In Revenue Ruling 2011-29 (the Ruling), the Internal Revenue Service (IRS) reversed a long-held position to now permit accrual-basis employers to accrue employee bonuses for federal income tax deduction purposes, even though the amount to be paid to specific employees is not known at the end of the year. Previously, the IRS had held that the deduction could not be claimed until both the identity of the bonus recipient and the specific amount of that bonus are both known.
The facts considered in the Ruling reflect a typical bonus arrangement in which the written terms of the employer’s plan require that an aggregate minimum bonus amount be determined by year end with the allocation to individual employees determined after year-end. The minimum total amount of bonuses to be paid to the employee group is determined either through a formula that is fixed prior to year-end or through corporate action, such as resolution of the compensation committee of the board of directors, made before year-end. The plan in the ruling also provides that any bonus amount allocable to an employee who leaves the employer before the bonus is paid will be reallocated to other eligible employees. The IRS concluded that the minimum bonus amount determined under the plan could be accrued at year end if paid by the 15th day of the 3rd month following year end (March 15 for a calendar year taxpayer).
This result has long been considered the correct treatment by many tax advisors based on a Supreme Court ruling on a related issue. It is, however, important guidance that resolves a bothersome controversy with the IRS. The IRS has indicated in a related document, Revenue Procedure 2011-14, that it will allow an automatic accounting method change to implement the treatment permitted in Revenue Ruling 2011-29. This change may be useful to employers who now wish to conform their plans in order to accelerate the related federal income tax deduction to 2011 for bonus that are expected to be paid in early 2012.