‘Income’ can be a difficult thing to define

One argument for a simple tax system is to apply a single tax rate to the taxpayer’s “income.” Those making this argument do not place income in quotation marks.

A tax practitioner is likely to use these quotation marks. Why? Because like anything that involves the law, words are often defined by statute. The “plain language” meaning of a word is used only when the law does not specifically define the term.

The tax law defines income quite broadly. So tax practitioners generally discuss whether the law says a particular benefit is not income rather than whether it is income.

Gifts are not income. Payments for services are income. Payments for services may often be deducted by the payer. Gifts may not be deducted by the payer.

It could then be said that the payer and the payee have conflicting interests in how to classify a payment. The payer would be expected to argue that a payment is for services. The payee would be expected to argue it is a gift.

Let’s say that the party receiving the payment is a minister. The payor is either the church that employs the minister, or perhaps a member of that church congregation.

If the church is the payer, as a not-for-profit organization it would not care about the ability to claim a tax deduction. The church would then be indifferent to classifying a payment to its minister as a gift or as a payment for services.

Gift classification would benefit the minister and not hurt the church. So why not just call payments to the minister a gift?

The tax law says a gift flows from “detached and disinterested generosity.” That is, nothing is expected in return for the payment. It would be very difficult to say that the payment from the church to its minister has no expectation of receiving anything in return.

But what if the payment comes from one or more members of the congregation? And what if the member(s) say that the payment is a gift? Does saying something make it so?

First we need to recognize that the payer and the payee may have different incentives for classification. The congregant can deduct a payment to the church as a charitable contribution; he or she cannot deduct a gift made directly to the minister.

To deduct a charitable gift, one must itemize deductions. Through the end of 2017 only about 30 percent of all taxpayers itemized. This means that roughly 70 percent of all congregants wouldn’t care how the payment was classified.

With that background, the Tax Court just held in a case called Felton that congregant payments classified as gifts to a minister were in fact payments for compensation. This is interesting because of what it says about the difficulty of defining income.

A gift means the payer is motivated by detached and disinterested generosity. Intent matters. Intent is hard to judge and is not always what someone says.

Felton’s congregation had white offering envelopes for “regular” gifts used to fund the church operating budget. They had blue envelopes to make gifts payable directly to Pastor Felton.

White envelopes were made available to everyone. Blue envelopes had to be requested from the ushers. White envelope offerings were reported, in year-end tax statements, as deductible contributions to the church. Blue envelope offerings were not.

Pastor Felton reported $40,000 of wages that came from white envelope offerings. One unusual thing was that even white envelope offerings had to designate a payment to Pastor Felton for him to receive it. Felton reported none of the blue offering gifts as income — he said they were gifts.

Felton lost. Why? Probably because blue offering gifts for the two years at issue were $234,826 and $258,001. With his tax-free housing allowance of $78,000, twothirds of his income came from designated “gifts.”

Gifts to a minister for officiating at a wedding or funeral, or perhaps even a more organized congregation effort at Christmas, may actually be nontaxable gifts — driven by detached and disinterested generosity.

The magnitude and regularity of the offerings to Pastor Felton was the undoing in this case. Names given to payments do not establish tax results. What is income is actually a very challenging question.