In PLR 200905016, an employee of a corporation was entitled to a benefit under a non-qualified deferred compensation plan. The employee designated his spouse as his beneficiary under the plan in the event of his death, provided she survives him for 45 days and does not disclaim the compensation. If she does not survive for 45 days or disclaims the compensation, it was to be paid to a charity.
The corporation sought a ruling that it could deduct the compensation even if it ended up being paid to the charity as a result of the spouse’s prior death or disclaimer. IRC Section 404(a)(5) provides that non-qualified deferred compensation is deductible by the payor only in the tax year in which it is included in the gross income of the employee/recipient. The employer probably sought the ruling because where the compensation was received by a charity, the charity would not pay tax on it. The IRS agreed the employer could deduct the compensation based on its interpretation of Treas. Reg. Section 1.404(a)-12 (b) as saying the compensation is considered to have been included in the taxable income of the employee even if it is received by a beneficiary that does not have to include it in gross income. It is not clear to us that the regulation is as broad as the IRS apparently reads it, but we take no issue with the result they reached.
The ruling does not address the tax consequences to the employee but there should not be an adverse tax result. This unpaid compensation is an item of “income in respect of a decedent” under IRC Section 691. It would be ordinary taxable income if received by the decedent’s estate after his death. However, where someone else becomes entitled to receive the compensation as a result of the decedent’s death, IRC Section 691(a)(1)(B) provides that party is subject to tax; however, in this case that party is a tax exempt entity.