The IRS Office of Chief Counsel (OCC) advised that a taxpayer could take a liability for bonus payments into account only in the year the bonus payments were made.
The taxpayer is a corporation that uses an accrual method of accounting for federal income tax purposes. Under the taxpayer’s nonexecutive incentive compensation plan, employees are required to be employed by the taxpayer on the date that bonuses are paid in order to receive a bonus. Any amounts not paid to employees as bonuses are forfeited and revert to the taxpayer. The IRS granted the taxpayer permission, per Sec. 461, to treat bonuses as incurred in the tax year in which all events have occurred to establish the fact of the liability, the amount of the liability can be determined with reasonable accuracy, and economic performance has occurred with respect to the liability.
The taxpayer, in an internal memorandum, obligated itself “to pay 90% of the amount accrued for financial statement purposes with respect to [the nonexecutive] incentive compensation plans” related to fiscal year 1 within the first two and a half months of year 2. The taxpayer would pay any amounts it did not pay to employees to a designated charity as a charitable contribution. For tax year 1, the taxpayer did not make a charitable contribution because it paid bonuses in excess of the 90% threshold. The taxpayer paid the year 1 bonuses during the first two and a half months of year 2. The taxpayer did not make the 90% obligation a part of the company’s bonus plan and did not communicate it to its employees in year 1 because it did not alter the bonus plan or terms for the employees.
The OCC was asked to advise on what year the taxpayer should take a deduction for the bonus payments. The taxpayer argued that it had a fixed and determinable liability at the end of year 1 for 90% of the amount accrued for financial statement purposes for the nonexecutive incentive compensation plans for year 1 and that, as a result, it was entitled to take that amount into account in year 1 under Secs. 404(a) and 461. It reasoned that the combination of its nonexecutive incentive compensation plans and its obligation to contribute to the charity any amounts not paid to employees was sufficient to fix its liability.
The OCC’s Opinion
The OCC advised that the requirement to make a charitable contribution of forfeited bonus payments did not affect when the liability for the bonus payments was deductible. According to the OCC, Secs. 170 and 461 apply to different types of liabilities and provide different timing rules for those liabilities. Therefore, the taxpayer’s liability to make bonus payments to its employees had to be analyzed separately from its liability to make a charitable contribution of any forfeited bonus payments.
Because the taxpayer never actually made a charitable contribution in years 1 or 2, under Sec. 170 there could be no deductible liability for charitable contributions at the end of year 1. The company’s obligation to make the bonus payments did not give rise to a deduction at the end of year 1 under Sec. 461 because at that point the bonus payments were contingent on employees’ working until a later date, and the obligation to make them was therefore not a fixed liability. In addition, under Sec. 461 a taxpayer can take a liability into account only after economic performance occurs, which in this case would happen when the bonus payments were made. Thus, the taxpayer could only deduct the bonus payments in the year paid.
The taxpayer’s obligating itself to make charitable contributions of amounts it did not pay to employees as bonuses was a somewhat clever idea to escape its all-events test conundrum. However, the OCC flatly rejected this ploy. Employers should take notice that to preserve deductibility in year 1 they must either fix the amount of bonuses (or the bonus pool) in year 1 or not require year 2 services from employees to be eligible for the bonus.
CCA 200949040 (12/4/09)