Rabbi trusts often hold employer stock to fund the benefits payable under nonqualified deferred compensation plans. It is common for such rabbi trusts to fund plans that cover employees of subsidiaries of the corporate parent that issued the stock.

Questions have arisen in recent years as to whether a subsidiary company could be subject to tax when parent company stock is distributed from a rabbi trust to the subsidiary’s employees. Section 1032 of the Internal Revenue Code generally permits a subsidiary to avoid any tax when it distributes to its employees shares that the subsidiary has acquired from its parent corporation. However, this special tax treatment is not available unless the subsidiary company transfers the parent company stock to its employees immediately after it acquires the stock from the parent company. This condition for favorable treatment under Section 1032 is referred to as the "immediacy requirement."

A subsidiary company’s use of a rabbi trust to hold parent company stock for future distribution to the subsidiary’s employees creates special problems under the immediacy requirement of Section 1032. The IRS takes the position that a rabbi trust must be subject to the claims of the subsidiary’s creditors in order for the trust to qualify as a rabbi trust. If the trust’s assets are subject to claims by the subsidiary’s creditors, then the subsidiary is treated as the grantor of the trust and the owner of trust’s assets. If a subsidiary owns parent stock for any length of time before distributing it to the subsidiary’s employees, the immediacy requirement of Section 1032 cannot be met.

The IRS has addressed this concern in Notice 2000-56. The notice provides that the immediacy requirements of Section 1032 will be met where a parent contributes its stock to a rabbi trust for subsidiary company nonqualified plans if:

• the parent company stock in the trust is subject to claims of both the creditors of the parent company and creditors of the subsidiary company; and
• any parent company stock that remains in the trust at the time the trust is terminated is required to revert to the parent company upon termination of the trust.

Under these conditions, the IRS will consider the parent company to be the owner of the trust’s assets. This has the important effect of delaying the time when the parent company is deemed to transfer its stock to the subsidiary company. The transfer is not considered to be made until distributions are made from the trust to employees of the subsidiary, or when creditors of the subsidiary make claims against the trust’s assets in the event of the subsidiary’s insolvency. The delay in the time at which parent company shares are deemed to be transferred to the subsidiary permits the immediacy requirement to be met.

In addition to making this clarification, the notice provides special transition relief. First, the IRS will not raise the Section 1032 gain issue for distributions that occur on or before May 16, 2001 so long as the distributions are made from rabbi trusts that were in existence on or before June 15, 2000. Second, companies have until May 16, 2001 to amend their trusts to reflect the requirements described above. Any amendments made by that date will not be treated as a constructive dividend to the parent company. Finally, employers that wish to adopt the model rabbi trust that the IRS published in Revenue Procedure 92-64 may modify the model trust language to conform to the guidance in the new notice without adversely affecting the status of the trust or the ability to obtain a ruling request from the IRS on a nonqualified deferred compensation plan funded with a rabbi trust based on the model trust document.