# Brief for the United States — United States v. Basye > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40386414_0107%3A04 ## Record - **Collection:** Supreme Court brief - **Document type:** Brief for the United States - **Published:** January 1, 1973 - **Citation:** 410 U.S. 441 ## Text reum ent: I. Payments made by Health Plan pursu- aant to its agreement with Medical Group, including both payments made directly to the partnership and those made to the trust, constituted partner- Ye eS: AL. Each partner in Medical Group, includ- at ship income ing the present respondents, should have included in his gross income for the years in question his distributive share of partnership income The decision below effectively circum- vents the limitations upon qualified pension trusts established by the Inter- nal Revenue Code of 1954 ey, Gar 35 CITATIONS 3 “Allen Commissioner, 410 F. 2d 398, af- . firming per curiam 50 T. C. 466 14, 15 Beck Chemical Equipment Corp. v. Com- missioner, 27 T.C. 840 20 Bell v. Commissioner, 219 F. 2d 442 20 Bingler v. Johnson, 594 U.. 741 16, 17 Bourne v. Commissioner, ms F. 2d 648, N certiorari denied, 290 U og 20 Canada) v. Guitteau, 86 F 14 Comer v. Davis, 107 F. 2d 355 Se Sage Commissioner v. Bonwit, 87 F. 2d 764, certiorari denied, 802 U.S. 694 14 Commissioner v. Culbertson, 337 U.S. 783 11, 15 nei v. First Security Bank, No. 70-805, decided March 21, 1972 15 Commissioner v. Goldberger’s Estate, 213 F. 2d 78 20 Commissioner v. Harmon, 323 U.S. 44. 15 Commissioner v. Laughton, 113 F. 2d 103 a 14 Commissioner v. LoBue, 351 U.S. 243— 16 Commissioner v. Sunnen, 383 U.S. 591__ 11, 15 deCousser v. Commissioner, 16 T. C. 65. 20 Earl v. Commissioner, 80 F. 2d 888 13 20 20 Galt v. 9 216 F. 2d 41, cer- ti.'/borari denied, 348 U.S. tei fa e v. Commissioner, 308 U.S. 355. 14 os Continued Page _Halkias v. Commissioner, 12 T.C. 1091 20 Heiner v. Mellon, 304 U.S. 271 9, 19 _ Helvering v. Eubank, 311 U.S. 122 14 Helvering v. Horst, 311 U.S. 112 15, 16 _ Hicks v. United States, 314 F. 2d 180 14 Hogle v. Commissioner, 132 F. 2d 66. 14, 22 Hulbert v. Commissioner, 227 F. 2d 399. 20 Jones v. Page, 102 F. 2d 144 14, 22 Lucas v. Earl, 281 U.S. 111 9, 11, 12, 13, 14, 15, 16, 17, 21, 22, 24 Mayes v. United States, 207 F. 2d 326 14 Megiboto v. Commissioner, 218 F. 2d 687. 14 Miller v. Commissioner, 144 F. 2d 287. 14 Poe v. Seaborn, 282 U.S. 11! 15 Saenger v. Commissioner, 69 F. 2d 631. 14 Schlude v. Commissioner, 372 U.S. 128. 17 Starr v. Commissioner, 267 F. 2d 148 20 Strauss v. Commissioner, 168 F. 2d 441, certiorari denied, 335 U.S. 858, rehear- ing denied, 335 U.S. 888 16 Teschner v. Commissioner, 38 T.C. 1003. 15 United States v. Baker, 233 F. 2d 195 20 United States v. Joliet & Chicago R. Co., 315 U.S. 44 15 VPillere v. Commissioner, 133 F. 2d 905. 14 Income Tax Act of 1913, e. 16, 38 Stat. 114, 166, Sec. II, D 18-19 Internal Revenue Code of 1954 (26 U.S. C.): Sec. 61 26 Sec. 61(a) 11, 16, 18, 19, 21, 26 Sec. 401 23, 24 Sec. 401(a) 23, 26-27 Iv. age , Sec. 404 24, 27-28 Sec. 672 (a) g 16 ‘See. 672 (-b — po 15 Secs. 674-678 16 Sec. 701 19 Secs. 701-704 is Sec. 702 : 28 See. 702 (a) 19, 21, 28-29 Sec. 708 - 19, 29 Sec. 704 19, 29 Sec. 705 (a) f 19 Sec. 731 (a) 19 Sec. 733 19 Sec. 6031 19 Revenue Act of 1918, c. 18, 40 Stat. 1057, Sec. 218(a) : 19 Self-Employed Individuals Tax Retire- ment Act of 1962, P.L. 87-792, 76 Stat. 809 23 Miscellaneous: H. Rep. No. 1387, 88d Cong., 2d Sess., p. 65 (3 U.S.C. Cong. & Adm. News (1954) 4017, 4091) Lyon and Eustice, Assignment of Income, 17 Tax L. Rev. 295 (1962) 0.D. 187, 1 Cum. Bull. 174 (1919) S. Rep. No. 1622, 88d Cong., 2d Sess., p. 89 (3 U.S.C. Cong. & Adm. News (1954) 4621, 4721-4722) _ Wolfman, Level for Determining Charac- ter of Partnership Income—“Entity” v. “Conduit” Principle in Partnership Traæation, 19 N. V. U. Institute on Fed- then 287 (1961) —_ Supreme Court of the Antted States OcToBer TERM, 1972 No. 71-1022 UNITED STATES or AMERICA, PETITIONER _ James A. Basye and Eve.yn E. BASYE, ET AL. o WRIT OF CERTIORARI TO THE UNITED STATES "COURT OF APPEALS FOR THE NINTH CIRCUIT BRIEF FOR THE UNITED STATES * * OPINIONS BELOW The opinion of the district court (Pet. 15-29)" is Teported at 295 F. Supp. 1289. The opinion of the court of appeals (Pet. 31-42) is reported at 450 F. 2d JURISDICTION : The judgments of the court of appeals (Pet. 43- _ 48) were entered on September 16, 1971. By order “Pet.” references are to the petition for certiorari. (1) dated December 10, 1971, Mr. Justice Douglas ex- tended the time for filing a petition for a writ of certiorari to and including February 12, 1972. The petition was filed on February 9, 1972, and certiorari was granted on April 3, 1972 (R. 220). The juris- diction of this Court rests on 28 U.S.C. 1254(1). QUESTION PRESENTED Whether compensation for services rendered by a medical partnership, made payable by contract, and paid, to a trust, is income of the partnership, and therefore taxable to the partners, as the United States contends, or whether, as the courts below held, such compensation is not partnership income and will con- stitute income to the beneficiaries of the trust only when distributed to them. STATUTES INVOLVED The pertinent provisions of Sections 61, 401, 404, 701, 702, 708 and 704 of the Internal Revenue Code of 1954 are set forth in the Appendix, infra, pp. 26- 29. 7 ) STATEMENT Respondents are physicians and partners in a medical partnership, Permanente Medical Group » hespondents“ refers collectively to James A. Basye, Carol L. Cook, Maurice C. Fishler, Henry Donald Grant, Wil- klum 8. Hunter, Jessamine 8. Hunter, and Nadia Sorokowski, . 8 eo tical Group”), which was organized in 1949 for wactice of medicine in California. In 1960 the rship had over 200 physician-partners, 41 ian-employees, and an unstated number of other ple (R. 82-83). Under the partnership agree- nt (R. 101-113), the partners had drawing ac- ounts varying with responsibility and seniority, but dere to share equally in net earnings in excess of rawing accounts (R. 105-106). The partnership d its income on the accrual basis, and for a year ending June 30th (R. 80-81, 82, 83, 105- 1959, Medical Group entered into a detailed ritten agreement (R. 114-154) with Kaiser Foun- dation Health Plan, Ine. (“Health Plan“), an or- ganization supplying prepaid medical care and hos- tal service to its members, of whom there were pro: y 359,000 in its Northern California Re- gion. This agreement, which succeeded earlier agree- ents between the two organizations, was for a period | two years from July 1, 1959, through June 30, 61, and from year to year thereafter, subject to rmination or renegotiation upon written notice ren by either party ninety days prior to the end of of whom was a physician and partner during the years ved. Evelyn E. Basye, Jack J. Cook, Phyllis H. Fishler, M. Grant, and George W. Sorokowski are parties to these as only because they filed joint income tax returns with respective spouses, and, in the case of Jean M. Grant he year 1960, because she reported one-half of the com- income in a separate return. . ae 7 any year, Under its terms, Medical Group agreed to provide to all members of Health Plan within its Northern California Region all medical services re- quired: by or incident to membership contracts. (R. 82-88, 121-122, 123, 124-125, 188.) ‘With; respect to compensation, the agreement pro- vided (R. 187): “As base compensation to Medical Group for Medical Services to be provided by Medical Group hereunder, Health Plan shall pay to Medical Group the amounts specified in this Article H.” Ar ticle H (R. 187-189) then set forth the two items _ constituting base compensation. The first, payable directly to Medical Group, was a stated amount (orig- inally $2.61329) per member per month, subject to adjustments as provided in Sections H-2 and H-3. The second item of base compensation called for the payments that have given rise to this litigation. It was to be made up Of payments required (R. 139) “In the event that Medical Group establishes a sav- ings and retirement plan or other deferred compensa- tion plan approved by Health Plan *.” Though establishment of this plan was thus stated to be contingent, and was deferred for several months, it was agreed that Health Plan’s contributions there- under (later agreed to be 12 cents per member per month) should commence as of July 1, 1959 (the effective date of the agreement), and that Health Plan's obligation to make such contributions should continue only so long as the agreement or any con- _ tinuation or extension generally similar to the agree- ‘ment should remain in effect. (R. 83, 187-139, 162.) 5 The plan contemplated by the agreement was es- ished later in 1959 by a trust agreement executed Medical Group, Health Plan, and a bank serving 1 trustee (R. 158-199). Under it, Health Plan made payment of $200,000 to the trust at the outset, and agreed to make further payments on a per-member, per- basis during the period in which the agree- went between Medical Group and Health Plan re- ‘mained in effect. The funds paid to the trust, less fees and expenses, were to be paid over to an insur. ance company in order to pay retirement benefits to partners and physician-employées of Medical Group, computed on a complex of factors such as age, years of service, and compensation level. Tentative alloca- 1 8 to potential beneficiaries were made when funds were received, but no interest vested prior to retire- ment, and potential benefits might be lost prior to, or after, retirement by withdrawal from Medical Group for practice other than with another group serving Health Plan’s members. In that event, amounts allocated to a participant’s tentative account e re-allocated to the tentative accounts of other participants. Upon retirement of a partner or a physician-employee qualified by age and years of bervice, the amounts credited to his tentative account s to be applied to purchase a retirement income In addition to the items of base compensation, it was ed that Health Plan should also pay to Medical Group contract. The trust was subject to amendment at a eee an rep ee Grog, (R. 88, 92-97, 162-168, 164-170, 182.) e ot. this agree ment was to create an incentive for physicians to remain with Medical Group, and thus to insure Health Plan that it would have a stable and reliable group of physicians providing services to its members with a minimum of turnover, However, as the respondents asserted in their claims for refund, it served also the independent, and in some respects conflicting, in- terests of Medical Group and the participating phy- sicians. (R. 11, 22, 47, 51, 55, 59, 83-84.) The agreement between Medical Group and Health Plan contemplated that membership in the partner- ship would change from time to time, and provided that the agreement should continue in effect regard- less of the withdrawal from Medical Group of indi- vidual partners or the addition of new partners as long as most physicians than partners continued their association as then organized or as reorganized through voluntary action. The. partnership agree- ment constituting Medical Group provided that the partnership should continue despite the death, retire- ment, or withdrawal of partners; it provided also for the addition of new partners, and for the method of termination of the partnership. The trust agree- ment also provided for its continuation as long as fifty percent of the participants continued in associa- tion or in reorganized form. In case of dissolution of the partnership or a reorganization not qualifying within the provisions for continuity, then the assets _ held under the trust agreement were to be promptly _ liquidated, and the net proceeds distributed by lump- zum payments to the participants then entitled there- to. (R. 97, 110, 113, 135, 174, 175.) N Health Plan paid to the trust, on a monthly basis, an aggregate of more than $2,000,000 during the period from its first payment in Medical Group’s fiscal year ending June 30, 1960, until it discontinued payments at a point in Medical Group’s fiscal year ending June 30, 1968. Medical Group did not in- elude these payments in its returns of taxable in- eome, and they were not included in the partners’ distributive shares of gross or taxable income. The Commissioner of Internal Revenue assessed defici- encies against the respondent partners for 1960 and 1961 on the ground that the compensation for serv- _ lees of the partnership constituted gross income of the partnership, deflected to the trust through con- tractual arrangement with Health Plan; and, there- fore, that the partners were taxable on their distrib- utive shares of such income. Respondents paid the taxes in dispute and, after their claims for refund were denied, brought these actions for refund. (R. 5 In the case of the respondents George W. Sorokowski and ‘Nadia Sorokowski, the assessments, claims for refund, and ‘of Internal Revenue on his own initiative made an adminis- rative determination that Dr. Sorokowski was entitled to a auction for 1968 equal to the sum of the amounts that had Ven the basis for deficiency assessments made against her 81, 84-86.) hak Sais obit e eee and were heard upon an agreed statement of facts (R. 80-88), accompanied by an Appendix (R. 89- 100), and documentary Exhibits A through F (R. 101-204). Both courts’ below held that the partnership re- alized no gross income from the payments made by Health Plan to the trust because the partnership “never had the right to receive them. They further held that the partnership should be considered merely the agent of the partners, and should otherwise be disregarded in determining their tax liabilities, Treat- ing the partners merely as contingent trust bene- ficiaries, the lower courts concluded that they would be taxable on payments to the trust only at such times as distributions were made by the trust. (Pet. 15-29, 31-42.) for 1960, 1961, 1962, and 1968, and computed an overpay- ment of the Sorokowskis’ income taxes for 1968 in the amount 9 SUMMARY OF ARGUMENT The government’s position in this case involves two steps, each grounded upon a fundamental income tax decision of this Court. ~ 1, The first principle of income taxation was es- "tablished by this Court's decision in Lucas v. Earl, - 281 U.S. 111, that income must be taxed to him who earns it, and that anticipatory arrangements to de- fleet payment elsewhere will not serve to avoid re- 15 ‘sponsibility for the tax on income from services. - Accordingly, when Health Plan agreed to pay, and paid, compensation for medical services rendered by _ Medica] Group to Health Plan's members, the entire amount of that compensation constituted partnership gross income to Medical Group, though part of it was paid, as agreed, to a trust rather than directly to Medical Group. The fact that the form of the pay- ment served to advance the interests of Health Plan macde it none the less income to Medical Group. 2. This Court held in Heiner v. Mellon, 304 U.S. 271, that each partner in a partnership must take into his current income his proportionate share of partnership income despite the fact that distribution Was necessarily held in abeyance. Accordingly, the fact that part of Medical Group’s partnership income was to be held in trust did not serve to avoid the partners liability for taxation of their proportionate shares. The court below simply disregarded this fundamental aspect of the taxation of partnerships and partners, and viewed the case as involving taxa- 10 tion of contingent beneficiaries of a trust. But partners are liable to taxation upon their propor- tionate shares of partnership income without refer- ence to whether they, or others, are beneficiaries of a trust created to receive and hold partnership in- 8. The effect of the decision below is to circumvent the limitations that Congress has imposed upon quali- fied pension trusts. Such trusts combine the tax bene- fits of current deductibility for employers with de- ferred taxation of employees. But their availability, both in the years here in question and subsequently, is restricted by a number of limitations, such as those against discrimination, that the trust in this case clearly does not meet. Nevertheless, the decision below affords to a clearly unqualified pension trust tax benefits that Congress has restricted to trusts meeting the rigorous standards established by the In- ternal Revenue Code. The effect is therefore to invite partnerships large and small, in any business or pro- fession, to defer the taxation of as much partnership income as they may choose by the device of having such income paid directly to a trust that meets none of the requirements of qualified pension trusts. _ |. -PAYMENTS MADE BY HEALTH PLAN PURSUANT T0 ITS AGREEMENT WITH MEDICAL GROUP, IN- ... CLUDING BOTH PAYMENTS MADE DIRECTLY TO _ THE PARTNERSHIP AND THOSE MADE TO THE _ RUST, CONSTITUTED PARTNERSHIP INCOME. } tes : _* Section 61(a) of the Internal Revenue Code of 1954, Appendix, infra, defines gross income to in- dude, among other items: (1) Compensation for _- Services, including fees, commissions, and similar = tbs ” More than forty years ago, in a decision that has _ stood without question as one of the foundations upon which the structure of the graduated income oe tax has been built, this Court held in Lucas v. Earl, 281 U.S. 111, that a taxpayer who has earned com. aoe pensation for services must include that compensation in his gross income even though, by effective assign- ment, payment has been deflected and channeled to “5 another. The Court has subsequently described that deeision as embodying “the first principle of income a taxation: that income must be taxed to him who ~~ earns it.” Commissioner v. Culbertson, 337 U.S. 733, 739.740. See also Commissioner v. Sunnen, 333 U.S. 5591, 604. The statements that the Court made in Lucas v. Furl set forth the basis of its decision with concise- ness and clarity (281 U.S, at 114-115): There is no doubt that the statute could tax salaries to those who earned them and provide 12 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 fit. That seems to us import of the. statute before us and we t that no distinction can be taken accordit e the arrangement by which the fruits are attri- ere ee fem See ne which „% e thin ease with as much directness and force as they did upon Lucas v. Earl. Though “anticipatory arrange- ments and contracts” may have prevented Health Plan's payments to the trust “from vesting even for à second” in Medical Group, they can not serve to ‘eliminate this element of the compensation for Medi- cal VVV taxable income. eee eee Plan's payments to the trust, as well as its payments directly to the partnership, were, and were intended to be, compensation for the services rendered by the partnership under the Medical Service Agreement (Ex. B, R. 114.157). They surely were not gifts, and they were made as a direct part of the employ- ment arrangement. The agreement called for medical ‘services by the partnership, and explicitly included (R. 137) in “base compensation” therefor the pay- ‘ments to be made to the trust as well as those to be made directly to the partnership, all as detailed in mele Bch. 187-139) of e Additional 13 contingent compensation was provided for in Article (R. 139-141). In Section C-8 (R. 126), in Article 1 (R. 189), and in Article J (R. 141), reference is Made to the compensatory arrangements set forth in Article H. The trust agreement itself (Ex. C, R. 158-199) refers to Health Plan's obligation to con- tribute to the trust as being derived from the service agreement with the partnership, and indicates the compensatory nature of the payments by providing that they will be coterminous with the effectiveness of the agreement with the partnership (R. 162). : Despite the patent parallelism between this case and Lucas v. Earl, the court below thought that that _ decision was not controlling here because (Pet. 39) = “a crucial element is missing here. Permanente ~~ never had the right itself to receive the payments made into the trust as current income.“ But that was equally true in Lucas v. Earl, and the same court “made much the same point when that case was be- ‘fore it. See Earl v. Commissioner, 30 F. 2d 898, 899 (C. A. 9). Mr. Earl made the effective assign- ‘ment in 1901, and the income there in question con- sisted of fees and salary earned in 1920 and 1921, 2 ‘0 that he also, “never had the right * * * to receive be escaped by anticipatory arrangements and contracts however skilfully devised to prevent the sal- ary when paid from vesting even for a second in the u who earned it.” It has been equally true in s cases following Lucas v. Earl, where de- 14 3 flecting arrangements were made prior to the rendi- . tion of services, that the taxpayer “never had the right itself to receive the payments. * And this Court's decision in Helvering v. Eubank, 311 U.S. 122, ö makes it clear that an attempted deflection of earned income is ineffective to avoid tax liability whether the _ deflecting arrangement is made before the income is 7 eee ebe y. Earl, or after, as in Helvering v. Eubank, 8 The controlling fact here, as in Lucas v. Earl, is ee eee ee personal services rendered, and those services were rendered, pursuant to the agreement, by the partners and employees of Permanente Medical Group. For more than 40 years, it has been established and ac- cepted in our tax law that the result of these facts is that the income is taxable to the entity individual or partnership which rendered the services, regard- less of any arrangement, anticipatory or otherwise, designed to deflect it elsewhere. Ts Allen v. Commissioner, 410 F. 2d 398 (C. A. 8), affirming per curiam, 50 T. C. 466; Hicks v. United States, 314 F. 2d VVV 218 F. 2d 687 (C. A. 8): Mayes v. United States, 207 F. 2d 826 (C. A. 10); Miller v. Commissioner, 144 F. 2d 287 (C. A. 4); Villere v. Commis- sioner, 188 F. 2d 905 (C. A. 5); Hogle v. Commissioner, 132 F. 2d 66 (C. A. 10); Comer v. Davis, 107 F. 2d 865 (C. A. 5); : Jones v. Page, 102 F. 2d 144 (C. A. ö); Commissioner v. Bon- wit, 87 F. 2d 764 (C. A. 2), certiorari denied, 302 U.S. 694: E dag v. Cittean, 86 F. 2d 808 (C. A. 6); Saenger v. Com- the phrasing of the Court’s opinion in Lucus v. . 466, affirmed per res 410 F. 2d 398 (CA. If a contractual arrangement to insulate a tax- yer from receipt of compensation he earned could mul him from taxation, the force of Lucas v. would be reduced to wavering admonition.’ Court long ago differentiated between consensual or etual arrangements for the deflection and division of me (Commissioner v. Harmon, 825 US. ee ided March 21, 1972. In Teschner v. Commissioner, 88 T. C. 1008, relied upon by both courts below, the majority stressed a factor not here present the fact that the taxpayer had no part in negotiating establishing the terms of the contest of which he was the Otherwise, the majority in Teschner wrote of de- flection of income, as did the court of appeals in this case, in terms of the discussion of control in Helvering v. Horst, 811 8. 112. While Horst is, of course, a leading decision on eee e ere eee dee x property, or control of the flow of income, are the 2» determinants. But with regard to the deflection e must be taxed to him who earns it” ( Commissioner v. ertson, supra, 387 U.S. at 789-740), so that “compensa- 16 the fact that the formal arrangements nade for payment to the trust of part of the partnership’s com- pensation advanced the interests of Health Plan does not make the payments any the less compensation, or remove them from the broad sweep of the definition of gross income in Section 61 (a). Commissioner v. TLoßue, 351 U.S. 248. This Court has only recently held that increased compensation paid with a view to reducing turnover and increasing stability in em- _ ployment is not for that reason any the less taxable _ income, Bingler v. Johnson, 894 U.S. 741. “[N]o dis- _ tinction can be taken according to the motives leading to the arrangement Lucas v. Earl, 281 U.S. at 115. The view of the court of appeals (Pet. p. 40) dat payments to the trust were not “compensation for tion for the continued, long-term services of indivi- dual physicians” is difficult to reconcil ile not only with the partnership obligation but also with the facts chat payments varied from month to month with the number of Health Plan’s members in the same fashion that direct payments to the partnership varied, that 17 Tax L. Rev. 256 888 (1962). Ses Strauss v. Commissioner, 168 F. 2d 441 (C. A. 2), certiorari denied, 885 U.S. 858, re- ſoes. Even by the Horst standards of control. applicable to in- eome from property, there would be basis for attributing to administration of the trust. (R. 166-168, 170, 175, 176-178.) Tuer had complete power to amend the trust. (R. 182.) Cf. participant in these powers, was a non-adverse party within 17 ‘were to be made while, but only while, the cal service agreement with the partnership was ect, and that membership in the partnership was subject to change (R. 108, 112, 113, 129-130, 35). But even if the court were correct in that w, the monthly payments, whether for current or "anticipated services, would be no less current in- é to the partnership. Bingler v. Johnson, 894 U.S. 757; Schlude v. Commissioner, 372 U.S. 128. I Health Plan's wish to create or encourage sta- lity in the group of physicians who served it were ‘the philosopher’s stone that would convert payments concurrent with service into something other than . e we should undoubtedly find marked nges in employment patterns throughout the na- deere who professed to seek enhanced sta- b ty in employment would undoubtedly soon be mak- example, educational trusts for the benefit of em- ‘ployees’ children. Grateful employees would find sat- faction in the prospect of tax deferred (or possibly tax-free) dollars being devoted to their families’ fu- 155 welfare. Only the revenues would suffer. In sum, if Lucas v. Earl is to retain the unques- ioned authority that it has had for forty years, ‘then all of Medical Group’s “base compensation” for services, including that part paid to the trust as ell as that part paid directly, must be included in 18 II. EACH : PARTNER IN MEDICAL GROUP, INCLUDING _ THE PRESENT RESPONDENTS, SHOULD HAVE INCLUDED IN HIS GROSS INCOME FOR THE ~ YEARS IN QUESTION HIS DISTRIBUTIVE SHARE f PARTNERSHIP INCOME. If, as we believe we have shown, the payments made by Health Plan to the trust as well as those made directly to the partnership were includable in partnership income, then each partner, including the Present respondents, should have included in his gross income his proportionate share of the increased part- nership income. Internal Revenue Code, Section 61 () (18). 5 “Though Subchapter K of Chapter 1 of the Internal Revenue Code of 1954 greatly expanded the detail wen, ctural scheme now embodied in Sections 701 ee came i ok has remained unchanged since the enactment of Section II, Dye of H. Rep. No. 1887, ssd Cong., 2d Sess., p. 65 (8 U.S.C. News (1954) 4017, 4091); 8. Rep. No. 1622, Cong., 2d Sess., p. 89 BURG Cong. & Adm. News (1954) 4621, 4721, 4722). : * Provided further, That any persons carrying on business in partnership shall be liable for income tax only in their individual ‘capacity, and the share of the profits of a partnership to which any taxable partner would be entitled if the same were divided, whether divided or otherwise, shall be returned for taxation and the tax paid, under the provisions he Income Tax Act of 1913, e. 16, 38 Stat. 114, 166: he partnership itself is not taxed,” but it prepares d files a return in much the same manner that is sired of an individual taxpayer," and the partners e required to take into their income their distribu- ive shares of partnership income.“ In Heiner v. Mellon, 304 U.S. 271, this Court held that “distri tive share” meant “proportionate share”, rather al “distributable share”, and that partners are required to take into their individual income their distribu- tive, or proportionate, shares of partnership income wen though applicable state law ‘prevented distribu- © tion, In so holding, it referred with approval (304 at 281, n. 8) to O.D. 187, 1 Cum. Bull. 174 19), in which the Treasury had held that partner- » income was currently taxable to the partners n the amount of their distributive shares although 2 contract it could not be distributed until later Secs. 708, 6031. un Secs. 61 (a) (18), 702 (a), 704. The phrase “distributive e” originated in Sec. 218 (a) of the Revenue Act of e. 18, 40 Stat. 1057. The correlative of these provisions is that amounts dis- _ tributed are not taxed to a partner upon distribution unless te amount of money distributed is in excess of the partner’s basis in his partnership interest. Sec. 781 (a) (1). That basis increased by the partner’s distributive share of partner- ip income, and decreased by distributions to him, and by is distributive share of partnership losses. Secs. 705 (a), 733. SA a an comes their proportionate shares of partnership in- It follows that if, Gi a ate iho cana Health Plan’s payments to the trust constituted partnership income, then the respondent partners were required to take into their income their increased distributive shares of the partnership income, despite any con- tractual arrangement, by trust or otherwise, to hold _ distribution in abeyance. Contrary to the court of — understanding (Pet. 37, 41), the govern- | por jon that the payments to the trust con- eee e fs and consequently eee gere | or “conduit” theory of partnerships. Those concept cali conte ide play ‘ily where there. is a e ot ‘characterizing Income for special treat- f 18 Starr v. Commissioner, 267 F. 28148 (C. A. 777 United States v. Baker, 288 F. 2d 195 (C. A. 10); Hulbert v. Commis- „27 F. 2d 399 (C. A. 7); Bell v. Commissioner, 219 442 (C. A. 5) Commissioner v. Goldberger s Estate, 218 m. 1 v. E e 27 T. C. 840; deCousser um ner, 16 T. C. 65; Halkias v. Commissioner, 12 T. C. 1001; Face ‘Commissioner, 10 T.C. 775. 1 and to a partner. See Sections 10 888 and 702 (a) (9). With respect to the pay- TTT e. But the fact that the partners were also gent beneficiaries of the trust is quite irrele- | ian-employees, who were equally contingent tiaries. It has not sought, arid does not seek, 8 of the partnership’s largesse. It .can hardly sh the partners’ liability for tax on their shares See Wolfman, Level for Determining Character of Part- ship Income—“Entity” v. “Conduit” Principle in Partner- Taxation, 19 N.Y.U. Institute on Federal Taxation 287 of partnership income that they were the principal contingent beneficiaries of the trust. The court of appeals persisted in this error when it concluded (Pet, 86) that had respondents “con- tracted individually with * * * [Health Plan] for payments into a retirement trust subject to the same conditions involved here, they would not be subject to taxation in the years the payments were made.” Under Lwoas v. Earl, an individual physician (or, for that matter, a corporation) contracting with Health Plan, with similar provisions for payments to a trust for himself and his employees, or for rela- tives or others, would be taxed currently on amounts irrevocably paid to the trust because, as to him, such payments would be no more than deflected compen- sation for services rendered. Cf. Hogle v. Commis- sioner, 182 F. 2d 66 (C. A. 10); Jones v. Page, 102 F. 2d 144 (C. A. 5). The cases upon which the court below relied (Pet. 36) would be relevant, irre- spective of whether an individual, a corporation, or a partnership contracted with Health Plan, only if the government looked to the trust as a source of in- come to berieficiaries, such as employees, who might never receive payment. They are of no relevance where, as here, the contracting party (the partner- ship) was irrevocably compensated by the bargained- for payments to the trust, and where we are con- cerned only with the tax liabilities of the individual partners, whether they were or were not beneficiaries of the trust. 28 . m. THE DECISION BELOW EFFECTIVELY CIRCUM.- VENTS THE LIMITATIONS UPON QUALIFIED PEN- SION TRUSTS ESTABLISHED BY THE INTERNAL compensated employees, Section 401 (a) (4). of these conditions, there could be no quali- ing 1960 and 1961. Though that restriction has been Telaxed somewhat in later years by amendments to the Code effected by the Self-Employed Individuals Tax fits only for professional physician- employees, could not qualify under either the standards of 1960 and 1961 or those of later years. Yet, contrary to the explicit statutory limitations on qualified pension trusts, the decision below produces for the partner. ship and the the principal tax benefits of ch.a trust, and thus openly invites partnerships to umvent ‘requirements carefully devised by $s conditions to obtaining thee, dere (RN. 116, 121-122, 129-180, 188, 155, 156.) : „it ths trast had constituted a pension trust for employees qualified under Section 401, the payments to the trust by Health Plan would still have constituted gross income to the Medical Group partnership but would, at the same time, have given rise to an offsetting deduction by Medical Group. How- ever, since, on several grounds, including the fact that it was es icles Goats wedi Mel eee pension trust under Section 401, the offsetting de 25 CONCLUSION For the reasons stated, the judgments of the court appeals should be reversed. APPENDIX | Internal Revenue Code of 1954 (26. USC): Sc. 61, Gross INCOME DEFINED. | 9 General Definition. Except as -other- wise provided in this subtitle, gross income ; means all income from whatever source derived, Re e ese not nes to) a following 5 0 0 ae 8 for pervices, including ge 3 ö been, aun. ot partner N 8 3 0 S850. 401. n PENSION, PRorIT-SHAR- wi ma, AND ST00K Bonus PLANS. NS (a) Requirements for Qualification—A trust created or organized in the United States and : _ forming part of a stock bonus, pension, or profit- _ sharing plan of an employer for the exclusive ‘benefit of his employees or their beneficiaries Beall constitnte s qualified trust under this sec (1) if. contributions are made to the N ‘trast by such employer, or employees, or : both, or by another employer who is entitled do deduet his contributions under section Me Ee (relating. to deduction for . ee plans), for the purpose of distribut- e eee 15 * 7 27 the corpus and income of the fund accumu- lated by the trust in accordance with such plan; (2) if under the trust instrument it is im- possible, at any time prior to the satisfac- tion of all liabilities with respect to em- ployees and their beneficiaries under the trust, for any part of the corpus or income to be (within the taxable year or there- after) used for, or diverted to, purposes other than for the exclusive benefit of his employees or their beneficiaries; * * * * a : = (4) if the contributions or benefits provided under the plan do not discriminate in favor of employees who are officers, shareholders, persons whose principal ‘duties consist in supervising the work of other employees, or highly compensated employees. 81x. 404. DEDUCTION FOR CONTRIBUTIONS oF : AN EMPLOYER TO AN EMPLOYEES’ TRUST OR ANNUITY PLAN AND COMPENSATION UNDER A DEFERRED-PAYMENT PLAN. (a) [as amended by Sec. 24, Technical Amend- ments Act of 1958, P. L. 85-866, 72 Stat. 1606] Senerul Rule.—If contributions are paid by an employer to or under a stock bonus, pension, : (5) Other plana in the taxable year When paid, if the plan is not one included in paragraph (1), (2), or (3), if the em- ployees’ rights to or derived from such em- ployer’s contribution or such compensation are nonforfeitable at the time the contri- bution or compensation is paid. * * * * SC. 701. PARTNERS, Nor PARTNERSHIPS, SUB- or To Tax. | A partnership as such shall not be subject: to the ineome tax imposed by this chapter. Persons ‘carrying on business as partners shall be liable dor income tax only in their separate or indi- vidual: capacities. ‘Sec. 702. INCOME AND CREDITS OF PARTNER. dea) General. Rule.—In determining his in- come tax, each partner shall take into account aie separately his deere share of the partner- oo | * * * * 29 (9) taxable income or loss, exclusive of items requiring separate computation under other paragraphs of this subsection. * 2 * * Sec. 703. PARTNERSHIP COMPUTATIONS. (a) Income and Deductions.—The taxable in- come of a partnership shall be computed in the Same manner as in the case of an individual except that— (1) the items described in section 702(a) shall be separately stated, and 4 * „ „ SEc. 704. PARTNER’s DISTRIBUTIVE SHARE. (a) Effect of Partnership Agreement.—A partner’s distributive share of income, gain, loss, deduction, or credit shall, except as otherwise provided in this section, be determined by the partnership agreement. * * * * * as. GOVERNMENT PRINTING OFFICE; 1972 470203 863 --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40386414_0107%3A04. Public record. Not legal advice.