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the earnings are taxed currently. Thus, if Morris were to design a plan under which the corporation
receives a current deduction for its contributions, Brad will pay tax now on money he will not receive
until the future. Since this is the exact opposite of what Brad (and most employees) have in mind,
Brad will most likely have to settle for his employer‟s unfunded promise to pay him the deferred
amount in the future.
Assuming Brad is interested in deferring some of his compensation, he and Morris might well
devise a plan that gives them as much flexibility as possible. For example, Morris might agree that the
day before the end of each pay period, Brad could notify the corporation of the amount of salary, if
any, he wishes to defer for that period. Any amount thus deferred would be carried on the books of the
corporation as a liability to be paid, per their agreement, with interest, after Brad‟s retirement.
Unfortunately, such an arrangement would be frustrated by the “constructive receipt” doctrine. Using
this potent weapon, the IRS will impose tax (allowing a corresponding employer deduction) upon any
compensation that Brad, the employee, has earned and might have chosen to receive, regardless of
whether he so chooses. The taxpayer may not turn his back upon income otherwise unconditionally
available to him. Further, under the recently enacted Section 409A of the Internal Revenue Code, the
IRS has been given additional weapons to use against optional deferral schemes.
Taking the constructive receipt theory to its logical conclusion, one might argue that deferred
compensation is taxable to the employee because he might have received it if he had simply negotiated
a different compensation package. After all, the impetus for deferral in this case comes exclusively
from Brad; Morris would have been happy to pay the full amount when earned. But the constructive
receipt doctrine does not have that extensive a reach. The IRS can tax only monies the taxpayer was
legally entitled to receive, not monies he might have received if he had negotiated differently.
Frankly, however, if Brad is convinced of the advisability of deferring a portion of his
compensation, he is likely to be less concerned about the irrevocability of such election as about
ensuring that the money will be available to him when it is eventually due. Thus, a mere unfunded
promise to pay in the future may result in years of nightmares over a possible declaration of
bankruptcy by his employer. Again, left to their own devices, Brad and Morris might well devise a
plan under which Morris contributes the deferred compensation to a trust for Brad‟s benefit, payable
to its beneficiary upon his retirement. Yet such an arrangement would be disastrous to Brad, since the
IRS would currently assess income tax to Brad using the much criticized “economic benefit” doctrine.
Under this theory, monies irrevocably set aside for Brad grant him an economic benefit (presumably
by improving his net worth or otherwise improving his creditworthiness) upon which he must pay tax.
If Brad were aware of this risk, he might choose another method to protect his eventual payout by
requiring the corporation to secure its promise to pay with such devices as a letter of credit or a
mortgage or security interest in its assets. All of these devices, however, have been successfully taxed
by the IRS under the self-same economic benefit doctrine. Very few devices have survived this attack.
However, the personal guarantee of Morris himself (merely another unsecured promise) would not be
considered an economic benefit by the IRS.
Another successful strategy is the so-called rabbi trust, a device first used by a rabbi who feared his
deferred compensation might be revoked by a future hostile congregation. This device works similarly
to the trust described earlier except that Brad would not be the only beneficiary of the money
contributed. Under the terms of the trust, were the corporation to experience financial reverses, the
trust property would be available to the corporation‟s creditors. Since the monies are thus not
irrevocably committed to Brad, the economic benefit doctrine is not invoked. This device does not