Luker v. State Tax Assessor.

• Decision Date: 03 May 2011
• Docket Number: Docket No. BCD–10–86.
• Citation: 17 A.3d 1198,2011 ME 52
• Parties: Daniel P. LUKER et al.v.STATE TAX ASSESSOR.
• Court: Maine Supreme Court

17 A.3d 1198

2011 ME 52

Daniel P. LUKER et al.

v.STATE TAX ASSESSOR.

Docket No. BCD–10–86.

Supreme Judicial Court of Maine.

Argued: Nov. 10, 2010.Decided: May 3, 2011.

Roy T. Pierce, Esq. (orally), Preti Flaherty, LLP, Portland, ME, for Daniel P. Luker, John M. Sullivan, and Simon C. Leeming.Janet T. Mills, Attorney General, Scott W. Boak, Asst. Atty. Gen. (orally), Office of the Attorney General, Augusta, ME, for the State Tax Assessor.Catherine R. Connors, Esq., James G. Good, Esq., Jonathan A. Block, Esq., Pierce Atwood LLP, One Monument Square, Portland, ME, for Pierce Atwood LLP and Maine Society of Certified Public Accountants.Panel: SAUFLEY, C.J., and ALEXANDER, LEVY, SILVER, MEAD, and GORMAN, JJ.Majority: SAUFLEY, C.J., and ALEXANDER, LEVY, MEAD, and GORMAN, JJ.Concurrence: ALEXANDER, J.Dissent: SILVER, J.GORMAN, J.

[¶ 1] Daniel P. Luker, John M. Sullivan, and Simon C. Leeming (the Attorneys) ¹ appeal from the entry of a summary judgment in the Business and Consumer Docket ( Humphrey, C.J.) in favor of the State Tax Assessor on the Attorneys' petitions for review of tax assessments for the 2004 and 2005 tax years, pursuant to M.R. Civ. P. 80C.² The Attorneys contend that the court erred by applying the assignment of income doctrine and taxing them individually on partnership distributions that were paid directly to their respective professional corporations. We disagree and affirm the judgment.

I. BACKGROUND

[¶ 2] The summary judgment record presented to the court consisted of 171 stipulated facts, in addition to separate statements of material facts filed by each side. The stipulated facts and the record support the following factual determinations. Preti, Flaherty, Beliveau, Pachios & Haley (Preti) is a Maine law firm organized as a limited liability partnership with its principal place of business in Portland, Maine. On May 1, 2002, while Preti was organized as a limited liability company (LLC),³ each Attorney joined Preti as an LLC member, but each worked out of Preti's Concord, New Hampshire office. Although the Attorneys lived and worked in New Hampshire, as members of a Maine LLC they were required to pay income taxes to the State of Maine on the monies they received from Preti.⁴ See 36 M.R.S.A. §§ 5111(4), 5142(1), (2) (1990 & Supp.2003); 36 M.R.S.A. § 5142(1) (Supp.2002); ⁵ see also Peterson v. State Tax Assessor, 1999 ME 23, ¶ 7, 724 A.2d 610, 612 (“Maine law imposes an income tax on the portion of income that a nonresident derives from sources within the State.”).

[¶ 3] In December 2003, each Attorney formed a New Hampshire professional corporation (PC) to hold his respective interest in Preti. When Preti reorganized as a limited liability partnership in March 2004, the new partnership agreement allowed each partner to transfer his or her partnership interest to a “professional corporation, professional association, or similar entity of which such Partner is the sole stockholder or equity holder.” Each Attorney then transferred his respective partnership interest in Preti to his PC, and each PC, through its respective Attorney, signed Preti's partnership agreement. Both the Attorneys and Preti understood that each Attorney would provide legal services to Preti and its clients on behalf of his respective PC. Each Attorney was the sole shareholder and director for his PC, and also served as the PC's president, treasurer, and secretary. None of the PCs ever employed other attorneys, paralegals, legal secretaries, or other full-time support staff in connection with the Attorneys' provision of legal services.

[¶ 4] Although each Attorney was the sole provider of legal services to Preti and its clients on behalf of his respective PC, none of the Attorneys had an employment contract with his PC. Instead, each PC entered into an arrangement through which it was designated a “co-employer” of the Attorney for purposes of Preti profit sharing and 401(k) benefits. In 2004 and 2005, each PC received partnership distributions from Preti, and it is the taxation of these distributions that forms the basis for this appeal. The size of each distribution was determined, in part, by considering the historical performance of the Attorney while individually a member of Preti. In each year, the PCs used these distributions to pay salaries to the Attorneys, and attempted to have the salaries be equal to the distributions. Each PC deducted all payments to its respective Attorney as a cost of doing business, thereby minimizing the PC's taxable income.

[¶ 5] Two of the PCs did file Maine income tax returns in 2004 and 2005, showing minimal taxable income; one of the PCs failed to file a Maine tax return.⁶ In November 2006, the Assessor sent an identical letter to each Attorney, stating that because it viewed the creation of the PCs as an attempt to evade Maine individual income taxes, it intended to disregard the PCs and treat the individual Attorneys as if they had received the partnership distributions.⁷ The Assessor subsequently issued assessments against each Attorney for income taxes, interest, and penalties for the 2004 and 2005 tax years, and later denied each Attorney's request for reconsideration of the assessments.

[¶ 6] Pursuant to M.R. Civ. P. 80C, 36 M.R.S. § 151 (2010), and the Maine Administrative Procedure Act, 5 M.R.S. § 11002 (2010), the Attorneys filed identical individual petitions for review ⁸ in the Superior Court on October 17, 2007, and the three cases were consolidated in November of 2007. The first count of each petition asserted that the Assessor erred in disregarding the separate corporate existence of the PCs. After extensive and contentious discovery, the Assessor moved for summary judgment on this count on March 3, 2009. The case was subsequently transferred to the Business and Consumer Docket, and by order dated January 22, 2010, the court granted summary judgment in favor of the Assessor on this count. Applying the assignment of income doctrine and the Johnson test, as established in Johnson v. Comm'r, 78 T.C. 882 (1982), aff'd, 734 F.2d 20 (9th Cir.1984), the court concluded that the Attorneys were the “true earners” of the income at issue, and the Assessor appropriately invoked the assignment of income doctrine to assign the income to each of the Attorneys as individuals. With support from amici curiae Pierce Atwood LLP and the Maine Society of Certified Public Accountants, the Attorneys appeal from the court's entry of a summary judgment in favor of the Assessor on Count I of their petitions.

II. DISCUSSION

[¶ 7] We review a grant of a motion for summary judgment de novo, viewing the evidence in the light most favorable to the nonprevailing party. Rainey v. Langen, 2010 ME 56, ¶ 23, 998 A.2d 342, 349. Summary judgment is appropriate when there is “no genuine issue of material fact that is in dispute,” and the moving party is entitled to judgment as a matter of law. Dyer v. Dep't of Transp., 2008 ME 106, ¶ 14, 951 A.2d 821, 825. In this case, the court's factual findings were based on the undisputed facts presented by the parties, so there can be no question about unresolved issues of material fact.⁹

[¶ 8] We are asked to determine whether the income received by the professional corporations in the form of Preti partnership distributions was income to those corporations or to the individual Attorneys. The court, as noted above, determined that the income derived from the Preti partnership distributions was income taxable to the individual Attorneys, based on its application of the assignment of income doctrine. This doctrine derives from Lucas v. Earl, 281 U.S. 111, 50 S.Ct. 241, 74 L.Ed. 731 (1930), which is often cited for the “first principle of income taxation”: income is taxed to the person who earns it. Comm'r v. Banks, 543 U.S. 426, 433–34, 125 S.Ct. 826, 160 L.Ed.2d 859 (2005) (quotation marks omitted); United States v. Basye, 410 U.S. 441, 449, 93 S.Ct. 1080, 35 L.Ed.2d 412 (1973) (quotation marks omitted).

[¶ 9] In Lucas v. Earl, the taxpayer contracted with his wife to hold as joint tenants all present and future earnings, including the fees he earned as an attorney. 281 U.S. at 113–14, 50 S.Ct. 241. Despite this agreement, the Commissioner of Internal Revenue treated all of the attorney fees as income to the taxpayer only, taxing him on the whole amount. Id. at 113, 50 S.Ct. 241. Upholding the Commissioner's decision, the Supreme Court stated that the Revenue Acts of 1918 and 1921 “tax[ed] salaries to those who earned them and provide[d] that the tax [could not] be escaped by anticipatory arrangements and contracts however skilfully devised to prevent the salary when paid from vesting even for a second in the man who earned it.” Id. at 114–15, 50 S.Ct. 241.

[¶ 10] The assignment of income doctrine has been applied to prevent a taxpayer from evading taxation by anticipatorily assigning income earned by the taxpayer to another person or entity. See Basye, 410 U.S. at 449–53, 93 S.Ct. 1080; Lucas, 281 U.S. at 114–15, 50 S.Ct. 241. While it is entirely appropriate for a taxpayer to endeavor to minimize or avoid paying taxes by creating corporations and employing arms-length contractual relationships, the corporate form or structure and the contracts defining the relationships must have some substance. See Lerman v. Comm'r, 939 F.2d 44, 54 (3d Cir.1991). As long as the purpose of a corporation “is the equivalent of business activity or is followed by the carrying on of business by the corporation, the corporation remains a separate taxable entity.” Moline Props., Inc. v. Comm'r, 319 U.S. 436, 439, 63 S.Ct. 1132, 87 L.Ed. 1499 (1943); cf. Theberge v. Darbro, Inc., 684 A.2d 1298, 1301 (Me.1996) (stating that a corporation is a separate legal entity); LaBelle v. Crepeau, 593 A.2d 653, 655 (Me.1991) (same). A taxpayer cannot minimize or avoid taxation solely by creating a separate taxable entity to receive income, however, as the creation alone will not...