Amounts included in income by employees under sec. 83 are not "received."

In Letter Ruling (TAM) 9443006, the IRS reached a highly questionable result regarding the deductibility of property transfers under Sec. 83. The Service concluded that it is possible for an amount to be included in the employee's income under Sec. 83 and still fail to meet the requirements for deductibility under Sec. 404(b).

Sec. 404 and the underlying regulations generally provide the deduction timing rules for compensation and benefits paid under a deferred compensation or deferred benefit arrangement. Specifically, Sec. 404(a)(5) states that compensation treated as deferred compensation is deductible "in the taxable year in which an amount attributable to the contribution is includible in the gross income of employees participating in the plan." However, the regulations make clear that a plan will not be treated as a deferred compensation plan when the compensation or benefits are "received by the employee" within 2 1/2, months of the employer's year-end.

In the TAM, the vacation time earned by the taxpayer's employees during its tax year could be taken before the end of its next tax year. On Mar. 13, 1992 (prior to the end of the 2 1/2-month period), the calendar-year taxpayer purchased an irrevocable standby letter of credit to secure its obligation to pay the unpaid vacation benefits accrued during the year ended Dec. 31, 1991. The letter of credit was secured by the taxpayer's general assets, and its employees, as a class, were named as its sole beneficiaries. Under this arrangement, if the taxpayer failed to pay secured vacation benefits, they would be paid by the issuer of the letter Of credit. Under applicable bankruptcy law, the taxpayer's general creditors would have no rights to payments made under the letter of credit.

The IRS ruled that the employees would recognize income under Sec. 83 when the employer purchased the letter of credit. Under Sec. 83, a service provider will recognize income when property is transferred to him, provided the property is either unrestricted or transferable. The term "property" for purposes of Sec. 83 includes real and personal property, other than money or an unfunded and unsecured promise to pay money or property in the future. Thus, a promise to pay money or property in the future is "property" if it is either funded or secured. In the ruling, the taxpayer's promise to pay vacation benefits was secured by an irrevocable standby letter of credit. Therefore, the Service concluded that property had been received by the employees.

However, it did not agree that the amounts were "received" by the employees (for purposes of determining the deductibility to the employer) within the meaning of Temp. Regs. Sec. 1.404(b)-1T, Q&A-2(c). Instead, it held that the employer would be entitled to the deduction only as each employee collected his vacation pay throughout 1992. This holding, therefore, creates the anomalous result that amounts can be included in income by cash-basis employees without being "received" by them for purposes of determining the timing of the employer's deduction.