Q: Our church agreed to pay our pastor a salary of $60,000 for 2013. Because of financial pressures our church is experiencing, our pastor is only accepting half of the agreed-upon salary. Is he taxed on the full salary of $60,000 even though he has declined to accept it, or is he taxed only on the salary that he actually receives?
A: The constructive receipt doctrine specifies:
Income although not actually reduced to a taxpayer's possession is constructively received by him in the taxable year during which it is credited to his account, set apart for him, or otherwise made available so that he may draw upon it at any time, or so that he could have drawn upon it during the taxable year if notice of intention to withdraw had been given. Treas. Reg. 1.451-2(a).
A number of courts have ruled that this principle requires employees to include in their taxable income any portion of their stated salary that they refuse to accept. On the other hand, some courts have reached the opposite conclusion.
Perhaps the most notable case is Giannini v. Commissioner, 129 F.2d 638 (9th Cir. 1942). This case involved a corporate president whose annual compensation was 5 percent of the company's profits. In the middle of one year, the president informed members of his company's board of directors that he would not accept any further compensation for the year and suggested that the company "do something worthwhile" with the money. The company never credited to the president any further compensation for the year, nor did it set any part of it aside for his use. The amount of salary refused by the president was nearly $1.5 million, and no part of this amount was reported by the president as taxable income in the year in question.
The IRS audited the president and insisted that the $1.5 million should have been reported as taxable income. The taxpayer appealed, and a federal appeals court rejected the IRS position:
The taxpayer did not receive the money, and … did not direct its disposition. What he did was unqualifiedly refuse to accept any further compensation for his services with the suggestion that the money be used for some worthwhile purpose. So far as the taxpayer was concerned, the corporation could have kept the money …. In these circumstances we cannot say as a matter of law that the money was beneficially received by the taxpayer and therefore subject to the income tax provisions.
The court acknowledged that the United States Supreme Court has observed that "one who is entitled to receive, at a future date, interest or compensation for services and who makes a gift of it by an anticipatory assignment, realizes taxable income quite as much as if he had collected the income and paid it over to the object of his bounty." Helvering v. Schaffner, 312 U. S. 579 (1941). However, the court distinguished this language by observing that "the dominance over the fund and taxpayer's direction show that he beneficially received the money by exercising his right to divert it to a use." This was not true of the corporate president in the present case, the court concluded.
In summary, there is some basis for treating as taxable income the portion of an employee's stated salary that is refused, particularly if the employee does not assign the income to a specified use but is content to leave the unpaid salary with the employer. But the IRS has cautioned that the correct treatment of salary refusals "depends on the facts and circumstances of each case," and that depending on the circumstances a different result may prevail. IRS Notice 2001-69. A tax professional should be consulted in such cases to render an opinion based on all the facts and circumstances.
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