Menu
Tax Notes logo

Pryor Bill Would Clarify Deferred Compensation Interest Deductions.

FEB. 28, 1994

S2023-S2024

DATED FEB. 28, 1994
DOCUMENT ATTRIBUTES
  • Authors
    Pryor, Sen. David
  • Institutional Authors
    U.S. Senate
  • Cross-Reference
    S. 1877
  • Code Sections
  • Subject Area/Tax Topics
  • Index Terms
    pension plans, contributions, employer
  • Jurisdictions
  • Language
    English
  • Tax Analysts Electronic Citation
    94 TNT 45-60
Citations: S2023-S2024
====== SUMMARY ======

Senate Finance Committee member David Pryor, D-Ark., has introduced S. 1877, which would clarify the deductibility of interest and similar amounts attributable to deferred compensation. The bill would disallow employer deductions of interest on deferred compensation until the interest is includable in the employer's income. Pryor introduced his bill in response to the Tax Court's decision in Albertson's Inc. v. Commissioner (for prior coverage, see Tax Notes, Jan. 10, 1994, p. 191, and Jan. 24, 1994, p. 405), in which the court ruled Albertson's could deduct the accrued but unpaid interest on deferred compensation. Pryor said if the ruling was allowed to stand it would "result in an unintended, indefensible and unmanageable tax loophole."

====== FULL TEXT ======

By Mr. PRYOR:

S. 1877. A bill to amend the Internal Revenue Code of 1986 to clarify the deductibility of interest and similar amounts attributable to deferred compensation; to the Committee on Finance.

NONQUALIFIED DEFERRED COMPENSATION CLARIFICATION ACT OF 1994

Mr. PRYOR. Mr. President, today I rise to introduce legislation in order to clarify the law with respect to nonqualified deferred compensation arrangements.

These arrangements are very important to businesses, both small and large, as a tool to attract and keep key employees. As such, certainty in the tax law is critical to these businesses' employers and employees, and further I might add that because of their widespread use, the U.S. Treasury has a very keen interest in seeing that the tax treatment of these arrangements is clearly defined, so that no unintended and/or indefensible tax loopholes are opened.

Mr. President, for many years employers and employees have entered into nonqualified deferred compensation agreements. In 1942, because of abuse in this area, Congress amended the 1939 Code to expressly deal with and clarify the tax treatment of these agreements. Since this time, the law was generally understood to be that compensation, including interest, paid or accrued pursuant to a nonqualified deferred compensation agreement is not deductible until includable in the income of the employee. Today, this matching rule is embodied in Internal Revenue Code section 404.

On December 30, 1993, this general principal of law has been disrupted by the Ninth Circuit Court of Appeal's opinion in Albertson's versus Commissioner of the Internal Revenue Service.

Albertson's involved an unfunded deferred compensation arrangement under which the employee's deferred compensation amount was increased each year by an amount which reflected the employer's time value of money, which the court referred to as additional amounts. Everyone agreed that the underlying deferred compensation amount was not deductible until includable in the income of the employee. The dispute centered on Albertson's claim for a current deduction of the accrued, but unpaid, additional amounts, on the reasoning that they constituted interest, not compensation, and were, therefore, not subject to the section 404 matching rules.

The ninth circuit opened the debate by posing the issue as whether the additional amounts were interest, and if so, whether interest was subject to the matching rules of section 404. In sum, the court held the additional amounts constituted interest which were not subject to the timing restrictions of section 404, allowing Albertson's to deduct currently the accrued, but unpaid, interest.

Mr. President, regardless of the merits of the court's reasoning in Albertson's, the ruling, if allowed to stand, will result in an unintended, indefensible and unmanageable tax loophole.

This loophole is created by the court's apparent departure from the matching principal. The result may be to create an investment vehicle that allows a current deduction for accrued interest against taxable income with no corresponding inclusion in the income of the employee until it is paid many years down the road. This favorable tax treatment was never intended for nonqualified deferred compensation arrangements which are generally for high paid individuals and not subject to discrimination rules to protect employees at all income levels.

Another result of the decision could be for some to interpret the ruling as not departing from the matching principal, and therefore, reason that the employee is required to include the interest amount in income at the same time the employer takes a current deduction for the accrued interest. Clearly, this result was never intended or expected. Employees should not be required to pay tax on deferred compensation until cash is received.

Mr. President, Albertson's is a case involving a 1983 tax year. In 1986, section 404 was amended to clarify, and arguably to broaden the scope of compensation under the law. The court, of course, did not interpret the effect of the 1986 amendment which may cause even more confusion with respect to the proper tax treatment of these arrangements since 1986. Also, I might add that, since this is a ninth circuit opinion, other regions of the country may or may not choose to adopt, in whole or in part, the ninth circuit's reasoning.

So, in the meantime, what course of action should a taxpayer take? Should employers amend their returns to take a current deduction under Albertson's or forgo the current deduction but risk losing it altogether when the deferred compensation is actually paid years later? Do employees face an accelerated tax liability with penalties and interest even though they have received no cash under the arrangement?

Also, the Government must view this development as holding the potential to cost the U.S. Treasury billions of dollars for a preferential tax regime that was never intended by Congress.

Mr. President, the court's decision in Albertson's may or may not stand. Further judicial developments could take years to resolve. I believe Congress has many compelling reasons to act now to clarify the law and no reason to stand idly by.

Congressional intent is clear: Interest, under a nonqualified deferred compensation agreement, is not deductible by an employer until includable in the income of an employee.

Mr. President, consistent with this intent, I offer this legislation to clarify the law in order to avoid imposing uncertainty on taxpayers, to protect the U.S. Treasury, and to prevent what could be years of litigation. I urge my colleagues to join me in this effort.

DOCUMENT ATTRIBUTES
  • Authors
    Pryor, Sen. David
  • Institutional Authors
    U.S. Senate
  • Cross-Reference
    S. 1877
  • Code Sections
  • Subject Area/Tax Topics
  • Index Terms
    pension plans, contributions, employer
  • Jurisdictions
  • Language
    English
  • Tax Analysts Electronic Citation
    94 TNT 45-60
Copy RID