FLORIDA TAX REVIEW
VOLUME 1 1993 NUMBER 11

Schneer v. Commissioner: Continuing Confusion
Over the Assignment of Income Doctrine

and Personal Service Income
Ronald H. Jensen*

I. INTRODUCTION

II. DEVELOPMENT OF THE ASSIGNMENT OF INCOME DOCTRINE AND
EXAMINATION OF ITS UNDERLYING RATIONALE

A. Gratuitous Assignments of Personal Service Income
B. Gratuitous Assignments of Investment Income
C. Rationale of the Assignment of Income Doctrine
D. Nongratuitous Assignments of Income: A Different Case

m1[. VARIATIONS ON A THEME: THE ASSIGNMENT OF INCOME IN

DIFFERENT CONTEXTS
IV. THE "SIMILARITY" AND "AGENCY" TESTS: FAILED SOLUTIONS

A. Introduction
B. The Similarity Test
C. The Agency Test

V. RESOLVING THE CONFLICTS: A RETURN TO BASICS

A. The Overlooked Distinction
B. Formal Statement of Approach
C. Issues Involved in Applying Proposed Approach
D. The Personal Service Corporation: A Case of Nonrecogni-

tion?
E. The Basketball Player: A Case of Deferral
F. A Loose End: Should Schneer Have Been Tared on tire Fee

that Was Fully Earned at the Time of the Assignment?
VI. CONCLUSION

* Professor of Law, Pace University School of Law. A.B., Yale University: LLB.,

Harvard Law School. I would like to express my appreciation to Gregory Holder for his
insight into the "Basketball Player Case," discussed infra part V.E., and to Charles H.
Simmons, Walter E. Swearingen, and Peter C. Bruzzese for research assistance.



Florida Tax Review

I. INTRODUCTION

More than sixty years have elapsed since Justice Holmes first
enunciated in Lucas v. Earl' the principle that income from personal services
"must be taxed to him who earns it"2 and that assignments of such income
"however skilfully devised"3 will not be respected for tax purposes. The
Supreme Court has described this principle-now known as the assignment
of income doctrine-as the "first principle of income taxation."4 Yet despite
its venerable lineage and importance, the doctrine remains today beset by
confusion and uncertainty. This was vividly demonstrated in Schneer v.
Commissioner5 where the Tax Court agonized over the application of the
doctrine to a simple, indeed pedestrian, set of facts. The twenty-page majority
opinion brought forth a concurrence,6 based on an entirely different theory,
and two vigorous dissents,7 one of which attacked the court's decision as
"unprincipled."8 The decision has given rise to considerable comment, some
of it heated. One commentator described the decision as not only wrong but
"exquisitely wrong, so misguided at every turn, that it becomes a wayward
sort of achievement,"9 while another described the first commentator's
analysis as "wrong, although not exquisitely wrong."'" All commentators,
however, have recognized the case's significance. The Tax Lawyer, the
official publication of the American Bar Association Section of Taxation,
designated the case as one of the important tax decisions of 1992," while

1. 281 U.S. 111 (1930).
2. Commissioner v. Culbertson, 337 U.S. 733, 739-40 (1949) (restating the holding

in Earl).
3. Earl, 281 U.S. at 115.
4. Culbertson, 337 U.S. at 739. The classic work on the assignment of income

doctrine is Charles S. Lyon & James S. Eustice, Assignment of Income: Fruit and Tree as
Irrigated by the P.G. Lake Case, 17 Tax L. Rev. 293 (1962), as supplemented by James S.
Eustice, Contract Rights, Capital Gain, and Assighiment of Income-the Ferrer Case, 20 Tax
L. Rev. 1 (1964).

5. 97 T.C. 643 (1991).
6. Id. at 663 (Beghe, J., concurring).
7. Id. at 664 (Wells, J., dissenting); id. at 667 (Halpern, J., dissenting).
8. Id. at 669.
9. Lee A. Sheppard, Partnership Mysticism and the Assignment-of-Income Doctrine,

News Analysis, 54 Tax Notes 8, 8 (Jan. 6, 1992).
10. Michael Asimow, Applying the Assignment of Income Principle Correctly,

Letter to the Editor, 54 Tax Notes 607, 607 (Feb. 3, 1992).
11. James P. Holden, Note, Important Tax Decisions of 1992: Forward, 46 Tax Law.

507, 510-11 (1993). See also Gina L. Bozajian, Note, A Case of Mistaken Identification: When
Income Is Earned and the Classification of Earnings as Individual or Partnership Income in
Schneer v. Commissioner, 46 Tax Law. 583 (1993). The Tax Lawyer was employing editorial
license in describing Schneer as one of the "important tax decisions of 1992"; the decision in

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Schneer v. Conunissioner

a publication of the Section on Taxation of the Association of American Law
Schools recommended its use in the classroom as the "practically perfect
case" for teaching the assignment of income doctrine.'2 The Schneer case
therefore presents an opportune occasion to reexamine the assignment of
income doctrine as applied to personal service income.

The facts of Schneer are as follows. Stephen Schneer, a law firm
associate, had an agreement with his firm entitling him to a certain percentage
of all fees collected from clients he brought to the firm. 3 Schneer thereafter
left the firm and became, on successive occasions, a partner in two other
firms.14 Schneer agreed, as a condition to becoming a partner in the latter
two firms, that while serving with them as a partner he would turn over to
them any fees he collected under his agreement with the first firm. 5

After leaving the first firm, Schneer continued to render legal advice
and consultation on those matters handled by the first firm in which he was
entitled to share the fees. 6 The parties themselves were uncertain whether
Schneer would have been entitled to share in the fees had he refused to
provide these consulting services. 7

Schneer fully complied with his agreements and turned over to the
second and third firms all fees he received from the first firm.'8 All of these
fees, save one in the amount of $1,250, involved work performed after
Schneer left his first firm; the $1,250 fee was fully earned before his
departure from that firm.' 9

The issue was whether the fees paid to Schneer were taxable to him
in full under the assignment of income doctrine, because he had earned them,
or whether they constituted partnership income, in which case Schneer would
be taxable only on his distributive share of such fees. Had the Service been
successful in applying the doctrine in this case, Schneer apparently would
have been taxed on more than 100% of such fees. He had already reported
his distributive share of the fees as income, and the Service did not offer to

Schneer was actually filed on December 12, 1991. Schneer, 97 T.C. at 643.
12. Boyd C Dyer, New Cases for Teachers, Newsl. (Ass'n of Am. Law Sch.,

Section on Taxation, Wash., D.C.), Apr. 1993, at 9.
13. Schneer, 97 T.C. at 644.
14. Id. at 645.
15. Id.
16. Id.
17. Id.
18. Id. at 646.
19. Id. Schneer received a total of $31,914 from the first firm, which he remitted

to the second and third firms. With the exception of one fee in the amount of S1,250, all of
these fees (representing more than 96% of the total amount of fees collected) were for work
performed after Schneer left the first firm. Id.

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Florida Tax Review

adjust his distributive share or allow him a deduction for the amounts paid
over to his new firms if the court applied the doctrine.20

The Tax Court held that the $1,250 fee which was fully earned before
Schneer left his first finn was taxable to him, because it had already accrued
to him under the "all events" test.2' In the case of the fees earned after
Schneer's departure from the first firm, the court perceived a conflict between
the assignment of income doctrine, which taxes income to the person who
earns it, and the principles of partnership taxation, which tax partnership
income to the partners in accordance with the terms of the partnership
agreement regardless of whose personal efforts generated the income.22

Relying on several revenue rulings and case authority, the Tax Court held
that income in such cases should be treated as partnership, not personal,
income provided the services performed by the partner in his individual
capacity were "similar" to those performed by the partnership.3 The court
held that since the consulting services performed by Schneer were essentially
of the same nature as those performed by the second and the third firms, the
fees which he turned over to them should be treated as partnership income.24

Schneer was therefore not taxable on such fees except to the extent of his
distributive share of them.

The court did not explain why the similarity between the taxpayer's
activities which generated the fees and work normally performed by the firm
should have any bearing on the application of the assignment of income
doctrine,' and it is this aspect of the decision which caused the dissent and
other critics to denounce it as "unprincipled. 26

20. See Martin B. Cowan, Tax Court Leaves Confusion in Wake of Decision on
Assignment of Income to Partnership, Special Report, 55 Tax Notes 1535, 1535 (June 15,
1992).

21. Schneer, 97 T.C. at 649-52. Although the Tax Court applied an accrual concept,
that is, the "all events" test, in determining that Schneer was taxable on the fee that was fully
earned before he left the first firm, he was a cash-basis taxpayer. Id. at 645.

22. Id. at 657-58.
23. Id. at 652-56.
24. Id. at 656.
25. Judge Halpern commented that:
[t]he majority fails to explain why the similarity of the work done by the
partner to earn the fees to the work of the partnership is determinative.
That failure not only casts doubt upon the correctness of this decision, but
foreshadows the difficulty future courts will have in resolving the question:
how similar is similar enough? Without any inkling of why similarity has
been deemed important, future courts will lack any effective guidelines for
answering that question.

Id. at 669 n.3 (Halpern, J., dissenting).
26. Id. at 669 (Halpern, J., dissenting). See Cowan, supra note 20, at 1541.

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Scmneer v. Conmissioner

I agree with the critics who have denounced the rationale of Schneer
as unprincipled, yet at the same time I believe the results in the case are
substantially correct. However, both the court and its critics failed to grasp
the true rationale for the assignment of income doctrine and were diverted
into chasing will-o'-the-wisps such as the tests of "similarity" and "agency."
The true nature of the assignment of income doctrine is simply this: it is a
remedial doctrine designed to prevent high income taxpayers from fragment-
ing their taxable income among related and lower income taxpayers thereby
undermining the graduated nature of the income tax system. The assignment
of income doctrine implements this policy by refusing to give effect, for tax
purposes, to gratuitous shifts of taxable income from one taxpayer to another.
If this widely accepted rationale of the doctrine is respected, many puzzles
encountered in applying the doctrine yield themselves to easy solution.

This is true of Schneer itself. Schneer did not involve the gratuitous
shifting of income from a high income family member to a low income
family member, the classic case for applying the doctrine, but rather it
involved a hard-headed negotiation conducted at arm's-length between
unrelated parties. For every dollar of taxable income that Schneer assigned
to his new partnership, he received (or expected to receive) a dollar of taxable
income in return. There is simply no reason to believe that taxable income
was being shifted in Scirneer from one taxpayer to another and thus no
occasion to apply the assignment of income doctrine.27 Somehow, the courts
and the Internal Revenue Service have lost sight of the crucial distinction
between gratuitous assignments of income and assignments of income for
value in personal service cases and as a result have produced a collection of
irreconcilable and inexplicable cases and rulings.

This article will analyze the proper application of the assignment of
income doctrine to personal service income. Part II will trace the historical
development of the assignment of income doctrine and will analyze the
doctrine's underlying rationale. The importance of distinguishing between
gratuitous and nongratuitous assignments of income will be developed in this
Part. Part III will present a number of hypothetical situations drawn from
actual cases and rulings that involve the application of the doctrine to
personal service income. This will both show the pervasiveness of the
doctrine and lay the basis for further analysis. Part IV will demonstrate that
the tests currently used by the Internal Revenue Service and the courts in
these situations-the "similarity" test and the "agency" test-fail to provide
either a rational or workable basis for solving these problems. Instead, they
have resulted in a welter of unintelligible and irreconcilable decisions.
Finally, Part V will show how reference to the doctrine's underlying purpose,

27. See discussion infra part V.A.

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and particularly to the basic distinction between gratuitous and nongratuitous
assignments of income, solves many of the puzzles besetting the application
of the doctrine.

II. DEVELOPMENT OF THE ASSIGNMENT OF INCOME DOCTRINE
AND EXAMINATION OF ITS UNDERLYING RATIONALE

A. Gratuitous Assignments of Personal Service Income

In Lucas v. Earl28 a married couple entered into an agreement in
1901 which granted each spouse absolute ownership of one-half of any
income earned by the other.29 On his 1920 and 1921 tax returns, the hus-
band reported only half of his earnings for those years as taxable income
contending that under the agreement the other half was owned by his wife
and thus was taxable to her.3" Justice Holmes, in a unanimous opinion for
the Supreme Court, held the husband taxable on all of his earnings:

There is no doubt that the statute could tax salaries to those
who earned them and provide that the tax could not be
escaped by anticipatory arrangements and contracts however
skilfully devised to prevent the salary when paid from
vesting even for a second in the man who earned it. That
seems to us the import of the statute before us and we think
that no distinction can be taken according to the motives
leading to the arrangement by which the fruits are attributed
to a different tree from that on which they grew.3

Thus was born the assignment of income doctrine: one is taxable on
all income earned through one's personal services, regardless of who actually
receives that income. This principle is so deeply embedded in our tax
jurisprudence it is difficult to consider it afresh. Nevertheless, we need to do
so to understand the basis for the doctrine. The holding in Earl is not self-
evident; indeed, the taxpayer's case was quite substantial. Mr. Earl argued
that income should be taxed to the person beneficially entitled to receive
it." The Court took for granted that the agreement was legally enforce-

28. 281 U.S. 111 (1930).
29. Id. at 113-14.
30. Id.
31. Id. at 114-15.
32. Id. at 114. See Alan Gunn, Tax Avoidance, 76 Mich. L. Rev. 733, 762 (1978)

(acknowledging that "[s]ome common definitions of income suggest the benefit approach");
Michael J. McIntyre & Oliver Oldman, Taxation of the Family in a Comprehensive and

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ScImeer v. Conunissioner

able.33 Thus, although the Court held Mr. Earl taxable on all his earnings,
he in fact had a legal right to only half of those earnings. Although the
practical effect of this agreement might be minimal in a harmonious marriage,
it would have significant consequences if the marriage were dissolved or
troubled, or the parties separated; and it might also have significant conse-
quences if the husband became insolvent and creditors sought to levy upon
his earnings. Moreover, the agreement clearly had not been made to avoid
tax, since it was entered into in 1901-twelve years before the adoption of
the Sixteenth Amendment. Given these considerations, the Court's conclusion
that income should be taxed to the person whose efforts generated the
income, rather than to the person entitled to receive it, is hardly incontrovert-
ible. Nor does the Court enlighten us as to why its conclusion should be so;
it merely states that this result "seems to us [to be] the import of the stat-
ute."

34

The rationale of the Court's holding must therefore be inferred. In
retrospect it appears that what concerned the Court was the effect a contrary
holding would have had upon the tax system. Had the Court upheld Mr.
Earl's claim, taxpayers could easily subvert the progressive tax rate structure
by making multiple assignments of income among family members.3 If
either the income earner dominated his family, or the family was a harmoni-
ous unit, such assignments would have little, if any, effect on the economic
status of the assignor. Of course, the Court could have implemented this
"policy" by limiting the Earl doctrine to tax-motivated assignments, but such
a limitation would have required lengthy, expensive, and uncertain findings
as to the assignor's motives. Moreover, such an approach would have laid
bare that the Court was making policy at a time when the prevailing jurispru-
dence held that courts should find, not make, law. Accordingly, the Court
held that "no distinction can be taken according to the motives leading to the
arrangement."

36

The result in Earl might have been explained by the husband's
continuing power to affect the flow of his earned income to his wife even

Simplified Income Tax, 90 Harv. L. Rev. 1573, 1582 (finding that assignment approach lacks
"support in any normative model of the income tax").

33. Earl, 281 U.S. at 114.
34. Id. at 115. As Professor Bittker has commented, "[the opinion in Lucas v. Earl

is late-vintage Holmes, magisterial in tone, studded with quotable phrases, and devoid of
analysis." Boris I. Bittker, Federal Income Taxation and the Family, 27 Stan. L Rev. 1389,
1401 (1975) (footnote omiued).

35. Ernest J. Brown, The Growing "Common Law" of Taxation, 34 S. Cal. L Rev.
235, 243 (1961) ("The Government, particularly in its petition for certiorari, less clearly in a
short brief on the merits, presented Mr. Earl's claim as a threat to the statutory scheme of
graduated rates.").

36. Earl, 281 U.S. at 115.

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Florida Tax Review

after he had assigned such income to her. That is, Mr. Earl, even after the
assignment, retained the ability to increase, decrease, or cut off altogether the
flow of earned income to his wife simply by working more, working less or
ceasing to work completely. This continuing ability to control the flow of the
income might be thought to justify taxing the husband on such income.
Therefore, the result might be different where the assignor had already earned
the income at the time of the assignment; in such a case, the assignor would
lose all ability to affect the flow of that income to the assignee once he made
the assignment. The Supreme Court rejected this distinction in Helvering v.
Eubank.3 7 There the taxpayer assigned to a family trust his right to future
insurance renewal commissions which he had earned through his sale of
insurance policies in prior years.3s Although Mr. Eubank forever lost his
ability to affect the amount of assigned income flowing to the trust once he
made the assignment, the Court in a brief, cryptic opinion held Mr. Eubank
fully taxable on all renewal commissions as they were paid to the trust. 9 In
so holding, the Court reinforced the rule that income is taxable to him who
earns it, and further limited the ability of taxpayers to circumvent the
graduated tax rate structure by making gratuitous assignments of income.

B. Gratuitous Assignments of Investment Income

In the meantime, the law relating to the gratuitous assignment of
investment income (that is, income derived from property as opposed to
income derived from personal services) developed along somewhat different
lines. The Supreme Court held that income from property, in contrast to
income from personal services, could be effectively assigned for tax purposes
provided that the assignor assigned the income-producing property itself.4"
Thus, a parent who gives stock to a child will not be taxed on future
dividends paid on the stock. By giving away the stock, the parent effectively
transfers the incidence of taxation on future dividends to the child. On the
other hand, if the taxpayer merely assigns income from the property while
retaining the property itself (or, in terms of Holmes's metaphor, merely
assigns the "fruit" but retains the "tree"), the taxpayer will continue to be
taxed on the assigned income as it is received by the assignee.4' Moreover,

37. 311 U.S. 122 (1940).
38. Id. at 124.
39. Id. at 125.
40. Blair v. Commissioner, 300 U.S. 5, 12 (1937) (stating that "tax liability attaches

to ownership").
41. Helvering v. Horst, 311 U.S. 112 (1940). Consequently, a parent who transfers

interest coupons to a child while retaining the bond will be taxed on the interest when the
coupons mature. Id.

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Scluzeer v Conunissioner

even where the taxpayer assigns the income-producing property he will be
taxed on any income that had already accrued on the property at the time of
the assignment.

4 2

C. Rationale of the Assignment of Income Doctrine

In making these decisions, the Supreme Court spoke in broad
conclusionary terms rather than in terms of the policies it was seeking to
implement. As Professor Chirelstein has written:

On the whole, the Supreme Court's opinions in this field are
over-long and confusing .... The problem throughout,
perhaps, was how the Court could aid in developing a set of
anti-tax avoidance rules-how it could act to give protection
to the graduated rate structure-without directly admitting
that it was engaged in judicial law-making. Operating under
a limited mandate, the Court sought to safeguard the rates by
manipulating the legal concepts of "income," "property," and
"ownership" instead of making bald utterances about tax-
avoidance.43

Of the seminal cases, only Helvering v. Clifford 4 alludes (and even then
obliquely) to the Court's underlying policy concern. In Clifford, a husband
had set up a five-year trust for the benefit of his wife but named himself
trustee and in that capacity retained extensive administrative powers as well
as the power to determine whether income would be paid currently to his
wife or accumulated for her benefit.45 The Court held that the totality of the
factors-the short duration of the trust, the retention of income within the
family group, and the husband's retained powers over the principal of the
trust as trustee-irresistibly led to the conclusion that the husband had parted
with no substantial control or benefit in the transferred property and hence
remained taxable on its income. 6 In posing the problem, the Court, through
Justice Douglas, stated that "where the grantor is the trustee and the benefi-
ciaries are members of his family group, special scrutiny of the arrangement

42. See generally Boris I. Bittker & Martin 1. McMahon. Jr., Federal Income
Taxation of Individuals 31.3, at 31-21 to 31-24 (1988).

43. Marvin A. Chirelstein, Federal Income Taxation: A Law Student's Guide to the
Leading Cases and Concepts 8.05, at 191-92 (6th ed. 1991).

44. 309 U.S. 331 (1940).
45. Id. at 332-33.
46. Id. at 335.

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is necessary lest what is in reality but one economic unit be multiplied into
two or more,"'47 and added:

We have at best a temporary reallocation of income within
an intimate family group. Since the income remains in the
family and since the husband retains control over the invest-
ment, he has rather complete assurance that the trust will not
effect any substantial change in his economic position....
For where the head of the household has income in excess of
normal needs, it may well make but little difference to him
(except income-tax-wise) where portions of that income are
routed-so long as its stays in the family group.4"

Here is the essence of the assignment of income doctrine: the concern that the
progressive tax rate schedule not be subverted by permitting income to be
artificially split among formally separate taxpayers who in fact constitute a
single economic unit.49 In more recent years, the courts have become more
candid in acknowledging this policy as the basis for the assignment of income
doctrine. For example, the Supreme Court in 1973 extolled the doctrine as "a
cornerstone of our graduated income tax system.' '50 Today, this explanation
is commonplace among both courts5' and commentators.5 2

47. Id.
48. Id. at 335-36.
49. This conclusion is reinforced by the Court's citation of Randolph E. Paul, The

Background of the Revenue Act of 1937, 5 U. Chi. L. Rev. 41 (1937). Clifford, 309 U.S. at
335 n.2. Mr. Paul emphasized that many of the tax "schemes" the 1937 Revenue Act was
designed to curtail involved splitting a taxpayer's income among multiple related taxpayers
comprising a single economic unit:

One characteristic underlies several of these devices; the
multiplication of the taxpayer's personality. A taxpayer, in almost all the
cases mentioned, starts with single individuality and subdivides himself by
various mechanisms into a group of people. He subdivides himself into
several people, some of whom are incorporated, and others of whom are
not. It is a common denominator of the several schemes that the income
of a family economic unit shall be treated as if there were no such
economic unit.

Paul, supra at 48-49 (footnotes omitted).
50. United States v. Basye, 410 U.S. 441, 450 (1973) (emphasis added).
51. See, e.g., Foglesong v. Commissioner, 621 F.2d 865 (7th Cir. 1980), wherein

the court states:
The impact of the graduated income tax is eroded when income is split
artificially among several entities or over several tax years. The assign-
ment of income doctrine under Section 61 of the Internal Revenue Code
(as formulated in Lucas v. Earl) seeks to recognize "economic reality" by
cumulating income diffused among several recipients through "artificial"

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Scimeer v. Conmmissioner

D. Nongratuitous Assignments of Income: A Different Case

All the cases above involved gratuitous assignments of income. What
should the rule be when the right to future personal service income is
assigned, or exchanged, for consideration? If, as is commonly agreed, the
assignment of income doctrine is intended to preserve the integrity of the
graduated tax rate schedule, the assignor should be taxed on the amount he
receives for the assignment but no more, while any amount collected by the
assignee over and above the amount paid for the assignment should be taxed
to the assignee. This is in fact the approach adopted by the courts.

The vice of a gratuitous assignment of income is that, if respected for
tax purposes, it would enable the assignor to shift the incidence of tax on the
assigned income to one or more other taxpayers. Therefore, a taxpayer, by
assigning income, could fragment his aggregate taxable income among
multiple taxpayers and thereby avoid the higher rates prescribed by the
progressive tax rate schedule. If, however, the assignor assigns his earned
income for full and adequate consideration, that is, if he "sells" his right to
the earned income for its full value, the incidence of taxation will not be
shifted since the taxpayer will receive, and report as taxable income, one
dollar for every dollar of income he assigns." Since the vice which the
doctrine seeks to prevent does not exist in this case, there is no reason to
apply the doctrine.

But what if the amount received by the assignor differs from the
amount ultimately collected by the assignee? Provided the transaction is at
arm's-length, the assignor still should be taxed on the amount he receives for

legal arrangements.
Id. at 868.

52. Bittker & McMahon, supra note 42, 1 31.1, at 31-3 ("[Tihe courts recognized
at the outset that transfers within the family, if honored by federal tax law, could seriously
undermine the progressive rate schedule."); Ralph S. Rice, Judicial Trends in Gratuitous
Assignments to Avoid Federal Income Taxes, 64 Yale L.J. 991, 991 (1955) (tracing doctrine
to the fact that "[t]axpayers in the higher income brackets often seek to redirect their income
to objects of their bounty in order to minimize the progressive features of the tax"), Lloyd G.
Soil, Intra-Family Assignments: Attribution and Realization of Income, 6 Tax L. Rev. 435,435
(1951) ("The problem of the gratuitous intra-family assignment is a creature of the progressive
surtax."). But see Gunn, supra note 32, at 760-65 (arguing that the assignment of income
doctrine is not based on notions of tax avoidance but rather on notions of convenience and
fairness).

53. Where the assignor receives full consideration for his assignment of income, the
assignment will generally not alter the total amount of income the assignor reports. The
assignment may, however, affect when he reports the income. For example, the assignor may
attempt to defer recognition of his income by assigning income which he is to receive over
the next three years in exchange for a lifetime annuity. The applicability of the assignment of
income doctrine to tax-motivated attempts to defer income is discussed infra part V.E.

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the assignment-no more, no less. This is particularly clear where the
assignor receives more from the assignee than the assignee collects. In such
case, the assignor should be taxed on the full amount received because that
is the amount which constitutes his accession to wealth.'

There are two possible reasons why the amount received by the
assignor may be less than the amount collected by the assignee: (1) the
shortfall may be a discount for early payment of the income representing the
time value of money; or (2) the shortfall may be the result of an improvident
bargain by the assignor. If the shortfall merely represents a discount for the
time value of money, the assignor clearly should be taxed only on the amount
he receives, since that amount is the financial equivalent of the amount
ultimately collected. The government will not lose under this approach, since
sale of the income right accelerates the taxation of the earned income and
thus the government collects its tax sooner.55

The crucial test of this approach comes where the assignor made an
improvident bargain and sold his right to receive income for less than the
amount ultimately collected by the assignee. If the dictum that "income must
be taxed to him who earns it"" is taken as a metaphysical truth rather than
a pragmatic device to prevent tax avoidance, then the assignor should be
taxed on all amounts collected on account of his personal services even where
that amount, after discount for the time value of money, exceeds what he
received from transferring his right to such income. Otherwise, not all of the
income will "be taxed to him who earns it."57

If, however, the doctrine is recognized as a prophylactic against tax
avoidance, the assignor should be taxed only on the amount he receives for
his assignment. This is the proper approach and the one adopted by the
courts.

The effect of this approach on tax revenues should be neutral. Where
the price of the assignment has been negotiated in good faith on an arm's-
length basis, there is no reason to suppose a priori that the amount paid for
the assignment will be less or greater than the amount ultimately collected
under the assignment. Naturally, in some cases the amount received for the
assignment will be less than the amount collected by the assignee, but among
all the assignments negotiated in good faith at arm's-length there should be

54. See Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 431 (1955) (treating
"undeniable accessions to wealth" as gross income).

55. Moreover, the assignee will have to report any amount he collects in excess of
what he paid for the assignment as taxable income. Wilkinson v. United States, 304 F.2d 469,
472 (Ct. Cl. 1962) ("[T]he assignee is taxed on any amount ultimately collected ... in excess
of his cost.").

56. Commissioner v. Culbertson, 337 U.S. 733, 739-40 (1949).
57. Id. at 740.

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Schmeer v. Commissioner

an equal number of cases where the reverse is true. As the Supreme Court
observed in a different context, "the United States is in business with enough
different taxpayers so that the law of averages has ample opportunity to
work."58

In many, probably most, gratuitous assignment of income cases the
assignee will be in a lower marginal tax bracket than the assignor, thereby
creating the loss of tax revenue. In contrast, there is no reason to suppose that
this will be true where the assignment of income is in exchange for valuable
consideration in an arm's-length transaction.

Moreover, taxing the assignor on income collected in excess of the
amount he received for his rights would give rise to double taxation. In the
case of gratuitous assignments of income, no problem of double taxation
arises because the collection of the assigned income by the assignee is simply
the realization of the "gift" from the assignor and is therefore excluded from
the assignee's income by section 102 of the Code. However, section 102 is
unavailable to protect the assignee who collects more than what he paid for
the assignment in an arm's-length transaction. Unless the assignor's income
is limited to the amount he receives, the excess amount collected by the
assignee would be taxed to both the assignor and the assignee.

Finally, taxing the assignor on income he does not receive seems
inequitable where he has transferred his right to that income in a bona fide
arm's-length transaction. Of course, the assignor is taxed on income he does
not receive in gratuitous assignment of income cases, but the harshness of this
result is mitigated since the assignee is an object of the assignor's bounty.
This is not true where the assignment is made in an arm's-length transaction.

One disadvantage of this approach is that the Service and the courts
will be required to monitor assignment-for-consideration cases to ensure that
they are truly negotiated at arm's-length and are not merely a cover for
transferring income to an intended beneficiary of the taxpayer for less than
a full and adequate consideration. But this problem is common in our tax
system and does not seem to have significantly hindered the effective
administration of the tax laws.59

Where the courts have recognized that a case involves a sale of an
income right for bona fide consideration, they have uniformly taxed the
assignor only on the amount he received from the sale, and no more. Thus,
insurance agents who sell their rights to renewal commissions are taxable
only on the amounts for which they sold their rights and not on the amount

58. Northeastern Pa. Nat'l Bank & Trust Co. v. United States, 387 U.S. 213, 224
(1967) (quoting Gelb v. Commissioner, 298 F.2d 544. 552 (2d Cir. 1962)).

59. One instance in which such a problem has arisen is in determining whether a
payment to the sole shareholder of a corporation is to be characterized as deductible
compensation or a nondeductible dividend.

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collected by the buyers of such rights; 6° a construction contractor who sells
his claim against the government for unpaid construction work is taxable only
on the amount for which he sold his claim and not on the amount collected
by the assignee;6' and one who sells his right to a contingent fee is taxed
only on the amount received by him on the sale and not the fee ultimately
collected.62

Thus the courts have firmly established two rules in the case of
assignments of personal service income: first, all amounts collected by an
assignee under a gratuitous assignment of personal service income will be
taxed to the assignor; second, a taxpayer who exchanges his right to such
income for bona fide consideration will be taxed on the consideration he
receives and no more.63 Unfortunately, the courts and the Service have

60. Cotlow v. Commissioner, 228 F.2d 186 (2d Cir. 1955). The case involved the
tax status of the purchaser of the renewal commissions, but in the course of its opinion the
court stated: "Where there is an arm's-length assignment of income rights for a valuable
consideration, it is clear that the assignor realizes only the amount of the consideration
received, and the assignee is taxable for receipts in excess of this amount." Id. at 188
(emphasis added) (citation omitted).

61. Jones v. Commissioner, 306 F.2d 292 (5th Cir. 1962).
62. In Wilkinson v. United States, 304 F.2d 469,472 (Ct. Cl. 1962), Captain Bonnin

had sold a partial interest in a contingent fee to Wilkinson in 1938 for $12,092.17. Wilkinson
gave that interest to charities in September 1951; later that year the court awarded total legal
fees of $2,794,616.43, of which Wilkinson's share came to $191,363.28. Id. The court held
that Wilkinson was taxable on the difference between the amount of the awarded fee
($191,363.28) and the amount he paid for the interest in the contingent fee ($12,092.17). Id.
at 474. This holding, together with the court's observation that "[i]n an arm's-length
transaction the assignor of a personal services contract right is taxed on the consideration
received, and the assignee is taxed on any amount ultimately collected under the assignment
in excess of his cost," id. at 472, strongly suggests that the court would have taxed Captain
Bonnin only on the consideration received from Wilkinson and not on the amount of the fee
ultimately awarded.

63. This rule is also applied where the taxpayer sells his right to future investment
income. See, e.g., Estate of Stranahan v. Commissioner, 472 F.2d 867 (6th Cir. 1973) (holding
seller of right to future dividends taxable on consideration received). A number of cases have
held that a purported sale of future income failed to accelerate the recognition of income. See,
e.g., Mapco, Inc. v. United States, 556 F.2d 1107 (Ct. Cl. 1977); Hydrometals, Inc. v.
Commissioner, 31 T.C. Memo (CCH) 1260, T.C. Memo (P-H) 72,254 (1972), aff'd per
curiam, 485 F.2d 1236 (5th Cir. 1973), cert. denied, 416 U.S. 938 (1974); Martin v.
Commissioner, 56 T.C. 1255 (1971), affd per curiam, 72-2 U.S. Tax Cas. (CCH) 9637, 30
A.F.T.R.2d (P-H) 72-5396 (5th Cir. 1972) (not officially reported). These cases do not reject
the principle that a bona fide sale of future investment income will cause the seller to be taxed
on the consideration received and no more; rather, they were decided on the ground that the
particular transaction before the court was in the nature of a "loan" rather than a bona fide
"sale." For example, the court in Mapco stated:

We ... recognize that a taxpayer may sell a property right to future
income. If the bona fide sale occurs at arm's-length for adequate consider-

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Sclmeer i Conunissioner

frequently failed to appreciate the relevance of this basic distinction between
gratuitous and compensated assignments of personal service income and have
instead been sidetracked by the chimera of the "similarity" and "agency"
tests.

U. VARIATIONS ON A THEME:

T-E ASSIGNMENT OF INCOME IN DIFFERENT CONTEXTS

Set forth below are a number of hypotheticals that have been drawn
from actual cases and revenue rulings; these represent the principal controver-
sies that have arisen over the application of the assignment of income
doctrine to personal service income. They provide an overview of the diverse
but intriguing situations where assignment of income questions occur while
at the same time laying the basis for further analysis in the following
Parts.

64

Army Reserve Pay Case: P is a partner in a law firm and
under the partnership agreement is obligated to pay over to
the firm all "outside" earned income. P is also a member of
the United States Army Reserves and pursuant to the partner-
ship agreement, he dutifully turns over all of his Army
Reserve pay to the firm. Is the Army Reserve pay reportable
by P, under the assignment of income doctrine, or by the
firm?

65

Vow-of-Poverty Case: Father John is a member of the Fran-
ciscan order. One of the order's missions is serving the poor
and the infirm. At the direction of the order, Father John
applies to become chaplain at a mental hospital run by the
state. His application is accepted and he undertakes the duties
of being a chaplain. One of his tasks is the celebration of the
Eucharist and the administration of the Sacraments, which in
the Roman Catholic Church can only be performed by a
priest. Father John's religious superior visits him annually to

ation, the seller is taxed in the year of sale on the amount of consideration
he actually receives and the buyer is taxed on any excess of income
received over his purchase price.

Mapco, 556 F.2d at 1110.
64. Unless otherwise indicated, the taxpayers in the hypothetical cases described in

this article employ the cash receipts and disbursements method of accounting.
65. This hypothetical was suggested by I.T. 3824, 1946-2 C.B. 37 (a partner's

compensation for service in the armed forces does not constitute partnership income).

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observe and monitor performance of his priestly duties.
Pursuant to Father John's vow of poverty (which is legally
enforceable), he remits all of his pay from the state, less a
small allowance for his subsistence, to his order. Is the
amount Father John remits taxable to him under the assign-
ment of income doctrine? 66

Law School Clinic Case: Law School X operates a criminal
law clinic which is supervised by a full-time faculty member
F. From time to time, F is appointed by the Federal District
Court under the Criminal Justice Act to represent indigent
defendants in criminal matters, and in those instances stu-
dents in the clinic assist F in the defense of the defendants.
The Act authorizes the payment of compensation to the
counsel of record-but not to the law school. However, F has
agreed with the law school, as a condition of her participa-
tion in the program, to turn over to the law school any fees
she may receive from the court. Therefore, F endorses all
checks received by her under the Act to Law School X. Is F
taxable on these fees under the assignment of income doc-
trine?67

Personal Service Corporation Case: 0 was a manufacturers'
representative for producers of steel tubing. Operating as a
sole proprietor, 0 netted about $250,000 a year. No more
than $5,000 of this amount represented a return on the few
assets he used in the business (e.g., his word processor,
photocopier, etc.); the balance ($245,000) was solely attribut-
able to O's personal services. On the advice of his attorney,
0 at the beginning of 1970 formed Newco, Inc. in which he
was the sole shareholder and employee. Thereafter, he
conducted his business of representing manufacturers through
the corporation. O's salary from Newco, Inc. for 1970 was
fixed at $100,000 leaving the corporation with a net profit of
$150,000. Was 0 taxable on $245,000 in 1970 under the
assignment of income doctrine, since that was the amount of
income his services produced?68

66. This hypothetical was suggested by Kircher v. United States, 872 F.2d 1014
(Fed. Cir. 1989).

67. This hypothetical was suggested by Rev. Rul. 74-581, 1974-2 C.B. 25.
68. This hypothetical was suggested by Foglesong v. Commissioner, 35 T.C. Memo

(CCH) 1309 (1976), rev'd and remanded, 621 F.2d 865 (7th Cir. 1980), on remand, 77 T.C.

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Schneer v. Conmmissioner

Basketball Player Case: B, a basketball player, is acutely
aware that the life of a professional athlete is short. He
wishes to spread out the income he earns during his "good
years" over his lifetime to reduce his overall tax burden. On
the advice of his attorney, he enters into an agreement with
an unrelated corporation, X Corp., to provide all his services
in professional sports to X Corp. for six years in return for
$18,000 a year for the rest of his life. B's attorney then
attempts to negotiate an agreement between Hawks, a profes-
sional basketball club, and X Corp. under the terms of which
X Corp. would provide the Hawks with B's services as a
basketball player for the next three years for $100,000 a year.
However, because of the Hawks' adamant insistence that it
will only deal directly with B, B enters into an agreement
with the Hawks to play basketball for it for the next three
years for $100,000 a year, and then assigns his rights to this
pay to X Corp. Is B taxable on $100,000 a year under the
assignment of income doctrine, or only on the $18,000 a year
he receives from X Corp.? 69

A preliminary question is whether the earner of the income in these
cases would be entitled to a deduction for the amounts he or she pays over
to the assignee even if the assignment of income doctrine applies? The
answer is that the payment over to the assignee generally qualifies as a
deduction but frequently fails to provide a full offset. If the earner is an
employee who turns over the earned income to her employer pursuant to her
employment contract (as in the "law school clinic case") the amount turned
over will qualify as an ordinary and necessary business deduction" but will
be deductible only to the extent that it and other "miscellaneous deductions"
exceed two percent of the employee's adjusted gross income.7' If the earner
turns his earned income over to a religious organization (as in the "vow-of-
poverty case"), the amount turned over will qualify as a charitable deduc-
tion72 but will only be deductible to the extent of fifty percent of the

1102 (1981), rev'd, 691 F.2d 848 (7th Cir. 1982).
69. This hypothetical was suggested by Johnson v. United States, 698 F.2d 372 (9th

Cir. 1982), and Johnson v. Commissioner, 78 T.C. 882 (1982), aff'd, 734 F.2d 20 (9th Cir.).
cert. denied, 469 U.S. 857 (1984).

70. See, e.g., Rev. Rul. 66-377, 1966-2 C.B. 21 (permitting a deduction under IRC
§ 162 for fees from private practice turned over to medical school by faculty members as
required by their employment agreements).

71. IRC § 67.
72. See, e.g., Rev. Rul. 76-323, 1976-2 C.B. 18 (holding compensation from outside

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earner's adjusted gross income.73 Since most members of religious orders
have no other taxable income, their income almost invariably exceeds the
amount deductible as a charitable contribution. If the earner is a partner who
turns his outside income over to his partnership pursuant to the partnership
agreement (as in the "Army Reserve pay case"), the answer is unclear. Judge
Beghe, who concurred with the result in Schneer, would allow a full deduc-
tion for the income turned over,74 but Judge Halpern in his dissent suggested
that possibly no portion of the amount turned over would be deductible since
it may constitute a nondeductible contribution to capital under section 721 of
the Code.75 In short, whether it is theoretically correct to apply the assign-
ment of income doctrine in the above cases is of crucial practical signifi-
cance.

IV. THE "SIMILARITY" AND "AGENCY" TESTS: FAILED SOLUTIONS

A. Introduction

This Part will review and analyze the attempts of the courts and the
Service to resolve assignment of income problems by using the "similarity"
and "agency" tests. This analysis will show that these tests are wholly
inadequate to the task; they are neither rational nor workable, and they lead
to irreconcilable results.

The most noteworthy feature of the cases and rulings discussed below
is failure of the courts and the Service to discern the relevance of the basic
distinction between gratuitous and nongratuitous assignments of income to
the question at hand. Not one of these cases or rulings even alludes to this
basic distinction despite its relevance. Part V will show that this distinction
provides a rational basis for resolving these problems and for reconciling the
cases and rulings.

employment remitted by member of religious order to order deductible under IRC § 170).
73. IRC § 170(b)(1)(A)(i) (limiting charitable deduction to 50% of donor's

contribution base); IRC § 170(b)(1)(F) (defining "contribution base" as taxpayer's adjusted
gross income computed without regard to any net operating loss carryback).

74. Schneer, 97 T.C. at 663-64 (Beghe, J., concurring).
75. Id. at 669-70 (Halpern, J., dissenting). Martin B. Cowan asserts that if the

amount paid over to the firm is a nondeductible capital contribution under IRC § 721, then that
amount must be excluded from the firm's taxable income. He further argues that the reduction
in the firm's taxable income must be allocated solely to the contributing partner's share of
taxable income to satisfy the economic effect requirement of IRC § 704(b). The result is that
the contributing partner will not be taxed twice on the same income. Cowan, supra note 20,
at 1542-44.

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Scimeer vt Conmissioner

B. The Similarity Test

Partnership agreements frequently require every partner to turn over
to the partnership all income he earns regardless of whether he earns that
income in his capacity as a partner or in his individual capacity. 6 Thus,
many law partnerships require their partners to turn over to the partnership
all fees they earn for serving as executors or as corporate directors.' The
purpose of this provision is to assure that no partner will be tempted to divert
his time and attention from partnership matters to those matters in which he
receives all the income.78 By requiring the partners to pool all their earned
income from whatever source derived, the partnership ensures that the
partners will maximize their efforts on behalf of the partnership as a whole.

A series of rulings has considered whether income earned by a
partner in his individual capacity which he pays over to the partnership
pursuant to such an agreement is taxable to the partner under the assignment
of income doctrine or reportable by the partnership. The Service initially
ruled that the income was taxable to the individual partner if the activity
producing the income was one which the partnership could not, or did not,
perform as an entity. Thus, it held that compensation received by a partner
for his active service in the military that he paid over to the partnership was
taxable to him and not reportable by the partnership:

Obviously, a partnership can not [sic] exist for the purpose
of serving in the armed forces, and it is clear that compensa-
tion and allowances received by an individual for military
service can not [sic] be transmuted, in the manner here
involved, into earnings and profits (as such) of a partnership
of which he is a member. 9

76. Cowan, supra note 20, at 1541; William L. Raby, Outside Income of Profession-
als Who Practice in Firms, 54 Tax Notes 423, 423-24 (Jan. 27, 1992) (listing types of income
that partners are usually required to turn over to their partnerships).

77. See Raby, supra note 76, at 423-24.
78. See Cowan, supra note 20, at 1541. The author noted that:
[a] firm cannot long exist if each partner can go off on his own whenever
he determines his personal interest would be benefitted by doing so....
Accordingly, it is common, if not close to universal, to insist that all
partners ... bring all of their law and law-related activities into the firm
and that any services they render in connection with such matters be on
behalf of the firm.

Id.
79. I.T. 3824, 1946-2 C.B. 37, 38.

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Likewise, it ruled that the salary received by a partner for his service as an
elected official which he turned over to the partnership was taxable to the
partner individually since "[a] partnership cannot exist for the purpose of
serving as an elected public official.""s

The Service retreated from this position in a 1964 ruling which held
that fees turned over to a partnership by a partner for a service which the
partnership did not, or could not, provide would nevertheless be reportable
by the partnership so long as the service was "similar" to those performed by
the partnership."' The Service expanded on the "similarity" test in a 1980
ruling which held that executor's commissions turned over by a partner to his
accounting firm pursuant to the partnership agreement were reportable by the
partnership, and not the partner, even though state law prohibited a partner-
ship from acting as executor.8 2 The ruling reasoned that although state law
prohibited a partnership from serving as executor, such a "function was
within the range of services undertaken by accountants," and added that "[i]t
is not unusual in an accounting or legal practice that specific responsibilities
must be assumed by an individual partner rather than by the partnership.""

In each of the above rulings, the Service made its pronouncements ex
cathedra; it did not deign to explain why the similarity between the services
performed by a partner in his individual capacity and the services performed
by the partnership as an entity should have any bearing on the applicability
or nonapplicability of the assignment of income doctrine. In Schneer v.
Commissioner, the Tax Court also held in favor of the taxpayer on the basis
of the similarity test: it found that the consulting services performed by
Schneer for the clients he had introduced to his old firm were "similar" to the
legal services provided by his new firm. 84 But like the Service, the court
offered no convincing rationale or justification for the similarity test. It was

80. Rev. Rul. 54-167, 1954-1 C.B. 152, 152. Cf. Hamm v. Commissioner, 40 T.C.
Memo (CCH) 284, T.C. Memo (P-H) 80,154 (1980) (holding that salary earned by partner
in his capacity as a judge did not constitute partnership income), aff'd, 683 F.2d 1303 (10th
Cir. 1982). The rationale of the holding is unclear. The Tax Court stated that income earned
by a partner for services "outside of the scope of his partnership duties" is taxable directly to
the partner even if he assigns it to the partnership, and it found that taxpayer's duties as "a
district court judge were not within the scope of any partnership duties." Hamm, 40 T.C.
Memo (CCH) at 285. However the court found that the salary was earned after the dissolution
of the partnership. Hamm, 40 T.C. Memo (CCH) at 285, T.C. Memo (P-H) at 80-747. The
Court of Appeals affirmed solely on the ground that the partnership had been dissolved.
Hamm, 683 F.2d at 1304.

81. Rev. Rul. 64-90, 1964-1 C.B. (Part I) 226, 227.
82. Rev. Rul. 80-338, 1980-2 C.B. 30.
83. Id.
84. Schneer, 97 T.C. at 656 ("His referral fee income was clearly earned through

activities 'within the ambit' of the business of his new partnerships.").

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Schneer v. Conmissioner

this aspect of the decision which caused Judge Halpern, and has since caused
others, to denounce the court's decision as "unprincipled."'

The Schneer court did find that an inherent tension existed between
the assignment of income doctrine and the partnership provisions of Subchap-
ter K.86 In a partnership, different individuals may agree in advance on the
division of partnership income. That agreement will be respected for tax
purposes even if it turns out that the amounts payable under the agreement
to some partners are disproportionately large or disproportionately small
relative to the amount of partnership income their services generated. In
effect, those partners whose efforts generated a disproportionately large
amount of income relative to their distributive shares are making assignments
of some of the income they earned to the other partners; yet those partners
are taxed only on their distributive shares and not the amount of income their
services produced. From this, the court concluded that Congress intended for
the partnership rules permitting the pooling of gains and losses to override,
at least in part, the assignment of income doctrine.' The problem, in the
court's mind, was to determine the extent to which the pooling permitted by
Subchapter K displaced the assignment of income doctrine. The court
concluded that the similarity test gave the answer pooling would be permit-
ted so long as the services performed by an individual partner are similar to
the services performed by the partnership. The trouble with the court's
opinion is its failure to provide any reason for its conclusion. If the pooling
provisions of Subchapter K override the assignment of income doctrine where
the individual partner's services are similar to those offered by the partner-
ship, why do they not also prevail where the individual's services are
unrelated to those offered by the partnership? The court gave no answer to
this question.8

Commentators, however, have offered several possible explanations
or justifications for the similarity test. One has suggested that the test
provides a "rough and ready" basis to determine the bona fides of the

85. Id. at 669 (Halpern, J., dissenting); see supra note 20.
86. Sclueer, 97 T.C. at 657-58.
87. Id.
88. The court observed that "[i]f the partners perform services in the name of the

partnership or individually they are, nonetheless, associated with the partnership as a partner.-
Id. at 661-62 (emphasis added). It is unclear whether this statement was meant to justify the
similarity test, but in any event the statement is equally true whether the services performed
by the partner are similar or dissimilar to those performed by the partnership. Consider the law
firm partner who is also a United States Senator and who turns his salary as Senator over to
the firm pursuant to the partnership agreement. Service as a Senator would probably not be
considered similar to the services provided by his law firm. Nonetheless, the notoriety of the
Senator's position and the possible perception that the Senator's position gives the firm's
clients access and influence (whether true or not) will inevitably increase the firm's business.

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Florida Tax Review

partnership. 89 For example, in Mayes v. Commissioner,9° the Tax Court
refused to permit a son's income as an airplane engine mechanic to be pooled
as partnership income with his father's accounting and real estate rental
income. 9' Although the court did not say so, perhaps it suspected that the
purported partnership was merely a device for splitting income between two
related parties to minimize their overall tax burden. The close family
relationship between the parties and the dissimilarity in the types of income
which they were attempting to pool may have fanned the court's skepticism.
This may indeed "explain" why the courts have used the similarity test, but
it does not "justify" its use. Even as a warning device alerting the court to
greater scrutiny, the similarity test has little utility where the parties are
unrelated and are dealing with each other at arm's-length. And where the
parties are related, the test's use should be limited to raising a cautionary "go
slow" sign, not for automatically disregarding a bona fide partnership.

Some have suggested that "public policy" concerns may justify the
use of the similarity test, at least in certain instances. 92 In other words, the
courts and the Service may have felt that it violated public policy to give
effect to an arrangement under which a publicly elected official, or a member
of the armed forces, shares his salary from these activities with his law
partnership. However, neither the courts nor the Service asserted public policy
as the basis for the similarity test.93 Moreover, it is difficult to discern any
compelling public policy that is being violated in these cases. Consider the
case of a law firm partner who is also a justice of the peace. The Code of
Judicial Conduct strictly prohibits him from hearing any case involving any

89. Cowan, supra note 20, at 1538.
90. 21 T.C. 286 (1953).
91. Id. The Court of Appeals for the Tenth Circuit reached the same result in a

proceeding involving the father's tax liability for other years. Mayes v. United States, 207 F.2d
326 (10th Cir. 1953). See also Villere v. Commissioner, 133 F.2d 905 (5th Cir. 1943), in
which the court refused to recognize a partnership between two brothers, who had purportedly
agreed to split their aggregate income equally, where one brother earned a large salary and had
dividend income while the other had only a small income.

92. Cowan, supra note 20, at 1541-42.
93. See, e.g., Rev. Rul. 64-90, 1964-1 C.B. (Part I) 226; Rev. Rul. 54-167, 1954-1

C.B. 152; I.T. 3824, 1946-2 C.B. 37. Moreover, the relatively mild sanction that these rulings
imposed upon a partner who did pool one of these types of income with partnership income
suggests that public policy was not the basis for their holdings. In general, these rulings
adopted an approach that, aside from matters of timing, produced the same taxable result as
if such income had been permitted to be pooled. Thus, if the amount of the income assigned
by a partner exceeded his share of the pooled income under the partnership agreement, the
rulings allowed him a deduction for the difference. For an illustration of this approach, see
Rev. Rul. 64-90, 1964-1 C.B. (Part I) 226, 226-27. Schneer appears to be the first instance
where the Service did not adjust the partner's distributive share of partnership income when
it applied the assignment of income doctrine.

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Scluzeer v. Conunissioner

client of his firm, regardless of the nature of his financial arrangement with
his firm. 4 Since this rule largely, if not entirely, precludes conflicts of
interest from arising between his role as judge and his role as a partner of the
firm, it is difficult to see how public policy is violated if he pays his justice
of the peace salary to his firm." It is even more difficult to see how public
policy is violated when a member of the armed forces pays his salary into the
firm. Furthermore, the Supreme Court has stated that the normal rules of
taxation should give way to public policy concerns only where the policy is
"sharply defined 96 and publicly stated. Diligent research has failed to
unearth any statute, cannon of ethics, bar association ruling, or case holding
that it is improper for a publicly elected official, a justice of the peace, or a
member of the armed forces to pay his salary into a partnership. Thus the

94. The Code of Judicial Conduct permits a part-time judge, such as a justice of the
peace, to continue to practice law. Model Code of Judicial Conduct, Compliance with the Code
of Judicial Conduct A(1) (1972). But he may not participate "in a proceeding in which his
impartiality might reasonably be questioned." Model Code of Judicial Conduct Canon 3C( 1).
This of course would preclude the justice of the peace from hearing any case in which his firm
was involved.

95. Cowan, supra note 20, at 1541-42 states:
Where a partner renders services as a corporate director or as a

fiduciary, the loyalty and conflict of interest issues normally require a
pooling, and there is no public policy that prohibits this. However.
working as a judge, or as a soldier, does not require pooling, and the
allocation of time, expenses, and other resources should be determined by
considerations that may be utterly inconsistent with those dictated by firm
loyalty and possible conflicts of interest. Serving in the armed forces or as
a judge requires sole loyalty to that employer, and a sharing of loyalty
with a partnership of other individuals is completely contrary to public
policy.

I have two observations. First, the issue of whether a partnership needs pooling with respect
to a given activity seems best resolved by the partners themselves. Second, the possibility of
significant conflicts of interest arising between a partnership and an outside party seems most
likely where the partnership and the outside party have an ongoing relationship, as in the case
of an estate or a corporation represented by the firm. Thus, in the case of a partner who serves
as an executor there will be obvious conflicts in selecting legal counsel for the estate,
determining the amount of legal fees to be charged, and determining whether the partner
should be permitted to receive both legal fees and executor's commissions. In contrast, the
possibility of significant conflicts of interest arising between a partnership and the United
States Army where a partner serves in the Army Reserves seems highly remote.

96. Commissioner v. Heininger, 320 U.S. 467, 473 (1943) (stating that "ordinary
and necessary" business deductions may be disallowed only if the allowance of such
deductions would "frustrate sharply defined national or state policies").

97. Lilly v. Commissioner, 343 U.S. 90, 96-97 (1952) (stating that "ordinary and
necessary" business deductions may be disallowed only where their allowance would frustrate
national or state policies which are "evidenced by some governmental declaration of them-).

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minimum requirements for invoking public policy in a tax case have not been
met.

An obvious difficulty in applying the similarity test is determining
whether one activity is similar to another. For example, in the District of
Columbia nonlawyers are permitted to be partners with lawyers.98 Are the
services performed by an economist or a lobbyist in such a firm similar to
those performed by lawyers?" Are services performed by a trust lawyer who
is primarily engaged in drafting and tax analysis similar to those of a criminal
lawyer who is constantly in court trying cases? What about services per-
formed by an architect and an engineer? 1° Since neither the Service in its
rulings nor the court in Schneer explains the reason for the similarity test,
there is no meaningful guidance on how to make this type of determina-
tion.

101

But the real deficiency of the similarity test is this: any test which
purports to define the limits and contours of a doctrine like the assignment
of income doctrine should be grounded in policies underlying that doctrine.
That is, the test should limit application of the doctrine where the policies
underlying the doctrine cease to be relevant. Neither Schneer nor the
Service's rulings justify the similarity test in terms of the policies underlying
the assignment of income doctrine. Part V below, shows how reference to the
policies underlying the assignment of income doctrine leads to a proper
resolution of the problem posed by Schneer and similar cases.

C. The Agency Test

Outside the partnership area, the most popular test for resolving
assignment of income questions is the "agency" test. Under this test, if the
person who earned the income was acting on his own behalf, the income will
be taxed to him; however, if he was acting as another's agent, the income
will be taxed to his principal.

This approach is illustrated by the "vow of poverty" cases where
typically a member of a religious order takes "outside" employment at the
order's direction and then, pursuant to her vow of poverty, turns over the
earnings from that employment to the order. The Service has consistently

98. See District of Columbia Rules of Professional Conduct Rule 5.4(b), reprinted
in D.C. R. Civ. P. 5.4(b).

99. This question is posed in Sheppard, supra note 9, at 9.
100. This question is posed in Cowan, supra note 20, at 1541.
101. In his dissent in Schneer, Judge Halpern observed that the failure of the

majority to articulate an understandable rationale for the similarity test left the courts without
"any effective guidelines" for resolving future cases. Schneer, 97 T.C. at 669 n.3 (Halpern, J.,
dissenting). See supra notes 25-26 and accompanying text.

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Schmeer v. Conmnissioner

ruled that a member's earnings are not taxable to her where she is acting as
the order's agent in working for the employer, but are taxable to her if she
is acting on her own behalf.0 2 Both the Service and the courts have recog-
nized that vows of poverty are legally enforceable so that if the member fails
to remit her earnings to the order, the order can legally collect them from
her.0 3 Early rulings involved situations where the work performed by the
member was unrelated to the work or mission of the order, for example,
where the member took a job in the plumbing or construction industry"1

or as an associate in a law firm. 05 In each of these rulings, the Service
found that the member was not acting as the order's agent but on her own
behalf to benefit the order and therefore was taxable on the full amount of
her earnings. None of these rulings explained the reasons for finding that the
member was not acting as her order's agent. It might have been inferred from
the facts that the crucial factor was the dissimilarity between the order's
mission and the services performed by the members-in other words, that the
Service was importing the similarity test from the partnership rulings-but a
1979 ruling made it clear that similarity, even identity, would not suffice to
make the member an agent of the order."° That ruling involved a military
chaplain in the United States Armed Forces who turned over his pay to the
order pursuant to his vow of poverty.0 7 Here, the services performed by the
chaplain were not only similar to the work or mission of the order, they were
identical with that of the order. Nevertheless, the ruling found that the
chaplain was working on behalf of himself and not as an agent of the order.
The ruling stated that "an agency relationship is established when it appears,
based on all the facts and circumstances, that the payer of the income is
looking directly to the order, rather than to the individual member, for the
performance of the services."'8 Since the chaplain was an employee of the
Armed Services and subject to its rules and regulations, the ruling found that
the Armed Services were looking to the chaplain, not his order, for the
performance of his services, and hence he was not acting as agent of his
order.'09

The agency test, as refined by the 1979 ruling, has become possibly
the most popular test in resolving assignment of income issues. In practice it

102. See, e.g., Rev. Rul. 77-290, 1977-2 C.B. 26, 27.
103. See, e.g., id. and Fogarty v. United States, 780 F.2d 1005, 1009 (Fed. Cir.

1986), each relying on Order of St. Benedict v. Steinhauser, 234 U.S. 640 (1914). for the
proposition that vows of poverty are legally enforceable.

104. Rev. Rul. 76-323, 1976-2 C.B. 18, 19.
105. Rev. Rul. 77-290, 1977-2 C.B. 26, 26-28.
106. Rev. Rul. 79-132, 1979-1 C.B. 62.
107. Id. at 62.
108. Id. at 63.
109. Id.

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works in a highly mechanistic manner: if a contract or agreement exists
between the employer and a third party under which the third party provides
the services of the employee to the employer, the employee will be treated
as the third party's agent. In the absence of such a contract or agreement, the
employee will be treated as acting on his own behalf and accordingly will be
taxed on his earnings.

The Tax Court adopted this approach, sometimes called the "agency
triangle" theory, in Schuster v. Commissioner, I0 another vow of poverty
case. Sister Francine Schuster was a member of an order one of whose
purposes was "the care and treatment of suffering humanity."''. Members
were allowed to obtain outside employment provided they received the prior
approval of the order; approval depended on whether the proposed employ-
ment furthered the charitable objectives of the order." 2 Members who
received outside employment agreed they would obey any direction of the
Provincial Superior concerning their employment including a direction to
terminate that employment.'' l Sister Schuster obtained the permission of the
order to serve as a midwife in an underserved area in a clinic aided by the
National Health Services Corps ("NHSC"), a federal agency."4 Sister
Schuster was employed by and received her checks from the NHSC." 5 The
order had attempted to enter into a contract directly with the NHSC but the
NHSC did not respond to the order's request.6 Sister Schuster, pursuant
to her vow of poverty, endorsed over to the order all checks she received
from the NHSC and asserted on her income tax returns that she was not
taxable on the salary she received from the NHSC since she was acting as the
agent of the order. 1' 7

The Tax Court rejected this claim because the order was under no
contractual liability to provide midwife services to the NHSC.

[I]n the legal sense, one can perform services for a
third party on someone's "behalf' only if some sort of
obligation to perform the services rests initially with the
person on whose behalf one wishes to act. If the "principal"
is under no duty to perform the services itself, or to ensure
that the services be performed, but merely approves of the

110. 84 T.C. 764 (1985), aff'd, 800 F.2d 672 (7th Cir. 1986).
111. Schuster, 800 F.2d at 673.
112. Id. at 673-74.
113. Id. at 674.
114. Id.
115. Id. at 675.
116. Id.
117. Id.

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Schneer v. Conunissioner

performance as an irrelevant bystander, then, in the legal
sense of the word, one cannot act on the other's behalf."'

A variation of the "agency triangle" theory was utilized by the Tax
Court in Johnson v. Commissioner" 9 which involved a so-called "loan out"
corporation. 20 Johnson was a basketball player with the San Francisco
Warriors. 2 ' In 1974, he entered into an agreement with an unrelated Pana-
manian corporation ("PMSA") under which he granted the corporation exclu-
sive rights to his professional services in sports for the next six years in
exchange for monthly payments of $1,500 for the rest of his life.
Johnson's attorney, who was negotiating the renewal of Johnson's contract
with the Warriors at that time, attempted to have the Warriors contract with
PMSA for Johnson's services.2' However, the Warriors adamantly insisted
that it would only sign a contract with Johnson." Consequently, Johnson
signed a contract directly with the Warriors and assigned his salary under the
contract to PMSA.2t The Internal Revenue Service determined a deficiency
based on the difference between the amount Johnson received from PMSA
and his salary under his contract with the Warriors.' -6 The court held for
the Service.

An examination of the case law from Lucas v. Earl hence
reveals two necessary elements before the corporation, rather
than its service-performer employee, may be considered the
controller of the income. First, the service-performer employ-
ee must be just that-an employee of the corporation whom
the corporation has the right to direct or control in some
meaningful sense.... Second, there must exist between the
corporation and the person or entity using the services a
contract or similar indicium recognizing the corporation's
controlling position.'27

118. Schuster, 84 T.C. at 774.
119. 78 T.C. 882 (1982), afftd, 734 F.2d 20 (9th Cir.), ccrt. denied, 469 U.S. 857

(1984).
120. Id.
121. Id. at 883.
122. Id. at 884. PMSA could terminate the S1,500 monthly payments if Johnson

failed to play for any professional athletic teams for any consecutive 24-month period. Id. at
886-87.

123. Id. at 884.
124. Id.
125. Id. at 884-85. In fact, Johnson assigned his salary to PMSA's assignee. Id.
126. Id. at 889.
127. Id. at 891 (footnote omitted) (citation omitted).

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Although the court assumed arguendo that the first requirement was met, it
held against Johnson since clearly the second requirement was not met. 2s

Some courts have rejected both the "agency triangle" theory and the
Johnson "two part test" as overly rigid and have opted instead for a suppos-
edly more flexible approach. On the appeal of the Schuster case from the Tax
Court, the Court of Appeals for the Seventh Circuit expressly rejected both
tests and chose instead to make its determination of whether an agency
relationship existed on the basis of the six factors listed by the Court of
Claims in Fogarty v. United States: 29

1) the degree of control exercised by the Order over the
member; 2) ownership rights [to the compensation as] be-
tween the member and the Order; 3) the purposes or mission
of the Order; 4) the type of work performed by the member
vis-a-vis the purposes or mission; 5) the dealings between the
member and the third-party employer, including the circum-
stances surrounding inquiries and interviews, and the control
or supervision exercised by the employer; and 6) the dealings
between the employer and the Order. 30

While the Schuster court acknowledged that the third and fourth factors
"arguably" pointed toward the existence of an agency relationship, it never-
theless held that Sister Schuster was not acting as agent of her order.'3 ' The
court emphasized that the order did not exercise "day-to-day control" over
Sister Schuster in her activities as midwife in the clinic (the first factor), that
the checks were issued to Sister Schuster rather than the order thereby giving
her greater control over the compensation (the second factor), and that Sister
Schuster, not her order, had been employed to act as midwife (the fifth and
sixth factors). 132 Although the Fogarty "six-part" factor test purports to be
more flexible than the "agency triangle" test or the Johnson "two part test,"

128. Id. at 891-92. In Sargent v. Commissioner, 93 T.C. 572 (1989), rev'd, 929 F.2d
1252 (8th Cir. 1991), the taxpayers, professional hockey players, formed professional service
corporations, which in turn contracted with the owner of the Minnesota North Stars hockey
team to furnish the services of the taxpayers. Thus, the second part of the Johnson test was
satisfied. However, the Tax Court found the hockey team exerted such extensive "on-the-job"
control over the taxpayers that it, rather than the professional service corporations, was the true
employer of the taxpayers. Sargent, 93 T.C. at 580. The Eighth Circuit reversed, holding that
the contracts between the taxpayers and their respective professional service corporations
established the requisite employer-employee relationships. Sargent, 929 F.2d at 1261.

129. 780 F.2d 1005 (Fed. Cir. 1986).
130. Schuster v. Commissioner, 800 F.2d 672, 677 (7th Cir. 1986).
131. Id. at 678.
132. Id. at 678-79.

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Scimeer v. Commissioner

it almost invariably will produce the same result. If the employer's contract
is with the member instead of the order, then the employer will normally
exercise more day-to-day control over the member than the order does and
the checks will be issued to the member instead of the order.

There are many difficulties with the agency tests as applied by the
Service and the courts. First, they are irreconcilable with many of the
Service's own rulings. In Revenue Ruling 58-515,'-" a police officer in the
performance of his official duties took a job in private industry "for the
purpose of obtaining certain information for the [police] department without
disclosure of his identity."' During this period of employment, the officer
continued to receive his regular pay from the department, and in accordance
with departmental regulations turned over his pay from the private employer
to the police pension fund. 3 ' The ruling held that the police officer was not
taxable on the pay from the private employer since he "was employed in
private industry as an agent of the police department."'" Obviously, the
private employer here was looking to the officer and not the police depart-
ment for the performance of his duties; it did not even know that its employ-
ee was a police officer. Obviously, it was the private employer, rather than
the department, that exercised greater control over the police officer in the
performance of his day-to-day activities on the employer's job, and both his
pay and the Form W-2 were issued to the officer and not the department.'"

Although the inconsistency may not be as pointed, other rulings also
diverge from the "agency triangle" theory and related tests. For instance, in
Revenue Ruling 65-28218 attorneys accepted employment at a fixed salary
with a legal aid society and agreed, as a condition of their employment, to
turn over any court-awarded fees to the society.' 3 Under the applicable
state statute, the court appointed individual attorneys to represent indigent
persons accused of crimes, and upon completion of their representation, the
attorneys were paid by the county on order of the appointing court." The
ruling held the attorneys who immediately paid over such fees to the society
in accordance with their employment agreements were not taxable on the fees
since "the attorneys are considered to be receiving the fees as agents for the
legal aid society.' 4' The ruling found that the individual attorneys were

133. 1958-2 C.B. 28.
134. Id. at 28 (emphasis added).
135. Id.
136. Id.
137. Id.
138. 1965-2 C.B. 21.
139. Id. at 21.
140. Id.
141. Id.

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agents of the society even though (1) the court appointed the individual
attorneys rather than the society to represent the indigent; (2) the court
exercised disciplinary authority over the individual attorneys; (3) there was
no contract between the court and the legal aid society for the society to
provide the services of the attorneys; (4) the court awarded the fees to the
attorney rather than the society; and (5) checks were issued to the attorney
and not the society.

The striking divergence in the Service's treatment of seemingly
similar cases is illustrated by a comparison of its holding in Revenue Ruling
74-581 142 with the Service's successful litigating position in Kircher v.
United States. 43 Revenue Ruling 74-581 involved a law school's clinical
program.' 44 From time to time, a Federal district court or a state supreme
court would assign a faculty member who was an attorney to represent an
indigent defendant in a criminal matter pursuant to the Criminal Justice Act
of 1964.145 Students in the clinical program would assist the attorney-
faculty member in the defense of the case. 146 The faculty members partici-
pating in the program had agreed, before entering the program, to endorse
over to the law school any fees received under the Criminal Justice Act. 47

In the ruling, the clerk of the court took the "generally acknowledged
position" that fees under the Act could not be paid to the law school but must
be paid directly to the assigned attorney. 48 Therefore, in practice, the
attorney-faculty member would submit vouchers to the appropriate court in
his or her name, and upon receipt of the check would endorse it to the law
school. 149 The ruling held, without explanation, that the attorney-faculty
member was not taxable on the fees. 50

In Kircher v. United States, a mental hospital operated by the State
of Ohio had an organized pastoral service to meet the needs of its
patients.' 5 ' The hospital required that before any candidate could be ap-
pointed as chaplain, he must first be appointed by the ecclesiastical body of
which he is a member. 52 Since only a priest can celebrate the Eucharist
and administer the Sacraments in the Roman Catholic Church, only ordained

142. 1974-2 C.B. 25.
143. 872 F.2d 1014 (Fed. Cir. 1989).
144. 1974-2 C.B. 25, 25.
145. Id.
146. Id.
147. Id.
148. Id. at 25-26.
149. Id. at 26.
150. Id.
151. 872 F.2d at 1016.
152. Id. at 1016.

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Schneer v. Conunissioner

priests could serve as Catholic chaplains at the mental hospital.' In 1972,
the Franciscan Order appointed Father Waldschmidt to serve as chaplain at
the state mental hospital."5 However, before undertaking his duties as
chaplain, Father Waldschmidt was required to submit his application for
employment to the hospital and have it approved by the superintendent of the
hospital; this was duly done.' The hospital did not interfere with Father
Waldschmidt's performance of his priestly duties, except to the extent his
duties "would violate the rules and regulations governing the care of the
patient."'56 Father Waldschmidt had an annual visitation by his religious
superior and various other visits by members of the Franciscan Order to
monitor the manner in which he was performing his duties.' The State of
Ohio treated Father Waldschmidt as a full-time state employee and issued
checks for his service payable to him which he then duly remitted to the
Franciscan Order.158 The court sustained the Service's contention that
Father Waldschmidt was not the order's agent and that therefore the salary
was taxable to him. 59

The results in Revenue Ruling 74-581 and Kircher cannot be
reconciled on the basis of any of the tests for determining agency. In both
cases, the contract or appointment from the third-party "employer" (the
hospital in Kircher and the court in the ruling) ran directly to the purported
agent rather than the purported principal; in neither case was there a contract
by the purported principal to provide the services of its agent to the third
party. In both cases, the checks were payable to the purported agent and not
the purported principal. In both cases, there was a close nexus between the
"principal's" mission and the services performed by its purported "agent."
Finally, nothing in the ruling suggests that the law school exercised any
greater control over the faculty member-attorney in his or her representation
of the indigent client than the Franciscan Order exercised over Father
Waldschmidt's performance of his priestly duties. In short, there seems to be
no principled basis for distinguishing the ruling and Kircher on the basis of
agency. Either Kircher is wrong or the ruling is wrong, or else the courts and
the Service have overlooked the basis on which they may be reconciled.

153. Id. at 1016-17.
154. Id. at 1017.
155. Id.
156. Id.
157. Id.
158. Id.
159. Id. at 1019-20.

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V. RESOLVING THE CONFLICTS: A RETURN TO BASICS

A. The Overlooked Distinction

Surprisingly none of the cases or rulings discussed above even alludes
to the basic distinction between gratuitous assignments of income and
assignments for consideration. Invariably, each of them cites the classic
gratuitous assignment of income cases-Earl, Horst, and Eubank-without
regard to the type of case under consideration. This is strange since some of
these cases fall in one category while the remainder fall in the other, and thus
are subject to dramatically different rules of taxation.

Schneer, for instance, is clearly an assignment-for-value case. In
negotiating the terms of his admission as partner to the second and third
firms, Schneer was engaged in an arm's-length transaction with unrelated
parties in an effort to maximize his economic position. Schneer intended to
get back a dollar for every dollar of income he assigned; and the law
presumes that in an ann's-length transaction the amount transferred by one
party equals what he receives in return.'6 Although the opinion is silent on
the point, the transcript shows that in return for Schneer's agreement to share
his fees from the first firm with the partners of the second firm, Schneer was
permitted to share in the fees the second firm collected for work it performed
before he joined the firm.16

1 Clearly, there was a quid pro quo for the
release of his right to the fees from the first firm. There is simply no reason
to believe that income was being gratuitously shifted in this case from one
taxpayer to another.

Revenue Ruling 74-58 1162 (the law school clinic ruling) and Reve-
nue Ruling 65-282 163 (the legal aid society ruling) are also assignment-for-
consideration cases. In Revenue Ruling 74-581, the full-time faculty member
operating the criminal law clinic received consideration, her law school
salary, for endorsing over her checks to the law school."64 Her salary was
intended to compensate her for all her duties as faculty member, including
her duties in running the law school clinic.' 65 Permitting her to retain both
the court-awarded fees and her salary would have resulted in double compen-

160. United States v. Davis, 370 U.S. 65, 72-73 (1962); Philadelphia Park
Amusement Co. v. United States, 126 F. Supp. 184, 189 (Ct. Cl. 1954).

161. Record at 28-29, Schneer (No. 31804-88) (testimony of Robert Sylvor).
162. 1974-2 C.B. 25.
163. 1965-2 C.B. 21.
164. 1974-2 C.B. 25, 25.
165. Id. "[T]he time spent in supervising work of students on these cases and in the

representation of the client is part of the faculty member's teaching duties for which the
faculty member is compensated by a total annual salary .... Id.

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Schmeer v. Conmmissioner

sation for the same services. If her salary did not fully compensate her for her
service to the law school, including her operation of the clinic, she presum-
ably would have declined to participate in the clinical program or else would
have bargained for an increase in her salary. On the other hand, if the law
school had permitted the faculty member to retain the court-awarded fees, it
undoubtedly would have reduced her law school salary by a corresponding
amount.' 66 There is no reason to believe that income either was intended
to be, or was in fact being, shifted from the faculty member to the law
school.

In Revenue Ruling 65-282, the attorneys in the legal aid society
received for their services and their agreement to pay over to the society all
court-awarded fees a fixed salary and presumably the use of office facilities
and staff support. 167 If this package of benefits did not fully compensate the
attorneys, they presumably would not have accepted employment from the
society. Again, there is no evidence that these attorneys intended to, or did
in fact, shift any income from themselves to the society.

In contrast, in the "vow-of-poverty" cases both the intent and effect
of gratuitously shifting income from the member to the order were present.
The member upon entering the order had vowed "never [to] claim or demand,
directly or indirectly, any wages, compensation, remuneration, or reward...
for the time or for the services or work I devote for or with [the Order]"
thereby evidencing his intent to benefit the order, t while the disparity
between the amount earned by the member and the small allowances he was
permitted to retain for his subsistence evidence the fact that income was
being shifted.

As shown above, in assignment for consideration cases, the earner is
taxed only on the consideration he receives in exchange for his earned

166. In fact, many firms and businesses resolve the "'outside income" issue by
permitting the partner or employee to keep the outside income and then crediting the amount
of such outside income against the amount of income the employee or partner would otherwise
be entitled to receive. For an example of such a provision in a partnership agreement and a
description of how it operates, see Raby, supra note 76, at 424-25.

167. 1965-2 C.B. 21.
168. Schuster v. Commissioner, 800 F.2d 672, 673 (7th Cir. 1986) (alterations in

original) (quoting vow which Sister Francine Schuster took upon entering the Order of the
Adorers of the Blood of Christ). The order's constitution provided that a member withdrawing
from the order was entitled to no compensation for the work she had performed while a
member of the order, since "like all the Adorers of the Blood of Christ. she freely chose to
serve the Lord and His people in a life of poverty, without personal gain." Schuster. 84 T.C.
at 767 (quoting the order's constitution). See generally Sharon L. Holland. Title 1: Norms
Common to All Institutes of Consecrated Life [cc. 573-6061, in The Code of Canon Law: A
Text and Commentary 453, 465-66 (James A. Coriden et al. eds., 1985) (quoting and
commenting on Canon 600, which elaborates on requirement of poverty imposed on all
members of Roman Catholic religious orders).

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Florida Tax Review

income.'69 This principle produces the following results. In Schneer, the
taxpayer would be taxed only on the consideration he received for surrender-
ing his right to receive payments from the first fin, that is, on his distribu-
tive share in the firm's profits. 7° In the legal aid society ruling, the attor-
neys would be taxed only on the consideration they received for surrendering
their right to court-awarded attorneys' fees, that is, on their fixed salaries. In
the law school clinic ruling, the faculty member would be taxed only on the
consideration she received for surrendering her right to court-awarded fees,
that is, on the portion of her law school salary allocable to her running of the
legal clinic program. In contrast, the vow-of-poverty cases involve gratuitous
assignments of income, and, as discussed below, the member of the religious
order should be taxed on the income his personal services generated, that is,
on the compensation that the third-party employer paid for his services.

These indicated results dovetail perfectly with the actual holdings in
those cases. Note, however, that these results were obtained under an
approach having nothing to do with the "similarity" or "agency" rationales
asserted in the those cases and rulings. As shown above, the "similarity" and
"agency" tests provide no intelligible reason for applying or not applying the
assignment of income doctrine.' Moreover, they have been applied so
inconsistently from one case to another as the courts and the Service have
strained to reach the "correct" result, that these tests afford no basis for
predicting results or structuring transactions. 172 In contrast, the approach

169. See discussion supra part II.D.
170. There has been an ongoing controversy as to whether a taxpayer's receipt of

a profits interest in a partnership in exchange for services is a taxable event requiring the
taxpayer to report immediately as income the present value of the profits interest, or whether
the taxpayer need only report as income his distributive share of the partnership's profits when
and as they are earned by the partnership. See generally I Arthur B. Willis et al., Partnership
Taxation ch. 46 (4th ed. 1993). Contrary to the hopes of the legal profession, the Eighth
Circuit's decision in Campbell v. Commissioner, 943 F.2d 815 (8th Cir. 1991), did not resolve
the basic issue since it held in favor of the taxpayer on the ground that his particular profits
interest lacked fair market value at the time of receipt and did not pass on the question of
whether receipt of a profits interest is, as a matter of law, nontaxable. Id. at 823. The Internal
Revenue Service recently issued Rev. Proc. 93-27, in which it stated that it would not treat
receipt of a profits interest in a partnership as a taxable event; however, the Revenue
Procedure does not apply where (i) the profits interest relates to a substantially certain and
predictable stream of income from partnership assets, such as income from high-quality debt
securities or a high-quality net lease, (ii) the partner disposes of his profits interest within two
years of receipt, or (iii) the profits interest is a limited partnership interest in a publicly traded
partnership as defined in IRC § 7704(b). 1993-24 I.R.B. 63, 64 (July 6) at § 4. In Schneer, the
Service did not treat Schneer's receipt of a profits interest in the second and third firms as
taxable events.

171. See discussion supra part IV.
172. See discussion supra part IV.

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Sciweer v. Conwiissioner

advocated here resolves these cases by reference to the basic purposes of the
assignment of income doctrine and thereby avoids the practical and theoreti-
cal infirmities of the "similarity" and "agency" tests.

Note moreover that this approach resolves many of the inconsisten-
cies created when the "similarity" or "agency" test is used. For example, it
was shown in the preceding Part that the results in Revenue Ruling 74-581
(the law school clinic ruling) and Kircher v. United States (where Father
Waldschmidt served as a chaplain in a state mental hospital) cannot be
reconciled under the agency test approach.17 3 But when one focuses on the
distinction between gratuitous and compensated assignments, the results
become self-evident, and the apparent inconsistencies disappear. Revenue
Ruling 74-581 is an assignment-for-value case (thus the doctrine does not
apply), while Kircher is a gratuitous assignment of income case (thus the
doctrine does apply).

Operation of this approach may be further illustrated by the following
example. Sister Joan, at direction of her order, teaches in a public school for
which she receives a salary of $25,000. This salary is paid directly to Sister
Joan, who, pursuant to her vow of poverty, endorses her pay checks over to
the order. Sister Joan's duties require her to live away from the convent, and
accordingly her order sends her a monthly stipend of $1,250, or $15,000 a
year, for her subsistence (rent, food, utilities, clothing, etc.). Analysis shows
this case involves both a gratuitous assignment of income and an assignment
for value. To the extent Sister Joan receives a stipend from the order in
connection with her services, her assignment of income is for value; hence
she should be taxed on the consideration received, or $15,000 a year. The
balance of the amount she remits to the order, $10,000, is gratuitous, and
hence she should also be taxed on this amount. Sister Joan should therefore
be taxed on a total of $25,000: $15,000 under the assignment for value rule,
and $10,000 under the gratuitous assignment of income rule."" This analy-

173. See supra notes 142-59 and accompanying text.
174. This bifurcated analysis is consistent with the holdings in Priv. Ltr. Rul.

8105008 (Sept. 29, 1980). This ruling concerned a member of a religious order who, at the
order's direction, taught in the public school system. Pursuant to her vow of poverty, she
endorsed all her pay checks over to the order, and the order in turn paid her for her personal
living expenses. Using the conventional "agency" analysis (i.e., the school system looked to
the member rather than the order for teaching services), the ruling held the member was
taxable on her salary.

However, the ruling used a more intricate analysis to determine whether the member
was entitled to a charitable deduction on the amounts she endorsed over to the order. The
ruling stated that a payment to a charitable organization could qualify as a charitable
contribution only to the extent it was a gift. It found that the amounts that the member
received for her personal living expenses were partial consideration for her assignment to the
order of her public school teacher's salary. Consequently, only "the excess of the amount

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sis also demonstrates that the value of Sister Joan's charitable contribution is
only $10,000, not $25,000.175

B. Formal Statement of Approach

Perhaps a more formal statement of the approach proposed here
would be helpful. First, of course, it must be determined that the taxpayer's
services generated the income. Then two questions must be answered.

1. At the time the income was earned, was the taxpayer entitled to
receive and retain the income, or was he legally compelled by agreement to
turn it over to another? If he could receive and keep the income, he must be
taxed on it. If he was compelled to pay the income to another, he may or
may not be taxable on the assigned income depending on the answer to
question 2.

2. Did the taxpayer receive consideration for agreeing to turn the
income over to another person, or was his assignment of that income
gratuitous? If the agreement was for consideration, the taxpayer will be taxed
only on the consideration he received; any income collected by the assignee
over and above the consideration paid will be taxed to the assignee. If the
assignment was gratuitous, the taxpayer will be taxed on the full amount of
income his personal services generated.

Question 1 makes it clear that a necessary, but not sufficient,
condition for a taxpayer to avoid being taxed on the assigned income is that
he be under a legal compulsion to turn it over to another. This requirement
may be thought of as a replacement for the similarity and agency tests. Under
the similarity test, income earned by a partner in his individual capacity will
be reportable by the partnership, rather than the partner, only if he has agreed
to turn it over to the partnership and the services he performs are similar to
those offered by the partnership as an entity. In contrast, the test proposed
here requires only that the partner have agreed, prior to the time he rendered
the services, to turn over the income to the partnership. This is the more
logical approach. If income from the sale of sophisticated electronic equip-
ment, the leasing of automobiles, and the sale of bread may be treated as
income of a single corporate conglomerate, there is no reason why such

Taxpayer remits to the order over the amounts she receives from the order for her personal
living expenses" was a gift and qualified as a charitable contribution. Id.

The ruling, in effect, bifurcated the member's assignment of her salary: (1) part of
her salary was exchanged for consideration, and (2) the remainder was gratuitously transferred
to the order. Although the ruling used this analysis only to determine the amount of the
member's charitable contribution, there is no reason why it should not also be used to
determine the extent to which the member is taxable on her salary.

175. Id.

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disparate types of income should not also be treated as the income of a single
partnership. The requirement proposed here recognizes that the business of
a partnership is whatever the partners agree to, and if they agree to pool
income from a given activity, that income becomes, by virtue of such
agreement, partnership income and the activity generating it part of the
partnership's business.176

Likewise, the proposed requirement obviates the need to find an
agency relationship in the nonpartnership cases. All that is required is that the
taxpayer have legally obligated himself to pay the income he earns over to
another. The proposed requirement recognizes that where a taxpayer agrees
to remit the income from a given activity to another, the taxpayer is acting
on the other person's behalf when he performs that activity. It is absurd to
say, as the Tax Court did in Schuster, that Sister Schuster was not acting on
the order's behalf in serving as midwife" when she was legally obligated
to turn over all her earnings from that activity to the order.

But being under a legal obligation to turn one's earnings over to
another does not, by itself, make the assignment of income doctrine inapplica-
ble. Otherwise, the assignment of income doctrine would not apply to the
vow-of-poverty cases. To make this determination, one must then answer
question 2: Was the assignment gratuitous or for consideration?

Applying these principles to the first three hypothetical cases in Part
IH produces the following results: the Army Reserve pay that P turns over to
his law partnership is reportable by the partnership and not by P; the fees
awarded by the court to F, the faculty member who operates the law school
clinic, is income to the law school and not to F; and Father John's salary as
a chaplain in a state hospital is taxed to Father John and not the order.

176. Cf. Cowan, supra note 20, at 1537-38:
Whether the partner is acting as an agent of the partnership with

respect to a specific activity seems to depend almost exclusively on the
terms of the partnership agreement.... For example, if a real estate
partnership with 100 partners and 200 employees is engaged in operating
shopping centers throughout the country, and one of the partners also acts
as a broker in the leasing and selling of properties other than shopping
centers, and all of the partners share in the profits and losses, and exposure
to liability, from that activity, the partnership is per se also in the business
of leasing and selling such other properties.... If there is a bona fide,
mutual sharing of the economic venture, including in profits and losses,
there is probably a partnership. (first emphasis added.)

However, Cowan would not recognize for tax purposes the pooling of a judge's salary or the
salary of a member of the armed forces: "Serving in the armed forces or as a judge requires
sole loyalty to that employer, and a sharing of loyalty with a partnership of other individuals
is completely contrary to public policy." Id. at 1541-42.

177. Schuster v. Commissioner, 84 T.C. 764, 774 (1985). aff'd, 800 F.2d 672 (7th
Cir. 1986).

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C. Issues Involved in Applying Proposed Approach

The idea that a person who assigns earned income for consideration
is taxed only on the consideration received is premised on the notion that for
every dollar of taxable income he assigns he will receive (or could expect to
receive) a dollar of taxable income in return. Thus, the tax treatment of the
assignor, on average, is not changed or bettered by the assignment. In two
cases, however, the assignor will benefit from the assignment of income.
First, the assignor will benefit if the transaction can be structured so that
amount received for the assignment of income avoids recognition. Second, the
assignor will benefit if the consideration is paid out over a longer period than
the earned income was to have been paid. Spreading out the income over a
longer period of time may benefit a taxpayer in a progressive tax regime by
causing more of the income to be taxed at lower rates than if it were
"bunched up" in one or a few years. These issues will be addressed below:
the nonrecognition issue in the discussion of the personal service corporation,
and the deferral issue in the discussion of the basketball player hypothetical.

D. The Personal Service Corporation: A Case of Nonrecognition?

Although personal service corporations no longer offer the same
opportunity for income tax savings as they did a couple of decades ago, they
merit study because of the light they shed on the proper reach of the
assignment of income doctrine. 178 At the height of their popularity in the

178. Immediately before the recent enactment of the Revenue Reconciliation Act
of 1993, Pub. L. No. 103-66, 107 Stat. 312 [hereinafter 1993 RRA], the personal service
corporation ("PSC") offered little opportunity for tax savings. This was primarily because the
highest marginal rate for C corporations, such as a PSC, was then higher than the highest
marginal tax rates for individuals and unincorporated businesses (34% vs. 31%). IRC §§ 1(a)-
(e), 11. In the 1970s, the situation was reversed. See infra notes 179-80 and accompanying
text. Other factors that made operating as a PSC unattractive were:

(1) Substantial elimination of the preferential tax rates for capital gains: The
substantial preference in tax rates for capital gains formerly in effect made it possible to sell
the stock of a PSC or to liquidate a PSC at a very favorable tax rate. In 1970, for example,
individuals were subject to a maximum tax rate of 70% on ordinary income, while the
maximum tax rate on long-term capital gains was only 35%. IRC §§ 1, 1202 (1970). However,
immediately prior to the enactment of the 1993 RRA, the highest individual tax rate on
ordinary income (31%) exceeded the highest individual tax rate on long-term capital gains
(28%) by only three percentage points. IRC § 1(a)-(e), (h).

(2) Denial of tax benefits for "personal service corporations" formed to avoid
income tax: Section 269A authorizes the IRS to disallow tax benefits in certain cases where
a "personal service corporation" (as defined therein) was formed for the principal purpose of
avoiding income tax. IRC § 269A.

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1970s, personal service corporations offered the prospect of substantial tax
savings. For example, the highest marginal tax rate for individuals in 1970
was seventy percent, 79 while the highest marginal tax rate for corporations
was forty-eight percent.'80 A high income taxpayer, by splitting off some
of his earned income to his wholly-owned corporation, could take advantage
of the lower corporate marginal rates and also a separate graduated tax
schedule, all the while retaining complete control over the diverted income.
If the individual died owning the stock of his personal service corporation,
his estate would receive a stepped-up basis in the stock of the corporation
equal to its date-of-death value;' ' this of course would reflect the value of
the corporation's accumulated income. The estate could then sell the corpora-

(3) Flat corporate tax rare of 34% for "qualified personal senice corporations":
Section 11(a), as in effect prior to enactment of the 1993 RRA, taxed a "qualified personal
service corporation" (as defined in § 448(d)(2)) at a flat rate of 34%---the highest marginal
rate imposed on a corporation. IRC §§ 11, 448(d)(2). This provision deprived a qualified
personal service corporation of the benefit of the lower corporate tax rate brackets.

(4) Double tax regime of Subchapter C: The double tax regime of Subchapter C
subjects corporate earnings to a double tax: first an income tax is imposed on the earnings
when the corporation earns them, and then an income tax is imposed on the earnings when the
corporation distributes them to the shareholders as dividends. IRC §§ 1I, 61(a)(7).

(5) Repeal of the "General Utilities" doctrine: Prior to the Tax Reform Act of 1986,
the Code made it possible for a corporation to sell its assets and distribute the sale proceeds
without the gain being taxed at the corporate level. This mitigation of the double tax regime
of Subchapter C was eliminated by the Tax Reform Act of 1986, Pub. L. No. 99-514, § 631.
100 Stat. 2085, 2269.

The 1993 RRA makes the following relevant changes: (1) it increases the maximum
individual income tax rate from 31% to 39.6%; (2) it increases the maximum corporate tax rate
to 35% but only for corporations whose taxable income exceeds SI0,000,000; and (3) it
imposes a flat rate of 35% on "qualified personal service corporations." 1993 RRA. §§ 13201,
13202, 13221.

As a result of the changes made by the 1993 RRA. PSCs may become attractive
again for high-income individuals, since the maximum individual tax rate for individuals
(39.6%) will now exceed the maximum tax rate for corporations (35%, but 34% for corpora-
tions having taxable income of less than $I,000,000). Also, the preferential tax rate for
capital gains is more significant (28% vs. a maximum tax rate of 39.6% on ordinary income).
But PSCs will not be as attractive as they were in the 1970s since taxpayers will now have
to deal with § 269A (authorizing the Service to deny tax benefits to personal service
corporations formed primarily to avoid tax), § I 1(b) (imposing a flat tax rate of 35% on
"qualified personal service corporations"), and the repeal of the General Utilities doctrine. See
generally Leonard Sloane, New Tax Law Limits the Draw of S Corporations, N.Y. Times,
Aug. 12, 1993, at D5.

179. IRC § 1 (1970). A special provision. IRC § 1348 (1970), repealed by
Economic Recovery Tax Act of 1981, Pub. L. No. 97-34, § 101(c), 95 Stat. 172, 183, limited
the maximum tax rate on earned income to 50%.

180. IRC § 11 (1970).
181. IRC § 1014 (1970).

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Florida Tax Review

tion's stock at no taxable gain. If this scenario were followed, the income tax
savings effected through the use of the personal service corporation would
become permanent. Even if the individual sold or liquidated the corporation
before his death, his taxable gain (again reflecting the value of the corpora-
tion's accumulated income) would be taxed at preferential capital gain
rates. 182

The personal service corporation thus represented in the seventies an
almost perfect case for applying the assignment of income doctrine, as all the
necessary elements were present. Consider the following hypothetical case
that was posed in Part III:

Personal Service Corporation Case: 0 was a manufacturers'
representative for producers of steel tubing. Operating as a
sole proprietor, 0 netted about $250,000 a year. No more
than $5,000 of this amount represented a return on the few
assets he used in the business (e.g., his word processor,
photocopier, etc.); the balance ($245,000) was solely attribut-
able to O's personal services. On the advice of his attorney,
0 at the beginning of 1970 formed Newco, Inc. in which he
was the sole shareholder and employee. Thereafter, he
conducted his business of representing manufacturers through
the corporation. O's salary from Newco, Inc. for 1970 was
fixed at $100,000 leaving the corporation with a net profit of
$150,000. Was 0 taxable on $245,000 in 1970 under the
assignment of income doctrine, since that was the amount of
income his services produced?

Here, 0 is in effect shifting some of the income earned through his
personal services, namely, $145,000 out of the $245,000 his services
produced, to a related taxpayer, namely, his wholly-owned corporation
Newco, Inc., to reduce his overall tax burden. Strangely, the efforts of the
Internal Revenue Service to apply the doctrine in these cases met with little
success. 183

182. The Code provided individuals with a deduction equal to 50% of the amount
by which an individual's net long-term capital gains exceeded his net short-term capital losses.
IRC § 1202 (1970), repealed by Tax Reform Act of 1986, Pub. L. No. 99-514, § 301(a), 100
Stat. 2216. Since the highest marginal tax rate on individuals was then 70%, IRC § 1 (1970),
this provision effectively capped the marginal tax rate on long-term capital gains at 35%.

183. Foglesong v. Commissioner, 621 F.2d 865(7th Cir. 1980) (rejecting application
of assignment of income doctrine, since its application conflicted with the policy of recogniz-
ing a corporation as a separate legal person and economic actor), on remand, 77 T.C. 1102
(1981), rev'd, 691 F.2d 848 (7th Cir. 1982); Rubin v. Commissioner, 429 F.2d 650 (2d Cir.
1970) (rejecting application of assignment of income doctrine to a personal service corporation

[VOL 1:11



Schmeer v. Conmmissioner

Professor Manning has argued that the doctrine should not apply to
an assignment of earned income to a wholly owned corporation.' 84 He
argues as follows: the assignment of income doctrine can properly be applied
only to a gratuitous assignment of income;"' an assignment to a wholly-
owned corporation is not gratuitous since the "value of the stock received or
the increase in the value of stock already owned, of necessity, equals the
value of the income transferred";'86 therefore, the doctrine cannot be ap-
plied to an assignment to a wholly-owned corporation.

Professor Manning confuses the purpose of the assignment of income
doctrine. It is true, as he points out, that the shareholder-employee suffers no
diminution of wealth in these cases. But the assignment of income doctrine
is not concerned about diminution of wealth but with tax avoidance. In the
seventies, a person by utilizing a personal service corporation could achieve
an unwarranted reduction in taxes in just the manner proscribed by the
assignment of income doctrine: the splitting of earned income among related
taxpayers thereby defeating the graduated tax system. That the taxpayer could
accomplish this without experiencing a diminution in wealth strengthens-
rather than weakens-the case for applying the doctrine. Recall in Clifford the
emphasis Justice Douglas placed on the fact that the purported transfer in that
case left the husband's economic status unchanged: "Since the income
remains in the family and since the husband retains control over the invest-
ment, he has rather complete assurance that the trust will not effect any
substantial change in his economic position."' 7 That the earner can still
control and enjoy income that he has purportedly assigned strengthens the
case for taxing him on that income. In Clifford, Justice Douglas assumed the
existence of a harmonious family unit in finding no change of economic
position. How much stronger is the case for taxation when the absence of
economic change is not based on the vagaries of inter-family relations but on
unfettered legal control of a wholly-owned corporation.

The question remains whether the proper result in these cases can be
obtained within the framework of the approach outlined above, or whether
that approach needs to be modified. No modification is necessary. If we
accept Professor Manning's characterization of the transaction as an assign-

because such application tended to undermine policy of treating corporation as a taxable entity
distinct from its shareholders, and because § 482 was available to deal with the problem).

184. Elliott Manning, The Service Corporation-Who Is Taxable on Its Income:
Reconciling Assignment of Income Principles, Section 482, and Section 351, 37 U. Miami L
Rev. 657, 669 (1983). Professor Manning would, however, apply § 482 to a shareholder-
employee who works exclusively for his wholly-owned corporation. Id. at 676-80.

185. Id. at 668.
186. Id. at 669 (footnote omitted).
187. Helvering v. Clifford, 309 U.S. 331, 335-36 (1940).

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Florida Tax Review

ment for value, then under the established rules the shareholder-employee is
taxable on the amount of consideration received. This amount, to use
Professor Manning's words, is the "value of the stock received or the increase
in the value of stock already owned, [which,] of necessity, equals the value
of the income transferred."' 188

In the above hypothetical, O's rendering of services to Newco, Inc.
for an inadequate consideration may be viewed as a transaction governed by
section 351 of the Code. 0, of course, did not receive any stock in return for
selling his services to Newco, Inc. at a bargain price, and thus the transaction
would not at first blush seem to be governed by section 351. But the courts
have held that issuance of additional stock to a 100% shareholder is an
"meaningless gesture," and that transactions involving a sole shareholder
should be analyzed as though additional stock had been issued. 89 Thus, 0
may, and should, be viewed as though he received stock from Newco, Inc.
having a value equal to the difference between the fair market value of his
services and the salary he actually received. However, even when the
transaction is cast in this form, 0 does not qualify for the nonrecognition rule
of section 35l.'90 0 is not contributing "property" to the corporation, but
rather his "services" which do not qualify for nonrecognition under section
351.'9' In response, it might be argued-weakly I think-that 0 is not
transferring services but the income which the services produce; that therefore
he is transferring "property" which qualifies for nonrecognition under section
351.192 Even acceptance of this dubious argument will not enable 0 to
avoid taxation. Both the courts and the Service hold that assignment of
income principles override the nonrecognition rule of section 351 where, as
here, the assignment is tax motivated and results in an artificial fragmentation
of income. 93

188. Manning, supra note 184, at 669 (footnote omitted).
189. See, e.g., Lessinger v. Commissioner, 85 T.C. 824, 831-36 (1985), rev'd on

another issue, 872 F.2d 519 (2d Cir. 1989), and authorities cited therein.
190. IRC § 351(a).
191. IRC § 351(d).
192. The courts and the Service have recognized that the transfer to a newly-formed

corporation of accounts receivable arising from services performed for the predecessor business
constitutes a transfer of "property" and not of "services." See Hempt Bros. v. United States,
490 F.2d 1172, 1175-76 (3d Cir.), cert. denied, 419 U.S. 826 (1974); Rev. Rul. 80-198, 1980-2
C.B. 113. In these situations, the services were performed before the transfer to the corporation
took place; hence, there were no "services" left to transfer but only a chose in action.
Moreover, the services were performed for a predecessor business, not for the new corporation.
However, in the case posed in the text, the services are being performed for the corporation.
Clearly, the performance of services on behalf of a corporation for a less than fair market
salary represents a contribution of "services" to the corporation.

193. Brown v. Commissioner, 40 B.T.A. 565 (1939), aff'd, 115 F.2d 337 (2d Cir.
1940); Rev. Rul. 80-198, 1980-2 C.B. 113.

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Sclheer v. Conunissioner

Other objections to applying the assignment of income doctrine to
personal service corporations include: (1) applying the doctrine undermines
the tax principle that a corporation is a separate and distinct taxpayer from
its shareholders;194 (2) applying the doctrine is a crude, sledgehammer
solution to a problem requiring a more delicate treatment;195 and (3) the
presence of a specific code provision (section 482) dealing with the problem
precludes resort to general judicial doctrines.19 The first two arguments are
without merit while the third requires modification.

The Supreme Court did not impugn the viability of Mrs. Earl as a
separate taxpayer when it applied the assignment of income doctrine to her
husband's salary. 197 Likewise, applying the doctrine to a personal service
corporation does not impugn the corporation's viability as a separate and
distinct taxpayer. Indeed, the assignment of income doctrine presupposes the
existence of a separate viable taxpayer. A finding that all or a portion of the
corporation's income should be taxed to the shareholder-employee does not
mean that the corporation's existence is being disregarded; it simply means
that the value of the shareholder-employee's services exceeds the salary he
has elected to take, and that such excess constitutes earned income which the
shareholder-employee has assigned to the corporation. If the corporation owns
other assets, either tangible or intangible (including goodwill), which
contribute to the profitability of the corporation, a reasonable portion of the
corporation's profits should be attributed to those assets and not the share-
holder-employee's services. Application of the doctrine is thus completely
compatible with the notion of a personal service corporation as a separate
income-generating taxpayer. Of course, if the corporation has no assets apart
from its right to the personal services of its shareholder-employee, as
sometimes occurs in the case of a personal service corporation, the corpora-
tion will have no taxable income after paying its shareholder-employee a fair
price for his services.

Moreover, the assignment of income doctrine need not-and should
not-be applied in a sledgehammer manner. Statements to the effect that
applying the assignment of income doctrine is like "crackling] walnuts with
a sledgehammer" ' 98 or represents an "all-or-nothing approach""' suggest

194. Foglesong, 621 F.2d at 868-69; Rubin, 429 F.2d at 652-53.
195. Foglesong, 621 F.2d at 872 (comparing application of assignment of income

doctrine to "crack[ing] walnuts with a sledgehammer"); Rubin, 429 F.2d at 653 (describing the
assignment of income doctrine as an "all-or-nothing approach").

196. Rubin, 429 F.2d at 653 (stating common law doctrines like the assignment of
income doctrine "have no place where, as here, there is a statutory provision [i.e.. § 482]
adequate to deal with the problem presented").

197. Lucas v. Earl, 281 U.S. 111 (1930).
198. Foglesong, 621 F.2d at 872.

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Florida Tax Review

that application of the doctrine to a personal service corporation inevitably
results in all of the corporation's income being taxed to the shareholder-
employee. But as shown above, the only portion of a corporation's income
properly taxable to the shareholder-employee under the assignment of income
doctrine is the amount by which the fair value of his services exceed his
salary: this is the amount that the shareholder-employee has assigned to the
corporation. If the corporation, for example, uses its own physical assets in
its business, a portion of the corporation's income represents a return on
those assets and should properly be taxed to the corporation. Application of
the doctrine therefore requires a refined and delicate analysis of the portion
of the firm's profits properly allocable to the services of the shareholder-
employee and the portion properly allocable to its other assets.2 °° Depend-
ing on the circumstances, a substantial portion of a corporation's profits
properly could be taxed to it notwithstanding application of the assignment
of income doctrine.20'

The principle stated above that a shareholder-employee should be
taxed on the fair value of his services to his corporation is subject to one
limitation: the amount of compensation deemed paid to him should not
exceed the income he would have recognized had he not incorporated.
Consider the case of an unsuccessful personal service corporation that earned
$10,000 in revenues and paid $8,000 in secretarial salary before it ceased

199. Rubin, 429 F.2d at 653.
200. Requiring the parties to determine the fair value of a shareholder-employee's

services to his personal service corporation does not seem unduly burdensome. Taxpayers and
the Service already confront a similar task in applying § 162(a)(1) which limits a taxpayer's
deduction to a "reasonable allowance" for compensation paid. Moreover, taxpayers and the
Service must make similar determinations in applying the "arm's-length" standard under § 482.

201. It is unclear whether the courts realize the need to make the refined analysis
called for in the text. The Tax Court, in sustaining the Commissioner's allocation of 98% of
the corporation's net commission income to Mr. Foglesong under § 482, stated:

The touchstone for determining whether the financial relations between the
petitioner and the corporation reflected those of unrelated parties dealing
at arm's-length is the extent to which the total remuneration to the
petitioner from the corporation for the services he performed ... was
essentially equivalent to that which he would have received absent
incorporation.

Foglesong v. Commissioner, 77 T.C. 1102, 1105-06 (1981), rev'd, 691 F.2d 848 (7th Cir.
1982). This test is too crude, since it fails to recognize that a sole proprietor's net taxable
income from the conduct of his unincorporated business may reflect a return on his physical
and intangible assets (including goodwill and going concern value) as well as remuneration
for his personal services. The case, however, may simply reflect a failure of proof on the part
of the taxpayer, since the decision makes no reference to any contention by the taxpayer that
the Commissioner's allocation failed to allow a reasonable return on the corporation's physical
and intangible assets.

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Scluzeer v. Conunissioner

operations. Assume that the fair value of the shareholder-employee's services
during the corporation's existence was $20,000. If the $20,000 were deemed
paid to the shareholder-employee, he would be taxed on $20,000 of compen-
sation income, and the corporation would recognize a taxable loss of $18,000
[$10,000 of revenues - $8,000 of secretarial salary - $20,000 of salary
deemed paid to shareholder-employee]. This result does not further the policy
of the assignment of income doctrine. The purpose of the doctrine is to
prevent a taxpayer from shifting taxable income from himself to related
taxpayers thereby avoiding the higher rates prescribed by the progressive tax
rate schedule. If the shareholder-employee had not incorporated, he would
have recognized taxable income of $2,000 [$10,000 of revenues - $8,000 of
secretarial salary]. Consequently, the shareholder-employee has shifted only
$2,000 of income from himself by operating through a corporation; and this
is the only amount he may properly be taxed on under the assignment of
income doctrine. Taxing him on this amount will cause the corporation to
break even [$10,000 of revenues - $8,000 of secretarial salary - $2,000 of
compensation paid to the shareholder-employee]. Other doctrines or statutory
provisions may cause the shareholder-employee to recognize more than
$2,000 of compensation income; - 2 but the assignment of income doctrine,
being concerned solely with the amount of taxable income a taxpayer shifts
to another party, should tax him only on this amount.

Where section 482 and the assignment of income doctrine produce
the same result, it becomes something of a quibble whether that result is
produced under the statutory provision, the judicial doctrine, or both.
However, one court has held that section 482 does not apply to a shareholder-
employee who works exclusively for his personal service corporation. -' 3 A

202. If § 482 applies to a shareholder-employee who works exclusively for his
personal service corporation, see infra note 203 and accompanying text, the shareholder-
employee will be taxed on the fair value of his services even if this causes the corporation to
recognize a loss. Regs. § 1.482-IA(d)(4) (as amended in 1993) (applicable to taxable years
beginning on or before April 21, 1993); Regs. § IA82-IT(d)(1)(ii) (1993) (applicable to
taxable years beginning after April 21, 1993). The validity of this rule has been sustained over
the objection that § 482 authorizes only the allocation of income, not the "creation of income."
Fitzgerald Motor Co. v. Commissioner, 508 F.2d 1096 (5th Cir. 1975). Kerry Inv. Co. v.
Commissioner, 500 F.2d 108 (9th Cir. 1974); Kahler Corp. v. Commissioner, 486 F.2d 1 (8th
Cir. 1973); B. Forman Co. v. Commissioner, 453 F.2d 1144 (2d Cir.). cert. denied. 407 U.S.
934 (1972); Latham Park Manor, Inc. v. Commissioner, 69 T.C. 199 (1977) (overruling prior
inconsistent Tax Court decisions). aff'd, 618 F.2d 100 (4th Cir. 1980).

203. Foglesong v. Commissioner, 691 F.2d 848 (7th Cir. 1982) (refusing to apply
§ 482 to a shareholder-employee who worked exclusively for his wholly owned corporation
because the "two or more organizations, trades, or businesses" requirement was not met). The
Service announced in Rev. Rul. 88-38, 1988-1 C.B. 246, that it would not follow this holding
in Foglesong, and the Tax Court in post-Foglesong cases has continued to apply § 482 in these
situations. E.g., Haag v. Commissioner, 88 T.C. 604 (1987).

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court following this ruling should have no hesitancy in applying the common
law assignment of income doctrine. If anything, section 482 should encourage
the courts to apply the doctrine to cases not falling within the section's literal
language, since the section represents Congressional endorsement of the
general philosophy of the doctrine: income should be taxed to the party that
earns it and not artificially split among related parties to produce tax bene-
fit.

2°4

E. The Basketball Player: A Case of Deferral

As mentioned above, a person who assigns his earned income for
valuable consideration may still derive a tax benefit if the consideration is
paid out over a longer period than the earned income was scheduled to have
been paid. By stretching out the payments, instead of "bunching" them in one
or a few years, more of the income will be taxed in lower brackets. This was
the tax plan in the "basketball player" hypothetical posed in Part III:

Basketball Player Case: B, a basketball player, is acutely
aware that the professional life of an athlete is short. He
wishes to spread out the income he earns during his "good
years" over his lifetime to reduce his overall tax burden. On
the advice of his attorney, he enters into an agreement with
an unrelated corporation, X Corp., to provide all his services
in professional sports to X Corp. for six years in return for
$18,000 a year for the rest of his life. B's attorney then
attempts to negotiate an agreement between Hawks, a profes-
sional basketball club, and X Corp. under the terms of which
X Corp. would provide the Hawks with B's services as a
basketball player for the next three years for $100,000 a year.
However, because of the Hawks' adamant insistence that it
will only deal directly with B, B enters into an agreement

204. In Philipp Bros. Chems. v. Commissioner, 435 F.2d 53 (2d Cir. 1970), the
court made the following observation regarding the policy of § 482: "The statute rests on the
well-settled policy that income is taxable under Section 61 of the 1954 Code to the party who
earns it and that it is economic reality rather than legal formality which determines who earns
income." Id. at 57.

In Keller v. Commissioner, 77 T.C. 1014, 1034 (1981), aff'd, 723 F.2d 58 (10th Cir.
1983), the court observed that "Section 482, and the regulations pursuant thereto, provide a
detailed mechanism to deal with the tax-avoidance problems which spur the assignment of
income doctrine. Section 482 and the assignment of income doctrine, therefore, should not lead
to different results in this case." See also Olla State Bank v. United States, 77-1 U.S. Tax Cas.
(CCH) 9455, at 87,148-49, 40 A.F.T.R.2d (P-H) 5073, 5073-74 (W.D. La.) ("§ 482 only
provides a method for making the determination allowed by § 61").

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Schmeer v. Corunissioner

with the Hawks to play basketball for it for the next three
years for $100,000 a year, and then assigns his rights to this
pay to X Corp. Is B taxable on $100,000 a year under the
assignment of income doctrine, or only on the $18,000 a year
he receives from X Corp.?

Note first what is not occurring here. B is not attempting to shift
income to another party; he was dealing at arm's-length with an unrelated
party to maximize his earnings; and he fully expected to receive back a dollar
of income for each dollar of income he assigned to X Corp. Under the
analysis employed above-that one who assigns his earned income for value
should be taxed only on the consideration received-B would only be taxed
on the payments received from X Corp. But another element is present here:
B is achieving a substantial tax saving by deferring his income. Since the
assignment of income doctrine is a remedial device to carry out basic tax
policy, the question becomes whether there is a compelling public policy
against achieving tax savings through deferral that justifies applying the
doctrine in these cases.

In fact, there seems to be no policy against it at all. Persons selling
property are free to structure the sale to qualify for the installment sale
provisions in the Internal Revenue Code and thereby spread out recognition
of their gain.2"' Employees and independent contractors desiring to stretch
out or defer their compensation to reduce their tax burden may negotiate
deferred compensation agreements.2- 6 Case law permits an employee who
has already deferred his income once to defer it again, even if already earned,
provided the agreement to further defer is made before the income was
scheduled to be paid.207 The attitude of the law is that if a taxpayer is will-
ing to accept delayed payment of his income he will be taxed accordingly.

Tax policy thus provides no warrant for using the assignment of
income doctrine to prevent tax savings through deferral. Not surprisingly
then, courts have declined to invoke the assignment of income doctrine to
prevent the deferral of income.

This was demonstrated in Rushing v. Commissioner-'s where two
corporations owned by the taxpayers adopted plans to liquidate within twelve
months of the day the plans were adopted.2' The reason for adopting these

205. IRC §§ 453, 453A, 453B.
206. Rev. Rul. 60-31, 1960-1 C.B. 174, modified by Rev. Rul. 64-279. 1964-2 C.B.

121 and Rev. Rul. 70-435, 1970-2 C.B. 100.
207. See Veit v. Commissioner, 8 T.C. Memo (CCH) 919 T.C. Memo (P-H)

49,253 (1949).
208. 441 F.2d 593 (5th Cir. 1971).
209. Id. at 593-94.

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Florida Tax Review

plans was to qualify under old section 337 which permitted a corporation to
avoid recognition of gain on the sale of its assets if it completely liquidated
within twelve months of the adoption of a plan of liquidation.2 0 Shortly
after the adoption of these plans, the corporations sold all their assets.2", A
few days before the deadline for liquidating, the taxpayers sold their stock in
the corporations to two trusts they had established for their children in
exchange for notes payable over a number of years.2"' The taxpayers elect-
ed to report the gains on the sales of their stock on the installment sales
method.213 Thereafter, the corporations were timely liquidated and the
proceeds paid to the trusts.214 Had the taxpayers retained their stock and
received the liquidation proceeds, they would have had to recognize the entire
gain on the liquidations in a single year, that is, the year in which the
liquidation proceeds were distributed. The Commissioner asserted that the
taxpayers were taxable on the liquidation proceeds under the assignment of
income doctrine and consequently were required to report their entire gains
in the year of the liquidations.2 5 His argument was that the liquidations
were foregone conclusions at the time of the stock sales; that the taxpayers
in selling their stock were merely assigning to the trusts the gains that had
already been earned on the liquidations; and that the taxpayers were thus
taxable on the gains under the assignment of income doctrine.2"6

The Court of Appeals for the Fifth Circuit affirmed the Tax Court's
holding in favor of the taxpayer.2 7 In an opinion by Judge Goldberg, the
court first found the assignment of income doctrine inapplicable:

At the outset we feel compelled to state what this
case is not about .... [T]his is not a case where one taxpayer
has attempted to shift the gain to a second taxable entity in

210. Id. at 593 n.2 (quoting IRC § 337 (1970), amended by Tax Reform Act of
1986, Pub. L. No. 99-514, § 631(a), 100 Stat. 2269).

211. Rushing, 441 F.2d at 593-94.
212. Id. at 594.
213. Id. at 595 n.4.
214. Id. at 595.
215. Rushing v. Commissioner, 52 T.C. 888, 896-97 (1969), aff'd, 441 F.2d 593

(5th Cir. 1971).
216. Id.
217. Rushing, 441 F.2d at 598. The Tax Court found for the taxpayers on the

dubious ground that "the trusts [as sole shareholders] could have voted to rescind the
resolutions of liquidation." Rushing, 52 T.C. at 897. This is highly unrealistic. Had the
liquidations not been completed within the 12-month period specified in the plans because of
the trustees' actions, the corporations would needlessly have incurred a huge tax on the gains
they realized on the sale of their assets; this would have injured the trusts' beneficiaries and
subjected the trustees to personal liability for their dereliction of duty.

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Schmeer v. Conunissioner

order to reap the benefits of the second entity's lower tax
rate. The price the trusts paid the taxpayers for the stock was
the full value of the stock, including the appreciation in value
which would be realized upon liquidation. We therefore find
the Commissioner's reliance upon the anticipator, assign-
ment of income theory entirely misplaced simply because no
income was assigned.2 8

The only question was "whether they must pay taxes on the entire amount of
the gain in the year the corporations were liquidated or ... over a period of
years as the installment payments are received from the trusts."219 The
answer to this question simply turned on whether the taxpayers had retained
any direct or indirect control over the proceeds or any economic benefit
therein.2' Since "[a]n autonomous entity [i.e., trust] controlled the pro-
ceeds, and no right of recapture inured to the benefit of the taxpayers," and
since the "taxpayers retained no effective benefit or control over the liquida-
tion dividend," the taxpayers were not taxable on the liquidation proceeds and
were permitted to recognize the gains on their stock sales under the install-
ment sales method.2'

Significantly, many courts have applied the assignment of income
doctrine in cases virtually identical to Rushing except for the fact that
taxpayers gave away rather than sold their stock. That is, the courts have
found in cases where the taxpayers gave away their stock that the gain on the
liquidation had already been earned at the time of the gift and thus was
taxable to the assignor." But in Rushing, where the stock was sold, the
court refused to treat the gain as already earned at the time of the sale. These
contrasting results demonstrate the basic premise of this article: the assign-
ment of income is not a metaphysical truth but a pragmatic device to carry
out basic tax policy. The courts will apply the doctrine when the taxpayer is

218. Rushing, 441 F.2d at 597 (emphasis added).
219. Id.
220. Id. at 598.
221. Id.
222. Jones v. United States, 531 F.2d 1343 (6th Cir. 1976); Kinsey v. Commission-

er, 477 F.2d 1058 (2d Cir. 1973); Hudspeth v. United States. 471 F.2d 275 (8th Cir. 1972);
Allen v. Commissioner, 66 T.C. 340 (1976). In the earlier cases, the courts relied in part on
the fact that the donees lacked the power to block unilaterally the scheduled liquidations.
Kinsey, 477 F.2d at 1063; Hudspeth, 471 F.2d at 279. The later cases, however, held this
factor was not decisive and found that under the "realities and substance" test the liquidations
were virtually certain to occur in those cases even though the donees possessed sufficient stock
to prevent the liquidations had they so desired. Jones, 531 F.2d at 1345-46 (donees together
with shareholders, other than donor, could stop liquidation); Allen. 66 T.C. at 347-48 (donee
received controlling stock interest).

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attempting to shift income to a lower tax bracket taxpayer through a gratu-
itous assignment but decline to apply it where the taxpayer sells his stock for
full value in an attempt to spread out recognition of his gain.223 Although
the courts have not articulated their reason for refusing to apply the doctrine
in the latter case, it is undoubtedly due to their perception-perhaps uncon-
scious-that no vital tax policy is at stake where the taxpayer merely attempts
to achieve a tax savings through deferring the receipt of his income.

The Treasury succeeded in having the Rushing result legislatively
modified in the Installment Sales Revision Act of 1980.224 The Treasury
was not concerned that taxpayers could transform an immediately recogniz-
able gain into a deferred gain, but that a group comprising a single economic
unit (such as a family) could enjoy immediate receipt of the proceeds while
recognizing the gain on a deferred basis.225 Thus, the statute was amended
to provide that where a taxpayer sold property on an installment sales basis
to a "related person," and the "related person" resold the property within two
years, the taxpayer would recognize his gain at the time the "related person"
realized his gain (if that resulted in earlier recognition of the gain).226

"Related person" was defined to include, among others, members of the same
family and trusts for the benefit of family members.227 Thus the result in
Rushing under the current law would be different: the taxpayers would have
recognized gain at the time the trusts for the benefit of their children

223. In Hudspeth, the court noted that the failure to apply the assignment of income
doctrine in Rushing only permitted the taxpayers to defer recognition of their gain and had "no
effect on the character or total amount of gain eventually recognized" whereas a failure to
apply the doctrine where the taxpayers gave the stock to charity would enable the taxpayers
to avoid recognition of the gain on liquidation entirely. Hudspeth, 471 F.2d at 278.

224. Pub. L. No. 96-471, 94 Stat. 2247 (codified as amended in scattered sections
of 26 U.S.C.).

225. The installment method is currently abused by taxpayers who sell
appreciated property to related persons (for example, a trust set up for the
benefit of the seller's children), who immediately resell the property to a
third party as a part of a prearranged transaction. The original seller defers
recognition of gain. The related person receives the full sale proceeds tax
free because the tax basis of the property in the hands of the related
person is its purchase price. Thus, the economic unit comprised of the two
related persons has cash equal to the value of the property while deferring
taxation of the gain which would have been immediately recognized had
the initial sale been for cash.

Installment Sales Revision Act of 1980 and Minor Bills: Hearings on H.R. 6883, H.R. 5616,
H.R. 5729, H.R. 6039, H.R. 6140, H.R. 6247, H.R. 6824, and H.R. 7009 Before the Subcomm.
on Select Revenue Measures of the House Ways and Means Committee, 96th Cong., 2d Sess.
25, 27 (1980) (statement of Harry L. Gutman, Deputy Tax Legislative Counsel, Treas. Dep't).

226. IRC § 453(e).
227. IRC § 453(f)(1).

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Scluzeer v. Conunissioner

recognized their gain, that is, at the time of the liquidations. Note, however,
that the statute applies only when the taxpayer sells to a "related person"; it
has no application to a sale to an unrelated person. Congress did not revise,
nor did the Treasury seek to revise, the rule dealing with sales to unrelated
parties. Thus, in sales to unrelated parties, the statute left intact the reasoning
of Rushing that the assignment of income doctrine has no application where
a party sells his right to income for fair consideration on a deferred basis.

Some additional support for the proposition that the assignment of
income doctrine should not be applied where the taxpayer merely seeks to
defer receipt of his income may be found in Keller v. Commissioner.'
There the taxpayer carried on his pathology practice as an employee of his
wholly owned professional service corporation. '  The Commissioner
asserted that the taxpayer was taxable on all earnings arising from his practice
under the assignment of income doctrine, and not merely his salary. 23' The
Tax Court recognized that the doctrine would apply if his total compensation
were less than what he would have received absent incorporation. " The
court found, however, that his salary plus the amount the corporation
contributed to the qualified retirement plan on his behalf plus the value of the
corporation's medical reimbursement plan approximated what he would have
received absent incorporation, -  and therefore the doctrine did not apply.
During the years in question, the amount of income that could be deferred
through a qualified plan was much greater in the case of an employee than
in the case of a self-employed individual. - Dr. Keller's arrangement thus
resulted in a much greater deferral of income than would have been possible
absent incorporation. The court's refusal to apply the assignment of income
doctrine under these circumstances suggests that it did not view mere deferral
of income as justifying application of the doctrine.

228. 77 T.C. 1014 (1981), aft'd, 723 F.2d 58 (10th Cir. 1983).
229. Id. at 1020-21.
230. Id. at 1021, 1029. The Commissioner relied on § 482 and the doctrines of lack

of business purpose and substance over form as well as the assignment of income doctrine. Id.
231. Id. at 1025. The court, in making this observation, was explaining the

application of § 482, rather than the assignment of income doctrine, to Dr. Keller and his
wholly-owned corporation. However, the court later stated that the assignment of income
doctrine produced the same result as § 482. Id. at 1029, 1033-34. Therefore, it seems fair to
conclude that the court's observation with respect to § 482 was equally applicable to the
manner in which the doctrine was to be applied.

232. Id. at 1028.
233. See, e.g., I Michie's Federal Tax Handbook 1977 1j 537. at 211 (Joseph E.

Gibson ed. 39th ed., 1977) (stating that "tax advantages obtainable by a sole proprietor or
partner from a pension, profit-sharing or annuity plan are not so spectacular as those granted
a regular employee, including the stockholder-officer of a corporation").

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Return now to the "basketball player" hypothetical. It has been shown
that neither policy nor precedent justifies applying the assignment of income
doctrine where the taxpayer merely defers receipt (and therefore recognition)
of his income. Certainly no warrant would exist for applying the doctrine to
B had the Hawks contracted directly with X Corp. rather than with B. Should
the result change merely because the Hawks, in the hypothetical, contracted
directly with B who then assigned his rights under that contract to X Corp.
pursuant to his pre-existing agreement with X Corp.? Reaching different
results in these cases would exalt form above substance. All relevant factors
are the same: in both cases, the payments made by the Hawks end up in the
hands of X Corp.; in both cases, B will receive the same amount; and in both
cases, B performs the same personal services. Therefore, the same result
should prevail and B should be taxed only on the amounts received from X
Corp.'

A more difficult question would be presented if B had been under no
obligation to assign his contract rights to X Corp. when he contracted with
the Hawks. In that case, it could be asserted that B's right to income from the
Hawks vested in him when he signed with the team, and thereafter it was too
late for him to disavow that income. Suppose the sequence of events had

234. B's initial agreement with X Corp. may be viewed as a sale or other
disposition of the right to his services giving rise to a taxable event under § 1001. A question
might arise as to whether B must immediately recognize a taxable gain equal to the difference
between the present value of his right to receive $18,000 a year for life (say, $220,000) and
B's basis in his services, zero. This is unlikely. If X Corp.'s obligation to B is unfunded and
unsecured, B will probably be taxed only when and as the $18,000 annual installments are paid
to him. See Rev. Rul. 60-31, 1960-1 C.B. 174, Examples (1) and (2). This is especially so,
since B's right to the payments is contingent upon his performing his obligations under the
contract. The subsequent transfer of the right to B's services to the Hawks should not cause
B any tax liability. First, the transfer should be treated as made by X Corp. and not by B. X
Corp. owned the right to B's services, and only it could lawfully dispose of such right. Second,
B should not realize any gain on the transfer of his services to the Hawks, since X Corp. is
entitled to receive all amounts realized on such transfer.

The above analysis is premised on the assumption that the agreement with X Corp.
and the subsequent agreement with the Hawks are separate and distinct events, and that X
Corp.'s $18,000-a-year obligation is fixed and independent of the agreement ultimately reached
with the Hawks. However, if the fact finder determines that both events are integral steps of
the same transaction and that the Hawks is the real employer of B, the result may be different.
The Service may argue that Hawks by making payments (either directly or indirectly) to X
Corp. is, in effect, funding its obligation to B and protecting B against the claims of the
Hawks's creditors. When an employer funds its obligation to an employee in a way that
immunizes the employee against the claims of the employer's creditors (for example, by
funding an escrow account or buying an annuity in the employee's name), the cases hold that
the employee receives an economic benefit which he must immediately recognize as income.
United States v. Drescher, 179 F.2d 863 (2d Cir.), cert. denied, 340 U.S. 821 (1950); Rev. Rul.
60-31, 1960-1 C.B. 174, Example (4).

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Sclmeer v. Conmmissioner

been as follows: (1) B enters into a player's contract with the Hawks under
which he is entitled to annual salary of $100,000 for three years; and (2) B
thereafter enters into an agreement with X Corp. under which he assigns his
rights under the contract to X Corp. in return for its promise to pay him
$18,000 a year for life. Unlike the hypothetical above, B at the time of his
contract with the Hawks was free to receive and keep those payments himself.
B's subsequent assignment of his rights under the Hawks contract to X Corp.
clearly constitutes a "sale or other disposition" of his contractual rights
triggering recognition of gain under section 1001. B (whose basis in his
contractual rights is probably zero) would therefore be taxed immediately on
the full present value of the right to receive $18,000 a year for life, unless he
could either avail himself of the installment sales method or successfully
argue that he should be taxed on the $18,000 payments only when and as he
receives them since he is a cash basis taxpayer. It is unclear under present
law whether B would prevail on either the cash basis argument or the
installment sales approach.25 In view of the great freedom that employees

235. The cash method argunment: Where there is a taxable sale or exchange, § 1001
requires that the seller recognize as the "amount realized" the cash received plus the fair
market value of any other property received. IRC § 1001(b). In the case of cash basis
taxpayers, like B, the cases have varied greatly in deciding whether an unfunded promise to
make future payments must be valued and taxed immediately under § 1001 or whether
recognition of income may be delayed until actual receipt of the payments. Some cases have
held that such obligations need be valued and taxed immediately only if they possess the
necessary element of negotiability while others have held they must be taxed immediately if
they can be sold by the taxpayer at any price. 4 Boris I. Bittker & Lawrence Lokken, Federal
Taxation of Income, Estates and Gifts [ 105.3.2 (2d ed. 1992). The Service takes the position
that Congress in enacting the comprehensive revision of the installment sales provisions in
1980 intended to make the installment sales method the exclusive method of deferring gain
where the amount of the payments is fixed. Id.

Ti installment sales approach: In Realty Loan Corp. v. Commissioner, 54 T.C.
1083 (1970), aff'd, 478 F.2d 1049 (9th Cir. 1973), both the Tax Court and the Ninth Circuit
held that a contract to perform services constituted "property" and therefore a sale of such a
contract could qualify for the installment sales method. This holding seems to cover B's sale
of his contractual rights with the Hawks to X Corp. But see Sorensen v. Commissioner, 22
T.C. 321 (1954). However, the Service can make a strong counterargument. A primary reason
for enactment of the installment sales method was to relieve a taxpayer of the hardship of
immediately paying the tax on the full gain when he had received cash in the year of the sale
for only a small portion of the sales price. Commissioner v. South Tex. Lumber Co.. 333 U.S.
496 (1948). In this case, B was originally entitled to receive annual payments of Sl00.000 over
a three-year period; he thereafter converted this right into a right to receive annual payments
of $18,000 over his lifetime. The hardship to B of paying a tax in a single year (or in three
years) on income that he will receive over a lifetime is self-inflicted. The Service might argue
that the installment sales method was not meant to enable a taxpayer to defer recognition of
income beyond the time when he would have received all of his cash payments under his
original contract. This argument seems implicit in the holding in Real. Loan Corp. where the
Tax Court upheld use of the installment sales method where its use did not extend the period

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Florida Tax Review

and sellers of property have in deferring recognition of income, it is difficult
to discern how tax policy would be subverted by either allowing B to use the
installment sales method or allowing him to defer recognition of income until
actual receipt of the annual payments. But whatever the answer to that
question, there is no warrant for applying the assignment of income doctrine
here. There is simply a deferral of income, and that is not a concern of the
assignment of income doctrine.

F. A Loose End: Should Schneer Have Been Taxed on the Fee that Was
Fully Earned at the Time of the Assignment?

All the judges in Schneer agreed that Schneer was taxable under the
assignment of income doctrine on the one fee, amounting to $1,250, which
had been fully earned before he left the first firm. 6 This conclusion is
almost surely wrong.

Since this fee had been fully earned when Schneer assigned it to the
second firm, it was in effect an account receivable. 37 Accounts receivable
are "property'2 '38 and thus are subject to the partnership basis rule of section
723. Pursuant to that rule, the second partnership took over Schneer's basis
in the account receivable, 239 that is, zero. Section 704(c)(1), as in effect
during the time in question, provided that in allocating gain or loss with
respect to the contributed property, the property was to be treated "as if [it]
had been purchased by the partnership." 4 ' The purpose and effect of this

for recognizing gain beyond the time when the taxpayer would have received and recognized
income under the original service contract. Realty Loan Corp., 54 T.C. at 1097-98. The Tax
Court distinguished Sorensen, which had disallowed the use of installment sales, on the ground
that its use in that case would have extended the time for recognizing gain beyond the time
the taxpayer would have otherwise received and reported his gain. Id. at 1097 (stating that the
sale of contract rights "could not change ... the time at which the amount was includable in
income").

236. Schneer, 97 T.C. at 651-52.
237. The opinion does not indicate whether the $1,250 was billed prior to Schneer's

departure from the first firm. However, the court found that it had accrued prior to his
departure from the first firm and it recognized that income would only accrue when all events
have occurred which fix the right to receive the income and the amount in question could be
determined with reasonable accuracy. Id. at 649-50. In any event, it is clear that Schneer was
at least contributing a chose in action, and a chose in action is "property" and not services.

238. Hempt Bros. v. United States, 490 F.2d 1172, 1175-76 (3d Cir.), cert. denied,
419 U.S. 826 (1974); see also Rev. Rul. 80-198, 1980-2 C.B. 113.

239. IRC § 723.
240. IRC § 704(c)(1) (1982). Section 704(c)(1) was amended by the Deficit

Reduction Act of 1984, Pub. L. No. 98-369, § 71, 98 Stat. 589, to provide that gain on
property contributed to the partnership was to be shared among the partners, pursuant to
regulations issued by the Service, to take account of the difference between the basis of the

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Schmeer v Conmissioner

language was to assure that the entire gain or loss realized with respect to the
contributed property was reported by the partnership instead of by the
contributing partner.24' The gain or loss would then be allocated among the
partners in accordance with the ratios specified in the partnership agreement
for sharing gains or losses.242 If they preferred, the partners could have
agreed pursuant to section 704(c)(2), as then in effect, to share the gain from
the collection of the receivable so as to take account of the difference
between the partnership's basis in the receivable and the receivable's fair
market value at the time of the contribution. 3 However, in Schneer there
was no such agreement.

Thus, under the statutory scheme then in effect, collection of the
$1,250 fee by Schneer's second firm was reportable by it (and not by
Schneer), and Schneer should have been taxed on this fee only to the extent
of his distributive share in it. The question is whether this statutorily mandat-
ed scheme was overridden by the assignment of income doctrine.

In Hempt Bros. v. United States,2 ' the court was confronted with
deciding whether section 351 and related provisions were overridden by the

property to the partnership and its fair market value at the time of the contribution. This meant
that the contributing partner would be required to recognize the "built-in gain" that existed on
the contributed property at the time of the contribution (i.e.. the difference between the
property's fair market value and its basis at the time of the contribution) when the partnership
sold or otherwise realized gain upon the contributed property. Thus, under the new rule,
Schneer would have been required to recognize all or a substantial part of the SI,250 when
his partnership collected this fee since Schneer's "built-in gain" in the fee was its fair market
value at the time of contribution less his basis in the fee (presumably zero).

However, the new rule applies only to "property contributed to the partnership after
March 31, 1984." Id. § 7 1(c), 98 Stat. at 589. Although the published opinion of the Tax Court
does not so state, a review of the Record in the case shows that a check from the first firm to
Schneer for the fee in question was dated January 30, 1984 and was endorsed and deposited
in the second firm's bank account on January 31, 1984. Record at Petitioners' Exhibit 22,
Schneer (No. 31804-88) (ledger of first firm showing payment of $1,250 forwarding fee to
Schneer on January 30, 1984); id. at Joint Exhibit 5-E (front and back of check no. 2331,
dated January 30, 1984, drawn by first firm and made payable to Stephen Schneer in the
amount of $1,250); id. at Joint Exhibit 10-J (deposit slip of second firm showing deposit on
January 31, 1984 of $1,250 received from first firm); id. at Joint Exhibit 12-L (second firm's
bank statement showing deposit of $1,250 on January 31. 1984). Thus, whether the date of the
contribution is deemed to be the date on which Schneer became a partner in the second firm.
or the actual date on which the fee was paid over to the second firm, it is clear that the
contribution occurred prior to April 1, 1984, and that the old rule applied.

241. 1 Arthur B. Willis et al., Partnership Taxation § 108.03 (4th ed. 1993).
242. IRC § 704(a) (1982); Willis et al., supra note 241, § 108.03.
243. IRC § 704(c)(2) (1982).
244. Hempt Bros. v. United States, 490 F.2d 1172, 1175-76 (3d Cir.), cert. denied.

419 U.S. 826 (1974).

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assignment of income doctrine.245 In that case, a cash basis partnership had
transferred its accounts receivable to a corporation upon its formation.246

Under the statutory scheme, the corporation would be taxed on the accounts
receivable when it collected them; however, the corporation argued this result
was precluded by the assignment of income doctrine which taxes income to
the person who earns it.247 The court rejected the corporation's claim,
holding that judicially created assignment of income doctrine "must give
way ... to the broad Congressional interest in facilitating the incorporation
of ongoing businesses" as evidenced by its enactment of section 35 1.248

Similar considerations are present here. Congress in enacting in
section 704(c) expressly recognized and sanctioned the ability of a contribut-
ing partner to shift taxable gains and losses on the contributed property to the
other partners.249 This scheme was consistent with the underlying objectives
of Congress in enacting Subchapter K in 1954: simplicity, flexibility and
equity as between the partners."0 The rule of section 704(c)(1), which
allocates all gain or loss to the partnership, has the virtue of simplicity25'
and is far simpler than the present rule which mandates that the gain or loss
be allocated between the contributing partner and the other partners in a
manner that takes account of the difference between the partnership's basis
in the property and its fair market value at the time of contribution. 52

Moreover, the rule of section 704(c) furthered the Congressional purpose of
flexibility since it permitted the partners to determine among themselves their
respective tax burdens. 53 Under section 704(c), as in effect during the
period in question, the partners could either have followed the rule of section

245. Id. at 1173.
246. Id. at 1174.
247. Id. at 1176.
248. Id. at 1178.
249. Willis et al., supra note 241, § 108.03.
250. H.R. Rep. No. 1337, 83d Cong., 2d Sess. 65 (1954), reprinted in 1954

U.S.C.C.A.N. 4025,4091; S. Rep. No. 1622, 83d Cong., 2d Sess. 89 (1954), reprinted in 1954
U.S.C.C.A.N. 4629, 4721.

251. Willis et al., supra note 241, § 108.03, at 108-7 (stating that "§ 704(c)(1) had
the attribute of simplicity").

252. For an insight into the complexity of the present rule, see Prop. Regs.
§§ 1.704-1(b)(1)(vi), 1.704-1(b)(2)(iv), 1.704-1(c), 1.704-3, 57 Fed. Reg. 61345 (1992). These
proposed regulations set forth three alternative methods to make the adjustments mandated by
IRC § 704(c); the proposed regulations result from Congressional concern that the regulations
under the formerly elective method might be inflexible and overly burdensome for taxpayers
in situations where there was little potential abuse.

253. See Foxman v. Commissioner, 41 T.C. 535, 551 (1964), aff'd, 352 F.2d 466
(3d Cir. 1965) ("Accordingly, one of the underlying philosophic objectives of the 1954 Code
was to permit the partners themselves to determine their tax burdens inter sese to a certain
extent, and this is what the committee reports meant when they referred to 'flexibility.' ").

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Sclmeer v. Conmmissioner

704(c)(1) of allocating all gain or loss to the partnership, or have agreed
under section 704(c)(2) on an allocation that took into account the difference
in the property's basis and its fair market value at the time of contribution.
The objective of equity was also advanced since it gave the partners the
opportunity to adopt the alternative approach of section 704(c)(2)-probably
the more equitable approach2- while allowing them to use the section
704(c)(1) approach if section 704(c)(2) proved too burdensome. Here, as in
Hempt Bros., the assignment of income doctrine must yield to the broad
Congressional purposes in enacting the statutory scheme.

Indeed, it was widely recognized by commentators that in non-abuse
situations, section 704(c), as in effect during the time in question, overrode
the assignment of income doctrine. -" This is shown by the following
excerpt from a leading treatise on partnership taxation:

Problem
A and B form an equal partnership to engage in the practice
of accountancy. A contributes $10,000 in money and B
contributes unrealized receivables which are valued at
$10,000 arising out of B's previous accounting practice.
Assuming the partnership reports on the cash method of
accounting, will the receipt of income from the collection of
the $10,000 of unrealized receivables contributed by B be
allocable for income tax purposes one-half to A and one-half
to B?

The famous case of Lucas v. Earl established at an early date
that a taxpayer may not assign earned income to another tax-
payer.... [However,] when the cash method AB partnership
collects the unrealized receivables and thereby realizes
taxable income, it is allocable 50% to A and 50% to B.
Thus, § 721(a) sanctions the assignment of income to a

254. See Willis et al., supra note 241, § 108.03 for possible inequities resulting to
partners under the § 704(c)(1) approach.

255. Arthur B. Willis et al., Partnership Taxation § 22.03 (3d ed. 19821; 1 William
S. McKee et al., Federal Taxation of Partnerships and Partners 14.02[21 (Ist ed. 1977) (stating
that in non-abuse cases, "the nonrecognition policy of § 721 should generally prevail over
assignment-of-income restrictions in order to facilitate the transfer of going businesses to
partnerships" referring specifically to contribution by accountants of accounts receivable from
their prior practices to new partnership); [1993] Partnership Tax Plan. & Prc. (CCH) 1 1595
(June 1993) (stating that under old § 704(c) "IRS rarely, if ever, asserted that the transfer of
earned but uncollected income... by a partner to a partnership ... was an anticipatory
assignment of income" even though the result under the statute was "an assignment of a
portion of the income from the contributing partner to the other partners").

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Florida Tax Review

partner where there is a transfer to the partnership of unreal-
ized receivables as a part of a genuine business transac-
tion.25

Since the Tax Court found that Schneer's agreement with his second firm was
a genuine transaction with "no apparent attempt to avoid the incidence of tax
by the formation or operation of the partnership,"" it should have taxed
the account receivable to the partnership and not to Schneer.

VI. CONCLUSION

Despite its venerable pedigree, the assignment of income doctrine as
applied to personal service contracts is still beset by confusion and uncertain-
ty. The key to resolving these questions is an understanding of the origin and
purpose of the doctrine: It is a judicially created device designed to preserve
the integrity of the graduated tax system by preventing taxpayers from
splitting their income among lower income tax bracket taxpayers.

This understanding in turn leads to further insights: (1) the doctrine
does not apply where the income earner has assigned his right to income for
consideration in an arm's-length transaction since this does not result in any
shifting of income; (2) the doctrine does not apply where the taxpayer merely
attempts to defer his income since there is no strong policy against reducing
one's tax burden through the deferral of income; and (3) when applying the
doctrine in connection with a nonrecognition section, one must determine
whether the policies Congress intended to implement by providing for
nonrecognition outweigh the policy of the doctrine in the case under consider-
ation.

A constant recognition of the purpose of the doctrine and its resulting
limitations as developed in this article will resolve many of the puzzles
currently encountered in its application.

256. Willis et al., supra note 255, § 22.03, at 22-3 to 22-4 (footnotes omitted).
257. Schneer, 97 T.C. at 663.

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