Basye v. United States

• Decision Date: 29 November 1968
• Docket Number: Civ. No. 44352-44356,45575.
• Citation: 295 F. Supp. 1289
• Parties: James A. BASYE and Evelyn E. Basye, Plaintiffs, v. UNITED STATES of America, Defendant. Jack J. COOK and Carol L. Cook, Plaintiffs, v. UNITED STATES of America, Defendant. Maurice C. FISHLER and Phyllis H. Fishler, Plaintiffs, v. UNITED STATES of America, Defendant. Henry Donald GRANT and Jean H. Grant, Plaintiffs, v. UNITED STATES of America, Defendant. William S. HUNTER and Jessamine S. Hunter, Plaintiffs, v. UNITED STATES of America, Defendant. George W. SOROKOWSKI and Nadia Sorokowski, Plaintiffs, v. UNITED STATES of America, Defendant.
• Court: U.S. District Court — Northern District of California

295 F. Supp. 1289

James A. BASYE and Evelyn E. Basye, Plaintiffs, v. UNITED STATES of America, Defendant.

Jack J. COOK and Carol L. Cook, Plaintiffs, v. UNITED STATES of America, Defendant.

Maurice C. FISHLER and Phyllis H. Fishler, Plaintiffs, v. UNITED STATES of America, Defendant.

Henry Donald GRANT and Jean H. Grant, Plaintiffs, v. UNITED STATES of America, Defendant.

William S. HUNTER and Jessamine S. Hunter, Plaintiffs, v. UNITED STATES of America, Defendant.

George W. SOROKOWSKI and Nadia Sorokowski, Plaintiffs, v. UNITED STATES of America, Defendant.

Civ. Nos. 44352-44356, 45575.

United States District Court N. D. California.

November 29, 1968.

Stark, Simon & Sparrowe, by John F. Wells; Leonard Marcussen, John F. Banker, Oakland, Cal., for plaintiffs.

Cecil F. Poole, U. S. Atty., San Francisco, Cal., by John M. Youngquist, Asst. U. S. Atty., for defendant, United States.

MEMORANDUM AND ORDER DIRECTING JUDGMENT FOR PLAINTIFFS

WOLLENBERG, District Judge.

These are consolidated actions for the refund of income taxes, and each one poses the identical problem which arises within the partnership provisions of the Internal Revenue Code. The facts have been stipulated to by the taxpayer petitioners and the respondent Commissioner of Internal Revenue. The petitioners are physicians who were each, during the years involved in their respective cases, general partners in a limited partnership of physicians organized in 1949 to practice medicine in California under the name of "The Permanente Medical Group" (hereinafter referred to as Permanente or as the partnership). This partnership used the accrual method of tax accounting in filing its partnership information returns. All partners used the cash method of accounting.

Prior to the years involved in these cases, Permanente contracted with Kaiser Foundation Health Plan, Inc. (hereafter referred to as Kaiser), a California nonprofit corporation, to provide medical services to members of Kaiser in its Northern California Region. Kaiser operates a contractual membership program providing pre-paid hospital and medical care to its dues paying members. The contract provided that Kaiser would not only pay a basic compensation to Permanente for the medical services, but would also make payments toward a retirement plan when such a plan was approved by Kaiser. On or about December 30, 1958, such a plan (hereafter referred to as the Retirement Plan) was established to take effect as of July 1, 1959, by a trust agreement among Kaiser, Permanente, and the Bank of America National Trust and Savings Association, as trustee. In entering into both the original medical services contract and the trust agreement, Permanente and Kaiser were and remained independent organizations contracting at arms length.

The primary purpose of the trust agreement and the retirement plan is to create an incentive for physicians to remain with Permanente, or if they left Permanente, then to join some other group of physicians contracting to serve Kaiser members, thereby ensuring Kaiser that it would have a stable and reliable pool of physicians providing medical services to its members. To secure this purpose, the Retirement Plan contains the following provisions. A trust fund under the Bank of America trusteeship was established, and is to be supported by payments from Kaiser in partial compensation for the services of Permanente. Each physician who had served two years within Permanente, both those who were partners and those who were merely employees, was assigned a certain number of "units", which took into account such factors as the physician's salary from Permanente, his past service with Permanente, and the age at which he became associated with Permanente. Tentative accounts were then set up for each physician, and these accounts were credited with portions of the trust fund earnings (which included payments from Kaiser plus interest accrued on the corpus), with each account receiving credits in proportion to the units assigned to that particular physician. The accounts are tentative because the eventual enjoyment by any physician of his accrued share of the fund depends on several contingencies. If either a partner-participant or an employee-participant in the Retirement Plan terminates his affiliation with Permanente, for reasons other than his death or disability, prior to reaching age 65 or serving Permanente for fifteen continuous years, and if the participant does not thereupon join another medical group serving Kaiser subscribers, he forfeits the amounts allocated to his tentative account. And even upon his becoming eligible to receive retirement benefits from his tentative account, a participant may lose his right to these benefits if he renders professional services for a competitor of Kaiser, or if, while he is physically fit and legally entitled to practice medicine, he refuses to render consulting services to any medical group under contract with Kaiser, when reasonably requested to do so. Moreover, a "Retirement Committee", composed of representatives selected by both Kaiser and Permanente, is given the power to prescribe further conditions to the receipt of Retirement Plan benefits by participants.

The effect on each participant's rights in the trust fund in the event of a dissolution or reorganization of Permanente is of particular interest in the present case. The trust agreement provides that if, in the event of a dissolution or reorganization of Permanente, at least 50% of the combined total of practicing partner-participants and employee-participants become reassociated with a reorganized Permanente or with another group serving Kaiser subscribers, then the trust fund shall be kept intact and any unretired physician-participant who does not join in the new grouping shall forfeit his rights in the trust fund. The forfeiture will not occur in either of two circumstances. First, if in connection with Permanente's dissolution or reorganization, Kaiser and Permanente jointly agree to use the trust funds to support a new retirement plan which they believe will provide better retirement benefits for the participants, or will better effect the original purpose of the trust agreement (viz., a reliable pool of doctors for Kaiser), then such a new retirement plan could provide that the accruals in the tentative accounts of all participants would be preserved. Second, if there is a dissolution or reorganization of Permanente without the above-mentioned 50% regrouping and without the creation of a new retirement plan by Permanente and Kaiser, then the assets held by the trust fund are to be liquidated and the proceeds distributed to all participants, retired and active, in lump sums prorated according to the tentative account balances.

The Commissioner of Internal Revenue determined that the partnership income returns filed by Permanente for its fiscal years ending June 30, 1960 through 1963 had understated income in omitting the sums of Kaiser's payments to the trust fund and the earnings on trust corpus. The Commissioner further determined that the increased partnership income was taxable to the partners for each calendar year in which the partnership fiscal year ended, and he assessed deficiencies in the individual income tax returns of each of the partners, including plaintiffs. In computing the deficiency for each partner, the Commissioner used the following formula. He calculated the total sum of payments attributable to the tentative accounts of employee-participants in the Retirement Plan, and he assessed each partner for these payments according to that partner's distributive share of general partnership income under the partnership articles.¹ He further assessed each partner for the annual increments in trust earnings attributable to that partner's own tentative account in the Retirement Plan, thereby treating the "unit" allocations under the trust agreement as a modification of the basic partnership agreement on the distribution of partnership earnings.²

It is this latter assessment which is contested here. Plaintiffs do not contend that they should never be taxed on the allocations to their tentative accounts, but rather that, in view of the many contingencies which condition their actual receipt of the proceeds represented in their accounts, the tax should be postponed until such actual receipt. The government prefers to tax the plaintiffs immediately, and to deal with subsequent forfeitures of rights to trust fund proceeds by allowing a loss deduction to a partner in the year of his forfeiture, and equivalent to the total tentative accruals forfeited. The remaining partners would then be taxed on the pro rata increases in their tentative accounts resulting from the liquidation of the forfeiting partner's account.³

The government and the plaintiffs have waged their battle on three separate legal fronts. For the reasons set out below, this Court finds that plaintiffs have prevailed in all three sectors.

I

One ground upon which the government seeks to uphold its action is by analogizing the facts here to those in Lucas v. Earl, 281 U.S. 111, 50 S.Ct. 241, 74 L.Ed. 731. In that case the Supreme Court refused to allow a husband to escape taxes on one-half of his income by having assigned one-half of it to his wife as a joint tenant. The Court declared that tax on a salary could not be avoided by the person earning the salary by anticipatory arrangements and contracts. The government here contends that it is the partnership which is earning the payments by Kaiser into the trust fund, and that, following Lucas v. Earl, the partnership (and hence the physician-partners qua partners) should not be allowed to escape immediate taxation through the assignment of the ultimate receipt of the payments to the partners qua individual trust fund participants. The government's contention has some persuasive force, but it ignores several lower court decisions which have...