The Internal Revenue Code allows a company to deduct bonuses paid to officers of the company. The timing of the deduction depends on the accounting method used by the company. A company must consider issues such as limits on deductible compensation and payroll taxes.
Bonuses paid in cash are generally deductible for federal tax purposes when the company writes a check to the officer or when the payment becomes due and is earned by the officer. If a company uses the cash method of accounting for tax purposes, the payment of a bonus will be deductible when paid to the officer. The bonus cannot be a voluntary prepayment for future services nor made for the sole purpose of trying to reduce taxable income.
Companies using the accrual method of accounting can deduct an officer's bonus when the bonus has been earned by the officer and the bonus amount is fixed. For example, Rhonda, a CEO, receives a bonus at year-end for achieving certain performance goals. Once the amount is determined and Rhonda has performed the necessary duties, the company can deduct the bonus for federal tax purposes even if it has not been paid yet. The IRS generally requires that the bonus be paid by March 15 if it is accrued by Dec. 31, or within 75 days after close of the company's tax year that does not coincide with the calendar year.
A bonus paid to an officer is subject to FICA and FUTA taxes. FICA is collected by the government to fund Social Security and Medicare, while FUTA funds an unemployment insurance program. FICA and FUTA taxes due from the employer are deductible if they are paid by year-end or if the tax amount is fixed at the end of the year. The company must pay the taxes within 75 days after the end of the year. In addition to the payments made by the employer, the employee must also have income tax and FICA taxes withheld from the bonus check.
Internal Revenue Code Section 162(m) limits the amount of compensation deductible by publically traded companies for federal tax purposes. Section 162(m) prohibits a company from deducting more than $1 million in compensation for any of its top four executives. For example, the company of which Mitch is the CEO pays him a salary of $1.2 million. Only $1 million is deductible for federal tax purposes. Certain commissions and bonuses, however, might not be subject to this limitation. Consult a CPA or tax attorney for more information on what bonuses and commissions are excluded by the limitation of Section 162(m).
- West Federal Taxation; Eugene Willis, et al.
- IRS.gov: Office of Chief Counsel Internal Revenue Service Memorandum
Michael Bootsma is a licensed attorney and certified public accountant. He has a Juris Doctor and a master's degree in accounting, both from the University of Iowa. Bootsma owns interests in two small businesses and teaches a variety of business classes at the undergraduate and graduate levels.