Employee death benefits.
135. If an employer is under contract to pay a death benefit to an employee's surviving spouse, is the benefit taxable income to the surviving spouse?
Death benefits payable under contract, or pursuant to an established plan of the employer, are taxable income. (2) Employee death benefits that are payable by reason of the death of certain terrorist attack victims or astronauts are excludable from gross income. (3)
Frequently, death benefits are funded by insurance on the life of the employee, with the insurance owned by and payable to the employer. But the fact that the death payments come from proceeds received tax-free by the employer does not cause them to be tax-exempt to the employee's surviving spouse. The surviving spouse receives them as compensation payments from the employer and not as life insurance proceeds. (4) (For tax effects of insurance funding, see Q 46, Q 47, and Q 63.) Employee death benefits rarely qualify as life insurance benefits wholly excludable under IRC Section 101(a). (5) See also Q 273, Q 275, Q 153.
Contractual death benefits are "income in respect of a decedent." (6) Consequently, where an estate tax has been paid, the recipient of the death payments is entitled to an income tax deduction for that portion of the estate tax attributable to the value of the payments. See Q 827.
136. Is a contractual death benefit payable to a surviving spouse deductible by the employer?
The employer can deduct the death payments provided they represent reasonable additional compensation for the employee's services. (7) See Q 109. However, payments can be deducted only in the year they are includable in the employee's income, regardless of the accounting method used by the employer. (8)
Usually questions as to whether the death payments constitute compensation for the employee's services and, if so, whether the compensation is reasonable, will arise only in connection with payments for stockholder-employees of a close corporation. In the following cases it was held that the payments--even though made under contract--were not compensation but rather, payments under a plan to provide financial security for the families of the stockholder-employees. Hence, the deductions were disallowed. (9) On the other hand, payments were held reasonable and for a substantial business purpose in M. Buten and Sons, Inc. v. Comm. (10)
An employer who prefunds benefits will be subject to limits discussed in Q 507 and Q 508. However, if the benefit is considered deferred compensation, the deduction is subject to the rules in Q 111 or Q 121.
Voluntary Death Benefits
137. If an employer voluntarily pays a death benefit to an employee's surviving spouse, is the benefit taxable income to the surviving spouse? Is it deductible by the employer?
The IRS has taken the position that voluntary death benefits are not gifts but compensation and are taxable income. (1) The courts, following the rules laid down by the United States Supreme Court in Commissioner v. Duberstein (2) have divided on the question of whether these payments are tax-free gifts or taxable compensation. Each case has been decided on its facts. (3) However, payments made after December 31, 1986 by an employer "to, or for the benefit of" an employee are not excludable as gifts. (4) Thus, a death benefit paid by an employer after December 31, 1986, would appear to be a payment for the benefit of an employee and, if so, would not be excludable as a gift. Employee death benefits that are payable by reason of the death of certain terrorist attack victims or astronauts are excludable from gross income. (5)
To be deductible by the employer, a voluntary death benefit must qualify as an ordinary and necessary business expense. (6) The payments will be deductible, therefore, if the circumstances show that they are additional reasonable compensation for the employee's services, or otherwise qualify as ordinary and necessary business expense. (7)
The deduction will be denied if the facts indicate that the payment was purely a gift or was made for the personal satisfaction of the directors. (8)
Where the widow is a controlling stockholder, the payments may very likely be treated as constructive dividends. In such a case, the entire death benefit would be taxable to her and not deductible by the corporation. (9) Even where the widow does not own a controlling interest, the payments may be treated as dividends, if the corporation is owned by a closely knit family group. (10) However, the payments will not be treated as dividends merely because the employee was a minority stockholder. Nor will they be treated as dividends in all cases where the widow is a substantial, but not controlling, stockholder. (11)
(1.) Notice 2002-24, 2002-16 IRB 785; Notice 90-24, 1990-1 CB 335.
(2.) Simpson v. U.S., 261 F.2d 497 (7th Cir. 1958); Robinson v. Comm., 42 TC 403 (1964).
(3.) IRC Sec. 101(i).
(4.) Essenfeld v. Comm., 311 F.2d 208 (2nd Cir. 1962).
(5.) See Edgar v. Comm., TC Memo 1979-524.
(6.) Est. of Wright v. Comm., 336 F.2d 121 (2nd Cir. 1964).
(7.) Southern Fruit Distributors v. U.S., 32 AFTR 2d 73-5598 (M.D. Fla. 1973).
(8.) IRC Sec. 404(a)(5); Rev. Rul. 55-212, 1955-1 CB 299.
(9.) Willmark Serv. Sys, Inc. v. Comm., 368 F.2d 359 (2d Cir. 1966); Wallace v. Comm.,TC Memo 1967-11; M.S.D. Inc. v. U.S., 79-2 USTC [paragraph] 9712 (6th Cir. 1979).
(10.) TC Memo 1972-44.
(1.) Rev. Rul. 62-102, 1962-2 CB 37.
(2.) 363 U.S. 278 (1960).
(3.) See Sweeney v. Comm., TC Memo 1987-550.
(4.) IRC Sec. 102(c).
(5.) IRC Sec. 101(i).
(6.) IRC Sec. 404(a)(5); Treas. Reg. [section] 1.404(a)-12.
(7.) Rubber Assoc., Inc. v. Comm., 335 F.2d 75 (6th Cir. 1964); Associated Ark. Newspapers Inc. v. Johnson, 18 AFTR 2d 5894 (E.D. Ark. 1966); Fifth Ave. Coach Lines, Inc. v. Comm., 31 TC 1080 (1959).
(8.) Loewy Drug Co. v. Comm., 356 F.2d 928 (4th Cir. 1965); Vesuvius Crucible Co. v. Comm., 356 F.2d 948 (3rd Cir. 1965); Montgomery Engg Co. v. Comm., 344 F.2d 996 (3rd Cir. 1965); Greentree's Inc. v. U.S. 16 AFTR 2d 5368 (E.D. Va. 1965); FoukeFur Co. v. Comm., 261 F. Supp. 367 (E.D. Mo. 1966).
(9.) Schner-Block Co., Inc. v. Comm., 329 F.2d 875 (2nd Cir. 1964); Nickerson Lumber Co. v. U.S., 214 F. Supp. 87 (D. Mass. 1963); Bacon v. Comm., 12 AFTR 2d 6076 (E.D. Ky. 1963).
(10.) Jordanos, Inc. v. Comm., 395 F.2d 829 (9th Cir. 1968).
(11.) Plastic Binding Corp. v. Comm., TC Memo 1967-147; see also John C. Nordt Co. v. Comm., 46 TC 431 (1966).