Thank you to the wonderful u/HarvardLawSB for this post. It’s been linked to our wiki for future reference. To understand why you should not be on your SDs payroll, click here.

I first want to address that there are some things that I will not be covering here in depth. Of note was the common request of information on essentially how to evade taxes, what kind of platforms people should use to avoid detection by the government, etc. I will answer cursory information about currency methods/reporting systems, but I’m not going to give people a roadmap to break the law. I also am not going to give advice on wills/trusts since that is based on state-specific law and not as easy to tackle as the federal tax code. For the same reason, I won’t be addressing state estate taxes which do exist in some states.

Secondly, I know there are some gaps between the information as written and the questions asked. There were some questions I do feel warrant answering but I wanted to get the main (easy-to-write) substance out quickly. As a result, I will be doing research on some of the harder to answer questions to make sure I’m maintaining accuracy. Therefore, if you see questions that are blank at the end of this post or your question hasn't been answered-- please know that I will get to them in time, but likely in about a week or so from now. If I don't by two weeks from now, give me a little nudge. I am a full-time law student and have other responsibilities. This is an unpaid labor of love.

Lastly (and very importantly) none of the below is legal advice. It’s merely a summary of the tax code as it is written and interpreted by courts today. Any responses I give based on personal information you may disclose in the comments below are simply my interpretations of the law and are not meant to be construed as anything in a representative capacity.

There’s a lot to cover so I will try to break things up into succinct categories but forgive me if sometimes I get a little wordy. Law is complicated and the most common answer to any question is “it depends.” Teasing out the nuance of how takes time and space.

TL;DR:

If you are an SB, you may have to pay taxes or you may not have to do anything (!)

Whether your PPM/allowance is income or a gift is a fact-dependent inquiry and therefore depends on your unique situation. The case law on this is conflicted, but general guidance is paying for a service = income; giving your romantic interest money because of care/affection = gift.

If your PPM/allowance is income, SBs must report on a 1040 Schedule C and pay self-employment taxes as well as income taxes.

If your PPM/allowance is a gift, SBs are not required to report anything.

Every gift is taxable and paid/reported by the SD unless it meets certain criteria.

No tax is due if…

• The amount is less than the annual exemption
• The amount is paid directly to an educational institution
• The amount is paid directly to a medical institution
• The amount is paid directly to a spouse

No tax is due but must be reported on a 709 form if…

• The amount does not fall into a category above AND exceeds the annual exemption BUT is less than the lifetime exemption

Tax is due only if…

• The lifetime exemption has been exhausted

Seriously, every gift is taxable that doesn’t meet the above exclusions, including:

• Paying off her credit card or other debts (that aren’t directly to an educational or medical institution)
• Opening a joint bank account and letting her withdraw money
• Giving her a car
• Paying her rent for her
• Loaning her money and then forgiving the loan

The amount of the lifetime and annual exemption change statutorily and can be looked up in the tax code  §2503(b) for annual exemption and §2010 for lifetime exemption

Now the long answer.

What are gift taxes and how do they work?

Almost every thing you’ve ever been given or item that’s been paid for on your behalf in your entire adult life has been taxable. That’s insane right?! So how come you likely haven’t paid any taxes on it? Well there’s a couple reasons for that. But first, let’s talk about what the gift tax is and what it was created to accomplish.

When you die, the government takes some of your money in estate taxes. Most people want to avoid giving the government money and started offloading a lot of their wealth before death. And so, the gift tax was born. Lots of tax law works like this: tax professionals find a loophole in the law and exploit it, lawmakers try to fill the loopholes. (Sidenote here: GST Tax is another great example of this—and can be a consideration if you have wealth that exceeds the lifetime exemption and your SB is 37.5 years younger than you.)

All gifts are taxable unless they qualify for an exclusion/exemption.

One such exemption is the annual exemption described in §2503(b). The annual exemption is currently 17k per year. It sounds like a low number but it’s actually quite generous. The figure is per person per year. That means I could give 17k to 100 different people and not exceed the exemption. If your spouse is aware of your sugaring endeavors, you can give or receive 34k per person.

There are a couple exclusions to any gift tax outlined in §2503(e) which states you don’t have to pay any gift tax if payments are made directly to an educational institution or medical institution.

You also do not have to pay tax on gifts made to your spouse according to §1041.

And then of course your last tax exemption lifeline is the lifetime exemption.

Because the gift tax was created to prevent folks from escaping the estate tax, we have a unified gift and estate tax system. The two taxes reach all assets transferred during lifetime or owned at death and the same rate schedule applies for both taxes. (Side note here: The gift tax is still ultimately better than estate tax because although it’s the same rate, the gift tax is tax-exclusive while the estate tax is tax-inclusive. And that’s also why if you make gifts in anticipation of death or even just accidentally within 3 years of death, it gets thrown back into your estate.)

The lifetime exemption has a long history and I’m not going to get into it. But I will say that it changes a lot with political whims and has been talked about being eliminated entirely or being heavily restricted. The lifetime exemption limit is determined by the amount of the unified credit as described in §2010. As it is now in 2023, the lifetime exemption is nearly 13MM. But if current legislation does not act, this amount will go down to around half of that in 2026 (actual amount depends on inflation).

The lifetime exemption is a “use it or lose it” type of thing. If folks have not used the 13MM of exemption before it goes down, that’s too bad, it’s gone forever (unless it goes back up again eventually, which it can do with legislation or just simply inflation). But if folks did use it and it later goes down, there is a no-clawback provision in place in §2001(g)(2) to protect people. So many UHNW individuals have opted for exhausting their lifetime credit before 2026. (Sidenote here: with the creation of portability, you can elect to transfer your exemption to your spouse at death—but the amount will remain the amount that it was when they died… Happy to explain more if anyone cares but don’t really feel it's relevant for these specific purposes)

With this lifetime exemption, every gift you give that is taxable is deducted from this amount (if it does not fall under one of the exceptions above and exceeds the annual exemption amount).  You keep track of these gifts on a Form 709 and submit them to the IRS. If you don’t exceed your lifetime exemption amount during your lifetime, your taxes are settled with your estate at death.

Assuming you have more assets at death than your remaining lifetime credit, you will owe taxes when you die. When you die, your gift tax payable (which is different from tax due) is calculated using the rates in effect at your death and the exemption in effect on the date of the gift. The method to do this is to add back the gifts, calculate the tax on the whole, and then subtract tax on the gifts. It’s super complicated because the government wants to make sure to tax the assets in a gross estate at the right place in the brackets after considering lifetime gifts and prior use of the unified credits. If you have enough money for this to matter to you, I truly hope you have an estate planner who can explain this more thoroughly than I will right now.

Can I have some concrete examples of the different exemptions in action?

Yeah sure! Please mods, allow me to use numbers here for the sake of explanation

Example A: Spenda Daddy A gives his SB an allowance of 1k/month. He does not meet the annual exemption limit and therefore does not have to file a 709.

Example B: Sugar Daddy B gives his SB an allowance of 1k/month. But he also pays for her bougie apartment and other bills that cost 5k/month. At the end of the year he will be responsible for 72k of gifts – 17k exemption = 55k taxable. He will report on a 709, but because he has not yet reached his lifetime exemption, he will not pay any taxes on the gifts at this time.

Example C: Smart Whale Daddy C gives his SB an allowance of 1k/month. But he also pays for her tuition directly to the school which amounts to 100k/year. 12k of allowance is smaller than the annual exemption limit and the 100k is an excludable gift so he doesn’t have to report anything for her on his 709.

Is my allowance/PPM a gift?

I think this is one of the biggest, if not the biggest, “it depends” sections of this post.

Basically, the closer you are to a relationship, the more likely it will be considered a gift. The closer you are to an escort situation, the more likely it will be considered income.

The US Supreme Court case Commissioner v. Duberstein has long been thought of the case that defines the distinction between gift and income. In this case, it was held that the donor’s intent is the “critical consideration” in distinguishing between gifts and income. But the meaning of a gift has always been a point of contention in different contexts.

Once the Tax Court determines the donor’s intent was for it to be a gift, it’s then a legal question whether the reason for the gift justifies nontaxable treatment. The caselaw in this respect varies greatly. If an employer gives an employee a gift, it is generally presumed to be a payment despite intent. If a person gives a gift to someone who regularly gives them referrals, it is presumed to be a payment despite intent. These contexts give doubt to the subjective intent of a gift.

If you want a general definition of a gift, the most used one we have is from the Duberstein case: a gift is given with the “detached and disinterested generosity . . . affection, respect, admiration, charity, or the like”

Most related to sugaring, members made reference to a iconic case 7th circuit case in this respect, US v. Harris. In this case, two young women were each given over half a million dollars by an older wealthy man. They were convicted of willfully evading their income tax obligations. They appealed and won.

Some take this ruling to mean that as long as you’re not selling discrete sex acts, you’re in the clear. But as with everything in law… it depends.

In Toms v. Commissioner which happened the year after Harris, the court ruled the other way in a similar case: “Petitioner bears the burden of proving that the funds from Mr. Cohen were gifts and not compensation for services. Whether a transfer of funds is a gift is based upon an objective inquiry into the facts. . . Mr. Cohen testified that he has not had sexual relations with petitioner. That is immaterial to our decision. Mr. Cohen paid petitioner for the first evening she spent with him and paid her most nights she saw him. This suggests a paid escort relationship, not gifts to a friend . . . While we do not question the importance Mr. Cohen places on his companionship with petitioner, we believe that his regular payments to her were not out of feelings of “‘detached and disinterested generosity,’ ‘out of affection, respect, admiration, charity or like impulses”’, as required under Commissioner v. Duberstein . . . Instead, we believe the payments were for services rendered, and therefore are not gifts . . . Accordingly, these payments are taxable income . . .”

A couple other cases are summarized here:  

A 24-year-old woman received money for living expenses and a house from a 54-year-old married man, these amounts were nontaxable gifts. They weren't taxable earnings in exchange for services (i.e., “companionship”) rendered.

A young married female nightclub dancer met an older man who paid her living expenses, plus $200 a week, and provided her with money for other things, such as investing, decorating her apartment, and buying a mink stole and a car, the payments (more than $100,000) over a five-year period were gifts. The Tax Court reached this conclusion notwithstanding the fact that the woman, who saw the man every Tuesday night at the nightclub and Wednesday afternoons for two hours at various places, such as her girl friend's apartment and hotels, stated that she “earned every penny” of the money.

A woman who had been convicted on five separate occasions for operating a house of prostitution failed to convince the Tax Court that money a man gave to her for living expenses, a house, and a fur coat were gifts. The court found “considerable merit” to IRS's argument that her promise to the man to stop from engaging in prostitution, and to grant her companionship to him, was sufficient consideration for the money received to make it taxable to her. Similarly, payments received by a madam from a married “admirer” weren't gifts in contemplation of marriage.

As with everything in law, IT DEPENDS. Even when the facts are INCREDIBLY similar.

What are the consequences of failing to report?

A willful attempt to evade a tax is a felony under §7201 and can result in jail time of up to five years and/or up to a 100k fine. Willful means “voluntary, intentional violation of a known legal duty.” The offense is committed when a taxpayer has actual knowledge of the existence of the obligation and a wrongful intent to evade it. There is no requirement for evil motive, just a specific intent to violate the law. Generally if you are conducting yourself in a way that is likely to mislead of conceal information, it’s sufficient to raise an inference of an affirmative willful attempt to evade taxes—even if a primary motive is to conceal a crime like prostitution or an affair from your spouse. You are now all officially on notice, sorry. Don’t kill the messenger. By the way, the filing of a false return is an independent crime.

Okay are you scared? Good! Compliance with the law is good! That said… most of the time only civil (not criminal) penalties are enforced and gift tax enforcement has historically been seen as relatively toothless. But you never know. Things change all the time.

I've always found the questions about wives clawing back sugar to be interesting. And whether there's a way for the SB to protect herself from this possibility.

If you live in a community property state, you should look up Shelly Sterling.

I’ve been writing all day so I’ll have to come back to this some other time….

if Zelle or Venmo is going to issue a 1099K but I’m treating my sugar as a gift, how does SB deal with the reporting of the income?

These channels usually only issue a 1099-K when it’s a payment for services and there is usually a way to delineate. If not, contact the company and they should be able to revise your 1099-K for you.

Any tips on what we should be aware of if we have cash (zelle, whatever) transactions going through our bank accounts that can't possibly be a result of the minimal W-2 and 1099 income we have?

Keep good records of your cash inflow and proof that it is a gift (if it is). If it’s income, report it.

What should an SD do if he doesn't want to come out to his accountant or tax attorney that he has a sugar baby?

Stop having a sugar baby.

Do I need to report that I’m receiving these monetary gifts?

No, you don’t have to report anything at all to the IRS as the receiver. However, you should keep good detailed records of your gifts and any proof that they are in fact gifts.

Do material gifts get included in the total value of what I’ve received from SD?

Yes.

Fraudulent conveyance for gifting from business accounts/embezzlement funds needing to be recorded as income

Stay tuned. More on this when I have the energy to write again.

How do I deposit money without unintentionally structuring?

I wouldn’t concern yourself with unintentionally structuring. Just deposit money as you get it. Don’t purposefully deposit certain sums of money to avoid the 10k reporting.

If my PPM/Allowance is considered income, how do I declare it?

You report your income on a 1040 Schedule C and pay self-employment taxes in addition to income tax.

What if the SD wants the SB to pay the taxes on a gift instead of him?

It is possible for recipients of gifts to be responsible for paying gift tax. If there is an agreement that the recipient will pay, this is called a net gift and the costs associated with paying the gift tax can be deducted from the gift itself.

However, unless the SD’s exemption is fully used up, it typically makes more sense, and is the default, for the gifter to pay the tax. If the SD is interested in this option, he should consult a tax professional.