Rev. Rul. 75-257

Advice has been requested concerning the Federal income tax treatment with respect to the transfer of an individual's property and "lifetime services" to the trust arrangement described below.

In 1974, C, as grantor, created a trust that he named "The C Family Estate (A Trust)" and referred to as a "pure trust," and "equity trust," or "constitutional trust" (hereinafter referred to as the Family Estate). C transferred to the trust certain property consisting of his personal residence, an apartment building, and income-producing securities. In addition, by affidavit, C assigned to the Family Estate the exclusive use of his "lifetime services" including all remuneration earned by him regardless of its source. In exchange, C received certificates representing all the "units of beneficial interest" in the Family Estate under the terms of the governing instrument.

At the time of the assignment of his "lifetime services" to the Family Estate, C was employed by the X corporation. C notified the corporation of the assignment of his services to the Family Estate and requested that such sums of money and any other forms of remuneration that would, but for the assignment, be due and payable to him be made payable to the Family Estate. However, X corporation refused to comply with C's request and continued to remit to C, in his own name, C's weekly salary check. C, in turn, endorsed the check and deposited it in the Family Estate's bank account.

C, his wife, and a third party are the designated trustees of the Family Estate. The trust instrument provides that a majority vote is necessary for any action to be taken by the Family Estate. As trustees they are given a broad grant of powers. They may do anything that any individual may legally do in any state or country, and they may deal with the trust assets and conduct any business as they see fit. They also have the powers to fix and pay compensation of all officers, employees, or agents in their discretion and to pay themselves such compensation for their services as may be determined by a majority of the board of trustees. The trust instrument further provides that a "Minute of Resolutions" of the trustees authorizing what they determine to do or have done shall be evidence that such an act is within their power. It also provides that the trustees' authority is similar to that of the executor of an estate wherein the testator directs that the executor is to handle the estate in the manner he thinks best, limited by the terms of the instrument and without the necessity to resort to the court for permission or approval of any transaction.

The grantor is designated as the executive manager of the Family Estate and his spouse as the secretary. As such, they are entitled to receive consultant fees from the Family Estate for services performed for the Family Estate. The trust instrument provides that C and his family may continue to live in the personal residence that C transferred to the Family Estate, purportedly because it is for the convenience of the Family Estate in its capacity as C's "employer." In addition, the Family Estate will supply the living costs and provide health care for the grantor and his family. The trust instrument further provides that the Family Estate shall continue for twenty years unless the trustees, by unanimous vote, agree to terminate the Family Estate on an earlier date.

Section 61(a) of the Internal Revenue Code of 1954 provides, in part, that gross income means all income from whatever source derived, unless excluded by law. Gross income includes income realized in any form, whether in money, property, or services. It is the first principle of income taxation that income must be taxed to him who earns it. Commissioner v. Culbertson, 337 U.S. 733, 739-740 (1949), 1949-2 C.B. 5. Further, one who earns income cannot avoid taxation by diverting it to another entity, since anticipatory assignment of income is ineffective as a means of avoiding tax liability. United States v. Basye, 410 U.S. 441, 449-450 (1973), 1973-1 C.B. 325.

In the case of Lucas v. Earl, 281 U.S. 111 (1930), the taxpayer entered into a contract with his wife under which all property (including salaries, fees, etc.) thereafter acquired by either was to be received and owned by both parties as joint tenants. In holding that all of the taxpayer's salary and fees were attributable to him for tax purposes, the Court stated at 114-115:

"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 skillfully 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."

Regardless of whether an assignment of income is an irrevocable assignment, and regardless of whether the income is assigned for a substantial period of time, the true earner of the income realizes economic gain from the disposition of such income and is taxable on it. Galt v. Commissioner, 216 F. 2d 41 (7th Cir. 1954). In resolving the question of who earns the income, the court will look to who has actual control over the earning of the income rather than who has apparent control over the income. American Savings Bank, 56 T.C. 828 (1971).

Similarly, in Rev. Rul. 55-2, 1955-1, C.B. 211, the Internal Revenue Service held that unpaid accounts receivable, which represent compensation for personal services and which were transferred by a taxpayer to an irrevocable trust for the benefit of his minor child were, upon collection, taxable to the taxpayer-grantor and not to the trust.

It is evident from the foregoing that one who transfers his future earned income by an anticipatory assignment realizes income quite as much as if he had collected the income and paid it over to the object of his bounty. It is of no consequence that such income has been assigned to a trust. See Comer v. Davis, 107 F. 2d 355 (5th Cir. 1939); Est. of Sidney S. Gorham, 38 B.T.A. 1450 (1938); Edward J. Luce, 18 B.T.A. 923 (1930), aff'd., 55 F. 2d 751 (D.C. Cir. 1932).

With respect to the services performed for X corporation, the legal relationship of employer and employee continues to exist between X corporation and C. It is C, not the trust, who earns the income as an employee of X corporation. The Family Estate merely has the right to receive C's earnings, reduced by amounts withheld by X corporation.

Accordingly, any income from services performed by C for the X corporation will be income to C and not income to the Family Estate.

The question of who is taxable on the income from the securities and rental property conveyed to the Family Estate is decided under subpart E of the Code (sections 671-678). These sections of the Code provide generally that the grantor is taxable on the income of a trust over which he has retained certain powers or rights that give him substantial dominion and control over the trust.

Section 671 of the Code provides, in part, that where it is specified in subpart E that the grantor or another person shall be treated as the owner of any portion of a trust, there shall then be included in computing the taxable income and credits of the grantor or the other person those items of income, deductions, and credits against tax of the trust which are attributable to that portion of the trust to the extent that such items would be taken into account under chapter 1 in computing taxable income or credits against the tax of an individual.

Section 674(a) of the Code provides that the grantor shall be treated as the owner of any portion of a trust in respect of which the beneficial enjoyment of the corpus or the income therefrom is subject to a power of disposition, exercisable by the grantor or a nonadverse party, or both, without the approval or consent of any adverse party.

Section 672(a) of the Code provides, in part, that for purposes of subpart E, the term "adverse party" means any person having a substantial beneficial interest in the trust which would be adversely affected by the exercise or nonexercise of the power which he possesses respecting the trust. Section 672(b) provides that, for purposes of subpart E, the term "nonadverse party" means any person who is not an adverse party. Pursuant to section 1.672(a)-1(a) of the Income Tax Regulations, a trustee is not an adverse party merely because of his interest as trustee.

The question of whether a particular interest is adverse or nonadverse is essentially one of fact which must be determined by considering in each case the particular interest created by the governing instrument. Floyd G. Paxton, 57 T.C. 627, 631 (1972). In the instant situation, the third-party trustee, who has no beneficial interest in the Family Estate, is not an adverse party. The grantor's wife, as trustee, has no direct beneficial interest in the Family Estate and therefore is also a nonadverse party.

The trust instrument specifies that affirmative action, except for early termination of the trust, may only be had upon a majority vote of the trustees. Thus, C, as grantor, could receive beneficial enjoyment from the Family Estate by the action of himself and either of the other trustees. Therefore, C is considered to be the owner of the trust under section 674 of the Code.

Section 676(a) of the Code provides, in part, that the grantor shall be treated as the owner of any portion of a trust, where at any time the power to revest in the grantor title to such portion is exercisable by the grantor or a nonadverse party, or both.

Pursuant to section 1.676(a)-1 of the regulations, if the title to a portion of the trust will revest in the grantor upon the exercise of a power by the grantor or a nonadverse party, or both, the grantor is treated as the owner of that portion regardless of whether the power is a power to revoke, to terminate, to alter or amend, or to appoint.

The trust instrument provides that the Family Estate will continue for a period of twenty years; however, the trustees can, by unanimous vote, terminate the Family Estate at an earlier date. If and when this occurs, the corpus and income of the Family Estate is to be distributed to the holders of units of beneficial interest. Since the other two trustees are nonadverse parties, the grantor could vote with either or both of them to vest title in himself.

Therefore, since the grantor is the only holder of units of beneficial interest in the Family Estate, he may be treated as the owner of the entire trust under section 676 of the Code.

Section 677(a) of the Code provides, in part, that the grantor shall be treated as the owner of any portion of a trust whose income without the approval or consent of any adverse party is, or, in the discretion of the grantor or a nonadverse party, or both, may be distributed to, or accumulated for future distribution to, the grantor or the grantor's spouse. Section 1.677(a)-1(d) of the regulations provides, in part, that under section 677 a grantor is, in general, treated as the owner of a portion of a trust whose income is, or in the discretion of the grantor or a nonadverse party, or both, may be applied in discharge of a legal obligation of the grantor (or his spouse in the case of property transferred in trust by the grantor after October 9, 1969).

Section 677(b) of the Code provides, in part, that the income of a trust shall not be considered taxable to the grantor under section 677(a) or any other provision of chapter 1 merely because such income, in the discretion of another person, the trustee, or the grantor acting as trustee or co-trustee, may be applied or distributed for the support and maintenance of a beneficiary (other than the grantor's spouse) whom the grantor is legally obligated to support or maintain except to the extent such income is so applied or distributed.

Section 1.677(b)-1(d) provides, in part, that the exception provided in section 677(b) relates solely to the satisfaction of the grantor's legal obligation to support or maintain a beneficiary. Consequently, the general rule of section 677(a) is applicable when in the discretion of the grantor or nonadverse parties income of a trust is or may be applied in discharge of a grantor's obligations other than his obligation of support or maintenance falling within section 677(b). Thus, if the grantor creates a trust the income of which may in the discretion of a nonadverse party be applied to the payment of the grantor's debts, such as the payment of his rent or other household expenses, he is treated as the owner of the trust regardless of whether the income is actually so applied.

In the case of Louis W. Hill, 33 BTA 891 (1936), affid., 88 F. 2d 941 (8th Cir. 1937), the court held that the grantor was taxable on income used to support his wife and maintain the home in which the grantor and his wife resided. Further, it has also been held that the grantor is the owner of a trust where the income, on authority of a nonadverse trustee, can be applied to satisfy the grantor's debts. See Herbert A. Loeb, 5 T.C. 1072 (1945), aff'd., 159 F. 2d 549 (7th Cir. 1946); Clifton B. Russell, 5 T.C. 974 (1945); and James L. Knight, 39 B.T.A. 436 (1939). Similarly, the Service has held that a taxpayer who has conveyed mortgaged property in trust and has a personal liability on the mortgage, which continues after the conveyance in trust, is taxable under a predecessor of section 677 of the Code on the use of the trust income in discharge of the interest or principal on the mortgage. Rev. Rul. 54-516, 1954-2 C.B. 54.

Although the trust instrument of the Family Estate does not specifically provide that the trustees have the power to distribute income to the holder of the beneficial interest (the grantor), under the authority inherent in the instrument, the trustees have exercised the power to distribute income to the grantor by discharging certain of his obligations for housing and health care.

Therefore, since the income of the trust has been and may be distributed to the grantor or his spouse either without the approval or consent of any adverse party, or in the discretion of the grantor and a trustee who is a nonadverse party, C is treated as the owner of the trust under section 677 of the Code.

Accordingly, because of his dominion and control over the Family Estate trust, for Federal income tax purposes, C will be considered the owner of the trust under either section 674, 676, or 677 of the Code, or a combination of these, as the case may be. Therefore, as provided by section 671, in computing his taxable income and credits he must include those items of income, deductions, and credits to the extent such items would be taken into account in computing taxable income or credits against the tax on an individual. See also Floyd G. Paxton, 57 T.C. 627 (1972), in which the grantor of a trust similar to the Family Estate was considered to be an owner of the trust.

¹ Also released as TIR-1383, dated June 9, 1975.