Revenue Ruling 172-85: Gift or Compensation?

When a corporation makes a payment to the surviving spouse of a deceased employee, the tax implications can be complex. The central issue is whether the payment constitutes a non-taxable gift or taxable compensation. This determination affects both the recipient’s tax liability and the corporation’s reporting duties. The Internal Revenue Service (IRS) provides a framework to analyze the specific facts and circumstances surrounding such payments.

Factors Indicating a Gift

Several factors may suggest that a payment from a corporation to a deceased employee’s surviving spouse is a gift. A primary indicator is when the payment is made directly to the widow or widower, rather than to the deceased employee’s estate. The nature of the payment is further clarified if the corporation had no pre-existing legal obligation to make it, meaning it was not part of an employment contract or established company policy.

Another consideration is whether the corporation derives any future economic benefit from the payment. If the payment does not serve to enhance employee morale or attract future talent, it is more likely to be seen as an act of generosity. Similarly, if the surviving spouse has never performed any services for the corporation, it reinforces the idea that the payment is not in exchange for any work. The payment is also more likely to be classified as a gift if the deceased employee had been fully and adequately compensated for all past services rendered, leaving no outstanding earnings to be settled.

The motivation behind the payment is a significant element in this analysis. Payments made out of affection, respect, or sympathy for the surviving spouse’s situation point toward a gift. The determination is based on the payer’s intent, and when that intent is driven by what the Supreme Court case Commissioner v. Duberstein called “detached and disinterested generosity,” the payment aligns with the definition of a gift under the tax code.

Factors Indicating Compensation

Conversely, certain circumstances strongly suggest that a payment to a surviving spouse is taxable compensation. If the payment is made pursuant to an established company plan or a consistent policy of making such payments, it implies a condition of employment. The characterization of the payment on the corporation’s internal books and records is also telling; treating it as a salary or wage expense indicates the company views it as compensation.

The method used to calculate the payment amount is another important factor. When the payment is determined based on the deceased employee’s salary rate, length of service, or other employment-related metrics, it creates a direct link to the services the employee provided. A payment that is essentially a continuation of the employee’s salary for a set period after death is almost always considered compensation.

These payments are often considered “income in respect of a decedent” (IRD) under the Internal Revenue Code. This classification applies to amounts the employee was entitled to but had not received before death. Payments that vest upon death, such as accrued bonuses or certain nonqualified deferred compensation, fall into this category and are treated as taxable income to the person who receives them.

Corporate Tax Treatment and Reporting

The tax treatment for the corporation making the payment does not always mirror the treatment for the recipient. The classification of the payment is critical for determining its deductibility. If the payment is considered a gift, the corporation’s deduction is generally limited to $25 per recipient per year. In contrast, payments classified as compensation are fully deductible by the corporation as an ordinary and necessary business expense.

If the payment is determined to be taxable compensation, the corporation is required to report it to the IRS and the recipient. This is done using Form 1099-MISC, “Miscellaneous Information,” with the amount reported in Box 3 as “Other income.” If the payment is properly classified as a gift, the corporation has no such reporting obligation. The burden of proof for classifying the payment as a gift rests with the taxpayer, making careful documentation of the decision-making process important for the corporation.