Revenue Ruling 83-73: Gift or Compensation?

When a company makes a payment to the surviving spouse of a deceased employee, it can be a non-taxable gift or taxable compensation, which has significant tax implications for both parties. The determination is based on the specific facts and circumstances surrounding the payment. The foundation for this analysis comes from the Supreme Court case, Commissioner v. Duberstein, which established the standard for what constitutes a gift. A gift proceeds from a “detached and disinterested generosity,” motivated by affection or respect. A payment is not a gift if it is a return for services rendered or if the payer expects to receive an economic benefit.

Factors for Determining Gift Status

Whether a payment to a surviving spouse is a gift hinges on a review of several factors, with no single one being decisive. The IRS analyzes the complete picture presented by the circumstances. A primary consideration is that the payment was made directly to the surviving spouse and not to the deceased employee’s estate. A payment to the estate is more likely viewed as a final settlement of compensation for past services.

A corporation’s history and policies are also scrutinized. If the company has an established plan, policy, or contractual obligation to make such payments, the IRS will likely classify the payment as compensation. A consistent practice of making these payments suggests it is part of a standard employee benefit package. For a payment to be a gift, it should be a voluntary, non-compulsory action.

Another factor is whether the corporation derives any economic benefit from the payment. The analysis focuses on direct benefits. If the payment is made to secure the future services of other employees or as a substitute for a more costly pension plan, it points toward compensation. A gift is made without the expectation of a future economic return.

The circumstances of the recipient and the deceased employee are also part of the evaluation. That the surviving spouse performed no services for the corporation is a strong indicator of a gift. The IRS also looks at whether the deceased employee had been fully compensated for all their prior work. If there were outstanding bonuses or unpaid salary, a payment to the spouse could be seen as settling that obligation.

Finally, the method used to determine the payment amount is relevant. A payment calculated based on the deceased employee’s former salary or length of service suggests it is deferred compensation. Conversely, if the board of directors inquired into the financial needs of the surviving spouse and tailored the payment accordingly, it strengthens the argument that the payment was motivated by generosity.

Corporate Tax Treatment and Documentation

The classification of a payment has direct consequences for the corporation’s tax obligations. If the payment is determined to be compensation for past services of the deceased employee, the corporation can deduct the full amount as a business expense. This treatment aligns with how the company handles other forms of employee compensation.

A different set of rules applies if the payment is classified as a gift. The corporation’s ability to take a tax deduction is limited, as the deduction for business gifts is capped at $25 per recipient per year. This small allowance means that for any substantial payment, the vast majority would not be deductible by the corporation.

The documentation created by the corporation at the time of the payment is important. The resolution passed by the company’s board of directors authorizing the payment serves as the primary evidence of the company’s intent. To support a gift classification, the resolution should be carefully worded to reflect motives of generosity and sympathy.

The board’s resolution should explicitly state that the payment is intended as a gift to the surviving spouse. It should avoid any language that suggests the payment is for past services rendered by the deceased employee or that the company expects any future benefit. Effective resolutions often include language expressing sympathy for the spouse’s loss, acknowledging the deceased employee’s valuable contributions, and noting that the board considered the financial needs of the surviving spouse in determining the amount. This formal record is what the IRS will review to understand the company’s intent.

Recipient Tax Reporting

From the perspective of the surviving spouse, the tax implications mirror the corporation’s treatment. The classification of the payment determines whether the money is subject to income tax. This creates a scenario where the interests of the corporation and the recipient may be opposed; the corporation benefits from a compensation classification, while the recipient benefits from a gift classification.

If the payment is established as a gift, the tax outcome for the recipient is highly favorable. Gross income does not include the value of property acquired by gift. This means the surviving spouse can receive the entire amount free of federal income tax. The funds are not reported as income on their tax return.

Should the payment be classified as compensation, the tax treatment for the recipient is different. The full amount of the payment is considered taxable income. The surviving spouse must report the payment on their federal income tax return for the year it was received and it would be subject to ordinary income tax rates.

In situations where the payment is deemed compensation, the corporation is responsible for reporting it to the recipient and the IRS. The company would issue a Form 1099-MISC or Form 1099-NEC to the surviving spouse. The form details the amount paid, and a copy is sent to the IRS. The issuance of one of these forms is a clear signal that the payer considers the funds to be taxable income.