Part C. Attribution of Income

• Pages: 259-310
• Author: Marvin A. Chirelstein,Lawrence Zelenak

259

Part C

ATTRIBUTION OF INCOME

Although a taxpayer may regard her immediate family—her

husband and minor childre n, say—as an eco nomic unit from the

standpoint of resources and expenditures, with a few important

exceptions the federal income tax treats e ach member of the family

as a separate taxable person.

1

This separate-taxable-person

treatment means, for example, that if a child has earned income in

his own right (for example, from work as an actor or from—to invoke

ancient history—delivering newspapers), the income is taxed to the

child himself. The tax law does not lump the child’s income togethe r

with his parents’, even though parents and children are obviously

members of a single household. The same is true of other family

“entities”, such as family trusts and family corporations. Such

entities, natural or otherwise, are ge nerally viewed as separate

taxpayers, each with its own independent status under the tax law.

2

At the same time, of course, the federal income tax structure is

progressive: as an individual receives additional income, his tax also

goes up but at a greater rate of increase. This is so because additional

segments of income may be taxed at higher marginal rates than their

predecessors. It follows that a family whose income is taxed to one

member only—say the father—would usually pay a higher overall

tax than a family whose income is divided evenly among all the

members of the group. For example, if a married couple with three

children has adjusted gross income of $272,200 in 2026, and claims

the standard deduction, the pre-credit tax (on a joint return) is about

$42,800. But if the same income can somehow be r eported on fo ur

returns (the joint return p lus one each for the three children) at the

rate of $68,050 for each return, the overall pre-credit tax on the

family will be about $22,200, and a tax-saving of roughly $20,600 will

have been achieved.

3

Potential saving s of this size operate as an inducement to the

taxpayer to find some means of shifting taxable income to the lower-

1

The two most significant exceptions to the separate-taxable-person treatment

of family members? First, the so-called kiddie tax (9.02) generally taxes unearned (i.e.,

investment) income of children at their parents’ marginal tax rate. Second, in many

(but not all) respects a husband and wife electing to file a joint return (9.04) are treated

as a single taxpayer.

2

There is a significant exception here as well. Income of a so-called grantor

trust (9.01) is taxed to the grantor, rather than to the trust.

3

This assumes a standard deduction—$32,200 for the parents, and $16,100 per

child—is available on each of the four returns.

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ATTRIBUTION OF INCOME

PT. C

bracket children. If part of the taxpayer’s income was derived from

property, for many decades a simple tax reduction strateg y was to

transfer that prop erty to the children by outright gift. Thus, if a

father gave a hundred shares of stock to his daughter, the periodic

dividends which the daughter received thereafter would be taxed to

her as owner of the property. Moreover, under the rule of Taft v.

Bowers (4.01), any unrealized appreciation in the value of the stock

also would be treated as belonging to the child, even though such

appreciation occurred before the gift was made. This strategy still

works with respect to gifts of income-producing property to non-

dependent adult children of the taxpayer (or, for that matter, to

friends and relations of the taxpayer other than the taxpayer’s

children), but the so-called kiddie tax (9.02)—added to the Code in

1986—now defeats this strategy in the case of gifts to minor children

and depe ndent adult children. Technically, the kiddie tax does not

change the rule that income from property is taxed to the owner of

the property, but it taxes the child on that income at the marginal

tax rate of the child’s parents, thus eliminating the income-shifting

benefits of gifts to minor children and dependent adult children.

What about those whose income is derived from personal efforts

rather than property ownership? If the tax on dividends, interest and

rents can be shifted by outright gifts of the underlying property (in

situations to which the kiddie tax does not apply), what about wages,

salaries and fees? One cannot give away one’s skills very easily, yet

there is something disturbing in the conclusion that income -shifting

is a device available to property owners alone. Can the tax on fruits

of personal services be shifted? If not, what justifies or at least

explains the apparent discrimination? And even with respect to

property owners, there may be questions of a troublesome nature

when the gift is other than a simple outright transfer of all

substantial rights. Suppose, for example, that the owner of income-

producing property transfers it to another family member (with

respect to whom the kiddie tax does not app ly) but retains a right to

revoke the transfer and take the property back whenever he chooses.

Will the property be regarded as belonging to the transferee for tax

purposes, or will the transferor’s revocation right be considered the

equivalent of continued ownership? The law must decide how far the

property owner should have to go in the direction of an outright

transfer to assure that the income from a gift of property will be taxed

to someone other than himself. Here, as in the case of gifts of personal

service income, there appear to be two candidates for taxability, each

with a significant link to the income in question. And as no legal basis

exists for apportioning the income between them, it is evidently

necessary for the law to choose one candidate to the e xclusion of the

other. The question, of course, is which.

SEC. 8

THE EARLY CASES

261

The development of leg al principles governing choice of taxable

person was largely left to judicial construction during the early days

of the income tax. Between 1930 and 1940 the Supreme Court

decided a substantial number of cases involving income attribution,

largely unde r the authority of what is now § 61. These early cases

generally favored the government (w ith certain significant

exceptions). While their results were “correct” in the sense that any

other set of outcomes would have put taxpayers in a position to

render the progressive rate structure a virtual nullity, the Court’s

use of § 61 for this purpose was, shall we say, creative. The section

defines gross income but says nothing directly about to whom the

income belongs. Yet the alternative to judicial rulemaking (at least

until Congress should act) would have been to allow taxpayers to

make the choice of taxable person for themselves, and thus to

minimize their tax burdens more or less at will.

The discussion that follows is divided into two sections. Section

8 dige sts the early cases and shows how the Supreme Court

formulated “common law” attribution principles under the general

authority of § 61. These decisions became the basis for subsequent

legislative action, particularly in the fields of trusts and family

partnerships. Although partly displaced by specific Code provisions,

the early decisions contin ue to have application in many situations

not expressly covered by statute, and for this reason they are part of

the basic professional vocabulary of every tax specialist. Section 9

considers some of the statutory rules on income attribution: 9.01

takes up the subject of gifts in trust, now largely dealt with by

detailed Code provisions; 9.02 describes the kiddie tax; 9.03 examines

family business associati ons, especially family partnerships. Brief

reference to another statutory “solution” —the split-income joint-

return procedure which is available to husbands and wives—is made

in the subsection immediately following, with further details at 9.04,

while the Co de treatment of alimony (drastically changed by 2017

legislation) is described at 9.05.

8. The Early Cases

8.01 Gifts of Personal Service Income; Lucas v. Earl; Poe

v. Seaborn

(a) Redirected Salary

In Lucas v. Earl,

4

the taxpayer, a lawyer, entered into a contract

with his wife in 1901, 12 years before the enactment of the modern

federal income tax. Unless the taxpayer was amazingly prescient,

4

281 U.S. 111 (1930).