what is the assignment of income doctrine

What is “Assignment of Income” Under the Tax Law?

Gross income is taxed to the individual who earns it or to owner of property that generates the income. Under the so-called “assignment of income doctrine,” a taxpayer may not avoid tax by assigning the right to income to another.

Specifically, the assignment of income doctrine holds that a taxpayer who earns income from services that the taxpayer performs or property that the taxpayer owns generally cannot avoid liability for tax on that income by assigning it to another person or entity. The doctrine is frequently applied to assignments to creditors, controlled entities, family trusts and charities.

A taxpayer cannot, for tax purposes, assign income that has already accrued from property the taxpayer owns. This aspect of the assignment of income doctrine is often applied to interest, dividends, rents, royalties, and trust income. And, under the same rationale, an assignment of an interest in a lottery ticket is effective only if it occurs before the ticket is ascertained to be a winning ticket.

However, a taxpayer can shift liability for capital gains on property not yet sold by making a bona fide gift of the underlying property. In that case, the donee of a gift of securities takes the “carryover” basis of the donor.  

For example, shares now valued at $50 gifted to a donee in which the donor has a tax basis of $10, would yield a taxable gain to the donee of its eventual sale price less the $10 carryover basis. The donor escapes income tax on any of the appreciation.

For guidance on this issue, please contact our professionals at 315.242.1120 or [email protected] .

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The Assignment of Income Doctrine: A Tax Trap for the Generous but Unwary A Practitioner's Guide to the Anticipatory Assignment of Income

• Posted on May 30, 2024

Flashbacks, Squirrels, and the Assignment of Income Doctrine

Understanding the assignment of income doctrine is crucial for taxpayers who want to pass their earnings to another individual or entity before receiving the income themselves. Equally important is grasping the Federal income tax treatment of such assignments to avoid unexpected tax liabilities. This doctrine, examined by Federal courts since the early 20th century, dictates that income must be taxed to the person who earns it, regardless of any anticipatory arrangements or contracts. Simply put, the IRS is more concerned about who’s holding the purse strings than who’s pocketing the change.

The irony of the adage “even a blind squirrel finds a nut every once in a while” is not lost on you as you receive a visit from your dactylally deficient Cousin Elmer .  As you may recall from our post on the FBAR filing requirements , Cousin Elmer has seven and a half fingers, a reminder of his unsuccessful guerrilla attack on a scurry of squirrels living in his attic using what can only be described as a Vietnam-era improvised explosive device.  That Elmer has as many flashbacks of “Charlie” as he does of those poor squirrels I, you think to yourself, karma in its purest form.

For reasons unknown to you, Elmer made a small fortune in the fireworks industry.  Though he left his job as chief munitions advisor three years ago after the unfortunate sciurine incident that cost him two and a half fingers (and not a small amount of his dignity), he earns royalties on a few patents that he developed including, “The Screaming Weasel,” “The Ring of Thunder,” and his personal favorite “Click, Click, Boom!” [1]

Elmer informs you that he has more than enough money, and he is tired of paying taxes to “The Man.”  ( You’ve come to understand that The Man is anyone in a position of authority, whether it be the entire Federal government, or Billy Joe, the manager of the bait shop, who has kicked Elmer out no less than seven times over the past six months. )

As such, Elmer wants you to draft up a contract whereby the royalties, which would have gone to Elmer, instead are paid directly to his illegitimate but charming son, Cletus.

After establishing goodwill with Elmer by affirming that “we” hate Billy Joe, [2] you sit him down for another one of your much appreciated tax talks, this time about the anticipatory assignment of income doctrine.

The Doctrine in a Nutshell

From time immemorial (or at least since 1930), [3] “the first principle of income taxation [is] that income must be taxed to him who earns it.” [4]   This principle holds true even if the right to that income is assigned to another person or entity. [5]   An individual who earns income cannot escape taxation “by anticipatory arrangements and contracts however skillfully devised….” [6]   You can see that Elmer understood at least a few snippets of what you just explained, as he lets out a huge sigh of disappointment leaving him, quite literally, deflated.

The assignment of income doctrine determines who is responsible for the tax on income, focusing on who earned the income or who controls the earning of the income rather than who ultimately receives it. [7]    If the assignor retains dominion over the income-generating asset, they cannot escape taxation by assigning the income. [8]  This focus on control “preserves the principle that income should be taxed to the party who earns the income and enjoys the consequent benefits.” [9]   Because Elmer earned the royalties, and he controls the right to direct the income to Cletus or whomever scuttles Billy Joe’s bass boat, the income will be taxed to Elmer, even if he never actually receives it.

History of Anticipatory Assignments of Income

For nearly a century, [10] federal courts have held that income generated from personal services must be reported in the gross income of the individual performing such personal services. [11]  Similarly, income derived from property should be reported in the gross income of the person that maintains beneficial ownership of that property. [12]   The process of identifying the true beneficiary of income‑producing property is a matter of examining the facts and circumstances of each assignment, including which taxpayer has the authority over the property and can enjoy its economic benefits or bear its economic burdens. [13]

When any individual or entity attempts to “avoid taxation by entering into a contractual arrangement whereby that income is diverted to some other person or entity,” courts have nearly universally held that this anticipatory assignment of income is improper, and such income “must be taxed to [the person or entity] who earns it.” [14]   The Supreme Court has gone as far as to state that this doctrine is a “foundational rule” of U.S. income taxation. [15]

Nearly a century ago Justice Oliver Wendell Holmes articulated the doctrine of anticipatory assignments of income in his seminal opinion in the case of Lucas v. Earl . [16]

In Lucas , the taxpayer‑husband entered into a contract with his wife whereby she became entitled to one-half of any income he might earn in the future.  On the belief that a taxpayer was accountable only for income he actually received, the husband thereafter reported only half of his income.  Nay, nay , sayeth Justice Holmes.

The Supreme Court was unwilling to accept that tax laws permitted such easy deflection of a taxpayer’s income tax liability, and it held that the taxpayer-husband was responsible for the entire amount of his income.  Subsequent to Lucas , numerous Supreme Court and Tax Court opinions have held that such anticipatory assignments of income are ineffective as means of avoiding tax liability.  To this end, in a 2021 Tax Court decision, authored by the inestimable Judge Mark V. Holmes, [17] the Tax Court observed that “the assignment-of-income doctrine does not immunize assignments of income to…entities.” [18]

The Assignment of Income Doctrine and Trusts (Contrary Results…Sometimes)

In the Supreme Court case of Blair v. Commissioner , [19] a taxpayer assigned the income from a testamentary trust to his children.  The trustee accepted the assignment and distributed the income directly to the assignee.  The Supreme Court was faced with the question of whether an assignment of income from a trust, which income was received by the beneficiary-children, was valid.

Because there were no earnings from personal services, which would have been taxed to the individual who earned them, the court found that Lucas was not on point.  Instead, “the tax is upon income as to which…the tax liability attaches to ownership.” [20]   Stated differently, if an individual owns a beneficial interest in the trust, then that individual will be taxed on his or her income derived from the trust.

“If under the law governing the trust the beneficial interest is assignable, and if it has been assigned without reservation, the assignee, thus, becomes the beneficiary and is entitled to rights and remedies accordingly.” [21]   Instead, “[t]he one who is to receive the income” through the assignment of the beneficial interest (the assignee) rather than the initial income beneficiary (the assignor), becomes “the owner of the beneficial interest” and is responsible for paying the tax on the income distributed from the trust. [22]

The phrase “without reservation” is critical, as the taxpayer learned in Harrison v. Schaffner , [23] where the Supreme Court determined that an assignment of specific dollar amounts of trust income for one-year periods did not shift the tax burden to the assignee.  In reaching its decision, the Court distinguished Blair , where the assignment was irrevocable for the life of the taxpayer , in contrast to the one-year assignments under review, which the Court found did not create a transfer of a substantial interest “without reservation” in the property. [24]

Similarly, in Rev. Rul. 55-38, the IRS determined that a beneficiary, who periodically gave his consent to pay a certain portion of the trust income to another individual, was responsible for the tax on such income.  This arrived at this determination because the assignor had not parted with a substantial interest in property other than the specified payments of income, the right to which he could have revoked at any time.

Income from Services

If a taxpayer performs personal services for compensation, the income is includible in the taxpayer’s gross income [25] —even if the taxpayer assigns and transfers the compensation to a third party.  Even if a taxpayer redirects a payor’s check to a third party without cashing it, the taxpayer must include all income the taxpayer earned from the performance of personal services attributable to the payment. [26]

This holds true if the check is sent to a third party at the direction of the taxpayer, who never touches the check, [27] or if payment is made to the third party through other means.  The income must be included in the taxpayer’s gross income.  The same applies if the payor uses the amount to settle a debt of the taxpayer. [28] Additionally, a taxpayer may not escape assignment of income by assigning accounts receivable that arise from the taxpayer’s performance of services but remain unpaid. [29]

If a taxpayer endorses a compensation check to a third party and receives back less than the total compensation, the entire amount still must be included in their gross income. [30]   This inclusion requirement is unaffected by whether the income is paid to another person under a court order, as long as it represents compensation for services performed by the taxpayer.  However, the assignment of income doctrine does not apply if the transferor-taxpayer’s right to the income in question is contingent and subject to conditions beyond the control of the transferor. [31]

The fundamental rule that income from the performance of personal services is included in the service-provider’s income applies equally if the assignee is an entity.  Thus, in the case of Johnson v. Commissioner , [32] the taxpayer formed a Panamanian corporation to which he assigned his NBA earnings.  The NBA sent the check to the corporation rather than the taxpayer.  Nevertheless, the Tax Court held that under the contract the taxpayer was to play basketball, and in return he would earn compensation; therefore, the contract was between the team and the taxpayer, not the taxpayer’s entity.  Instead of looking at the “actual earner” of the compensation, the Tax Court turned to the inquiry of “who controls the earning of the income.” [33]

Similarly, in Leavell v. Commissioner , [34] the Tax Court held that a professional basketball player was an employee of the team for which he played even though the team had executed an employment contract with the player’s professional service corporation (“PSC”).  The Tax Court reached this conclusion by “examin[ing] all the facts and circumstances in order to determine the reality of who has control over the manner and means by which the individual service provider delivers services.” [35]

The Tax Court decided numerous cases in the 1980s, [36] in which the court held that income was not re-allocable from a PSC to the service‑provider under the assignment of income doctrine if the service-provider met both prongs of a two-prong control test evolving from case law beginning with Lucas .  Under this two-prong test, a PSC controls the service-provider, and, hence, earns the income, if: (1) the service-provider is an employee of the PSC, and the PSC has the right to direct and control him or her in a meaningful sense; and (2) the PSC and the service-recipient had “a contract or similar indicium recognizing the controlling position of the PSC.” [37]

By contrast, if a contract exists between the taxpayer’s entity and a third-party, the assignment of income doctrine historically has not been applied by the Tax Court. [38]   In the case of Laughton v. Commissioner , [39] an actor formed a corporation with which he contracted to receive a weekly payment for his exclusive services.  The corporation executed contracts with two film studios, and the corporation “loaned” the taxpayer’s services to the film studios.

The Court held the amounts paid to the corporation by the studios were not includible in the taxpayer’s gross income because those amounts were paid “under contracts between it [the actor’s corporation] and the studios,” and, as such, there was no assignment of income by the taxpayer. [40] This result is contrary to Leavell , but the Tax Court found the facts and circumstances distinguishable.  (Translation: the wind blew in a different direction for the taxpayer in Laughton than it did for the basketball player in Leavell .)

Assignment and Transfer of Income-Producing Property

As noted in the introduction, income produced by the transferred property should be reported in the gross income of the person who holds the beneficial ownership of that property. [41]   Stated differently, a taxpayer’s gross income includes income from property over which the taxpayer exercises the same degree and manner of control that the taxpayer exercised before the attempted transfer. [42]

In Commissioner v. Sunnen , [43] the taxpayer-husband assigned the underlying contracts to receive royalties on the taxpayer-husband’s patented invention to his wife in addition to giving her the right to receive the royalty payments.  It is important to note that in Sunnen , the failure of the husband to give up control over the underlying licenses (contracts) scuttled the assignment.  This retained control arose out of two separate considerations.  First, the assignment consisted of nonexclusive licenses, which were terminable by either party without liability.  Second, the licenses were held by a corporation, of which the taxpayer-husband owned 89% of the stock.

As president, director, and owner of 89% of the stock of the corporation, the taxpayer remained in a position to exercise extensive control over the license contracts after assigning them to his wife.  Thus, any assignment of the underlying contracts must not “merely involve[] a transfer of the right to receive income;” instead, the assignment must take the form of “a complete disposition of all the taxpayer’s interest in the contract and the income.” [44]

Similarly, in Schaffner the Supreme Court observed that “[e]ven though the gift of income [was] in form accomplished by the temporary disposition of the donor’s property which produces the income.” [45]    Thus, the Court found that the donor retained “every other substantial interest in it, [and the Supreme Court has] not allowed the form to obscure the reality.”

Ultimately, the Supreme Court held that the assignment of the income for the tax year of the trust of which the taxpayer was a beneficiary was not a substantial disposition of trust property so as to disrupt the taxpayer’s enjoyment of the income from the property, and the taxpayer’s power to assign the income was a benefit of the right to receive that income.  Thus, the assignment of income doctrine applied.

The assignment of income doctrine also comes into play when a taxpayer attempts, but fails, to completely transfer their property.  In such scenario, the income derived from the property must be included in the gross income of the taxpayer, not in that of the intended recipient.  Instances where this is particularly relevant include invalid gifts, where the failure to effectively shift the income to the assignees results in the income reverting to the donor.  Similarly, transactions masquerading as sales but failing to genuinely transfer ownership rights are not recognized as legitimate transfers under this doctrine.

For a property transfer to be considered valid, a fundamental shift in the economic relationship between the taxpayer and the property is necessary.  This means that if the taxpayer retains any significant rights or control over the property, such as risk of loss or full authority, the transfer is deemed ineffective.  The mere intention to transfer property at a future date does not suffice.  Conversely, if a transfer is bona fide, with the transferor relinquishing all control over the property, the assignment of income doctrine will not apply.  Likewise, if the rights retained by the transferor are negligible, the doctrine is not applicable.

The doctrine further stipulates that an agreement to allocate the income generated by a taxpayer’s property to someone else does not constitute a transfer of the property itself.  Consequently, the income remains part of the taxpayer’s gross income.  Moreover, if the property is not effectively passed to the transferee, owing to a lack of delivery effort by the taxpayer, the transfer is considered null, and the resulting income is included in the taxpayer’s gross income.

When assessing whether a transfer by purported gift is valid, several conditions must be met: (a) the donor must be competent to make the gift; (b) the recipient must be capable of accepting the gift; (c) the donor must have a clear intention to irrevocably transfer the title, dominion, and control of the property; (d) the transfer must be irrevocable; (e) there must be actual delivery of the gift or control over it; and (f) the recipient must accept the gift. Failure to meet any of these conditions results in the income from the property remaining with the original owner for tax purposes.

The assignment of income doctrine is complicated and nuanced.  There are, however, a few black letter rules that we can distill from the morass of the judicial creation:

• Income is taxed to the person who earns it, even if the right to that income is assigned to another person or entity. [46]
• An individual who earns income cannot escape taxation “by anticipatory arrangements and contracts however skillfully devised.” [47] Note: This does not mean that contracts do not play an important role—only that an individual cannot contract in anticipation of assigning income at a later date. [48]
• Income earned from the performance of personal services is included in the service‑provider’s income even if the assignee is an entity. [49]
• Income produced by the property transferred by the taxpayer is includible in the gross income of the person who holds beneficial ownership of such property. [50] Beneficial ownership is a facts and circumstances test.
• If an assignment would otherwise be effective to transfer income to a third-party assignee, the assignment must be a complete disposition of all the taxpayer’s interest in the contract and the income. [51] Retention of significant rights or control over the property—whether it be a risk of loss or full authority and discretion to dispose of the property—will nullify the transfer, and the income will be includible in the assignor’s income.

Elmer dozed off somewhere between the discussion of trusts and talk of basketball players.  ( Elmer is strictly a football and hockey aficionado, who was turned off from basketball in the early 1980s by the tiny shorts and continues to be turned off by professional wrestling for much the same reasons. )

Hope springs eternal that subconsciously he understood (a) the nuances of the anticipatory assignment of income doctrine, and (b) that you were only trying to help.  You leave him in his chair to sleep, but as you leave you could swear you heard him say something about “napalm” and “that damn bait shop.”  You make a mental note to check for napalm the next time you visit Elmer’s homestead…  

Footnotes :

[1] Though you advised Elmer to pick another name, so as not to infringe on the copyright of the band Saliva from their 2001 song of the same name, Elmer assumed that you were joking.  The band did not, and Elmer settled out of court by providing the band a lifetime supply of Screaming Weasels, which now feature prominently in their shows.  Granted, the ear-splitting fireworks are not quite Kiss level pyrotechnics, but Saliva is not quite Kiss, after all.

[2] The use of the royal “we” is nosism at its finest.

[3] See Lucas v. Earl , 281 U.S. 111 (1930).

[4] United States v. Basye , 410 U.S. 441, 449 (1973) (quoting Commissioner v. Culbertson , 337 U.S. 733, 739-740 (1949)).

[5] Commissioner v. Culbertson , 337 U.S. 733, 739-40 (1949).

[6] Lucas , 281 U.S. at 115.

[7] Blair v. Commissioner , 300 U.S. 5 (1937); Vercio v. Commissioner , 73 T.C. 1246, 1253 (1980); Commissioner v. Banks , 543 U.S. 426, 434 (2005).

[8] Helvering v. Horst , 311 U.S. 112, 116-17 (1940).

[9] Banks , 543 U.S. at 435.

[10] N.B. , because the assignment of income doctrine developed in the courts and has not been codified by statute, “the case law has been generally unaffected by statutory changes.  Thus, many of the authorities are older than the 1954 Code but continue to be the leading cases on issues settled many years ago.”  Bloomberg BNA Portfolio 502-4th, “Gross income: Tax Benefit, Claim of Right, and Assignment of Income” (2023).

[11] Lucas , 281 U.S. at 115.

[12] Blair , 300 U.S. at 13.

[13] Hang v. Commissioner , 95 T.C. 74 (1990).

[16] 281 U.S. 111 (1930).

[17] On which Senior Tax Court Judge your dear editor may or may not have an untoward amount of admiration and utter respect for the sarcasm present in every one of his opinions…

[18] Ernest S. Ryder & Assocs., Inc., APLC v. Commissioner , T.C. Memo, 2021-88, slip op. at *118.

[19] 300 U.S. 5 (1937).

[20] Id. at 12.

[21] Id. at 13.

[23] 312 U.S. 579 (1941).

[24] Id. ; see also PLR 202047005.

[25] Tang v. Commissioner , T.C. Memo 1996-326.

[26] United States v. Allen , 551 F.2d 208 (8th Cir. 1977).

[27] Roberts v. Commissioner , T.C. Memo 1996-225.

[28] Hunt v. Commissioner , T.C. Memo 1991-566.

[29] Mensik v. Commissioner , 37 T.C. 703 (1962), aff’d , 328 F.2d 147 (7th Cir. 1964).

[30] Page v. Commissioner , T.C. Memo 1983-515.

[31] Thompson v. Commissioner , T.C. Memo 1964-198.

[32] 78 T.C. 882 (1982).

[33] Id. at 892.

[34] 104 T.C. 140 (1995).

[35] Id. at 155.

[36] Haag v. Commissioner , 88 T.C. 604, 610-614 (1987), aff’d without published opinion 855 F.2d 855 (8th Cir. 1988); Bagley v. Commissioner , 85 T.C. 663, 674-676 (1985), aff’d 806 F.2d 169 (8th Cir. 1986); Johnson , 78 T.C. at 889‑92; Pacella v. Commissioner , 78 T.C. 604, 622 (1982); and Pflug v. Commissioner , T.C. Memo. 1989-615.

[37] Leavell , 104 T.C. at 181 (Laro, J. dissenting).

[38] See, e.g. , Fox v. Commissioner , 37 B.T.A. 271 (1938).

[39] 40 B.T.A. 101 (1939).

[40] Laughton , 40 B.T.A at 106-07.

[41] Blair , 300 U.S. at 13.

[42] See Viralam v. Commissioner , 136 T.C. 151 (2011).

[43] 333 U.S. 591 (1948).

[44] Sunnen , 333 U.S. at 610.

[45] 312 U.S. at 583 (emphasis added).

[46] Commissioner v. Culbertson , 337 U.S. 733, 739-40 (1949).

[47] Lucas v. Earl , 281 U.S. 111, 115 (1930).

[48] See, e.g. , Sunnen , 333 U.S. at 610 (noting that had the taxpayer-husband given up control, the assignment of income doctrine would not have applied).

[50] Blair , 300 U.S. at 13.

[51] Sunnen , 333 U.S. at 610.

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• Tags: Anticipatory Assignment of Income Doctrine , Assignment of Income , Cousin Elmer , Income , Income Inclusion , Judge Holmes , Lucas v. Earl , Oliver Wendell Holmes , Professional Service Corporations , Scurry of Squirrels

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FAQ: What Is the Assignment of Income?

Assignment of income allows you to assign part of your income directly to another person. While there are several valid reasons to assign your income to someone else, many taxpayers mistakenly believe that it can help lower their taxable income. While assignment of income allows you to divert income, you cannot divert taxes.

In this article, we’ll provide some examples of failed attempts at avoiding income taxes through the assignment of income and the valid reasons someone might want to assign income to someone else.

RELATED: Tax Evasion Vs. Tax Avoidance: The Difference and Why It Matters

You Can’t Use Assignment of Income to Avoid Paying Taxes

The assignment of income doctrine states that the taxpayer who earns the income must pay the tax on that income, even if he gave the right to collect the income to another person.

The doctrine is quite clear: taxpayers must pay their own taxes. However, that doesn’t stop many people from thinking they can avoid paying taxes or minimize their taxable income through the assignment of income.

Here are a few scenarios we commonly see.

• High-Earning Individuals: In an attempt to avoid having to pay the higher tax rates on their substantial income, high-earning individuals sometimes try to divert income to a lower-income family member in a significantly lower tax bracket. The assignment of income doctrine prevents this scheme from working.
• Charitable Donating : Even if a taxpayer assigns part of their income to a charitable organization, they will still have to pay the taxes. However, they might be eligible to claim a deduction for donations to charity while building some good karma by helping others in need.
• Owning Multiple Businesses: A taxpayer who controls multiple businesses might try to divert income from one business to another, especially if one has the potential to receive a tax benefit but requires a higher income to do so. Not only is this illegal, but it also will not lower the taxable income of the business.

You Can Use Assignment of Income to… Assign Your Income

The assignment of income doctrine does not stop you from diverting part of your income to someone else. In fact, that’s the whole point! Maybe you’re helping to support an elderly family member, or you consistently donate to the same charity every month or year. Whatever the case, you can assign the desired amount of your income to go to another person or organization.

While there are no tax benefits involved in assigning income versus making traditional payments or donations, it can be a more convenient option if you’re making regular payments throughout the year.

S.H. Block Tax Services Provides Clear Answers For Complicated Questions

If you have any questions about how to go about assigning part of your income to a family member in need or a separate business entity, please contact S.H. Block Tax Services today. We can answer all of your questions and address all of your concerns regarding the assignment of income and provide suggestions on valid and legal ways to save on your taxes.

Please call us today at  (410) 872-8376  or complete  this brief contact form  to get started on the path toward tax compliance and financial freedom.

The content provided here is for informational purposes only and should not be construed as legal advice on any subject.

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S.H. Block Tax Services

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ASSIGNMENT OF INCOME DOCTRINE – SECTION 61 INTERNAL REVENUE CODE – J. RONALD JACKSON

I don’t want to pay tax on this income, assignment of income doctrine.

By:  J Ronald “Ron” Jackson, MBA, CPA

Under federal income tax law gross income is taxed to the person who earns it or to the owner of property that generates the income. It is not uncommon for a high tax bracket taxpayer to want to shift income to a lower tax bracket family member in order to save on taxes and the income stay within the family unit. Alternatively, one who has appreciated stock or other type of property that he knows will be sold in the near future may wish to save on income taxes by gifting a portion of the property to a lower tax bracket family member who will report the sale at his or her lower income tax bracket. Alternatively, the individual may want a double benefit by gifting the appreciated property to a qualified charity thereby gaining a charitable income tax deduction for the value of the contributed property and being relieved of paying income taxes on the gain from the sale of the gifted property. This shifting of income, if permitted for income tax purposes, may provide considerable income tax savings.

The assignment of income doctrine was developed from court decisions which decided the issues, including the various methods employed in attempting to determine who earned the income. There was a time during the World War II years and thereafter, until around 1963, that the top income tax brackets could be as high as 91% – 93%. In addition to family members, the issues often arose when a high bracket taxpayer would make a gift of property (often the issues were gifts of appreciated stock that were to be sold shortly) to a qualified charity. The taxpayer would then take a charitable income tax deduction and not report the gain as he no longer owned the stock when sold. This shifting of income to a lower bracket taxpayer could have large savings in taxes for the high bracket taxpayer.

A simple example of income earned and taxed to the one who earns the income is when one works for weekly wages. The work week ends on Friday but the actual paycheck is not delivered until the following Wednesday. The wages are earned, for income tax purposes, at the end of the week (Friday). If the individual tells his employer to pay the earned wages to the individual’s mother, and the employer did that, the wages would still be taxed for federal income tax purposes to the individual since he earned the wages. The fact he may have made a gift of his earned wages does not change the income tax treatment as his employer has to include the earned wages on the individual’s W-2 form.

The above is a simple illustration of the doctrine that one who earns the income has to pay income tax on the wages. Let’s look at another situation. Suppose Perry, an individual taxpayer, owns all of the stock ownership in a very successful corporation (Company A) that he has run for many years. Perry is approached by the owners of another corporation (Company B) with an interest in purchasing Perry’s stock ownership in Company A. Negotiations have progressed and a total value has been tentatively negotiated of $5,000,000.00. The actual contract is still to be finalized and there are some remaining details to settle. Perry believes it will be finalized and signed within a reasonably short time. Perry, who is in a very high federal income tax bracket and who is a very civic-minded individual, has been told of the benefit of donating appreciated property to charity. Perry contacts the local Community Foundation and arranges to create the Perry Charitable Fund through the Community Foundation. The charitable fund will provide donations to his church and to other qualified charities that Perry usually supports. Perry then donates fifteen percent of his stock ownership, valued at $750,000.00 to the Community Foundation. Later after negotiations are completed, all of Company A’s stock is sold to Company B for the negotiated price of $5,000,000.00. Perry is happy. He has made a substantial profit from his years of work, made a donation to his favorite charity for which he plans to take a charitable income tax deduction, and will only have to report and pay income tax at capital gain rates on 85% of his stock as he has given 15% away.

Perry files his income tax return for the year and reports his taxable gain on the sale of his 85% ownership interest in Company A. About one year later Perry is audited by the IRS. The IRS agent questions why he did not report gain on the 15% of stock given to the Foundation. Perry replies that he did not own the stock as it was gifted to the charity before the date of the sale. The IRS auditor states that Perry should pay income tax on the gain on the stock given to the Community Foundation since it appears to have been a “done deal” before Perry gave the stock away and for that reason Perry owes income tax on all of the stock. Perry argues that no contracts were signed until weeks after the gift and that the deal could have fallen through at any time before signed by all parties. Perry disagreed with the audit. His tax dispute is now pending before the United States Tax Court. How will the court decide?

Section 61 of the Internal Revenue Code provides that gross income means all income earned from whatever source derived, and then lists several examples such as wages, services rendered, gains from the sales of property, and several other examples. In 1930, the U. S. Supreme Court summarized when addressing who earned income that “The fruits cannot be attributed to a different tree from that on which they grew.” Lucas v. Earl, 281 U.S. 111 (1930). This in effect clarified that gross income is to be taxed to the one that earns it and led to the fact that one cannot avoid paying income tax on earned income by gifting the property that created the income when it has been earned on or before the gift. An example would be when a corporation declares a dividend payable say on November 1st to stockholders of record on October 10th. A stockholder who owned the stock on October 10th is the one who has earned the income even if he or she sells or assigns their stock between October 10th and November 1st. The dividend is taxed to the owner on October 10, the date the dividend was declared.

In Perry’s case he argues that the negotiations were not complete when he made his gift, and that Company B could have backed out of the deal. When the court decides it will consider the stage of the negotiations, whether Company B had the financial backing to complete the deal, whether any contracts or preliminary statements of intent were prepared for review, and how long was the interval between the tentative agreement and the actual sale will all be considered. Situations like these happen from time to time. When the issue arises, it should be discussed in advance of the transaction, if possible, with your legal tax advisors who should be well versed in this area of tax law. One should be aware of the assignment of income doctrine in situations where it could apply in connection with his/her estate planning. What if this had been a publicly traded company?

If you have questions regarding   Assignment of Income Doctrine   and would like to discuss these issues, please contact Cody Walls, MBA, CPA at Denton Law Firm at 270-450-8253.

THIS ARTICLE IS DESIGNED TO PROVIDE GENERAL INFORMATION PREPARED BY THE PROFESSIONALS AT DENTON LAW FIRM, PLLC IN REGARD TO THE SUBJECT MATTER COVERED. IT IS PROVIDED WITH THE UNDERSTANDING THAT THE AUTHOR IS NOT ENGAGED IN RENDERING LEGAL, ACCOUNTING, OR OTHER PROFESSIONAL SERVICE. ALTHOUGH PREPARED BY PROFESSIONALS, THESE MATERIALS SHOULD NOT BE UTILIZED AS A SUBSTITUTE FOR PROFESSIONAL SERVICE IN SPECIFIC SITUATIONS. IF LEGAL ADVICE OR OTHER EXPERT ASSISTANCE IS REQUIRED, THE SERVICE OF A PROFESSIONAL SHOULD BE SOUGHT.

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Gross Income: Tax Benefit, Claim of Right and Assignment of Income (Portfolio 502)

James Maule

Professor of Law, Emeritus

Villanova University School of Law

At a glance

I. Introduction II. Tax Benefit Doctrine III. Claim of Right Doctrine IV. Assignment of Income

The Bloomberg Tax Portfolio, Gross Income: Tax Benefit, Claim of Right and Assignment of Income, No. 502, addresses three areas of gross income that are substantially judicial in origin and nature. It analyzes in depth the nature, concept, scope, and application of the tax benefit doctrine, the claim of right doctrine, and the assignment of income doctrine.

The tax benefit doctrine excludes from a taxpayer's gross income any recovery or refund of an amount deducted in a prior taxable year to the extent the deduction did not reduce tax liability. Under the claim of right doctrine, a taxpayer must include in gross income for the year of receipt any income received under a claim of right free of restrictions.

Under the assignment of income doctrine, gross income from personal services must be included in the gross income of the person who rendered the services. In addition, under that doctrine, gross income from property must be included in the gross income of the person who beneficially owns the property.

The Worksheets include relevant legislative history for provisions discussed in detail and for which regulations have not yet been issued.

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Tax Alert | Tax Court Guidance on Charitable Contributions and Assignment of Income

February 26, 2024

Today is the first of two alerts dealing with the Estate of Hoensheid v. Commissioner of Internal Revenue, T.C. Memo 2023-34 (2023). In this, the first, the standard for determining whether a taxpayer has made an anticipatory assignment of income is discussed. The judicially created anticipatory assignment of income doctrine recognizes that income is taxed to those who earn or otherwise create the right to receive it and that it cannot be assigned or gifted away.

Hoensheid involves a common fact pattern. The taxpayer was one of three owners of a closely held business, wishing to both sell and to contribute part or all of the proceeds to a tax-exempt charity or donor advised fund, the assignee. If properly structured, the owner receives a charitable deduction equal to the fair market value of the contributed property and the built-in gain on the investment is taxed to the charity. In order to do so, the owner must contribute the ownership interest (in this case 1380 shares of stock) to the charity, but when? Like most owners, the taxpayer in Hoensheid wanted to wait as long as possible before making the actual contribution. During the course of the negotiations concerning the sale, the taxpayer was advised that the contribution had to be completed before any purchase agreement was executed. This is referred to the binding agreement test and has its origin in Rev. Rul. 78-197. If you contribute before the purchase agreement is signed, no anticipatory assignment. If you contribute after the purchase agreement is signed, anticipatory assignment. It provides a bright line for taxpayers. But is it that simple?

The Tax Court first analyzed the requirements under state law to determine when the gift was completed. It concluded the gift took place on July 13, 2015, two days before the signing of the SPA on July 15, 2015, seemingly within the bright line test of Rev. Rul. 78-197. The Tax Court agreed that the gift occurred before the sale and that the charity was not obligated to sell at the time of the gift, but that although the donee’s legal obligation to sell is significant to the assignment of income analysis, it was only one factor.

In short, there is no bright line but there are multiple factors in an assignment of income analysis of a fact pattern. Instead, the ultimate question is whether the transferor, considering the reality and substance of all the circumstances, had a fixed right to income in the property at the time of transfer. If the sale was virtually certain to occur, the anticipatory assignment of income doctrine is satisfied and the taxpayer, not the charity, is taxed on the sales proceeds from the charity’s sale.

In this case, the relevant factors in determining whether the sale of shares was virtually certain to occur include:

• Any legal obligation to sell by the donee.
• The actions already taken by the parties to effect the transaction.
• The remaining unresolved transactional contingencies.
• The status of the corporate formalities required to finalize the transactions.

With regard to the first factor, the Tax Court held that there was no proof of any obligation of the charity to sell the shares, either formal or informal. This was a favorable factor for the taxpayer.

With regard to the second factor, the Tax Court found that there were bonus and shareholder distributions made before the SPA was executed. This factor indicates that the income was earned at an earlier point in time.

With regard to the third factor, the Tax Court found that there were major transactional contingencies (environmental obligations) but that they had been resolved before the SPA was executed. This factor indicates that the income was earned at an earlier point in time.

With regard to the fourth factor, the Tax Court found that after the SPA was executed there were only ministerial actions remaining. This factor indicates that the income was earned at an earlier point in time.

The tax court, based on the various factors mentioned above, determined that the income or gain from the sale was earned at an earlier point in time, resulting in the taxpayer being treated as the seller of the shares of stock purportedly gifted to the charity.

In summary, as the Tax Court found, to avoid an anticipatory assignment of income on the contribution of appreciated shares of stock followed by a sale of the donee, a donor must bear at least some risk at the time of contribution that the sale will not close. The bright line of Rev. Rul. 78-187 was a factor but compliance with that alone did not provide a safe harbor. Other factors needed to be considered to determine if the gain was earned before the sale and taxable to the donor.

If you are the owner of a closely held business and are contemplating a charitable gift of a portion of your ownership interest, do not hesitate to contact either David Ritter, Stuart Gladstone, Bob Kosicki, or Cheryl Ritter for guidance in dealing with the multiple factors set forth in the anticipatory assignment of income doctrine.

For more information or assistance, please contact:

David J. Ritter, Esq. , Member and Chair, Tax Practice , at [email protected] or 973-403-3117

Stuart M. Gladstone, Esq. , Member, Tax Practice , at [email protected] or 973-403-3109

Robert A. Kosicki, Esq. , Counsel, Tax Practice , at [email protected] or 973-403-3122

Cheryl L. Ritter, Esq. , Counsel, Tax Practice , at [email protected] or 973-364-8307

About Brach Eichler LLC

Brach Eichler LLC is a full-service law firm based in Roseland, NJ. With over 80 attorneys, the firm is focused in the following practice areas: Healthcare Law; Real Estate; Litigation; Trusts and Estates; Corporate Transactions & Financial Services; Personal Injury; Criminal Defense and Government Investigations; Labor and Employment; Environmental and Land Use; Family Law Services; Patent, Intellectual Property & Information Technology; Real Estate Tax Appeals; Tax; and Cannabis Law. Brach Eichler attorneys have been recognized by clients and peers alike in The Best Lawyers in America©, Chambers USA, and New Jersey Super Lawyers. For more information, visit www.bracheichler.com .

This alert is intended for informational and discussion purposes only. The information contained in this alert is not intended to provide, and does not constitute legal advice or establish the attorney/client relationship by way of any information contained herein. Brach Eichler LLC does not guarantee the accuracy, completeness, usefulness or adequacy of any information contained herein. Readers are advised to consult with a qualified attorney concerning the specifics of a particular situation.

David J. Ritter

Member Tax, Corporate Transactions & Financial Services, Trusts and Estates

973.403.3117 · 973.618.5517 Fax

Stuart M. Gladstone

Member Trusts and Estates, Corporate Transactions & Financial Services, Tax

973.403.3109 · 973.618.5509 Fax

Robert A. Kosicki

Counsel Corporate Transactions & Financial Services, Family Law Services, Patent, Intellectual Property & IT, Tax, Trusts and Estates

973.403.3122 · 973.618.5522 Fax

Cheryl L. Ritter

Counsel Tax, Trusts and Estates

973.364.8307 · 973.618.5508 Fax

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Related Attorney:   Cheryl L. Ritter , David J. Ritter , Stuart M. Gladstone , Robert A. Kosicki

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Tax Law on “Assignment of Income”

Gross income is taxed to the individual who earns it or to an owner of property that generates the income. Under the so-called “assignment of income doctrine,” a taxpayer may not avoid tax by assigning the right to income to another. Specifically, the assignment of income doctrine holds that a taxpayer who earns income from services that the taxpayer performs or property that the taxpayer owns generally cannot avoid liability for tax on that income by assigning it to another person or entity. The doctrine is frequently applied to assignments to creditors, controlled entities, family trusts and charities.

A taxpayer cannot, for tax purposes, assign income that has already accrued from property the taxpayer owns. This aspect of the assignment of income doctrine is often applied to interest, dividends, rents, royalties, and trust income. And, under the same rationale, an assignment of an interest in a lottery ticket is effective only if it occurs before the ticket is ascertained to be a winning ticket. However, a taxpayer can shift liability for capital gains on property not yet sold by making a bona fide gift of the underlying property. In that case, the donee of a gift of securities takes the “carryover” basis of the donor. For example, shares now valued at $50 gifted to a donee in which the donor has a tax basis of $10, would yield a taxable gain to the donee of its eventual sale price less the $10 carryover basis. The donor escapes income tax on any of the appreciation.

For more information about this article, please contact our tax professionals at [email protected] or toll free at 844.4WINDES (844.494.6337).

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