Companies that give employees the opportunity to earn year-end bonuses may not actually pay them until after year-end. Question: Can the bonuses be deducted in the year of accrual – before they are paid to employees?
Answer: Maybe, if the company uses the accrual method of accounting for tax purposes and certain tax law requirements are met. For one, the bonuses must be paid within the 2 ½ -month period following the close of the tax year.
The key is that the employer’s liability for the aggregate amount of bonuses is set by the end of the tax year in which the services are performed. The amount payable to each individual employee does not need to be determined at year-end. For example, if the employer decided to pay $50,000 in year-end bonuses, but he hasn’t decided how to allocate that amount between Employees A, Employee B, and Employee C at year-end. The liability exists as long as the total bonus pool has been determined.
The IRS indicates that any change in an employer’s treatment of bonuses to conform with this new guidance is a change in method of accounting and must be handled in accordance with applicable procedures; however, the ruling provides employers with an opportunity to modify their bonus plans without removing the employment requirement to obtain a current deduction for accrued bonuses paid within 2½ months of the tax year-end.
ShareSource: Journal of Accountancy