Our tax laws are usually spelled out precisely; it's real-life situations that don't always fall conveniently into place. For instance, there's a mile-wide definition of income that entitles the Internal Revenue Service to share in "all income from whatever source derived," including payments that are "compensation for services." On the other hand, the term "income" doesn't include gifts.
As a result, the courts often have to resolve the troublesome question of whether a tax-free "gift" was actually a payment for services rendered. Not surprisingly, the question has come up when the IRS insisted on its share of sizable amounts received by women from men who weren't their husbands.
Consider the 1955 U.S. Tax Court decision in the unusual case of Thelma Blevins, a Louisville divorcee who was a jill-of-all-trades and became the target of a painstaking IRS investigation. She didn't limit herself to supervising a staff of six engaged in the oldest of professions. Thelma occasionally filled in herself and staged unique shows for her guests. Among other things, the tax collectors charged that Jim Mulhall enjoyed a close relationship with Thelma and that the money he gave her before and after her divorce should have been reported on her returns. Thelma and Jim explained to the court that these payments were gifts that had been made "in contemplation of marriage" and not compensation. The judge, however, accepted the IRS's version of what these payments were for; after all, they spanned a 12-year period and Jim made no attempt to separate from his wife during that period.
Another gift-or-income bout involved Margaret Brizendine, whose career tracked Thelma's. The way Margaret told it to the judge, she met a gentleman at a restaurant in Roanoke, Va., and became his friend. During the next five years, he provided her with a house, a fur coat, and a weekly allowance. Margaret thought these items were gifts because she received them in exchange "for her promise not to engage in prostitution and to grant him her companionship," whereas the judge thought it was stretching things to call them gifts. In fact, in its 1957 decision, the Tax Court took a damned-if-you-do-or-don't approach and said payments for vowing to abstain are just as taxable as payments for services rendered.
Atlanta bartender and cocktail waitress Lyna Kathryn Jones bestowed amorous attentions on a gentleman who rewarded her with generous amounts of cash. The largess came to the attention of the IRS, which assessed taxes against Lyna. She maintained that the money wasn't taxable income, but a gift from her benefactor, tactfully identified only as "James" by the Tax Court in a 1977 decision. Unfortunately, Lyna proved to be a spectacularly poor witness. During a sardonic cross-examination, a government attorney elicited the tart response that James "was getting his money's worth." Her choice of words was interpreted by the court as evidence that the cash was compensation, not a gift.
The IRS doesn't always have its way in these disputes. In 1966, an understanding Tax Court came to the rescue of Greta Starks. Her saga began in the pre-inflation 1950s when Greta, then in her twenties and employed occasionally as a Detroit fashion model, became involved in what the court discreetly described as a "very personal relationship" with a married gentleman in his fifties, who proceeded to spend a minimum of $65,000 on a shopping list that included a home, new car, jewelry, furs and clothes from Saks Fifth Avenue.
In some way, the IRS discovered their arrangement. In addition to arguing that Greta should have paid income taxes on the $65,000, it tried to collect self-employment taxes (Social Security taxes on self-employment income) on the grounds that she had been engaged in a business venture. Greta testified that the items in question were gifts and was backed up by her friend's description of the payments as made "to insure her companionship and more or less a personal investment in my future." Though less than impressed with this testimony, the court decided that Greta hadn't performed services for pay and relieved her of any tax liability.
Julian Block writes and practices law in Larchmont, N.Y. and was formerly with the IRS as a special agent (criminal investigator) and an attorney. He is frequently quoted in the New York Times, the Wall Street Journal, and the Washington Post, and has been cited as: "a leading tax professional" (New York Times); "an accomplished writer on taxes" (Wall Street Journal); and "an authority on tax planning" (Financial Planning Magazine). This article is excerpted from "Julian Block's Easy Tax Tips for marriage and Divorce," available for Kindle at Amazon.com and as a print copy at julianblocktaxexpert.com