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TAX CLINIC

Sec. 404(a)(5) states that a deduction for any deferred compensation
is only allowable in the tax year in which the compensation
is includible in the employee’s gross income as compensation.

highlighted how complications can paid or incurred during the tax year in assets, the cash-basis seller includes the
arise in this context. carrying on a trade or business. If costs liability in the amount realized (see Sec.
In this case, Hoops LP (Hoops), the are contributed by an employer under a 1001), even though it has not been re-
owners of the NBA team the Memphis plan of deferred compensation, however, corded for tax purposes, but also receives
Grizzlies, in 2021 sold the franchise the deduction of these costs is governed an immediate deduction as if the liability
to Memphis Basketball LLC. In the by Sec. 404(a). Sec. 404(a)(5) states that was paid, under Regs. Sec. 1.461-4(d)
transaction, Memphis Basketball bought a deduction for any deferred compensa- (5)(i). Hoops argued that in its case, it
substantially all the assets and assumed tion is only allowable in the tax year in should obtain the same result under the
the liabilities of Hoops LP. Among these which the compensation is includible regulation, which provides:
liabilities were deferred compensation in the employee’s gross income as com-
contracts for two Grizzlies’ players, Zach pensation. Generally, this is the year the If, in connection with the sale or
Randolph and Mike Conley. Under compensation is paid. In Hoops, the issue exchange of a trade or business by
these contracts, at the time of the sale, was whether the seller of a business was a taxpayer, the purchaser expressly
the players were owed $12.6 million of entitled to deduct the deferred compen- assumes a liability arising out of the
deferred compensation for services pro- sation costs. trade or business that the taxpayer
vided before the sale that were due to be In a typical taxable asset sale, the but for the economic performance
paid after the sale. general rule on assumption of liabilities requirement would have been en-
In computing gain on the sale, Hoops is relatively clear. When a buyer assumes titled to incur as of the date of the
reported a total amount realized of $420 a seller’s liability, the assumption of that sale, economic performance with
million, which included $220 million liability is included in the consideration respect to that liability occurs as the
of assumed liabilities and other adjust- paid to the seller. From the buyer’s per- amount of the liability is properly
ments. In determining the amount real- spective, the assumption of liabilities is included in the amount realized on
ized, Hoops included $10.7 million (the treated as an additional amount “paid” the transaction by the taxpayer.
present value of the $12.6 million owed by the buyer to acquire the assets. That
to Randolph and Conley) for Memphis amount is capitalized and added to The Hoops case
Basketball’s assumption of the deferred the buyer’s basis for the assets acquired Similar to the cash-basis example above,
compensation liability. at the time the liability is treated as Hoops argued that under Regs. Sec.
Hoops did not claim the deduction incurred under the buyer’s method of 1.461-4(d)(5)(i), economic performance
of $10.7 million related to the deferred accounting. If the buyer does not get a occurred at the time of the NBA
compensation liability on its original tax deduction for the payment of the liabil- franchise sales transaction, allowing an
return, nor did it reduce its amount real- ity, who does? Depending on the type of acceleration of the deduction for the
ized on the sale for the deferred com- liability, that answer is not so clear, and deferred compensation. In rejecting this
pensation liability. However, Hoops later the tax treatment for the seller may not argument, the court noted that the tim-
amended its tax return and claimed the be symmetrical to the buyer. ing restrictions of Sec. 404(a)(5), which
$10.7 million as a compensation deduc- Consider an example where the buyer govern the timing of the deduction for
tion. In March 2018, the IRS disallowed assumes an operating expense liability deferred compensation, do not allow
the deduction. (accounts payable or accrued expense) an employer to deduct a compensation
of the seller, but the seller uses the cash payment until it is included in the em-
Deductibility of deferred method of accounting (expenses gener- ployee’s income (i.e., it is paid to the em-
compensation ally deducted as paid) and, therefore, has ployee). Thus, Hoops’ reliance on Regs.
Sec. 162(a) generally allows a deduction not taken a deduction related to the un- Sec. 1.461-4(d)(5)(i) was misplaced be-
for all ordinary and necessary expenses paid liability. At the time of the sale of cause it was the Sec. 404(a)(5) deduction

18 August 2022 The Tax Adviser