IRS proposes revoking deferred compensation ruling.

• Author: Cvach, Gary Q.

The IRS has "tentatively concluded" that the part of Letter Ruling 9235006 that held that a parent company would be treated as the sole owner and grantor of a trust it established to provide nonqualified deferred compensation benefits to its own executives and those of its affiliates was incorrect. As a result, the Service has proposed revoking that holding, as well as its conclusions that (1) dividends paid on the parent's stock held by the trust will not be includible in the parent's gross income and (2) the parent will not recognize any gain or loss on the trustee's receipt of money or other property in exchange for the parent's stock.

Company X is the parent of an affiliated group. A few years ago, X requested a ruling on the income tax consequences of establishing a trust to assist X in providing nonqualified deferred compensation under a plan for certain executives of X and its affiliates. Although the purpose of the trust was to pay X's and the affiliates' benefit obligations to participating executives, the trustee was obligated to hold the trust assets and income for the benefit of X's and the affiliates' general creditors in the event X or the affiliates became insolvent. The trust agreement further provided that plan participants had no beneficial ownership in, or preferred claim on, the trust assets. Thus, although the assets were held in trust, in the event of X's or the affiliates' insolvency, the assets were within the reach of X's or the affiliates' general creditors. Under the terms of the trust, trust assets were to be invested in X stock.

In Letter Ruling 9235006, the IRS ruled that:

1. X would be treated as the trust's owner under Sec. 675(4), relating to grantor trusts; therefore, under Sec. 671, all the trust's items of income, deductions and credits would be included in computing X's taxable income and credits.

2. Because X was treated as the owner of the entire trust, it was treated under Rev. Rul. 85-13 as the owner of the trust's assets for Federal income tax purposes.

3. Provided X remained the owner of the trust, (1) dividends paid on X stock held by the trust would not be includible in X's income (since X would, in effect, be paying itself a dividend) and (2) under Sec. 1032, X would not recognize gain or loss on the trustee's receipt of money or other property in exchange for X stock...