NBA Owner Misses Shot at Deferred Comp Deduction

Foul on the play! In a new case, Hoops, LP, TC Memo 2022-9, 2/23/22, the former owner of a professional basketball team tried to deduct nonqualified deferred compensation that was owed to two of their players. But the Tax Court determined that taking a current deduction was a violation of the rules.   

First, here’s some background information. A nonqualified deferred compensation plan is an arrangement that is usually set up to supplement a qualified retirement plan like a 401(k) plan. It is often an attractive recruiting tool for employers.

For starters, the plan is exempt from most reporting requirements and strict ERISA rules, so it can discriminate in favor of highly-compensated employees (HCEs). In addition, it is not subject to the required minimum distribution (RMD) rules for qualified plans. As a result, such plans can appeal to employees currently in the prime of their careers.

Also, if the employer is experiencing cash flow problems, payments are postponed until a time when it is more feasible. And the plan can reward HCEs for meeting specific performance standards—either individually or for the overall operation—while providing vesting over time or upon the occurrence of certain events stated in the agreement.

As long as the plan is unfunded—in other words, amounts aren’t set aside and specifically earmarked for this purpose—the employee doesn‘t owe tax until a future date—usually at retirement. But this also defers the employer’s deduction until the time the employee recognizes income.

Facts of the new case: In 2000, Hoops Inc., led by Michael Heisley, acquired the Vancouver Grizzlies, an NBA franchise. After the Grizzlies moved to Memphis in 2001, Hoops continued to own and operate the team until it sold it in 2012.

As part of the deal, the buyer agreed to purchase substantially all of the assets and to assume substantially all of the liabilities and obligations of Hoops. This included binding contracts for two players, Zach Randolph and Michael Conley. The contracts provided for nonqualified deferred comp arrangements totaling $11 million.

The former owner of the Grizzlies deducted the deferred compensation amounts in 2012, the year of the sale. However, the players didn’t owe any tax on the income yet under the terms of their agreements. When the IRS disallowed the deduction, the case proceeded to the Tax Court.

Game over: The Court sided with the IRS. Based on the tax code and applicable regulations, it said that the nonqualified deferred comp is deductible only in the year in which the employees include those amounts in income. This outcome applies even if the seller uses the accrual method of accounting.

Keep these tax principles in mind when working you’re working on a game plan for clients.