The Top 10 Tax Court Cases Of 2018: When Is A Gift Not A Gift?

What. A. Year.

When tax geeks arose from their slumber on January 1, 2018, we were greeted by a strange and unfamiliar world. Gone were personal exemptions, Section 199, and 50% bonus depreciation. In their place were a doubled standard deduction, Section 199A, and 100% bonus depreciation. These changes, in addition to countless others, were the end result of a whirlwind legislative process that overhauled our beloved Internal Revenue Code in a mere seven weeks, an act of Congressional hubris that tax professionals will rue for years to come.

As a result of this sweeping new legislation, ever since the calendar turned to 2018, all of our attention has been focused on getting up to speed on the new law. But while we’ve been up to the strained waistline of our pleated Dockers in Opportunity Zones and interest limitations, the century worth of tax law that existed prior to the Tax Cuts and Jobs Act has been completely ignored. Thousands of provisions survived the recent round of reform, and throughout 2018, many of those provisions have found their way into the Tax Court, where disputes between taxpayers and the IRS have ended in all-important judicial precedent.

But anyone who claims to have kept up with the Tax Court in 2018 is flat-out lying. Save for the occasional Wesley Snipes appearance, most of the cases decided by the court in 2018 have gone largely unnoticed, lost to the piles of proposed regulations that have been published on the new law.

And that, quite frankly, is unacceptable. We can’t be like Homer, who once lamented that every time he learned something new, it pushed some old stuff out of his brain. We’ve got to do it all: get a grasp on the new law, while continuing to master the old. After all, Judge Holmes ain’t offering up that word play for no one to read it.

So let’s do this. Over the next twelve weeks, lets dissect one Tax Court case from each month of 2018. Keep in mind, these cases are not necessarily the most important decisions of each month, but rather the ones that I believe to be most useful to your humble workaday tax pro. If you disagree, write your own damn list.

For January’s case, we covered Conner v. Commissioner, T.C. Memo 2018-6, a case addressing whether the sale of real estate generated ordinary income or capital gain. 

For February, check out Meruelo v. Commissioner, TC Memo 2018-16, in which we discussed the many ways shareholders in an S corporation screw up trying to obtain “debt basis.” 

For March, we went through Simonsen v. Commissioner, 150 T.C. 8, and discovered that the tax treatment of short sales and foreclosures is anything but straightforward.

In April, we looked at Povolny Group, Inc. v. Commissioner, T.C. Memo 2018-37, and discovered that sometimes a loan isn’t a loan.

For May, we beat up Barker v. Commissioner, T.C. Memo 2018-67.

In June, it was  Alterman v. Commissioner, TC Memo 2018-83, which took a look at the tax treatment of marijuana facilities.

For July, we covered Martin v. Commissioner, T.C. Memo 2019-109, and learned who qualifies as a real estate professional, or to put it more accurately, who doesn’t. 

In August, we took a look at Lakner v. Commissioner, T.C. Memo 2018-127, a case that helped us understand when you can receive a legal settlement or judgment tax-free under Section 104.

When September came around, we broke down Frankel v. Commissioner, T.C. Summary Opinion 2018-45, a case that delved into the numerous traps for the unwary that arise when claiming a deduction for mortgage interest expense.

We’ve reached October, and we’re going to take a break from the heavy lifting and look at a case that’s more “good theater” than “vital precedent.” In Felton v. Commissioner, T.C. Memo 2018-168, the court had the task of examining amounts paid from a congregation to its pastor, and deciding whether those amounts represented “gifts” or taxable income.

What Makes It Special 

The line between a gift and income is a thin one, particularly when the recipient of those amounts is a religious figure. Think about it: a minister, pastor, or reverend clearly provides services, but doesn’t always ask to be directly paid for those services; rather, they usually solicit on behalf of the church in general. There are complications on the donors’ end as well: when you’re offering payment to a person who you not only love and cherish, but that undeniably offers services that you value, are you making a gift or paying a salary?

The Felton case is fascinating because it shows how in situations such as this, there can never be a bright-line test; rather, every single specific fact and circumstance surrounding the payment will come into play. And after those facts and circumstances have been identified, they must be compared to decades of judicial precedent in search of the correct result. Let’s see what happened in Felton.

Facts in Felton 

Wayne Felton was the reverend for the Holy Christian Church in Minnesota. The church was established in 2000 and quickly grew to a congregation of more than 600 families, owing largely to Felton’s impassioned sermons and the regular musical performances of Randy Watson and his band, Sexual Chocolate.*

*last part may not be true 

When he wasn’t running his church — or sister churches in Rawanda, Jamaica, Liberia, and Florida — Felton counseled anyone in need, from professional athletes to those struggling with their marriage.

The church was run in a businesslike manner. Felton and his wife sat on the executive board, but did not participate in board decisions about their salaries. Felton followed the church bylaws, and never overrode any business decisions made by the board.

As churches tend to do, Holy Christian collected offerings from its members. Those offerings were generally made in either white, gold, and blue envelopes.

White envelopes were used for normal contributions that sustained the church. They contained a line marked “pastoral,” and contributions on those lines went directly to Reverent Felton. White envelopes were everywhere; members could grab them on their way into church, and ushers constantly notified congregants of their availability during the service by holding them up for all to see. The amounts on the “pastoral” line were included in Felton’s taxable income.

Gold envelopes were used for special programs and retreats, and amounts contributed via these envelopes were not included in Felton’s taxable income.

Blue envelopes were special. These were created by Felton specifically for those congregants who wanted to make a donation that was NOT tax-deductible as a charitable contribution; in other words, the member specifically wanted it to be viewed as a “gift.” Blue envelopes were not as ubiquitous as white envelopes. Ushers didn’t hand them out; rather, members would have to ask for one if they wanted to give in that manner.

In each of 2008 and 2009, approximately $1,000,000 worth of donations were made via white envelopes; of those amounts, $40,000 in each year were “pastoral” donations and included in Felton’s taxable income. In addition, another $250,000 made its way to Felton in each year via the blue envelopes, but as mentioned above, those amounts were NOT included in the Reverend’s taxable income.

The church paid Felton no salary in either year. It did, however, make available to Felton a generous monthly parsonage allowance of $6,500, which was tax-free to him under Section 107(2). (For more on Section 107(2), read this.)

The IRS audited Felton’s returns for 2008 and 2009 and made several adjustments, including increasing Felton’s taxable income by the $250,000 of contributions made in each year via the blue envelopes. The Service’s position was that these amounts were not “gifts,” but rather compensation for services.

Relevant Law 

Section 61(a) provides the overarching rule of income taxation: unless specifically excluded, gross income means income from ALL sources derived, including “compensation for services.” One such exclusion from gross income appears in Section 102, which removes from income “the value of property acquired by gift.” Specifically excluded from the definition of a gift, however, is “any amount transferred by or for an employer to, or for the benefit of, an employee.”

The dispute in this case was simple: Felton argued that the amounts on the blue envelopes were gifts. The IRS said they represented compensation. Who was right?

Gifts, In General 

In Duberstein, the Supreme Court defined a gift as proceeding “from a detached and disinterested generosity…out of affection, respect, admiration, charity, or like impulses.” In other words, the critical consideration is the transferor’s intention when the payment was made. Intent, of course, is open to interpretation, which is precisely what makes “gift versus income” disputes like the one in Felton so difficult. And when things get difficult, well…the Tax Court looks to judicial precedent. Fortunately, there are no shortage of decisions dealing with the taxability of transfers from the faithful to the clergy.

United States v. Terrell 

Terrell is perhaps the most egregious piece of precedent. Terrell was an evangelist who preached at churches and tent revivals where he collected “lover offerings.” He repeatedly made appeals for contributions, often claiming that he was a prophet and that those who gave to him would receive a “prophet’s reward.” Terrell’s church did not pay him a salary, and he neglected to file a tax return. When the IRS reconstructed his income, the Service established that Terrell had to live off something, and that the most likely source of that income was the contributions. In deciding the case in favor of the IRS, the 5th Circuit established an important and accurate statement of the law:

The federal income tax is levied on income received by ministers. When an individual provides ministerial services as his trade or business, controls the money he receives in that business, and receives no separate salary, the income of that business is taxable to the minister. Voluntary contributions, when received by the minister, are income to him. Payments made to a minister as compensation for his services also constitute income to him. If money is given to a minister for religious purposes, any money used instead for the personal benefit of the minister becomes taxable income to him. 

 Mutch  v. Commissioner

There are also cases that trend the other direction; where donations labeled “honoraria” or “salary” have been held to be non-taxable gifts. In Mutch, a beloved minister had to retire when his health went bad. The church was worried that he would not be able to live out his years in an appropriate manner, and passed a resolution to give him a modest monthly honorarium contingent on the church’s future prosperity. The Third Circuit, in looking at the intent behind the payments, concluded that the amounts were gifts, rather than compensation, because they were motivated by the congregation’s “love and affection.”

Banks v. Commissioner; Goodwin v. Commissioner

Then, of course, there are those cases where the line between income and gifts is particularly blurred. In Banks, a minister drew a salary from the church, but members also gave her cash on four “special” days each year: her birthday, Mother’s Day, the church’s anniversary, and Christmas. Members testified that they made the “special” donations to show their appreciation for Banks and to say thank you.

The Tax Court found that the special donations were taxable income; they were not made out of a “detached and disinterested generosity,” but rather to reward Banks for her services and to entice her to continue as pastor. Also damning was the fact that the four “special” days represented a structured program for transferring money to Banks on a regular basis; this regularity was more indicative of compensation than a gift.

In Goodwin, the Reverend was pastor at his church for more than 20 years. Like in Banks, the church had a program for making special gifts to Goodwin on the same three days each year. The dates were advertised well in advance, and the church strongly encouraged the entire congregation to contribute.

The Eighth Circuit concluded that the gifts were income, stating that the “cash payments were gathered by congregation leaders in a routinized, highly structured program.” The court highlighted the following points:

  • the congregation funds the church, and that included Reverend Goodwin,
  • the “special occasion” gifts were substantial when compared to his salary,
  • the congregation knew that without the gifts, it couldn’t keep Reverend Goodwin, and
  • regular, sizable payments made by persons to whom the taxpayer provides services are customarily regarded as a form of compensation.

Judicial Factors

Based on this body of case law, the Tax Court in Felton identified four factors that are vital in distinguishing between taxable compensation and gifts:

  1. whether the donations are objectively provided in exchange for services,
  2. whether the cleric requested the personal donations,
  3. whether the donations were part of a routinized, highly structured program, and given by individual church members or the congregation as a whole, and
  4. whether the cleric receives a separate salary from teh church and the amount of that salary in comparison to the personal donations.

The court then took on the factors one-by-one.

Whether the donations were objectively provided in exchange for services

The court noted that unlike the minister in Mutch, Felton was not retiring. Rather, he was a devoted pastor, and the court believed that the payments were objectively made to ensure that Felton continued to lead the church.

There was an interesting subplot to this discussion, however. You may recall, if a person makes a charitable contribution, they are required to reduce the amount of the contribution by the value of any “consideration” the donor receives in exchange for the gift. Then why is one allowed to deduct amounts to a church? Aren’t they receiving immeasurable value in the form of the provision of sacraments or the transmission of God’s word? Well, in the tax law, those returns on a faithful person’s donation are called “intangible religious benefits” under Section 170(f)(8)(B)(iii), and thus don’t count as an item of value received by the donor in exchange for the donation.

Whether the cleric requested the personal donations 

While Reverend Felton developed the idea of the blue envelopes, he rarely spoke of them, and never encouraged those donations during his sermons. Congregants had to specifically seek them out. This, the Tax Court concluded, was an objective sign that the donations were a gift, rather than income.

Routinized, highly structured program

The court found that the blue envelope program was similar to those structured programs in Banks and Goodwin. While the donations in Felton were not made on “special days” as they were in those two cases, the mere presence of the separate blue envelope represented a structured program. The envelopes said “pastoral gift” on them and listed all the necessary information about the church and how to make checks out to Reverend Felton personally. In addition, the fact that the contributions in the blue envelopes were so large in both 2008 and 2009 — and nearly identical in each year — was evidence that they were the result of a highly organized program to transfer cash from church members to Felton. As a result, this factor favored the finding of compensation.

Ratio of church salary to personal donations

Reverent Felton received no salary in 2008 or 2009. He did receive the pastoral donations on the white envelopes and report those amounts as income, but those only amounted to $40,000 annually, whereas the blue envelopes added another $250,000 in payments each year. Based on these proportions, the court concluded that those making the donations must have been aware that without the blue envelope donations, they wouldn’t be able to afford to keep their beloved minister.


Adding it all together, the court determined that the $250,000 in payments made in each of 2008 and 2009 to Felton represented taxable compensation for services rather than non-taxable gifts. It was not an obvious decision — as, for example, the decision in Terrell had been — but nonetheless, the totality of the factors favored that the intention of the payments was to reward Felton for his services and to implore him to continue providing them, rather than to make a gift out of a “detached and disinterested generosity.”

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