Baker v. Commissioner

Charles Baker (plaintiff) was the sole beneficiary of an irrevocable, complex trust established by his parents. The trust documents allow the trustee, who was Charles Baker, to determine what was income and what was principal from the trust. In 1982, the trust reported income of $80,043.05 in capital gains, $36,410.32 in interest, and $1,031.60 in dividends. The trust reported partnership losses of $43,690.96, which included loss attributable to investment in Sentinel Government Securities (Sentinel) of $5,424.82. The trust also reported interest expenses of $52.24 and trustee fees of $832.33. On his 1982 taxes, Baker indicated $50,000 as distribution of trust income, all of which he indicated to be long-term capital gain. He also claimed a deduction of $7,142.61 for partnership losses allocated to him by the trust. Accordingly, Baker reported $42,857.39 in gross income from the trust, which was identical to the trust’s claimed $42,857.39 in distributable net income. In 1988, the United States Tax Court found that Sentinel had been created solely to generate tax losses, and accordingly, the government (defendant) disallowed $5,424.82 of the $7,142.61 in partnership losses that Baker had claimed on his own income-tax return in 1982, with the remaining $1,717.79 being Baker’s proper share of loss from the trust. The government argued that Baker was liable for the full deficiency unless he could prove that the Sentinel loss was not part of the partnership loss he had claimed as a deduction. In the alternative, the government posited that the trust should increase its income and distributable net income to factor in the disallowance of the Sentinel loss. Baker argued that the Sentinel loss should be divided between himself and the trust, with the trust covering the remainder of the deficiency.