Taxing Lessons From Court Decisions

Decisions — Incoming Gift

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Pastors get by with a little help from parishioners. But is that help a gift? Or taxable income?

In T.C. Memo. 2018-168 (Felton), parishioners gave their pastor over $200,000 in cash and personal checks in addition to regular church offerings. The pastor says the money was nontaxable gifts. The IRS says the money is taxable income.

Members of the church made donations in white, blue, and gold envelopes. White envelopes were used for normal church contributions. Contributions made in gold envelopes were used for special programs and retreats. Blue envelopes were for “shake-hand” contributions that church members wanted to donate directly to the pastor.

Church members were told they wouldn’t get a tax deduction for blue envelope contributions. They had to ask for a blue envelope if they wished to give in that way. The church opened white envelopes and tracked the donations made in them, but all the blue envelopes were handed over to the pastor unopened.

The church itself didn’t pay the pastor a salary. The pastor preached at the church for almost thirteen years without a salary and, although the executive board authorized a salary for him in 2008 and 2009, he didn’t take it. However, the church did track the “pastoral donations” that congregants made in white envelopes and issued a report to the pastor about those at the end of the year. The report for 2008 showed just over $40,000 in pastoral donations in white envelopes.

The church also gave the pastor $6,500 per month, as a housing allowance.

The pastor filed tax returns for 2008 and 2009 more than a year after the returns were due. He didn’t report any of the donations from the blue envelopes, but did report about $40,000 in wages for each year. These reported wages were the amounts made in white envelopes that donors had designated as “pastoral” donations. The pastor excluded the almost $80,000 parsonage allowance from gross income under internal revenue code section 107.

Here’s a breakdown of the various donations and payments.

 

Image source: Screen capture from court case

At issue were the donations received in the blue envelopes for 2008 and 2008. The pastor said the “blue envelope” donations were gifts from individual church members. The IRS said they were taxable income.

To reach a decision, the court began by defining a gift under tax law as “* * * proceeds from a ‘detached and disinterested generosity,’ * * * ‘out of affection, respect, admiration, charity or like impulses.'”

In addition, the court said the most critical consideration is the transferor’s intention when the payment was made, though “there must be an objective inquiry as to whether what is called a gift amounts to it in reality.”

Since a “bright line” test to determine between gift and income doesn’t exist, the court focused on four factors.

1. Whether the donations were objectively provided in exchange for services

The question here is whether the donations are of the magnitude and type that would make the court doubt that what is called a gift amounts to one in reality.

In other words, are the donations an incentive to keep the pastor preaching at the church?

WHAT WOULD YOU DECIDE?

or

 

2. Whether the pastor (or other church authorities) requested the personal donations

Per the court, the pastor introduced the blue envelopes at the church’s annual business meeting, where he explained that members could use them to make personal donations to him but that there would be no tax deduction if they did. Congregants had to specifically ask an usher for a blue envelope and the pastor never preached about personal donations in blue envelopes.

WHAT WOULD YOU DECIDE?

or

 

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

The blue-envelope donations were made by individual church members, and were made throughout the year. The envelopes say “pastoral gift” on them, and they list all the necessary information about the church and how to make checks out to the pastor personally.

WHAT WOULD YOU DECIDE?

or

 

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

Though the executive board approved a salary for the pastor in 2008 and 2009, the church didn’t actually pay it out to him in either of those years.

The pastor testified that he had in fact preached at the church for almost thirteen years without a salary. He did receive personal donations from some members of the congregation in white envelopes, and he did report them as wages in 2008 and 2009. The church also gave him a parsonage allowance of almost $80,000 per year.

WHAT WOULD YOU DECIDE?

or

 

THE COURT’S DECISION

 

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Note: Taxing Lessons provides a summarized version of sometimes lengthy court decisions. The full case may include facts and issues not presented here. Please use the link provided in the post to read the entire case.

This information should not be considered legal, investment, or tax advice. Taxing Lessons and Top Drawer Ink Corp. do not provide legal, investment, or tax advice. Always consult your legal, investment, and/or tax advisor regarding your personal situation.

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Sorry, wrong answer :(
Right answer!

We find that by this measure the contributions made in blue envelopes were not gifts as that term has developed in tax law, but are rather—from an objective perspective—meant to keep the pastor preaching where he is. He provides intangible religious benefits and the blue envelopes are in exchange for them and would to any reasonable person look like an incentive for him to keep providing them.

This factor tilts towards income.

Right answer!

The fact that the church didn’t solicit blue-envelope donations is an objective sign that the transferors proceeded “from a ‘detached and disinterested generosity,’ * * * ‘out of affection, respect, admiration, charity or like impulses.'”

This factor tilts towards gift.

Sorry, wrong answer :(
Sorry, wrong answer :(
Right answer!

We can’t ignore the sheer size of blue-envelope donations in 2008 and 2009, or the fact that they are very similar in amount in both years—within 10% of each other. We find it more likely than not that this means there was a “regularity of the payments from member to member and year to year,” which “indicates that they were the result of a highly organized program to transfer cash from church members” to the pastor.

These are regular, sizable payments made by people that the pastor provides a service for, and they are therefore hard to distinguish from compensation.

This factor tilts towards income.

Sorry, wrong answer :(
Right answer!

Even if we treat the white-envelope donations as salary—as the pastor seems to have done on his returns—the ratio of that income and the parsonage allowance to blue-envelope donations gives the distinct impression that the transferors knew that, without the donations, they wouldn’t be able to keep their “popular and successful minister.”

The pastor’s purported gifts are around double the total of his deemed salary and parsonage allowance for both of the years at issue.

This all makes the blue-envelope donations seem more like income than gifts.

For the IRS.

When comparatively so much money flows to a person from people for whom he provides services (even intangible ones), and to whom he expects to provide services in the future, we find it to be income and not gifts.

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