Reviewing Bonus Plans to Ensure Appropriate Yearly Deductions Should be a Best Practice for Employers

Most taxpayers accrue bonuses at the end of the year and take a tax deduction as long as these bonuses are paid by March 15th of the following year.  The IRS has been challenging this belief that employers can deduct a bonus in the year accrued rather than the year paid.

The IRS issued a memorandum which lays out their reasoning.  Under the accrual method of accounting, a liability is incurred and taken into account for income tax purposes in the tax year which:

  1. All events have occurred that establish the fact of the liability
  2. The amount of the liability can be established with reasonable accuracy
  3. Economic performance has occurred for the liability

If an employer waits until 2015 to verify that the 2014 performance goals were achieved or if the employee evaluations or board certification does not occur until 2015, then “all events” with respect to the bonus are not completed until the year of payment.  In addition if the employer retains the right to amend or eliminate the amount of the bonus, no legal binding right to the bonus has been created until paid.

Many employers have bonus plans that follow these examples.  It may be a good time for employers to review their bonus plans and make changes to ensure they deduct these payments in the appropriate year.