Tax Deduction for Deferred Compensation

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7^th Circuit Court of Appeals

Case Name: Hoops, LP v. CIR

Case No.: 22-2012

Officials: Brennan, Scudder, and Kirsch, Circuit Judges.

Focus: Tax Deduction for Deferred Compensation

Hoops, the proprietor of an NBA franchise (the Grizzlies), sought a sizeable tax deduction amounting to $10.7 million for deferred compensation it owed to two of its players, a sum earned based on their past performances across preceding seasons, as of the conclusion of the 2012 tax year. As guided by 26 U.S.C. 404(a)(5), Hoops, an entity utilizing the accrual-based method for tax purposes, is only permitted to claim deductions for deferred compensation expenses in the specific tax years when disbursements are made to its personnel or contributions are channeled into qualified plans, such as trust or pension funds. However, Hoops did not engage in either of these actions during the 2012 period.

In 2012, Hoops divested a considerable portion of its assets and obligations. As part of this transaction, the acquiring party undertook responsibility for Hoops’s deferred compensation liability amounting to $10.7 million. Hoops perceived this $10.7 million as a virtual payment made to the buyer, essentially compensating them for assuming the obligation linked to deferred compensation. In response, Hoops claimed a tax deduction, contending that the buyer’s adoption of the $10.7 million liability should be recognized as an ordinary business expense that is deductible at the time of the sale.

However, the Internal Revenue Service (IRS) negated the deduction request. Subsequently, both the Tax Court and the Seventh Circuit Court of Appeals upheld this denial. It was substantiated that Section 404(a)(5) precluded Hoops from availing the deduction for deferred compensation during the 2012 tax year since no payment was extended to the players within that particular year. The statute explicitly mandates that Hoops can only claim the deduction upon payment to the players, establishing a direct linkage between disbursement and deduction.

Affirmed

Decided 08/09/23

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