Income tax and compensation for services

Introduction

Under Section 61(a)(1) of the Internal Revenue Code, a taxpayer must include all compensation for services in gross income. Typically, a taxpayer receives compensation for services directly from the party for whom the services were performed. However, when the taxpayer does not receive the compensation directly, different courts have interpreted the meaning of Section 61(a)(1).

Old Colony Trust Co. v Commissioner

In 1929, the United States Supreme Court decided the case of Old Colony Trust Co. v. Commissioner. The employer paid incomes taxes on behalf of an employee, and the Court questioned whether that payment constituted additional taxable income to the employee. The Court decided that the payment constituted income to the employee because “the discharge by a third person of an obligation to him is equivalent to receipt by the person taxed.” Thus, even when a taxpayer does not directly receive compensation for services, the compensation may be considered gross income if the payment releases the taxpayer from an obligation.

McCann v. United States

The issue of whether indirect payments for services should be included in gross income arose again in McCann v. United States. In McCann, the court had to decide whether travel expenses paid by an employer to enable an employee to attend a company conference were part of the employee’s gross income. The company provided the travel award to the employee for good work in increasing net sales during 1972. The court held that the travel expenses were compensation to the employee for services rendered to the company during 1972 and should be included in gross income. Therefore, when a company pays travel expenses, a taxpayer must include such compensation in gross income when the excursion is viewed as a reward for outstanding employee success within the company.

United States v. Gotcher

Similar to McCann, the issue in United States v. Gotcher involved an expense-paid trip. The employer paid for the employee to travel to Germany to induce the employee to undertake further business endeavors. The court held that the employee’s expenses paid by the employer were not gross income because the “indirect economic gain subordinate to an overall business purpose.” However, the court found that the employee’s wife, who accompanied her husband on the trip, incurred gross income because the wife’s trip was primarily a vacation. As such, a taxpayer does not acquire gross income from an expense-paid trip provided by the employer when the primary and overall purpose relates to business interests.

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