Schneer v. Commissioner

WELLS, J., dissenting: With due respect, I cannot agree with the majority’s analysis and conclusion with respect to the primary issue to be decided in the instant case. Consequently, I must dissent.

The critical threshold issue framed by the majority is whether the fees were paid to petitioner for services he performed prior to leaving BSI or for services he performed after he left BSI. If the fees were for services performed by petitioner prior to the time he left BSI, they are “past services” which should be taxed to petitioner under the rule of Helvering v. Eubank, 111 U.S. 122 (1940). 1 On the other hand, if the fees were paid to petitioner for services to be performed by him after he left BSI, they are future services, Eubank does not apply, and the income should be taxed to the partners of petitioner’s subsequent law firms.

To decide the issue, we must ask what petitioner did to earn the fees in question. The analysis necessary to such an inquiry should be made by examining the agreement and course of dealing between petitioner and BSI. Instead, the majority inaptly uses accrual accounting principles to decide the issue and concludes that certain contingencies prevented the income from being earned by petitioner until after he left BSI. I submit that accrual accounting principles have little to do with the analysis of whether a cash method taxpayer should be taxed on fees earned by him. Furthermore, even if the majority uses such principles only by analogy, I disagree with the conclusion it reaches under its own analysis. When the agreement and course of dealing between petitioner and BSI are examined closely, I am impelled to conclude that the fees in question actually were paid on account of petitioner’s services in bringing or referring the clients to BSI, or at the very least, that petitioner failed to carry his burden of proving that the fees were not paid for such services.

The majority has found that, during the period he worked for BSI, petitioner’s compensation included a portion of the fees generated by clients he brought to the firm. When petitioner left BSI, his understanding with BSI was that he would continue to receive his percentage of the fees from such clients even if he had not been called upon to perform any consulting services. Petitioner was expected to consult with BSI regarding such clients, if called upon to do so, but neither BSI nor petitioner had contemplated whether petitioner would have been entitled to receive the fees if he refused to consult with BSI. Curiously, without a supporting finding of fact, the majority prefaces its analysis with the statement that “petitioner believes that his failure to consult would have resulted in loss of the fees.” (Majority op. p. 647, emphasis added.) The majority is unclear as to whether such statement is fact or argument. 2 Even if the statement is fact, however, considering the other facts found by the majority, I cannot conclude that the fees were earned after petitioner left BSI. Rather, the record proves the opposite.

Several considerations support a conclusion that the fees were not earned by petitioner after he left BSI. As found by the majority, the basis of petitioner’s entitlement to fees from BSI was the act of having brought or referred clients to BSI. Neither BSI nor petitioner contemplated that petitioner would be called on to “consult” with respect to any of BSI’s other clients (those not referred by petitioner). Thus, petitioner’s previous act of referring clients such as Prince and Terri Girl to BSI appears to be the only reason for a continued relationship between petitioner and BSI. Furthermore, the “consultation” services actually performed by petitioner must have been inconsequential, as the majority does not even take the trouble to detail them. We do not even know whether BSI billed the clients for such services. Indeed, BSI apparently could not have demanded any substantial services from petitioner in exchange for the fees. The amount of petitioner’s fee was in no way related to the value of the services he performed. To the contrary, the amount of the fee was dependent upon the value of the services BSI rendered to the clients, a matter over which petitioner had little or no control. Finally, the fact that petitioner and BSI did not address whether petitioner’s right to the fees would be jeopardized by his failure to consult indicates that BSI’s right, and, for that matter, the clients’ right to obtain additional services from petitioner was not important to them and was not the reason for the fee arrangement. As discussed above, petitioner’s “belief” that such consultation was necessary appears to be nothing more than self-serving argument and, in any event, does not establish that performance of additional services was required in order to earn the fees. In that regard, the majority states that “it was, at very least, questionable” (majority op. p. 651) whether petitioner would receive his fee without performing consulting services. The majority’s statement, however, is little more than speculation and appears to incorrectly place the burden of proof on respondent regarding the establishment of such fact. The majority’s mere speculation and petitioner’s unsupported assertion do not warrant the conclusion that the fees were not earned until after petitioner left BSI.

After obscuring the issue by grounding its analysis on accrual accounting principles, the majority finds that certain “contingencies” prevented petitioner from earning the income in question until after he had left BSI. Upon closer examination, the illusory nature of such contingencies becomes apparent. Petitioner’s right to receive the fees was contingent upon BSl’s performance of services for the clients. While the fees were contingent upon the performance of services by BSI for the clients, such a contingency is not materially different than the one involved in Eubank, where the insurance agent’s right to receive renewal commissions was dependent upon the policyholder’s continued payment of premiums and maintenance of the insurance in force. Eubank v. Commissioner, 39 B.T.A. 583, 590 (1939), revd. 110 F.2d 737 (2d Cir.), revd. 311 U.S. 122 (1940). Because the commissions in Eubank had been earned for past services, such contingency did not prevent the insurance agent from being taxed on the commissions when they were paid. In the instant case, the majority finds an additional contingency, namely, the possibility that petitioner might be called upon to perform additional services. As discussed above, however, whether such a possibility is in fact a “contingency” 3 is speculative and uncertain.

Petitioner must show that the subsequent performance of services was the act giving rise to his right to the fees in order to put his case beyond the scope of Eubank. In my view, not only has he failed to do so, the majority’s findings concerning the nature of the relationship between petitioner and BSI shows that the actual event giving rise to the right to the fees was the past services of petitioner in securing the clients for BSI. Accordingly, I would hold that the fee income was taxable to petitioner under assignment of income principles, as required by Eubank.

Helvering v. Eubank, 111 U.S. 122 (1940), involved an insurance agent who assigned the right to receive future renewal commissions paid on account of services he had rendered in selling insurance policies. The Supreme Court held that the commission income should be taxed to the agent, reasoning that an assignment of the right to receive income paid on account of past services was insufficient to shift the incidence of taxation on such income from the earner.

In relying on petitioner’s belief, the majority appears to suggest that the test of whether a taxpayer has earned income is subjective, and that income cannot be considered earned until the earner “believes” that he has earned it. Such a holding is contrary to established principles of income tax law and should not form the basis for deciding the true nature of a transaction for tax purposes.

Because contingencies only go to the question of when income should be taxed, i.e. timing, rather than the question of to whom the income should be taxed, i.e., who is the true earner, the fact that a payment is subject to a contingency does not answer the latter question — it only answers the former.