Undue influence over elderly man results in taxable income and penalties for caregiver

The Tax Court held that over $900,000 in checks an elderly man transferred to his caregiver was taxable income to her. The court also held that the income was subject to self-employment tax and that her returns that failed to report the income were subject to a fraud penalty.

Facts: Arthur Marsh worked as an optometrist in a California town. He never married and lived alone and frugally, saving more than $1 million by the time he retired in the 1980s, which through prudent investing grew to over $3 million. After 2000, his health declined. He suffered a stroke and was diagnosed with dementia. In 2007, when he was 91, his doctor insisted that he hire a home health care assistant before he could return to his apartment from a hospitalization. Marsh hired Angelina Alhadi, a nursing assistant. During the next two years, Alhadi persuaded Marsh to give her more than $900,000.

When Marsh and Alhadi attempted to obtain additional funds from his brokerage account with The Vanguard Group, the firm's fraud team contacted the California Department of Health and Human Services. Desperate for more funds, Alhadi drove Marsh to an estate attorney, seeking to create a power of attorney and requesting to be placed in his will. The attorney urged Alhadi to return the funds transferred by Marsh. She refused. Shortly afterward, a court created a conservatorship for Marsh on a petition from the local public guardian's office. Marsh died in 2009.

The IRS assessed a deficiency for Alhadi stemming from more than $1 million of unreported income for 2007 and 2008, plus penalties.

Issues: Alhadi claimed that the transfers from Marsh were a loan or, alternatively, a nontaxable gift. The IRS asserted that the money was taxable self-employment income and that Alhadi's failure to report it was fraudulent.

Holding: The Tax Court held that over $900,000 in checks to Alhadi was taxable income subject to self-employment tax and penalties, including under Sec. 6663 for fraud.

The court noted that a loan is "an agreement, either express of implied, whereby one person advances money to the other and the other agrees to repay it upon such terms as to time and rate of interest, or without interest, as the parties may agree" (Welch, 204 F.3d 1228, 1230 (9th Cir. 2000)).

Additionally, a debtor-creditor relationship is established, which is a question of fact. The court found that the funds were not a loan, noting that Marsh never referred to the money as anything other than compensation. The court also pointed to a document that Alhadi prepared that purported to forgive all "loans" after Marsh's death, which the court said demonstrated that she never intended to repay the money.

To be a gift, the court noted, a transfer must proceed from a "detached and disinterested generosity" (Duberstein, 363 U.S. 278, 285 (1960)). Where payment is for past services or an inducement for services in the future, it is not a gift (id. at 292). The court noted that there is a strong presumption that payments made beyond an employee's salary are compensation for services and not gifts.
Alhadi's entire case rested on her uncorroborated testimony and the word "gift" written on the memo lines on some checks.

With respect to the money transferred to Alhadi, other than the amounts that had been called compensation, the court determined that these transfers would not be gifts (and thus would fall under the presumption of being compensation) if any donative intent that Marsh had was negated by undue influence, as defined by state law. After examining California law and the evidence, the court found that Alhadi had exerted undue influence over Marsh, using her relationship to isolate him from his family and financial advisers, thereby negating any donative intent he had. Consequently, all the money she received from Marsh was taxable compensation income.

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Undue influence over elderly man results in taxable income and penalties for caregiver