TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Thursday, April 20, 2006

Tax Court: Couple Must Report as Income $25k Paid by Wife's Paramour

Tax_court_26 The Tax Court yesterday decided an interesting gift v. income case, Peebles v. Commissioner, T.C. Summ. Op. 2006-61 (4/19/06).  You don't often find facts like these in a tax case:

Petitioners are married and lived in DeWitt, Arkansas, when they filed the petition....In 1999, Milton D. Peebles (petitioner) was a police officer in DeWitt. Mrs. Peebles was a patient of Dr. John M. Hestir (Dr. Hestir), who had a medical practice in DeWitt. Petitioner discovered in October 1999 that Dr. Hestir and Mrs. Peebles were having an affair.

Petitioner then lured Dr. Hestir to petitioners’ home on the pretext that Mrs. Peebles needed medical care. Petitioner is about 20 years younger than Dr. Hestir and is capable of being loud and garrulous when angry....Petitioner was angry when Dr. Hestir arrived. At that time, petitioner confronted him with the evidence of the affair and threatened to sue him for $150,000....Dr. Hestir told petitioner that he did not have $150,000,but he did have $25,000. They agreed to meet 2 days later so that Dr. Hestir could pay that amount to petitioner....

Petitioner and Dr. Hestir met in the parking lot of DeWitt Bank & Trust, and Dr. Hestir gave petitioner $25,000 in cash. During the exchange, petitioner and Dr. Hestir had a conversation which petitioner taped. Dr. Hestir said he was sorry about the affair and stated that this was “free money”, but that petitioner should be careful how he spent it because it could be considered income.

Dr. Hestir was right -- the Tax Court concluded that the $25,000 was income and not a gift:

On February 8, 2000, Dr. Hestir’s accountant prepared a Form 1099-MISC, Miscellaneous Income, reporting that he had paid $25,000 to petitioner. Petitioners did not report the $25,000 on their timely filed Federal income tax return for 1999....

Petitioners contend that the $25,000 payment was a gift because it was Dr. Hestir’s idea to pay it, and petitioner did not force him to pay it....

We believe that Dr. Hestir thought petitioner wanted a payment because of the affair. We also believe that Dr. Hestir offered the payment not because of detached generosity, but rather as a way to close the matter and avoid being sued by petitioner....

Petitioners contend that Dr. Hestir paid the $25,000 out of a feeling of guilt or moral obligation. Petitioners point out that a newspaper article states that Dr. Hestir said he paid petitioner, ended the affair, and reported himself to the medical board because of his guilty conscience. A payment made because of the constraining force of moral or legal duty is not a gift.

Dr. Hestir’s accountant filed the Form 1099-MISC a few days after the medical board hearing. Petitioners contend that Dr. Hestir did that to punish petitioner for reporting the matter to the medical board and to incorrectly make it appear that the $25,000 payment was not a gift. We disagree; the payment was not actually a gift.

We conclude that the $25,000 payment by Dr. Hestir was not the result of detached and disinterested generosity or paid out of affection, respect, admiration, or charity. Instead it was paid to avoid a lawsuit, to avoid public and professional embarrassment, and to assuage his own feelings of guilt or moral obligation. Therefore, the $25,000 payment in 1999 is not a gift and is includable in petitioners’ gross income for that year.

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Comments

sounds more like a bribe. Bribes are non-taxable.

Posted by: Mark | Apr 20, 2006 10:35:06 AM

What we need is tart reform!

Posted by: Robert | Apr 20, 2006 1:03:08 PM

It's a good signal the tax code is a little complicated if it includes rules about the intent of a transfer of money. Holy moly.

Posted by: Morgan | Apr 20, 2006 2:08:14 PM

Maybe it's just me thinking this, but isn't it income because Mr. Peebles pimped out his wife?

What are the laws regarding running a prostitution ring (albeit a small one) in Arkansas?

Ag

Posted by: Ag | Apr 20, 2006 2:13:54 PM

Maybe it's justs me thinking this, but isn't it taxable income because Mr. Peebles pimped out his wife?

I don't know what the laws regarding running a prostitution ring (albeit a small one) in Arkasas are, but Mr. and Mrs. Peebles might have other problems as well.

Ag

Posted by: Ag | Apr 20, 2006 2:19:22 PM

I need to know two things 1) Did Dr. Hestir properly and in a timely manner supply a copy of 1099 Misc to Officer Peebles in an envelope clearly marked "Important Tax Information" and 2) did Dr. Hestir deduct the payout as a business expense -- i.e. as money that needed to be paid to hang on to his medical practice?

You don't just file 1099 Misc with the IRS -- you have to give copies to the payee as well, and not following the procedures on 1099 filings is a form of tax malfeasance. Then if Officer Peebles received said 1099 Misc, what business does he have of not reporting it as income?

Then again, is a tort settlement considered income? A legitimate business expense? Maybe Officer Peebles should have simply retained an attorney, filed his lawsuit, and settled it for $25,000.

Finally, Dr. Hestir's warning "that could be taxable, be careful how you spend it" could be interpreted to be entering into a conspiracy with Officer Peebles to commit tax fraud. Dr. Hestir didn't say "I serving you with a 1099 Misc for that" or "you had better report this in your income tax if you know what is good for you." He was suggesting that Officer Peebles keep this cash under the mattress.

So why did Dr. Hestir pay cash instead of writing a check? And then why did Dr. Hestir serve up the 1099 Misc (which I don't think he was required to do unless he was planning on taking the money as a business expense) -- Dr. Hestir's name would be all over the 1099 as written evidence, confounding the cash payment. Did Dr. Hestir (or his accountant) believe that he was separating himself from the conspiracy to commit tax fraud by serving up the 1099?

Posted by: Paul Milenkovic | Apr 20, 2006 3:17:48 PM

Bribes ARE taxable, see Traficant, James Jr., (1987) 89 TC 501 , affd on other issue(1989, CA6) 64 AFTR 2d 89-5560 , 884 F2d 258 , 89-2 USTC ¶9513. But they're not deductible (see Code sec. 162(c)), so it's a lose-lose situation.
Of course, Dr. Hestir's payment isn't deductible in any case unless he has the chutzpah to claim it as a trade or business expense since he met Mrs. Peebles in the course of business.

Posted by: Harris Abrams | Apr 20, 2006 3:46:02 PM

Mark - surely bribes are taxable income to the recipient. If not, then from here on out, I don't get paid wages by my employer. He bribes me to work!

But bribes are generally not deductible expenses for the person who pays the bribe.

Posted by: harmon | Apr 20, 2006 4:05:17 PM

Sounds like the Dr. took the $25,000 as a deduction, since his accountant filed a 1099-MISC.

Posted by: schroedinger's cat | Apr 20, 2006 4:10:38 PM

I was under the impression that even if the payment is non-taxable, for example, a householder paying a maid, that a 1099 must be filed if the payments exceed $600 in a year.

Posted by: Anthony | Apr 20, 2006 8:50:02 PM

someone suggested that the Dr. took $25,000 as deduction! Is it right or allowable to take deductions, when the nature of payment is to keep the mouth shut rather then facilitating a business.

Posted by: Karam | Apr 23, 2006 2:16:01 PM

How much do you think he will end up having to pay, including penalties, interest and fines? Thats over 6 yrs. ago. Does anybody know the fine for fraud? Wow it might be more than he got from Hestir in the first place.
Nancy

Posted by: Nancy | Apr 24, 2006 6:32:53 PM

Simple question--are the proceeds of a stock redemption reportable on Form 1099?

Posted by: Mark | Aug 9, 2006 4:53:37 PM

Unless it is in the ordinary course of business I don't believe it is required to file a 1099. However, even back then it was required to report cash transactions of $10,000 or more and for that the doctor may be in trouble.

Posted by: Tom | Aug 10, 2006 11:38:06 PM