Revenue Ruling 83-27: Gift or Compensation to a Spouse?

When a corporation pays a deceased employee’s surviving spouse, its tax treatment depends on the company’s intent. Revenue Ruling 83-27 and related case law provide a framework to determine if the payment is a tax-free gift or taxable compensation. This classification has significant financial implications for both the corporation and the spouse. The determination relies on a factual analysis of the circumstances surrounding the payment, where the substance of the transaction dictates the tax outcome.

Tax Consequences of the Payment Classification

The financial effects of classifying a payment as either a gift or compensation impact both the giver and the receiver. For the corporation, the primary issue is the deductibility of the payment as a business expense. For the surviving spouse, the concern is whether the amount received constitutes taxable income.

If the Payment is a Gift

If a payment is classified as a gift, it is not considered taxable income for the recipient. The payment must stem from the corporation’s “detached and disinterested generosity.” The Internal Revenue Code presumes that payments from an employer are taxable compensation, so a corporation must provide clear evidence that the payment was motivated by generosity rather than a business purpose.

From the corporation’s perspective, a payment classified as a gift is not a deductible business expense beyond the $25 annual limit per recipient. This means a substantial gift payment provides a negligible tax deduction for the company.

If the Payment is Compensation

If the payment is compensation, the amount is fully taxable to the surviving spouse as income and is subject to ordinary income tax rates. This classification assumes the payment is for the deceased’s past services or to create a future business benefit, such as boosting employee morale.

For the corporation, the payment is fully deductible as a business expense, provided the deceased’s total compensation is considered reasonable. This deduction can lower the corporation’s taxable income.

Factors for Determining Payment Intent

The IRS and courts evaluate several factors to determine the corporation’s intent. The decision is based on a comprehensive review of all facts and circumstances, with no single factor being definitive.

• Whether the payment was made directly to the surviving spouse or to the deceased employee’s estate. A payment to the spouse is more indicative of a gift, as it suggests a focus on the individual’s needs, while a payment to the estate is often viewed as a final settlement of compensation.
• The existence of a pre-established plan or policy. If the corporation has a formal, written policy of making such payments, it strongly suggests the payments are part of a compensatory benefits package rather than spontaneous generosity.
• Whether the deceased employee had been fully compensated for their work during their lifetime. If the company can demonstrate that the employee’s salary and bonuses were adequate, it strengthens the argument that the posthumous payment is a gift.
• The corporation’s potential to derive an economic benefit from the payment. If the payment is made to improve employee morale or enhance the company’s public image, a business purpose is implied, pointing toward compensation.
• The financial condition of the surviving spouse. When a corporation investigates the spouse’s financial needs and bases the payment amount on those needs, it supports the characterization of the payment as a gift.
• Whether the surviving spouse performed any services for the corporation. If the spouse has never been an employee and provides no services in exchange for the payment, it helps solidify the payment’s status as a gift.

Required Documentation and Corporate Actions

To substantiate the intended tax treatment, a corporation must create a clear record of its decision-making process. A formal resolution from the Board of Directors is the primary documentation. This resolution should be drafted and approved near the time the payment is authorized, not retroactively.

The language within the resolution is a key factor. If the intent is for the payment to be a gift, the resolution should explicitly state this. It should reference motives that align with “detached and disinterested generosity,” such as respect for the deceased and consideration of the surviving spouse’s financial needs.

Conversely, if the payment is intended as compensation, the resolution should reflect a business purpose. It might characterize the payment as recognition for the employee’s past contributions or as part of a company policy to support employee morale. Other corporate records can support the classification. Minutes from the board meeting where the payment was discussed can provide context, and internal memorandums outlining the justification can also serve as evidence of the company’s intent.

Tax Reporting and Filing Requirements

The tax reporting for the payment is dictated by its classification. The procedural requirements differ for compensation and gifts, and following them is necessary to avoid issues with the IRS.

Reporting Compensation

If the payment is compensation, the reporting method depends on its timing. When a payment occurs in the same calendar year as the employee’s death, it is subject to Social Security and Medicare taxes, which are reported on the deceased’s final Form W-2. The gross payment is also reported to the surviving spouse on Form 1099-MISC as “Other Income.”

If the payment is made in a calendar year after the employee’s death, it is not subject to these taxes or income tax withholding. The payment is then reported only on a Form 1099-MISC issued to the surviving spouse.

Reporting a Gift

When a payment is classified as a gift, the reporting requirements are simpler. The corporation does not issue a Form 1099-MISC or a Form W-2 to the surviving spouse because the payment is not taxable income. The spouse does not need to report the gift on their income tax return.