The GWE, a (not so new) tax exclusion worth a look: under the general welfare exception (GWE), certain payments of social benefit programs are excluded from income. This article describes the GWE requirements and the kinds of payments covered.

• Author: Wood, Robert W.

EXECUTIVE SUMMARY

* Under the GWE, certain governmental payments, such as payments to natural disaster vices, do not constitute gross income.

* The GWE is generally, limited to individuals who receive governmental payments for their individual needs.

* The GWE does not apply to payments for a recipient's performance of services.

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Most people know that the Internal Revenue Code casts a wide net. For example, under Sec. 61, gross income for tax purposes includes just about everything. According to the courts, this net subsumes income from every source, including wages, gains, prizes--even treasure trove (whether buried or not). (1) A million dollars found inside a piano is includible in the income of the lucky finder. (2) So is $20 found on the street; never mind that the person who lost the money probably cannot china a deduction. Who said tax is fair?

Courts have agreed that all income is subject to taxation unless excluded by law. (3) Income is defined as broadly as possible by the IRS. (4) Exclusions from income are narrowly construed and generally have been limited to those specified in the Code. (5) Nevertheless, a little known administrative exception exists, which eludes the gross income net. It is called the general welfare exception (GWE). This article describes the kinds of government payments that can qualify for the GWE.

GWE

Under the GWE, certain government payments do not constitute gross income to the recipients. The GWE doctrine has been applied by the IRS to a handful of disparate government payments. Historically, the classic example of the GWE's application is a government payment made to victims of a natural disaster. For example, although the Service has not ruled on this particular issue, payments made by the Federal Emergency Management Agency (FEMA) to hurricane victims are of the type of payment that historically qualified for relief under the GWE. (6)

Requirements

The GWE requires the payments to be made under legislatively provided social benefit programs for the promotion of the general welfare. (7) In determining whether the GWE applies to payments, the IRS requires the payments to be:

1. Made from a governmental general welfare fund;

2. For the promotion of the general welfare (i.e., on the basis of need rather than to all residents); and

3. Not made as payment with respect to services. (8)

The GWE has generally been limited to individuals who receive governmental payments to help them with their individual needs (e.g., housing, education and basic sustenance). (9) Payments that compensate for lost profits or business income (whether to individuals or businesses) do not qualify for the GWE. (10)

Payment Origin

The first prong of the GWE requires payments to be made from a governmental general welfare fund. (11) What does not seem to matter is whether these payments originate from the Federal, state or a county government. (12)

The first requirement appears to be relatively straightforward, and there does not seem to be any authority that analyzes it. In extant GWE authorities, the fact that a payment originates in the general welfare fund appears to be generally assumed (or at least the IRS must believe that this would be easy to verify), and thus this first prong is not discussed. This suggests that the determination of whether a payment is made from a governmental general welfare fund is mechanical, and has not been subject to interpretive differences that would require guidance.

Promotion of General Welfare

The second prong of the GWE requires that the payments promote the general welfare. This can be a Quixotic inquiry and has produced the vast majority of the GWE jurisprudence. This area continues to evolve, suggesting a more expansive exception to gross income than might first seem apparent.

The Service has consistently ruled that the governmental payments must be made on the basis of need. (13) As a means of assessing need, some authority looks to the payment recipient's income level. For example, in some authority, the GWE applies only to individuals who fall below certain income thresholds. In one ruling, (14) the income had to be below 80% of the county or metropolitan area median. Nevertheless, most GWE authority appears not to discuss precise income thresholds, and seems to rely on the particular needs of individuals. (15)

The IRS's determination of what constitutes a needs-based payment varies depending on the need. As noted above, the classic example of a needs-based payment qualifying for exclusion under the GWE is a payment made for disaster relief. In Rev. Rul. 2003-12, (16) a state was affected by a flood that was a Presidentially declared disaster area. (17) The state enacted emergency legislation to provide grants to pay or reimburse medical expenses, temporary housing and transportation expenses not compensated by insurance. The grants were not intended to indemnify all flood losses nor to reimburse nonessential luxury items.

The Service haled (18) that these "reasonable and necessary" payments were excluded from the recipient's gross income under the GWE. Notably, it also ruled that these payments qualify for exclusion under recently enacted Sec. 139, stating that the section codifies but does not supplant the GWE as to certain disaster payments. Next, the ruling discusses relief payments originating from charities and employers, neither of which meet the GWE requirements became the payments do not stem from the government. Nonetheless, payments from charities were held to be...