Rev. Rul. 69-650

Advice has been requested regarding the treatment for Federal income tax purposes of amounts deferred under the contractual arrangement described below.

An employee, on the cash receipts and disbursements method of accounting, and his employer-corporation, on the accrual method of accounting, executed an employment contract under which the employee may irrevocably elect to defer receipt of a portion of his following year's scheduled salary.

The contract provides that each full-time employee, including officers (excluding the chairman of the board), who attains the age of 40 on or before any December 31 and who earns a specified amount in normal compensation during the twelve-month period ending with such December 31 may irrevocably elect to defer receipt of a portion of his scheduled salary for the twelve-month period following such December 31. Normal compensation is defined in the contract as the scheduled salary payable for an employee's services rendered to the corporation.

Under the contract, each employee may elect, in the year prior to the year in which the amounts are earned, to defer receipt of either 5 percent or 10 percent of his scheduled salary. For each employee so electing, the corporation establishes a deferred compensation account and credits to such account the amount the employee elected to defer. The amounts deferred are to be satisfied from the general corporate funds which are subject to the claims of the creditors.

The amount in an employee's account is to be distributed to him in installments on January 1 of each of the 10 years next following the date of termination of his regular full-time employment. Distribution in a like manner is also to be made after the expiration of any period of six calendar months during which the employee is disabled so as to be unable to render full-time services to the corporation. If the employee should die prior to receiving the total amount credited to his account, the entire balance remaining is to be promptly paid to his legal representative.

The employee in the instant case elected, in accordance with the employment contract, to defer a portion of his scheduled salary which would otherwise be received during the twelve-month period following December 31, 1967.

Section 1.451-2(a) of the Income Tax Regulations provides, in part, that income is constructively received in the taxable year during which it is credited to the taxpayer's account, set apart for him, or otherwise made available so that he may obtain it at any time. However, income is not constructively received if the taxpayer's control of its receipt is subject to substantial limitations or restrictions.

In the instant case, it is held that the portion of the employee's salary deferred in accordance with the terms of the described contract is not includible in income in the year earned (1968). The amount thus deferred is includible in the gross income of the recipient in the later taxable year(s) in which it is actually received by or otherwise made available to him, whichever is earlier.

The employer-corporation, although on the accrual method of accounting, is entitled to deduct this deferred amount under section 404(a)(5) of the Internal Revenue Code of 1954 only in the taxable year in which payments are actually made to the employee or his legal representative, to the extent such payments are ordinary and necessary expenses within the meaning of section 162 of the Code.