Facts
- Stephen B. Schneer, an attorney, left Ballon, Stoll & Itzler (BSI) on February 25, 1983, after working there as an associate.
- At BSI, Schneer had a contractual right to receive a percentage of fees collected from clients he brought or referred to BSI, including after he left the firm; consultation on those matters was expected but not a condition to payment.
- After leaving BSI, Schneer became a partner at Bandler & Kass (B&K) in February 1983 and later became a partner at Sylvor, Schneer, Gold & Morelli (SSG&M) in August 1985.
- Under the B&K and SSG&M partnership agreements, Schneer was required to contribute to the partnership all legal fees he earned, including fees not generated through the partnership’s own client matters.
- In 1984 and 1985, BSI paid Schneer his percentage of fees from referred-client matters; Schneer turned the 1984 amounts over to B&K and the 1985 amounts over to SSG&M.
- The partnerships treated the BSI payments as partnership receipts, and the partners reported their distributive shares accordingly.
- The IRS issued deficiency notices for 1984 and 1985, asserting the BSI payments were taxable to Schneer individually and seeking negligence additions under I.R.C. § 6653(a)(1) and (2) for underpayments attributable to the fee-income treatment (other penalty issues were resolved by agreement).
Issues
- Whether the BSI payments in 1984 and 1985 were taxable to Schneer individually under the assignment-of-income doctrine or reportable as income of his later law partnerships and allocable among the partners under the partnership agreements.
- Whether underpayments attributable to the fee-income reclassification were subject to negligence additions under I.R.C. § 6653(a)(1) and (2).
Decision
- The Tax Court held that, with one exception, the disputed BSI fees were earned after Schneer became a partner in his subsequent firms and were properly reportable as partnership income, allocable among the partners under the partnership agreements.
- The court held one fee that was fully earned before Schneer became a partner remained taxable to Schneer individually.
- The court ruled on the remaining § 6653(a) negligence additions consistent with its income-attribution holdings and the parties’ prior settlements of other penalty matters.
Legal Principles
- Income is generally taxed to the person who earns it; a taxpayer cannot avoid tax by assigning an already-earned right to receive income to another (assignment-of-income doctrine).
- For professional service income, the timing of when the fee is earned controls whether the taxpayer held a fixed, already-earned right before any transfer or agreement to remit the income.
- A partner’s service income may be treated as partnership income when (i) the income arises from services of the type performed in the partnership’s business and (ii) there is an enforceable agreement requiring the partner to contribute such fees to the partnership, followed in practice.
- A contractual expectancy created before joining a partnership is not, by itself, determinative; the court focuses on when the underlying services generating the fee were performed and when the fee became payable.
Conclusion
The Tax Court treated most referral-fee payments from the attorney’s former firm as partnership income because the fees were earned after he joined his later partnerships and were subject to binding contribution provisions, but it taxed one pre-earned fee to him personally and adjusted negligence additions accordingly.