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Installment/lump-sum benefits election.

Installment/Lump-Sum Benefits Election

In a recent case of first impression, the Tax Court has determined that employees did not "constructively receive" shadow stock benefits either at the time a lump-sum option became available or at the time they elected to receive installments.

The constructive receipt doctrine holds that a cash basis taxpayer cannot postpone the reporting of gross income by failure to exercise his or her unrestricted right to collect it (IRS Regulations 1.451-2(a)). However, income is not constructively received if the taxpayer's control is subject to "substantial limitations or restrictions."

In the 1960s, the taxpayers' company established a management profit sharing plan in which key employees received profit sharing units. In 1981, the company adopted a new shadow stock deferred benefits plan. (Shadow stock is used as a measure of deferred compensation plan obligations but is not actually purchased or sold.) Employees electing this new plan surrendered their old plan units in exchange for the new shadow stock. Under the new plan, employees were to receive their payment in a lump-sum unless they elected to receive it in 10 annual installments.

This election was required to be made prior to employment termination. In the same year in which the new plan was adopted, the taxpayers either retired or were forced to leave the company. The IRS asserted that the taxpayers had constructively received the deferred compensation benefits in 1981 since they had an "unfettered" choice in that year to receive a lump-sum distribution. The Service conceded that mere ability of a plan participant to choose among distribution alternatives at the time of entry into a plan does not result in constructive receipt of benefits. The IRS argued, however, constructive receipt does occur in the year benefits are sought if a taxpayer has a choice before electing to receive benefits.

In siding with the taxpayers, the court cited IRS Regulations and found that despite the fact that the benefits were available, they were not yet "credited, set apart or made available in such a way that the taxpayers could have drawn on the funds." Substantial limitations and restrictions remained at the time the new plan was initiated including the fact that the participants could obtain payment of their benefits only by forfeiting the right to receive future contributions of shadow stock, the right to participate in the company's future equity growth without risking actual capital and the right to future payment based upon common stock dividends. The court also found that it was significant that the investment/lump-sum election could only be made before the new plan's benefits became "due and fully ascertainable."
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Title Annotation:tax rule on shadow stock benefits of employees not actually received as non-taxable
Publication:The National Public Accountant
Article Type:Brief Article
Date:Sep 1, 1991
Words:436
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