Can A Severance Be A Gift?

I am looking at a case wondering why a tax practitioner would take it to Tax Court.

Then I noticed that it is a pro se case.

We have talked about this before: pro se means that the taxpayer is representing himself/herself. Technically that is not correct (for example, someone could drag me in and still be considered pro se), but it is close enough for our discussion.

Here is the issue:

Can an employer make a nontaxable gift to an employee?

Jennifer Fields thought so.

She worked at Paragon Canada from 2009 to 2017. Apparently, she was on good terms with her boss, as the company …

·      Wired her 35,000 Canadian dollars in 2012

·      Wired her $53,020 in 2014 to help with the down payment on a house in Washington state.

I am somewhat jealous. I am a career CPA, and CPA firms are not known for … well, doing what Paragon did for Jennifer.

She separated from Paragon in 2017.

They discussed a severance package.

Part of the package was forgiveness of the loan arising from those wires.

Forgiveness here does not mean what it means on Sunday. The company may forgive repayment, but the IRS will still consider the amount forgiven to be taxable income. The actual forgiveness is therefore the after-tax amount. If one’s tax rate is 25%, then the actual forgiveness would be 75% of the amount forgiven. It is still a good deal but not free.

Paragon requested and she provided a Form W-9 (the form requesting her social security number).

Well, we know that she will be getting a W-2 or a 1099 for that loan.

A W-2 would be nice. Paragon would pick-up half of the social security and Medicare taxes. If she is really lucky, they might even gross-up her bonus to include the taxes thereon, making the severance as financially painless as possible.

She received a 1099.

Oh well.

She left the 1099 off her tax return.

The IRS computers caught it.

Because … of course.

Off to Tax Court they went.

This is not highbrow tax law, folks. She worked somewhere. She received a paycheck. She left work. She received a final paycheck. What is different about that last one?

·      She tried to get Paragon to consider some of her severance as a gift.

The Court was curt on this point. You can try to be a bird, but you better not be jumping off tall buildings thinking you can fly.

·      She was good friends with her boss. She produced e-mails, text messages and what-not.

That’s nice, said the Court, but this is a job. There is an extremely high presumption in the tax Code that any payment to an employee is compensatory.

But my boss and I were good friends, she pressed. The law allows a gift when the relationship between employer and employee is personal and the payment is unrelated to work.

Huh, I wonder what that means.

Anyway, the Court was not buying:

Paragon’s inclusion of the disputed amount in the signed and executed severance agreement and the subsequent issuance of a Form 1099-MISC indicates that the payments were not intended to be a gift.”

She really did not have a chance.

The IRS also wanted penalties. Not just your average morning-drive-through penalties, no sir. They wanted the Section 6662(a) “accuracy related” penalty. Why? Well, because that penalty is 20%, and it is triggered if the taxpayer omits enough income to underpay tax by the greater of $5 grand or 10% of what the tax should have been.

Think biggie size.

The Court agreed on the penalty.

I was thinking what I would have done if Jennifer had been my client.

First, I would have explained that her chance of winning was almost nonexistent.

COMMENT: She would have fired me then, realistically.

Our best course would be to resolve the matter administratively.

I want the penalties dropped.

That means we are bound for Appeals. There is no chance of getting that penalty dropped before then.

I would argue reasonable cause. I would likely get slapped down, but I would argue. I might get something from the Appeals Officer.

Our case this time was Fields v Commissioner, T.C. Summary Opinion 2022-22.