by Mary Howley *
Although gifts are generally excluded from income, gifts from employers to employees are generally included in income. Achievement awards given to employees from employers may be excluded from income in certain cases. Holiday gifts of food or other merchandise of nominal value are not taxable income to the employee, but may be deducted as an ordinary and necessary business expense by the employer. Shareholder gifts of stock generally result in income to the employee and a deduction by the employer.Deductible compensation payments must be reasonable and must be for the payment of services. Payments labeled as compensation may be determined to be dividends. Payments labeled as a loan may be determined to be compensation.
Compensation versus Gift
Gross income generally does not include the value of property acquired by gift. [IRC § 102(a).] Amounts transferred by or for an employer to or for the benefit of an employee, however, are not considered gifts and are includable in gross income. [IRC § 102(c).] Exceptions to this rule apply in the case of certain employee awards, qualified scholarships, and de minimis fringe benefits. Amounts transferred to nonemployees will be includable in income if the gifts are primarily the result of a legal or moral duty or consideration for services rendered or because of an anticipated economic benefit. [Commissioner v. Duberstein, 363 U.S. 278 (U.S. 1960).]
Amounts received as prizes and awards are generally included in gross income. [IRC § 74(a).] Exceptions are made for qualified scholarships [IRC § 117] and certain prizes and awards from an employer to an employee in recognition of some achievement in connection with employment. [IRC § 74(b); Treas. Reg. § 1.74-1(a).]
Whether an award is presented as part of a meaningful presentation is determined by a facts and circumstances test. While the presentation need not be elaborate, it must be a ceremonious observance emphasizing the recipient's achievement in the area of safety or length of service. [Prop Treas Reg § 1.274-8(c)(3).]An award is considered disguised compensation if the conditions and circumstances surrounding the award create a significant likelihood that it is payment of compensation, such as the making of the award at the time of annual salary reviews or in lieu of a prior bonus program. [Prop Treas Reg § 1.274-8(c)(4).]
Holiday and Other Gifts
The Service has ruled that, even aside from the de minimis fringe benefit exception, holiday gifts of food or other merchandise of nominal value are not taxable income to the employee, but may be deducted as an ordinary and necessary business expense by the employer. [Treas. Reg. § 1.132-6(a).] This rule does not apply to cash, or items readily convertible to cash. Gift certificates redeemable for merchandise in stores of the employer's customers, where the amount was $25 for all regular employees regardless of salary, were nontaxable gifts. [Hallmark Cards, Inc. v. United States, 200 F. Supp. 847 (W.D. Mo. 1961).]
Shareholder Gifts of Stock
The distribution of stock to employees, even if labeled as a gift, will generally be taxable as compensation. Employees will be taxable on the fair market value of the stock. [IRC § 83(a).]
An employer may deduct compensation paid as an ordinary and necessary business expense. [IRC § 162.] The test for whether compensation payments are deductible is whether the payments are reasonable and are in fact payments purely for services. [Treas. Reg. § 1.162-7(a).]...
Companies may extend low-cost or no-cost loans to employees. In certain cases, the loan is really disguised compensation. [Tussaud's Wax Museums, Inc. v. Commissioner, T.C. Memo 1966-211 (T.C. 1966).]Factors that indicate the existence of a bona fide loan include:
• the existence of a promissory note,
• cash payments according to a specified repayment schedule,
• interest is charged, and
• there is security for the loan. [See Reed v. Commissioner, T.C. Memo 1994-611 (T.C. 1994); Frierdich v. Commissioner, T.C. Memo 1989-103 (T.C. 1989), affd, 925 F2d 180 (7th Cir 1991).]
Interest is imputed on below-market loans, including compensation-related loans. A demand loan is a below-market loan if interest is payable at a rate less than the applicable Federal rate. A term loan is a below-market loan if the amount loaned exceeds the present value of all payments due under the loan, determined as of the day the loan is made, using a discount rate equal to the applicable Federal rate in effect on the day the loan is made. [IRC § 7872(a).]
Compensation-Related Loans Defined
IRC Section 7872(a) applies to compensation-related loans. A compensation-related loan is any below-market loan directly or indirectly between:
• an employer and an employee,
• an independent contractor and a person for whom such independent contractor provides services, or
• A partnership and a partner if the loan is made in consideration for services performed by the partner acting other than in his capacity as a member of the partnership. [IRC Section 7872(c)(1)(B); Prop Treas Reg § 1.7872-4(c)(1).]
Forgone Interest on Compensation-Related Loans.
Forgone interest, with respect to any period during which a loan is outstanding, means:
• the amount of interest that would have been payable on the loan for the period if interest accrued on the loan at the applicable Federal rate and were payable annually on the last day of the calendar year, over
• the amount of interest on the loan. [IRC Section 7872(e).]
De Minimis Exception for Compensation-Related Loan
IRC Section 7872 does not apply to any day on which the aggregate outstanding amount of loans between the borrower and lender does not exceed $ 10,000. [IRC § 7872(c)(3)(A).] However, this exception does not apply where one of the principal purposes of the interest arrangement of the loan is tax avoidance. [IRC § 7872(c)(3)(B).]
A compensation-related loan will be exempt from IRC Section 7872, where the loan is secured by a mortgage on the employee's new principal residence, acquired in connection with the transfer of the employee to a new principal place of work, if the following conditions are satisfied:
• The loan is a demand loan or is a term loan the benefits of the interest arrangements of which are not transferable by the employee and are conditioned on the future performance of substantial services by the employee;
• The employee certifies to the employer that the employee reasonably expects to be entitled to and will itemize deductions for each year the loan is outstanding; and
• The loan agreement requires that the loan proceeds be used only to purchase the new principal residence of the employee. [ Prop Treas Reg § 1.7872-5(c)(1)(i).]
LEXIS users can access the complete commentary HERE. Additional fees may apply. (Approx. 20 pages)
* Mary Howley, Esq. is a federal tax author who works on such publications as Matthew Bender's Federal Tax Guidebook, Federal Income, Gift and Estate Taxation, and Professional Corporations and Associations. Ms. Howley received a B.A. from Albany State University, a J.D. from St. John's Law School, and was admitted to the New York State bar in 1983. She holds an LL.M. in taxation from New York University.Information referenced herein is provided for educational purposes only. For legal advice applicable to the facts of your particular situation, you should obtain the services of a qualified attorney licensed to practice law in your state.
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