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IRS rules are not always black or white, and something that I find myself struggling with is what is considered a gift.

Hypothetically, suppose I am moving soon and have a broken leg so I cannot do it myself, or even assist. I get a quote from two different moving companies and they are both exactly $300. Consider the following scenarios:

  1. My friend, upon hearing that I am going to pay $300 to move, offers to move me for $150. I agree and pay him $150.
    My Assumption: this is not a gift. My friend should declare the $150 as income.
  2. My friend, upon hearing that I am going to pay $300 to move, offers to move me for free. I happily agree, but since I know my friend is hurting for money right now, afterwards I give him $150 since he really helped me out. I still come out ahead compared to if he didn't do me the favor.
    My Original Assumption: My initial reaction would have been to say this is a gift. My friend had zero expectation of receiving anything, so from his point of view he received a generous gift from me.

But after thinking about this more, (as strange as it feels to me), I now think my friend should declare the $150 as income in both scenarios. My thinking now is that a gift is defined from the point of view of the giver, not the receiver. The IRS defines a gift as:

What is considered a gift?
Any transfer to an individual, either directly or indirectly, where full consideration (measured in money or money's worth) is not received in return.

Based on that definition, from my point of view, I received "consideration" from my friend that was worth $300 to me. (Arguably it would be some amount less than $300 since the moving companies probably are insured and my friend is not, but if nothing was damaged, for the purposes of this hypothetical let's assume the value of what my friend provided was worth about $300 to me.)

My New Assumption for #2: Since I did receive "full consideration" and then some (I received twice as much consideration compared to what I paid), my payment should not be considered a gift from my point of view, and therefore my friend should treat it as income.

  1. Now suppose the same scenario as #2, except this time I'm feeling really nice and since I know my friend is hurting financially, and I'm so moved by his willingness to help me for free that I decide to give him $1,000!
    My Assumption: Since the consideration I received is worth at most $300, I did not receive "full consideration" and therefore this is considered a gift.

My question: Are my conclusions correct that my friend should declare #1 and #2 as income, but #3 should be considered a gift? If yes, in scenario 3, is the entire $1,000 treated as a gift, or should $300 be declared as income and $700 of it is considered a gift? (My gut tells me the latter would be more fair but I can't find any evidence of that being the case.)

Note: I realize the numbers used in these scenarios are too small to practically matter. If it's easier to conceptualize, you could multiply them all by 10 or 100. (Though if you use 100 I hope the answer would not be tainted by entering into the Gift Tax realm.) I'm more interested in the proper definition of income vs gift, instead of the practical application for the amounts in question.

Update: I found it more difficult than usual to choose a correct answer to this question, particularly because there are two plausible answers which are the exact opposite of each other. (Everything is a gift vs everything is income.) I found the accepted answer more persuasive mainly due to the idea that what matters most is not what the parties involved are thinking (or are attempting to accomplish), but what a 3rd party (such as an IRS auditor) would think when looking at the situation from an omniscient point of view.

TTT
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    Can you clarify why, in your first two examples, you are willing to consider the value of your friend's services to be $300 although you paid only $150, whereas in the last example, you are unwilling to consider the value to be $400 although that is in fact what you paid? The determination of what is fair consideration involves some subjectivity, and there can be more than one fair price. Just because you could have obtained moving services for $300 doesn't automatically mean paying $400 makes it a gift. It depends whether the extra $100 was reasonable or justifiable in some way. – BrenBarn Jun 23 '16 at 18:17
  • @BrenBarn - good question! My thinking was that in order to assign a valuation to the consideration I received, it would help to have a good baseline, and the average of service providers which I would have used if not for my friend seemed like a fair way to determine the baseline. I suppose I may have extrapolated from the FMV determination when gifting property: https://www.irs.gov/businesses/small-businesses-self-employed/frequently-asked-questions-on-gift-taxes#8 – TTT Jun 23 '16 at 19:08
  • @BrenBarn - Regarding your last sentence - I was trying to make the distinction that if my friend thinks he's helping for free, and I pay him more than it would have cost me to hire someone else, then it would not be justifiable as payment for service. I suppose we could exaggerate it by saying I was so moved by his helping me that I gave him $4,000. Then it would be more obvious that it's a gift- and perhaps the same questions could remain? – TTT Jun 23 '16 at 19:11
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    I want to downvote your question because of the first sentence. However, I will upvote. – Pete B. Jun 23 '16 at 19:46
  • @PeteB. - Haha. After re-reading my question later, I considered removing the very first phrase, but more than 5 minutes had elapsed and I didn't want to edit the question just because of that. If I do end up editing it, I'll probably strip that phrase out. – TTT Jun 23 '16 at 19:48
  • @TTT: In some sense the same questions could remain, but in practice the numbers do matter, for the reasons I outlined above. If one person quotes you $300 for a service and you decide to pay someone else $400, you may be able to justify that and it could still be considered a fair market rate. If you are quoted $300 but decide to pay $4000, that is going to much more difficult to justify. In theory, if the "true value" of the service was exactly $300, then paying even $301 would be a gift of $1; but in practice the difference must be fairly large to prove there was a difference at all. – BrenBarn Jun 23 '16 at 19:49
  • @BrenBarn - good points again. I changed it to $1,000 so it is more likely to be construed as too much to just be compensation for the service. (I thought $4,000 would be too high as it's so much more than the possible value of the service that maybe it could somehow swallow up the need to declare part of it as income, even if one normally should.) – TTT Jun 23 '16 at 20:05
  • @PeteB - fixed. ;) – TTT Jun 23 '16 at 20:05
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    And that's why you always pay friends who help you move in cases of beer. – user662852 Jun 23 '16 at 21:28

3 Answers3

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There are a few things that this question prompts -

  • The step transaction doctrine. I wrote a full page on it, but it's defined as "In short, the tax liability should be determined by viewing the transaction as a whole, disregarding one or more non substantive, intervening transactions taken to achieve the final result.” The original question that let to this one was "Is this investment opportunity problematic?" The linked question contains multiple issues, but the very trail of money suggests there's a profit for the lender and the profit is taxable.
  • Quid Pro Quo - On my blog or at this site, the person reading often gets value for their time. There are tax situations, for example, where the wrong move results in a huge tax bill (say, in an IRA withdrawal, vs letting it ride, and taking small withdrawals). If a grateful reader were to send a member a "gift," it's easy to feel that there was no consideration, but in fact, quid pro quo means "this for that," and what looks like a gift from a stranger is really taxable income.
  • Bartering - also taxable, with the same gray area of the one time exchange of favors, vs the organized time banks where multiple neighbors are bartering their expertise and time.
  • The reality - When friends help friends move and a small amount of money is given, I doubt many actually declare it on their taxes. I don't know how many 12 year olds claim the $10 they got for babysitting. But I do know that when I saw my daughter getting $10/hour, I told her to track it all in a notebook. It was worth declaring the $2000 she made, as it enabled her to open a Roth IRA. The blogger getting a one time $25 might not think twice, but if he has a "tip jar" on his site and regular funds coming in, he's taking a risk avoiding the taxes due.
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JTP - Apologise to Monica
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  • Some great points here! Would you mind mentioning how they apply to the specific questions? (I'd rather not require the readers to extrapolate and get it wrong.) Also, regarding Quid Pro Quo, in scenario 2, from the payee's point of view the moving services were "This for nothing" and the payment was a surprise, but from the payor's POV the payment is "This for that". One of the points Scenario 2 tries to make is that when the POV differs between the parties, perhaps the payor's POV should take precedence. – TTT Jun 24 '16 at 14:21
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    Bullet 4 is really what applies to the question. A one-time event that never actually gets reported. Quid pro quo is POV from a 3rd party, usually the auditor. "you did this, you got that, and you expect me to believe it's not related?" But in reality, cash has no paper trail. Not this little cash. – JTP - Apologise to Monica Jun 24 '16 at 14:38
  • So then, it sounds like you agree with the question's assumptions? The first two scenarios should be called income, and #3 has at least some income involved? Would you agree with the latter choice in #3- that some of the payment is income and the rest is a gift? (And btw, I just added a note to the question about the practicality of the low numbers, since others have mentioned that too.) – TTT Jun 24 '16 at 15:56
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    All 3 are income, none are likely to be reported. – JTP - Apologise to Monica Jun 24 '16 at 16:00
  • Now I feel like I'm badgering you (my apologies) but I want to make sure it's clear. For scenario 3, I assume you wouldn't consider all of it income, correct? Only the reasonable amount that could be payment for the service? The rest would be a gift? – TTT Jun 24 '16 at 16:11
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    No worries. I'd maintain the full sum is taxable. Part for services rendered, the rest a "tip". But again, I acknowledge these things don't get claimed. That's why I offered the scenarios I did in my answer. – JTP - Apologise to Monica Jun 24 '16 at 16:14
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    Interesting. Wow- I didn't see "the full sum is taxable" coming. Thank you for clarifying, and BTW, excellent clarification that Quid Pro Quo is from a 3rd Party POV. That option didn't occur to me, and it really makes it so much clearer when you look at it that way. – TTT Jun 24 '16 at 16:16
  • +1 for finding the phrase that escaped me - Quid Pro Quo! Exactly. The pattern of the overall transaction and expectation between the parties is the key! Good answer – jkuz Jun 28 '16 at 16:37
  • I think what makes these specific examples difficult is that there is an existing relationship between the parties (they are friends). This makes Quid Pro Quo and profit far more complicated than a babysitter, blogger tip jar, or kickback from a random stranger. – jkuz Jun 28 '16 at 16:57
  • How is income from bartering judged? Is it based on the typical market value of the exchanged goods/services? Do both sides of the transaction have to pay taxes on the bartered goods? – JAB Sep 14 '17 at 15:15
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Part of 'consideration', I imagine, would be the obligation of either party to follow through on an agreement, not only fair market value.

Look at the thought experiment from the opposite perspective.

  • If you did not pay him $150 (maybe just $50 or even $0), would you be breaking a contractual obligation to him?

  • If he left after 2 hours because he forgot about a family event and did not finish your move, would he be breaking a contractual obligation to you even if you gave him $150?

It seems it can be considered a gift (Update: in all cases)

There was no agreement of what either party viewed as full consideration in a mutual exchange.

To put it another way: From your examples, there is no evidence that the performance of either party hinged on receiving mutual consideration from the other.

More Updates from comments:

Patterns Matter

Similarly to how the IRS may determine W2 employee vs independent contractor, patterns do matter.

If your friend has a pattern of helping people move in exchange for tens of thousands of dollars in gifts every year, the IRS would view that in a different light. A waitress/waiter has a pattern of accepting 'gifts' of tips in exchange for good service as a part of their established job duties.

If you gifted your friend with $150/week when they watched your kids every Monday-Wednesday, that would be different. You are establishing a pattern, and I would suggest you may be establishing mutual consideration. In that case, consult a professional if you are worried.

Amounts Matter

This is why the gift tax exemption was created. The IRS does not care about the amounts in question here. It is too much of a burden to track and account for transactions that are this questionable and this small.

You gift your friend with a $20k car? Now you need to pay attention. Consult your CPA.

You gift your friend $1k for helping build your new deck? The IRS does not care.

Intent Matters

Even in the first case, it is not necessarily true that your friend considers $150 to be mutual consideration for his services. Would he open a business where he offers that rate to the general public? I doubt it. He intends to gift you services out of his own free will, not because there will be an equitable exchange of value.

The intent of both parties is to give a gift. There is no evidence that would suggest otherwise to the IRS, it seems, even if they cared in the first place.

jkuz
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  • Are you suggesting that all 3 scenarios could be considered a gift? – TTT Jun 23 '16 at 21:08
  • It seems to me like they must be. No party is obligated to follow through with 'their part' in any scenario, and mutual consideration does not seem to be established. I don't see how it could be argued as a payment if both parties consider it a gift. – jkuz Jun 23 '16 at 21:20
  • If one party insists that it was payment, that is a different story. – jkuz Jun 23 '16 at 21:20
  • I feel like there is a contractual obligation in scenario 1 though... – TTT Jun 23 '16 at 22:15
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    Interesting theory. However, when I go to a restaurant, I am under no legal obligation to tip. And yet when I do, the server is required to pay tax on it; the IRS does not consider that a gift, but payment for a service. – Ben Miller Jun 24 '16 at 13:01
  • @BenMiller yes, i see what you mean. I updated the post, but I think that in some service roles, a tip is part of an established payment pattern. Therefore it is considered regular income. Certainly tipping a stranger for service is an arms-length transaction, at least. – jkuz Jun 24 '16 at 13:33
  • @TTT in scenario 1, if you didn't pay you would mostly be a bad friend, I think. ;-) – jkuz Jun 24 '16 at 13:34
  • You are inserting terms such as "established payment pattern" that I am not aware of having ever been used to determine whether an amount is taxable. The amounts are taxable regardless of their regularity (at least, in any jurisdiction I am familiar with). – Grade 'Eh' Bacon Jun 28 '16 at 15:01
  • @Grade'Eh'Bacon Under an audit, how would the IRS determine gift vs taxable income for the friend in these scenarios? Neither party was under any obligation/contract to perform services in return for 'full consideration'. Both claim that the exchanges were gifts. – jkuz Jun 28 '16 at 16:11
  • @jkuz See my comment's to Max8126's answer below - the IRS doesn't need to prove that the linkage exists - they have ultimately a low burden of proof. To fight that burden of proof may require you to go to court. So the reality is that if something looks maybe fishy, even when it actually isn't, prepare to fight the IRS on it. And fighting the IRS is not fun, regardless of whether you are actually right. – Grade 'Eh' Bacon Jun 28 '16 at 16:15
  • @Grade'Eh'Bacon It is not that I disagree with your point - it is well taken. The IRS has plenty of power and uses it. What to consider is this: when these topics are discussed it is usually in the context of large property transfers and inheritance. Generally, no one (including the IRS) is fretting over how you did the taxes on the $1k you gave to your brother last year when he fixed your car. Certainly, if you actually hired your brother, he should declare it, but these scenarios here are more gray. I would argue that the IRS definition of a gift is left vague for just this reason. – jkuz Jun 28 '16 at 16:33
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The IRS definition of gift you quoted has "full consideration ... received in return". If your friend's help is not contingent upon your monetary offer (as is the case in all your scenarios I believe?), then it shouldn't be viewed as consideration in return of your money, right?

xiaomy
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    Are you suggesting my dentist can give me a root canal ($2000 value) as a gift, and unrelated, I tutor his kids to pass math this year (also $2000 value) and somehow these are gifts of time? When does the bartering issue come into play? – JTP - Apologise to Monica Jun 23 '16 at 22:25
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    @JoeTaxpayer I suppose it depends on how realistically "unrelated" they are. – xiaomy Jun 23 '16 at 23:36
  • @max8126 You can argue that they are unrelated all you want. Will the (insert your favourite tax authority here) agree? Generally speaking the IRS et al can assess tax on a basis of evidence far lower than "beyond a reasonable doubt". That is why Al Capone was infamously brought down on tax evasion rather than racketeering. – Grade 'Eh' Bacon Jun 28 '16 at 15:11
  • @Grade'Eh'Bacon Indeed, which is why I mentioned “realistically" in my comment earlier. – xiaomy Jun 28 '16 at 15:15
  • Right, but the important point is that the 'realistic nature' of the linkage is going to be determined by the IRS, and not the individual. If the individual wants to fight that determination, they may need to take the IRS to court over it. – Grade 'Eh' Bacon Jun 28 '16 at 15:19
  • @Grade'Eh'Bacon Agreed. – xiaomy Jun 28 '16 at 15:22