United States v. Basye
410 U.S. 441, 35 L. Ed. 2d 412, 1973 U.S. LEXIS 187 (1973)
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Rule of Law:
Income is taxable to the party who earns it, and tax liability cannot be avoided through an anticipatory assignment of that income to another person or entity. Partners are taxable on their distributive shares of current partnership income, regardless of whether the income is actually distributed to them.
Facts:
- Permanente Medical Group (Permanente), a partnership of physicians, entered into a service agreement in 1959 with Kaiser Foundation Health Plan, Inc. (Kaiser).
- Under the agreement, Permanente's physicians provided medical services to Kaiser's members.
- In exchange for these services, Kaiser agreed to make two forms of payment: direct monthly payments to the partnership, and payments into a retirement trust established for Permanente's physicians.
- Kaiser made all payments to the retirement trust directly to a trustee bank; the funds never passed through Permanente's accounts.
- A physician's interest in the retirement trust was contingent and non-vested until they met specific age and length-of-service requirements.
- A physician would forfeit their entire interest if their relationship with Permanente terminated before retirement for reasons other than death or disability.
- Permanente did not report the payments made by Kaiser into the trust as income on its partnership returns, and the individual partners did not include a share of these payments in their personal income computations.
Procedural Posture:
- The Commissioner of Internal Revenue assessed tax deficiencies against the individual partner-respondents for their shares of the retirement plan contributions.
- The partners paid the deficiencies and filed a consolidated suit for a refund in the U.S. District Court for the Northern District of California.
- The District Court, as the court of first instance, ruled in favor of the partners, granting the refund.
- The United States Government, as appellant, appealed the decision to the U.S. Court of Appeals for the Ninth Circuit.
- The Ninth Circuit, an intermediate appellate court, affirmed the District Court's judgment in favor of the partners (appellees).
- The United States petitioned the U.S. Supreme Court for a writ of certiorari, which was granted.
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Issue:
Do payments made by a health plan provider directly into a retirement trust for a medical partnership's physicians, as compensation for the partnership's services, constitute income to the partnership, thereby making the individual partners currently taxable on their distributive shares of these payments?
Opinions:
Majority - Mr. Justice Powell
Yes. Payments made by Kaiser into the retirement trust constitute income to the Permanente partnership because the partnership earned them. The two foundational principles of income taxation that control this case are that income is taxed to the party who earns it, and partners are taxable on their distributive shares of partnership income regardless of actual distribution. The partnership cannot avoid taxation by entering into an 'anticipatory assignment of income,' a contractual arrangement where income it has earned is diverted to another entity, as established in Lucas v. Earl. The payments were clearly compensation for the services Permanente rendered, and the partnership was responsible for directing their diversion into the trust. It is irrelevant that the partnership never physically received the funds or that Kaiser had its own motives for the arrangement. Once it is established that the partnership earned the income, it is axiomatic under Heiner v. Mellon that each partner must pay taxes on his distributive share, and the fact that an individual partner's ultimate receipt of the funds is contingent or forfeitable is immaterial to the partnership's tax liability.
Analysis:
This decision strongly reaffirms the assignment of income doctrine and its application to partnership taxation, preventing the use of sophisticated contractual arrangements to defer or avoid tax on earned income. By treating the partnership as an 'entity' for the purpose of calculating income, the Court clarified that income is realized by the partnership at the moment it is earned, regardless of where it is paid. The case establishes that the contingent nature of an individual partner's benefit in a deferred compensation plan does not affect the current taxability of the income to the partnership itself. This ruling significantly limits the ability of partnerships to create tax-deferred compensation schemes outside of specific statutory provisions like qualified pension plans.
