Progressivity and Assignment of Income

• Author: William Kratzke
• Pages: 255-289

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Chapter 5: Progressivity and Assignment of Income

The principle of progressive taxation is

that tax rates applicable to increments

of taxable income increase. Currently

there are seven marginal brackets –

eight if we count income that is below

the threshold of taxable income.65 If a

taxpayer can spread her income among

other taxpayers, more of taxpayer’s

income will be subject to lower

marginal rates of tax.

The following table represents the

computation of the income tax burden

of a person whose taxable income is

$210,000. Imaginary marginal tax

brackets are as noted. The total tax

burden of this taxpayer is $50,000.

Income range

Marginal Tax Rate

Tax

$0 to $10,000

0%

$0

$10,000 to $60,000

10%

$5000

$60,000 to $110,000

20%

$10,000

$110,000 to $160,000

30%

$15,000

$160,000 to $210,000

40%

$20,000

Total

$50,000

Our taxpayer might try to reduce her tax burden by “assigning” some of her taxable

income to persons she controls – perhaps two children. Our taxpayer might decide

65 The personal exemption and the standar d deduction assure that some income i s not subject to any

income tax.

The Tax Formula:

(gross income)

MINUS deductions named in § 62

EQUALS (adjusted gross income (AGI))

MINUS (standard deduction or

itemized deductions)

MINUS (personal exemptions)

EQUALS (taxable income)



Com pute incom e tax liability from

tables in § 1 (indexed for inflation)

MINUS (credits against tax)

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that she and each of the two children should receive $70,000 of the original

$210,000 total. The new tax computation table would be the following:

Income range

Marginal Tax Rate

Tax

$0 to $10,000

0%

$0

$10,000 to $60,000

10%

$5000

$60,000 to $110,000

20%

$200066

Total

$7000 x 3 = $21,000

The total tax burden of three different persons, each with taxable income of

$70,000, would be less than half the tax burden of one person with taxable income

of $210,000. This characteristic of progressive tax rates has led taxpayers to create

many schemes to “split income” so that more of it would be subject to lower rates

of income tax.

The courts have created the “assignment of income”67 doctrine to prevent abusive

income splitting. In addition, Congress has created some statutory rules that limit

assignments of income. We begin with the leading case.

I. Compensation for Services

Lucas v. Earl, 281 U.S. 111 (1930).

JUSTICE HOLMES delivered the opinion of the Court.

This case presents the question whether the respondent, Earl, could be taxed for the

whole of the salary and attorney’s fees earned by him in the years 1920 and 1921,

or should be taxed for only a half of them in view of a contract with his wife which

we shall mention. The Commissioner of Internal Revenue and the Board of Tax

Appeals imposed a tax upon the whole, but their decision was reversed by the

66 Only $10,000 of each taxpayer ’s taxable income would be subject to the 20% rate of income tax.

67 This is really a misnomer. T he “assignment of income” doctrine prevents assignme nt of income.

A more accurate name would be the “non-assignment of income” doctrine.

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circuit court of appeals. A writ of certiorari was granted by this Court.

By the contract, made in 1901, Earl and his wife agreed “that any property either

of us now has or may hereafter acquire ... in any way, either by earnings (including

salaries, fees, etc.), or any rights by contract or otherwise, during the existence of

our marriage, or which we or either of us may receive by gift, bequest, devise, or

inheritance, and all the proceeds, issues, and profits of any and all such property

shall be treated and considered, and hereby is declared to be received, held, taken,

and owned by us as joint tenants, and not otherwise, with the right of survivorship.”

The validity of the contract is not questioned, and we assume it to be unquestionable

under the law of the California, in which the parties lived. Nevertheless we are of

opinion that the Commissioner and Board of Tax Appeals were right.

The Revenue Act of 1918 approved February 24, 1919, c. 18, §§ 210, 211, 212(a),

213(a), 40 Stat. 1057, 1062, 1064, 1065, imposes a tax upon the net income of every

individual including “income derived from salaries, wages, or compensation for

personal service ... of whatever kind and in whatever form paid,” § 213(a). The

provisions of the Revenue Act of 1921 … are similar to those of the above. A very

forcible argument is presented to the effect that the statute seeks to tax only income

beneficially received, and that, taking the question more technically, the salary and

fees became the joint property of Earl and his wife on the very first instant on which

they were received. We well might hesitate upon the latter proposition, because,

however the matter might stand between husband and wife, he was the only party

to the contracts by which the salary and fees were earned, and it is somewhat hard

to say that the last step in the performance of those contracts could be taken by

anyone but himself alone. But this case is not to be decided by attenuated subtleties.

It turns on the import and reasonable construction of the taxing act. There is no

doubt that the statute could tax salaries to those who earned them, and provide that

the tax could not be escaped by anticipatory arrangements and contracts, however

skillfully devised, to prevent the salary when paid from vesting even for a second

in the man who earned it. That seems to us the import of the statute before us, and

we think that no distinction can be taken according to the motives leading to the

arrangement by which the fruits are attributed to a different tree from that on which

they grew.

Judgment reversed.