Revenue Ruling 60-31

1960-1 C.B. 174
Sec. 404
Sec. 451
Modified by Rev. Rul. 70-435
Modified by Rev. Rul. 64-279

IRS Headnote
Discussion of the application of the doctrine of constructive receipt to certain deferred compensation arrangements.

Full Text
Rev. Rul. 60-31

Advice has been requested regarding the taxable year of inclusion in gross income of a taxpayer, using the cash receipts and disbursements method of accounting, of compensation for services received under the circumstances described below.

  1. On January 1, 1958, the taxpayer and corporation X executed an employment contract under which the taxpayer is to be employed by the corporation in an executive capacity for a period of five years. Under the contract, the taxpayer is entitled to a stated annual salary and to additional compensation of 10 x dollars for each year. The additional compensation will be credited to a bookkeeping reserve account and will be deferred, accumulated, and paid in annual installments equal to one-fifth of the amount in the reserve as of the close of the year immediately preceding the year of first payment. The payments are to begin only upon (a) termination of the taxpayer's employment by the corporation; (b) the taxpayer's becoming a part-time employee of the corporation; or (c) the taxpayer's becoming partially or totally incapacitated. Under the terms of the agreement, corporation X is under a merely contractual obligation to make the payments when due, and the parties did not intend that the amounts in the reserve be held by the corporation in trust for the taxpayer.

    The contract further provides that if the taxpayer should fail or refuse to perform his duties, the corporation will be relieved of any obligation to make further credits to the reserve (but not of the obligation to distribute amounts previously contributed); but, if the taxpayer should become incapacitated from performing his duties, then credits to the reserve will continue for one year from the date of the incapacity, but not beyond the expiration of the five-year term of the contract. There is no specific provision in the contract for forfeiture by the taxpayer of his right to distribution from the reserve; and, in the event he should die prior to his receipt in full of the balance in the account, the remaining balance is distributable to his personal representative at the rate of one-fifth per year for five years, beginning three months after his death.

  2. The taxpayer is an officer and director of corporation A , which has a plan for making future payments of additional compensation for current services to certain officers and key employees designated by its board of directors. This plan provides that a percentage of the annual net earnings (before Federal income taxes) in excess of 4,000 x dollars is to be designated for division among the participants in proportion to their respective salaries. This amount is not currently paid to the participants; but, the corporation has set up on its books a separate account for each participant and each year it credits thereto the dollar amount of his participation for the year, reduced by a proportionate part of the corporation's income taxes attributable to the additional compensation. Each account is also credited with the net amount, if any, realized from investing any portion of the amount in the account.

    Distributions are to be made from these accounts annually beginning when the employee (a) reaches age 60, (b) is no longer employed by the company, including cessation of employment due to death, or (c) becomes totally disable to perform his duties, whichever occurs first. The annual distribution will equal a stated percentage of the balance in the employee's account at the close of the year immediately preceding the year of first payment, and distributions will continue until the account is exhausted. However, the corporation's liability to make these distributions is contingent upon the employee's (a) refraining from engaging in any business competitive to that of the corporation, (b) making himself available to the corporation for consultation and advice after retirement or termination of his services, unless disabled, and (c) retaining unencumbered any interest or benefit under the plan. In the event of his death, either before or after the beginning of payments, amounts in an employee's account are distributable in installments computed in the same way to his designated beneficiaries or heirs-at-law. Under the terms of the compensation plan, corporation A is under a merely contractual obligation to make the payments when due, and the parties did not intend that the amounts in each account be held by the corporation in trust for the participants.

  3. On October 1, 1957, the taxpayer, an author, and corporation Y , a publisher, executed an agreement under which the taxpayer granted to the publisher the exclusive right to print, publish and sell a book he had written. This agreement provides that the publisher will (1) pay the author specified royalties based on the actual cash received from the sale of the published work, (2) render semiannual statements of the sales, and (3) at the time of rendering each statement make settlement for the amount due. On the same day, another agreement was signed by the same parties, mutually agreeing that, in consideration of, and notwithstanding any contrary provisions contained in the first contract, the publisher shall not pay the taxpayer more than 100 x dollars in any one calendar year. Under this supplemental contract, sums in excess of 100 x dollars accruing in any one calendar year are to be carried over by the publisher into succeeding accounting periods; and the publisher shall not be required either to pay interest to the taxpayer on any such excess sums or to segregate any such sums in any manner.

  4. In June 1957, the taxpayer, a football player, entered into a two-year standard player's contract with a football club in which he agreed to play football and engage in activities related to football during the two-year term only for the club. In addition to a specified salary for the two-year term, it was mutually agreed that as an inducement for signing the contract the taxpayer would be paid a bonus of 150 x dollars. The taxpayer could have demanded and received payment of this bonus at the time of signing the contract, but at his suggestion there was added to the standard contract form a paragraph providing substantially as follows:

    The player shall receive the sum of 150 x dollars upon signing of this contract, contingent upon the payment of this 150 x dollars to an escrow agent designated by him. The escrow agreement shall be subject to approval by the legal representatives of the player, the Club, and the escrow agent.

    Pursuant to this added provision, an escrow agreement was executed on June 25, 1957, in which the club agreed to pay 150 x dollars on that date to the Y bank, as escrow and the escrow agent agreed to pay this amount, plus interest, to the taxpayer in installments over a period of five years. The escrow agreement also provides that the account established by the escrow agent is to bear the taxpayer's name; that payments from such account may be made only in accordance with the terms of the agreement; that the agreement is binding upon the parties thereto and their successors or assigns; and that in the event of the taxpayer's death during the escrow period the balance due will become part of his estate.
  5. The taxpayer, a boxer, entered into an agreement with a boxing club to fight a particular opponent at a specified time and place. The place of the fight agreed to was decided upon because of the insistence of the taxpayer that it be held there. The agreement was on the standard form of contract required by the state athletic commission and provided, in part, that for his performance taxpayer was to receive 16 x percent of the gross receipts derived from the match. Simultaneously, the same parties executed a separate agreement providing for payment of the taxpayer's share of the receipts from the match as follows: 25 percent thereof not later than two weeks after the bout, and 25 percent thereof during each of the three years following the year of the bout in equal semiannual installments. Such deferments are not customary in prize fighting contracts, and the supplemental agreement was executed at the demand of the taxpayer. Upon the taxpayer's insistence, the agreements also provided than any telecast of the fight must receive his prior consent and that he was to approve or disapprove all proposed sales of radio and motion picture rights.

Section 1.451-1(a) of the Income Tax Regulations provides in part as follows:

Gains, profits, and income are to be included in gross income for the taxable year in which they are actually or constructively received by the taxpayer unless includible for a different year in accordance with the taxpayer's method of accounting. * * *.

And, with respect to the cash receipts and disbursements method of accounting, section 1.446-1(c)(1)(i) provides in part:

Generally, under the cash receipts and disbursements method in the computation of taxable income, all items which constitute gross income (whether in the form of cash, property, or services) are to be included for the taxable year in which actually or constructively received. * * * .

As previously stated, the individual concerned in each of the situations described above, employs the cash receipts and disbursements method of accounting. Under that method, as indicated by the above quoted provisions of the regulations, he is required to include the compensation concerned in gross income only for the taxable year in which it is actually or constructively received. Consequently, the question for resolution is whether in each of the situations described the income in question was constructively received in a taxable year prior to the taxable year of actual receipt.

A mere promise to pay, not represented by notes or secured in any way, is not regarded as a receipt of income within the intendment of the cash receipts and disbursements method. See United States v. Christine Oil & Gas Co. , 269 Fed. 458; William J. Jackson v. Smietanka , 272 Fed. 970, Ct. D. 5, C.B. 4, 96 (1921); and E. F. Cremin v. Commissioner , 5 B.T.A. 1164, acquiescence, C.B. VI-1, 2 (1927). Also C. Florian Zittle v. Commissioner , 12 B.T.A. 675, in which, holding a salary to be taxable when received, the Board said: `Taxpayers on a receipts and disbursements basis are required to report only income actually received no matter how binding any contracts they may have to receive more.'

This should not be construed to mean that under the cash receipts and disbursements method income may be taxed only when realized in cash. For, under that method a taxpayer is required to include in income that which is received in cash or cash equivalent. W. P. Henritze v. Commissioner , 41 B.T.A. 505. And, as stated in the above quoted provisions of the regulations, the `receipt' contemplated by the cash method may be actual or constructive.

With respect to the constructive receipt of income, section 1.451-2(a) of the Income Tax Regulations (which accords with prior regulations extending back to, and including, Article 53 of Regulations 45 under the Revenue Act of 1918) provides, in part, as follows:

Income although not actually reduced to a taxpayer's possession is constructively received by him in the taxable year during which it is credited to his account or set apart for him so that he may drawn upon it at any time. However, income is not constructively received if the taxpayer's control of its receipt is subject to substantial limitations or restrictions. Thus, if a corporation credits its employees with bonus stock, but the stock is not available to such employees until some future date, the mere crediting on the books of the corporation does not constitute receipt.

Thus, under the doctrine of constructive receipt, a taxpayer may no deliberately turn his back upon income and thereby select the year not deliberately turn his back upon The Hamilton National Bank of Chattanooga, as Administrator of the Estate of S. Strang Nicklin, Deceased , v. Commissioner , 29 B.T.A. 63. Nor may a taxpayer, by a private agreement, postpone receipt of income from one taxable year to another. James E. Lewis v. Commissioner , 30 B.T.A. 318.

However, the statute cannot be administered by speculating whether the payor would have been willing to agree to an earlier payment. See, for example, J. D. Amend, et ux. , v. Commissioner , 13 T.C. 178, acquiescence, C.B. 1950-1, 1; and C. E. Gullett, et al. , v. Commissioner , 31 B.T.A. 1067, in which the court, citing a number of authorities for its holding, stated:

It is clear that the doctrine of constructive receipt is to be sparingly used; that amounts due from a corporation but unpaid, are not to be included in the income of an individual reporting his income on a cash receipts basis unless it appears that the money was available to him, that the corporation was able and ready to pay him, that his right to receive was not restricted, and that his failure to receive resulted from exercise of his own choice.

Consequently, it seems clear that in each case involving a deferral of compensation a determination of whether the doctrine of constructive receipt is applicable must be made upon the basis of the specific factual situation involved.

Applying the foregoing criteria to the situations described above, the following conclusions have been reached:

(1) The additional compensation to be received by the taxpayer under the employment contract concerned will be includible in his gross income only in the taxable years in which the taxpayer actually receives installment payments in cash or other property previously credited to his account. To hold otherwise would be contrary to the provisions of the regulations and the court decisions mentioned above,

(2) For the reasons in (1) above, it is held that the taxpayer here involved also will be required to include the deferred compensation concerned in his gross income only in the taxable years in which the taxpayer actually receives installment payments in cash or other property previously credited to his account.

In arriving at this conclusion and the conclusion reached in case `(1),' consideration has been given to section 1.402(b)-1 of the Income Tax Regulations and to Revenue Ruling 57-37, C.B. 1957-1, 18, as modified by Revenue Ruling 57-528, C.B. 1957-2, 263. Section 1.402(b)-1(a)(1) provides in part, with an exception not here relevant, that any contribution made by an employer on behalf of an employee to a trust during a taxable year of the employer which ends within or with a taxable year of the trust for which the trust is not exempt under section 501(a) of the Code, shall be included in income of the employee for his taxable year during which the contribution is made if his interest in the contribution is nonforfeitable at the time the contribution is made. Revenue Ruling 57-37, as modified by Revenue Ruling 57-528, held, inter alia , that certain contributions conveying fully vested and nonforfeitable interests made by an employer into separate independently controlled trusts for the purpose of furnishing unemployment and other benefits to its eligible employees constituted additional compensation to the employees includible, under section 402(b) of the Code and section 1.402(b)-1(a)(1) of the regulations, in their income for the taxable year in which such contributions were made. These Revenue Rulings are distinguishable from cases `(1)' and `(2)' in that, under all the facts and circumstances of these cases, no trusts for the benefit of the taxpayers were created and no contributions are to be made thereto. Consequently, section 402(b) of the Code and section 1.402(b)-1(a)(1) of the regulations are inapplicable.

(3) Here the principal agreement provided that the royalties were payable substantially as earned, and this agreement was supplemented by a further concurrent agreement which made the royalties payable over a period of years. This supplemental agreement, however, was made before the royalties were earned; in fact, in was made on the same day as the principal agreement and the two agreements were a part of the same transaction. Thus, for all practical purposes, the arrangement from the beginning is similar to that in (1) -above. Therefore, it is also held that the author concerned will be required to include the royalties in his gross income only in the taxable years in which they are actually received in cash or other property.

(4) In arriving at a determination as to the includibility of the 150 x dollars concerned in the gross income of the football player, under the circumstances described, in addition to the authorities cited above, consideration also has been given to Revenue Ruling 55-527, C.B. 1955-2, 25, and to the decision in E. T. Sproull v. Commissioner , 16 T.C. 244.

In Revenue Ruling 55-727, the taxpayer, a professional baseball player, entered into a contract in 1953 in which he agreed to render services for a baseball club and to refrain from playing baseball for any other club during the term of the contract. In addition to specified compensation, the contract provided for a bonus to the player or his estate, payable one-half in January 1954 and one-half in January 1955, whether or not he was able to render services. The primary question was whether the bonus was capital gain or ordinary income; and, in holding that the bonus payments constituted ordinary income, it was stated that they were taxable for the year in which received by the player. However, under the facts set forth in Revenue Ruling 55-727 there was no arrangement, as here, for placing the amount of the bonus in escrow. Consequently, the instant situation is distinguishable from that considered in Revenue Ruling 55-727.

In E. T. Sproull v. Commissioner , 16 T.C. 244, affirmed, 194 Fed.(2d) 541, the petitioner's employer in 1945 transferred in trust for the petitioner the amount of $10,500. The trustee was directed to pay out of principal to the petitioner the sum of $5,250 in 1945 and the balance, including income, in 1947. In the event of the petitioner's prior death, the amounts were to be paid to his administrator, executor, or heirs. The petitioner contended that the Commissioner erred in including the sum of $10,500 in his taxable income for 1945. In this connection, the court stated:

* * * it is undoubtedly true that the amount which the Commissioner has included in petitioner's income for 1945 was used in that year for his benefit * * * in setting up the trust of which petitioner, or, in the event of his death then his estate, was the sole beneficiary * * *.

The question then becomes * * * was `any economic or financial benefit conferred on the employee as compensation' in the taxable year. If so, it was taxable to him in that year. This question we must answer in the affirmative. The employer's part of the transaction terminated in 1945. It was then that the amount of the compensation was fixed at $10,500 and irrevocably paid out for petitioner's sole benefit. * * *.' Applying the principles stated in the Sproull decision to the facts here, it is concluded that the 150 x -dollar bonus is includible in the gross income of the football player concerned in 1957, the year in which the club unconditionally paid such amount to the escrow agent.

(5) In this case, the taxpayer and the boxing club, as well as the opponent whom taxpayer had agreed to meet, are each acting in his or its own right, the proposed match is a joint venture by all of these participants, and the taxpayer is not an employee of the boxing club. The taxpayer's share of the gross receipts from the match belong to him and never belonged to the boxing club. Thus, the taxpayer acquired all of the benefits of his share of the receipts except the right of immediate physical possession; and, although the club retained physical possession, it was by virtue of an arrangement with the taxpayer who, in substance and effect, authorized the boxing club to take possession and hold for him. The receipts, therefore, were income to the taxpayer at the time they were paid to and retained by the boxing club by his agreement and, in substance, at his direction, and are includible in his gross income in the taxable year in which so paid to the club. See the Sproull case, supra , and Lucas v. Guy C. Earl , 281 U.S. 111. As previously stated, in each case involving a deferral of compensation, a determination of whether the doctrine of constructive receipt is applicable must be made upon the basis of the specific factual situation involved.

Consistent with the foregoing, the nonacquiescence published in C.B. 1952-2, 5, with respect to the decision in Commissioner v. James F. Oates , 18 T.C. 570, affirmed, 207 Fed.(2d) 711, has been withdrawn and acquiescence substituted therefor at page 5 of this Bulletin.

With respect to deductions for payments made by an employer under a deferred compensation plan, 404(a)(5) of the 1954 Code and section 1.404(a)-12 of the Income Tax Regulations.

In the application of those sections to unfunded plans, no deduction is allowable for any compensation paid or accrued by an employer on account of any employee under such a plan except in the year when paid and then only to the extent allowable under section 404(a). Thus, under an unfunded plan, if compensation is paid by an employer directly to a former employee, such amounts are deductible under section 404(a)(5) when actually paid in cash or other property to the employee , provided that such amounts meet the requirements of section 162 or section 212.

Advance rulings will not be issued in specific cases involving deferred compensation arrangements.



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