any 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.
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).
The requirement that participants’ rights to bonuses be vested (that is, the obligation to pay the bonuses be fixed) as of yearend can be met in one of two ways. An individual participant’s right to a bonus may be vested at yearend. Even if the person quits the following year (but before the bonus is paid), he or she still would be entitled to it.
Conversely, an employer can set up a fixed-dollar bonus pool and provide for it to be allocated among and paid to employees who satisfy the plan’s terms as of the payment date. If the employer has to pay out the bonus pool—even if only one employee ultimately meets the requirements—the all-events test should be satisfied.
For more information, see the Tax Clinic, edited by Annette Smith, in the July 2003 issue of The Tax Adviser.
—Lesli Laffie, editor