Academic journal article Journal of Accountancy

Deductions for Bonus Plans: Attempting to Ensure an Accelerated Deduction

Academic journal article Journal of Accountancy

Deductions for Bonus Plans: Attempting to Ensure an Accelerated Deduction

Article excerpt

Many annual bonus and long-term incentive plans provide for payments to participants within 2 1/2 months of the end of the employer's tax year, so the employer can deduct the payments in the prior tax year (for example, for a calendar-year employer, payment by March 15, 2004, for a 2003 deduction). But the plan also must meet other requirements. CPAs should become familiar with these rules in order to advise eligible clients.

OVERVIEW

Under IRC section 461 and the regulations, an accrual-basis taxpayer generally can deduct expenses that meet the all-events test: (1) All events have occurred that determine the fact of the liability, and (2) the amount of such liability can be determined with reasonable accuracy. In addition, the test is met for any item only if "economic performance" (such as the employee performance that triggered the bonus payout) has occurred.

BONUS ARRANGEMENTS

Many employers sponsor annual bonus or incentive plans, under which eligibility or payout is based on certain annual measures (for example, sales, productivity and personal performance ratings). Both the plan's terms and the payment's timing are critical in determining payment deductibility.

For plans that pay awards within 2 1/2 months of the employer's yearend, the plan terms determine whether the employer can deduct the awards for the year just ended or in the payment year. To satisfy economic performance and the all-events test, the award amounts and the obligation to pay must be fixed by yearend.

A plan based entirely on financial data (for example, return on assets or sales growth) should meet the requirement that bonus amounts be fixed as of yearend, because the information needed for calculating the bonus is available at yearend (even if the numbers still need to be audited). …

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