Ralph H. Minor and Jackie C. Minor v. United States
56 A.F.T.R.2d (RIA) 6037, 772 F.2d 1472, 6 Employee Benefits Cas. (BNA) 2473 (1985)
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Rule of Law:
The economic benefit doctrine does not apply to make deferred compensation currently taxable if the employer's promise to pay is unfunded, unsecured from the employer's general creditors, and thus not capable of present valuation.
Facts:
- In 1959, Ralph H. Minor, a physician, entered an agreement with Snohomish County Physicians Corporation (Snohomish Physicians) to render medical services to its prepaid medical plan subscribers for fees.
- In 1967, Snohomish Physicians adopted a voluntary deferred compensation plan for its participating physicians.
- Minor entered a "Supplemental Agreement" with Snohomish Physicians, electing to receive a designated percentage (initially 50%, then 10%) of his scheduled fees, with the balance contributed to a deferred compensation fund.
- Snohomish Physicians established a trust to provide for its obligations under the Supplemental Agreement, designating itself as both the settlor and beneficiary of the trust; Minor was one of the trustees.
- The trust assets were used to purchase retirement annuity policies, with benefits payable to Minor or his beneficiaries upon retirement, death, disability, or leaving the service area.
- Minor agreed to specific conditions for receiving these benefits, including continuing to provide services, limiting his practice after retirement, offering emergency/consulting services, and refraining from competing with Snohomish Physicians.
- On his federal income tax returns for 1970, 1971, and 1973, Minor included only the percentage of scheduled fees he actually received, excluding the portion placed in the deferred compensation trust.
Procedural Posture:
- Ralph H. Minor filed a tax refund lawsuit against the United States in the United States District Court for the Western District of Washington.
- The District Court entered a judgment in favor of Minor, holding that contributions to the deferred compensation plan were not currently taxable.
- The United States (government) appealed the tax refund judgment to the United States Court of Appeals for the Ninth Circuit.
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Issue:
Is deferred compensation currently taxable under the economic benefit doctrine when the employer's promise to pay is unfunded, unsecured against the employer's creditors, and the employee's rights are subject to a risk of forfeiture?
Opinions:
Majority - Goodwin, Circuit Judge
No, deferred compensation is not currently taxable under the economic benefit doctrine when the employer's promise to pay is unfunded and unsecured against the employer's creditors. The court affirmed the district court's judgment, focusing on the economic benefit doctrine as the IRS conceded that Minor did not constructively receive the income. The economic benefit doctrine applies only if the employer's promise is capable of valuation, which typically requires the contribution to be nonforfeitable, fully vested in the employee, and secured against the employer's creditors by a trust arrangement, as indicated in Rev.Rul. 60-31. In this case, Snohomish Physicians was both the settlor and the beneficiary of the trust, not Minor or the other plan participants. As such, the trust assets remained solely those of Snohomish Physicians and were subject to the claims of its general creditors, rendering the plan unfunded and unsecured. The court distinguished Sproull v. Commissioner, where the employee was the direct beneficiary of the trust and had significant control over the funds. Since the plan was unfunded and unsecured, it did not confer a present taxable economic benefit to Minor, meaning it was not capable of valuation as taxable property under 26 U.S.C. § 83. The court acknowledged that Minor's benefits were subject to conditions (e.g., limiting post-retirement practice, non-compete), which might constitute a substantial risk of forfeiture. However, it explicitly stated that it did not need to determine the substantiality of this risk because the plan's unfunded and unsecured nature already precluded the application of the economic benefit doctrine.
Analysis:
This case significantly clarifies the application of the economic benefit doctrine to non-qualified deferred compensation plans. It establishes that for deferred compensation to be currently taxable, the employee's interest must be truly secured against the employer's creditors, not merely held in a trust where the employer remains the beneficiary. The ruling provides critical guidance for structuring deferred compensation to achieve tax deferral by emphasizing the necessity of the plan remaining 'unfunded' in the context of creditor protection. It reinforces that a mere promise to pay in the future, even with a trust for the employer's benefit, does not constitute a current taxable economic benefit to the employee if the funds are not shielded from the employer's insolvency. This case helps define the line between a mere contractual promise and a present property interest for tax purposes.
