assignment of income stream

Battling Uphill Against the Assignment of Income Doctrine: Ryder

Benjamin Alarie

Kathrin Gardhouse

Benjamin Alarie is the Osler Chair in Business Law at the University of Toronto and the CEO of Blue J Legal Inc. Kathrin Gardhouse is a legal research associate at Blue J Legal .

In this article, Alarie and Gardhouse examine the Tax Court ’s recent decision in Ryder and use machine-learning models to evaluate the strength of the legal factors that determine the outcome of assignment of income cases.

Copyright 2021 Benjamin Alarie and Kathrin Gardhouse . All rights reserved.

I. Introduction

Researching federal income tax issues demands distilling the law from the code, regulations, revenue rulings, administrative guidance, and sometimes hundreds of tax cases that may all be relevant to a particular situation. When a judicial doctrine has been developed over many decades and applied in many different types of cases, the case-based part of this research can be particularly time consuming. Despite an attorney’s best efforts, uncertainty often remains regarding how courts will decide a new set of facts, as previously decided cases are often distinguished and the exercise of judicial discretion can at times lead to surprises. To minimize surprises as well as the time and effort involved in generating tax advice, Blue J ’s machine-learning modules allow tax practitioners to assess the likely outcome of a case if it were to go to court based on the analysis of data from previous decisions using machine learning. Blue J also identifies cases with similar facts, permitting more efficient research.

In previous installments of Blue J Predicts, we examined the strengths and weaknesses of ongoing or recently decided appellate cases, yielding machine-learning-generated insights about the law and predicting the outcomes of cases. In this month’s column, we look at a Tax Court case that our predictor suggests was correctly decided (with more than 95 percent confidence). The Ryder case 1 has received significant attention from the tax community. It involved tax avoidance schemes marketed by the law firm Ernest S. Ryder & Associates Inc. (R&A) that produced more than $31 million in revenue between 2003 and 2011 and for which the firm reported zero taxable income. The IRS unmasked more than 1,000 corporate entities that R&A’s owner, Ernest S. Ryder , had created and into which he funneled the money. By exposing the functions that these entities performed, the IRS played the most difficult role in the case. Yet, there are deeper lessons that can be drawn from the litigation by subjecting it to analysis using machine learning.

In this installment of Blue J Predicts, we shine an algorithmic spotlight on the legal factors that determine the outcomes of assignment of income cases such as Ryder . For Ryder , the time for filing an appeal has elapsed and the matter is settled. Thus, we use it to examine the various factors that courts look to in this area and to show the effect those factors have in assignment of income cases. Equipped with our machine-learning module, we are able to highlight the fine line between legitimate tax planning and illegitimate tax avoidance in the context of the assignment of income doctrine.

II. Background

In its most basic iteration, the assignment of income doctrine stands for the proposition that income is taxed to the individual who earns it, even if the right to that income is assigned to someone else. 2 Courts have held that the income earner is responsible for the income tax in the overwhelming majority of cases, including Ryder . It is only in a small number of cases that courts have been willing to accept the legitimacy of an assignment and have held that the assignee is liable for the earned income. Indeed, Blue J ’s “Assigned Income From Services” predictor, which draws on a total of 242 cases and IRS rulings, includes only 10 decisions in which the assignee has been found to be liable to pay tax on the income at issue.

The wide applicability of the assignment of income doctrine was demonstrated in Ryder , in which the court applied the doctrine to several different transactions that occurred between 1996 and 2011. Ryder founded his professional law corporation R&A in 1996 and used his accounting background, law degree, and graduate degree in taxation for the benefit of his clients. R&A designed, marketed, sold, and administered six aggressive tax-saving products that promised clients the ability to “defer a much greater portion of their income than they ever dreamed possible, and, as a result, substantially reduce their tax liability.” 3 In 2003 the IRS caught on to Ryder ’s activities when his application to have 800 employee stock option plans qualified at the same time was flagged for review. A decade of investigations and audits of Ryder and his law firm spanning from 2002 to 2011 followed.

What is interesting in this case is that Ryder , through his law firm R&A, directly contracted with his clients for only three of the six tax-saving products that his firm designed, marketed, and sold (the stand-alone products). The fees collected by R&A from two of the stand-alone products were then assigned to two other entities through two quite distinct mechanisms. For the other three tax-saving products, the clients contracted — at least on paper — with other entities that Ryder created (the group-tax products). Yet, the court treated the income from all six tax-saving products identically. The differences between the six types of transactions did not affect the outcome of the case — namely, that it is R&A’s income in all six instances. Blue J ’s predictor can explain why: The factors that our predictor highlights as relevant for answering the question whether the assignment of income doctrine applies have less to do with the particular strategy that the income earner conjures up for making it look like the income belongs to someone else, and more to do with different ways of pinpointing who actually controls the products, services, and funds. In Ryder , the choices ultimately come down to whether that is R&A or the other entity.

We will begin the analysis of the case by taking a closer look at two of the six tax-saving products, paying particular attention to the flow of income from R&A’s clients to R&A and Ryder ’s assignment of income to the other entities. We have selected one of the tax-saving products in which Ryder drew up an explicit assignment agreement, and another one in which he tried to make it look like the income was directly earned by another entity he had set up. Regardless of the structures and means employed, the court, based on the IRS ’s evidence, traced this income to R&A and applied the assignment of income doctrine to treat it as R&A’s income.

This article will not cover in detail the parts of the decision in which the court reconstructs the many transactions Ryder and his wife engaged in to purchase various ranches using the income that had found its way to R& A. As the court puts it, the complexity of the revenues and flow of funds is “baroque” when R&A is concerned, and when it comes to the ranches, it becomes “ rococo .” 4 We will also not cover the fraud and penalty determinations that the court made in this case.

III. The Tax Avoidance Schemes

We will analyze two of the six schemes discussed in the case. The first is the staffing product, and the second is the American Specialty Insurance Group Ltd. (ASIG) product. Each serves as an example of different mechanisms Ryder employed to divert income tax liability away from R&A. In the case of the staffing product, Ryder assigned income explicitly to another entity. The ASIG product involved setting up another entity that Ryder argued earned the income directly itself.

A. The Staffing Product

R&A offered a product to its clients in the course of which the client could lease its services to a staffing corporation, which would in turn lease the client’s services back to the client’s operating business. The intended tax benefit lay “with the difference between the lease payment and the wages received becoming a form of compensation that was supposedly immune from current taxation.” 5 At first, the fees from the staffing product were invoiced by and paid to R&A. When the IRS started its investigation, Ryder drew up an “Agreement of Assignment and Assumption” with the intent to assign all the clients and the income from the staffing product to ESOP Legal Consultants Inc. ( ELC ). Despite the contractual terms limiting the agreement to the 2004-2006 tax years, Ryder used ELC ’s bank account until 2011 to receive fees paid by the various S corporations he had set up for his clients to make the staffing product work. R&A would then move the money from this bank account into Ryder ’s pocket in one way or another. ELC had no office space, and the only evidence of employees was six names on the letterhead of ELC indicating their positions. When testifying in front of the court, two of these employees failed to mention that they were employed by ELC , and one of them was unable to describe the work ELC was allegedly performing. Hence, the court concluded that ELC did not have any true employees of its own and did not conduct any business. Instead, it was R&A’s employees that provided any required services to the clients. 6

B. The ASIG Product

R&A sold “disability and professional liability income insurance” policies to its clients using ASIG, a Turks and Caicos corporation that was a captive insurer owned by Capital Mexicana . Ryder had created these two companies during his previous job with the help of the Turks and Caicos accounting firm Morris Cottingham Ltd. The policies Ryder sold to his clients required them to pay premiums to ASIG as consideration for the insurance. The premiums were physically mailed to R& A. Also , the clients were required to pay a 2 percent annual fee, which was deposited into ASIG’s bank account. In return, the clients received 98 percent of the policy’s cash value in the event that they became disabled, separated from employment, turned 60, or terminated the policy. 7

R&A’s involvement in these deals, aside from setting up ASIG, was to find the clients who bought the policies, assign them a policy number, draft a policy, and open a bank account for the client, as well as provide legal services for the deal as needed. It was R&A that billed the client and that ensured, with Morris Cottingham ’s help, that the fees were paid. R&A employees would record the ASIG policy fee paid by the clients, noting at times that “pymt bypassed [R&A’s] books.” 8 Quite an effort went into disguising R&A’s involvement.

First, there was no mention of R&A on the policy itself. Second, ASIG’s office was located at Morris Cottingham’s Turks and Caicos corporate services. Ryder also set up a post office box for ASIG in Las Vegas. Any mail sent to it was forwarded to Ryder . Third, to collect the fees, R&A would send a letter to Morris Cottingham for signature, receive the signed letter back, and then fax it to the financial institution where ASIG had two accounts. One of these was nominally in ASIG’s name but really for the client’s benefit, and the other account was in Ryder ’s name. The financial institution would then move the amount owed in fees from the former to the latter account. Whenever a client filed for a benefit under the policy, the client would prepare a claim package and pay a termination fee that also went into the ASIG account held in Ryder ’s name. The exchanges between the clients and ASIG indicate that these fees were to reimburse ASIG for its costs and services, as well as to allow it to derive a profit therefrom. But the court found that ASIG itself did nothing. Even the invoices sent to clients detailing these fee payments that were on ASIG letterhead were in fact prepared by R&A. In addition to the annual fees and the termination fee, clients paid legal fees on a biannual basis for services Ryder provided. These legal fees, too, were paid into the ASIG account in Ryder ’s name. 9

IV. Assignment of Income Doctrine

The assignment of income doctrine attributes income tax to the individual who earns the income, even if the right to that income is assigned to another entity. The policy rationale underlying the doctrine is to prevent high-income taxpayers from shifting their taxable income to others. 10 The doctrine is judicial and was first developed in 1930 by the Supreme Court in Lucas , a decision that involved contractual assignment of personal services income between a husband and wife. 11 The doctrine expanded significantly over the next 20 years and beyond, and it has been applied in many different types of cases involving gratuitous transfers of income or property. 12 The staffing product, as of January 2004, involved an anticipatory assignment of income to which the assignment of services income doctrine had been held to apply in Banks . 13 The doctrine is not limited to situations in which the income earner explicitly assigns the income to another entity; it also captures situations in which the actual income earner sets up another entity and makes it seem as if that entity had earned the income itself, as was the case with the ASIG product. 14

In cases in which the true income earner is in question, the courts have held that “the taxable party is the person or entity who directed and controlled the earning of the income, rather than the person or entity who received the income.” 15 Factors that the courts consider to determine who is in control of the income depend on the particular situation at issue in the case. For example, when a personal services business is involved, the court looks at the relationship between the hirer and the worker and who has the right to direct the worker’s activities. In partnership cases, the courts apply the similarity test, asking whether the services the partnership provided are similar to those the partner provided. In other cases, the courts have inquired whether an agency relationship can be established. In yet other cases the courts have taken a broad and flexible approach and consulted all the available evidence to determine who has the ultimate direction and control over the earnings. 16

V. Factors Considered in Ryder

Judge Mark V. Holmes took a flexible approach in Ryder . He found that none of the entities that Ryder papered into existence had their own office or their own employees. They were thus unable to provide the services Ryder claims they were paid for. In fact, the entities did not provide any services at all — the services were R&A’s doing. To top it off, R&A did nothing but set up the entities, market their tax benefits, and move money around once the clients signed up for the products. There was no actual business activity conducted. The court further found that the written agreements the clients entered into with the entities that purported to provide services to them were a sham and that oral contracts with R&A were in fact what established the relevant relationship, so that R&A must be considered the contracting party. In the case of the ASIG product, for example, a client testified that the fees he paid to Ryder were part of his retirement plan. Ryder had represented to him that the ASIG product was established to create an alternative way to accumulate retirement savings. 17

Regarding the staffing product in which there existed an explicit assignment of income agreement between R&A and ELC , the court found that ELC only existed on paper and in the form of bank accounts, with the effect that R&A was ultimately controlling the income even after the assignment. A further factor that the court emphasized repeatedly was that R&A, and Ryder personally as R&A’s owner, kept benefitting from the income after the assignment (for example, in the staffing product case) or, as in the case of the ASIG product, despite the income allegedly having been earned by a third party (that is, ASIG). 18

VI. Analysis

The aforementioned factors are reflected in Blue J ’s Assigned Income From Services predictor. 19 We performed predictions for the following scenarios:

the staffing product and R&A’s assignment of the income it generated to ELC with the facts as found by the court;

the staffing product and R&A’s assignment of the income it generated to ELC if Ryder ’s version of the facts were accepted;

the ASIG product and service as the court interpreted and characterized the facts; and

the ASIG product and service according to Ryder ’s narrative.

What is interesting and indicative of the benefits that machine-learning tools such as Blue J ’s predictor can provide to tax practitioners is that even if the court had found in Ryder ’s favor on all the factual issues reasonably in dispute, Ryder would still not have been able to shift the tax liability to ELC or ASIG respectively, according to our model and analysis.

The court found that R&A contracted directly with, invoiced, and received payments from its clients regarding the staffing product up until 2004, when Ryder assigned the income generated from this product explicitly to ELC . From then onward, ELC received the payments from the clients instead of R&A. Further, the court found that ELC did not have its own employees or office space and did not conduct any business activity. Our data show that the change in the recipient of the money would have made no difference regarding the likelihood of R&A’s liability for the income tax in this scenario.

According to Ryder ’s version of the facts, ELC did have its own employees, 20 even though there is no mention of a separate office space from which ELC allegedly operated. Yet, Ryder maintains that ELC was the one providing the staffing services to its clients after the assignment of the clients to the company in January 2004. Even if Ryder had been able to convince the court of his version of the facts, it would hardly have made a dent in the likelihood of the outcome that R&A would be held liable for the tax payable on the income from the staffing product.

With Ryder ’s narrative as the underlying facts, our predictor is still 94 percent confident that R&A would have been held liable for the tax. The taxation of the income in the hands of the one who earned it is not easily avoided with a simple assignment agreement, particularly if the income earner keeps benefiting from the income after the assignment and continues to provide services himself without giving up control over the services for the benefit of the assignee. The insight gained from the decision regarding the staffing product is that the court will take a careful look behind the assignment agreement and, if it is not able to spot a legitimate assignee, the assignment agreement will be disregarded.

The court made the same factual findings regarding the ASIG product as it did for the staffing product post-assignment. Ryder , however, had more to say here in support of his case. For one, he pointed to ASIG’s main office that was located at the Morris Cottingham offices. Morris Cottingham was also the one that, on paper, contracted with clients for the insurance services and the collection of fees was conducted, again on paper, in the name of Morris Cottingham . The court also refers to actual claims that the clients made under their policies. There is also a paper trail that indicates that the clients were explicitly acknowledging and in fact paying ASIG for its costs and services. From all this we can conclude that Ryder was able to argue that ASIG had its own independent office, had one or more employees providing services, and that ASIG engaged in actual business activity. However, even if these facts had been admitted as accurately reflecting the ASIG product, our data show that with a 92 percent certainty R&A would still be liable for the income tax payable on the income the ASIG product generated. It is clear that winning a case involving the assignment of income doctrine on facts such as the ones in Ryder is an uphill battle. If the person behind the scenes remains involved with the services provided without giving up control over them, and benefits from the income generated, it is a lost cause to argue that the assignment of income doctrine should be applied with the effect that the entity that provides the services on paper is liable for the income tax.

C. Ryder as ASIG’s Agent

Our data reveal that to have a more substantial shot at succeeding with his case under the assignment of income doctrine, Ryder would have had to pursue a different line of argument altogether. Had he set R&A up as ASIG’s agent rather than tried to disguise its involvement with the purported insurance business, Ryder would have been more likely to succeed in shifting the income tax liability to ASIG. For our analysis of the effect of the different factors discussed by the court in Ryder , we assume at the outset that Ryder would do everything right — that is, ASIG would have its own workers and office, and it would do something other than just moving money around (best-case scenario). We then modify each factor one by one to reveal their respective effect.

From this scenario testing, we can conclude that if R&A had had an agency agreement with ASIG, received some form of compensation for its services from ASIG, held itself out to act on ASIG’s behalf, and the client was interested in R&A’s service because of its affiliation with ASIG, Ryder would have reduced the likelihood to 73 percent of R&A being liable for the income tax. Add to these agency factors an element of monitoring by ASIG and the most likely result flips — there would be a 64 percent likelihood that ASIG would be liable for the income tax. If ASIG were to go beyond monitoring R&A’s services by controlling them too, the likelihood that ASIG would be liable for the income tax would increase to 82 percent. Let’s say Ryder had given Morris Cottingham oversight and control over R&A’s services for ASIG, then the question whether ASIG employs any workers other than R&A arguably becomes moot because there would necessarily be an ASIG employee who oversees R&A. Accordingly, there is hardly any change in the confidence level of the prediction that ASIG is liable for the income tax when the worker factor is absent.

Interestingly, this is quite different from the effect of the office factor. Keeping everything else as-is, the absence of having its own ASIG-controlled office decreases the likelihood of ASIG being liable to pay the income tax from 82 to 54 percent. Note here that our Assigned Income From Services predictor is trained on data from relatively old cases; only 14 are from the last decade. This may explain why the existence of a physical office space is predicted to play such an important role when the courts determine whether the entity that allegedly earns the income is a legitimate business. In a post-pandemic world, it may be possible that a trend will emerge that puts less emphasis on the physical office space when determining the legitimacy of a business.

The factor that stands out as the most important one in our hypothetical scenario in which R&A is the agent of ASIG is the characterization of ASIG’s own business activity. In the absence of ASIG conducting its own business, nothing can save Ryder ’s case. This makes intuitive sense because if ASIG conducts no business, it must be R&A’s services alone that generate the income; hence R&A is liable for the tax on the income. Also very important is the contracting party factor: If the client were to contract with R&A rather than ASIG in our hypothetical scenario, the likelihood that R&A would be held liable for the income tax is back up to 72 percent, all else being equal. If the client were to contract with both R&A and ASIG, it is a close case, leaning towards ASIG’s liability with 58 percent confidence. Much less significant is who receives the payment between the two. If it is R&A, ASIG remains liable for the income tax with a likelihood of 71 percent, indicating a drop in confidence by 11 percent compared with a scenario in which ASIG received the payment.

To summarize, if Ryder had pursued a line of argument in which he set up R&A as ASIG’s agent, giving ASIG’s employee(s) monitoring power and ideally control over R&A’s services for ASIG, he would have had a better chance of succeeding under the assignment of income doctrine. As we have seen, the main prerequisite for his success would have been to convince the court that it would be appropriate to characterize ASIG as conducting business. Ideally, Ryder also would have made sure that the client contracted for the services with ASIG and not with R&A. However, it is significantly less important that ASIG receives the money from the client. The historical case law also suggests that Ryder would have been well advised to set up a physical office for ASIG; however, given the new reality of working from home, this factor may no longer be as relevant as these older previously decided cases indicate.

VII. Conclusion

We have seen that R&A’s chances to shift the liability for the tax payable on the staffing and the ASIG product income was virtually nonexistent. The difficulty of this case from the perspective of the IRS certainly lay in gathering the evidence, tracing the money through the winding paths of Ryder ’s paper labyrinth, and making it comprehensible for the court. Once this had been accomplished, the IRS had a more-or-less slam-dunk case regarding the applicability of the assignment of income doctrine. As mentioned at the outset, an assignment of income case will always be an uphill battle for the taxpayer because income is generally taxable to whoever earns it.

Yet, in cases in which the disputed question is who earned the income and not whether the assignment agreement has shifted the income tax liability, the parties must lean into the factors discussed here to convince the court of the legitimacy (or the illegitimacy, in the case of the government) of the ostensibly income-earning entity and its business. Our analysis can help decide which of the factors must be present to have a plausible argument, which ones are nice to have, and which should be given little attention in determining an efficient litigation strategy.

1   Ernest S. Ryder & Associates Inc. v. Commissioner , T.C. Memo. 2021-88 .

2   Lucas v. Earl , 281 U.S. 111, 114-115 (1930).

3   Ryder , T.C. Memo. 2021-88, at 7.

4   Id. at 32.

5   Id. at 17, 19, and 111-112.

6   Id. at 51-52, 111-112, and 123-126.

7   Id. at 9-12.

8   Id. at 96.

10  CCH, Federal Taxation Comprehensive Topics, at 4201.

11   Lucas , 281 U.S. at 115.

12   See , e.g. , “familial partnership” cases — Burnet v. Leininger , 285 U.S. 136 (1932); Commissioner v. Tower , 327 U.S. 280 (1946); and Commissioner v. Culbertson , 337 U.S. 733 (1949). For an application in the commercial context, see Commissioner v. Banks , 543 U.S. 426 (2005).

13   Banks , 543 U.S. at 426.

14   See , e.g. , Johnston v. Commissioner , T.C. Memo. 2000-315 , at 487.

16   Ray v. Commissioner , T.C. Memo. 2018-160 .

17   Ryder , T.C. Memo. 2021-88, at 90-91.

18   Id. at 48, 51, and 52.

19  The predictor considered several further factors that play a greater role in other fact patterns.

20  The court mentions that ELC’s letterhead set out six employees and their respective positions with the company.

END FOOTNOTES

What is “Assignment of Income” Under the Tax Law?

Gross income is taxed to the individual who earns it or to owner of property that generates the income. Under the so-called “assignment of income doctrine,” a taxpayer may not avoid tax by assigning the right to income to another.

Specifically, the assignment of income doctrine holds that a taxpayer who earns income from services that the taxpayer performs or property that the taxpayer owns generally cannot avoid liability for tax on that income by assigning it to another person or entity. The doctrine is frequently applied to assignments to creditors, controlled entities, family trusts and charities.

A taxpayer cannot, for tax purposes, assign income that has already accrued from property the taxpayer owns. This aspect of the assignment of income doctrine is often applied to interest, dividends, rents, royalties, and trust income. And, under the same rationale, an assignment of an interest in a lottery ticket is effective only if it occurs before the ticket is ascertained to be a winning ticket.

However, a taxpayer can shift liability for capital gains on property not yet sold by making a bona fide gift of the underlying property. In that case, the donee of a gift of securities takes the “carryover” basis of the donor.  

For example, shares now valued at $50 gifted to a donee in which the donor has a tax basis of $10, would yield a taxable gain to the donee of its eventual sale price less the $10 carryover basis. The donor escapes income tax on any of the appreciation.

For guidance on this issue, please contact our professionals at 315.242.1120 or [email protected] .

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Recognizing when the IRS can reallocate income

• C Corporation Income Taxation
• IRS Practice & Procedure

Transactions between related parties come under close scrutiny by the IRS because they are not always conducted at arm's length. If the amounts involved in the transaction do not represent fair market values, the IRS can change the characteristics of the transaction to reflect its actual nature.

The IRS may attempt to reallocate income between a closely held corporation and its shareholders based on several sets of rules, including the following:

• Assignment-of-income rules that have been developed through the courts;
• The allocation-of-income theory of Sec. 482; and
• The rules for allocation of income between a personal service corporation and its employee-owners of Sec. 269A.

Income reallocation under the assignment - of - income doctrine is dependent on determining who earns or controls the income. Justice Oliver Wendell Holmes made the classic statement of the assignment - of - income doctrine when he stated that the Supreme Court would not recognize for income tax purposes an "arrangement by which the fruits are attributed to a different tree from that on which they grew" ( Lucas v. Earl , 281 U.S. 111, 115 (1930)).

Reallocation under Sec. 482 is used to prevent tax evasion or to more clearly reflect income when two or more entities are controlled by the same interests. Note the use of the word "or" in the preceding sentence. The Code empowers the IRS to allocate income even if tax evasion is not present if the allocation will more clearly reflect the income of the controlled interests. The intent of these provisions is to place the controlled entity in the same position as if it were not controlled so that the income of the controlled entity is clearly reflected (Regs. Sec. 1. 482 - 1 (a)) .

Example 1. Performing services for another group member:   Corporations P and S are members of the same controlled group. S asks P to have its financial staff perform an analysis to determine S' s borrowing needs. P does not charge S for this service. Under Sec. 482, the IRS could adjust each corporation's taxable income to reflect an arm's - length charge by P for the services it provided to S .

Under Sec. 269A(a), the IRS has the authority to allocate income, deductions, credits, exclusions, and other items between a personal service corporation (PSC) and its employee - owners if:

• The PSC performs substantially all of its services for or on behalf of another corporation, partnership, or other entity; and
• The PSC was formed or used for the principal purpose of avoiding or evading federal income tax by reducing the income or securing the benefit of any expense, deduction, credit, exclusion, or other item for any employee-owner that would not otherwise be available.

A PSC will not be considered to have been formed or availed of for the principal purpose of avoiding or evading federal income taxes if a safe harbor is met. The safe harbor applies if the employee - owner's federal income tax liability is not reduced by more than the lesser of (1) $2,500 or (2) 10% of the federal income tax liability of the employee - owner that would have resulted if the employee - owner personally performed the services (Prop. Regs. Sec. 1. 269A - 1 (c)).

For purposes of this rule, a PSC is a corporation, the principal activity of which is the performance of personal services when those services are substantially performed by employee - owners (Sec. 269A(b)(1)). An employee - owner is any employee who owns on any day during the tax year more than 10% of the PSC's outstanding stock. As with many related - party provisions, the Sec. 318 stock attribution rules (with modifications) apply in determining stock ownership (Sec. 269A(b)(2)).

Example 2. Reallocation of income: H forms M Corp., which is a PSC. A few months later, he transfers shares of stock of an unrelated corporation to M . The following year, M receives dividends from the unrelated corporation and claims the Sec. 243(a) 50% dividend exclusion. The IRS may reallocate the dividend income from M to H if the principal purpose of the transfer of the unrelated stock to M was to use the 50% dividend exclusion under Sec. 243. However, the amounts to reallocate to H must exceed the safe - harbor amounts.

These rules usually apply when an individual performs personal services for an employer that does not offer tax - advantaged employee benefits (such as a qualified retirement plan and other employee fringe benefits). In those situations, the individual may set up a 100%- owned C corporation that contracts with the employer. The employer then pays the corporation. The individual functions as the employee of the corporation, and the corporation sets up tax - advantaged fringe benefit programs. The individual generally is able to "zero out" the income of the corporation with payments for salary and fringe benefits.

Despite the significant authority that Sec. 269A grants to the IRS, there is little evidence of the IRS or the courts using this statute. In a 1987 private letter ruling, the IRS held that a one - owner , one - employee medical corporation did not violate the statute, even though it retained only nominal amounts of taxable income, and the corporate structure allowed the individual to achieve a significant pension plan deduction. These facts were not sufficient to establish a principal purpose of tax avoidance (IRS Letter Ruling 8737001). In Sargent , 929 F.2d 1252 (8th Cir. 1991), the Eighth Circuit indicated a lack of interest in applying Sec. 269A because, in that case, the court felt the PSC had been set up for other legitimate reasons.    

This case study has been adapted from PPC's Tax Planning Guide — Closely Held Corporations , 31st Edition (March 2018), by Albert L. Grasso, R. Barry Johnson, and Lewis A. Siegel. Published by Thomson Reuters/Tax & Accounting, Carrollton, Texas, 2018 (800-431-9025; tax.thomsonreuters.com ).

A $10.7 million compensation deduction miss

Short-term relief for foreign tax credit woes, irs rules that conversion of llc not a debt modification, a look at revised form 8308, state responses to federal changes to sec. 174.

This article discusses the history of the deduction of business meal expenses and the new rules under the TCJA and the regulations and provides a framework for documenting and substantiating the deduction.

PRACTICE MANAGEMENT

CPAs assess how their return preparation products performed.

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• Finance Law

Assignment of Income Lawyers

(This may not be the same place you live)

  What Happens if you Assign your Income?

There are some instances when a person may choose to assign a portion of their income to another individual. You may be able to do this by asking your employer to send your paycheck directly to a third party.

It should be noted, however, that if you choose to assign your income to a third party, then this does not mean that you will be able to avoid paying taxes on that income. In other words, you will still be responsible for paying taxes on that income regardless of whether you decide to assign your income to a third party or not. This guideline is known as the “assignment of income doctrine.”

The primary purpose of the “assignment of income doctrine” is to ensure that a person does not simply assign their income to a third party to avoid having to pay taxes. If they do, then they can be charged and convicted of committing tax evasion .

One other important thing to bear in mind about income assignments is that they are often confused with the concept of wage garnishments. However, income or wage assignments are different from wage garnishments. In a situation that involves wage garnishment, a person’s paycheck is involuntarily withheld from them to pay off a debt like outstanding child support payments and is typically ordered by a court.

In contrast, an income or wage assignment is when a person voluntarily agrees to assign their income to someone else through a contract or a similar type of agreement.

How is Assigned Income Taxed?

Are there any exceptions, should i consult with an attorney.

As previously discussed, a taxpayer will still be required to pay taxes on any income that is assigned to a third party. The person who earns the income is the one who will be responsible for paying taxes on the income, not the person to whom it is assigned. The same rule applies to income that a person receives from property or assets.

For example, if a person earns money through a source of what is considered to be a passive stream of income, such as from stock dividends, the person who owns these assets will be the one responsible for paying taxes on the income they receive from it. The reason for this is because income is generally taxed to the person who owns any income-generating property under the law.

If a person chooses to give away their income-generating property and/or assets as a gift to a family member, then they will no longer be taxed on any income that is earned from those property or assets. This rule will be triggered the moment that the owner has given up their complete control and rights over the property in question.

In order to demonstrate how this might work, consider the following example:

• Instead, the person to whom the apartment building was transferred will now be liable for paying taxes on any income they receive from tenants paying rent to live in the building since they are the new owner.

There is one exception to the rule provided by the assignment of income doctrine and that is when income is assigned in a scenario that involves a principal-agent relationship . For example, if an agent receives income from a third-party that is intended to be paid to the principal, then this income is usually not taxable to the agent. Instead, it will be taxable to the principal in this relationship.

Briefly, an agent is a person who acts on behalf of another (i.e., the principal) in certain situations or in regard to specific transactions. On the other hand, a principal is someone who authorizes another person (i.e., the agent) to act on their behalf and represent their interests under particular circumstances.

For example, imagine a sales representative that is employed by a large corporation. When the sales representative sells the corporation’s product or service to a customer, they will receive money from the customer in exchange for that service or product. Although the sales representative is the one being paid in the transaction, the money actually belongs to the corporation. Thus, it is the corporation who would be liable for paying taxes on the income.

In other words, despite the fact that this income may appear to have been earned by the corporation’s agent (i.e., the sales representation in this scenario), the corporation (i.e., the principal) will still be taxed on the income since the sales representative is acting on behalf of the corporation to generate income for them.

One other exception that may apply here is known as a “kiddie tax.” A kiddie tax is unearned or investment-related income that belongs to a child, but must be paid by the earning child’s parent and at the tax rate assigned to adults (as opposed to children). This is also to help prevent parents from abusing the tax system by using their child’s lower tax rate to shift over assets or earned income and take advantage of their child’s lower tax bracket rate.

So, even though a parent has assigned money or assets to a child that could be considered their earned income, the money will still have to be paid by the parent and taxed at a rate that is reserved for adults. The child will not need to pay any taxes on this earned income until it reaches a certain amount.

In general, the tax rules that exist under the assignment of income doctrine can be confusing. There are several exceptions to these rules and many of them require knowing how to properly apply them to the specific facts of each individual case.

Therefore, if you have any questions about taxable income streams or are involved in a dispute over taxable income with the IRS, then it may be in your best interest to contact an accountant or a local tax attorney to provide further guidance on the matter. An experienced tax attorney can help you to avoid incurring extra tax penalties and can assist you in resolving your income tax issue in an efficient manner.

Your attorney will also be able to explain the situation and can recommend various options to settle the assignment of income issue or any related concerns. In addition, your attorney will be able to communicate with the IRS on your behalf and can provide legal representation if you need to appear in court.

Lastly, if you think you are not liable for paying taxes on income that has been assigned to you by someone else, then your lawyer can review the facts of your claim and can find out whether you may be able to avoid having to pay taxes on that income.

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Tax treatment of royalty monetization transactions – sale or loan?

A life science company that holds the right to receive a stream of future royalties may want to monetize the royalty stream. The monetization transaction would involve a significant upfront cash payment to the company from another party (the Financing Party) in exchange for some or all of the company’s rights to receive the royalty stream over time.

For tax purposes, is the royalty stream monetization a sale of property rights, or is it a loan? If the transaction constitutes a sale for tax purposes, generally:

• The upfront payment from the Financing Party to the company would constitute sale proceeds, and
• The stream of future royalty payments would constitute income to the Financing Party and not the company.

If the transaction is instead treated as a loan for tax purposes, generally:

• The upfront payment from the Financing Party to the company would constitute loan proceeds and not taxable income, and
• The future royalty stream would constitute taxable income to the company, even if the company immediately remits the payments to the Financing Party.

Note that the federal tax treatment may differ from the company’s financial reporting of the monetization transaction. Additionally, the transaction’s tax treatment may differ from descriptions set out in the governing legal documents.

Example of a royalty monetization transaction

CureCo is dedicated to finding a cure for a rare disease. CureCo has developed a pharmaceutical drug approved in a number of countries to treat the rare disease. CureCo manufactures, markets, and distributes the drug in the United States. CureCo has entered into a licensing agreement with an established European drug distributor that can market and distribute the drug in Europe (the European License Agreement). The distributor acquires exclusive rights to distribute the drug in Europe for 10 years and CureCo receives annual royalty payments based on the level of European sales of the drug.

The partnership with the distributor is a success, generating annual royalty payments averaging $30 million from 2018 – 2021. Assuming continuing viability of the drug, CureCo expects to receive annual royalty payments of $30 – $40 million from the European distributor for the next 10 years.

In 2021, CureCo would like to invest in additional new drug development, which will require a large amount of cash. A Financing Party offers to purchase the next five years’ worth of European License Agreement royalty payments for a single $100 million up-front payment. CureCo accepts the offer, and enters into a Royalty Purchase Agreement with the Financing Party.

Royalty monetization – sale or loan?

How is the royalty monetization transaction viewed from a tax perspective? Is the sale truly a sale? Or is it a loan? If it is a sale, does it result in capital gain, or ordinary income?

A transaction’s tax treatment typically is determined in accordance with its substance, not merely by its form.1 The question of substance over form may arise in regard to a taxpayer’s receipt of cash in exchange for an obligation that could be viewed as debt or as something else from a tax perspective. For example, there are many tax cases addressing whether an advance to a corporation from its shareholder should be treated as debt or equity for tax purposes. Courts generally have ruled that an advance constitutes debt if there are firm rights to and expectation of repayment,2 and not debt if firm rights to repayment or expectation of repayment is not present.3 In differentiating between debt and equity, the case law generally requires an examination of numerous factors,4 including the right to repayment of a fixed or ascertainable sum, at a fixed or ascertainable maturity date, with repayment not heavily dependent upon the borrower’s profits or revenues.5

In the case of royalty monetization transactions, the issue is whether the cash advance constitutes sale proceeds or loan proceeds. Courts have on numerous occasions addressed whether a transaction involving an upfront payment to an owner of property constitutes a sale or a loan for federal tax purposes. A key differentiating factor courts look to is whether the risk of loss and opportunity for gain with respect to the property has been shifted.6 Some cases of this type have resulted in courts holding that a transaction documented as a sale was treated as a loan for federal tax purposes,7 while others resulted in courts holding that the transaction was treated as a sale.8The chief distinguishing factor generally was whether there was certainty of repayment, or whether the purchasing or financing party instead bore the risk of loss with respect to the subject property.9

One court has succinctly summarized the tax law in this area:

For disbursements to constitute true loans there must have been, at the time the funds were transferred, an unconditional obligation on the part of the transferee to repay the money, and an unconditional intention on the part of the transferor to secure repayment. In the absence of direct evidence of intent, the nature of the transaction may be inferred from its objective characteristics....10

Accordingly, the case law’s principal focus in determining whether a sale of property rights should be treated as a loan is not the form of the transaction but whether the seller has an unconditional obligation to repay the money advanced or whether the risk of loss with respect to the subject property has instead shifted to the buyer (i.e., to the Financing Party).11 A royalty monetization transaction where the Financing Party’s rights to future repayment are not fixed or ascertainable repayment but are instead contingent on whether the property produces sufficient income would often be viewed for tax purposes as a sale rather than a loan. However, each transaction should be analyzed on its own facts.

Income from royalty monetization transactions – ordinary income or capital gain?

If a royalty stream monetization transaction is treated for federal income tax purposes as a sale and not loan, the income that the company realizes in the transaction often is characterized as ordinary income under the substantial rights test and/or the assignment of income doctrine.

Capital gains and losses are generated by the sale or exchange of a capital assets. Capital assets are defined to include all property, other than specifically enumerated types of property.12 Intangible assets are frequently licensed or leased in exchange for royalties. The owner’s receipt of royalty income is taxed as ordinary income, not as capital gain.13 The owner (licensor) must generally include any advance royalty or rental payments in gross income for the year in which the owner receives the payments, regardless of the period covered or the method of accounting the owner uses.14

License versus sale of IP

The distinction between capital gain and ordinary income15 is one of the principal reasons why it is important to characterize intangible asset transfers as sales or licenses for tax purposes.16 To distinguish a license from a sale, the courts and the IRS typically apply a “substantial rights” test, which looks to whether the transferor retained a substantial right in the asset.17 For example, a patent holder’s transfer of a nonexclusive right to use a patent asset typically would not qualify for sale treatment because it is not a transfer of all substantial rights.18

An intangible asset transfer generally is treated as a license and not sale of the underlying asset if it consists of only a right to use the asset for a period less than the estimated useful life of the asset.19 In  Pickren , for example, the court determined that the transfer of a formula for liquid wax products for a 25-year period was a license and not sale of the underlying asset because the useful life of the formula extended beyond the 25-year period.20 The transfer was not a sale because the remainder interest retained by the transferor comprised a substantial right in the asset.21

Assignment of income doctrine

Property that produces ordinary income may generate capital gain when it is sold. Examples include a sale of real property that generates ordinary rental income or a sale of stock or bonds that yields ordinary dividend or interest income. Taxpayers’ ability to treat the sale of an ordinary income stream as generating capital gain is subject to various limitations besides the substantial rights test discussed above; one of these limitations is the assignment of income doctrine.22

For example, in the seminal  P.G. Lake  case, the Supreme Court ruled that proceeds received by the transferors in exchange for the assignments of oil payment rights represented assignments of the transferors’ rights to receive future income and were therefore taxable as ordinary income.23 In several cases, taxpayers assigned rights to compensation for service they rendered and pointed to contingencies or valuation difficulties, hoping their transactions would not fall within the scope of the assignment of income doctrine. However, courts generally rejected these attempts and treated these transactions as assignments of the right to receive ordinary income.24

Accordingly, if a royalty stream monetization transaction is treated for federal income tax purposes as a sale, the income that the company realizes in the transaction often is characterized as ordinary income. Each monetization transaction, however, should be analyzed on its specific facts.

Royalty stream monetization transactions often are treated as sales and not loans for federal income tax purposes. However, each transaction must be judged based on its particular facts and circumstances. The transaction’s characterization under tax rules may differ from its characterization in legal document or its characterization for financial accounting purposes. Due to the complexities surrounding royalty monetization transactions, taxpayers entering into them should consult with their tax advisors.

1 See ,  e.g., Frank Lyon v. United States , 435 U.S. 561, 573 (1978) (“[t]he Court has never regarded the simple expedient of drawing up papers as controlling for tax purposes when the objective economic realities are to the contrary.”) (internal quotation marks and citations omitted);  Higgins v. Smith , 308 U.S. 473 (1940);  Gregory v. Helvering , 293 U.S. 465 (1935). 2  See, e.g., Gilbert v. Comm’r , 248 F.2d 399 (2d Cir. 1957),  on remand , 17 T.C.M. 29 (1958),  aff'd , 262 F.2d 512 (2d Cir.),  cert. denied , 359 U.S. 1002 (1959). 3  See, e.g., United States v. Title Guarantee & Trust Co.,  133 F.2d 990 (6th Cir. 1943).  See also Slappey Drive Indus. Park v. United States , 561 F.2d 572 (5th Cir. 1977). 4 See, e.g., Bauer v. Comm’r , 748 F.2d 1365 (9th Cir. 1984);  Estate of Mixon v. United States , 464 F.2d 394 (5th Cir. 1972). 5  See Gilbert, supra. See generally  Plumb,  The Federal Income Tax Significance of Corporate Debt: A Critical Analysis and a Proposal , 26 Tax L. Rev. 369 (1971) (“when money is advanced ... not for the return of the principal, but for payment of a percentage of profits or sales, indefinitely or for a specified period, the arrangement lacks even the form of debt ...”) 6 See United Surgical Steel Co. v. Comm'r , 54 T.C. 1229-1230 (1970);  Town & Country Food Co. v. Comm'r , 51 T.C. 1057 (1969);  Grodt McKay Realty Inc. v. Comm'r , 77 T.C. 1221 (1981).  See also Illinois Power Co. v. Comm'r , 87 T.C. 1417 (1986);  Coleman v. Comm'r , 87 T.C. 178 (1986),  aff’d , 833 F. 2d 303 (3d Cir. 1987). 7An interesting application of the question of sale versus loan involves taxpayers with expiring tax net operating losses (NOLs) who arrange to sell future income in an effort to utilize the benefits of the losses in the current year. In  Hydrometals , for example, a taxpayer with an expiring NOL took the following steps: The company sold a fixed amount of its receivables to a buyer (who had borrowed cash from a bank to finance the purchase), purchased certificates of deposit with the sale proceeds, deposited these certificates with the bank that had loaned funds to the buyer, and agreed to maintain these certificates until the buyer received the revenue it had purchased. Because the buyer’s repayment was virtually guaranteed, the court concluded that the “sale” was in substance a loan.  Hydrometals, Inc. v. Comm’r , T.C. Memo. 1972-254,  aff’d per curiam , 485 F.2d 1236 (5th Cir. 1973).  See also Mapco, Inc. v. United States , 556 F.2d 1107 (Ct. Cl. 1977). 8 In  Stranahan , for example, the court concluded that a tax-motivated sale of future dividends was actually a sale and not a loan. The taxpayer, who desired to generate taxable gain to offset a large interest deduction, sold the right to receive future stock dividends. The court held that although the sale was motivated solely by tax savings, the transaction could not be recharacterized as a loan, because a genuine risk did exist that enough dividends might not be declared in the future to fully repay the buyer for his cash outlay.  Stranahan v. Comm'r , 472 F.2d 867 (6th Cir. 1973).   See also Cotlow v. Comm’r , 228 F.2d 186 (2d Cir.1955) (assignment of life insurance policy renewal commissions treated as a sale and not a loan because buyer bore the risk that the policies would not be renewed) . 9 See, e.g., Stranahan, supra; Cotlow, supra; Mapco, supra.  The issue of sale versus loan characterization can similarly arise in the context of factoring. Factoring refers to where a company sells its receivables to a financing party, called a factor. Generally, if the sale to the factor is at arms-length and the factor assumes risk of loss with respect to the receivables, the sale is respected for tax purposes.  See ,  e.g ., CCA 200519048 (Jan. 27, 2005) (risk of loss had shifted to factor and taxpayer must therefore include as income the factor’s lump sum payment). 10 Geftman v. Comm'r , 154 F.3d 61 (3d Cir. 1998) (internal quotation marks omitted). 11In various contexts, courts have emphasized that ownership of property for tax purposes does not depend merely on legal title.  See ,  e.g. ,  Grodt McKay Realty Inc. v. Comm'r , 77 T.C. 1221 (1981). 12Sections 1222(1). Section 1221(a)(3) excludes certain patents and other intangible property from capital asset treatment. The exclusion applies to certain property created by the holder's personal efforts (or property received in exchange for such property). This article does not further discuss the section 1221(a)(3) exclusion. 13Section 61(a)(6). 14Reg. sections 1.61-8(a) and -8(b). 15Capital gain treatment generally is more advantageous for taxpayers than ordinary income treatment, for reasons that differ for differently situated taxpayers and that this article does not discuss. 16We have used the terms “sale” and “license” for the sale of colloquial clarity here. We note also that the substantial rights test authorities discussed below generally hold that a transfer that fails to transfer all substantial rights results in ordinary income treatment without concluding whether the transfer is or is not treated as a sale for federal income tax purposes. Aside from its relevance to the capital versus ordinary character question, another reason that treatment of a transaction as a sale may be important is that sale transactions generally permit the seller to recover the tax basis of the property sold.  See generally  Section 1001. Since life science companies engaging in royalty stream monetization transactions generally have little if any tax basis in their monetized royalty rights, this article does not address basis recovery. 17 See  Section 1235(a) and Reg. section 1.1235-2 (regarding transfer of substantial rights to a patent);  Pickren v. United States , 378 F.2d 595 (5th Cir. 1967) (right to terminate transfer agreement at will is retention of substantial right when trade secret's useful life extends beyond term of agreement);  Cubic Corp. v. United States , 72-1 U.S.T.C. ¶ 9165 (S.D. Cal. 1971) (license agreement because owner transferred less than all of substantial rights); Rev. Rul. 64-56, 1964-1 C.B. 133,  amplified by  Rev. Rul. 71-564, 1971-2 C.B. 179. Transfer of all substantial rights within a specified jurisdiction or territory may receive sale treatment even if rights in other jurisdictions or territories are retained. See  Glen O’Brien Partition Co. v. Comm’r , 70 T.C. 492 (1978); Rev. Rul. 64-56,  supra, amplified by  Rev. Rul. 71-564,  supra. 18 See generally  Reg. section 1.1235-2. 19 See  Reg. section 1.1235-2(b)(1)(i) (patents). 20 Pickren ,  supra . 21 Id. See also  Rev. Rul. 64-56,  supra  (transfer of know-how is a sale only if the transfer is exclusive and perpetual). 22 See, e.g., Hort v. Comm’r , 313 U.S. 28 (1941);  Comm’r v. P.G. Lake, Inc ., 356 U.S. 260 (1958).  See also  Rev. Rul. 69-471, 1969-2 C.B. 10 (wife’s receipt of a lump sum, pursuant to a divorce degree, in exchange for relinquishment of rights with respect to husband's retirement pay is ordinary income under the assignment of income doctrine). 23 P.G. Lake, supra  (the “... substance of what was assigned was the right to receive future income”). 24 See ,   e.g. ,  O'Neill v. Comm’r , 23 T.C.M. 7(1964) (“[p]etitioner argues that where a taxpayer sells a right to receive income which has not accrued or which cannot be ascertained with accuracy, then the gain realized from such sale is a capital gain. We cannot agree.”);  Turner v. Comm’r , 38 T.C. 304 (1962) (sale of rights to receive future commissions on renewal of insurance policies).

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A Tax Planning Cautionary Tale: Timing and Formalities Are Critical

A business owner learned the hard way (and at great cost) not to dawdle or cut corners when it comes to tax plans involving the sale of a business.

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This cautionary tale is based upon the recent tax case of Estate of Hoensheid v Commissioner , TC Memo 2023-34. When owners of a company plan to sell their business, there is very often a desire to minimize the resultant income tax. This tax is effectively taxing the increase in the value of the business often earned over many years and decades into a single year. The resultant tax will often be at the highest marginal rate, substantially reducing the net proceeds to the seller.

Many of the tools used to minimize income tax in this situation have a charitable giving component. When properly planned and implemented, three separate goals are achieved.

First, a portion of the otherwise taxable gain on the sale becomes nontaxable because a portion of the asset being sold is transferred to an IRS-recognized charitable structure.

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Second, there is an income tax deduction equal to the fair market value of the appreciated asset contributed to the charitable structure. This compounds the economic value of the tax savings structure. A portion of the gain is sold tax-free by the charitable organization, and the seller receives a charitable deduction equal to the fair market value of the asset contributed. For example, if we are selling a company for a $20 million taxable gain, we could expect a tax of $6 million based upon a 30% combined federal and state tax rate. This leaves net proceeds of $14 million.

Note also that the seller has no say in how the $6 million in tax is spent by the government. If we gift a portion of the company to an IRS-recognized charitable structure, then you could direct the funds to be used for the Wounded Warrior Project , the Make-A-Wish Foundation or any legitimate charitable cause that you wish. Note that those funds would need to be distributed to a 501(c)(3) charity focusing on that desired purpose.

If we transfer $5 million to a charitable structure before the sale, the taxable gain itself is now only $15 million. This is because the net gain is reduced by the $5 million contributed to charity. The stock owned by the charity is sold tax free. Then the taxable gain is further reduced by a charitable contribution deduction equal to the fair market value of the stock contributed to charity. This results in a net tax of approximately $3 million. However, this is only a small part of the story.

The third goal is where the magic happens. Contributing the appreciated asset to a well-planned charitable structure provides an economic benefit to the charity and builds substantial wealth for the family, typically due to the time value of money. These structures provide independent economic value or wealth to the family and to the charity. Careful consideration must be given to each client’s financial and nonfinancial goals.

These charitable structures are typically referred to by acronyms, leading to a veritable alphabet soup of alternatives: CRTs (charitable remainder trusts), CLTs (charitable lead trusts), PIFs (pooled income funds), CHLLCs (charitable limited liability companies), to name just a few overall categories. For my clients, we always recommend a structure that provides the client investment control of the funds while invested within the charitable structure. These structures can also provide significant asset protection for the client and their family.

An example of a $7 million investment into an intergenerational split interest trust PIF (a form of a pooled income fund) would provide the following results for a family where Dad is 49 years old and has kids ages 28, 24 and 11:

• $7 million contribution
• Income tax deduction: $2,171,200
• Projected annual income of 6%: $420,000 per year to Dad for his entire life and, at his death, to his children for their entire lives
• Client can maintain investment control
• Trust can own investment income real estate, if desired

Alternatively, a $3 million investment into a deferred inheritance trust (a form of CLAT) could provide an overall benefit to the family of over $16 million. The charity would also receive over $8 million. A dollar-for-dollar income tax deduction is provided of $3 million. This provides an estimated tax savings of $1,289,100. With the tax savings, the net cost of the $3 million investment is only $1,710,900.

Here’s how that would work: The client invests $3 million into the deferred inheritance trust. Of that amount, $150,000 is invested in municipal bonds to pay the required annual charitable distributions. $2,850,000 is used to acquire a life insurance policy within the deferred inheritance trust. This will provide over $8 million to the charity and almost $17 million to the client’s children, income- and estate-tax-free.

These are only a few of the economic possibilities available with this type of planning. The key is to first identify your financial and nonfinancial goals, such as establish minimum cash flow and not worth needs. Goals may include providing predictable safe, risk-free income for yourself and your kids or other loved ones, or asset protection for yourself or your loved ones. Then identify the alternatives that best satisfy those goals.

What was lost in the case of Estate of Hoensheid v Commissioner

Any possible benefit from the above type of planning was lost to the owners of Commercial Steel Treaty Corporation (CSTC). CSTC was owned by the taxpayer in the case and his two brothers (collectively, the business owners). The loss in planning benefits is directly attributable to the taxpayer’s own conduct and behavior in waiting too long to implement and trying to save money on appraisal costs.

The business owners received a letter of intent on April 2015 from a buyer who would pay $92 million for their company. The business owners wished to make a contribution to utilize the type of tax planning referred to above, but only if the sale of the company actually closed or was completed. In correspondence with the tax attorney, the brothers indicated that they wanted to “wait as long as possible to pull the trigger” on the contributor. In part, because if the sale did not go through, then the contributor would own less stock than his two brothers and have less control over the company.

The stock was contributed to Fidelity Charitable two days before the sale actually closed. The taxpayer (probably hoping to save a few dollars) did not hire an IRS-recognized and qualified appraiser.

The court relied upon the “assignment of income doctrine” to determine that the sale had progressed too far for Fidelity Charitable to be an owner for income tax purposes. This means that the entire gain, including the portion transferred to Fidelity Charitable, is deemed owned by and taxed entirely to the taxpayer at closing for income tax purposes. In other words, the sale or deal was virtually certain to close or be completed even though the sale did not formally close for two more days.

The assignment of income doctrine is a long-standing “first principle of income taxation” that recognizes that income is taxed to those “who earn or otherwise create the right to receive it” and that tax cannot be avoided by “anticipatory arrangements and contracts however skillfully devised.” The court believed that the charitable transfer of stock was subject to a pending, pre-negotiated transaction with a fixed right to proceeds in the transaction. The court did not believe that Fidelity Charitable or the taxpayer had any meaningful risk that the sale would not close.

A qualified appraisal is important, emphasis on ‘qualified’

The case itself is replete with damaging correspondence and testimony evidence that the taxpayer did not wish to contribute any amount if the sale did not close. The result is that our first goal above was lost because the entire sale was taxable to the owner. The court then went further and denied the charitable contribution deduction itself. The taxpayer did not comply with the regulatory requirements to substantiate the deductions found in Internal Revenue Code Section 170 . In particular, the court determined that the taxpayer did not obtain a “qualified appraisal.” The taxpayer obtained a price quote from a qualified appraiser, but used an unqualified, presumably cheaper, alternative.

The bottom-line result was particularly harsh for the taxpayer. Fidelity Charitable was contractually entitled to a portion of the sale proceeds even though the entire gain was taxable to the business owner. The business owner was also not even entitled to the charitable contribution deduction due to the failure to have a qualified appraiser/appraisal. Definitely not the desired economic result for the taxpayer and his family.

Three lessons to learn from this case

1. All planning should be implemented far sooner. All planning particularly charitable and noncharitable alternatives involving a transfer of ownership prior to the sale must be completed well before the formal closing of the sale or deal. If the sale or deal has progressed too far, you run the risk of any presale transfers being disregarded for tax purposes under the assignment of income doctrine. “Too far” means there is a meaningful possibility that the sale will not actually close.

The issuance of a letter of intent (LOI), which is not typically binding, begins a countdown for completion. Try to implement the plan before the LOI is issued, even though the LOI is subject to negotiation. Note that the best planning is done long before the sale is in progress. Some of the best results are obtained by planning at least two years prior to the sale.

2. Seek a qualified tax attorney’s advice. A qualified tax attorney can guide you through the maze of decisions involved with business sales. Note that many mergers and acquisitions attorneys specifically say that they do not give tax advice. Retain and listen to the advice of your tax attorney. Be candid about concerns that you may have, such as the possibility that the sale may not close. Creative solutions may be available.

3. Carefully follow the IRS rules for the tax planning or structure. In tax planning and in life, we should strive to minimize risk and maximize benefits. Here, the taxpayer did not bother to use an IRS-qualified appraiser.

The appraisal itself did not include a statement that the appraisal was prepared for federal tax purposes, included an incorrect date of contribution (possibly as a result of the application of the assignment of income doctrine), included a premature date of appraisal, did not adequately describe the method of valuation, was not even signed by the appraiser, did not include the appraiser’s qualifications, did not describe the property contributed in sufficient detail, and did not include an explanation of the specific basis for the valuation.

The simplest advice here is to dot the i’s and cross the t’s on a timely basis. The cheapest advice may actually be the more expensive, as happened here.

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This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA .

Founder of The Goralka Law Firm , John M. Goralka assists business owners, real estate owners and successful families to achieve their enlightened dreams by better protecting their assets, minimizing income and estate tax and resolving messes and transitions to preserve, protect and enhance their legacy. John is one of few California attorneys certified as a Specialist by the State Bar of California Board of Legal Specialization in both Taxation and Estate Planning, Trust and Probate.

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Tax Law on “Assignment of Income”

Gross income is taxed to the individual who earns it or to an owner of property that generates the income. Under the so-called “assignment of income doctrine,” a taxpayer may not avoid tax by assigning the right to income to another. Specifically, the assignment of income doctrine holds that a taxpayer who earns income from services that the taxpayer performs or property that the taxpayer owns generally cannot avoid liability for tax on that income by assigning it to another person or entity. The doctrine is frequently applied to assignments to creditors, controlled entities, family trusts and charities.

A taxpayer cannot, for tax purposes, assign income that has already accrued from property the taxpayer owns. This aspect of the assignment of income doctrine is often applied to interest, dividends, rents, royalties, and trust income. And, under the same rationale, an assignment of an interest in a lottery ticket is effective only if it occurs before the ticket is ascertained to be a winning ticket. However, a taxpayer can shift liability for capital gains on property not yet sold by making a bona fide gift of the underlying property. In that case, the donee of a gift of securities takes the “carryover” basis of the donor. For example, shares now valued at $50 gifted to a donee in which the donor has a tax basis of $10, would yield a taxable gain to the donee of its eventual sale price less the $10 carryover basis. The donor escapes income tax on any of the appreciation.

For more information about this article, please contact our tax professionals at [email protected] or toll free at 844.4WINDES (844.494.6337).

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FAQ: What Is the Assignment of Income?

Assignment of income allows you to assign part of your income directly to another person. While there are several valid reasons to assign your income to someone else, many taxpayers mistakenly believe that it can help lower their taxable income. While assignment of income allows you to divert income, you cannot divert taxes.

In this article, we’ll provide some examples of failed attempts at avoiding income taxes through the assignment of income and the valid reasons someone might want to assign income to someone else.

RELATED: Tax Evasion Vs. Tax Avoidance: The Difference and Why It Matters

You Can’t Use Assignment of Income to Avoid Paying Taxes

The assignment of income doctrine states that the taxpayer who earns the income must pay the tax on that income, even if he gave the right to collect the income to another person.

The doctrine is quite clear: taxpayers must pay their own taxes. However, that doesn’t stop many people from thinking they can avoid paying taxes or minimize their taxable income through the assignment of income.

Here are a few scenarios we commonly see.

• High-Earning Individuals: In an attempt to avoid having to pay the higher tax rates on their substantial income, high-earning individuals sometimes try to divert income to a lower-income family member in a significantly lower tax bracket. The assignment of income doctrine prevents this scheme from working.
• Charitable Donating : Even if a taxpayer assigns part of their income to a charitable organization, they will still have to pay the taxes. However, they might be eligible to claim a deduction for donations to charity while building some good karma by helping others in need.
• Owning Multiple Businesses: A taxpayer who controls multiple businesses might try to divert income from one business to another, especially if one has the potential to receive a tax benefit but requires a higher income to do so. Not only is this illegal, but it also will not lower the taxable income of the business.

You Can Use Assignment of Income to… Assign Your Income

The assignment of income doctrine does not stop you from diverting part of your income to someone else. In fact, that’s the whole point! Maybe you’re helping to support an elderly family member, or you consistently donate to the same charity every month or year. Whatever the case, you can assign the desired amount of your income to go to another person or organization.

While there are no tax benefits involved in assigning income versus making traditional payments or donations, it can be a more convenient option if you’re making regular payments throughout the year.

S.H. Block Tax Services Provides Clear Answers For Complicated Questions

If you have any questions about how to go about assigning part of your income to a family member in need or a separate business entity, please contact S.H. Block Tax Services today. We can answer all of your questions and address all of your concerns regarding the assignment of income and provide suggestions on valid and legal ways to save on your taxes.

Please call us today at  (410) 872-8376  or complete  this brief contact form  to get started on the path toward tax compliance and financial freedom.

The content provided here is for informational purposes only and should not be construed as legal advice on any subject.

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Basic Federal Income Taxation: Assignment of Income: Assignment of Income: Property

This lesson is best used after studying Federal Income Taxation: Assignment of Income in class. The lesson includes problem sets to work through, allowing you to apply the Code and Regs. to a variety of situations involving assignment of income from property and the determination of whether income is included in an individual's gross income.

Learning Outcomes

On completion of the lesson, the student will be able to: 1. Explain the significance of the power to direct the use of income. 2. Distinguish between gifts of stock made before and after the date that a dividend is declared. 3. Explain the federal income tax effect of a gratuitous assignment of income-producing property under a contract for sale.

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ASSIGNMENT OF INCOME DOCTRINE – SECTION 61 INTERNAL REVENUE CODE – J. RONALD JACKSON

I don’t want to pay tax on this income, assignment of income doctrine.

By:  J Ronald “Ron” Jackson, MBA, CPA

Under federal income tax law gross income is taxed to the person who earns it or to the owner of property that generates the income. It is not uncommon for a high tax bracket taxpayer to want to shift income to a lower tax bracket family member in order to save on taxes and the income stay within the family unit. Alternatively, one who has appreciated stock or other type of property that he knows will be sold in the near future may wish to save on income taxes by gifting a portion of the property to a lower tax bracket family member who will report the sale at his or her lower income tax bracket. Alternatively, the individual may want a double benefit by gifting the appreciated property to a qualified charity thereby gaining a charitable income tax deduction for the value of the contributed property and being relieved of paying income taxes on the gain from the sale of the gifted property. This shifting of income, if permitted for income tax purposes, may provide considerable income tax savings.

The assignment of income doctrine was developed from court decisions which decided the issues, including the various methods employed in attempting to determine who earned the income. There was a time during the World War II years and thereafter, until around 1963, that the top income tax brackets could be as high as 91% – 93%. In addition to family members, the issues often arose when a high bracket taxpayer would make a gift of property (often the issues were gifts of appreciated stock that were to be sold shortly) to a qualified charity. The taxpayer would then take a charitable income tax deduction and not report the gain as he no longer owned the stock when sold. This shifting of income to a lower bracket taxpayer could have large savings in taxes for the high bracket taxpayer.

A simple example of income earned and taxed to the one who earns the income is when one works for weekly wages. The work week ends on Friday but the actual paycheck is not delivered until the following Wednesday. The wages are earned, for income tax purposes, at the end of the week (Friday). If the individual tells his employer to pay the earned wages to the individual’s mother, and the employer did that, the wages would still be taxed for federal income tax purposes to the individual since he earned the wages. The fact he may have made a gift of his earned wages does not change the income tax treatment as his employer has to include the earned wages on the individual’s W-2 form.

The above is a simple illustration of the doctrine that one who earns the income has to pay income tax on the wages. Let’s look at another situation. Suppose Perry, an individual taxpayer, owns all of the stock ownership in a very successful corporation (Company A) that he has run for many years. Perry is approached by the owners of another corporation (Company B) with an interest in purchasing Perry’s stock ownership in Company A. Negotiations have progressed and a total value has been tentatively negotiated of $5,000,000.00. The actual contract is still to be finalized and there are some remaining details to settle. Perry believes it will be finalized and signed within a reasonably short time. Perry, who is in a very high federal income tax bracket and who is a very civic-minded individual, has been told of the benefit of donating appreciated property to charity. Perry contacts the local Community Foundation and arranges to create the Perry Charitable Fund through the Community Foundation. The charitable fund will provide donations to his church and to other qualified charities that Perry usually supports. Perry then donates fifteen percent of his stock ownership, valued at $750,000.00 to the Community Foundation. Later after negotiations are completed, all of Company A’s stock is sold to Company B for the negotiated price of $5,000,000.00. Perry is happy. He has made a substantial profit from his years of work, made a donation to his favorite charity for which he plans to take a charitable income tax deduction, and will only have to report and pay income tax at capital gain rates on 85% of his stock as he has given 15% away.

Perry files his income tax return for the year and reports his taxable gain on the sale of his 85% ownership interest in Company A. About one year later Perry is audited by the IRS. The IRS agent questions why he did not report gain on the 15% of stock given to the Foundation. Perry replies that he did not own the stock as it was gifted to the charity before the date of the sale. The IRS auditor states that Perry should pay income tax on the gain on the stock given to the Community Foundation since it appears to have been a “done deal” before Perry gave the stock away and for that reason Perry owes income tax on all of the stock. Perry argues that no contracts were signed until weeks after the gift and that the deal could have fallen through at any time before signed by all parties. Perry disagreed with the audit. His tax dispute is now pending before the United States Tax Court. How will the court decide?

Section 61 of the Internal Revenue Code provides that gross income means all income earned from whatever source derived, and then lists several examples such as wages, services rendered, gains from the sales of property, and several other examples. In 1930, the U. S. Supreme Court summarized when addressing who earned income that “The fruits cannot be attributed to a different tree from that on which they grew.” Lucas v. Earl, 281 U.S. 111 (1930). This in effect clarified that gross income is to be taxed to the one that earns it and led to the fact that one cannot avoid paying income tax on earned income by gifting the property that created the income when it has been earned on or before the gift. An example would be when a corporation declares a dividend payable say on November 1st to stockholders of record on October 10th. A stockholder who owned the stock on October 10th is the one who has earned the income even if he or she sells or assigns their stock between October 10th and November 1st. The dividend is taxed to the owner on October 10, the date the dividend was declared.

In Perry’s case he argues that the negotiations were not complete when he made his gift, and that Company B could have backed out of the deal. When the court decides it will consider the stage of the negotiations, whether Company B had the financial backing to complete the deal, whether any contracts or preliminary statements of intent were prepared for review, and how long was the interval between the tentative agreement and the actual sale will all be considered. Situations like these happen from time to time. When the issue arises, it should be discussed in advance of the transaction, if possible, with your legal tax advisors who should be well versed in this area of tax law. One should be aware of the assignment of income doctrine in situations where it could apply in connection with his/her estate planning. What if this had been a publicly traded company?

If you have questions regarding   Assignment of Income Doctrine   and would like to discuss these issues, please contact Cody Walls, MBA, CPA at Denton Law Firm at 270-450-8253.

THIS ARTICLE IS DESIGNED TO PROVIDE GENERAL INFORMATION PREPARED BY THE PROFESSIONALS AT DENTON LAW FIRM, PLLC IN REGARD TO THE SUBJECT MATTER COVERED. IT IS PROVIDED WITH THE UNDERSTANDING THAT THE AUTHOR IS NOT ENGAGED IN RENDERING LEGAL, ACCOUNTING, OR OTHER PROFESSIONAL SERVICE. ALTHOUGH PREPARED BY PROFESSIONALS, THESE MATERIALS SHOULD NOT BE UTILIZED AS A SUBSTITUTE FOR PROFESSIONAL SERVICE IN SPECIFIC SITUATIONS. IF LEGAL ADVICE OR OTHER EXPERT ASSISTANCE IS REQUIRED, THE SERVICE OF A PROFESSIONAL SHOULD BE SOUGHT.

Assignment Of Income Streams To Special Needs Trusts (Part 3)

(This is part 3 of a 4-part blog post on the subject of the assignment of various types of income to a special needs trust. This post discusses the assignment of child support to a special needs trust. Prior blog posts on this subject can be found here and here .)

• Child Support

SSI’s treatment of child support payments is outlined in POMS §SI 00830.420. According to that POMS section, child support payments made on behalf of an SSI child are unearned income to the child, with a one-third income disregard for an eligible child by an absent (non-custodial) parent. POMS §SI 00830.420.B.1.Current child support that is received for an adult child is income to the adult child, and is not subject to the one-third income disregard. POMS §SI 00830.420.C.1.

However, the POMS recognizes an exception to this rule for the irrevocable assignment of child support payments to a special needs trust:

A legally assignable payment … that is assigned to a trust, is income for SSI purposes unless the assignment is irrevocable. For example, child support …  payments paid directly to a trust as a result of a court order, are not income. If the assignment is revocable, the payment is income to the individual legally entitled to receive it. POMS §SI 01120.200.G.1.d. (emphasis supplied).

Although, as set forth below, it appears that child support payments belong to the child and thus require the proper receptacle of child support payments to be a self-settled SNT, the POMS example regarding child support payments not being income when irrevocably assigned to a trust appears in §SI 01120.200, applicable to third-party SNTs, and not in SSI 01120.201, the section that is applicable to self-settled SNTs.

A central issue involved in the assignment of child support payments is whether the special needs trust must be self-settled (with a payback provision) or may be third-party (with no payback provision). If characterized as “child support,” certain protections, such as enforcement of payments through the probation department, are available. However, as discussed in more detail infra , “child support” payments belong to the child. Because the child has a legal right to receive child support, many practitioners opine that the special needs trust that is created must be a self-settled trust, and payback provisions must be included. Mazart, G. and Spielberg, R., Trusts for the Benefit of Disabled Persons: Understanding the Differences Between Special Needs Trusts and Supplemental Benefits Trusts , New Jersey Lawyer Magazine, No. 256, February 2009. Indeed, the POMS section addressing self-settled special needs trusts includes the following example:

A disabled SSI recipient over age 18 receives child support which is assigned by court order directly into the trust. Since the child support is the SSI recipient’s income, the recipient is the grantor of the trust and the trust is a resource unless it meets an exception in SSI 01120.203 [the self-settled special needs trust exception]. If the trust meets an exception and is not a resource, the child support is income unless it is irrevocably assigned to the trust, per SI 01120.201J.1.d. In this example, the court ordered the child support to be paid directly into the trust, so we consider it to be irrevocably assigned to the trust. POMS §SI 01120.201.C.2.b.

However, some practitioners recommend that, if a divorcing couple agrees to forego protections such as the enforcement rights that come with payments of “child support,” the couple enter into a settlement that does not include “child support,” but instead obligates the parent to make payments to a third-party special needs trust on behalf of the disabled child, as part of a property settlement agreement. Although the parent’s obligation to make these payments would not be the subject of child support enforcement protections, the obligation can be enforced as a contract right under the property settlement agreement.

Other practitioners recommend voluntary payments of income by the parent to a third-party SNT, separate from and in addition to court-ordered child support. Harshman, S. and Schaller, G., Introduction to Planning for Persons with Disabilities , §4.16G.

Choosing between these alternatives requires an examination of various issues, including a parent’s legal duty of support; the emancipation of an adult disabled child; and the child’s receipt of public benefits. By way of example, if a parent has a legal duty to support a disabled child, even beyond the age of majority, then payments in lieu of child support paid to a third-party SNT would violate the parent’s duty of support; accordingly, the possibility exists that these payments to a third-party SNT would jeopardize that child’s eligibility for public benefits.

A discussion of the interplay between a parent’s child support obligation and a disabled child’s public benefits was addressed in the context of a comprehensive examination of autism and divorce by Lawrence R. Jones and David L. Holmes. Jones, J. and Holmes, D., Autism and Divorce: Guidelines for Family Court Practice , New Jersey Lawyer Magazine, No. 256 (Feb. 2009).  As the authors explain, a court generally calculates a child support obligation based upon the parents’ incomes, pursuant to the New Jersey Child Support Guidelines set forth in Appendix IX of the New Jersey Court Rules. However, a parent may request that the court disregard the Child Support Guidelines as inapplicable, where “good cause” is shown.

With regard to the issue of emancipation, a parent’s responsibility to support a disabled child after the age of majority is an issue of state law. Begley, Jr., T. and Jeffreys, J., Representing the Elderly Client , §12.07[C][2] (2010 Supplement) (Wolters Kluwer NY). Although the laws of New Jersey do not fix an age at which legal emancipation of a child occurs, there is a statutory presumption that emancipation occurs at age 18. Proft v. Proft , 2005 WL 3429503, 2005 N.J. Super. Unpubd LEXIS 139 (N.J. Super. A.D. Dec. 15, 2005) (citing N.J.S.A. 9:17B-3). That presumption, however, may be rebutted. Courts of New Jersey recognize that child support may continue beyond minority where, on reaching the age of majority, the child is disabled from supporting himself:

Children who are unable to care for themselves because of their minority are no less entitled to the court’s solicitude when they continue to suffer, after they have attained their majority, from a physical or mental disability which continues to render them incapable of self-support. Normal instincts of humanity and plain common sense would seem to dictate that in such cases the statutory obligation of the parent should not automatically terminate at age 21, but should continue until the need no longer exists. Grotshy v. Grotsky , 58 N.J. 354 (1971) (quoting Kruvant v. Kruvant , 100 N.J. Super. 107 (App. Div. 1968)).

Accordingly, until emancipation, a parent remains charged with the duty of support. Id .

Notably, the right to child support is considered the right of the child, rather than the right of the parent, and is based upon an evaluation of the child’s needs. Proft v. Proft , supra (citing Pascale v. Pascale , 140 N.J. 583, 591 (1995)). In the unreported Proft decision, for example, the father of the disabled adult child sought an order emancipating the child, and granting reimbursement of past child support payments made, because of the child’s subsequent personal injury settlement. Although the case did not address the public benefits aspect of child support, the court’s observations have ramifications on this issue:

… we are mindful that [the father’s] support obligation … was established by consent. It was not calculated in accordance with the Child Support Guidelines, and may well have been measured by his ability to pay, rather than by the needs of [the child]. As a consequence, even if the [personal injury] settlement were found upon remand to be properly allocated to [child] support, an additional support obligation could remain, depending on the nature and extent of [the child’s] disability, its anticipated duration, and [the child’s] short- and long-term needs. Proft v. Proft , supra .

California practitioners have noted that California courts have not yet addressed whether the existence of an SNT for the child’s benefit would affect a parent’s duty of support, but that one California court allowed consideration of an adult disabled child’s independent income and assets in order to reduce the parent’s child support obligation. Harshman, S. and Schaller, G., Introduction to Planning for Persons with Disabilities, supra, at §4.16G. However, other states have held that an SNT for the benefit of a child has no impact on a parent’s duty of support. Id .

How a child’s eligibility for public benefits (absent receipt of child support) affects a parent’s responsibility to provide child support to that child is a thorny issue. As one matrimonial law journal opines,

Because SSI is only meant to be supplemental and not substitutionary, a noncustodial parent’s child support obligation should not be impacted if a child receives SSI [in the disabled child’s name]. SSI benefits are “gratuitous contributions from the government” and do not reduce any obligation by either parent…. Along these same lines, a parent cannot refuse to pay child support with the reason that paying would cause the child’s public assistance to end. At least one [Colorado] court has refused that argument, stating that public assistance is paid to substitute the missing parent’s support to provide for a child’s needs. If a parent is no longer missing, it is the parent’s duty to provide for the child, and the substitutionary public assistance has no reason to continue. Copperwheat, D., Cutting Edge Issues in Family Law: Comment: Impact of a Child’s Income on Child Support Payments , 21 J. Am. Acad. Matrimonial Law 677 (2008).

See also, Case Proves There Are No Easy Answers When It Comes To Divorce And Children With Special Needs , Academy of Special Needs Planners website, www.specialneedsanswers.com/resources/article.asp?id=19395 (citing Minnesota case denying father’s request to terminate child support obligation for adult disabled child based upon child’s relocation to group home covered by county medical assistance, finding that “the primary obligation of support of a child should fall on parents rather than the public”).

Practitioners struggle with the competing issues of a parent’s duty of support, and what the child’s “needs” are when public benefits would otherwise provide for those needs. New Jersey courts have held that, in the case of an adult disabled child, “[t]he child’s’ own resources should first be applied to the cost of his care.” Kruvant v. Kruvant , 100 N.J. Super. 107, 118 (App. Div. 1968). However, in Monmouth County Division of Social Services v. C.R. , 316 N.J. Super. 600 (Ch. Div. 1998), in connection with a DYFS placement of a disabled child, the parents entered into a voluntary agreement with DYFS to provide financial support based on the parents’ income and resources. When the child attained the age of 21, the father sought to be retroactively reimbursed for support payments he made to DYFS following the child’s 18 th birthday, claiming that he was “no longer legally responsible for the cost of maintenance of [his son] incurred by the Division of Youth and Family Services.” The court denied the request, citing, inter alia , “the basic support obligation of every parent to his child, which transcends any temporary source used to help meet this obligation.” It concluded that the parent’s “limited, but voluntary, financial involvement in meeting his son’s needs is really the affirmation of what was always his fundamental duty, even in the presence of a concurrent role required or permitted of public authorities.”

According to Jones and Holmes, supra ,

If the government pays benefits to or for a child (disability, Social Security, etc.), these payments may in some cases reduce a parent’s child support obligation, since the benefits reduce the parents’ costs of raising the child [ citing New Jersey Child Support Guidelines, New Jersey Court Rules Appendix IX-A 10(c)]. Receipt of Social Security Disability benefits may reduce child support, while receipt of Supplemental Security Income (SSI) benefits may not reduce support, since SSI supplements parental income based on financial need. Jones, J. and Holmes, D., Autism and Divorce: Guidelines for Family Court Practice, supra.

However, these authors also opine that,

in a case where the [disabled] person is living with neither parent but in another environment such as a group home for developmentally disabled adults, there may be little or no daily out-of-pocket support expenses incurred by either parent, and thus little or no need at that specific time for child support. Jones, J. and Holmes, D., Autism and Divorce: Guidelines for Family Court Practice, supra.

Despite the substantial authority supporting payments of child support into a special needs trust, some practitioners have observed that families rarely seek to have a court order the irrevocable assignment of child support or alimony payments into a trust, “because of the complexity of [the] issue… and the lack of sophistication at the local Social Security office” with this approach:

In our experience, families generally handle the child support/emancipation question in one of two ways: They forego formal support at age 18 and get their child enrolled in all the benefit programs that he or she qualifies for, while making an informal arrangement for supplemental support, or they forego public benefits until age 22 when their child is out of school, and they continue child support payments until then. Hines, A. and Margolis, H., Divorce in Special Needs Planning, supra.

(The final article in this series in an upcoming blog post discusses the assignment of annuities, IRAs and other retirement benefits to a special needs trust. The entire article, including all footnotes which are omitted in large part in the blog posts, can be found on my website by clicking here .)

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Savings and Investment Manual

Saim11010 - transfers of income streams: overview, transfers of income streams: overview.

Selling an income stream is a device designed to try to turn economic income into a return that is treated by tax law as capital. For example shareholders could sell the right to receive a large company dividend in exchange for an amount almost equal to the dividend, without selling the shares. Without any legislative provision to counteract this, the income tax bill on the receipt might be eliminated.

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A financially independent accountant and former banker explains the '3 pillars of earning' — and how to build revenue streams outside your 9-to-5

• Nischa Shah believes that having just one income stream is "too close to none."
• She identifies three income "pillars": active income, business income, and investing.
• Her advice is to take some of your active income and use it to create new, passive income streams.

If you're relying on a single revenue stream, whether that's your 9-to-5 salary or business income, "that's too close to none," accountant and former banker Nischa Shah told Business Insider.

"Having other income streams that could keep you going if one of them falls through will protect you," she added, especially during economically uncertain times when companies across various industries are cutting jobs.

Shah, who left an investment banking career to build her personal finance brand , has amassed nearly 1 million YouTube subscribers since launching her channel in 2021. She says her main revenue stream is YouTube AdSense, but she also earns income from her real-estate portfolio, speaker events, brand partnerships, and affiliate marketing.

"I look at the different ways to make money as pillars," she said — and there are three main ones anyone can tap into.

1. Active income

"The first way to make money is through active income — and the majority of us start here," said Shah. This is any money you're earning that is tied to your time. For example, with a 9-to-5, you're trading about 40 hours a week for your salary or twice-a-month paycheck.

"It starts off as your biggest income stream," she said, but "the aim is slowly, over time, for that to become your smallest because your other income streams start overtaking it." That's what eventually happened for Shah, who quit her day job as soon as her side income was enough to cover her fixed costs.

The key is to take a percentage of your day job income and use it to create other (more passive) income streams , which leads us to the second pillar.

2. Business income

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The second pillar is business or side hustle income outside of your 9-to-5 earnings.

"Although you're starting off by putting in a lot of upfront work or money, the goal is to make it more passive by setting up the right systems and hiring the right people so that you can slowly start taking a step away," she said. Otherwise, your business will always feel like an active income source, which could lead to burnout especially if you're still working a full-time day job. You want to get to the point where you're "working on your business, not within your business, which is where a lot of entrepreneurs fail."

Her top advice for launching a side hustle is to start with a skill or hobby you already have. For example, as an accountant and banker, she was already answering money questions from her friends and family and thought, why not do that on a bigger scale? In her first YouTube video, she discussed a real-estate investing strategy she'd personally used.

"Think about what your skills are, what your strengths are, what you really enjoy doing, and what the world needs from you," she said. "Thinking about those things will lead you down a path where you can make money doing what you love. If you're missing one of those parts you're either making money and not enjoying what you love or you're doing what you love but you're not able to make money from it."

Shah is in what she categorizes as a "content-based business," but you might consider the product-based (selling a physical or digital product) or service-based (something like one-to-one coaching or physical training) business model.

"Think about how you can incorporate what you want to do into what you're already doing because that is the way to get started straight away," she said — and getting started is the most important step. You don't want to get to the point where you're looking back and thinking, "'I wish I just went for it. I spent the last three or five years thinking about it, reading all the books about it, taking courses on it. But I just didn't do the thing.'"

3. Investing

The third pillar, investing, is what will help your money grow and compound over time.

"At the start, this will make up a pretty small amount of your total streams, but as you progress the aim is for it to become a larger and larger and larger portion because you continue putting money from your active income or your business income to work," said Shah, who personally invests in index funds and real estate.

Technically, this is "the easiest passive income stream out there," she added. Anyone can open an account with brokerages such as Fidelity or Vanguard, select an index to invest in, and buy shares.

As for the key to long-term successful investing, it's three-fold, she said: "Diversify, start early, and be consistent with it. That is the recipe to get to where you want to by the time you retire."

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