A Case Study on Employee Payments as Gifts

Employers often ask whether a payment they make to an employee can be considered a gift.  Courts have addressed the issue of gifts in the employment context many times, always with the same finding:  employee payments are not gifts.  Recently, the U.S. Tax Court dealt with an analogous situation, and its reasoning illustrates the logic courts apply in determining whether a payment qualifies as a gift.

In the dispute considered by the U.S. Tax Court, a Minnesota church reverend offered congregants three types of envelopes each week to make contributions: 1) white envelopes for contributions supporting the church, including amounts directed to the reverend for his income; 2) gold envelopes for special programs; and 3) blue envelopes designated as “pastoral gifts.”  The reverend included the amounts from the white envelopes in his salary, but accepted the amounts donated in the blue envelopes as “gifts.”  As a result, over a several-year period the reverend actually took no salary but instead received over $200,000 in “gifts” each year.  Because the funds were considered gift, the reverend did not claim the funds as wages when filing his tax returns.  The IRS disagreed, and the case made its way to the U.S. Tax Court.

In making its determination regarding whether the money received by the reverend was wages or gifts, the court looked at four factors:

  1. Whether, from an objective standpoint, the donations were provided in exchange for services;

  2. Whether the reverend requested the donations;

  3. Whether the donations were part of a routinized, highly structured program and given by individual members, or given by the congregation as a whole; and

  4. Whether the reverend received a separate salary from the church, and the amount of that salary in comparison to the personal donations. 

While in the situation here the “gifts” were made by congregants, it is similar to when an employer seeks to give a gift to its employee.  Because the blue envelopes were only provided upon request and the reverend made no comments about providing such a gift, the court found the second factor weighed in favor of the reverend’s position that such donations were gifts.  However, based on its analysis of the first, third, and fourth factors, the court found the donations were more appropriately classified as wages, determining the donations were provided in exchange for the reverend’s services, the amounts received by the reverend were similar each year and provided in a structural system, and the “gifts” effectively replaced the reverend’s salary.  Because the court found three factors in favor of the payments being income, the payments were ultimately deemed income, and the reverend was required to pay back taxes, fines, and penalties.

While this particular fact pattern may not apply to your organization, the analysis supplies a good lesson regarding the risks of treating any income as a gift wherever a business or service provider relationship also exists.