Establishing the 'fact of the liability' for bonus compensation.

• Author: Watkins, Tracy

A recent IRS legal memorandum (ILM 201246029) serves as a reminder to business taxpayers to consider modifying or updating their employee bonus plans to enable a deduction for bonus compensation accrued in the year of the related services, as provided in Rev. Rul. 2011-29.

In Rev. Rul. 2011-29, X's bonus program established a minimum total amount of bonuses payable, either through a formula that was fixed prior to the end of the tax year or through other corporate action made by the end of the tax year, such as a resolution of X's board of directors or compensation committee. To be eligible under the program, employees needed to perform services during the tax year and be employed on the date of the bonus payment. Any bonus amounts allocable to employees who were not employed on the payment date were reallocated to the other eligible employees. Thus, the departure of any employee did not affect the aggregate amount of the bonus payment. X paid the bonuses after the end of the tax year of the related services and before the 15th day of the third calendar month after the close of that year.

Based on these facts, the IRS stated that the fact of X's liability for the minimum amount of bonuses was established by the end of the year in which the services were rendered. Accordingly, the IRS determined that an employer can thus establish the "fact of the liability" under Sec. 461 for bonuses payable to a group of employees, even though the employer does not know the identity of any particular bonus recipient and the amount payable to that recipient until after the end of the tax year.

In contrast to Rev. Rul. 2011-29, the IRS concluded in 1LM 201246029 that a taxpayer must take a liability for bonus compensation into account in the year the bonuses were paid because some unpaid bonuses reverted to the taxpayer if an employee left employment after the bonus was allocated to him or her.

Under its incentive compensation plan (ICP), the taxpayer finalized the aggregate amount of bonuses for book purposes at the end of a plan year based on the number of eligible employees employed on Dec. 31. The taxpayer paid the bonuses by March 15 in the year following the plan year. In January or February of the plan year, the taxpayer determined bonuses in the annual compensation planning process. The aggregate amount of bonuses paid generally did not exceed the amount accrued for book purposes at the end of the plan year. The TCP required all eligible employees to...