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Economic Benefit Doctrine

The Economic Benefit Doctrine requires that any benefit granted to an individual that has economic or financial value be included as compensation for income tax purposes in the year the benefit is granted.

In essence, if something of value is granted to an employee that has a real and measurable value in terms of money, then the current value is taxable to the employee. This would be true even if the employee does not have a current right to receive the property in question.

An example will help clarify the situation:

In a famous court case (Sproull v. Commissioner), an amount of money was set aside in an irrevocable trust for an employee. The trustee was directed to pay out principal and interest from the trust in subsequent years. The money in the trust was for the sole benefit of the employee, and non-forfeitable. Although the employee did not have the right to draw on the money immediately (i.e. did not have Constructive Receipt), the courts ruled that the trust's value was immediately taxable to the employee, since an economic benefit was conferred upon him. In other words, as soon as there is no manner in which the trust value could be forfeited, it became taxable to the employee.

The key to avoiding the imposition of the Economic Benefit Doctrine is the existence of a substantial risk of forfeiture. A necessary criteria for the existence of a substantial risk of forfeiture is that the plan must remain "unfunded". A plan is "unfunded" when there are no formal assets set aside to pay plan benefits. Any informal assets associated with the plan must be subject to the corporation's general creditors (see Rabbi Trust and Secular Trust).

This however, does not prevent an employer from purchasing mutual funds, life insurance, etc. as a reserve fund to cover their liability, as long as the fund remains a general asset of the corporation.

 

 

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