Summary:
Sometimes IRS increases taxes by converting an intended gift into compensation income.

Former Enron Corp. manager Lawrence M. Lawyer pleaded guilty to filing a false tax return.

The criminal indictment said Lawyer didn't report as income $79,000 he "disguised as gifts." He received it from a partnership called RADR, which he had helped organize. The partnership had acquired an interest in wind farms owned by Enron, which is now in bankruptcy. His attorney said investors made the gift to show their appreciation for Lawyer's good work. He faces a fine of up to $250,000 and a prison sentence of up to three years.

Gift or compensation? The money Lawyer received didn't qualify as a gift for federal tax purposes because most transfers to an employee are considered compensation. Exceptions include minor fringe benefits, achievement awards and traditional awards such as a gold watch upon retirement. Other than these, to qualify as a gift, the transfer from the employer must relate to a personal event or situation. An example: a gift from a mother-employer to her son-employee.

The $79,469 paid to Lawyer was not a transfer made because of a personal event or situation; therefore, it was taxable compensation income.

Transfer for personal reasons. Could transfers of $750,000 in six years from a boss to his unrelated secretary qualify as gifts?

Jane Young served as Hampton Powell's secretary for 26 years and handled his personal and financial affairs as well. He was chief executive officer of the Lane Company, a furniture manufacturer based in AltaVista, Va. Powell relied on Young for tax and estate planning and preparing his and his wife's tax returns.

The generous executive gave company stock to churches, charities, family members and Young each Christmas. He gave an equal amount of stock to her, his wife and his sister. During the year, he also gave Young clothing, jewelry, perfume, candy, collectibles and housewares.

The Powells had no children, and he viewed Young as a daughter. He was interested in her family and her children. She viewed him as a father and her best friend and promised she would look after Mrs. Powell after he died. She visited him in the hospital. She also went to the Powell home every month or so to discuss his finances and to socialize.

Beyond his usual generosity, he was concerned about her future welfare because of her widowhood and recent retirement. Over the last six years of his life, he gave her $798,250 in cash and other gifts and paid gift taxes.

Mrs. Powell died a year after Powell. Her estate's executor, John E. Lane III, saw an opportunity to get money for the estate. He amended Powell's returns, deleting the transfers to Young out of the gift returns, and deducted them as compensation expense on the income returns. He then asked the IRS for a refund of gift and income taxes.

U. S. District Court. The court considered these factors:

• Powell was generous and felt a fatherly affection for Young.
  
• He paid gift taxes rather than deducting the payments as an expense on his income tax returns.
  

• She couldn't have duped a sophisticated businessman like him into characterizing the payments to her as gifts.
  

The court ruled the transfers were gifts and denied refunds to the executor:

"It is reassuring that the law does not permit John Lane to tarnish the memory of two peoples' friendship by undoing their kindness toward each other."

(more at Business)