No good deed ... taxation of gifts and bequests from employers.

• Author: Sheridan, Eileen F.
• Position: Estate planning

A client once asked, "My employee is like a son ... why can't I just give or bequeath assets to him?"

"Well, it's complicated," I answered.

Many people want to leave cash or assets from their estate to one or more of their employees. Some want to provide them with a gift above and beyond their compensation. These employees may have become more than just workers. They are more akin to family members. And while this level of relationship tends to develop more frequently in the case of household employees, it can also occur between employees and business owners. In any case, determining the tax treatment of these gifts and bequests is ... well, complicated.

The Income Tax Problem

IRC Sec. 102(a) states that gross income shall not include the value of property acquired by gift, bequest, devise or inheritance (a "gratuitous transfer"). If only we could stop there. Congress, however, enacted Sec. 102(c) in 1986. Paragraph (1) of this subsection states that, in the case of employer gifts, subsection (a) shall not exclude from gross income any amount transferred by or for an employer to, or for the benefit of, an employee.

Does that mean that an employer absolutely cannot make any gift to an employee without it being taxable income to the employee? Let's look at two extreme examples:

* An employer was pleased with the employee's performance and purchased him a new car. This would be taxable income to the employee as it represents a "bonus" type of payment.

* An unmarried man with no children left his business and entire estate to his surrogate son, who also happened to be employed by the man. Would the entire estate value be taxable income to the employee under Sec. 102(c)? The answer here lies in various shades of gray.

Gratuitous Transfers

Prior to Sec. 102(c), the leading authority on the definitional issue of gratuitous transfers was the seminal Supreme Court case Commissioner v. Duberstein, 363 U.S. 278 (1960).

This case provided that a gift is a transfer proceeding from a detached and disinterested generosity. Conversely, if the payment proceeds primarily from the constraining force of any moral or legal duty, or from the incentive of anticipated benefit of an economic nature, it's not a gift. As a result, the question of whether a gift has occurred, and is therefore excludible from the employee's gross income under Sec. 102(a), is a question of fact pertaining exclusively to the transferor's intentions.

While Duberstein provided significant...