United States

Accrual method taxpayer may deduct bonus accruals under pooled arrangements


When determining the proper timing of an accrual method taxpayer's deduction for its bonus accrual, it is often unclear whether a certain bonus accrual meets the all events test either (a) at the end of the year in which the services are provided, or (b) in the year in which the bonuses are actually paid. Many accrual method taxpayers either deduct bonuses when paid, or deduct them when accrued, even if the liability is not fixed for tax purposes. In determining the proper time to deduct a bonus accrual, it is imperative to understand both the bonus plan terms and the timing of the actual payments. Whether an accrual method taxpayer's bonus accrual is fixed by year-end for tax purposes must be determined based on the taxpayer's facts and circumstances, and depends primarily on whether the employee has an enforceable obligation at year-end. Thus, for example, a taxpayer's bonus accrual may not be fixed if such amount is either 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 if the taxpayer requires that the employee to whom the bonus is due must be employed on the payout date in order to receive the bonus, and the taxpayer will not reallocate and pay any forfeited bonuses to the remaining bonus-eligible employees.

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 deductibility of this type of arrangement was upheld by the court in Washington Post Co. v. United States1, wherein 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. In making its determination, 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.2 However, the IRS announced that it would not follow Washington Post in Rev. Rul. 76-345.3 Subsequently, though, in United States v. Hughes Properties, Inc.,4 the Supreme Court allowed a casino operator to deduct amounts guaranteed for payment of progressive slot machine jackpots that had not yet been won by casino patrons. The Court reasoned that the taxpayer had a fixed obligation to pay the guaranteed amounts to somebody under the Nevada gambling regulations, and the identification of the eventual recipients of the progressive jackpots was inconsequential. The Supreme Court's decision in Hughes Properties clearly trumped Rev. Rul. 76-345 and thus mooted the controversy over pooled bonus arrangements. As a result, the Department of the Treasury's 2011-2012 Priority Guidance Plan contained a project to issue a "Revenue ruling under section 461 reconsidering Revenue Ruling 76-345 regarding accrual of liabilities to unknown payees. Such guidance plan project was recently issued in Rev. Rul. 2011-29, as discussed below.


In Rev. Rul. 2011-29, the IRS considered whether an employer can establish the "fact of the liability" under section 461 for bonuses payable to a group of employees if 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 taxable year. Under the facts of the ruling, X, an accrual method taxpayer, paid bonuses to a group of its employees for services performed under a bonus program. X communicated the general terms of the program to employees when they became eligible and whenever the program changed. The minimum total amount of bonuses payable was determined either through a formula that was fixed prior to the end of the taxable year, taking into account financial data reflecting results as of the end of that taxable year; or through other corporate action, such as a resolution of X's board of directors or compensation committee, made before the end of the taxable year, that fixed the bonuses payable to the employees as a group. To be eligible for a bonus, employees had to perform services during the taxable year and be employed on the date that the bonuses were paid. Bonuses were paid after the end of the taxable year in which they were earned but before the fifteenth day of the third calendar month after the close of that year. Bonuses allocable to an employee who was not employed on the bonus payment date were reallocated among the remaining eligible employees.

Under section 461(a) and Reg. section 1.461-1(a)(2)(i), an accrual method taxpayer generally takes a liability into account in the taxable year in which: 1) all the events have occurred that establish the fact of the liability, 2) the amount of the liability can be determined with reasonable accuracy, and 3) economic performance has occurred for the liability (collectively, the "all events test".5 Generally, all events occur to establish the fact of a liability when: 1) the event fixing the liability, whether that be the required performance or other event, occurs, or (2) payment is unconditionally due.6 Reg. section 1.461-4(d)(2)(i) generally provides that if a taxpayer's liability arises out of the providing of services to the taxpayer by another person, economic performance occurs as the services are provided. With respect to liabilities for employee benefits, Reg. section 1.461-4(d)(2)(iii)(A) further provides that "the economic performance requirement is satisfied to the extent that any amount is otherwise deductible under section 404 (employer contributions to a plan of deferred compensation), section 404A (certain foreign deferred compensation plans), and section 419 (welfare benefit funds). Section 404 limits a taxpayer's deduction for compensation paid to employees more than 2 ½ months after the end of the year. If payment is made after that time, the payments are considered deferred compensation subject to the deduction timing rules of section 404, and the employer is not entitled to a deduction until the year in which the employee includes the amount of the payment in income.7 Thus, a bonus will not constitute deferred compensation subject to the 2 ½ month rule of section 404 as long as the employer pays it to the employee within the 2 ½ month period.

Rev. Rul. 2011-29 only addresses the first prong of the all events test, e.g., whether all the events have occurred that establish the fact of the liability. In relying on Washington Post and Hughes Properties, the IRS noted that X had a liability to pay a minimum amount that was fixed at the end of the taxable year in question because any bonus allocable to a former employee was mandatorily reallocated to other eligible employees. Thus, the fact of X's liability was established by the end of the year in which the services were rendered.8 Citing Hughes Properties, the IRS noted that "This is true even though the identity of the ultimate recipients and the amount, if any, that each employee will receive cannot be determined prior to the end of the taxable year. Accordingly, the IRS found that the fact that the taxpayer was required to pay a known minimum liability was sufficient to establish the fact of the liability, even if all of the details, such as the eventual payee, were not known. Thus, the IRS held that the taxpayer's bonus liability was fixed under section 461 even though it did not know the identity of any particular bonus recipient or the amount payable to such recipient until after year-end.


Rev. Rul. 2011-29 favorably upholds the current deductibility of a bonus pool that is determined based on a formula or board-approved amount by year-end with employment required on payment date, which occurs within 2 1/2 months of year-end. Taxpayers with pooled bonus arrangements that have been deducting such bonuses in the year of payment are generally eligible for automatic consent to change to comply with Rev. Rul. 2011-29.9

Rev. Rul. 2011-29 also serves as an important reminder for taxpayers to review the specific provisions of their bonus plans to ensure they are deducting bonuses paid within 2 ½ months of year-end for which their liability was fixed and determinable by year-end. Changes to properly deduct bonus accruals are generally eligible for automatic consent.10

1 405 F.2d 1279 (Ct. Cl. 1969).
2 Id. At 1284.
3 1976-2 C.B. 134, revoked by Rev. Rul. 2011-29.
4 476 U.S. 593 (1986).
5 See also Reg. section 1.446-1(c)(1)(ii)(A).
6 Rev. Rul. 2007-3, 2007-1 C.B. 350; Rev. Rul. 80-230, 1980-2 C.B. 169; Rev. Rul. 79-410, 1979-2 C.B. 213, amplified by Rev. Rul. 2003-90, 2003-2 C.B. 353.
7 See Reg. section 1.404(b)-1T, Q&A-2(b)(1).
8 See also Rev. Rul. 55-446, 1955-2 C.B. 531, as modified by Rev. Rul. 61-127, 1961-2 C.B. 36.
9 See App. section 19.01(2) of Rev. Proc. 2011-14.
10 See App. section 13.02 and 19.01(2) of Rev. Proc. 2011-14.


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