What Is IRS Revenue Ruling 79-36?
IRS Revenue Ruling 79-36 provides guidance for classifying payments to a surviving spouse as either a non-taxable gift or as taxable compensation.
When an employee dies, payments from their former employer to the surviving spouse can be either a gift or compensation, a distinction with significant tax consequences. Guidance for this issue comes from the U.S. Supreme Court case Commissioner v. Duberstein, which established that the payment’s nature is determined by the employer’s intent based on the specific facts and circumstances. A prior $5,000 death benefit exclusion was repealed in 1996, making the determination between a gift and compensation more important.
Factors for Determining Tax Treatment
The Internal Revenue Service (IRS) evaluates several factors to ascertain the employer’s primary motivation. One consideration is whether the payment was made directly to the surviving spouse rather than to the deceased employee’s estate. Payments to the spouse are more likely viewed as generosity, while payments to an estate suggest a business obligation. The existence of a formal plan or an established policy for making such payments also influences the determination, as a consistent practice suggests a compensatory framework.
Another factor is the surviving spouse’s relationship with the corporation, such as being a shareholder or service provider. The IRS also scrutinizes how the payment amount was calculated. A payment based on the deceased’s salary points toward compensation, while an amount determined by the surviving spouse’s financial needs is more indicative of a gift.
The analysis also considers if the corporation derived any economic benefit, such as boosting employee morale, which could be interpreted as a business expense. The company’s formal characterization of the payment in its records and resolutions is also reviewed, as this provides insight into its intent.
Tax Implications for Payer and Recipient
The classification of the payment as either a gift or compensation creates distinct tax outcomes. If the payment is determined to be a gift, the corporation’s deduction is generally limited to $25 per year for that recipient. For the surviving spouse, the payment is typically excluded from their gross income.
Should the payment be classified as compensation, the tax implications are reversed. The corporation can generally deduct the full amount as an ordinary and necessary business expense. For the surviving spouse, the payment is considered taxable income, often reported on Form 1099-MISC as “Other Income.”