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Be Tax Savvy! Do Gifts = Income?

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By Tanya Roth, Esq. on February 08, 2010 2:02 PM

Did you know that some of your gifts could be included in your income tax calculation?

But only those that the IRS says are "not really" gifts.

Let's break this concept down.   

Also, keep in mind that there is a tax that is entirely separate from income tax and it is called "gift tax." It has its own tax return and its own set of tax rules. But gift tax is beyond the scope of this post. 

1.  Gifts are generally excluded from gross income.

Not so fast. If it doesn't walk like a duck or talk like a duck, can you really call it a duck? 

First of all, the income produced by the gift must be reported. Thus, if the tree is the gift, you don't report it but you must report the apples it produces. Or, if the gift is a house, you don't report the house but you report the rental income you get from the tenants.   

Secondly, you can't simply slap on the name "gift" just to avoid including it in your income tax calculation. In one case interpretting the taxation of gifts, the Supreme Court described "gifts" as being characterized by "a detached and disinterested generosity out of affection, respect, admiration charity or like impulses."

Here's an example:

Annie owned a marketing firm. Zara owned a PR firm. Over the course of the year, Annie sent many clients over to Zara's firm. Zara was thrilled and in order to keep Annie happy for the coming year, Zara sent Annie a $20,000 designer bag.  

Now, that's easy, you say. Of course, it's a gift!  Annie shouldn't have to report the $20,000 in her income tax calculation!

Think again. The income tax rules certainly won't let Annie off the hook that easily. The IRS will want to know what Zara's motivation was in giving that handbag. Did Zara deduct it as a business expense? Was the handbag more of a "compensation" for Annie's services, even if Annie didn't expect it?

2.  Gifts given from an employer to an employee are not gifts!

The exception: if the gift falls under the definition of "employee achievement awards." It must be awarded for a length of service or for a safety achievement and as part of a meaningful presentation. The most concerning criterion, however, is that the award must not be disguised compensation. Although I will not address that concept in detail, it's fair to say that you should address this with your tax professional, if you received an employee achievement award.  

So, what lessons do we take away? Well, before you accept a large and substantial gift, ask yourself whether it is really a gift that is motivated out of sheer generosity. If there are strings attached or if it has any hint of compensation, then you need to think about discussing it with your tax professional.

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