Estate and Elder Law

Morrison & Foerster LLP: Gifts and Bequests to Employees

By Wendy M. Greenberg, Esq., Morrison & Foerster LLP

It is not at all uncommon for our clients to make provisions for long-time employees in their wills or trusts.  Most of the time, we don't think twice about these bequests, because we know that our clients think of the beneficiaries as friends, or even family members, first, and as employees second.  But, there are a few traps for the unwary here, including possibly unintended tax consequences.1

Internal Revenue Code Section 102(a) states generally that gross income does not include the value of property acquired by gift, bequest, devise, or inheritance.  However, subsection (c) of that same Section 102 provides that amounts transferred by an employer to or for the benefit of an employee shall nevertheless be includable in the employee's gross income.  There is some indication in the case law that this rule may not be as absolute as it appears (see, e.g., T.C. Memos 2003-97 [enhanced version available to subscribers] and 2008-73 [enhanced version]), and that where a transfer between an employer and employee is completely unrelated to the employment relationship, it could be deemed a gratuitous transfer not subject to income tax (but subject to gift, estate, and/or generation-skipping tax instead).

The seminal case on this issue is Commissioner v. Duberstein,2 a Supreme Court case from 1960.  Duberstein actually considered two cases, one (Duberstein) in which a business owner gifted a frequent referrer of clients with a Cadillac, and one (Stanton) in which a comptroller of a church was given $20,000 upon his resignation, "in appreciation of the services rendered" by him.  The principles that resulted from these cases are not exactly black-and-white, but the factors used to determine whether a payment may be treated as compensation, rather than as a gift,  may be summarized as follows:

1. Could the payment be seen as recompense for past services?

2. Could the payment be seen as an inducement for future services?

3. Could the payment be seen as satisfaction of an obligation of the employer?

Seen from the other side, to be truly gratuitous, a transfer must be made out of "detached and disinterested generosity,"3 rather than in a business context. 

Given the lack of clarity regarding the application of Section 102(a), it seems most prudent to attempt to firmly cast a transfer to an employee as either completely compensatory, tied to services provided or to be provided, or completely gratuitous, having nothing to do with the employee/employer relationship.  As specifically one or the other, the tax consequences will be limited to either the income tax realm or the gift and estate tax realm, without concern for imposition of both types of taxes.

Pure Compensation

An employment agreement whereby the client is required to transfer certain property to the employee at the client's death (if the employment relationship is then intact) renders the amount to be transferred a debt that will be deductible for estate tax purposes.  The transfer could be grossed up to ensure that the beneficiary has enough cash to pay the income tax. 

Generally, as long as the top income and gift/estate tax rates are both applicable and fairly equal, the tax consequences of treating a transfer to an employee as either pure compensation or pure bequest would also be fairly equal.  But, keep in mind that a transfer structured as pure compensation would never have any generation-skipping tax implications, so, where an employee is more than one generation younger than the client, the employment agreement approach is preferable.  Of course, the agreement could provide for at-will termination, so that the client continues to have the same flexibility as he or she would if the transfer were testamentary.

Pure Bequest

The most salient concern regarding the described employment agreement is that it requires the client to inform the employee of the proposed transfer.  If the client would rather keep the transfer testamentary, you should ensure that the relevant provisions in the client's will or trust do not condition the transfer on the employee's continued employment in order to more firmly characterize the transfer as a gratuitous bequest.  There will still be a risk that the transfer will also be treated as taxable compensation to the employee.

There probably is no one-size-fits-all solution for tax efficiency in transfers to employees, but with some consideration, the possibility of double taxation, at least, might be averted.


[1]  There are particularly broad requirements and ramifications where the employee-beneficiary is a caregiver under California State law, discussion of which is outside the scope of this article.

[2] 363 US 278 (1960) [enhanced version / unenhanced version available from lexisONE Free Case Law].

[3] Commissioner v. LoBue, 351 US 243 [enhanced version / unenhanced version].

Morrison & Foerster's Trusts and Estates group provides sophisticated planning and administration services to a broad variety of clients.  If you would like additional information or assistance, please contact Patrick McCabe at (415) 268-6926 or

© Copyright 2011 Morrison & Foerster LLP.  This article is published with permission of Morrison & Foerster LLP.  Further duplication without the permission of Morrison & Foerster LLP is prohibited.  All rights reserved.  The views expressed in this article are those of the authors only, are intended to be general in nature, and are not attributable to Morrison & Foerster LLP or any of its clients.  The information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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