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TAX TRENDS

including compensation paid or incurred liability would be accelerated due to the that Sec. 404(a)(5) is a congressionally
by an employer to or on account of an assumption of the liability in the sale of mandated deviation from the clear-
employee. However, Sec. 404(a) governs the Grizzlies. reflection-of-income principle.
the deductibility of such amounts if Under Sec. 461 and Regs. Secs. The Tax Court, citing its own and
they are contributed by an employer 1.461-1(a)(2)(i) and 1.446-1(c)(1)(ii)(A), Ninth Circuit precedent, concluded that
under a pension, annuity, stock bonus, or a taxpayer is generally allowed to deduct based on Congress’s intent to deviate
profit-sharing plan, or under any plan of an expense when it is incurred, and a from the clear-reflection-of-income
deferred compensation. liability is incurred when economic per- principle and to ensure matching
The parties agreed that Randolph’s formance occurs for the liability. How- of income inclusion and deduction
and Conley’s deferred compensation ever, the regulations further state that, between employee and employer under
was paid under a nonqualified plan of if, as Hoops did, the taxpayer uses an nonqualified plans, disallowing a
deferred compensation subject to Sec. accrual method of accounting, “[a]ppli- deduction for Hoops in the year of its
404(a) and that, specifically, Sec. 404(a) cable provisions of the Code, the Income sale of the Grizzlies would not lead to
(5) applied to the deferred compensation Tax Regulations, and other guidance a “ridiculous result.” Rather, the result
at issue. Sec. 404(a)(5) provides that, in a published by the Secretary prescribe the was in line with the clear purpose of
case of a nonqualified plan, a deduction manner in which a liability that has been Sec. 404.
for deferred compensation paid or incurred is taken into account.” Finally, in the alternative, Hoops
accrued is allowable for the tax year for Thus, according to the Tax Court, argued that, if the Tax Court found the
which an amount attributable to the the initial question was whether another partnership was allowed to deduct the
contribution is includible in the gross provision of the Code or regulations deferred compensation liability in 2012,
income of the employees participating in governed how the deferred compensa- then the partnership should not have
the plan. tion liability is taken into account. The included the deferred compensation
The Tax Court concluded that court stated that, as it had already deter- liability in the sale price of the Grizzlies,
under the plain language of Sec. 404(a) mined, Sec. 404(a)(5) governed how the or it should be entitled to offset or
(5), Hoops could not deduct deferred deferred compensation liability is taken reduce the amount realized on the
compensation until the tax year for into account, and, under this section, sale by the amount of the deferred
which an amount attributable to the Hoops was not entitled to deduct the compensation liability.
compensation is includible in the liability in 2012, regardless of whether Sec. 1001(a) provides that the gain
employee’s gross income. Hoops and it used the accrual method. Accordingly, from the sale or other disposition of
the IRS agreed that Hoops had not the Tax Court concluded that because property shall be the excess of the
paid any of the deferred compensation Sec. 404(a)(5), not Hoops’s failure amount realized from the sale or other
liability owed to Randolph and to satisfy the economic performance disposition over the property’s adjusted
Conley in 2012 and no amounts were requirement, precluded the partnership basis. The amount realized is the sum
includible in the players’ gross incomes from deducting the deferred compensa- of any money received plus the fair
as compensation in 2012. Therefore, tion liability in 2012, Hoops’s reliance market value of the property (other than
the IRS had correctly disallowed the on the economic performance require- money) received, including the amount
additional deduction for the deferred ment was misplaced. of liabilities from which the transferor
compensation liability Hoops took on its Hoops also argued that if Sec. 404(a) is discharged as a result of the sale or
2012 amended return. (5) and the tax accounting rules were other disposition.
Hoops argued that despite Sec. applied in a manner that would deny a The Tax Court stated that, by
404(a)(5), under Sec. 461(h) and the deduction for the deferred compensa- claiming that it should not have to
regulations thereunder, it was allowed tion liability, this would “lead to the include the liability in the sales price,
to deduct the deferred compensation ridiculous result” of the partnership’s Hoops was in effect arguing that the
liability in the year it sold the Grizzlies. including the deferred compensation li- deferred compensation liability was
In particular, the partnership argued ability in its sale proceeds but potentially not a liability within the meaning of
that the rule in Sec. 404(a) regarding never obtaining an offsetting deduction. Sec. 1001 because it was not included
the timing of the deduction is incorpo- Thus, allowing it to deduct the deferred in the basis and did not give rise to
rated into the economic performance compensation liability for the year of a deduction. Hoops supported this
requirement of Sec. 461(h) and that the 2012 sale was consistent with the position by asserting that Congress
under Regs. Sec. 1.461-4(d)(5)(i), the purpose of clearly reflecting income. The intended for Sec. 404(a)(5) to delay the
deduction for the deferred compensation IRS, citing legislative history, countered employer’s deduction to the year for

60 May 2022 The Tax Adviser