Question

Propose an alternative to the taxation of deferred compensation that would be fair to all taxpayers and support the financial needs of the federal government. Indicate substantive ways in which your recommendation would achieve fairness to taxpayers and the United States Treasury.

Answer 1

Having a life insurance policy may be the better alternative to the taxation of deferred compensation that would be fair to all taxpayers and support the financial needs of the federal government

Life insurance can have some of the same general benefits as qualified plans

One of the general principles of income taxation is that an employer can take a deduction for wages paid only when the employee is required to report the wages as income. Usually, this is when the wages are paid. Deferred compensation, which generally includes retirement and pension payments, is compensation received in a later year than when earned and currently is not deductible by the employer. However, qualified deferred compensation provides two important benefits:

1. The employer may deduct the compensation when it is, in fact, set aside for the employee, but the employee does not report the compensation as income until he or she actually receives it. This is one of the few areas where the Internal Revenue Code (IRC) sanctions a mismatch of deduction and inclusion.

2. The compensation that is set aside for the employee can earn and accumulate income tax-free until the employee receives it.