Like most CPAs, I’m paid a pauper’s wage. Lucky for me, my wife is a kindergarten teacher. That’s where the big money’s at.
Sure, wrestling with ever-shortening nap times, an exhausting nine consecutive months of employment, and the life-altering decision of whether to give little Jimmy an alligator or kangaroo in spelling makes her life a stressful one, but when she kicks back after a long six-hour day by puffing on a Cuban lit with a crisp $100 bill, the spoils make it all worth it.
Then there’s my son. Kid’s never worked a day in his life, and he seems content to live off his mother’s riches. Sure, some may argue, “He’s only two-and-a-half,” but if you can you put a minimum age on accountability, you’re a more tolerant parent than I am.
With my son’s sloth, however, comes the benefit of a low tax bracket. So the wife and I have been toying with the idea of having the school pay a portion of her salary to the boy, subjecting some of her income to his favorable tax rate. Will it work?
The answer, obviously, is no. But why not? Because of the assignment of income doctrine.
Established some 80 years ago in the landmark decision in Lucas v. Earl,[i] this judicial doctrine provides that taxpayers may not shift their tax liability by merely assigning income that the taxpayer earned to someone else. This principle was illustrated and applied today by the Tax Court in Walker v. Commissioner.[ii]
Walker was a dentist and oral surgeon who, prior to 2000, operated his dental practice as a wholly-owned S corporation.Walker’s attorney, Scott Cole, maintained that Walker could minimize income and payroll taxes by patterning the structure of his dental business after the one used by Cole in his legal practice, requiring two tiers of LLCs.[iii]
In pursuit of these tax savings, Walker and Cole established Walker LLC and L&R LLC (L&R). Walker LLC held Walker’s dental practice, with its income allocated 1% to Walker and 99% to L&R. L&R’s income — which was comprised entirely of the allocated dental income from Walker LLC — was in turn allocated 16% to each of Walker’s five children and 20% to Walker.
While the reporting of L&R’s income on the individual returns of the Walker children resulted in significant tax liabilities on those returns, these allocations reduced the total taxes reported on the income earned from Walker’s dental practice, as some of the children paid tax at lower rates than Walker.
The Tax Court, applying the assignment of income doctrine, held that L&R must be disregarded, and all of the income earned by Walker LLC was taxable to Walker. In reaching its decision, the court noted the following:
- Walker was the only individual that contributed any property to L & R when it was organized. The children did nothing to “earn” their 16% ownership interests.
- L&R conducted no business in its own name and it had no employees.
- L&R was not involved in the practice of dentistry, other than by its alleged ownership of 99 percent of the Walker LLC, and did not have any licenses or permits to practice dentistry or any other business.
The lesson? In the tax world, the fruits of labor may not be attributed to a different tree than the one on which they grew.
[i] 281 U.S. 111 (1930).
[ii] T.C. Memo 2012-5, (2012).