“Can you give us your grumpiest server?”
That was the request made by two men at a Nebraska Cracker Barrel.
The hostess couldn’t accommodate their request. There are no grumpy servers here, she told them. Instead, she said, I’ll seat you with our happiest.
The happiest turned out to be 18 year old Abigail Sailors. As the two ate, they peppered Sailors with questions and she answered them, telling them about her childhood. It was far from idyllic. Her parents were in a serious accident when she was young, landing Sailors and her siblings in a number of foster homes, where she was abused. After being adrift for awhile, Sailors finally found a home with the folks who would ultimately give her a real home.
Sailors attended college for a semester. But college is expensive and she didn’t have the money to attend for a second semester. Instead, she was waiting tables and hoping to save some money.
Despite all of her hardships, Sailors remained cheerful. That struck a chord with the two men.
After their meal, the pair left Sailors a $100 tip. Sailors split that with another server.
But that wasn’t all that the two men left Sailors. One of the men, an alum from Trinity Bible College, the same school Sailors had attended, left two checks. One was a check made payable to Trinity for $5,000, to pay Sailors’ tuition. The remaining check was for $1,000, for Sailors.
In total, the men left behind $6,100. That’s quite a tip. Or is it?
I don’t think so.
Tips are taxable to the recipient as wages – even really, really big ones. That makes the federal income tax consequences predictable. I think we’d all agree that the $50 that Sailors received as a tip (her share of the tip) is taxable.
But what about the rest?
I think Sailors gets a pass on those two checks and here’s why: they’re gifts.
The IRS considers a gift to be “any transfer to an individual, either directly or indirectly, where full consideration (measured in money or money’s worth) is not received in return.” That’s different from compensation – like a tip – when you’ve received something of value (good service).
I think Sailors can make a successful argument that the checks were meant to be gifts. Those amounts were clearly over and above what would be appropriate for even outstanding service at a Cracker Barrel. I can say that having been to a Cracker Barrel or two in my lifetime.
And clearly, the two gentlemen understood that distinction – which is why they wrote separate checks.
Gifts do have some tax consequences but lucky for Sailors, those fall to the donor and not the recipient. Under current law, you can gift up to $14,000 per person per year without any federal gift tax consequences. The annual exclusion for 2014 is the same as for 2013. The exclusion is indexed for inflation inflation has remained low.
If a donor is feeling particularly generous and exceeds that amount, the donor has made a taxable gift. The donor must then either file a gift tax return with IRS and pay gift tax or make an adjustment to their lifetime exemption. But for the recipient? Nothing. There are no federal gift tax consequences to the person receiving the gift – whether it’s $15,000 or $15,000,000.
But even better? For federal income tax purposes, gifts are not taxable to the recipient. So, the recipient gets a pass on reporting and paying tax on the money.
And while it’s generally the rule that a gift is still a gift even if made indirectly, there are two big exceptions: checks written directly to a qualifying educational institution for tuition or to a health care provider for medical expenses are not subject to the gift tax even if they exceed the annual exclusion. It’s important to note that the educational exclusion is only for tuition and not for for books, supplies, room and board, or similar expenses. But those are the big exceptions. Any other payments on your behalf – like to your student loan provider or the company that holds the note on your car – isn’t excluded. Those checks are still considered gifts to you.
So that check written to Trinity for Sailors’ tuition? It’s clearly a gift. But it’s not a taxable gift. Even if either of the gentlemen came back next week and gave Sailors more money, the check for tuition never gets counted. The only gift that would count towards the threshold was the $1,000 check for personal expenses.
But that raises another point. What if those gentlemen do come back? Gifts are counted on a calendar year basis. The amount that matters is the total: that $14,000 represents the aggregate amount of gifts that a donor can give to any one recipient for the entire year without and gift tax consequences.
The fact that Sailors wasn’t related to the donors isn’t important. The only relationship that really matters for gift tax reasons is your spouse: you can make an unlimited amount of gifts to your citizen spouse (non-citizen spouses are limited). The $14,000 threshold applies to everybody else, whether it’s your kid, your brother, your neighbor or your best friend. Or your tax professional. Just saying.
Keep in mind that the threshold is per person. Donors can give up to the threshold to any one donor in a year without gift tax consequences. But they can also give up to the threshold to a million donors in a year without gift tax consequences. The key is per person per year.
So that $6,100 that Sailors received? She has to report $50 as compensation for income tax purposes (her share of the tip). But everything else was gravy. And since it was a Cracker Barrel, it was likely Sawmill gravy.
In the end, it turns out that Sailors has a lot to be happy about.
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