Rubin v. Commissioner, 51 T. C. 251 (1968)

Management fees paid to a corporation are taxable to the individual performing the services if the individual controls both the corporation receiving the fees and the corporation paying the fees.

Summary

Richard Rubin managed Dorman Mills through Park International, Inc. , a corporation he controlled with his brothers. Dorman Mills paid management fees to Park, which Rubin argued should be taxed to Park. However, the Tax Court ruled that Rubin, who controlled both Park and Dorman Mills, was the true earner of the fees. The court applied the substance-over-form and assignment-of-income doctrines, concluding that Rubin should be taxed on the net management-service income because he directed and controlled the earning of the income, not Park.

Facts

Richard Rubin, an officer of Rubin Bros. , Inc. , acquired an option to purchase a majority interest in Dorman Mills, Inc. , a struggling textile manufacturer. He then established Park International, Inc. , with himself owning 70% of the shares, to manage Dorman Mills. Dorman Mills entered into a management contract with Park, paying fees for Rubin’s services. Rubin continued to work for Rubin Bros. and its subsidiaries while managing Dorman Mills. In 1963, Dorman Mills was sold to United Merchants, which terminated the contract with Park and hired Rubin directly.

Procedural History

The Commissioner of Internal Revenue determined deficiencies in Rubin’s income tax for 1960 and 1961, asserting that the management fees paid to Park should be taxed to Rubin. Rubin petitioned the Tax Court, which ruled against him, holding that the substance of the transaction was that Rubin earned the income directly from Dorman Mills.

Issue(s)

1. Whether the management fees paid by Dorman Mills to Park International, Inc. , are taxable to Richard Rubin under Section 61 of the Internal Revenue Code?

Holding

1. Yes, because Rubin controlled both Park and Dorman Mills, and in substance, he earned the management fees directly from Dorman Mills, not Park.

Court’s Reasoning

The court applied the substance-over-form doctrine, stating that Rubin had the burden to prove a business purpose for the transaction’s form. The court found no such purpose, noting that Rubin controlled both corporations involved in the transaction. Additionally, the court applied the assignment-of-income doctrine, determining that Rubin directed and controlled the earning of the income. The court distinguished this case from others where the individual was contractually bound to work exclusively for the corporation and did not control the corporation paying the fees. The court emphasized that Rubin’s control over both Park and Dorman Mills, along with his ability to engage in other work, indicated that he was the true earner of the income. The court also rejected Rubin’s arguments based on excess profits tax laws and personal holding company provisions, stating that these did not limit the government’s ability to tax income to the true earner.

Practical Implications

This decision underscores the importance of substance over form in tax law, particularly in cases involving personal service corporations. It implies that individuals who control both the service-providing and service-receiving entities may be taxed on income that is ostensibly earned by a corporation they control. Practitioners should advise clients to structure transactions with clear business purposes and ensure that corporate formalities are respected to avoid similar reallocations of income. This case may influence how similar arrangements are analyzed, particularly in the context of management service agreements and the use of corporate entities to manage personal services. Later cases, such as those involving the assignment of income, may reference Rubin v. Commissioner to determine the true earner of income in complex corporate arrangements.