Employer stock rabbi trusts.

• Author: Bowers, Jennifer J.

A nonqualified deferred compensation plan can be a valuable incentive tool for an employer wishing to reward officers and other top management. It can be used to supplement the benefits received from the employer's qualified plans or may be useful for the employer unable (or unwilling) to shoulder the expense and complexity associated with qualified retirement plans.

Through the use of a rabbi trust, an employer may provide an additional level of comfort to participants in unfunded plans by making contributions to a grantor trust. The trust is usually (but not always) irrevocable, and the employer is treated as the owner under the grantor trust rules of Secs. 671-678. The Department of Labor (DOL) does not consider a rabbi trust arrangement to be funded for ERISA purposes solely because of the establishment and operation of a trust (DOL Advisory Opinion 89-22A).

IRS Letter Ruling 9235006 illustrated how an employer may successfully use employer securities to fund such a trust and limit taxable income generated by trust earnings. An affiliated group of employers proposed to fund an irrevocable trust primarily with stock of the parent corporation, a publicly traded company. The trust had an independent trustee but provided that the parent had the sole discretion, subject to some timing restrictions, to substitute assets in the trust with assets of equal fair market value.

The IRS ruled that the parent was the owner of the trust for income tax purposes, and deductions for benefit payments under Sec. 404(a)(5) would be allowed when the amount was included in the participants' gross income. As long as the parent remained the trust's owner, the receipt of dividends paid on the parent's stock would not be includible in the parent's gross income in the year paid. Any substitution of assets for the employer stock likewise would not cause the parent to recognize any gain or loss from a sale or exchange of the assets. The result is a...