If you’re an employer, you may think of your employees as family. But if you plan to provide for employees in your estate plan, watch out for unintended tax consequences.
IRS rules
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.
A solution
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 a “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. And you can always “gross up” the transferred amount to ensure that the recipient has enough cash to pay the income and payroll taxes.
If you’re considering including employees in your estate plan, contact us for more information.
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