Rev. Rul. 82-95

ISSUE

If a corporation funds its potential liabilities under a state workmen's compensation act by regular contributions to a trust dedicated to discharging such liabilities, may the corporation deduct under section 162 of the Internal Revenue Code its contributions at the time they are made?

FACTS

Under the workmen's compensation act of state ST, employers in ST must provide compensation for the benefit of their employees in the event of injury, sickness, or death occurring in the course of their employment. X, a corporation that conducts business in ST, contributes to a trust that it formed to provide such compensation for its own employees. The trust, however, was not created pursuant to a collective bargaining agreement and the trust does not qualify for exemption under section 501(c)(9) of the Code.

Although the contributions have been determined actuarially to be sufficient to cover all claims and expenses, the contributions do not discharge X's legal obligation to pay workmen's compensation benefits. No part of the corpus or income of the trust will vest in X or be used for any purpose other than paying claims. Neither X nor its officers have any power of administration of the trust.

LAW AND ANALYSIS

Section 677(a) of the Code provides that a grantor is treated as the owner of any portion of a trust whose income (1) is distributed to the grantor without the approval or consent of any adverse party, or (2) in the discretion of the grantor or a nonadverse party or both, may be distributed to the grantor without the approval or consent of any adverse party.

Section 1.677(a)-1(d) of the Income Tax Regulations provides, in general, that a grantor is treated as the owner of a portion of a trust whose income (1) is applied in discharge of a legal obligation of the grantor, or (2) in the discretion of the grantor or a nonadverse party or both, may be applied in discharge of a legal obligation of the grantor.

Section 671 of the Code provides that when the grantor is treated as the owner of any portion of a trust, the grantor's taxable income and credits include those items of the trust's income, deductions, and credits attributable to the portion of the trust that the grantor is treated as owning.

Section 1.671-2(c) of the regulations provides that an item of income, deduction, or credit included in computing a grantor's taxable income and credits is treated as if the grantor (whether or not an individual) had received or paid it directly.

Section 1.671-3(a)(1) of the regulations provides that if the grantor is treated as the owner of an entire trust, the grantor takes into account in computing income tax liability all items of income, deduction, and credit to which the grantor would have been entitled if the trust had not been in existence during the period the grantor is treated as the owner.

Section 1.671-2(e) of the regulations provides that the term "grantor" includes a corporation.

Section 162 of the Code allows as a deduction all the ordinary and necessary expenses paid or incurred during the tax year in carrying on any trade or business.

Section 1.162-10(a) of the regulations provides that (1) amounts paid or accrued by a taxpayer because of injuries received by employees, and (2) lump-sum amounts paid or accrued as compensation for injuries are proper deductions as ordinary and necessary expenses. In addition, amounts paid or accrued within the tax year for a sickness, accident, hospitalization, medical expense, or similar benefit plan are deductible under section 162(a) of the Code if they are ordinary and necessary expenses of the trade or business.

In Rev. Rul. 71-209, 1971-1 C.B. 53, an employer made contributions under a private plan established under title 43, Chapter 21 of the Revised Statutes of New Jersey, to provide for payment of nonoccupational disability benefits to employees. The revenue ruling concludes that these contributions are deductible as ordinary and necessary business expenses under section 162(a) of the Code.

Rev. Rul. 72-191, 1972-1 C.B. 45, concludes that employer contributions to a fund maintained by the state under the New York Workmen's Compensation Law to pay occupational and nonoccupational disability benefits are ordinary and necessary business expenses deductible by the employer under section 162 of the Code.

In the present case, because the trust's income and corpus are used to discharge X's legal obligations to its employees, X is considered the owner of the entire trust under section 677(a) of the Code. Under section 671, X must include the trust's items of income, deduction, and credit in computing its taxable income. Under section 1.671-3(a)(1) of the regulations, X may deduct the compensation benefits when they are paid or accrued by the trust, subject to the rules of section 461. X may not deduct payments into the trust. See Rev. Rul. 57-390, 1957-2 C.B. 326, which concludes that the method of accounting used by a grantor trust is disregarded and gross income from the trust properties must be determined by the grantor as if the trust had not been created.

Rev. Rul. 71-209 and Rev. Rul. 72-191 both conclude that an employer's payments to provide for the payment of disability benefits to employees are deductible under section 162 of the Code. In Rev. Rul. 72-191 the payments did not represent contributions to a trust; under the facts in Rev. Rul. 71-209, it is possible the payments could have represented contributions to a trust although this is not specifically stated. Thus, Rev. Rul. 72-191 and Rev. Rul. 71-209, to the extent the payments were made to a state-administered fund under the New York statute or similar state law, to insurance carriers, or directly to the employees, section 671 has no application. If, on the other hand, the payments in either revenue ruling had been made to a trust then they would be deductible only in accordance with the principles in this revenue ruling.

HOLDING

The contributions by X to the trust are not deductible under section 162 of the Code. Instead, X is allowed a deduction under section 1.162-10(a) of the regulations when the liabilities under the workmen's compensation act of ST are paid or accrued pursuant to the method of accounting used by X.

EFFECT ON OTHER REVENUE RULINGS

Rev. Rul. 72-191 is distinguished.

Rev. Rul. 71-209 is distinguished and clarified to conform with the conclusion reached in this revenue ruling.