Timing of Deduction for Bonus Accruals Under Pooled Arrangements

By Cody Villella, J.D., LL.M., Washington, DC, and Natalie Tucker, CPA, MTA, Jacksonville, FL

Editors: Mindy Tyson Cozewith, CPA, M. Tax., and Sean Fox, MPA

Expenses & Deductions

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 F.2d 1279 (Ct. Cl. 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 discussed below).

Subsequently, in Hughes Properties, Inc., 476 U.S. 593 (1986), 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 ruling 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, Treasury’s 2011–2012 Priority Guidance Plan contained a project to issue a “[r]evenue ruling under §461 reconsidering Revenue Ruling 76-345 regarding accrual of liabilities to unknown payees.” The IRS addressed that guidance plan project by issuing Rev. Rul. 2011-29.


In Rev. Rul. 2011-29, the IRS considered whether an employer can establish the “fact of the liability” under Sec. 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 tax 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 tax year, taking into account financial data reflecting results as of the end of that tax year, or through other corporate action that occurred before the end of the tax year and that fixed the bonuses payable to the employees as a group, such as a resolution by the board of directors or compensation committee.

To be eligible for a bonus, employees had to perform services during the tax year and be employed on the date that the bonuses were paid. Bonuses were paid after the end of the tax year in which they were earned but before the 15th 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 Sec. 461(a) and Regs. Sec. 1.461-1(a)(2)(i), an accrual-method taxpayer generally takes a liability into account in the tax 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; see also Regs. Sec. 1.446-1(c)(1)(ii)(A)). Generally, all events occur to establish the fact of a liability when (1) the event fixing the liability occurs, whether that is the required performance or other event, or (2) payment is unconditionally due. See Rev. Rul. 2007-3; Rev. Rul. 80-230; and Rev. Rul. 79-410, amplified by Rev. Rul. 2003-90.

Regs. Sec. 1.461-4(d)(2)(i) generally provides that, if a taxpayer’s liability arises out of another person’s services to the taxpayer, economic performance occurs as the services are provided. With respect to liabilities for employee benefits, Regs. Sec. 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).”

Sec. 404 limits a taxpayer’s deduction for compensation paid to employees more than 2 ½ months after the end of the year. If an employer makes a payment after that time, the payments are considered deferred compensation subject to the deduction timing rules of Sec. 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. (See Temp. Regs. Sec. 1.404(b)-1T, Q&A-2(b)(1).) Thus, a bonus that is fixed and determinable at year end will not constitute deferred compensation subject to the 2½ month rule of Sec. 404 as long as the employer pays it to the employee within the 2½-month period.

Rev. Rul. 2011-29 addressed only the first prong of the all-events test, i.e., 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 was liable to pay a minimum amount that was fixed at the end of the tax year in question because any bonus allocable to a former employee was mandatorily re-allocated 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. (See Rev. Rul. 55-446 as modified by Rev. Rul. 61-127.) In citing Hughes Properties , the IRS noted that, “This is true even though the identity of the ultimate recipients and the amount, if any, 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 Sec. 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 a payment date within 2 ½ 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 (Rev. Proc. 2011-14, Appendix §19.01(2)).

Rev. Rul. 2011-29 also serves as an important reminder for taxpayers to review the specific provisions of their bonus plans to ensure the deduction for bonuses paid within 2½ months of year end relates to a liability that was fixed and determinable by year end. Changes to deduct bonus accruals properly are generally eligible for automatic consent (Rev. Proc. 2011-14, Appendix §§13.02 and 19.01(2)).


Mindy Tyson Cozewith is a director, Washington National Tax in Atlanta, and Sean Fox is a director, Washington National Tax in Washington, DC, for McGladrey & Pullen LLP.

For additional information about these items, contact Ms. Cozewith at (404) 751-9089 or mindy.cozewith@mcgladrey.com.

Unless otherwise noted, contributors are members of or associated with McGladrey & Pullen LLP.

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