Revenge is a dish best served cold. In a recent case, a disenchanted suitor not only sued to recover gifts he made to his former lover but also reported those gifts to the IRS as income payments! See Diane Blagaich, TC Memo 2016–2.
Here’s what happened. Taxpayer and Boyfriend were in a romantic relationship from November 2009 until March 2011. In November 2010, they entered into a written agreement intended to formalize their “respect, appreciation and affection for each other” that required Boyfriend to make an immediate payment of $400,000 to Taxpayer.
Earlier that year, Boyfriend had given her $273,819 in cash, a $70,000 Corvette, and a diamond ring.
The relationship then went sour. In March 2011, Boyfriend sued Taxpayer in state court seeking nullification of the agreement, return of the Corvette and diamond ring, and an order directing disgorgement of cash and other gifts “totaling in excess of $700,000.”
But clearly the lawsuit wasn’t enough for Boyfriend. He then filed a Form 1099-MISC with the IRS reporting that he had paid Taxpayer $743,819 in 2010. The IRS determined a deficiency in that amount and Taxpayer filed a petition in Tax Court.
In November 2013, the state court found that Taxpayer had fraudulently induced Boyfriend to enter into the agreement and entered a $400,000 judgment against her. Taxpayer paid $400,000 to Boyfriend’s estate in compliance with the order. (Boyfriend died shortly after the trial).
Taxpayer asked the Tax Court to take judicial notice of the state court’s finding that all other cash amounts and property paid or given to her were “clearly gifts.” Under IRC §102, gifts and inheritances are excluded from taxable income. Taxpayer further argued that the return of $400,000 to the estate invoked the doctrine of rescission, eliminating all grounds for a deficiency in her 2010 income tax.
Her arguments didn’t go well. The Tax Court denied Taxpayer’s motion for summary judgment, holding that the IRS wasn’t collaterally estopped from litigating the state court’s gift finding because it wasn’t in privity with a party to the state court action. And the doctrine of rescission didn’t apply because Taxpayer didn’t repay the $400,000 in the year she received it.
Taxpayer could still show the other items were gifts, but she probably can’t avoid the taxes on $400,000 of income she later lost.
For more on the income tax gift exclusion in a trust distribution context, see CEB’s California Estate Planning §§13.48–13.51. Also check out CEB’s California Will Drafting §28.26 on devises in lieu of compensation for services.
Other CEBblog™ posts you may find interesting:
© The Regents of the University of California, 2016. Unauthorized use and/or duplication of this material without express and written permission from this blog’s author and/or owner is strictly prohibited.