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How To Deduct Bonuses in 2015 But Pay Them in 2016

December 29, 2015

It may surprise you, but, in certain circumstances, tax law allows accrual-basis taxpayers to deduct bonuses in 2015 that are not paid until early 2016.

It may surprise you, but, in certain circumstances, tax law allows accrual-basis taxpayers to deduct bonuses in 2015 that are not paid until early 2016. If your business is looking to defer taxes to 2016 by accelerating deductions into 2015, this strategy might be right for you. But you need to check that your bonus plan qualifies for this advantageous tax treatment.

Generally tax law allows accrual-basis taxpayers to deduct expenses associated with a tax year in that tax year even when not paid until the following tax year if all events have occurred that establish the taxpayer’s liability for the expense and the amount of the expense can be determined with reasonable accuracy.

When it comes to bonuses, if they’re earned during the tax year, they’re generally deductible on that year’s return as long as they are paid by the 15th day of the third month after the close of the tax year (March 15 for calendar-year businesses) — and your bonus plan meets certain requirements.

Under a 2011 IRS ruling, accrual-basis taxpayers can deduct bonuses even if they do not calculate the amount of the bonus pool or specify who’ll receive bonuses until after year end — if the bonus plan meets certain requirements:

  • The bonuses are compensation for services performed during the tax year.
  • The terms and conditions under which bonuses will be paid are defined, and they’re communicated to employees when they become eligible and also any time the plan is changed.
  • The minimum bonus pool to be paid is determined through a formula that’s set before year end or based on a board resolution or other corporate action taken before year end.
  • If anyone originally eligible for a bonus is no longer an employee on the payment date, his or her bonus will be reallocated among the remaining eligible employees.

Keep in mind that bonuses paid to owners generally can’t be deducted until they’re actually paid. The definition of “owner” for bonus deduction purposes depends on the type of entity. For partnerships and limited liability companies, all partners or members are considered to be owners. For S corporations, anyone who owns more than 2% of the corporation’s stock is considered an owner. For a C corporation, the threshold is more than 50%.

Questions about whether your bonus plan is eligible for this tax-advantaged treatment or what you need to do before year end to deduct bonuses paid in early 2016?

If it turns out you can’t take advantage of this break this year, you might consider revising your bonus plan in 2016 so you can take advantage of it next year. Contact us.

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