IRS Revenue Ruling 82-53: Tax Rules for Corp Payments
IRS Revenue Ruling 82-53 clarifies tax implications for payments to a deceased employee's heirs by analyzing the corporation's primary intent.
The tax treatment of payments from a corporation to the surviving spouse or heirs of a deceased employee-shareholder depends on whether they are a gift, compensation for past services, or a dividend. This classification dictates the tax consequences for both the corporation and the recipient under the Internal Revenue Code.
Determining the Nature of the Payment
The Internal Revenue Service (IRS) evaluates several factors to understand the corporation’s primary motivation for making a payment to the survivors of a deceased employee-shareholder. No single factor is controlling; instead, they are weighed together to paint a complete picture of the transaction’s intent. This analysis is grounded in case law, such as Commissioner v. Duberstein, which emphasized that a gift proceeds from a “detached and disinterested generosity.”
A primary consideration is whether the payment was made directly to the surviving spouse or heirs, rather than to the deceased employee’s estate. Payments to an estate are more likely to be viewed as settlement of a debt. Another factor is the existence of a legal obligation. If the corporation was contractually bound to make the payment, it cannot be classified as a gift.
The IRS also investigates whether the payment was for the employee’s past services. If the amount is tied to the employee’s salary or performance, it suggests the payment is compensatory. If the payment amount was determined by the financial needs of the surviving family, it lends weight to the argument that it was a gift. The board of directors’ resolution authorizing the payment is examined for language that characterizes its purpose.
Corporate Tax Treatment
If the payment is a gift, the corporation is not permitted to deduct the amount. Gifts are not considered ordinary and necessary business expenses.
When the payment is classified as compensation for the past services of the deceased employee, it is generally deductible by the corporation as a business expense. For the deduction to be allowed, the total compensation paid for the employee’s services, including this final payment, must be deemed reasonable in amount.
Should the payment be classified as a dividend, it is not deductible by the corporation. A dividend represents a distribution of the corporation’s earnings and profits to its shareholders. Payments to a survivor can be interpreted as a constructive dividend if the payment amount corresponds to the decedent’s stock ownership.
Recipient Tax Treatment
The tax consequences for the surviving spouse or heir who receives the payment depend on its classification. While a corporation may intend for a payment to be a gift, it is very difficult for the recipient to treat it as a non-taxable gift.
Under the Internal Revenue Code, the exclusion for gifts from gross income generally does not apply to amounts transferred by an employer to an employee’s survivors. Because the payment arises from the employment relationship, the IRS almost always views it as taxable income to the recipient.
If the payment is categorized as compensation, it is fully taxable to the recipient as ordinary income and considered “income in respect of a decedent.” If the payment is treated as a dividend, it is also taxable to the recipient. The amount would be reported as dividend income, which may be taxed at preferential rates.