Advanced Individual Income Tax

Accounting 811: Spring, 1998

Week 12: Entities

 Outline (c) 1997-98 Robert H. Daniels

1. Choice of the Taxable Person

progressivity: Reason it makes a difference:

tax rate an Y item differs, depending on Tp's other income

Desire to get multiple rides up thru the lowest brackets

Progressivity now reviving after 1986 bracket compression

Entity principle

Tax is on individuals and entities

"Family" not seen as a basic taxable entity
eg. Sec. 73: income of child

Entity tax depends on legal form, not income source

Corporations, partnerships, fiduciaries

all others must fit into these categories

Ltd liability company, GmBH, business trust
Specialized rules for Banks, Ins. Cos., RICS

Adaptations of entity rules to the family

Dependency deduction, or "exemptions": Sec. 152

MFJ, MFS, HoH, rate schedules: Sec. 1

Surviving Spouse: Sec. 2(a)
HoH Sec. 2(b)

"kiddie tax": Sec. 1(g)

2. Evolution of choice of taxpayer rules

Largely case law   "fruits and trees"

Lucas v. Earl

Facts

E marries Mrs E in 1901: contract that all to be owned as joint tenants
E receives salary and attorneys fees in 1920, 1921

Issue: Should E be taxed on the full amount

case is before MFS, MFJ was adopted

Holding: yes

Reasoning:

Note its a Holmes decision: terse and appealing to common sense. Homes was @ 90 years old at the time

"This case is not to be decided by attenuated subtleties"

Tax salaries to those who earn them:
cannot escape by anticipatory arrangements that prevent vesting in the earner

Tree and fruit metaphor originates here

Followup.

Cal adopts comm prop. This splits Y by operation of law.

Congress creates MFJ and MFS as a response

Helvering v. Horst

Facts:  H detaches coupons from bonds and gives them to son, who collects them

Issue: is the gift a realization of Y taxable to donor?

Holding: yes

Reasoning

Ownership includes power to command payment to others
One need not get $ directly to have realized income

Income is receipt of $ or direction of disposition of $ to obtain satisfaction
including the satisfaction of making a family gift

"The power to dispose of Y is equivalent to ownership"

fruits and trees

Query: gift in year 1 and maturity in year 2? When Y? Why no tax to S?

Suppose bond was in major arrears, gift of Y valued at 50, pays off 100?

Estate of Stranahan: a role reversal

S wanted to accelerate Y to offset interest deduction
Sold to child right to receive future dividends on stock

Issue: were the dividends taxable to parent?

Held: Held: no. was sale for value. Was economic risk (div nonpayment?)

Usual fn references to tax planning: 

Like a sale now of right to get fruit from tree next year...

Q: were the dividends taxable to parent?

Susie Salvatore

Facts

S had inherited gas station run by her sons
Family conference decided to sell
S to get $100K: to continue Y she had received 
Rest to go to kids 
S signed contract on 7/24/63.
Deeded 1/2 to kids 8
/28/63. All deeded to Texaco 8/28/63

What's going on here?

Procedure:

P fild gift tax return, $10K paid from kids share

When IRS assessed vs. S, kids filed protective refund claims

Issue: is S taxable on all or 1/2 the gain

Holding: all

Reasoning

Court Holding Co.: concept of "conduit through whom title passes:

S owned all the station. "Family" didn't own the property
S had contracted to sell before she deeded to kids
meant. their deeds were subject to the sales K

3. Introduction to Taxation of Entities

Corporations

Separate taxpayer. Traditional double tax model
Subchapter C for Corp-shareholder relationship
Transfers in can be tax deferred (Sec. 351)
Transfers out are taxable
 
Use of corp for Y splitting: the Fogelsang saga
F was sales rep. for steel. Set up corp. kids had preferred
Earnings retained in corp taxed at corp rates (15%)
IRS attacks:Lucas v Earl.? Y "really" earned by corp
482? Not 2 businesses: only 1 business
 
Congress responds: Sec. 269A

Partnerships

Never pays tax. Reports operations to owners, who pay
Report separately the things treated alike and those differently
Use basis tracking to prevent double tax
e.g. yr 1 Y paid out in yr 2)
Transfers in and Y create basis,
transfers out and losses consume it

Culbertson

Diversion of income thru family partnerships
Facts
C was partner w/ Coon. Was buying out Coon
Coon insisted C take C's 4 sons ages 16 to 24 into business: preserve the herd (How likely is this?)
C sold a 1/2 interest to sons for a note -- paid off from gifts by C and a loan, covered by income
Reported Y in proportion to partner's capital
Issue: is C taxed on all the Y
Holding: unclear. Depends on intent. Remand
Reasoning:
key is "true" intent to be partners
Capital and services are just facts which show intent
 
Congress response: Sec. 704(e)

S-Corporations

Corporations with tax operating rules like p'ships
Election and qualifications
Basis tracking like p'ships

Fiduciaries: Trusts and Estates

What is a trust? a relationship
 
Who is taxed on trust Y?
Grantor if strings, bene if distributed, Tr if retained
Retain then distribute, if bene not a minor, "throwback"
Repealed in 1997 tax act
 
Income splitting and anti-splitting rules
Example of rules which outlived usefulness

Corliss v. Bowers: Grantor Trusts

Another Holmes opinion
Facts: H to trustee: Y to W, princip then to Ch, reserved power to modify:
Object: Earl: income split
Held: taxable to grantor
"taxation not concerned w/ refinements of title but with command over the property taxed"
If Tp allows another to enjoy Tp's income at Tp's sufferance, it's still Tp's income
 
Congressional Response: Secs. 671 ff.Note 674 (a) and 676(a)
 
Current issues:
 
the deliberately defective grantor trust
Procedure for reporting "living trusts"
 

      Build date 4/28/98