Tax Facts

3640 / If an employer voluntarily pays a death benefit to an employee’s surviving spouse, is the benefit taxable income to the surviving spouse, and is it deductible by the employer?

The IRS has taken the position that voluntary death benefits are not gifts, but are compensation and therefore taxable income.1 The courts, following the rules developed by the United States Supreme Court in Commissioner v. Duberstein,2 have divided on the question of whether these payments are tax-free gifts or taxable compensation. Each case has been decided on its facts.3



Payments made after December 31, 1986 by an employer “to, or for the benefit of” an employee are not excludable as gifts, however.4 Thus, a death benefit paid by an employer after December 31, 1986 would appear to be a payment for the benefit of an employee and, if so, would be taxable compensation not an excludable gift. Employee death benefits that are payable by reason of the death of certain terrorist attack victims or astronauts are excludable from gross income.5

To be deductible by the employer, a voluntary death benefit must qualify as an ordinary and necessary business expense.6 Payments will be deductible, therefore, if the circumstances show that they are additional reasonable compensation for the employee’s services, or otherwise qualify as an ordinary and necessary business expense.7

The deduction will be denied if the facts indicate that the payment was purely a gift or was made for the personal satisfaction of the directors.8

Where the surviving spouse is a controlling stockholder, the payments may very likely be treated as constructive dividends. In such a case, the entire death benefit would be taxable to the surviving spouse but not deductible by the corporation.9 Even where the surviving spouse does not own a controlling interest, the payments may be treated as dividends, if the corporation is owned by a closely knit family group.10 The payments will not be treated as dividends merely because the employee was a minority stockholder. They also will not be treated as dividends in all cases where the surviving spouse is a substantial, but not a controlling, stockholder.11






1.   Rev. Rul. 62-102, 1962-2 CB 37.

2.   363 U.S. 278 (1960).

3.   See Sweeney v. Comm., TC Memo 1987-550.

4.   IRC § 102(c).

5.   IRC § 101(i).

6.   IRC § 404(a)(5); Treas. Reg. § 1.404(a)-12.

7.   Rubber Assoc., Inc. v. Comm., 335 F.2d 75 (6th Cir. 1964); Associated Ark. Newspapers Inc. v. Johnson, 18 AFTR 2d 5894 (E.D. Ark. 1966); Fifth Ave. Coach Lines, Inc. v. Comm., 31 TC 1080 (1959).

8.   Loewy Drug Co. v. Comm., 356 F.2d 928 (4th Cir. 1966); Vesuvius Crucible Co. v. Comm., 356 F.2d 948 (3d Cir. 1965); Montgomery Eng’g Co. v. Comm., 344 F.2d 996 (3d Cir. 1965); Greentree’s Inc. v. U.S. 16 AFTR 2d 5368 (E.D. Va. 1965); Fouke Fur Co. v. Comm., 261 F. Supp. 367 (E.D. Mo. 1966).

9.   Schner-Block Co., Inc. v. Comm., 329 F.2d 875 (2d Cir. 1964); Nickerson Lumber Co. v. U.S., 214 F. Supp. 87 (D. Mass. 1963); Bacon v. Comm., 12 AFTR 2d 6076 (E.D. Ky. 1963).

10.   Jordanos, Inc. v. Comm., 396 F.2d 829 (9th Cir. 1968).

11.   Plastic Binding Corp. v. Comm., TC Memo 1967-147; see also John C. Nordt Co. v. Comm., 46 TC 431 (1966).

Tax Facts Premium Tools
Calculators
100+ calculators specifically designed to help you easily assist clients with specific planning situations and calculations.
Practice Guidance
Designed to help you discover new ways for which to build and maintain client relationships.
Concepts Illustrated
Specifically designed to help you easily assist clients with specific planning situations and calculations.
Tax Facts Archives
Access to the entire library of Tax Facts dating back to 2012 allowing you to look up the exact tax figures from prior years.