Now that 2018 has drawn to a close, the options for reducing your tax liability are slim. One option that is still available to reduce liability is to pay 2018 employee bonuses now and deduct them on your 2018 tax return. Often, businesses can deduct bonuses earned by employees if they are paid within 2 ½ months after the end of the tax year (March 15 for a calendar year company).
This post year deduction is available only to accrual-basis taxpayers; cash basis taxpayers are not eligible.
For the accrual-basis companies that qualify the 2 ½ month rule is not automatically applied. Bonuses can be deducted only if they’re earned in 2018, and if the businesses liability was fixed before the end of the year.
A liability, such as a bonus, is deductible when incurred by accrual-basis taxpayers. The IRS determines this qualification using an “all-events-test.” This test determines that a liability was incurred under the following circumstances:
- All events have occurred that establish the taxpayer’s liability
- The amount of liability can be determined with reasonable accuracy
- Economic performance has occurred
Economic performance is usually a simple requirement to meet. When an employee performs services required to earn a bonus, economic performance has occurred. The other two requirements are not as straightforward and can sometimes delay your tax deduction until the year of payment depending on the design of your bonus plan.
For example, some bonus plans require that employees are still employed by the company on the date of payment to receive the bonus, meaning if they leave before payment date they forfeit the bonus. Using this setup, even when each employee’s bonus amount is fixed the all-events test is not satisfied. This is because if forfeiture of bonuses is possible, the businesses liability for bonuses is not fixed until the payment date.
The right setup
Accelerating your deductions is possible if your company uses a carefully designed bonus pool arrangement. The IRS allows employers to deduct bonuses for the year they are earned, even under the risk of forfeiture, so long as forfeited bonuses are reallocated to remaining employees, and not retained by the employer. This fixes the liability amount as an aggregate bonus, meeting the all-events-test.
We can help
Every situation and timeline is a bit different, but we can help to determine when your current plan allows you to take 2018 deductions for early 2019 bonuses. If you don’t qualify to accelerate your bonus deductions now, we can set up a bonus plan for 2019 that will allow accelerating your deductions when you file your 2019 return.
Contact us at 949-860-9902 or click here, and we will contact you.