Timing of deduction for bonus accruals under pooled arrangements.

• Author: Villella, Cody

Many accrual-method taxpayers deduct compensation bonuses either when paid or when accrued, even if the liability is not yet fixed for tax purposes. This is often due to the difficulty in determining the proper timing of the deduction for a bonus accrual. For example, it is often unclear whether a bonus accrual meets the required all-events test either at the end of the year in which the services are provided or in the year in which it is actually paid.

The determination of whether the bonus accrual is fixed and determinable by year end (i.e., meets the all-events test) is based on the taxpayer's facts and circumstances and depends primarily on whether the employee has an enforceable obligation against the taxpayer at year end. Thus, for example, a taxpayer's bonus accrual may not be fixed and determinable if it is not approved by its board of directors by year end or is subject to management discretion after year end. In addition, a bonus accrual may not be fixed and determinable if the taxpayer requires that the employee to whom the bonus is due is employed by the taxpayer on the payout date to receive it, and the taxpayer will not reallocate and pay any forfeited bonuses to the remaining bonus-eligible employees. Therefore, it is imperative to understand both the bonus plan terms and the timing of the actual payments.

To complicate matters further, many taxpayers are using pooled bonus arrangements. Under such plans, any portion of the accrued bonus pool that would have been payable to an individual who is no longer employed by the taxpayer will not revert to the taxpayer but rather will be reallocated among the remaining eligible employees.

The Court of Claims upheld the deductibility of this type of arrangement in Washington Post Co., 405 R2d 1279 (Ct. CI. 1969). The court found that the taxpayer's bonus liability was fixed and determinable at year end because the taxpayer had a formalized profit-sharing plan that obligated the taxpayer to pay the bonuses, and any amounts forfeited were reallocated and paid to other eligible participants. The court noted that "when a 'group liability' is involved, it is the certainty of the liability which is of utmost importance in the 'all events' test, and not necessarily either the certainty of the time over which payment will be made or the identity of the payees." However, the IRS announced that it would not follow Washington Post in Rev. Rul. 76-345 (which Rev. Rul. 2011-29 recently revoked, as...