In addition to my usual December reminder about the requirement to achieve the accelerated deductibility of annual bonuses (nothing says Happy Holidays! like a blog on deductibility), this year I want to highlight that the IRS Office of the Chief Counsel recently issued Field Attorney Advice Memorandum 20134301F in an attempt to clarify further employers’ ability to deduct annual bonuses paid to employees in the year of the employees’ service rather than the year bonuses are actually paid.
As most readers know, Code Sec. 461 generally allows an employer to deduct in its Year 1 tax year, bonuses that it pays to employees within the first 2 ½ months of Year 2 (for example, for a calendar-year employer, payment by March 15, 2014, for a deduction in 2013) and the employees are not taxed until Year 2. Treas. Reg. Sec. 1.461-1(a)(2)(i) provides that, 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 (1) all the events have occurred that establish the fact of the liability, (2) the amount of the liability can be determined with reasonable accuracy, and (3) economic performance has occurred with respect to the liability.
Thus, this 2 ½ month grace period into the next fiscal year only applies if “all events” fixing the obligation have occurred by the end of Year 1. To the extent that a company’s bonus plan requires an employee to remain employed until the actual payment date in Year 2, the plan may not satisfy the all events test and the deduction may not be available until the Year 2 tax year.
Under the facts of FAA 20134301F, the taxpayer/employer maintained a variety of annual bonus plans. Each plan provided that covered employees must be employed as of the last day of Year 1 to receive the bonus in Year 2. The IRS Chief Counsel addressed three other issues:
- Do amounts paid under the terms of the taxpayer’s cash bonus plans, which plans provide that the taxpayer retains the unilateral right to modify or eliminate the bonuses at any time prior to payment, meet the all events test any earlier that the date the amounts are paid.
- Do amounts paid under the terms of the taxpayer’s plans, which amounts must be approved by a committee of the taxpayer’s board of directors before being paid, meet the all events test any earlier that the date the amounts are approved.
- Do amounts paid under the terms of certain of the taxpayer’s plans, the computation of which are dependent, in part, on subjective employee performance appraisals, meet the all events test any earlier that the date the employee performance appraisals are completed.
The IRS Chief Counsel concluded that neither the fact of liability prong nor the amount of liability prong was met with respect to bonuses so long as (i) the taxpayer retains the unilateral right to modify or eliminate the bonuses at any time prior to payment, (ii) the bonuses are subject to board or committee approval, or (iii) subjective calculation need to be made to calculate the amount of the bonuses.
These conclusions are generally consistent with previous IRS interpretations of the all events test. In late 2011, the IRS issued Revenue Ruling 2011-29, which held that: an employer can satisfy the “fact of the liability” test and achieve early deductibility under Code Sec. 461 for bonuses payable to a group of employees even though the employer does not know the identity of any particular bonus recipient and the amount payable to that recipient until after the end of the taxable year. Put another way, Revenue Ruling 2011-29 indicated that an employer would meet the “all events test” for purposes of determining when a bonus pool amount is deductible if the company were obligated at the end of the current year to pay the full bonus pool amount without any contingencies.
Under the bonus program of Rev. Rul. 2011-29, any bonus amount allocable to an employee who is not employed on the date on which the employer pays bonuses is reallocated among other eligible employees. Thus, the aggregate minimum amount of bonuses the employer pays to its group of eligible employees is not reduced by the departure of an employee after the end of the taxable year but before the employer pays bonuses for that year.
- The employer’s liability to pay a minimum amount of bonuses to the group of eligible employees is fixed at the end of the year in which the services are rendered;
- The employer is obligated under the program to pay to the group the minimum amount of bonuses determined by the end of the taxable year; and
- Any bonus allocable to an employee who is not employed on the date on which bonuses are paid is reallocated to other eligible employees.
Thus, this bonus program established the employer’s liability for the minimum amount of bonuses by the end of the year in which the employees render services and, thus, the bonus payments are deductible for that year, even though paid in the next year.
In late 2012, the IRS Chief Counsel Office opined that, if it is possible for any portion of the bonus pool to be forfeited after the current tax year, the entire bonus pool could only be deducted in the year it is paid. In CCA 201246029, the IRS concluded that taxpayer/employer’s liability arising from bonus compensation is taken into account in the year the bonuses are paid because taxpayer’s employees must still be employed to receive their bonuses and because forfeited amounts revert back to taxpayer.