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Acuity Blog
Can you pay bonuses in 2017 but deduct them this year?
You may be aware of the rule that allows businesses to deduct bonuses employees have earned during a tax year if the bonuses are paid within 2½ months after the end of that year (by March 15 for a calendar-year company). But this favorable tax treatment isn’t always available.
For one thing, only accrual-basis taxpayers can take advantage of the 2½ month rule — cash-basis taxpayers must deduct bonuses in the year they’re paid, regardless of when they’re earned. Even for accrual-basis taxpayers, however, the 2½ month rule isn’t automatic. The bonuses can be deducted in the year they’re earned only if the employer’s bonus liability is fixed by the end of the year.
The all-events test
For accrual-basis taxpayers, the IRS determines when a liability (such as a bonus) has been incurred — and, therefore, is deductible — by applying the “all-events test.” Under this test, a liability is deductible when:
- All events have occurred that establish the taxpayer’s liability,
- The amount of the liability can be determined with reasonable accuracy, and
- Economic performance has occurred.
Generally, the third requirement isn’t an issue; it’s satisfied when an employee performs the services required to earn a bonus. But the first two requirements can delay your tax deduction until the year of payment, depending on how your bonus plan is designed.
For example, many bonus plans require an employee to remain in the company’s employ on the payment date as a condition of receiving the bonus. Even if the amount of the bonus is fixed at the end of the tax year, and employees who leave the company before the payment date forfeit their bonuses, the all-events test isn’t satisfied until the payment date. Fortunately, it’s possible to accelerate deductions with a carefully designed bonus pool arrangement.
How a bonus pool works
In a 2011 ruling, the IRS said that employers may deduct bonuses in the year they’re earned — even if there’s a risk of forfeiture — as long as any forfeited bonuses are reallocated among the remaining employees in the bonus pool rather than retained by the employer. Under such a plan, an employer satisfies the all-events test because the aggregate bonus amount is fixed at the end of the year, even though amounts allocated to specific employees aren’t determined until the payment date.
Additional rules and limits apply to this strategy. To learn whether your current bonus plan allows you to take 2016 deductions for bonuses paid in early 2017, contact us. If you don’t qualify this year, we can also help you design a bonus plan for 2017 that will allow you to accelerate deductions next year.
© 2016
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Reporting UTPs
Navigating the tax code — and staying atop the latest tax law developments — can be challenging for business owners. In turn, financial reporting for uncertain tax positions (UTPs), such as pending IRS audits or lawsuits, is complicated and subjective. Here’s some guidance to help clarify matters.
Applying the threshold
Companies that follow U.S. Generally Accepted Accounting Principles (GAAP) must identify, measure and disclose UTPs using a “more-likely-than-not” threshold. In short, tax accruals are booked only for uncertain positions that meet this threshold.
This means that a tax benefit is allowed only if there is a more than 50% likelihood that the position would be sustained if challenged and considered by the highest court in the relevant jurisdiction. Unrecognizable benefits with less than a 50% cumulative chance of sustaining an IRS challenge should be reported on the balance sheet as a separate UTP liability.
Identifying tax positions
When reporting UTPs, companies should presume that returns will be audited and tax authorities will have access to all information. Then, management must identify all material tax positions, including those that:
- Exclude specific income streams from taxable income,
- Assert an equity restructuring is tax-free,
- Refrain from filing a tax return in a particular jurisdiction, or
- Accelerate expense or delay income recognition, such as depreciation or amortization expenses.
When reporting UTPs, management is required to create detailed tabular disclosures and factor into its estimates such costs as accrued interest and penalties. Moreover, unresolved UTPs must be reassessed as of each balance sheet date. Developments such as emerging case law, tax law changes or interactions with taxing authorities could affect tax benefits formerly recognized. In fact, tax reform proposals that Congress plans to introduce in early 2017 could affect UTP estimates for the end of 2016.
Supporting your position
Estimating probabilities and future settlement amounts is a subjective activity and requires the expertise of an experienced CPA. Among the factors an expert will consider are the company’s expected settlement strategy, the nature of the tax liability and applicable tax law precedents. Unsure how to measure and disclose UTPs in today’s uncertain business environment? We are atop the latest proposals and can help you comply with GAAP.
© 2016
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There’s Still Time to Benefit on Your 2016 Tax Bill by Buying Business Assets
In order to take advantage of two important depreciation tax breaks for business assets, you must place the assets in service by the end of the tax year. So you still have time to act for 2016.
Section 179 deduction
The Sec. 179 deduction is valuable because it allows businesses to deduct as depreciation up to 100% of the cost of qualifying assets in year 1 instead of depreciating the cost over a number of years. Sec. 179 can be used for fixed assets, such as equipment, software and leasehold improvements. Beginning in 2016, air conditioning and heating units were added to the list.
The maximum Sec. 179 deduction for 2016 is $500,000. The deduction begins to phase out dollar-for-dollar for 2016 when total asset acquisitions for the tax year exceed $2,010,000.
Real property improvements used to be ineligible. However, an exception that began in 2010 was made permanent for tax years beginning in 2016. Under the exception, you can claim a Sec. 179 deduction of up to $500,000 for certain qualified real property improvement costs.
Note: You can use Sec. 179 to buy an eligible heavy SUV for business use, but the rules are different from buying other assets. Heavy SUVs are subject to a $25,000 deduction limitation.
First-year bonus depreciation
For qualified new assets (including software) that your business places in service in 2016, you can claim 50% first-year bonus depreciation. (Used assets don’t qualify.) This break is available when buying computer systems, software, machinery, equipment, and office furniture.
Additionally, 50% bonus depreciation can be claimed for qualified improvement property, which means any eligible improvement to the interior of a nonresidential building if the improvement is made after the date the building was first placed in service. However, certain improvements aren’t eligible, such as enlarging a building and installing an elevator or escalator.
Contemplate what your business needs now
If you’ve been thinking about buying business assets, consider doing it before year end. This article explains only some of the rules involved with the Sec. 179 and bonus depreciation tax breaks. Contact us for ideas on how you can maximize your depreciation deductions.
© 2016
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Are You Ready for Audit Season?
It’s almost audit season for calendar-year entities. A little preparation can go a long way toward facilitating the external audit process, minimizing audit adjustments and surprises, lowering your audit fees in the future and getting more value out of the audit process. Here are some ways to plan ahead.
The mindset
Before fieldwork begins, meet with your office team to explain the purpose and benefits of financial statement audits. Novice staff members may confuse financial audits with IRS audits, which can sometimes become contentious and stressful. Also designate a liaison in the accounting department who will answer inquiries and prepare document requests for auditors.
Reconciliation
Enter all transactions into the accounting system before the auditors arrive, and prepare a schedule that reconciles each account balance. Be ready to discuss any estimates that underlie account balances, such as allowances for uncollectible accounts, warranty reserves or percentage of completion.
Check the schedules to reveal discrepancies from what’s expected based on the company’s budget or prior year’s balance. Also review last year’s adjusting journal entries to see if they’ll be needed again this year. An internal review is one of the most effective ways to minimize errors and adjusting journal entries during a financial statement audit.
Work papers
Auditors are grateful when clients prepare work papers to reconcile account balances and transactions in advance. Auditors also will ask for original source documents to verify what’s reported on the financial statements, such as bank statements, sales contracts, leases and loan agreements.
Compile these documents before your audit team arrives. They may also inquire about changes to contractual agreements, regulatory or legal developments, additions to the chart of accounts and major complex transactions that occurred in 2016.
Internal controls
Evaluate internal controls before your auditor arrives. Correct any “deficiencies” or “weaknesses” in internal control policies, such as a lack of segregation of duties, managerial review or physical safeguards. Then the auditor will have fewer recommendations to report when he or she delivers the financial statements.
Value-added
Financial statement audits should be seen as a learning opportunity. Preparing for your auditor’s arrival not only facilitates the process and promotes timeliness, but also engenders a sense of teamwork between your office staff and external accountants.
© 2016
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