Assignment of Income

Posted on May 29, 2008 
Filed Under Federal Income Tax, Key Concepts

The assignment of income doctrine, as outlined by , is a very ambitious doctrine, a doctrine that attempts to answer two elemental questions in federal income tax law: (1) the “who” (the person or entity to be taxed) and (2) the “what,” that is, the character of the income received (i.e., or ).

In the famous Supreme Court case, , the Court held invalid the contract between the taxpayer-attorney and his wife wherein all the couple’s acquisitions (including income from his personal services as an attorney) were to be shared equally: the “fruits” from the attorney’s “tree” cannot be attributed to the wife’s “tree.” In other words, despite the legal form of the couple’s contract, the Court looked to the substance of the contract and deemed it tax avoidance. From this decision emerges the general rule that taxes on income from personal services are attributable (assignable) to the person performing the services. In this case, the obvious answers to the “who” and “what” questions are the taxpayer-attorney is taxable and the character of the income received is ordinary (compensation for services).

The assignment of income doctrine also helps to differentiate between transfers of and associated with, or attached to, that property. The basic principle is that in an effective, substantial transfer of the entire underlying property, the , not , is taxed on future income from the property. In short, the assignment of income doctrine does not apply.

However, if the property is transferred with income attached (e.g., any interest accrued on a will be taxable to the assignor in the year he or she transfers the interest-bearing security) or the assignor transfers only the right to receive income yet retains the income-producing property, the assignment of income doctrine will apply even if the form of the transfer is gratuitous (a gift). Put differently, to avoid classification as a and be effective for federal income tax purposes, the transfer must be real and effective for state law purposes and the donor must not retain excessive controls over the income-producing property transferred.

And this brings us to another important distinction: gratuitous assignments versus assignments for . The key issue in gratuitous assignments is the “who” question, that is, the person or entity taxable. In assignments of income for consideration, the pressing issue is the character of the consideration received or the “what” question, namely, the classification of consideration received as capital gain or ordinary income. As a general rule, if the assignor receives bona fide consideration for transferring a right to income, the tax burden falls on the assignee and one must look to the character of the right transferred to determine whether it will produce capital gain or ordinary income.

For example, in the Supreme Court Case , the lessee paid the lessor a lump-sum payment in order to cancel a lease. Looking to the character of the payment received in consideration for cancellation of the lease, the Court reached a conclusion contrary to the lessor-taxpayer’s claim that the payment be recognized as capital gain. Instead, the Court ruled that the character of the amount received by the lessor was in substance ordinary income since it was a substitute for rent.

For additional information on the assignment of income doctrine, please consult the following resources:

Many happy returns, Roger

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