Tax Treatment for Year-End Bonuses

11/10/2011

By Andrew Marshall, CPA

With the end of the year rapidly approaching many companies are beginning to plan for their year-end bonuses. As with any business decision, employers should consider the tax effects of these expenses. Since many businesses base their year-end bonuses on the current year’s results, it is often difficult to make these payments during the current tax year. However, there are certain circumstances where the IRS will allow payments made after year-end to be included on the current year’s tax return as a deduction.

Typically an accrual-basis tax payer can deduct a bonus paid after year-end if they meet three requirements:

• All events must have occurred that determine the fact of the liability
• The amount of the liability must be able to be determined with reasonable accuracy
• “Economic performance” must have occurred (e.g. the employees performance that earned them the bonus)

These items are generally referred to as the “all-events test.” Additionally, the bonus must be paid within 2 1/2 months of the end of the tax year (March 15th for tax payers on a calendar year basis).

There are a few items to consider in order to ensure the requirements above are met. If the employer has a requirement that the employee be employed on the date of the payment, then economic performance has not occurred until that date. Also, if the bonus structure states that board or management approval is necessary, then it is best to have this documented prior to year-end. Additionally, if the employee receiving the bonus is more than a 50% shareholder in the company, the bonus must be deducted in the same year that the employee reports the bonus as income.

As with any other tax issue, feel free to contact us with any questions you may have.