## Facts

- La Verne and Barbara Schulz created a “family trust” in 1972 and transferred substantially all family property to it, including business assets, personal property, and the right to Barbara’s wages.
- The trust named family members as primary beneficiaries and installed La Verne, Barbara, and a third party as trustees; trustees generally acted by majority vote, while early termination required unanimous consent.
- The trust term was lengthy and renewable, and the family retained practical control over trust assets and operations.
- La Verne continued operating the same dairy farm and real estate activities as before, but characterized his role as a paid “consultant” to the trust and reported that salary on his individual return.
- The trust reported income and claimed substantial “administrative expenses,” including items such as life insurance, vehicle costs, health-care costs, and home-related expenses; no distributions were made to beneficiaries in the years at issue.
- Russell and Mrs. White used a substantially similar prepackaged trust arrangement, transferring family assets to a trust controlled by family trustees and claiming comparable “administrative” expenses tied to household support.
- The IRS determined deficiencies, reallocating income from the trusts to the individual taxpayers and disallowing deductions it characterized as nondeductible personal expenses.
- The Tax Court sustained the IRS determinations; the taxpayers appealed.

## Issues

1. Whether the family trusts should be respected for federal income tax purposes so that income from property and activities associated with the trusts was taxable to the trusts (or their beneficiaries) rather than to the individual taxpayers.
2. Whether expenses paid by the trusts for items such as insurance, health care, vehicle costs, and home-related costs were deductible as trust administrative expenses.
3. Whether the arrangements, despite formal transfers of title, failed in substance because the taxpayers retained dominion, control, and enjoyment of the income and assets.

## Decision

- The Seventh Circuit affirmed the Tax Court.
- The court upheld reallocating the relevant income to the individual taxpayers, concluding the trusts did not effectively shift the incidence of taxation from those who earned and controlled the income.
- The court upheld disallowance of the challenged deductions, treating the claimed “administrative expenses” as personal and family living expenses.
- The court accepted the IRS deficiency determinations for the consolidated cases involving substantially similar “family trust” structures.

## Legal Principles

- Federal tax liability turns on substance rather than formal labels; transferring nominal title to a closely controlled trust does not shift taxable income when the same individuals retain practical control and benefit.
- Income is taxed to the person who earns it or controls the income-producing property; routing earnings through a family trust does not change that result when control and enjoyment remain unchanged.
- Personal and family living expenses are nondeductible; paying them through a trust and calling them administrative expenses does not alter their tax character.
- Courts may disregard family trust arrangements marketed as standardized tax-reduction devices when they function primarily to recharacterize personal consumption and shift income without a genuine economic transfer.

## Conclusion

The Seventh Circuit upheld IRS deficiencies by treating the family trust arrangements as ineffective for income shifting where the taxpayers retained control and benefits, and by rejecting deductions for household and personal expenses merely because the trusts paid them.


Schulz v. Comm’r, 686 F.2d 490 (7th Cir. 1982)