328 Planning and Forecasting
an arrangement would be disastrous to Brad, since the IRS would currently as-
sess income tax to Brad on such an arrangement, using the much criticized “eco-
nomic benefit” doctrine. Under this theory, monies irrevocably set aside for
Brad grant him an economic benefit (presumably by improving his net worth or
other wise improving his creditworthiness) upon which he must pay tax.
If Brad were aware of this risk, he might choose another method to pro-
tect his eventual payout by requiring the corporation to secure its promise to
pay with such devices as a letter of credit or a mortgage or security interest in
its assets. All of these devices, however, have been successfully taxed by the
IRS under the same economic benefit doctrine. Very few devices have sur-
vived this attack. However, the personal guarantee of Morris himself (merely
another unsecured promise) would not be considered an economic benefit by
the IRS.
Another successful strategy is the so-called rabbi trust, a device first
used by a rabbi who feared his deferred compensation might be revoked by a
future hostile congregation. This device works similarly to the trust de-
scribed earlier except that Brad would not be the only beneficiary of the
money contributed. Under the terms of the trust, were the corporation to ex-
perience financial reverses, the trust property would be available to the cor-
poration’s creditors. Since the monies are thus not irrevocably committed to
Brad, the economic benefit doctrine is not invoked. This device does not pro-
tect Brad from the scenario of his bankruptcy nightmares, but it does protect
him from a corporate change of heart regarding his eventual payout. From
Morris’s point of view, he may not object to contributing to a rabbi trust,
since he was willing to pay all the money to Brad as salary, but he should be
aware that since Brad escapes current taxation the corporation will not re-
ceive a deduction for these expenses until the money is paid out of the trust
in the future.
Interest-Free Loans
As a further enticement to agree to work for the new ownership of the plant,
Morris might additionally offer to lend Brad a significant amount of money to
be used, for example, to purchase a new home or acquire an investment port-
folio. Significant up-front money is often part of an executive compensation
package. While this money could be paid as a bonus, Morris might well want
some future repayment (perhaps as a way to encourage Brad to stay in his new
position). Brad might wish to avoid the income tax bite on such a bonus so he
can retain the full amount of the payment for his preferred use. Morris and
Brad might well agree to an interest rate well below the market or even no in-
terest at all to further entice Brad to take his new position. Economically, this
would give Brad free use of the money for a period of time during which it
could earn him additional income with no offsetting expense. In a sense, he
would be receiving his salary in advance while not paying any income tax until
he earned it. Morris might well formalize the arrangement by reserving the