What Is the Anticipatory Assignment of Income Doctrine?
Learn the tax principles that distinguish between a valid gift of an asset and an invalid attempt to shift income tax liability to another person.
The anticipatory assignment of income doctrine is a principle of United States tax law ensuring that income is taxed to the individual who earns it or the entity that owns the asset producing it. This judicial doctrine prevents taxpayers from lowering their tax burden by redirecting income to someone in a lower tax bracket, like a family member. The rule focuses on the substance of a transaction rather than its form. It prevents arrangements where a taxpayer who has earned income attempts to have it paid directly to someone else, ensuring that tax liability follows the earner.
The “Fruit of the Tree” Doctrine
The legal reasoning behind the assignment of income doctrine is captured by the “fruit of the tree” metaphor from the U.S. Supreme Court. In this metaphor, the “tree” represents the source of the income, such as a person’s labor or an income-producing asset like stocks or bonds. The “fruit” is the income itself, such as salary, wages, interest, or dividends.
The doctrine holds that one cannot avoid taxation on the fruit by giving it away while retaining ownership of the tree. This principle was established in the 1930 Supreme Court case Lucas v. Earl, where a husband contracted with his wife to treat all future income as joint property. Despite the contract, the Court ruled the husband must pay tax on his entire salary. Justice Oliver Wendell Holmes concluded with the metaphor, asserting that the “fruits cannot be attributed to a different tree from that on which they grew.” This case established that income from personal services is taxable to the person who performs them, regardless of any private agreement.
Distinguishing Income from Income-Producing Property
Applying the assignment of income doctrine requires understanding the difference between an invalid assignment of income and a valid transfer of the property that generates it. This distinction determines who is responsible for the tax. An attempt to redirect the “fruit” is improper, while a genuine transfer of the “tree” itself shifts future tax liability to the new owner. The substance of the transaction guides the Internal Revenue Service (IRS) and the courts.
An invalid assignment of income occurs when a taxpayer gives the right to receive income to someone else while keeping the underlying asset. A key example is the Supreme Court case Helvering v. Horst. In this case, a father owned bonds and, shortly before interest payments were due, detached the interest coupons and gave them to his son. The Court held that the father was liable for the tax on the interest because he retained ownership of the bonds—the “tree”—and merely gave away the “fruit.” The Court reasoned that the power to dispose of income is equivalent to ownership of it.
Other examples of invalid assignments include directing an employer to pay one’s salary to a family member, assigning commissions already earned but not yet paid, or transferring royalty payments from a patent while still owning the patent. In each scenario, the right to the income was controlled by the original taxpayer at the time of the transfer, making it an attempt to deflect income to another person.
A valid transfer that shifts the tax burden involves giving away the entire income-producing property. For example, if the father in Horst had gifted the entire bond to his son, the son would then be the owner of the “tree.” Consequently, any future interest payments generated by that bond would be taxable to the son, not the father. The father would have relinquished all control over the asset.
Similarly, a valid transfer occurs when an individual gifts shares of stock to another person, as the new owner is then taxed on any dividends paid after they take ownership. If an inventor transfers complete ownership of their patent to a child, the child is taxed on all future royalties. The transfer must be complete, divesting the original owner of their rights to the property before the income is realized.
Tax Implications and Consequences
When the IRS determines that a taxpayer has improperly assigned income, the transaction is disregarded for tax purposes. The income is reallocated back to the person who earned it or owned the property that produced it. This means the original taxpayer is held liable for the tax on that amount, and the IRS will issue a notice of deficiency for the unpaid tax.
Beyond the initial tax liability, the taxpayer must pay interest on the underpayment. This interest accrues from the original due date of the tax return and compounds daily. The total amount owed can grow substantially if the issue is not discovered for several years.
The IRS can also impose penalties. A common one is the accuracy-related penalty under Internal Revenue Code Section 6662, which is 20% of the tax underpayment attributable to negligence or a disregard of the rules. For an individual, this can be triggered if the tax understatement exceeds the greater of 10% of the correct tax or $5,000. If the IRS proves the assignment was a fraudulent attempt to evade taxes, the civil fraud penalty could be as high as 75% of the underpayment.