Employee Compensation

[Burke]

A business employer long ago agreed to pay an employee's daughter's college education expenses. The day has now come. I believe this is W-2 compensation to the employee. Do you agree?

[Grumpy]

Maybe - but also could be considered a gift. Would probably depend on the details of the agreement.

[Burke]

This was an informal agreement at the time in order to give the employee a reason not to leave for another job. Employer will honor the commitment. I think because of the employer-employee relationship, it cannot be considered a gift at this time. Beyond that, it would be over the gift exclusion amount for one year.

[les grans]

If the only relationship among these three people is the employment of the employee by the employer, this is not - this cannot be - a gift. The only thing a payment to or for an employee can be is compensation. That's what the IRS says, and the courts agree with them.

[Burke]

That's my take on it as well. Actually, I have found further information on this. There was
a Tax Court case on a similar situation, and a cash payment was found to be taxable compensation. In that case, a 1099MISC, Box 7 was issued to the employee for the payment. It was picked up by the IRS as unreported income, naturally, since she did not put it on her 1040. She argued in Tax Court that it was a gift, which did not fly. As far as I can tell they did not dispute the method of reporting. There is no mention that they deemed it to be W-2 income. How would you treat it? I have to do one or the other.

[les grans]

Even if - especially if - the employer and the employee are having a secret, steamy, torrid love affair, you should keep your nose out of it, and do the right thing: The payment is just compensation, and taxable as such.
And when you say that the promise was made "...in order to give the employee a reason not to leave for another job" that seals it... Put it on the W-2, subject to payroll taxes and you've done it exactly right.

[Burke]

Thanks for the confirmation on the W2. The Tax Court case I mentioned did involve the issues you stipulated; but take it from me, nothing of that sort is going on with my client. I know them both, and she would have a stroke if anyone thought that. The issue just came up as to whether it was taxable to the employee or not, and as far as I could tell, it was. The only similarity to the other case was that it was an inducement not to leave employment.

[Burke]

Well, life does get more complicated. It turns out that this was NOT an informal agreement, there is an actual contract written 9/2/2004 between them regarding this issue. However, the contract states nothing about continued employment on the employee's part; it is between the two individuals personally, not the company; requires that payment be made directly to the educational institution; and even states that in the event of the payor's (i.e, employer's) death, his estate will continue the payments. Does this change anything in your opinion?