Tax deferral opportunities offered by 401k and other qualified retirement plans are adequate for most of us, but fall short for top executives, star athletes, and other high-income individuals. They sometimes turn to nonqualified deferred compensation. A key rule here: until payment is made, the individual whose compensation is deferred doesn’t report income, and the payer doesn’t get a deduction.
This rule raised an issue when a partnership calling itself Hoops LP sold the Memphis Grizzlies basketball team. The partnership owed $10.7 million in deferred compensation to two players, Mike Conley and Zach Randolph. At the time of the sale they had already earned this income, but their arrangements called for payment in a later year. The outfit buying the team agreed to pay the players when the time came. This of course meant the buyers reduced their purchase price by the same amount. Hoops said that because their sale price was reduced by $10.7 million, they should be treated as having paid the compensation and allowed a deduction. The IRS called a foul.
The Tax Court sided with the IRS, and the ruling on the court went up for review. The review officials (U.S. Court of Appeals) held that a deduction is allowed only when payment is made to the players. Hoops passed the ball to the team’s buyer, but the players wouldn’t score this income until later years. The net effect was to block the seller’s shot at a deduction.