December 2009
The Office of Chief
Counsel of the IRS recently issued a memorandum that
established the timing of a tax deduction for certain
bonuses earned by employees of an accrual basis corporate
employer. In general, the IRS effectively denied the
deduction of an accrual basis taxpayer’s bonus obligations
until the bonuses were actually paid to the employees. The
following outlines how the IRS reached its conclusion.
All events test
For tax purposes, under
the accrual method of accounting, a liability is incurred and
is generally taken into account for federal income tax
purposes in the taxable year in which
·
all the events
have occurred that establish the fact of the liability,
·
the amount of the
liability can be determined with reasonable accuracy, and
·
economic
performance has occurred with respect to the liability.
To satisfy the “all
events test” for determining when an item is incurred for
federal income tax purposes, the liability must be final and
definite in amount, must be fixed and absolute, and must be
unconditional.
Taxpayer’s bonus plan
In this case, the
taxpayer pays bonuses to its employees under a plan that
requires employees to be employed by the taxpayer on the
date that bonuses are paid in order to receive that
compensation. Under the terms of the plan, any amounts not
paid to employees by virtue of their leaving the company
revert back to the taxpayer.
Conclusion of the IRS
The memorandum issued by
the Office of the Chief Counsel indicates that a liability
for bonus compensation paid under such a plan is not a fixed
liability in the year of the related service. Liabilities
meet the all events test only to the extent that they are
firmly established and not contingent. If employees cannot
receive bonuses unless they are employed on the date of
payment, the liability for that bonus compensation is
subject to a contingency. Therefore, the liability does not
become fixed until the contingency is satisfied—that is,
when the employee is still employed on the date of payment
and receives the bonus compensation.
If you have any questions
please contact James E. Traester, LLC, CPA, at 203.932.2931.
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