A recently issued revenue ruling (Rev. Rul. 2011-29) provides accrual-method employers with a potential planning opportunity to secure a current deduction for accrued bonuses paid within 2½ months of their tax year-end. This opportunity can apply even though the bonus plan includes a contingency, that is, a requirement that the employee actually be employed on the date the bonuses are paid.
The ruling appears to be in response to the IRS’ position outlined in Chief Counsel Advice (CCA) 200949040, which concluded that an accrual-method corporation’s liability arising from bonus compensation paid to employees pursuant to an incentive compensation plan is taken into account in the year that bonuses are paid. In the CCA, the taxpayer paid bonuses to its employees under a bonus plan that requires employees to still be employed by the taxpayer on the date that bonuses are paid in order to receive the compensation. Under the terms of the bonus plan, any amounts not paid to employees because they have left the company revert back to the taxpayer.
The IRS advised in the CCA that, because the taxpayer did not know at the end of the year in which the employees performed the related service whether it owed bonus compensation to any employee, the liability to pay the bonus was not a fixed liability in that year but became fixed only when the contingency was satisfied—that is, when the employee was still employed on the date of payment and received the bonus.
The requirement that an employee actually be employed on the date a bonus is paid is not a provision that many employers want to remove from their bonus plans. Rev. Rul. 2011-29 provides a planning opportunity to secure a current deduction for accrued bonuses paid within 2½ months of year-end, provided the aggregate amount of the bonus payable is fixed across a group of employees, even though the amount per employee is not determined until the date of payment. In the facts discussed in the revenue ruling, the minimum aggregate amount of bonuses payable under a plan to the employees as a group is calculated either through a formula that is fixed at the end of the tax year, or through a corporate action (for example, a board resolution) made before the end of the tax year. The employee must perform services during the tax year and be employed on the date of payment to be eligible to receive a bonus. Bonuses are paid within 2½ months of the end of the tax year in which the services are performed to avoid their being treated as deferred compensation. The bonus plan also provides that any bonus amount allocable to an employee who is no longer employed on the date of payment is reallocated to the other covered employees—it does not revert to the employer.
Under the Sec. 461 all-events test, a liability is taken into account in the tax year in which (1) all events have occurred to establish the fact of the liability, (2) the amount of the liability can be determined with reasonable accuracy and (3) economic performance has occurred for the liability. The IRS states that the ruling addresses the “fact of the liability” portion of the all-events test.
The ruling provides that an accrual-method employer can deduct accrued bonuses paid within 2½ months of year-end provided the following requirements are satisfied:
- The employer’s liability to pay a minimum amount of bonuses to the eligible employees is fixed at the end of the tax year in which the services are rendered;
- The employer is obligated under the bonus plan to pay a minimum bonus amount (in aggregate to all employees covered by the bonus plan) as calculated by the end of the tax year; and
- A bonus allocable to an employee who is no longer employed on the date on which bonuses are paid is reallocated to other eligible employees.
The key is that the employer’s liability for the minimum amount of bonuses is set by the end of the tax year in which the services are performed. It does not matter that the amount of bonus payable to each employee cannot be ascertained prior to the end of the tax year—the “fact of liability” component of the all-events test is satisfied provided the employer is obligated to pay a minimum amount of bonuses in aggregate.
The IRS indicates that any change in an employer’s treatment of bonuses to conform with this new guidance is a change in method of accounting and must be handled in accordance with applicable procedures; however, the ruling provides employers with an opportunity to modify their bonus plans without removing the employment requirement to obtain a current deduction for accrued bonuses paid within 2½ months of the tax year-end.
By Michael R. Milazzo, CPA, MBA, ( firstname.lastname@example.org ) a tax partner with Skoda Minotti & Co. in Fairlawn, Ohio.
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