## Facts

- A medical partnership (Permanente) contracted with Kaiser Foundation Health Plan to provide medical services.
- Kaiser paid for those services partly in cash and partly by making contributions directly to a retirement trust for the benefit of Permanente’s physician-partners.
- The trust maintained “tentative” accounts for physicians, but no physician could receive amounts before retirement after specified service, and no interest vested before retirement.
- A physician who left before retirement would forfeit his tentative account, with forfeited amounts redistributed among remaining participants.
- Once Kaiser made contributions, it could not recoup them.
- The Commissioner treated Kaiser’s trust contributions as partnership income and assessed deficiencies against each partner for his distributive share, even though the funds were paid directly into the trust and were subject to forfeiture conditions.
- The partners paid the deficiencies and filed a refund action on stipulated facts.

## Issues

1. Whether payments made by a third party directly into a retirement trust as part of the consideration for a partnership’s services constitute taxable income to the partnership under Subchapter K.
2. Whether partners must include in current income their distributive shares of such partnership income even when their rights to trust benefits are contingent, nonvested, and forfeitable.

## Decision

- The Supreme Court reversed the Ninth Circuit in an 8–1 decision.
- The Court held that the trust contributions were compensation for services rendered by the partnership and therefore were includible in the partnership’s gross income.
- The Court held that each partner had to include his distributive share of that income in his individual return.
- The Court ruled that conditions on a partner’s actual receipt of income fully earned by the partnership do not affect current taxability.
- Justice Douglas dissented.

## Legal Principles

- Amounts paid as bargained-for consideration for a partnership’s services are partnership income even if routed directly to a trust rather than paid through the partnership.
- Partners are taxed on their distributive shares of partnership income when the partnership earns the income, regardless of whether partners presently receive cash or have a vested, nonforfeitable right to payment.
- Deferral, nonvesting, and forfeiture provisions affecting individual partners’ ultimate enjoyment of the benefit do not prevent current inclusion when the partnership has earned the compensation.
- Substance governs over form in determining whether compensation earned by a partnership remains taxable to the partnership and its partners despite being directed to a third-party vehicle.

## Conclusion

The Court treated the retirement trust contributions as part of the partnership’s compensation for services and required current inclusion in partnership income and in each partner’s distributive share, notwithstanding that the payments went directly to a trust and individual partners’ interests were contingent and forfeitable.


United States v. Basye, 410 U.S. 441 (1973)