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March 23, 2014 The Tax Lawyer

I Am the Master(s) of My Fate: Owen v. Commissioner and the Assignment of Income Doctrine in the Context of Personal Service Corporations

Volume 67, No. 2 - Winter 2014

Robert D. Stewart


    Despite the Supreme Court holding in 1930 that earned income is presumptively taxable to the person who actually earns the income, determining who actually earned the income has long been a point of contention between the Service, taxpayers, and the courts, especially where taxpayers have acted to lower their tax burden by assigning earned income to entities other than themselves (e.g., a spouse or a trust). To prevent perceived abuses of the Code, the Service has used, among other tools, various iterations of the assignment of income doctrine to prevent taxpayers from escaping tax liability through "anticipatory arrangements and contracts however skillfully devised." However, while the Service and the courts have often emphasized the importance of substance over form, the modern iteration of the assignment of income doctrine indicates a striking preference for a form-based test, as exemplified in Owen v. Commissioner.

    In Owen, the Tax Court invoked the assignment of income doctrine and the related control of income test from Johnson v. Commissioner to find against a taxpayer with respect to his attempts to have earned income taxed to his personal service corporation (PSC) rather than to himself. Pursuant to a condition of the 2002 sale by the taxpayer of his companies to Amerus Annuity Group Co. (Amerus), the taxpayer agreed to continue in his executive position; the agreement allowed him to earn marketing allowances, incentive bonuses, and commissions. Over the next few years, the taxpayer assigned these income streams to his PSC. In each case, the assigned income was reported on the PSC's tax returns and taxed to the PSC; none of the assigned income was reported on the taxpayer's personal income tax returns.

    The Service determined that the taxpayer owed accuracy-related penalties for several disputed assignments of income. The Tax Court examined five such assignments of income and, on the basis of the two-part control of income test from Johnson, concluded that four of the assignments of income were improper because they had not met certain requirements of form developed through Johnson and its progeny, and were thus correctly subject to section 6662(a) accuracy-related penalties. However, the court did find for the taxpayer in one case, where he observed more closely the requirements of form.

    This Note argues that while the result in Owen was likely correct under current doctrine, it highlights the doctrine's flawed emphasis on form over substance, which allows disparate outcomes for substantively analogous situations based solely on differences in form. Part II traces the relevant case law and doctrinal development. Part III examines the assignments of income in Owen and the resulting opinion. Part IV analyzes the decision in the context of the assignment of income doctrine, highlights flaws in the current approach, and offers ideas for the rectifying of these flaws, including the possibility of clarifying regulations creating a safe harbor for taxpayers. Without such repairs, the emphasis on form over substance evidenced by Owen will likely allow savvy taxpayers to abuse the legal framework, while less savvy taxpayers are singled out by the Service for not adhering to unclear standards.

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