Obtaining Tax Refunds For Deferred Compensation Discharged In Bankruptcy

• Published date: 30 November 2020
• Subject Matter: Employment and HR, Insolvency/Bankruptcy/Re-structuring, Insolvency/Bankruptcy, Retirement, Superannuation & Pensions, Employee Benefits & Compensation
• Law Firm: Chamberlain, Hrdlicka, White, Williams & Aughtry
• Author: Mr Peter A. Lowy

Taxpayers should never be taxed on income they don't receive. But it happens. It occurred in a recent decision, Koopmann v. United States, No. 09-CV-333 T (Fed. Cl. Sept. 30, 2020), and there are lessons that may be learned from what went wrong for the litigant in that case.

In Koopmann, the taxpayer retired from United Airlines in 2000, and was covered by United Airlines' non-qualified deferred compensation plan. About two years after the taxpayer's retirement, United Airlines filed a Chapter 11 bankruptcy petition, which ultimately resulted in an approved reorganization plan in 2006. As part of the reorganization plan, United Airlines' obligation to pay the taxpayer's deferred compensation was discharged. The taxpayer had received a portion of his deferred compensation from 2001 through the 2006 date of discharge, however a substantial portion of the deferred compensation was never paid the taxpayer.

The tax rub in this scenario is that notwithstanding the deferred nature of the compensation, there is a special timing rule under which taxpayers still pay FICA on compensation they receive under a non-qualified deferred compensation plan. Under the 'special timing rule' FICA tax is assessed only once, at the later of either: (A) the date services are performed or (B) the date when there is no substantial risk of forfeiture of the rights to such amount. See 26 C.F.R. ' 31.3121(v)(2)-1.

For the taxpayer in Koopmann, he paid FICA taxes on $415,025.91 worth of non-qualified deferred compensation at the time of his retirement, but prior to the discharge had received only $248,293, spread out from 2001 - 2006. If there had been signs of a bankruptcy at the time of his retirement, the taxpayer might have taken the position that it was premature to pay FICA taxes due to an exigent or impending risk of forfeiture, but presumably the taxpayer had not reached that conclusion. In any event, by 2006 when the deferred compensation was discharged, the 3-year statute of limitations in Section 6511 had, on its face, long expired for claiming tax payments for returns filed in 2001. In an attempt to overcome this statute of limitations problem, the taxpayer advances several legal theories.

Koopmann's main argument hinged on the Fifth Amendment - specifically, that it would violate the Due Process Clause to bar a refund on statute of limitations grounds when the purported eligibility for that refund --- the discharge of United Airlines' obligation to make payments towards...