The fourth article in our Cash Gifting Basics series discusses the role of the IRS and income tax in cash gifting, and how the law may not be as clear as cash gifting programs may claim.
Tony Hayes has provided a rebuttal to this article, presenting an alternative view of cash gifting and tax law. His article follows ours.
If you’ve either investigated or participated in a cash gifting program, you’ve almost certainly been assured that cash gifting is recognized by the IRS as a perfectly legal way to lower your taxes - and that’s completely true.
In Tax Code Title 26, Sections 2501-2504 and 2511, the IRS says that you may give $12,000 per person to as many individuals as you choose during the course of a calendar year (or $24,000 per married couple), and that these gifts are non-taxable. The IRS makes it quite clear, however, that in order to qualify under Title 26, your gifts must be given with absolutely no expectation of receiving anything in return. Title 26 is intended to help people lower their estate taxes by distributing assets during their lifetimes.
Any cash gifting program which invokes Title 26 as proof of its legality, however, is not being totally honest with you as to how the IRS views their operation. Here’s what IRS agent Connie Lorz, President of the California Society of Enrolled Agents from 2002 to 2003, had to say on the subject:
Some of these ‘gifting’ organizations claim the money is tax-free, but the IRS considers all income derived from them to be reportable income. Of course, for most of those who get involved in these gifting parties, it’s a moot point, as they’re never going to see any profit or even get their original stake back.
Those individuals who got involved in the scam early and have their piece of dessert are subject to tax evasion charges if they haven’t declared their gains.
One cash gifting group, Elite Activities Resurrected, has tried to bypass IRS requirements by calling themselves charitable organizations under a Internal Revenue Code 501 (c)(3) license.
The IRS classifies some charitable groups as tax-exempt:
To be tax-exempt under section 501(c)(3) of the Internal Revenue Code, an organization must be organized and operated exclusively for exempt purposes set forth in section 501(c)(3), and none of its earnings may inure to any private shareholder or individual …
But there’s more to 501 (c)(3):
An organization will not be regarded as operated “exclusively” for IRC 501(c)(3) purposes if more than an insubstantial part of its activities is not in furtherance of an exempt purpose. The presence of a single non-charitable purpose, if substantial in nature, will destroy the exemption regardless of the number or importance of truly charitable purposes.
Better Business Bureau v. United States, 326 U.S. 279 (1945).
Therefore, if an organization engages in illegal acts that are a substantial part of its activities, it does not qualify for exemption under IRC 501(c)(3).
Every state has a statute against pyramid schemes, making them illegal activities. Elite Activities Resurrected’s predecessor, Elite Activities, was shut down by the state of Texas in 2005, and its founder, Harry Dockstader, sentenced to two years in prison. His conviction was upheld by the Texas Court of Appeals in 2007.
Once prospects join a cash gifting program, they may also be advised on various means of depositing and handling of cash gifts so as not to arouse suspicion or trigger flags at financial institutions, which routinely report to the IRS. If cash gifting were fully in line with tax law, such instructions would be necessary.
If you are considering a cash gifting program, you are strongly encouraged to consult with a qualified tax attorney or professional.
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