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Rev. proc. 92-64 and rev. proc. 92-65 relating to rabbi trusts.

On November 5, 1992, TEI filed comments on Rev. Proc. 92-64 and Rev. Proc. 92-65, relating to deferred compensation arrangements that employ trusts known popularity as "rabbi trusts." TEI's comments were prepared under the aegis of its Employee Benefits Subcommittee whose chair is David L. Klausman of Westinghouse Corporation. Contributing substantially to the development of TEI's remarks were Paul Cherecwich, Jr. of Thiokol Corporation, W. Kurt Maier of Morton International Corporation, and Susan A. Williams of Hewlett-Packard Corporation.

The Internal Revenue Service recently released Revenue Procedures 92-64 and 92-65 (1992-33 I.R.B. 11 and 16, respectively), relating to deferred compensation arrangements popularly referred to as "rabbi trusts." Since many taxpayers obtain private letter rulings concerning the validity of their deferred compensation arrangements, Rev. Proc. 92-65 provides general guidance for securing advance rulings for arrangements that employ the rabbi trust device. In a complementary fashion, Rev. Proc. 92-64 sets forth model trust provisions to assist taxpayers in drafting trust instruments acceptable to the IRS. Section 7 of Rev. Proc. 92-64 invites public comments. This letter responds to that request.


In designing and implementing nonqualified deferred compensation plans, companies must balance the demands of the tax law with the desires of their employees for security and preservation of company assets to pay the promised compensation. Specifically, to defer taxation to the employee of the promised but unpaid sums, a nonqualified deferred compensation plan must comply with the separate but related tax doctrines of constructive receipt and economic benefit.

One means of balancing these competing demands is to create an employer-sponsored grantor trust arrangement for deferred compensation -- loosely referred to as rabbi trusts. Briefly described, rabbi trusts involve a transfer of property by a corporate employer to a trust for the benefit generally of a class of selected employees to secure partially or fully a promise to pay the compensation at a future time. In order to avoid the doctrines of constructive receipt or economic benefit from being invoked against the employee (thereby subjecting the unpaid sums to current tax), the trust must be a grantor trust, the assets of which are subject to claims of the employer's general creditors. As a result, trust arrangements serve mainly to ensure that the employer will have the funds available at a future date to pay the promise, upon either a change in control or management of the employer or termination or retirement of the employee.

General Comments

The model grantor trust provisions in Rev. Proc. 92-64 are intended to provide a safe harbor for taxpayers adopting and maintaining a grantor trust in connection with a plan of deferred compensation. To be effective, the underlying plan must be structured to ensure that there is no constructive receipt of income. Rev. Proc. 71-19 (1971-1 C.B. 698), as modified by Rev. Proc. 92-65, provides guidance concerning the requirements that must be met in structuring a plan to obtain an advance ruling on the application of the constructive receipt doctrine.

Rev. Proc. 92-64 states that "except in rare and unusual circumstances," private rulings will be issued for deferred compensation arrangements involving a grantor trust only if the model trust provisions are used. (1992-33 I.R.B. at 11.) TEI is concerned that revenue agents may infer that the model trust provisions are the exclusive provisions to be employed and that deviations from the model trust provisions reflect a flawed -- i.e., taxable -- arrangement. While TEI appreciates the desire for administrative ease impelling the creation of a model trust to expedite the ruling process, we do not believe that taxpayers should be required to use what are essentially safe harbors for plans adopted or amended subsequent to the issuance of the revenue procedures. More important, taxpayers should not be compelled to amend existing deferred compensation arrangements to conform to the ruling guidelines or the model trust provisions.

One way to assuage TEI's concern is to clarify that rulings will continue generally to be issued on grantor trust arrangements that do not employ the model trust language. In cases where the model trust language is not used, it may be proper to impose a higher user fee as a condition to obtaining the ruling, since such rulings may require additional scrutiny or processing time. Another way to address TEI's concerns is to state specifically that no adverse inference should be drawn where a deferred compensation arrangement contains features or provisions that differ from those enumerated in the revenue procedures.

Specific Comments

1. Trust Investments. The introduction to the model trust provisions in section 5.01 of Rev. Proc. 92-64 states that the trustee must be given some "investment discretion" and then lists examples of various permissible investments. Additional guidance should be issued concerning the requirement that the trustee possess "investment discretion." Specifically, TEI recommends that the IRS clarify whether the company sponsoring the deferred compensation arrangement is precluded from requiring the trustee to invest solely (or predominately) in securities or obligations of the company.(1) In addition, we recommend that the examples of permissible investments set forth in the introduction to the model trust provisions be expanded to include real estate.

2. Creditors Rights. The model trust requires the plan trustee to suspend payment of benefits upon written notification from a purported creditor that the employer has become insolvent. Under section 3(b)(1) of the model trust, payments must be discontinued pending the trustee's determination of the claim. TEI believes this provision creates an undue preference among the general creditors of a company solely at the expense of current or former employees. Under this provision, a purported creditor could interfere with legitimate payments to a class of acknowledged creditors (recipients of deferred compensation) without affecting the payments to be made to any other general, unsecured creditors. As stated, the language is ripe for mischief-making.

A better approach is to require the alleged creditor to introduce evidence to the plan trustee of the employer's insolvency and the specifics of the creditor's claim. As a safeguard against spurious creditor's claims, a grace period should also be established to permit the employer to confirm its solvency or rebut the purported creditor's claim before the trustee is obliged to suspend payments. In the absence of such safeguards, a single purported creditor may create personal hardships for individuals who have retired or separated from the employer.

3. Election to Defer Compensation. To avoid constructive receipt of income, an employee's election to defer compensation must generally be made before the beginning of the period of service for which the compensation is payable. Rev. Proc. 92-65 states that, "the period of service for purposes of this requirement generally has been regarded by the Service as the employee's taxable year for cash basis, calendar year taxpayers." (Section 3.01(a), Rev. Proc. 92-65.) This statement, however, does not adequately address the situation of fiscal-year employers with calendar-year employees. For example, an employer may offer employees an opportunity to defer receipt of incentive compensation earned on the basis of fiscal year results, say July 1, 19x1 to June 30, 19x2. A literal interpretation of Rev. Proc. 92-65 requires the employee to make the deferral election before January 1, 19x1, the beginning of the employee's taxable year, for services to be performed during the fiscal year commencing July 1. TEI believes Rev. Proc. 92-65 raises an unnecessary barrier for a fiscal-year employer and its employees because the determination of employees eligible for incentive compensation is often not made until immediately prior to the commencement of a fiscal year. TEI recommends that the deferral election be permitted to be made on any day prior to the beginning of an employer's fiscal year.(2)

4. Method of Payment. In order to obtain a favorable ruling, any plan of deferred compensation must define the time and method for payment of deferred compensation (Section 3.01(b), Rev. Proc.(92-65.) In connection with excess benefit or "top-hat" plans, it is not clear how precisely the method of payment must be defined.

An issue that arises in connection with deferred compensation arrangements is whether the plan may permit the employee to elect at a subsequent date the form of payment at retirement. In our view, such subsequent elections concerning the payment of benefits finds support in Martin v. Commissioner, 96 T.C. 814 (1991).

Typically, payments from excess benefit top-hat plans supplement payments from a qualified pension plan. Qualified benefit plans generally permit an employee to elect the form of payment upon retirement -- whether in the form of a life annuity, a joint-and-survivor annuity, fixed period of years, etc. Employees generally prefer to elect to receive payments on a basis similar to the qualified plan payments.(3) Since top-hat plans are established for a select group of employees, the employees' ages upon entry into the plan will vary dramatically. Requiring an employee to elect a payment method upon entry or shortly thereafter at, say, age 40, for payments that will not begin until perhaps 65 is unduly restrictive and inequitable to the employee. Similarly, compelling an employee to accept, and an employer to administer, payments on a schedule fixed far in advance of the time when payments commence undermines the goal of providing the employee with a responsive retirement income. So long as the funds for a deferred compensation arrangement are not credited, set apart, or otherwise made available to the employee, a subsequent payment-form election -- made at the time other benefit plan elections are made -- should be permitted as an alternative trust provision in Rev. Proc. 92-64.


We are pleased to have had the opportunity to submit our views on Rev. Proc. 92-64 and Rev. Proc. 92-65. If you have any questions about TEI's position please feel free to call either David L. Klausman of Westinghouse Electric Corporation, chair of TEI's Employee Benefits Subcommittee, at (412) 642-3354 or Jeffery P. Rasmussen of the Institute's professional tax staff at (202) 638-5601. (1) If the trust investments must be diversified beyond the sponsoring company's obligations or securities, what portion of the trust investments may be invested in company securities? The second Alternative Section 5(a) of the model trust provisions permits investments in the sponsoring company stock and obligations. Some companies, however, prefer that their deferred compensation obligations be satisfied exclusively through the use of company stock. (2) The recommendation in the text relates to the ruling guidelines of Rev. Proc. 92-65. No adverse inference should arise from failing to meet the ruling guidelines. We believe that a terminable-at-will employee should properly be able to elect to defer future, unearned compensation at any time prior to the period for which the compensation is earned. For example, a quarterly bonus plan that permits a terminable-at-will employee to elect to defer the bonus prior to the beginning of the quarter for which the bonus will be calculated will avoid the constructive receipt problem where the employee is subject to a substantial risk of forfeiture under the terms of the plan. (3) Likewise, employers prefer that the elections be made at the time of retirement because the amount of the nonqualified payment is often dependent upon the amount of the qualified plan payment. The so-called top-hat plan benefit supplements the primary benefit calculated under the qualified plan. The calculation of the amount due to the retiring employee is facilitated by having the elections made contemporaneously under both plans.
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Publication:Tax Executive
Date:Nov 1, 1992
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