Wolder v. Commissioner: Compensation vs. Bequest

The tax case Wolder v. Commissioner examines the distinction between a tax-free inheritance and taxable compensation. The case involved an attorney who received assets from a client’s will as part of a pre-existing agreement for services. The court’s decision established a precedent that the substance of a transaction, not its form, determines its taxability.

Factual Background of the Agreement

The case began with a formal, written agreement between attorney Victor R. Wolder and his client, Marguerite K. Boyce. In 1947, they entered into a contract where Wolder agreed to provide Boyce with all legal services she required for the remainder of her life, free of charge. This meant Wolder would not bill her for his time or expertise.

In exchange, Boyce agreed to a provision in her will bequeathing certain assets to Wolder. These assets were initially 500 shares of stock in White Laboratories, which later became 750 shares of Schering Corporation and other securities after a merger. The agreement specified that Wolder would be entitled to these replacement securities.

For nearly two decades, both parties adhered to their contract. Wolder provided legal counsel without invoicing Boyce, and she maintained the provision in her will. This arrangement created a binding obligation linking the services to the property Wolder would receive.

The Tax Dispute

The tax dispute arose after Boyce’s death in 1965. As agreed, Wolder received 750 shares of Schering Corporation stock and $15,845 in cash from her estate.

On his tax return, Wolder treated the stock and cash as a tax-free bequest under Internal Revenue Code Section 102. This section excludes the value of property acquired by inheritance from gross income. He therefore did not report the assets as taxable.

The IRS challenged this treatment. The Commissioner of Internal Revenue disagreed with Wolder’s characterization of the assets, asserting they were not a tax-free bequest but rather payment for the legal services he provided.

The IRS issued a notice of deficiency, stating the assets’ fair market value should have been included in Wolder’s gross income. Wolder maintained the transfer was a tax-exempt inheritance. The Commissioner argued it was taxable compensation.

The Court’s Ruling and Rationale

The court addressed whether property transferred via a will to fulfill a service contract could be a tax-free bequest. The U.S. Court of Appeals ruled against Wolder, finding the assets were taxable income. The decision was based on the principle that the substance of a transaction prevails over its form.

The court’s rationale cited the absence of “detached and disinterested generosity,” a standard from the earlier case of Commissioner v. Duberstein. This principle holds that a true bequest must be motivated by affection or respect, not in return for services. The transfer to Wolder was not a spontaneous act of generosity but the fulfillment of a legally enforceable contract.

The court emphasized the transfer satisfied a binding obligation. Wolder provided legal services with the documented expectation of future payment, which was deferred until Boyce’s death. The will was merely the vehicle for delivering this payment, and its use did not change the payment’s character as compensation.

The court reasoned that if Boyce had paid Wolder annually, the payments would have been taxable income. Delaying payment through her estate did not alter this tax reality. The transaction was a bargained-for exchange, and the assets were the result of his labor, not an inheritance.

The Established Tax Principle

The Wolder case solidified a principle in U.S. tax law: the intent behind a transfer, not its method, determines its tax treatment. Compensation for services is taxable as gross income under Internal Revenue Code Section 61. This is true whether payment is made directly or through a provision in a will.

This ruling distinguishes tax-free bequests from taxable income. A true bequest stems from donative intent, given without expectation of anything in return. In contrast, a transfer made to pay for services is compensation, and a contract is strong evidence that the transfer is not a gift.

The precedent from Wolder guides individuals and professionals structuring service agreements, particularly those with deferred or estate-based payments. It shows that one cannot simply label a payment a “bequest” to avoid taxation if it is, in substance, earned income. The IRS and courts will look beyond such labels to the economic reality of the transaction.