Albertson's, Inc. v. Comm'r of Internal Revenue

• Decision Date: 09 October 1990
• Docket Number: Docket No. 10439-87.
• Citation: 95 T.C. 415,12 Employee Benefits Cas. 2567,95 T.C. No. 30,59 USLW 2260
• Parties: ALBERTSON'S, INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: U.S. Tax Court

12 Employee Benefits Cas. 2567

59 USLW 2260

95 T.C. 415

95 T.C. No. 30

ALBERTSON'S, INC., Petitioner

v.COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 10439-87.

United States Tax Court

Filed October 9, 1990.

P, an accrual basis taxpayer, established nonqualified deferred compensation arrangements (DCAs) for eight ‘key‘ executives and one outside member of its board of directors (DCA Participants). Under the DCAs, P and the DCA Participants agreed to defer payments for future personal services the DCA Participants would otherwise have been entitled to receive upon the performance of those services. The DCAs were unfunded and represented the unsecured contractual obligations of P to pay each DCA Participant upon termination, retirement, or attainment of a specified age.

P maintained bookkeeping accounts to calculate the deferred compensation of each DCA Participant. The accounts for each DCA Participant reflected the amount of compensation that was originally deferred plus an amount designated as ‘interest.‘ P compounded and accrued the interest component of the DCAs with respect to each DCA Participant's accumulated account balance. P deducted this amount separately as an ‘interest expense.‘

HELD: The amount designated as interest under the DCAs is not interest deductible under sec. 163, I.R.C. 1954, but instead represents additional deferred compensation for personal services deductible only as permitted by sec. 404(a)(5) or (d). Robert S. Erikson, Edwin V. Apel, Jr., Cathy R. Silak, and David A. Channer, for the petitioner. ^*

Joyce E. Brit, Julia M. Dewey, and Virginia Draper, for the respondent.

RUWE, JUDGE: ^*

Respondent determined a deficiency in petitioner's Federal income tax in the amount of $718,936 for fiscal year ending February 3, 1983. Originally, three issues were presented for decision: (1) The investment tax credit issue; (2) the WIN Credit issue; and (3) the interest/deferred compensation issue. By an Order dated December 27, 1988, this Court severed the investment tax credit issue from the other issues and decided it in petitioner's favor. See Albertson's, Inc. v. Commissioner, T.C. Memo. 1988-582. Supplemental briefs with respect to the WIN Credit and the interest/deferred compensation issues were ordered filed. We subsequently separated the two remaining issues and decided the WIN Credit issue in respondent's favor. See Albertson's, Inc. v. Commissioner, T.C. Memo. 1990-153. This Opinion involves the interest/deferred compensation issue. Specifically, we address whether the amounts designated as interest under petitioner's deferred compensation arrangements are deductible in the year accrued. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954, as amended and in effect for the year in issue. All Rule references are to the Tax Court Rules of Practice and Procedure.

FINDINGS OF FACT

Some of the facts have been stipulated. The stipulation of facts and attached exhibits are incorporated herein by this reference.

Petitioner, a Delaware corporation, had its principal place of business in Boise, Idaho at the time the petition in this case was filed. During the year in issue, petitioner operated over 400 retail food and drug stores in the western, southern, and southeastern United States. Petitioner is an accrual basis taxpayer.

Prior to the fiscal year in issue, petitioner established nonqualified deferred compensation arrangements (DCAs) for eight ‘key‘ executives (Employee DCAs) and for one outside member of its board of directors (Director DCA). The executives and the director participating in the DCAs will be referred to as DCA Participants. The DCAs were unfunded and represented the unsecured contractual obligations of petitioner to pay a specified sum, determined in accordance with the terms of each DCA, to each DCA Participant at or after a specified time. The time specified was retirement, termination of employment, or, in the case of the outside director, age 72. Petitioner's purpose in establishing the DCAs and offering them to its executives and directors was to attract and retain the services of qualified persons for those positions.

Under the DCAs, petitioner and the DCA Participants agreed to defer payments for future personal services the DCA Participants would otherwise have been entitled to receive in the year they performed said services. The agreement was struck as a result of arm's-length negotiations conducted prior to the year personal services were performed. Each participant in an Employee DCA deferred either a specified portion of his or her future salary or annual bonus, or both. The participant of the Director DCA deferred 100 percent of his monthly retainer fees and board and committee meeting fees.

Prior to the beginning of a fiscal year of petitioner, each DCA Participant could elect not to participate in his or her respective arrangement for that year. If a DCA Participant elected not to participate, his or her compensation for the year would not be deferred and would actually be paid to him or her as earned.

Petitioner maintained bookkeeping accounts to calculate the deferred personal service compensation of each DCA Participant. The accounts for each DCA Participant reflected the amount of compensation that was originally deferred plus an amount designated as ‘interest.‘ For the year in issue, the provisions defining deferred compensation that were contained in the Employee DCAs were as follows: ¹

3. DEFERRED COMPENSATION:

3.1 The COMPANY agrees to defer payment of certain compensation earned by EMPLOYEE during each fiscal year, such deferred compensation to be paid to EMPLOYEE after EMPLOYEE'S employment is terminated. The compensation to be deferred in each fiscal year shall be as set forth in subparagraphs (a) and (b) below:

(a) The sum of $ _____. This amount will be prorated for any partial fiscal year upon retirement or termination.

(b) The bonus earned by EMPLOYEE for such fiscal year pursuant to any bonus plan or plans then in effect unless EMPLOYEE, by written notice to the Secretary of the COMPANY prior to the beginning of any fiscal year, elects to have only a portion of such bonus deferred for such fiscal year. In such event, the portion of such bonus which EMPLOYEE elects not to be deferred shall be paid in accordance with the provisions of the bonus plan.

3.2 The COMPANY agrees to pay to EMPLOYEE a further sum of money equal to the amount of interest accrued which shall be calculated by applying a rate of interest to the total accumulated amount of deferred compensation including accrued interest compounded monthly. The rate to be used will be the weighted average of the COMPANY'S long term borrowing rate for that current fiscal year.

3.3 As used in Section 3.2 above, ‘total accumulated amount of deferred compensation‘ means compensation deferred pursuant to previous deferred compensation agreements between the COMPANY and EMPLOYEE (including phantom stock agreements) as well as this agreement.

3.4 For purposes of this agreement a ‘year‘ is defined as a ‘fiscal year‘ coincident with the COMPANY'S fiscal year.‘

With respect to the Director's DCA, the interest component was als o compounded monthly, but was determined by reference to The Wall Street Journal and the rate there quoted as being paid by major banks on new issues of negotiable certificates of deposit in amounts of $1,000,000 or more. The DCA Participants' rights to receive payment under the DCAs could not be commuted, encumbered, assigned, or otherwise disposed of.

For taxable years prior to the year in issue, petitioner did not claim a deduction with respect to its DCAs' interest component unless a deduction was permitted by section 404(a) by reason of the amount actually being paid and included in the gross income of the recipient. ² On June 14, 1982, petitioner filed with respondent a request for a change of accounting method with respect to its DCAs' interest component. Petitioner requested it be allowed to account for the interest component by deducting it in the year accrued rather than the year paid. On August 26, 1983, respondent issued a letter permitting petitioner to change, as requested, its method of accounting for its DCAs' interest component. The change year involved was the year in issue, petitioner's fiscal year ending February 3, 1983.

Another reason why deductions attributable to petitioner's DCAs should be limited to amounts actually paid and includable in the gross income of recipients can be inferred from the literal provisions of section 404. Section 404(a) provides that ‘If CONTRIBUTIONS ARE PAID‘ under certain types of designated plans (including pension plans) or ‘if COMPENSATION IS PAID OR ACCRUED on account of any employee under a plan deferring the receipt of such compensation, such contributions or compensation shall not be deductible under section 162‘ but shall be deductible under section 404(a). (Emphasis added.) Both parties agree that the timing of deductions for the employees' deferred ‘compensation‘ in this case is controlled by section 404(a)(5). Section 404(a)(5) provides that deductions are to be taken ‘in the taxable year in which an amount attributable to the CONTRIBUTION is includable in the gross income of employees participating in the plan.‘ (Emphasis added.) Section 404(a)(5) makes no reference to ‘compensation.‘ It simply provides for deduction by the employer in the year the ‘amount attributable to the CONTRIBUTION‘ is reportable by the employee. Throughout section 404, the term ‘contribution‘ is used in conjunction with the word ‘paid,‘ and it is clear that unless there is an actual outlay of funds by an employer, there is no ‘contribution‘ within the meaning of section 404(a)(5). The only payments pursuant to the DCAs were to be made upon the employee's retirement or termination. Query: What is the ‘contribution‘ or ‘amount attributable to the contribution‘ in petitioner's...