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When Are You Paying Your Bonuses?

12 Jun 2012

Companies often deduct their annual bonus expense the year prior to paying the bonus, on the basis that the bonus is being deducted in the year that it is earned, rather than the subsequent year in which it is paid. But the IRS has changed its position on whether or not this should be the case. Taxand US investigates this issue further.

In general, companies are entitled to deduct compensation paid to employees in the year in which compensation is required to be recognised as income on the employees' tax return. However, there is an exception to this rule for accrual-method taxpayers: Accrual-method taxpayers can deduct the annual bonus amount in the year earned, if the bonus is (i) paid within two and a half months after year-end and (ii) the all-events test is satisfied. The all-events test is the requirement that all the events fixing an accrual-method taxpayer's right to receive income or incur expense must occur before the taxpayer can report an item of income or expense.

In November 2011, the IRS introduced Revenue Ruling 2011-29 to clarify the facts surrounding this issue. Whilst this Revenue Ruling provides clarifcation for the all-events test, it does not expand on the notion that the amount liability (ie, the amount that will be paid as bonus in the following year) can be determined with reasonable accuracy, and that economic performance has occurred for this liability.

Taxand US explores bonus payments

Taxand's Take

By accelerating your company's bonus payout into 2012, it is easy to eliminate any doubt over the timing of your company's bonus deduction. This is particularly advantageous this year as current tax rates are set to expire at the end of 2012 with 2013 rates set to be considerably higher.

If your company still wishes to pay bonuses the year after they are earned, it is important to remember to check your company's 2011 bonus plan to ensure that the annual bonus is deducted in the correct tax year (prior to finalising your 2011 tax return). You can also use this opportunity to evaluate your company's 2012 bonus plan, and ensure that the 2012 annual bonus satisfies the requirements to be deducted on the 2012 tax return.

Your Taxand contacts for further queries are:
Brian Cumberland
T. +1 214 438 1013

J.D. Ivy
T.+1 214 438 1028

Taxand's Take Author