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  1. #1
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    Jul 2020
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    Question Loss of Non-Qualified Wages to Bankruptcy

    Hello everyone - had a portion of my wages deferred via a non-qualified plan for some years and am now facing the likelihood of not receiving a penny of these wages due to my company filing for bankruptcy. Question for the group is whether I can claim the amount that will now never come back to me on my Federal income taxes next year?

    If so, where / how does it get entered and am I limited to claiming a certain amount per year (i.e. $3K for capital gains losses)?

    If not, why as these are wages that I was paid for services rendered but I never realized the benefit of?

    Thanks in advance for everyone's help.

    TJ

  2. #2
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    Sep 2010
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    Default Re: Loss of Non-Qualified Wages to Bankruptcy

    If you never were taxed on the NDCP, there's nothing to recover. Were you taxed on any of it (any withholding, even FICA/Medicare)?

  3. #3
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    Default Re: Loss of Non-Qualified Wages to Bankruptcy

    Thanks for the quick response flyingron, but no; I was never taxed on the wages...that was to occur as deferred wages were distributed.

    But now I'm not going to realize even one red cent of all the monies that were put aside...so why would I not be able to claim this as a loss in some way? The point is that these were real wages that set aside for future distribution...every penny is a portion of my salary that will never recover due to the company's bankruptcy.

    How can this not be a loss to me yet I can buy a stock for $100 and sell it for $50 and book a loss? Just doesn't sound right...

    TJ

  4. #4
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    Oct 2006
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    Default Re: Loss of Non-Qualified Wages to Bankruptcy

    Quote Quoting TJ6
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    Thanks for the quick response flyingron, but no; I was never taxed on the wages...that was to occur as deferred wages were distributed.

    But now I'm not going to realize even one red cent of all the monies that were put aside...so why would I not be able to claim this as a loss in some way? The point is that these were real wages that set aside for future distribution...every penny is a portion of my salary that will never recover due to the company's bankruptcy.

    How can this not be a loss to me yet I can buy a stock for $100 and sell it for $50 and book a loss? Just doesn't sound right...

    TJ
    If you buy a stock for $100 you are using money to buy the stock that you paid tax on previously.

    If you have a 401K that buys and sells stocks you don't pay capital gains tax on the stock gains of the 401k nor get to deduct stock losses on the 401k because you never paid income tax on the money put into the 401k.

    However, depending on the type of deferred account there may be some protections in place.

  5. #5
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    Oct 2014
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    Default Re: Loss of Non-Qualified Wages to Bankruptcy

    Quote Quoting TJ6
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    How can this not be a loss to me yet I can buy a stock for $100 and sell it for $50 and book a loss? Just doesn't sound right...
    I think the others that replied weren't thinking of what is really happening with the asset in bankruptcy. Unfortunately, though, that doesn't help you here. The answer as to the tax treatment is worse than you realize. Not only don't you get a loss, you or the bankrupt estate will have taxable income.

    Losing an asset to a creditor in bankruptcy does not automatically result in a taxable loss. Let's use the stock as an example. You have stock worth $110 that you bought for $100. The trustee takes the stock, sells it for the $110 it is worth, and uses that to pay your creditor. Since the stock sold for more than it was worth, there is a $10 capital gain that either you or the bankrupt estate (depending on the type of bankruptcy) would include in income and pay tax upon. Note that it is the same tax result you would have gotten had you sold the stock for $110 outside of bankruptcy and then used that money to pay your creditors. The fact that you lost the stock to the trustee in the bankruptcy does not mean you have loss of the investment in the stock. You are still benefiting from the stock your debts are being paid with it.

    Your deferred comp account will be treated the same way. You are not losing the account value. Rather, the trustee taking the account and paying your debts with it is no different than had you liquidated the account yourself and then used the money to pay the creditors. You are getting the benefit of the money in that debts of yours are being paid with it. Since the wages were never taxed going into the deferred comp account they are taxable when distributed later. So if the trustee does take the account and liquidates it (takes a distribution of the account) to get money to pay your creditors, either you or the bankrupt estate will have taxable income in the amount of the distribution. That certainly is not a result that feels good to someone just going through bankruptcy but the rule makes sense since the application of the tax law in bankruptcy mirrors the same thing that would have happened had you done outside bankruptcy what the trustee does: liquidate the asset and use the money to pay creditors. This is why it can be a good idea for persons considering bankruptcy to consult a tax professional familiar with taxation in bankruptcy you don't want to be caught by surprise by the tax consequences.

    Taking the asset to use to pay your creditors is different from the situation in which the account drops in value. With a stock, you are using money already taxed or that was exempt from tax to buy that share for $100. If you sell the share later for $50 you then have a capital loss of $50. The same would be the case for this investment had you used taxed wages to invest in it. You include the $100 in income the year it is paid then buy into the plan. You liquidate the plan later and get only $50. You have a loss of $50. So you deduct the loss, which means that now effectively only $50 of those wages were taxed.

    But here you have wages that would have been taxed but for the fact that they went into a deferred comp plan. So if you put $100 of non taxed wages into such a plan, the distribution all of it is subject to tax later. Again, let's say you liquidate the entire account and only get $50 because the investment went down in value. You have $50 in income. That makes sense because now you have the situation where the $100 in wages were not taxed up front and now you have $50 that is taxed. That is exactly the same result you get if you had the $100 in wages taxed up front and then you deduct the $50 loss later. In the end, only $50 of the wages ended up being taxed.

    If you could deduct the $50 loss on the deferred comp plan then not only would the $100 of wages never get taxed, but you'd get a bonus of an additional deduction of $50. That would be like buying stock with $100 of already taxed income, selling the stock for $50 but getting a deduction of $100. You'd get a $100 tax benefit for only $50 of taxable income realized. Obviously that's not the right outcome.


    By the way, because of the way the deferred comp account will be treated if the trustee takes it to pay your creditors, I suggest you ensure that there is enough withholding taking from the distribution to cover the tax on the income realized so that at least you don't have to cough up a check for the tax on it when it comes time to file you return. That would mean less money to pay your creditors, but if you are getting a discharge in the bankruptcy that wouldn't be a big concern for you. Talk to your bankruptcy lawyer about that.

  6. #6
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    Default Re: Loss of Non-Qualified Wages to Bankruptcy

    TM, I think you misunderstood the question. TJ6 isn't filing for bankruptcy, it's the comapny who is deferring the compensation to him that's going into bankruptcy. It's not "his" creditors.

  7. #7
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    Default Re: Loss of Non-Qualified Wages to Bankruptcy

    Quote Quoting flyingron
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    TM, I think you misunderstood the question. TJ6 isn't filing for bankruptcy, it's the comapny who is deferring the compensation to him that's going into bankruptcy. It's not "his" creditors.
    I agree with flyingron TM, its the company (the OP's employer) in bankruptcy and the deferred account is apparently being held by the company in some way.

  8. #8
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    Default Re: Loss of Non-Qualified Wages to Bankruptcy

    Quote Quoting llworking
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    I agree with flyingron TM, its the company (the OP's employer) in bankruptcy and the deferred account is apparently being held by the company in some way.
    If it is the company filing bankruptcy (and upon reading it again I can see that's the likely thing happening) then as you both noted, TJ6 gets no deduction for it. Nothing included income, but no deduction. The second part of my previous post explains the reasoning for that. It's unfortunate that non qualified deferred comp plans can be lost if the employer goes belly up, unlike qualified retirement plans that are managed by a trustee and are not part of the employer assets and thus not affected by an employer's bankruptcy or other demise.

  9. #9
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    Jul 2020
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    Default Re: Loss of Non-Qualified Wages to Bankruptcy

    Hello All - thanks for the comments and direction on my scenario. I get the 401K example...if I made bad investment decisions and my value declined from $20K to $5K, I'd pay tax on the $5K when withdrawing the money and wouldn't/couldn't file a loss for the $15K I lost due to my investing mistakes.

    But in my mind, my non-qualified scenario is different as it's my (former) company's business negligence that forced them to file for bankruptcy (and now place my deferred salary at risk) vs something of my doing. Thankfully I was able to get 1 payment out of them before they filed (and of course I paid uncle sam his share at the time)...but due to status of the stock market at the timing of their bankruptcy filing, all the monies in the account they've been holding are my deferred salary. Hence this is what I thought I'd be able to do assuming $100K in deferred salary / account value:

    - Without bankruptcy the $100K would be disbursed to me as taxable income. Assuming a 25% tax rate, I'd net $75K after taxes.

    But if w/bankruptcy I GET NONE of my $100K back, then I would think I can book the $75K loss of after-tax wages that I earn for services rendered but never realized a red cent of.

    TJ

  10. #10
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    Sep 2010
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    Default Re: Loss of Non-Qualified Wages to Bankruptcy

    Taxes don't work that way. In order for you to claim it as a loss, you'd first have to have had it as income. Had this money been wages, you'd have a very high priority claim against them in the bankruptcy. As a non-qualified deferral, that was as far as the law is concerned just a "promise" of a future payment. You are thus an unsecured creditor.

    You don't get to "book" money you didn't make no matter how hard you worked not making it.

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