What Tax Court Taught Us: A Gift is not always a Gift
Every year the tax court looks at different cases and makes rulings that greatly affect taxpayers. We’re going to look at several different tax court cases and how they affect taxpayers and what the biggest takeaways are. Our first case will cover the case of Felton v. Commissioner. This is a case that saw the tax court move the needle on what is considered a gift.
Wayne Felton was a reverend for a church in Minnesota. The church collected offerings from its members like most churches. Felton’s church however collected offerings using three different envelopes. Offerings were usually made in either white, gold or blue envelopes. Each envelope had its own purpose. White envelopes were used for contributions that would help maintain the church. In the envelope, there was a line marked with the word pastoral, and any contributions on those lines went directly to Reverent Felton. White envelopes were placed everywhere in the church and were readily available. The gold envelopes were used to make contributions to special programs and retreats. Blue envelopes were created by Felton for members of the church who wanted to make a contribution that was not tax-deductible or was seen as a gift. Blue envelopes were not handed out to everyone, members of the church would have to specifically ask for them.
Through the white envelopes, Felton was given $40,000 in pastoral donations and this amount was included in his taxable income. Through the blue envelopes, received another $250,000. This was not included in Felton’s taxable income. Felton did not receive a salary form the church but did get a generous monthly parsonage.
The IRS ended up auditing Felton for two tax years and ended up making several changes, including increasing Felton’s taxable income by the $250,0000 of contributions for both years. The IRS claimed that the money given was not a gift but as compensation for services.
When the case was presented to the tax court, they used four factors to determine if the money should be considered a gift or compensation. The court first looked at whether the donations were objectively provided in exchange for services. The court believes that the contributions in the blue envelope were objectively made to ensure that Felton continued to preach at the church. The second thing the court looked at was if Felton requested the personal donations. Felton had developed the idea of the blue envelopes, but he rarely would talk about them to the congregation. He didn’t bring them up or encourage people to donate to the blue envelopes in his sermons. The court concluded that this was an objective sign that the donations were gifts. Thirdly, the Tax Court looked at whether the donations were part of a routinized program. The court found that the blue envelope program was structured because the mere presence of the separate blue envelope represented a structured program. The envelopes said “pastoral gifts” on them and listed information about how to make checks out to Reverend Felton personally. Also, the court found that the contributions in the blue envelopes were nearly identical for two years, which showed that they were the result of a highly organized program to transfer cash from church members to Felton. This led the court to believe that the donations were compensation, not gifts. The fourth and final factor the court looked at was whether Felton received a separate salary from the church and the amount of salary in comparison to the personal donations. Felton did not receive a salary for those two years but he did receive pastoral donations from the white envelopes and he reported those as income. The white envelopes amounted to $40,000 while the blue envelopes amounted to another $250,000. Due to the differences in payments, the court concluded that the members of the church making the donations would have been aware that without the blue donations, they wouldn’t have been able to afford to keep their reverend.
In the end, the court decided that the $250,000 that Felton received from the blue envelopes was compensation, not a gift and therefore it was subject to taxation. Ultimately the Tax Court decided that gifts of cash that the pastor was receiving enabled him to continue his ministry and preach as a result. Thus, although there was no express agreement, the members were found to be receiving an intangible benefit such as a religious benefit in exchange for the cash they gave the pastor.