Rev. Rul. 64-220

Advice has been requested with respect to the treatment for purposes of the Self-Employment Contributions Act (chapter 2, subtitle A, Internal Revenue Code of 1954) of amounts received by the beneficiary supervising property held in trust by a trust company as trustee.

A trust company holds only the legal title to an office building which was conveyed to it in trust by a father for the benefit of his four children. Under the terms of the trust agreement the four children, as beneficiaries, have the sole right to control and manage the property, including the collection and disposition of the rents. Each beneficiary is to share in the trust property and income. The interests of the beneficiaries may be assigned and transferred and the death of any beneficiary does not terminate the trust. The trust company is required, under the terms of the trust agreement, to dispose of the property remaining at the end of the trust period and to divide the proceeds among those entitled to receive them under the agreement.

Under an agreement with the other beneficiaries, one of the beneficiaries supervises the property in accordance with management policies and decisions determined by majority vote of all the beneficiaries. The beneficiary supervising the property shows and rents office space, performs the janitorial services, collects the rents, deposits them in a checking account in his name as agent for the building trust, and pays all expenses in connection with the management of the property. His janitorial services consist of cleaning the public entrances, exits, stairways and lobbies, collecting trash, and so forth. As remuneration for his services he receives a specified amount each week from the gross rents collected. Monthly financial reports are required and are submitted to each of the beneficiaries. At the end of each month the four beneficiaries divide the net income from the property on the basis of their respective interests in the trust.

In deciding whether the income derived by the beneficiary supervising the property should be considered `net earnings from self-employment' within the meaning of section 1402(a) of the Act, it is first necessary to determine whether the arrangement is classifiable for tax purposes as a partnership and not as a corporation or a trust within the meaning of the Code.

Section 301.7701-3 of the Regulations on Procedure and Administration provides that the term `partnership' includes a syndicate, group, pool, joint venture, or other unincorporated organization through or by means of which any business, financial operation, or venture is carried on, and which is not a corporation or a trust or estate within the meaning of the Code.

Section 301.7701-4(b) of the regulations states that there are arrangements which are known as trusts because the legal title to property is conveyed to trustees for the benefit of beneficiaries, but which are not classified as trusts for the purposes of the Code because they are not simply arrangements to protect or conserve the property for the beneficiaries. The fact that any organization is technically cast in the trust form, by conveying title to property to trustees for the benefit of persons designated as beneficiaries, will not change the real character of the organization if the organization more nearly resembles an association or a partnership than a trust.

Section 301.7701-2(a)(1) of the regulations provides that the term `association' refers to an organization whose characteristics require it to be classified for purposes of taxation as a corporation rather than as another type of organization such as a partnership or a trust. There are a number of major characteristics ordinarily found in a pure corporation which, taken together, distinguish it from other organizations. These are: (i) associates, (ii) an objective to carry on business and divide the gains therefrom, (iii) continuity of life, (iv) centralization of management, (v) liability for corporate debts limited to corporate property, and (vi) free transferability of interests. An organization will be treated as an association if the corporate characteristics are such that the organization more nearly resembles a corporation than a partnership or trust.

Section 301.7701-2(a)(3) of the regulations states that an unincorporated organization is not classified as an association unless it has more corporate characteristics than noncorporate characteristics.

The arrangement as set forth in the agreement in the instant case encompasses a holding of legal title to the property by a trustee with management, control, and operation of the property vested in the beneficiaries. A power to direct the trustee in dealing with title to the trust property is held by the beneficiaries. Each beneficiary has a designated percentage interest in the trust property and income. They are associated in carrying on the business, that is, the operation and management of the property and division of the gains therefrom. Therefore, the arrangement clearly has the corporate characteristics of associates and an objective to carry on business and divide the gains therefrom.

The organization has continuity of life since the death of a beneficiary does not terminate the arrangement but merely results in a shift of title to his interest, to his estate, or other successor in interest.

The organization does not have centralization of management since no person, or group of persons less than all of the members, can have exclusive authority to make the management decisions necessary for the conduct of the business.

Where beneficiaries of a trust have the power to manage the trust property and direct the trustee, they have been held liable as partners to third parties ( Conover's Estate , 295 Ill.App. 443, 14 N.E.2d 980 (1938)). Since management and control of the trust property is in the beneficiaries, the arrangement does not have the corporate characteristic of limited liability.

The trust instrument places no restrictions on transfer of the beneficiaries' intersts in the trust. The only requirement set forth in the instrument is that the original or a duplicate of an assignment of an interest must be lodged with the trustee. The arrangement, therefore, has the corporate characteristic of free transferability of interests.

Although technically cast in trust form, the arrangement lacks the characteristics of limited liability and centralization of management which are generally common to trusts. The lack of these characteristics, coupled with the presence of associates and an objective to carry on business and divide the gains therefrom, characteristics which are common to both corporations and partnerships and generally lacking in trusts, indicates that the arrangement is not merely to protect and conserve the property for the beneficiaries but is an arrangement whereby the bare legal title to the business property has been transferred to a trustee to facilitate holding of title and the beneficiaries operate the business either as an association or a partnership.

Since the arrangement has the two corporate characteristics of free transferability of interests and continuity of life, and does not have the corporate characteristics of centralization of management and limited liability, the arrangement does not have more corporate than noncorporate characteristics.

It is concluded, therefore, that the arrangement is classifiable as a joint venture or a partnership for Federal income and self-employment tax purposes with the beneficiaries as members thereof.

Section 1402(a) of the Act defines the term `net earnings from self-employment' as gross income derived by an individual from any trade or business carried on by such individual, less the deductions allowed for income tax purposes which are attributable to such trade or business, plus his distributive share, whether or not distributed, of certain income or loss from any trade or business carried on by a partnership of which he is a member, with certain exclusions.

Paragraph (1) of section 1402(a), supra, excludes from net earnings from self-employment rentals from real estate and from personal property leased with the real estate, together with deductions attributable thereto, unless such rentals are recieved in the course of a trade or business as a real estate dealer.

In defining rentals from real estate, section 1.1402(a)-4(c)(2) of the Income Tax Regulations provides that payments for the use or occupancy of rooms or other space where services are also rendered to the occupant, such as for the use or occupancy of rooms or other quarters in hotels, boarding house, or apartment houses furnishing hotel services, and so forth, do not constitute rentals from real estate and, consequently, such payments are included in determining net earnings from self-employment. See Rev. Rul. 55-559, C.B. 1955-2, 315. Generally, services are considered rendered to the occupant if they are primarily for his convenience and are other than those usually or customarily rendered in connection with the rental of rooms or other space for occupancy only, such as maid service. However, the furnishing of heat and light, the cleaning of public entrances; exits, stairways and lobbies, the collection of trash, and so forth, are not considered as services rendered to the occupant.

In the instant case, the services performed by the beneficiary supervising the property do not constitute services rendered to the occupants as contemplated by the regulations.

Accordingly, it also is concluded that the weekly payments made to the supervising beneficiary and his distributive share of the profits from the rental of space in the office building constitute rentals from real estate and are excluded in computing net earnings from self-employment for purposes of the Self-Employment Contributions Act. They are, however, includible in computing gross income for Federal income tax purposes.