Can bonuses that were accrued and expensed before 12/31 (but not yet paid) be deducted on my tax return?
In typical tax fashion, the answer to the question is, it depends. Entities that use the cash basis of accounting, cannot deduct expenses until they are paid. Following this general rule, a company cannot deduct a bonus on the 2018 tax return if it has not been paid before 12/31/2018, even if it relates to work completed in 2018. The company would have to wait to deduct this expense on the 2019 tax return.
However, accrual basis taxpayers may be in luck. Generally, entities that are on the accrual method may deduct expenses in the year they were accrued and not paid when the all events test is met. Under this test the following conditions need be met:
- All events must have occurred to establish the fact of the liability by year end;
- The amount of the liability must be determinable with reasonable accuracy by year-end;
- Economic performance must occur by year-end; and
- Payment must be made within 2.5 months of year-end.
In addition to meeting the criteria of the all events test, for bonus plans that meet additional guidelines, deductions may be taken even if not yet paid prior to year-end:
- Bonuses are awarded for services performed in the year accrued,
- The criteria for determining the bonus pool is established before year end,
- The amount of the bonus pool is determined before year end,
- The employee being paid the bonus is still employed on the date the bonus is paid, or the amount forfeited by an ex-employee is reallocated to the bonus pool
In recent years, the IRS has focused in on the deductibility of bonuses under the all events test and whether the amount is fixed and determinable. Using the option to reallocate the bonus pool to remaining employees or fixing at least a certain amount of the bonus, will make the accrual eligible for earlier deduction. Most companies should be able to estimate bonus payments and fix a set amount of bonuses.
However, one limitation to keep in mind is that the bonuses paid to owners cannot be deducted until the year they are claimed on the owner’s personal tax return. Who is an owner depends on the entity choice. For C-Corporations “owners” are shareholders that own more than 50% of the company. The threshold for S-Corporation owners is a lot lower, because the IRS considers shareholders that own 2% of the corporation an “owner” in that setting. Partnerships and LLCs are mostly ineligible to accelerate bonuses since all partners or members are considered owners.