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United States v. Basye - 410 U.S. 441, 93 S. Ct. 1080 (1973)


The foundational rule of tax accountability is that income must be taxed to him who earns it. The entity earning the income, whether a partnership or an individual taxpayer, cannot avoid taxation by entering into a contractual arrangement whereby that income is diverted to some other person or entity. Such arrangements, known to the tax law as anticipatory assignments of income, have frequently been held ineffective as means of avoiding tax liability.


A medical partnership (“Permanente”), in which respondent physicians were partners, made an agreement to supply medical services to members of a health foundation (Kaiser). A portion of Kaiser's compensation to Permanente was in the form of payments into a retirement trust for the benefit of Permanente's physicians, none of whom was eligible to receive the amounts in his tentative account prior to retirement after specified years of service. No interest in the account was deemed to vest in a particular beneficiary before retirement, and a physician's preretirement severance from Permanente would occasion the forfeiture of his interest, with redistribution to the remaining participants. Under no circumstances, however, could Kaiser recoup the payments once made. The Commissioner of Internal Revenue assessed a deficiency against each partner-respondent for his distributive share of the amount paid by Kaiser, which he had not reported as taxable income. Petitioner contended that payments made to respondent partnership deflected to a retirement plan were actually compensation to the partnership and should have been reported as income when received. The respondents sought a refund with the District Court, which held that the respondents were entitled to a refund and that the payments to the fund were not income to the partnership because it did not receive and had no "right to receive" them. On appeal, the Court of Appeals affirmed.


Were respondents, physicians, and partners in Permanente entitled to a refund for income taxes previously paid?




The Supreme Court reversed and found that payments made to respondent partnership for services were compensation; thus, the partnership was obligated to report such payments as income presently received. The fact that the partnership deflected payments to a retirement trust fund and that such funds were currently unavailable to respondent physicians was irrelevant. The Supreme Court found that the agreement from which such payments derived called for two types of base compensation to be paid in exchange for services provided by respondents. Such compensation included direct payments to the partnership and payments to be deflected to a retirement fund to induce the partners to remain with the partnership and thus insure the continuity and quality of services provided by respondents. Payments to the trust were not forfeitable by the partnership or recoverable by an entity making such payments. As such, the payments deflected to a retirement fund were income to the partnership and should have been reported as such, and the individual partners should have included their shares of that income in their individual returns.

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