The opinion
HALPERN, J., concurring: I concur with the result reached by the majority, but I disagree, in part, with the majority’s analysis. I do not think that the case turns on whether the “interest” component of the deferred compensation represents payments made by petitioner for the use of money “borrowed” from its employees and director. A central focus of the time value of money legislation of the last 10 years was to identify hidden interest. Congress clearly understood that transactions involving deferred payments for services contained an interest element. 1 Thus, given our current understanding of the interest element inherent in deferred payment transactions, the majority’s analysis seems anachronistic. Moreover, had the participants in the deferred compensation arrangements here in question computed their taxable income under the accrual method of accounting, thus being required to take into income their “base” compensation in the year earned (notwithstanding its deferred receipt), would the majority still maintain that the “interest” element accruing each year did not, indeed, constitute interest for Federal income tax purposes? The majority’s conclusion that no payments of interest are being made is dependent on its prior conclusion that the petitioner had not borrowed anything from its employees and director. I do not see how that prior conclusion can turn on the accounting method of petitioner’s employees and director. 2
The inquiry as to whether petitioner has, in a property law sense, borrowed anything from its employees and director is, I believe, not a helpful inquiry. The proper inquiry, I believe, is whether deductibility of the “interest” component of the deferred payment is governed by section 404. I believe that it is. With regard to nonqualified deferred compensation, the plain purpose of section 404 is to require matching of income inclusion and deduction as between the employee and employer. 3 Subsection (a) of section 404 disallows a deduction under the normal rules of deductibility and tax accounting for compensation the receipt of which is deferred. However, if such compensation otherwise would be deductible, the subsection allows a deduction under the special rules found in section 404. Subsection (a)(5) provides a limitation on the amount deductible in any year in connection with a nonqualified plan deferring the receipt of compensation. In pertinent part, it provides for a deduction in the taxable year in which an amount attributable to the compensation is includable in the gross income of an employee participating in the plan. Section 1.404(a)-12(b)(2) of the income tax regulations illustrates the application of section 404 with regard to the payment of unfunded (nonqualified) pensions. In pertinent part, it states: “If unfunded pensions are paid directly to former employees, such payments are includible in their gross income when paid, and accordingly, such amounts are deductible under section 404(a)(5) when paid.” 4 It would be unusual for a pension plan not to have an investment (or “interest”) element to it, yet the regulation unambiguously allows a deduction equal to the pension payment only when such payment is includable in gross income. I see no reason why a different rule should apply to the payments of deferred compensation here in question. Whether the parties label a portion of the payments interest does not matter. To allow an accrual method employer to deduct interest in advance of inclusion by employees would frustrate the matching principle apparent in the statute. It can be said that the effect of that matching principle is that the employer is being taxed in substitution for not currently taxing the employee. 5 If the employer were allowed an interest deduction, then the present discounted value of the tax burden on the employer would not be equivalent (i.e., would be less than) an immediate tax on the employee (assuming, of course, equal tax rates). 6 We need not allow that result.
Hamblen, Cohen, and Parr, JJ., agree with this concurring opinion. See, e.g., S. Rept. 98-169 (Vol. 1), at 249-250 (1984) (“Present law provides exceptions to the rules requiring annual recognition and deduction of OID for the following: * * * (6) obligations issued in exchange for services, fn. * * * Present law is unclear as to whether all deferred payments for services are within the scope of sections 404 and 404A.”)
Those individuals computed taxable income under the cash method of accounting. As a result, they do not, for tax purposes, realize income prior to receipt. Perhaps, then, for tax purposes, it could be said that, since they have received nothing, they have nothing to lend. Such an analysis, although helpful on a theoretical level, does not, I believe, aid in the problem of statutory construction here presented.
See H. Kept. 2333, 77th Cong., 1st Sess. (1942), 1942- 2 C.B. 372 , 451-452; S. Rept. 1631, 77th Cong., 2d Sess. (1942), 1942- 2 C.B. 504 , 609.
Compare sec. 1.404(a)-12(b)(1), which describes a deduction equal only to the employer’s contribution to the plan but, apparently, deals only with a funded plan.
See Halperin, “Interest in Disguise: Taxing the ‘Time Value of Money,’ ” 95 Yale L.J. 506 , 520.
See the discussion in Halperin, supra at 519-524.