Clients should pay their bills on time or risk deferring the deduction.

• Author: Kafka, Stephen G.

Accrual-basis taxpayers that delay the payment of accrued liabilities for compensation to independent contractors (e.g., accountants, lawyers, repair service people, computer programmers) beyond 2 1/2 months may find that the deduction will not be allowed until a tax year following the year of accrual. This results from the interaction of Regs. Sec. 1.461l1[a][2], Sec. 404{d} and Sec. 4041b1.

Generally, when services are performed before year-end for an accrual-basis taxpayer, an accrual for the related fees for compensation] generally can be made at year-end. Regs. Sec. 1.461-1[a][2] allows a liability to be accrued at such time as the liability is considered incurred. A liability is considered incurred in the tax year in which all the events establishing the fact of the liability have occurred, the amount of the liability is determinable with reasonable accuracy, and economic performance has occurred with respect to the liability. Economic performance with respect to a liability arising out of the provision of services to a taxpayer occurs when the services are provided [Regs. Sec. 1.461-4[d].

Although compensation expense may be properly accrued under Regs. Sec. 1.461-4[d], Sec. 404[d] will govern the time for deduction of compensation incurred by a taxpayer under a plan, method or arrangement deferring its receipt by service providers for services for which there is no employer-employee relationship. Accordingly, compensation expense incurred under such circumstances is not deductible until the amount is includible in the gross income of the service provider. Temp. Regs. Sec. 1.404[d]-lT states that Sec. 404(a) and (b)both directed at employer-employee relationships--and the regulations thereunder apply as if the person providing the services was the employee and the person to whom the services are provided was the employer.

Compensation expense accrued at year-end and received later than 2 1/2 months after year-end by an employee [or a service provider as provided under Temp. Regs. Sec. 1.404[d]J-lT] is presumed to be pursuant to a plan, method or arrangement deferring the receipt of compensation [Temp. Regs. Sec. 1.404[b]-IT). This determination is made separately for each service provider and the presumption of the existence of a plan, method or arrangement is rebuttable.

To rebut this presumption, a taxpayer must show that it is impracticable, either administratively or economically, to avoid the receipt of the compensation by the...