Farmington Hills, MI (PRWEB) May 08, 2014
Businesses will often pay bonuses to employees within the first 2 1/2 months of year-end allowing for a deduction in the year the bonus is earned. This practice used to reward and maintain key individuals has also become an important component of year-end tax planning. In most instances, it is advantageous for the company to take the deduction for the bonuses in the year earned as opposed to the year paid. Additional guidance has been released covering three scenarios where taxpayers are not able to deduct bonuses until the year in which they are paid.
In order to deduct an accrued liability paid within 2 1/2 months of year-end, the Internal Revenue Service (IRS) has followed an “all events test” in which the event fixing the liability has occurred or the payment is due, whichever is earliest. In recently released IRS field attorney advice, the proper tax treatment is discussed.
The first scenario involves a taxpayer whose bonus plan allows the company to modify or eliminate the bonuses at any time prior to payment. Since the company retains the right to eliminate or modify the bonuses at any time prior to payment, there is no legal obligation to pay the bonuses. In this scenario, the bonus is deductible in the tax year in which it is actually paid.
In the second scenario, the amounts paid by the taxpayer must be approved by the board of directors before being paid. Similar to scenario one, no legal obligation exists since the board of directors has the ability to reject or modify the bonus payments.
The final scenario in the release covers plans where employee bonuses are computed based on an employee performance appraisal conducted after year-end. These bonuses are also not deductible until the year paid since the amount is unknown until the appraisal is conducted.
Employers should design their bonus or incentive plans to ensure the all events test is met allowing for the accelerated deduction. Here are some tips to make sure your plan qualifies:
- Make the plan based on financial data since the obligation will be determinable at year-end
- Make the individual participant rights to a bonus vest at year-end. Requirements that the employee retain employment when the bonus is eventually paid with not meet the all events test
- Set up fixed dollar bonus pools in which a specific amount will be allocated amongst employees who satisfy the plan’s terms
Taxpayers are encouraged to review their current incentive compensation plans to ensure they meet the all events test. For assistance, please contact your professional at UHY LLP in Farmington Hills 248 355 1040 or Sterling Heights 586 254 1040 or visit us on the web at http://www.uhy-us.com.
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