02.07.12

Swimming in the Deep End of the Bonus Pool: A Fact of Liability

by Brendan Sullivan, Manager

March is a beautiful time of year.  Spring is in the air, the weather is getting warmer and employees receive their annual bonuses on March 15th.  The IRS has recently released a revenue ruling seeking to clarify the establishment of an accrued bonus liability and the timing of the tax year in which it is deducted.   Under the accrual method of accounting, a liability is incurred and is generally taken into account in the taxable year in which the following have transpired:

1. All events have occurred that establish the “fact of liability”,
2. The amount of the liability can be determined with reasonable accuracy, and
3. Economic performance has occurred for the liability.

The issue with accrued bonuses and the contingencies associated with them has been establishing the “fact of liability” when the recipient and amount of the bonus is unknown.
In order for a company to be able to establish a “fact of liability”, the bonus pool program must have the following distinct features:

1. It must contain a minimum amount of total bonuses payable under the program that is either calculated through a formula fixed prior to the end of the taxable year or through corporate action (e.g., a Board resolution) made before the end of the taxable year of inclusion that will fix the amount of the bonus payable to the employees as a group.
2. For the employees to be eligible to receive this bonus they must have performed services during the taxable year and be employed on the date that the bonus is paid.
3. Any bonus amount allocated to an employee who is no longer employed on the date the bonus is paid must be allocated amongst the remaining participants in the program.

Additionally, the bonus must be paid out no later than the 15th day of the third month (i.e., March 15th for calendar year taxpayers) following the company's tax year end to be deductible in the prior year's tax return.

Whether the bonus pool has ten or one hundred employees, the established minimum amount of bonuses will not fluctuate when an employee leaves, it just changes the allocation of the bonus to the remaining employees.  Through the use of a formula or corporate action and the reallocation of bonuses, the company has fixed the liability and fulfilled the all events requirement which establishes a “fact of liability”.  When considering your particular facts, remember that a change in accounting for the bonus plan constitutes a change in the method of accounting.  The Internal Revenue Service may require the company to file Form 3115 for the company to change its accounting method to conform to this revenue ruling.

For more information on this article please contact Brendan Sullivan bsullivan@argy.com.

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