Report Offering Proposals Regarding the Deduction Deferral Rule of IRC Section 404(a)(5)

SUMMARY

The Committee on Taxation of Business Entities (Philip S. Gross, Chair) issued a report offering proposals regarding the deduction timing and deferral rule of Section 404(a)(5) of the Internal Revenue Code and certain provisions of the Treasury Regulations promulgated thereunder.  Various types of acquisition transactions can create a short taxable year for an acquired corporation or partnership. Typically, in connection with such transactions, payments are made to employees or other service providers that may constitute payments made under a “plan deferring the receipt of compensation” at or shortly before closing. There is little published IRS or Treasury guidance on what constitutes a “plan deferring the receipt of compensation,” which makes the tax treatment of a number of such widely used plans unclear. Current Treasury Regulations and rulings require the deduction of payments made under such plans to be deferred to the post-closing taxable year, even if payments of deferred compensation are accrued and made by the target during the short pre-closing taxable year (or, if the transaction is a stock purchase, may be disallowed permanently due to the lack of any post-deemed-liquidation taxable year of the target corporation). This treatment is inconsistent with the current thrust of Treasury tax accounting policy. The Committee offers a number of proposals, including: clarifying the scope of “plan deferring the receipt of compensation”; amending Treasury Regulation Section 1.404(a)-12(b) to provide that the deduction of deferred compensation be allowed in the first taxable year of the employer in which the date the employee recognizes income from the payment falls; and that the rule confirm that a payment made on the closing date of a transaction would be deemed to have been made in the first short taxable year of the payor.