Back in 1913, Woodrow Wilson began his first term as president, and Americans first filed Form 1040s. Right from the beginning, Congress told the IRS to enforce rigid rules for compensation and to forget about gifts. The IRS followed orders. It tells individuals who receive money or other assets as compensation for their efforts that they have to report those items as income, and it tells individuals who receive money or other assets as “gifts” that they don’t have to report those items as income.
Given these differences, the courts often have to resolve vexing wrangles about whether cash and other items at issue should be characterized as gifts, as the recipients assert, or should be characterized as compensation for services rendered, as the IRS asserts. Not unexpectedly, that becomes the key issue in disputes that pit the agency against individuals who are recipients of cash, cars, dwellings, fur coats, gems and other goodies from benefactors other than their spouses or family members. Sometimes, the courts quickly decide income-versus-gift disputes. Here’s how the U.S. Tax Court cut to the chase and resolved one particular case. Drawing a line It all began in Boston in November of 1962. That’s where and when Byrnece S. Green, then 36 years old and a divorced secretary with a 15-year-old son, met Maxwell Richmond, a wealthy 49-year-old bachelor, whose holdings included licenses to operate three radio stations. They "met cute" and fell in love, just like Meg Ryan and Tom Hanks in "Sleepless in Seattle." About a month after they first met, Maxwell proposed marriage and Byrnece accepted. They announced their wedding plans to their families and friends. Cut to October 1963, when he begged Byrnece to cancel their engagement. The snag: Maxwell’s "mental hang-up" about marriage. She reluctantly went along with his solution: Just agree to live with him without the benefits of matrimony. In return, he’d leave her "everything." Spoiler alert: The arrangement proved to be more advantageous for him than for her. She was loyal to the nth degree and savvy. Even better, Byrnece was an around-the-clock multitasker. She worked as a stockbroker, spoke on his radio station about financial matters, advised him on his business affairs and investments, monitored his diet, cared for him during illnesses, and accompanied him on business trips and social engagements. Maxwell somehow never got around to showing his will to Byrnece, but assured his inamorata it provided for her. The two were inseparable until October of 1971, when he died in her arms during a heart attack. That’s when she first became aware of a will that left "Mr. Right’s" entire $7 million estate to his brother and sister. She sued the estate for the value of services rendered in reliance on his promise. The protracted litigation ended when she agreed to settle for $900,000 payable over two years. The government gets involved This wasn't the end, though. Enter the IRS, because Byrnece decided that she didn’t have to include those payments in her tax returns for 1977 and 1978. The 1040s were accompanied by statements explaining that the payments were nontaxable gifts or bequests from Maxwell; she claimed that all the initiatives that she’d performed were "wifely services." The IRS thought otherwise. It determined that she received compensation and owed back taxes and interest. Byrnece decided to try her luck with the U.S. Tax Court. It sided with the IRS, as did the U.S. Court of Appeals for the 2nd Circuit. The U.S. Tax Court’s decision emphasized that "the taxability of the proceeds of a lawsuit depends ... upon the nature of the claim." Because Byrnece based her claim on the value of her services, the $900,000 was clearly taxable income. This is a lesson on the strictures of tax law and the importance of clear estate planning. Comments are closed.
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