If you’re the owner of a small business, you may think of your tight-knit group of employees as a family. SmolenPlevy Principals Jason Smolen and Dan Ruttenberg say it’s critical to be aware of possible unintended tax consequences if you wish to include them as beneficiaries in your estate plan.
Unraveling the (tax) code
Generally, money or other property received by gift or inheritance is excluded from the recipient’s income for federal tax purposes. But there’s an exception for gifts or bequests to employees: Under Internal Revenue Code Section 102(c), the exclusion doesn’t apply to “any amount transferred by or for an employer to, or for the benefit of, an employee.”
Certain gifts to employees aren’t taxable, including “de minimis” fringe benefits, employee achievement awards and qualified disaster relief payments. Otherwise, the IRS generally views transfers to employees as “supplemental wages” subject to income and payroll taxes.
U.S. Supreme Court weighs in
Despite Sec. 102(c), it may be possible to make a gift to an employee that avoids income taxes. According to the U.S. Supreme Court, such a gift must be made under “detached and disinterested generosity” or “out of affection, respect, admiration, charity or like impulses.” In contrast, if a gift is intended to reward an employee for past performance or serve as an incentive for future performance, it’s considered compensation and is subject to income and payroll taxes. Unfortunately, the intent behind a gift can be difficult to prove.
“Keep in mind that treating a gift or bequest as compensation isn’t necessarily a bad thing. In some cases, the income and payroll taxes may be less severe than the gift, estate and generation-skipping transfer taxes that otherwise would apply,” says Dan Ruttenberg. And you can always “gross up” the transferred amount to ensure that the recipient has enough cash to pay the taxes.
Contact Jason Smolen at jdsmolen@smolenplevy.com and Dan Ruttenberg at dhruttenberg@smolenplevy.com if you’re considering including employees in your estate plan.
About the Authors
Jason Smolen
Jason Smolen is a founding principal of SmolenPlevy. Smolen’s knowledge of complex estate and business issues has drawn the attention of ABC News, USA Today, E! Online, Realty Times and the Bank of America Small Business Online Community. Mr. Smolen is a graduate of the City College of the City University of New York and the George Mason University School of Law. Smolen also serves as a board member of a local citizens association and recently co-authored an article titled Why You Should Think About Spousal Limited Access Trusts (SLATS).
Daniel H. Ruttenberg
Daniel H. Ruttenberg, JD, CPA, LLM is a principal with the firm. Mr. Ruttenberg received his Bachelor of Science degree with a double major in Accounting and Finance from the University of Maryland. He earned his Juris Doctor with Honors from George Mason University School of Law and his Master of Laws in Taxation with Distinction from Georgetown University Law Center. Mr. Ruttenberg also served as the Director of the Fairfax Bar Association (FBA) for seven years. During this period, he was also elected president – the youngest in FBA history and served as a member of the Board of Directors for the Fairfax Law Foundation.
