Many companies pay their employees annual bonuses between January 1 and March 15. If it’s done right, the company can take a tax deduction for the amount of the bonuses in the previous year (if it’s a calendar-year tax filer), but the employee doesn’t recognize the income until the year of receipt.
But here’s a problem: Many companies also require that employees remain with the company to get a bonus. So if an annual bonus would typically be paid in February, but an employee quits in January, he or she forfeits the bonus.
In the past, such a “forfeiture” requirement was a huge issue for the IRS. Because it wasn’t absolutely clear on December 31 how much would be paid out in bonuses (since an employee could always quit and forfeit the money), the IRS wouldn’t allow the company to take a tax deduction in the previous year. It would require the company to wait until the following year for the deduction.
Now, however, the IRS has given employers a way around this problem. It says that a company can take a deduction in the previous year, if it’s willing to reallocate any departing employee’s bonus among the other employees in the bonus pool.
In other words, if a company determines by December 31 either the total dollar figure that will be paid out, or else a formula to determine how much will be paid out (based on final year-end results), it can take a deduction in the earlier year – even if it doesn’t know for sure exactly which employees will be dividing the spoils.