January 16, 2014 The Tax Lawyer

The Careful Employer: Taxpayer Guidance Under the All Events Test and Revenue Ruling 2011-29

Volume 67, No. 1 - Fall 2013

Sarah W. Colangelo

Abstract

        Employee bonus plans tying an employee’s personal gain to a company’s well-being can improve company retention and morale, but as a tax matter have posed particular timing problems for both employers (as taxpayers) and the Service. For many years, a combination of “[i]nconsistent judicial decisions and conflicting positions” by courts and the Service provided contradictory guidance on the appropriate treatment of accounting and tax deductions for bonus payments for taxpayers. Prior to 2011, while an accrual method taxpayer would account for employee bonus payments “on the books” in the fiscal year in which the employee’s service accrued the bonus payments, the Service required a taxpayer to report and deduct the bonus payments in the taxable year in which bonus payments were actually paid out, which usually was the next taxable year. This guidance led to a mismatch between deductions and reported income for many taxpayers and caused taxpayers to treat employee bonus plans as if the taxpayer were using the cash method.

    Revenue Ruling 2011-29 has brought needed clarity to this situation, although not providing complete closure concerning the Service’s position. The Revenue Ruling holds that an accrual method taxpayer can and must “establish the ‘fact of the liability’ under section 461” for a minimum amount of “bonuses payable to a group of employees” during that taxable year. Fixing this liability is possible “even though 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.” The Revenue Ruling is premised on the idea that while a taxpayer may not know the individual amount of a bonus going to any particular employee until the taxable year has ended, the taxpayer will know the aggregate minimum amount of bonuses to be paid out by the end of the year, and all events have occurred by the end of the taxable year to fix the taxpayer’s liability for that minimum amount of bonuses. The Revenue Ruling is a significant change to the Service’s treatment of employee bonus plans and confirms that taxpayers may take deductions in one taxable year for fixed, minimum bonus payments that are paid out in the first two and a half months of the next taxable year.

    This Comment argues that despite not fully explaining past conflicting guidance by the Service, Revenue Ruling 2011-29 was correctly issued and brings the Service’s treatment of bonus plans in line with decades of case law. Part II of this Comment examines the all events test and the Service’s litigation position prior to Revenue Ruling 2011-29. Part III examines Revenue Ruling 2011-29 itself. Part IV.A recognizes that practically, there are unlikely to be either increased instances of tax abuse with respect to such deductions or major changes in the drafting of bonus plans. Part IV.B examines the various areas of expense into which the Revenue Ruling’s rationale might extend, and Part IV.C notes that past inconsistent Service guidance has not been fully addressed by the Revenue Ruling. Part V concludes that despite the lack of full clarification, the Revenue Ruling was correctly issued and brings needed resolution to an area of confusion.

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