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

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.