Protecting the Deduction of Year-End Bonus Accruals
Nov. 14, 2013
The IRS has increasingly challenged the deduction of accrued bonuses over the past few years. Recent guidance from the IRS highlights some of the steps that must be taken to perfect a deduction for these accruals.
Generally, a year-end bonus accrual is deductible when accrued if all events have occurred that fix the amount of the liability, the liability can be determined with reasonable accuracy, the employees have earned the bonuses, and the bonuses are paid to employees within two and a half months of year-end.
A recently released IRS field attorney advice (FAA) focused on three common issues taxpayers face when determining if a year-end bonus accrual is deductible.
- Bonus accruals when taxpayer had the ability to modify or eliminate the bonuses prior to payment after year-end. Not surprisingly, the IRS found that a board’s ability to modify or eliminate bonuses after year-end meant that the amount of the liability was not fixed at the end of the year and the deduction was deferred until payment.
- Bonus accruals requiring approval of a committee of the board of directors after year-end. The IRS found these amounts were not fixed at the close of the year and the deduction was deferred until payment.
- Bonus accruals that are contingent upon subjective employee evaluations conducted after year-end. The IRS found that the fact that a bonus accrual is dependent upon actions that do not take place before year-end results in an accrual that is not deductible until paid.
The first two items addressed in the FAA reiterate the long-standing policy of the IRS that if a company’s board of directors approves bonuses after year-end, or the company can modify the amount of bonus payments after year-end, no deduction will be allowed until the bonuses are paid in the subsequent year. Viewed independently, the use of post-year-end performance evaluations to determine employee bonuses is problematic. Other design elements in the company’s bonus plan, such as a floor bonus pool approved by the board of directors before year-end, may allow year-end bonus accrual deductions even if employee performance evaluations related to bonus payments are not performed until after year-end.
As the end of 2013 approaches, taxpayers should review their bonus policies to confirm whether any accrued bonus amount will be able to be deducted for 2013.
For More Information