Accrued payroll tax liability is deductible even if compensation is deferred under Sec. 404.

• Author: O'Driscoll, David

A recent ruling states that accrual-method taxpayers may deduct payroll tax liability incurred in the current year, for compensation deferred and deductible in the following year, under Sec. 404, provided the all-events test and recurring-item exception of Sec. 461 are met.

Facts

X, a corporation, uses an accrual method of accounting and files its Federal income tax returns on a calendar-year basis. As of the end of year 1,X has a fixed liability to pay compensation for services provided by its employees during year 1. As of the end of that year, all events have occurred to establish X's liability for the taxes owed under Secs. 3111 (the employer's share of FICA taxes) and 3301 (FUTA taxes) and the amount of the payroll tax liability can be determined with reasonable accuracy. X properly adopted the recurring-item exception under Regs. Sec. 1.461-5 as a method of accounting for the payroll taxes. X pays the payroll taxes either (1) in year 1 or (2) before the earlier of September 15 of year 2 or the date X files a timely (including extensions) Federal income tax return for year 1. Thus, under Sec. 461, the payroll taxes generally would be treated as incurred by X in year 1. However, the compensation to which the payroll taxes relate is deferred compensation properly deductible under Sec. 404 in year 2.

Sec. 404

In general, compensation is deductible under Sec. 404 if it is paid or accrued under a deferred-compensation plan. However, an employer's payroll tax liability is not compensation. Thus, Sec. 404 does not control the deductibility of X's payroll tax liability, even though it relates to a deferred-compensation liability subject to Sec. 404, nor does it alter the timing of the accrual of such payroll tax liability under Sec. 461.

Sec. 461

Regs. Sec. 1.461-1(a)(2)(i) provides that, under the accrual method, a liability is incurred, and generally taken into account for Federal income tax purposes, in the tax 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 as to the liability (the all-events test).

For a payroll tax liability, Kegs. Sec. 1.461-4(g)(6) provides generally that economic performance occurs as the tax is paid to the governmental authority that imposed it. However, Regs. Sec. 1.461-5(b)(1) provides a recurring-item exception to the general rule of economic performance...