Incentive or Gift? What’s the Difference?
By Douglas L. Cassel, Esquire
To attract new clients it is common for REALTORS® to provide incentives in the form of gifts like cash rebates, gift certificates, moving services or home warranties.
At the Legal Hotline, we answer questions about this issue nearly every day. One major concern is whether such gifts are illegal referral payments. They are not. While paying referral fees to an unlicensed person is viewed by the PA Real Estate Commission as illegal under the PA Real Estate Licensing Act, giving incentives to clients is a legal method for inducing new business.
Recently REALTORS® have expressed concerns as to whether such incentives are considered taxable income. Since the Internal Revenue Code defines gross income as “all income from whatever source derived,” it’s only natural to wonder if client incentives are considered a gift.
In general, in order for a “gift” to exist there must be “detached and disinterested” generosity. Giving a client an incentive is a business transaction and does not qualify as a “gift” for tax purposes. In other words, the client has used your services with the promise that he or she will receive this incentive in return, hence such generosity is not present.
While it may seem that this discussion is leading to bad news, it is our opinion that client incentives, if treated properly, are not necessarily income to your clients. In essence, client incentives are only a portion of a larger business transaction and have a legitimate business purpose related to that transaction. In the simplest example, an offer of a reduced commission by a listing broker is certainly not income to his client, it is simply a reduced charge. Rebates and gifts, especially on the buying side of the transaction, are a little more complex but not more troubling – if handled properly.
It may be argued that on the buyer’s side of the transaction giving a “rebate” is impossible if the buyer never paid his agent in the first place; there is nothing to be rebated. This is typical of a transaction where the buyer broker receives all compensation from the listing broker. This argument, though, would seem to put form over substance.
In reality, buyers are paying a price for the house that the seller has calculated to cover payment of all real estate commissions, including those to a buyer broker. Therefore, any consideration given to the buyer by her agent can be traced back to the price the buyer paid for the home. A legitimate business purpose exists in this transaction and as a result, an attack by the IRS is unlikely.
These inducements, however, should be reflected on the Settlement Sheet. This illustrates their legitimate business purpose and relation to the transaction. It is more likely that the IRS may consider an inducement not shown on the Settlement Sheet to be income to the recipient since it would not appear as part of the transaction. If this is the case, the licensee is required to report the income by filing a 1099MISC form for amounts in excess of $600.
There are a multitude of other issues that could arise but that are beyond the scope of this article. Each licensee should consult his own tax professional regarding these inducements. To the best of our knowledge, the IRS has not ruled or issued any guidance on this matter. While we believe our assessment to be correct, there is no guarantee as to how the IRS would treat these inducements. Any licensee providing incentives should advise her clients to consult their independent tax professional with any concerns.
Mr. Cassel is an attorney with Caldwell & Kearns and serves as associate general counsel to PAR. A substantial portion of his practice is dedicated to general real estate law and business planning. He routinely counsels business clients on various matters and is also one of the voices of the PAR Legal Hotline.