The distinction between taxable compensation and non-taxable gifts comes up in a number of contexts and has led to a number of tax disputes. Severance payments made to workers are an example. The recent Felton v. Commissioner, T.C. Memo. 2018-168, court case addressed this issue in the context of segregated donations made by a congregation to a church pastor.
The Facts & Procedural History
The taxpayers are a charismatic pastor and his wife. The court case focused on donations the congregation made to the church and the pastor.
His church collected its offerings in three different envelopes: white, gold, and blue.
The white envelopes were used for normal contributions. They had a line on them marked “pastoral” which were to be paid directly to the pastor. The church recorded these in its accounting software, the church reported them as contributions in the member statements, and the church reported the amounts as income to the pastor.
The gold envelopes were used for special programs and retreats.
The blue envelopes were used for donations directly to the pastor. The church explained to members that the contributions made in blue envelopes were not deductible.
The church did not go out of its way to solicit donations in the blue envelopes, as it did with the white envelopes.
During the years at issue, the pastor received over $40,000 in white “pastoral” donations and over $200,000 in blue envelope donations. The pastor reported the $40,000 but not the $200,000. On audit, the IRS argued that the $200,000 was taxable as income for the pastor.
Compensation for Services vs. Gifts
The general rule is that all accessions to wealth are treated as income that is subject to tax. This includes compensation for services rendered.
There is an exception for gifts, which are not subject to tax. There is no bright line rule for what qualifies as a gift.
The law defining what a gift is is summarized as follows:
- A gift is a voluntary amount paid with an ‘detached and disinterested generosity’ made ‘out of affection, respect, admiration, charity or like impulses.’
- The most critical consideration is the transferor’s intention when the payment was made.
- But the transferor’s characterization of his intention “is not determinative.”
The question in this case is whether the donations in the blue envelopes were taxable compensation for services or non-taxable gifts.
Balancing the Compensation vs. Gift Factors
The court considered several prior cases in which churches paid a departing pastor. The payments were not in exchange for the pastor continuing to provide services. Rather, they were in the form of payments to ensure the pastors maintained a basic income after they stopped providing services to the church. The courts found these payments to be non-taxable gifts and not income. The courts reached these decisions by noting the intent was to make a gift.
Next the court considered a prior court case in which the church members made contributions to the pastor on holidays and testified that they made the payments to keep the pastor employed with the church. The court in that case had found the contributions to be income to the pastor.
In applying these cases, the court noted that the following factors would have to be present to be non-taxable gifts:
- Not be provided in exchange for services.
- Not be actively solicited.
- Be made pursuant to a plan or structured program by the church.
- Be separate from the salary paid to the pastor and reasonable in amount in light of the salary.
In applying these factors, the court concluded that the contributions in the blue envelopes were compensation for services taxable as income rather than non-taxable gifts.