Q: My sister has been employed only intermittently since her employer went out of business a couple of years ago. Her resources ran out around the end of 1983, and since then my husband and I have sent her more than $5,000. (Her son has contributed an additional $1,200.) Because this represents a sizable portion of our income, we asked the Internal Revenue Service if there is some way to deduct this amount on our federal tax return. The IRS replied that we would get our reward in heaven. Isn't there some way to deduct the money from our taxable income -- perhaps as a tax-free gift?
A: Perhaps you will get your reward in heaven, but I can understand your desire to find some solace along the way. Unfortunately, there is no way to claim this gift to your sister as a schedule deduction on your tax return.
Although it is certainly a tax-free gift, "tax-free" in this context refers to freedom from gift tax and carries no implication of income tax relief.
The only way to recoup any of the money on your tax return is to establish your sister as your dependent. To do this, the circumstances would have to meet a couple of tests. First, your sister would have to have less than $1,000 in taxable income during the year; and second, you -- or you and your nephew together -- would have to provide more than half of your sister's total support during the year.
For details on how to determine whether you meet these tests, see IRS Publication 501, entitled "Exemptions." It is available free from any IRS office or by mail from your district director; you also might find a copy at your local library. If your situation doesn't fit the IRS requirements, you may have to resign yourself to waiting for the hereafter and give up on the here and now.
Q: In your column for April 29, you said that a lump-sum payment for accrued leave to a retiring federal employe is not considered earned income for the purposes of an Individual Retirement Account. That doesn't sound right. The lump-sum payment is shown in box 10 of the W-2 form issued at the end of the year for tax purposes. To my knowledge, the amount in box 10 is wages and qualifies for an IRA. I have been unable to find anything that even implies otherwise. Can you please tell your readers where in the regulations your statement can be found?
A: The preceding letter is a composite of several I received questioning that April 29 item. There is no absolutely clear and unambiguous statement, either in the statutes or in IRS regulations, of the rule governing lump-sum payments for accrued leave.
The only statement that comes close is found in IRS Publication 590, "Individual Retirement Arrangements," (and several other places): "The term 'compensation' also does not include any amount received as . . . deferred compensation." This statement is supported by Code Section 219(f)(3).
A new definition of "compensation" is in the works at the IRS, as a result of language in the Social Security Amendments of 1983 and the Tax Reform Act of 1984. But the IRS has literally hundreds of ongoing regulation-writing projects, some dating back to even earlier tax legislation, and there is no projected target date for this particular assignment.
However, the work done so far points quite clearly to a ruling that a lump-sum payment for leave time accrued in preceding years is a form of deferred compensation. Thus, while the lump-sum payment would be subject to federal income tax as ordinary income, it would not be considered earned income for the purpose of qualifying for an IRA contribution.
The status of leave accrued during the year of retirement is not so clear. The IRS experts may find that since that portion was accrued for work performed in the current year, it would be considered current earnings and thus eligible for an IRA contribution.
But this decision has not yet been made official. I can only repeat that in general, payment at retirement for accrued leave is a form of deferred compensation and may not be counted as earnings for IRA purposes. If you're interested in making an IRA contribution on the basis of payment received for leave time accrued in the current year, you'll have to hang tight and wait for the IRS determination.