Accelerating Deductions for Annual Bonuses and Stock Units Paid in 2018
Included in both the Senate and House tax reform bills is a reduction in the corporate tax rate from 35% to 20% (but, it appears the reconciled bill includes a corporate tax rate of 21%). The Senate plan cuts the corporate tax rate effective in 2019 and the House plan in 2018. The rate and effective date are still being negotiated by the tax bill conferees. However, both bills also make major changes to the deductions for executive compensation, effective for tax years starting in 2018, by requiring performance bonuses and stock option compensation to be counted, in determining if compensation exceeds $1 million, and also by expanding the group of executives and former executives whose compensation is subject to potential disallowance.
An accrual basis taxpayer may generally deduct bonuses in the taxable year accrued. A cash bonus, however, is generally deductible only in the year in which it was paid, rather than the year accrued, if paid later than 2½ months after the year in which related services are rendered. Accordingly, many corporate employers are taking steps to ensure that cash bonuses payable within the first 2½ months of 2018, as well as bonuses payable in vested company stock in 2018, are accrued by the end of their 2017 fiscal years.
Under Section 461 of the Internal Revenue Code and related Internal Revenue Service (IRS) guidance, a bonus is accrued in the taxable year in which (1) all events have occurred that establish the fact of an employer’s liability to pay the bonus, (2) the bonus amount can be determined with reasonable accuracy, and (3) economic performance has occurred with respect to the liability. Economic performance occurs when services giving rise to the bonus have been rendered.
The IRS has concluded that a bonus does not accrue in a taxable year if the employer’s liability is contingent as of the end of that year, for example, if (i) an employer retains the unilateral right to reduce the bonus before payment for any reason, such as an employee’s termination of employment prior to the bonus payment date, (ii) the payment of the bonus is contingent on committee approval in the following year, or (iii) the minimum amount payable to all employees eligible to receive a bonus under the plan is not fixed as of the end of the year. The IRS has conceded, however, that as long as the minimum aggregate bonus amount payable is fixed as of the end of the performance year, and any amounts forfeited in a subsequent year (because, for example, a participant is no longer employed as of the payment date) are reallocated among other participants in the bonus plan in the prior year, an employer may still establish that the bonus liability was fixed as of the end of the performance year.
Companies whose 2018 bonus payments may not be accruable in 2017 because of these or similar contingencies might still amend their bonus plans before the end of their 2017 fiscal year in order to accrue the liability and support a deduction in 2017. To do this, a company might consider the following steps: (1) establish a “fixed minimum bonus payment,” and/or a “fixed minimum RSU (restricted stock units)/PSU (performance stock units) payment” for the entire group of employees in the company’s bonus and equity plans (or for a portion of that group), (2) communicate that “minimum promise” to the affected employees; and (3) clarify or amend existing plans, to ensure that this minimum promised amount cannot be reduced after year-end. These steps would help support an accrual in fiscal year 2017 (or in fiscal years stretching into 2018) of the promised aggregate minimum bonus (or RSU/PSU) payments.
The value of bonus deductions could be significantly reduced for taxable years beginning after 2017. Corporations must act fast to ensure bonus deductibility for 2017.