Tuesday, June 2, 2009

A family trust was disregared in this case using "substance over form" principles

C. Lizalek, et al. v. Commissioner.

Dkt. No. 3202-07L , 14297-07 , 14298-07 , 14299-07 , TC Memo. 2009-122, June 1, 2009.


A. Reporting of Income
Section 61(a) defines gross income as "all income from whatever source derived". A fundamental principle of income taxation is that income is taxable to the person who earns it. Lucas v. Earl, 281 U.S. 111, 114-115 (1930). An anticipatory assignment of income from a true income earner to another entity by means of a contractual arrangement does not relieve the true income earner from tax and is not effective for Federal income tax purposes regardless of whether the contract is valid under State law. Id.; Vercio v. Commissioner, 73 T.C. 1246, 1253 (1980). Although taxpayers are entitled to arrange and conduct their affairs and structure their transactions to minimize taxes, a trust is disregarded for Federal tax purposes if it lacks economic substance and was formed solely for tax avoidance purposes. Gregory v. Helvering, 293 U.S. 465, 469 (1935); Zmuda v. Commissioner, 79 T.C. 714, 719-720 (1982), affd. 731 F.2d 1417 (9th Cir. 1984).

Petitioner contends that the Social Security Administration (SSA) created the Lizalek Trust when it issued a Social Security card to petitioner, which constituted a transfer of property. Petitioner further contends that he serves as trustee and the United States is the sole beneficiary. Petitioner asserts that he submitted a written indenture for the Lizalek Trust to the SSA reflecting this relationship that the SSA accepted based on its failure to respond as required by the Privacy Act and the Administrative Procedure Act. Similarly, petitioner argues that the IRS accepted that the Lizalek Trust existed when it assigned an EIN to the Lizalek Trust upon submission of a Form SS-4, Application for Employer Identification Number. Finally, petitioner argues that the Lizalek Trust was the employee that earned the wages and other income at issue and that the trust properly reported the income on Form 1041. Respondent contends that the purported trust does not exist in fact or alternatively the Lizalek Trust is a sham or grantor trust.

Petitioner has not established that a valid trust exists. The issuance of a Social Security card is not a transfer of property that creates a trust as petitioner contends. Petitioner's submission of a purported trust document to the SSA and a Form SS-4 to the IRS does not create or in any way acknowledge the existence of a trust. Petitioner has not provided any legitimate trust documents forming the purported trust. The purported trust does not reflect economic reality and is not recognized for Federal tax purposes. Accordingly, we hold that petitioner earned the wages and other income at issue, and the income is includable in his gross income. See McManus v. Commissioner, T.C. Memo. 2006-68; Nichols v. Commissioner, T.C. Memo. 2003-24, affd. 79 Fed. Appx. 282 (9th Cir. 2003).

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