In the case of Felton v. Commissioner, TC Memo 2018-168, the Tax Court was faced with a minister who claimed that $200,000 given to him by parishioners in addition to their regular offers were gifts and not compensation.

The issue has its beginnings in a tradition for some evangelical churches that Reverend Felton discovered as he began his career in the ministry. As the opinion notes:

Reverend Felton found his vocation at Tuskegee University, where he assisted the dean of the school’s chapel while still a student. He also first learned about “shake-hand” money at that chapel — the custom in some evangelical churches of handing donations to the pastor on the way out of the church. Reverend Felton didn’t like the way the chapel handled these donations and silently resolved to do things differently if he ever had a church of his own to run.

The church Reverend Felton presided over used envelopes to allow members of the congregation to designate what their contributions would be used for, including a line that allowed for pastoral contributions. Contributions made with such envelopes would be accounted for by the church, with the donors given statements regarding their contributions.

However, some members were not comfortable with giving pastoral donations in that manner because they did not want Reverend Felton paying tax on such donations. But, as was noted, Reverend Felton was not comfortable with “shake hand” money donations not subjected to the church’s controls on donated funds. That lead to the creation of the blue envelope solution:

Blue envelopes came later than white and gold. Reverend Felton was, as we wrote, uncomfortable with “shake-hand” money; he recognized, however, that his congregation wanted to give, and he “didn’t want to necessarily hurt anyone’s feelings.” White envelopes already allowed for pastoral donations, but they caused an unusual problem: Reverend Felton felt that some congregants wanted to make sure they did not get a tax deduction for the amounts they gave him — “there were some who said * * * ‘I did not want this to be counted for tax, I wanted it to be a gift.’” So Reverend Felton and the rest of the executive board came up with a solution — the blue envelope. (We have no idea how many church members itemize or the ratio of those who pick white envelopes compared to those who choose blue.)

Reverend Felton first told his congregation about the blue envelopes at the church's annual business meeting. He explained that if members were so inclined they could donate to him in blue envelopes but they wouldn't get a tax deduction if they did. Blue envelopes weren't as ubiquitous as white envelopes — ushers didn't hand them out at the church's entrance and, although ushers had them, they followed the custom that a member had to ask for one if he wished to give in that way. And, while Reverend Felton regularly preached about tithes and offerings — made in the white envelopes — he didn't preach about making personal donations to him in the blue. Those weren't the only differences between white and blue envelopes. The church opened white envelopes and tracked the donations made in them, but all the blue envelopes were handed over to Reverend Felton unopened.

Reverend Felton reported the pastoral offerings as follows on his personal return:

The Feltons didn’t report as income on those returns any of the donations they got in blue envelopes, but they did report about $40,000 in wages for each year. These reported wages were the amounts made in white envelopes that donors had designated as “pastoral” donations.

The Reverend claimed that the blue envelope payments were gifts made to him by those attending his church and thus not taxable compensation.

The Tax Court begins by looking at the definition of what is a gift for income tax purposes, noting:

What’s a gift? The Supreme Court has defined it: “A gift in the statutory sense * * * proceeds from a ‘detached and disinterested generosity,’ * * * ‘out of affection, respect, admiration, charity or like impulses.’” Commissioner v. Duberstein, 363 U.S. 278, 285 (1960) (first quoting Commissioner v. LoBue, 351 U.S. 243, 246 (1956); and then quoting Robertson v. United States, 343 U.S. 711, 714 (1952)). The Court also recognized that this definition might not be easy for a trial court to apply, because it “does not lend itself to a[ ] * * * definitive statement that would produce a talisman for the solution of concrete cases.” Id. at 284-85. The Court held that the most critical consideration is the transferor’s intention when the payment was made. Id. at 285-86 (citing Bogardus v. Commissioner, 302 U.S. 34, 43 (1937); id. at 45 (Brandeis, Stone, Cardozo, Black, JJ., dissenting)). But the transferor’s characterization of his intention “is not determinative,” the Court warned; “there must be an objective inquiry as to whether what is called a gift amounts to it in reality.” Id. at 286 (citing Bogardus, 302 U.S. at 40). With all that said, there is no bright-line test, and decisions “in these cases must be based ultimately on the application of the fact-finding tribunal’s experience with the mainsprings of human conduct to the totality of the facts of each case.” Id. at 289.

The opinion analyzed a number of cases where the courts had found, based on the facts, that payments made to a minister in various situations were or were not considered nontaxable gifts. Following that analysis, the opinion noted that the Court uses the following four tests in making this determination:

whether the donations are objectively provided in exchange for services;
whether the cleric (or other church authorities) requested the personal donations;
whether the donations were part of a routinized, highly structured program, and given by individual church members or the congregation as a whole; and
whether the cleric receives a separate salary from the church and the amount of that salary in comparison to the personal donations.

The Court first determined that the payments were for services, as they were meant by the Congregation to keep him preaching where he currently was preaching. The Court distinguished this case from those dealing with retiring ministers where the members clearly understood no future services would be provided. Thus, this factor favored the finding of compensation rather than a gift.

Alternatively, the Court noted that Reverend Felton did not request these donations. He did not speak about them in church, though he regularly called for donations to be made in the regular envelopes. Those attending the service had to specifically ask the ushers for a blue envelope, while the ushers freely offered the white ones at each service. The Court found this factor favored a finding as a gift.

The Court noted that the blue envelopes were part of routinized, highly-structured program. The envelopes gave all the information necessary to make a pastoral gift to Reverend Felton. The payments were of a similar amount from year to year, suggesting many members had paid these gifts part of their normal routine. This factor favored a finding of compensation.

Finally, there was the fact that the blue envelope payments were larger than the housing allowance and salary combined. This factor favored a finding that the payments were compensation.

The Court concluded:

As another former seminarian is widely thought (though unlikely actually) to have said: “Quantity has a quality all its own.” When comparatively so much money flows to a person from people for whom he provides services (even intangible ones), and to whom he expects to provide services in the future, we find it to be income and not gifts.