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Lucas, Commissioner of Internal Revenue, v. Earl

Supreme Court of United States
281 U.S. 111 (1930)
ELI5:

Rule of Law:

Income is taxable to the person who earns it, and this tax liability cannot be escaped by an anticipatory arrangement or contract that assigns the income to another person before it is received.


Facts:

  • In 1901, Guy C. Earl and his wife entered into a legally valid contract.
  • The contract stipulated that any property, including earnings like salaries and fees, acquired by either spouse during their marriage would be treated as owned by them as joint tenants.
  • During the years 1920 and 1921, Guy C. Earl earned a salary and attorney's fees for his personal services.
  • Relying on the 1901 contract, Earl reported only half of these earnings as his income for tax purposes.

Procedural Posture:

  • The Commissioner of Internal Revenue assessed a tax on the whole of Earl's salary and fees for 1920 and 1921.
  • The Board of Tax Appeals upheld the Commissioner's determination.
  • Earl, the taxpayer, appealed to the United States Circuit Court of Appeals.
  • The Circuit Court of Appeals reversed the decision of the Board of Tax Appeals, holding in favor of Earl.
  • The Commissioner of Internal Revenue (Lucas) petitioned for, and was granted, a writ of certiorari by the U.S. Supreme Court.

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Issue:

Does a legally valid contract that assigns a portion of a taxpayer's future earnings to his spouse prevent the entirety of that income from being taxed to the taxpayer who earned it?


Opinions:

Majority - Mr. Justice Holmes

No. A taxpayer's legally binding contract to assign future income does not prevent that income from being taxed to the person who earned it. The Revenue Act of 1918 imposes a tax on an individual's net income, including compensation for personal service. The Court reasoned that the tax cannot be escaped by "anticipatory arrangements and contracts however skilfully devised" to prevent the income from vesting in the earner. The determining factor is not who ultimately receives the income, but who earns it. The Court used the metaphor that the tax should be levied on the tree on which the fruit grew, meaning the income (the fruit) is attributable to the earner of that income (the tree).



Analysis:

This case establishes the foundational "fruit of the tree" doctrine in U.S. income tax law, a critical principle of assignment of income. The decision prevents taxpayers from avoiding progressive tax rates by splitting their income with family members or other entities in lower tax brackets. It solidifies the rule that tax liability follows the earner of the income, not necessarily the recipient, thereby preventing a wide range of potential tax avoidance schemes based on the contractual assignment of future earnings.

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