Earl was looking to lower the
amount he was required to pay in taxes. He signed a contract with his
wife that said that any property or income either of them acquired in any
way would be split between the two of them equally.
Earl worked, while his wife
didn't (so her income was $0). By splitting his income, he hoped to
basically pay two low tax bills instead of one high tax bill.
Due to progressive tax
rates, the last dollar a person earns in a year is taxed at a
significantly higher tax rate than the first dollar they earn. Earl
wanted to take the top half of his income and give it to his wife, so
they'd both get the advantage of having the majority of their income
taxed a low rate.
The IRS determined that Earl
should be taxed on his entire salary, regardless of any deals he made with
his wife. Earl appealed.
The Tax Court found for the
IRS. Earl appealed.
The Appellate Court reversed.
The IRS appealed.
The US Supreme Court reversed
and found for the IRS.
The US Supreme Court found that
since Earl earned the income, he was the one who should be taxed on his
entire earnings.
The Court found that there
was "no doubt that the statute required salaries to be taxed by
those who earned them and provided 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."
The Court found that
"the fruits cannot be attributed to a different tree from that on
which they grew."
The Court distinguished
Earl's case from Poe v. Seaborn
(281 U.S. 101 (1930)). In this case, the husband and wife signed a
voluntary contract given each other rights to their property. Seaborn
was different because he didn't sign a contract, he was just following
the property laws of his State, which held that all property between
spouses is community property and is equally owned by each spouse.
This case established the Assignment
of Interest Doctrine, which basically
says that a taxpayer cannot evade taxes by giving (assigning) his income
to someone else in a lower tax bracket.
