Rev. Rul. 55-446

Advice has been requested whether bonus payments under an incentive compensation plan which cannot be determined or paid by the employer until after the close of the taxable year will be properly accruable and deductible for income tax purposes under section 23(a) of the Internal Revenue Code of 1939 as business expenses in the year to which they relate, or under section 23(p) of the Code as payments under a deferred compensation plan.

It has been the policy of the taxpayer, a company on the accrual basis of accounting, to compensate its salaried employees by means of regular annual salaries plus a year-end bonus dependent upon the profits earned by the company. Recently, this procedure was formalized by the approval of an incentive compensation plan whereby a formula specifies the amount of profits available for bonus payments. When the net income of the company exceeds the dividend requirements there will be set aside, out of such excess, a percentage of the total net income as a general incentive fund. An employee's participation, generally, will not exceed 16 2/3 percent of his base salary, but in exceptional cases of meritorious performance participation not to exceed 100 percent of base salary will be allowed.

From the balance of the net income, including the provision for the general incentive fund, there is set aside a graduated percentage as an executive incentive fund in an amount not in excess of 100 percent of the aggregate base salaries (in respect of the year for which the incentive payments are made) of the key executives who participate in such fund, but in no event to exceed a net cost to the company of $200,000 x .

A salary and incentive committee meets in early December of each year to decide how much of each fund will be distributed to whom, and in what amounts. Its action is approved by the company's board of directors. Each employee is advised before the end of the year as to the percentage of the total bonus which he will receive. Payment of the bonuses is made early in the following year, after the company's auditors have determined the net income or have certified that the earnings were sufficient to pay the schedule of proposed bonuses, but in any event prior to the due date of the company's Federal income tax return for the year in which the bonuses were earned.

Section 23(a) of the Code provides that in computing net income there shall be allowed as deductions:

All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered * * *.

Section 23(p) of the Code provides in part as follows:

* * * if compensation is paid or accrued on account of any employee under a plan deferring the receipt of such compensation, such * * * compensation shall not be deductible under subsection (a) but shall be deductible, if deductible under subsection (a) without regard to this subsection, under this subsection * * *

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(D) In the taxable year when paid, if the plan is not one included in paragraph (A), (B), or (C), if the employees' rights to or derived from such * * * compensation are nonforfeitable at the time the * * * compensation is paid.

In the instant case, it appears that the payments are current payments for current services rendered and therefore are not deferred compensation within the contemplation of section 23(p) of the Code.

Accordingly, it is held that bonuses payable under an incentive compensation plan, the exact amounts of which cannot be determined and paid by an accrual basis taxpayer until early in the year immediately following the close of the taxable year of accrual, would properly be accruable and deductible for Federal income tax purposes, subject to the test of `reasonableness' under section 23(a) of the Code, for the year to which they relate, provided the total bonuses are definitely determinable through a formula in effect prior to the end of the taxable year and the employer has definitely obligated itself, prior to the close of such taxable year, to make payment thereof by delivering to each employee concerned either a written or oral notice of the percentage of such total to be awarded to him and that payment of such bonuses is made as soon after the close of the taxable year as is administratively feasible.

This ruling is not applicable to payments made to a beneficiary because of the death of an employee