Rabbi trust
Encyclopedia
In the United States
a Rabbi trust is a type of trust
used by businesses or other entities to defer the taxability to the person or entity receiving (the payee) such payments as employee compensation or purchase payments in the acquisition of another business
.
, resulting in the name. Revenue Procedure 92-64 further clarified the acceptable rules for Rabbi trusts along with a model trust document and the required features to avoid constructive receipt of income to the employee.
plan.
The Rabbi trust is likewise applicable when one business purchases another business but wants to set aside part of the purchase price and defer its payment as well as taxability to the payee upon the satisfaction of conditions to which both parties agree.
for the employee's future. Ordinarily, this would cause current inclusion into gross income even though the employer has yet to reduce the money to income because of the economic benefit theory doctrine. So the IRS allowed by private letter ruling
that the trust would not result in income, according to Section 83(a) of the Code, if the assets of the trust were available to the reach of the employer's general creditors. This is because until the employee is vested, he is under a substantial risk of forfeiture and under Section 83(a) and accompanying regulations 1.83-1 and as such is not subject to current inclusion into gross income.
All non-qualified deferred-compensation plans must involve substantial risk of forfeiture or other methods of avoiding constructive receipt, such as conditioning payment upon performance of future conditions or service. The unique feature of the Rabbi trust is that the money placed in it is protected from changes of heart of the employer. Once placed in the trust the money cannot be revoked by decisions of the employer. So as long as the employer's financial position is sound, the money is relatively protected. If, however, the employer goes into bankruptcy proceedings, the money may be subjected to the claims of the employer's general unsecured creditors.
For the Rabbi trust to be successfully applied, there must be a real risk of forfeiture upon the failure by the payee to fulfill the agreed upon conditions. If the condition is impossible to fail, then constructive receipt
may overcome the successful application of the Rabbi trust.
United States
The United States of America is a federal constitutional republic comprising fifty states and a federal district...
a Rabbi trust is a type of trust
Trust law
In common law legal systems, a trust is a relationship whereby property is held by one party for the benefit of another...
used by businesses or other entities to defer the taxability to the person or entity receiving (the payee) such payments as employee compensation or purchase payments in the acquisition of another business
Business acquisition
Business acquisition is the process of acquiring a company to build on strengths or weaknesses of the acquiring company. A merger is similar to an acquisition but refers more strictly to combining all of the interests of both companies in to a stronger single company...
.
History
The first such trust set up was for the benefit of a rabbiRabbi
In Judaism, a rabbi is a teacher of Torah. This title derives from the Hebrew word רבי , meaning "My Master" , which is the way a student would address a master of Torah...
, resulting in the name. Revenue Procedure 92-64 further clarified the acceptable rules for Rabbi trusts along with a model trust document and the required features to avoid constructive receipt of income to the employee.
Applications
An example of a Rabbi trust applying where an employee receives compensation the taxation of which is deferrable is a nonqualified deferred compensationNonqualified deferred compensation
In the United States, the question whether any compensation plan is qualified or non-qualified is primarily a question of taxation under the Internal Revenue Code . Any business prefers to deduct its expenses from its income, which will reduce the income subject to taxation. Expenses which are...
plan.
The Rabbi trust is likewise applicable when one business purchases another business but wants to set aside part of the purchase price and defer its payment as well as taxability to the payee upon the satisfaction of conditions to which both parties agree.
Non-qualified deferred compensation plans
A non-qualified deferred compensation plan is where current income of an employee is deferred but not taxable to the employee. The employer, however, sets aside the assets in a separate trustIncome trust
An income trust is an investment that may hold equities, debt instruments, royalty interests or real properties. The trust can receive interest, royalty or lease payments from an operating entity carrying on a business, as well as dividends and a return of capital.The main attraction of income...
for the employee's future. Ordinarily, this would cause current inclusion into gross income even though the employer has yet to reduce the money to income because of the economic benefit theory doctrine. So the IRS allowed by private letter ruling
Private letter ruling
Private letter rulings , in the United States, are written decisions by the Internal Revenue Service in response to taxpayer requests for guidance. A private letter ruling binds only the IRS and the requesting taxpayer. Thus, a private ruling may not be cited or relied upon as precedent...
that the trust would not result in income, according to Section 83(a) of the Code, if the assets of the trust were available to the reach of the employer's general creditors. This is because until the employee is vested, he is under a substantial risk of forfeiture and under Section 83(a) and accompanying regulations 1.83-1 and as such is not subject to current inclusion into gross income.
All non-qualified deferred-compensation plans must involve substantial risk of forfeiture or other methods of avoiding constructive receipt, such as conditioning payment upon performance of future conditions or service. The unique feature of the Rabbi trust is that the money placed in it is protected from changes of heart of the employer. Once placed in the trust the money cannot be revoked by decisions of the employer. So as long as the employer's financial position is sound, the money is relatively protected. If, however, the employer goes into bankruptcy proceedings, the money may be subjected to the claims of the employer's general unsecured creditors.
Acquisition of a business
When one business purchases another business, the purchasing business may want to set aside part of the purchase price and defer its payment to the payee upon the satisfaction of conditions to which both parties agree. A Rabbi trust may be used in this situation to defer the taxability to the payee of the deferred payments of the purchase price.For the Rabbi trust to be successfully applied, there must be a real risk of forfeiture upon the failure by the payee to fulfill the agreed upon conditions. If the condition is impossible to fail, then constructive receipt
Constructive receipt
For federal income tax purposes, the doctrine of constructive receipt is used to determine when a cash-basis taxpayer has received gross income. A taxpayer is subject to tax in the current year if he or she has unfettered control in determining when items of income will or should be paid...
may overcome the successful application of the Rabbi trust.
Impact
The Rabbi trust allows the deferment of compensation whether employment income or the purchase price of a business acquisition, and the absence of this would result in the taxability to the payee of the compensation not yet received by the payee. This would serve as a disincentive for deferring such payments.External links
- http://www.finance.cch.com/text/c40s10d440.asp
- http://www.nysscpa.org/cpajournal/2003/0303/features/f033403.htm