Are You Deducting Bonus Payments in the Proper Year?
Acme Company has an annual bonus program under which certain employees are entitled to a bonus based upon the financial results for Acme’s calendar fiscal year. However, the employees must remain employed through the date that the bonus is paid in order to receive the bonus. Bonuses are always paid by March 15 of the following year and, because few employees terminate their employment before the bonuses are paid, Acme has historically paid over 90% of the accrued bonus amount. We were recently asked whether Acme can deduct the bonus payments in the year in which they are generally earned (2009), rather than the year in which they are paid (2010).
Under the general deduction rules, the tax code allows an employer to deduct compensation accrued in one year if the amounts are paid within two and one-half months of the close of that year. Under an exception to that general rule, the deduction for payments to certain related parties can be taken only in the year paid. Under these general rules, one would think that Acme could deduct in 2009 the 2009 bonuses paid to employees other than Acme owners.
The IRS recently released an internal memorandum, however, that takes the position that the deduction would not be allowed until 2010 because employees must work into 2010 to be eligible for the bonus. According to the IRS, all events have not occurred by December 31, 2009, to allow the proper accrual of any of the bonuses in 2009, even if the employer could show that over 90% of the bonus amounts accrued at year end are actually paid the following year. If employees did not have to be employed on the bonus payment date, but only had to be employed through the end of the calendar year in which the bonus was earned, the deduction would be allowed for 2009. Based on this IRS position, Acme decided to change its bonus plan so as not to require employment on the bonus payment date.
Employers who require that bonus-eligible employees remain employed through a bonus payment date may wish to revisit the terms of their plan in light of this recent IRS pronouncement. Attorneys in Leonard, Street and Deinard’s Compensation and Employee Benefits practice group are available to assist clients reconsidering their bonus arrangements.