Sixth Circuit Holds that Forfeited Deferred Compensation Account is Not Taxable to Defendant (3/27/25)

In Hubbard v. Commissioner, ___ F.4th ___ (6th Cir. 3/19/25), CA6 here and GS here, the Court held that the Government’s judicial forfeiture in a criminal case of a deferred compensation account—here a “simplified employee pension”—followed by distribution to the Government from the account did not give rise to taxable income to the defendant. The law is settled that the distribution from such an account to the employee or to another (including the IRS) to meet an obligation of the employee generates taxable income to the employee. The Court avoided that rule because the form of the forfeiture was that the account was forfeited to the Government rather than the proceeds of the account.

JAT Comments:

1. I think the Court focuses on formalities rather than substance. I suspect that the IRS applied the distribution proceeds in payment of the employee’s tax liability, thus giving the employee the benefit of the distribution, despite the fact that the distribution was formally to the Government rather than the employee. I assume that the IRS assessed the tax liability on the distribution as a restitution-based assessment and applied the payment to Hubbard’s account accordingly.

2. It may be in a defendant’s best interest to have a deferred compensation account treated as the income of the employee. That is because the distribution, if taxed to the defendant, will still result in an amount exceeding the tax liability on the amount(s) distributed that can then be applied to tax liability on other income. (I am not sure that, if the excess amount could have otherwise generated a refund (a phenomenon where restitution exceeds the defendant’s tax liability), the IRS could refund since it is part of the restitution.)

3. In any event, on the possibility that Hubbard may be correct (at least it is in the Sixth Circuit now until overturned), practitioners with defendant clients having deferred compensation accounts should consider Hubbard in their tax planning with respect to restitution.

4. According to the opinion, Hubbard represented himself pro se on appeal. Pro se taxpayers often are not able to mount persuasive arguments, but Hubbard apparently did in this case, at least well enough to encourage the Court to not accept the Government’s argument as presented.