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From the Tax Court Files: Is That Money a Gift or Income?

Jun 16th 2015
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Our tax laws are usually spelled out precisely; it's real-life situations that don't always fall conveniently into place.

For instance, there's a mile-wide definition of income that entitles the IRS to share in “all income from whatever source derived,” including payments that are “compensation for services.” On the other hand, the term “income” doesn't include gifts.

As a result, the courts often have to resolve the troublesome question of whether a tax-free “gift” was actually a payment for services rendered. Not surprisingly, the question has come up when the IRS insisted on its share of sizable amounts received by women from men who weren't their husbands.

Consider the 1955 US Tax Court decision in the unusual case of Thelma Blevins, a divorcee from Louisville, Kentucky, who was a jill-of-all-trades and became the target of a painstaking IRS investigation. She didn't limit herself to supervising a staff of six engaged in the oldest of professions. Thelma occasionally filled in herself and staged unique shows for her guests.

Among other things, the tax collectors charged that Jim Mulhall enjoyed a close relationship with Thelma and that the money he gave her before and after her divorce should have been reported on her returns. Thelma and Jim explained to the court that these payments were gifts that had been made “in contemplation of marriage” and not compensation. The judge, however, accepted the IRS's version of what these payments were for; after all, they spanned a 12-year period and Jim made no attempt to separate from his wife during that time.

Another gift-or-income bout involved Margaret Brizendine, whose career tracked Thelma's. The way Margaret told it to the judge, she met a gentleman at a restaurant in Roanoke, Virginia, and became his friend. During the next five years, he provided her with a house, a fur coat, and a weekly allowance. Margaret thought these items were gifts because she received them in exchange “for her promise not to engage in prostitution and to grant him her companionship,” whereas the judge thought it was stretching things to call them gifts. In fact, in its 1957 decision, the Tax Court took a damned-if-you-do-or-don't approach and said payments for vowing to abstain are just as taxable as payments for services rendered.

The IRS doesn't always have its way in these disputes. In 1966, an understanding Tax Court came to the rescue of Greta Starks. Her saga began in the pre-inflation 1950s when Greta, then in her 20s and employed occasionally as a Detroit fashion model, became involved in what the court discreetly described as a “very personal relationship” with a married gentleman in his 50s, who proceeded to spend a minimum of $65,000 on a shopping list that included a home, new car, jewelry, furs, and clothes from Saks Fifth Avenue.

In some way, the IRS discovered their arrangement. In addition to arguing that Greta should have paid income taxes on the $65,000, the agency tried to collect self-employment taxes (Social Security taxes on self-employment income) on the grounds that she had been engaged in a business venture. Greta testified that the items in question were gifts and was backed up by her friend's description of the payments as made “to insure her companionship and more or less a personal investment in my future.” Though less than impressed with this testimony, the court decided that Greta hadn't performed services for pay and relieved her of any tax liability.

About the author:
Julian Block writes and practices law in Larchmont, New York, and was formerly with the IRS as a special agent (criminal investigator) and an attorney. More on this topic is available from “Julian Block's Year Round Tax Strategies,” available at julianblocktaxexpert.com.

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