When is a gift not a gift? According to the US supreme court, “determination in each individual case as to whether the transaction in question was a “gift” must be based ultimately on the application of the factfinding tribunal’s experience with the mainsprings of human conduct to the totality of the facts in the case, and appellate review of the conclusion reached by the fact-finding tribunal must be quite restricted.”
Yes, that means exactly what you think it means. The answer is—it depends, probably the two most frequently used words in tax. Why do we care? Because when a gift is not a gift, the transfer might be taxable income.
In T.C. Memo. 2018-190 (Duncan) the taxpayer, a retired police officer, was a self-employed attorney specializing in workers’ compensation cases for police and fire officials.
The taxpayer successfully represented a former police officer who was injured in the line of duty in a lawsuit against the city that was the officer’s former employer and a state pension fund. The taxpayer was the attorney from the time the lawsuit began in 1994 through its conclusion in 2008. The taxpayer’s client got a lump-sum payment for accrued pension benefits of more than $360,000.
The taxpayer received a $2,500 “flat fee” at the outset of the lawsuit in 1994. After the lawsuit concluded, the taxpayer’s client gave him a check for $30,000. The taxpayer deposited the check into his personal checking account on November 10, 2008.
The taxpayer’s client self-prepared his own federal income tax return for 2008. He deducted the $30,000 payment as a legal expense, and he did not file a federal gift tax return for 2008.
The taxpayer did not report the $30,000 on his 2008 federal income tax return. He believes the money was a nontaxable gift. He says the client gave him the money out of disinterested generosity resulting from a personal relationship to which the taxpayer’s representation in the lawsuit against the city and the pension fund was incidental. He argues that there was no binding contract or legal obligation requiring the client to make the payment. He agrees that even though the client considered the taxpayer a friend as well as his attorney, the client would not have given $30,000 to the taxpayer if he had not received the lump-sum payment.
The IRS says that even if the taxpayer and his client developed a personal relationship over time, their primary relationship was that of lawyer and client, and the client gave the taxpayer $30,000 out of his proceeds from the lawsuit as compensation for that relationship. The IRS argues that the client’s deduction of the payment as a legal expense on his own federal tax return demonstrates his intent.
Both the taxpayer and the IRS relied on a supreme court case from 1960 (Duberstein) to support their arguments.
In the Duberstein case, the supreme court said the existence of a personal relationship between a donor and a donee, the lack of moral or legal obligation on the donor to make a payment, and the donor’s tax treatment of the payment, each standing alone, were all deemed irrelevant or subordinate considerations. Instead, the characterization of a transfer depends on the factfinder’s perception in the light of all the evidence.
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For the IRS.
After weighing the evidence in the record, including the client’s testimony, we hold that the client gave $30,000 to the taxpayer primarily out of gratitude for attorney services and for bringing the lawsuit to a successful conclusion after 14 years.
We find most persuasive as clear indications that the client was not making a gift to the taxpayer the facts that
(1) he would not have given $30,000 to the taxpayer but for his receipt of the lump-sum payment exceeding $360,000 from the lawsuit and
(2) he deducted the $30,000 on his federal income tax return.
The facts in this case in many ways mimic the facts of Duberstein—even though the taxpayer did not solicit it, the payment from the client appears intended as compensation for a job well done (akin to a tip or gratuity for exceptional services rendered) and much more directly so than in many cases in which we have similarly held.
We sustain the IRS’s determination that the taxpayer had additional business income for 2008 of $30,000.