM: Tax Court Memo – this means it’s a factual determination not a question of law
3. Is Income from Property or Services?
Heim v. Fitzpatrick, 1959 page 481
Facts: Heim invented something and got a patent. He made some improvements to the invention and got another patent for the improvements. He assigned the patents to a corporation in exchange for the right to receive royalties. He transferred some of his rights under the licensing agreement to his wife and children.
Holding: because a prior assignment of the copyright or patent would suffice to shift the taxable income to the donee, a subsequent gift of the royalty contract must be treated similarly.
He had something more than a right to receive a royalty. He had a right to get his property back and an option to cancel. He owned income-producing property.
Have to prove that you have
It wasn’t clear whether the right to exploit Miller’s name/reputation was “property.”
When there is no proof that one has a protectable property asset, as here, the amount received gets ordinary (not capital) tax treatment.
1. The Statutory Framework
a. Property Held for Sale to Customers
Malat v. Riddell, 1966 page 552
Facts: joint venture bought land, then sold off part of that land and hoped to develop the rest. B/c of financial problems, they did not develop it. Rather, they just sold off the rest of the land. (Looks like relinquishment of property)They wanted to treat this land as a capital asset.
Issue: whether § 1221(a)(1) applies: was this land held primarily for sale to customers?
Holding: primarily means “of first importance” or “principally.” The court derived this meaning from the legislative intent of the statute. Unless there is some reason to believe that Congress did not intend for the language to have its ordinary, everyday meaning, then we go to the dictionary.
Look at all the reasons why the taxpayer acquired/owned/held the property- we don’t know at what point to judge what the primary purpose was.
Doesn’t look like it in this case, because the land that was withheld from sale was intended to be used for development. Once they decided against the development, they liquidated the property interest. Was not primarily for sale. – Fernando
International Shoe Machine Corp. v. United States, 1974 page 514
Facts: International was in the business of renting out shoe manufacturing machines. The tax law changed, making it advantageous for users to buy rather than lease the machinery. International Shoe, therefore, began selling the equipment they owned.
Issue: whether International Shoe had changed its purpose so that it was no longer holding the equipment for rental, but rather it was holding it primarily for sale to customers.
Holding: International Shoe effectively changed their purpose so that at the time of the sale, they were holding the equipment for sale to customers.
The exception under § 1221(a)(1) now applies, so the machines are not capital assets.
See also, Continental Can v. United States (1970) pg. 514
Series of 5th Circuit cases involving sale of land-
United States v. Winthrop, 1969 (NIB) Factors in Bramblett
Facts: taxpayer had some land outside of Tallahassee, FL that had been in his family since 1936. As the relatives started dying, he started inheriting more and more of the land, beginning in 1936. As the city was expanding, potential buyers approached the taxpayer about buying a portion of his land. He sold a total of 456 lots over 19 years (1945-1963).
Issue: whether the taxpayer was merely liquidating his investment, or whether he is starting to hold the property primarily for the sale to customers.
LOOKS LIKE LIQUIDATION OF INVESTMENT TO ME
The determination must be all or nothing- can’t say part was investment and part inventory.
Look at why it was acquired, why it was being held, and what the purpose was at the time of the sale.
Of those, the most important is the purpose at the time of the sale.
The number and frequency of sales help us to determine the purpose at the time of the sales.
To determine whether sale of land is sale of a capital asset or sale of property held primarily for sale to customers, ask:
Was the taxpayer engaged in a trade or business? Not really. If yes, what trade or business?
Was the taxpayer holding the property primarily for sale in that trade or business? Not really.
Were the sales contemplated by the taxpayer in the ordinary course of that trade or business?
Factors to consider when answering these questions-
The nature and purpose of the acquisition of the property and the duration of the ownership
The extent and nature of the taxpayer’s efforts to sell the property
The number, extent, continuity and substantiality of the sales
The extent of subdividing, developing, and advertising to increase sales.
The use of a business office for the sale of the property
The character and degree of supervision or control exercised by the taxpayer over any representative selling the property.
The time and effort the taxpayer habitually devoted to the sales.