Deduction for bonuses deferred due to employment contingency.

• Author: Chou, Yuan

The IRS Office of Chief Counsel has concluded that a liability arising from bonus compensation is deductible in the year the bonus is paid if payment of the bonus is contingent on the taxpayer's employees being employed on the payout date. Chief Counsel Advice (CCA) 200949040 affirms the view held by many tax practitioners that an employment contingency within the bonus or incentive compensation plan prevents the all-events test from being met at year end under Sec. 461 even though the bonus is paid within the 21/2-month period after the end of the tax year in which the bonus is earned.

Facts

The taxpayer for which the CCA was issued is a corporation that uses the accrual method of accounting for federal income tax purposes. The taxpayer offers a non executive incentive compensation plan to certain employees. The plan requires employees to be employed by the taxpayer on the date that bonuses are paid in order to receive them. Any bonuses not paid to an employee are forfeited and revert back to the taxpayer. The facts further indicate that the taxpayer had previously filed an advance consent Form 3115, Application for Change in Accounting Method, to change its method of accounting to treat bonuses as incurred in the tax year in which all events occurred to establish the fact of the liability; the amount of the liability can be determined with reasonable accuracy; and economic performance has occurred with respect to the liability.

After signing the consent letter for the Form 3115, the taxpayer obligated itself to pay 90% of the amount accrued for financial statement purposes with respect to the bonus related to year 1 within the first 21/2 months of year 2. Amounts not paid to employees would be paid to a charity as a charitable contribution. The 90% obligation was not made a part of the existing non executive incentive compensation plan. Further, it was not communicated to the employees in year 1 because it did not alter the bonus plan or terms for the employees. Instead, the 90% obligation was expressed in a memorandum to files from the company's president/CEO and executive vice president/CFO. In year 1, no charitable contribution was made because bonuses in excess of the 90% threshold were in fact paid within the first 2]/2 months of year 2.

General Rules

Bonus compensation payments are generally deductible as an ordinary and necessary trade or business expense under Sec. 162, provided that two tests are met: (1) the all-events test...