Schneer v. Comm'r of Internal Revenue

• Decision Date: 12 December 1991
• Docket Number: Docket No. 31804-88.
• Citation: 97 T.C. 643,97 T.C. No. 45,60 USLW 2450
• Parties: STEPHEN B. SCHNEER AND NANCY K. SCHNEER, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: U.S. Tax Court

60 USLW 2450

97 T.C. 643

97 T.C. No. 45

STEPHEN B. SCHNEER AND NANCY K. SCHNEER, Petitioners

v.COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 31804-88.

United States Tax Court

Filed December 12, 1991.

P referred clients to law firm A, by whom he was employed as an associate. He received a salary and a percentage of fees generated by the referred clients. P then left law firm A and became a partner of law firm B and agreed to turn over any income from his practice of law to B from that date forward. After he became a partner of B, P consulted concerning clients he had referred to A. With one exception, the fees were earned after P left A. When fees were received from A, P turned them over to B. B accounted for and reported the fees, for tax purposes, as partnership income which P reported in accord with his share of B's income. R determined that P should report all income from A because he had earned the income prior to its assignment to B and/or it was an assignment of income because it was not earned in the partnership business of B. P argues that he was required to consult and that the fees were not earned until the services were performed. P also argues that R's administrative position, as set forth in revenue rulings and approved by various courts, permits the reporting of the income by the partnership.

HELD: With one exception, P had not earned the fees prior to becoming a partner. HELD FURTHER: Income earned after P became a partner of B should be reported by partnership B and recognized by each partner in their respective partnership shares. Richard L. Gold, for the petitioners.

Andrew I. Ouslander, for the respondent.

GERBER, JUDGE:

Respondent, by means of separate notices of deficiency, determined deficiencies in Federal income tax for petitioners' 1984 and 1985 taxable years in the amounts of $49,708 and $25,252, respectively. Respondent, in both years, also determined additions to tax under section 6653(a)(1) ¹ and an additional 50- percent interest on $45,437 of the 1984 deficiency and on $25,252 of the 1985 deficiency under section 6653(a)(2). Respondent also determined additions to tax under section 6661 and increased interest under section 6621(c) for both taxable years. By agreement, the parties have resolved the additions to tax under section 6661 and increased interest under section 6621(c). The parties have also resolved the additions to tax under section 6653(a)(1) and (2) in connection with the adjustments concerning the Coal Venture II tax shelter for both taxable years. There remain for our consideration issues concerning: (1) Whether fees received from petitioner husband's prior law firm (where he was not a partner) are taxable to petitioner husband or the partners of his new law firm (where he is a partner); and (2) whether petitioners are liable for additions to tax under section 6653(a)(1) and (2) with respect to any portion of the deficiencies in income tax attributable to issue (1).

FINDINGS OF FACT

The parties' stipulations of facts and referenced exhibits are incorporated herein by this reference.

Petitioners resided at Croton-On-Hudson, New York, at the time the petition was filed in this case. Stephen B. Schneer (hereinafter petitioner, when used in the singular, shall refer to Stephen B. Schneer), was a practicing attorney during the years 1983, 1984, and 1985. Until February 25, 1983, petitioner was an associate with the law firm of Ballon, Stoll & Itzler (BSI). BSI was a partnership. Petitioner was not a partner in BSI and he did not share in general partnership profits. Petitioner's financial arrangement with BSI consisted of a fixed or set salary and a percentage of any fees which arose from clients petitioner brought or referred to the firm.

BSI did not have a written partnership agreement, and no written agreement existed in connection with petitioner's relationship as an associate with BSI. When petitioner left BSI he had an understanding that he would continue to receive his percentage of fees which arose from clients he had referred when he was an associate with BSI. Petitioner was expected to consult regarding clients he referred to BSI and whose fees were to be shared by petitioner. Petitioner would have become entitled to his percentage of the fees even if he had not been called upon to consult.

After petitioner left BSI and while he was a partner of two other law partnerships (other than BSI) he consulted on numerous occasions concerning BSI clients. Most of the 1984 and 1985 fees received under this agreement were attributable to Terri Girl and Prince, clients that petitioner had brought to BSI. Neither the remaining BSI attorneys nor petitioner had contemplated whether petitioner would receive the fees if he refused to consult concerning the clients referred by petitioner. For the years under consideration, petitioner consulted with BSI attorneys on each occasion his services were requested. The services provided by petitioner to BSI consisted of legal advice and consultation on legal matters.

Late in February 1983, petitioner became a partner in the law firm of Bandler & Kass (B&K), and on August 1, 1985, petitioner became a partner in the law firm of Sylvor, Schneer, Gold & Morelli (SSG&M). BSI, B&K, SSG&M, and petitioner, at all pertinent times, kept their books and reported their income on the cash method of accounting. Neither B&K nor SSG&M had written partnership agreements. The agreement between the partners of B&K was that each partner would receive a percentage of the partnership profits derived from all fees received beginning the date the partner joined the partnership. In addition, petitioner agreed to turn over to the partnership all legal fees received after joining the partnership, regardless of whether the fees were earned in the partnership's name or from the partnership's contractual relationship with the client. The same agreement existed between the partners of SSG&M, including petitioner.

During 1984 and 1985, BSI remitted $21,329 and $10,585 to petitioner. The amounts represented petitioner's percentage of fees from BSI clients that he had referred to BSI at a time when he was an associate with BSI. With the exception of $1,250 for the 1984 taxable year, all of the fees received during 1984 and 1985 were for work performed after petitioner left BSI. Petitioner, pursuant to his agreements with B&K and SSG&M, turned those amounts over to the appropriate partnership. B&K and SSG&M, in turn, treated the amounts as partnership income which was distributed to each partner (including petitioner) according to the partner's percentage share of partnership profits.

BSI's 1984 records reflect that of the $21,329 total, $944 was attributable to Prince and $17,060 was attributable to Terri Girl. The remainder of the $21,329 remitted for 1984 ($3,325) was attributable to BSI clients for which petitioner had not consulted since leaving BSI during February 1983. The 1985 records of BSI reflect that the entire amount ($10,585) was attributable to Prince. BSI records reflect that billings and fees were made and received from BSI clients at various times during the year, but that petitioner received one annual aggregate payment.

OPINION

We consider here basic principles of income taxation. There is agreement that the amounts paid to petitioner by his former employer- law firm are income in the year of receipt. The question is whether petitioner (individually) or the partners of petitioner's partnerships (including petitioner) should report the income in their respective shares.

The parties have couched the issue in terms of the anticipatory assignment-of-income principles. See Lucas v. Earl, 281 U.S. 111 (1930). Equally important to this case, however, is the viability of the principle that partners may pool their earnings and report partnership income in amounts different from their contribution to the pool. See sec. 704(a) and (b). The parties' arguments bring into focus potential conflict between these two principles and compel us to address both.

First, we examine the parties' arguments with respect to the assignment-of-income doctrine. Respondent argues that petitioner earned the income in question before leaving BSI, despite the fact that petitioner did not receive that income until he was a partner in B&K and, later, SSG&M. According to respondent, by entering into partnership agreements requiring payment of all legal fees to his new partnerships, petitioner anticipatorily assigned to those partnerships the income earned but not yet received from BSI.

Respondent also raises the question of petitioner's method of accounting -- the cash method. Respondent notes that the cash method requires taxpayers to postpone reporting income until received, whether or not earned prior to receipt. See secs. 1.446-1(c)(1), 1.451-1(a), Income Tax Regs. While the concepts of recognition, receipt, and accounting method are sometimes necessary for a complete analysis of an assignment-of-income case, respondent here appears primarily concerned with the possibility that petitioner's method of accounting will obscure our perception of when petitioner earned the income in question. ²

Petitioner contends that the income in question was not earned until after he left BSI and joined B&K and SSG&M. He argues that the income received from BSI is reportable by the partners of the B&K and SSG&M partnerships (including petitioner) in their respective shares. Petitioner also points out that partnership agreements, which like the ones in issue allocate and redistribute partners' income, have received the approval of respondent in Rev. Rul. 64-90, 1964-1 (Part 1) C.B. 226. Petitioner argues that he was obligated to consult with BSI in order to be entitled to the BSI fees. Petitioner concedes that, for some of the income in question, no consultation was performed or requested. He emphasizes, however, that a substantial amount (about 90 percent) of the fees...