Readers will know that I have blogged on the proper timing of employers' deduction of annual bonus payments several times over the last eight years. 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, 2012, for a deduction in 2011) and the employees are not taxed until Year 2. However, that grace period only applies if "all events" fixing the obligation have occurred by the end of Year 1. To the extent that an employee must remain employed until the actual payment date in Year 2, the all events test may not be satisfied and the deduction may not be available until the Year 2 tax year.
Today the IRS issued Revenue Ruling 2011-29, which adds some clarity to one of the issues that arise in the bonus deductibility area. Rev. Rul. 2011-29 holds 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.
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.
Under the facts of Rev. Rul. 2011-29, the employer pays bonuses to a group of employees under a written program that the employer communicates to its employees when they become eligible and whenever the program is changed. The employer pays bonuses after the end of the taxable year in which the employee performed the related services but before March 15 of the next taxable year. However, to be eligible for a bonus, an employee must be employed on the date that the employer pays bonuses.
The employer determines the minimum total amount of bonuses payable under the program to the employees as a group either (a) through a formula that is fixed prior to the end of the taxable year, taking into account financial data reflecting results as of the end of that taxable year, or (b) by resolution of the employer's board of directors or compensation committee, made before the end of the taxable year, which fixes the bonuses payable to the employees as a group.
Under the bonus program, 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 bonuses are paid for that year.
In Rev. Rul. 2011-29, the IRS held that, under these facts, the employer can establish the "fact of the liability" under Code Sec. 461, because:
- 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, the fact of the employer's liability for the minimum amount of bonuses is established by the end of the year in which the services are rendered and the bonus payments are deductible for that year, even though paid in the next year.