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Guest Article

Deloitte logo

(From the January 25, 2010 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

Accrual-Basis Taxpayer Cannot Take Bonuses into Account until Paid

A recent IRS Chief Counsel Memorandum outlined the requirements for taking a bonus liability into account under an accrual method of accounting and explained that, if the employee is required to be employed on the payment date, the liability cannot be taken into account until the year the bonus is actually paid. Office of Chief Counsel Internal Revenue Service Memorandum 200949040, Release Date December 4, 2009.

Liability Is Not "Fixed" If Future Performance Is Required

An IRS release that received a bit of attention in recent weeks is Memorandum 200949040, which reiterates well-established law regarding when, under an accrual method of accounting, a bonus accrual is fixed and can be taken into account for tax purposes. Under the facts, the employer established a bonus plan for non-executive employees by which it would award bonuses to the employees in Year 1 and would pay the bonuses within the first 2 months of the following year (i.e., Year 2). However, if the award recipient was not employed on the payment date in Year 2, the bonus would instead be paid to charity in Year 2. The IRS concluded that, because the employees were required to be employed in Year 2 to receive the bonuses, the bonuses were not a fixed liability in Year 1 and could not be taken into account that year. Rather, the liability became fixed when the bonuses were actually paid to the individuals who remained employed on the payment date in Year 2. Moreover, since no contributions were actually made by the employer to charity in Year 2 (because the bonus awards were all paid to the employees since they remained employed on the payment date), the employer had no entitlement to accrue a liability for a charitable deduction in Year 1.

The Memorandum is intriguing because of the employer's argument that it had a fixed and determinable liability at the end of Year 1 to pay the accrued liability one way or another either as a bonus or as a charitable contribution. Its reasoning was not persuasive, however, as the IRS observed that IRC § 170 which provides the deduction for charitable contributions, and IRC § 461 which provides the deduction for accrued bonuses, apply to different liabilities and apply different timing rules. Since the employer actually made no charitable contribution in Year 2, the only amount in question for the IRS was the accrued bonus under IRC § 461. The IRS explained that IRC § 461 permits an accrual basis taxpayer to take a liability into account in the taxable year in which:

  1. all events have occurred that establish 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. IRC § 461 (h) and Treas. Reg. § 1.461-1(a)(2)(i).

Generally, "all events" have occurred when the payment is unconditionally due, or the event that fixes the liability whether that event is required performance or something else has occurred. Applying this test, the IRS reasoned:

Where, as here, 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.

Further, the IRS pointed out that the "all events" test cannot be satisfied earlier than when the "economic performance" occurs. Because the employer's bonus plan required the employees to continue their service to the company until the date the bonuses were paid, the economic performance did not occur and the liability was not fixed until the date the bonuses were actually paid.

Deloitte logoThe information in this Washington Bulletin is general in nature only and not intended to provide advice or guidance for specific situations.

If you have any questions or need additional information about articles appearing in this or previous versions of Washington Bulletin, please contact: Robert Davis 202.879.3094, Elizabeth Drigotas 202.879.4985, Mary Jones 202.378.5067, Stephen LaGarde 202.879-5608, Bart Massey 202.220.2104, Mark Neilio 202.378.5046, Tom Pevarnik 202.879.5314, Sandra Rolitsky 202.220.2025, Deborah Walker 202.879.4955.

Copyright 2010, Deloitte.

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