Why is this Topic Important to Wealth Managers? Discusses additional events and situations that may or may not trigger specific tax consequences related to common transactions.  Also provides distinctions common to these theories as well as methods to recognize particular fact patterns in relation to such.

The economic benefit doctrine is at issue when the taxpayer receives some benefit in connection with a business or contractual relationship with a current, real and measurable value. [1] One instance when an individual receives an economic or financial benefit or property is for compensation for services, whereby the value of the benefit or property is currently includible in the individual’s gross income. [2] This instance will be examined in further detail below.

Another common example is a promise to pay, which also provides a good illustration of how the doctrine applies.  A mere promise to pay, unsupported by notes or other evidences of indebtedness which by and large is unsecured, is not income to a cash method taxpayer. [3]

On the other hand, there is the cash equivalency doctrine, which states, where a promise to pay that is supported by notes or otherwise secured by a solvent obligor, which is unconditional and assignable, not subject to sett-offs, and issued at a reasonable discount, is therefore considered a cash equivalent.  Since, such notes are considered cash equivalents the notes are taxable in a like manner as cash, i.e., if cash instead of the note was received by the taxpayer the taxpayer would be taxed on the cash received.  “More simply, the cash equivalency doctrine provides that, if the right to receive a payment in the future is reduced to writing and is transferable, such as in the case of a note or a bond, the right is considered to be the equivalent of cash and the value of the right is includible in gross income.” [4]

Two additional examples of the economic benefit doctrine to further illustrate:

A football player entered into a two-year standard player’s contract with the Giants in 2009. In addition to salary, he received a signing bonus that was to be paid to an escrow agent designated by him. Under the agreement, the bonus plus interest were payable to the player over five years. The football player is taxed in full in 2009 when the payment was made to the escrow agent, because in that year, “the employer’s part in the transaction ended, and the amount of the compensation was fixed and irrevocably set aside for the player’s sole benefit” [5]

At the other end of the spectrum, consider ABC, a cash-basis taxpayer, who shares the top floor of an office building with the landlord. On December 31, 2009, a tenant from another floor mistakenly leaves cash rent in ABC’s office lobby, and ABC inadvertently deposits it. ABC discovers the error on January 5, 2010, and promptly issues a check to the landlord. The fact that ABC had dominion and control over the cash rent is irrelevant since it did not represent economic income to ABC. Therefore, ABC is not required to pay tax on the rent. [6]

Additionally, as briefly mentioned above, if an individual receives “any economic or financial benefit or property as compensation for services, the value of the benefit or property is currently includible in the individual’s gross income.” [7] Furthermore, an employee is required to include in his gross income, the value of assets that have been vested unconditionally and irrevocably, and transferred into a fund for the employee’s sole benefit, so long as the employee’s interest is not subject to financial forfeiture or transferable.  [8] A common example of this situation occurs when employee retirement programs are funded with employer stock options.

Tomorrow’s blogticle will discuss the ever popular economic substance doctrine.

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

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[1] See generally, Advisor Fx: Two Tax Doctrines: Constructive Receipt and Economic Benefit.

[2] Internal Revenue Service—Department of the Treasury.  “Nonqualified Deferred Compensation Audit Techniques Guide”.  02-2005.  http://www.irs.gov/businesses/corporations/article/0,,id=134878,00.html. Page Last Reviewed or Updated: March 31, 2010.  Last Accessed 10/23/10.

[3] Tax Management Federal Income Portfolio. “Economic Benefit, Cash Equivalency, and Assignment of Income”.  No. 385 s V, (BNA), 20XX WL 4742238 (FEDERAL).  Compensation Planning Series– 385-4th: Deferred Compensation Arrangements.  Westlaw.  Citing Rev. Rul. 60-31

[4] Internal Revenue Service.  “Nonqualified Deferred Compensation Audit Techniques Guide”.

[5] Tax Management Federal Income Portfolio. “Economic Benefit, Cash Equivalency, and Assignment of Income”.  Citing Ex. 4 of Rev. Rul. 60-31, Rev. Rul. 55-727, [other citations omitted]; Rev. Rul. Rul. 60-31.

[6] CCH Federal Taxation Comprehensive Topics. Chapter 13, Exhibit 17b.  35 of 70.  blue.utb.edu/…/2006%20CCH%20Comp%20Topics%20Ch%2013.ppt.  Last accessed 10/23/10.

[7] Internal Revenue Service.  “Nonqualified Deferred Compensation Audit Techniques Guide”.

[8] 26 U.S.C § 83; Advisor Fx: Two Tax Doctrines: Constructive Receipt and Economic Benefit. ([09-36] 09/01/2009); Internal Revenue Service.  “Nonqualified Deferred Compensation Audit Techniques Guide”.

Tags: Business, Cash and cash equivalents, Constructive Receipt, Employee benefit, Gross income, Human Resources, Income, Internal Revenue Service

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