Rev. Rul. 61-127

Advice has been requested regarding the amount of bonuses which may be accrued and deducted in a taxable year by an employer under the circumstances described below.

For many years the taxpayer, employing the accrual method of accounting, has paid bonuses to its administrative employees. The bonuses were paid in March or April based upon the profits for the previous taxable year ending January 31. Previously, the taxpayer issued bonus letters to each eligible employee before the end of the taxable year notifying him of the percentage of the total bonuses to be awarded to him, pursuant to Revenue Ruling 55-446, C.B. 1955-2, 531.

That ruling holds, in part, that bonuses are accruable and deductible for the taxable year to which they relate, provided the taxpayer has obligated himself prior to the end of the taxable year to pay the bonuses, by delivery to each employee concerned a written or oral notice of the percentage of the total award he is entitled to receive.

In order to reduce the cost of preparing letters to each employee specifying his or her percentage share of the bonus fund, the taxpayer adopted a new bonus plan for its administrative employees. The plan provides that bonuses shall be paid not later than April 15 of the following fiscal year, in an aggregate amount of not less than two percent nor more than three percent of the company's profits for the taxable year just ended, with certain adjustments not here material. The plan further provides that the bonuses will be paid only to those administrative employees who are on the payroll on the last day of the taxable year and who otherwise qualify under the terms of the plan. Continued employment after the end of the taxable year is not required under the plan, nor is payment of the bonus to the employee otherwise conditional. The taxpayer communicated the terms of the plan to the administrative employees as a group prior to the close of the taxable year. Under the plan, the percentage of the bonus fund in excess of two percent cannot be determined until after the close of the taxable year.

Section 162(a) of the Internal Revenue Code of 1954 provides, in part, that there shall be allowed as a deduction 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 461(a) of the Code provides the general rule for determining the taxable year in which allowable deductions should be taken. Section 1.461-1(a)(2) of the Income Tax Regulations provides, in part, that under an accrual method of accounting, an expense is deductible for the taxable year in which all the events have occurred which determine the fact of the liability and the amount thereof can be determined with reasonable accuracy.

Under the above stated facts, there was a minimum amount payable to the employees qualifying under the taxpayer's bonus plan, which amount was determinable by means of a formula in effect prior to the end of the taxable year. Since the terms of the plan were communicated to the employees involved before the end of the taxable year, in view of the foregoing facts, an obligation arose to pay at least the minimum amount of bonuses which could have been enforced by the employees involved. Thus, all the events had occurred prior to the end of the taxable year in question which determined the fact and the minimum amount (two percent of the profits) of the taxpayer's liability under the bonus plan.

Accordingly, it is held that the bonuses based on two percent of the company's `profits' are accruable and deductible for Federal income tax purposes for the year to which they relate, subject to the test of `reasonableness' under section 162 of the Code. However, since the taxpayer is not legally obligated prior to the close of the taxable year to pay an amount in excess of two percent of the `profits,' any excess is deductible only in the following taxable year, provided the amounts so paid meet the `reasonabless' test.

Revenue Ruling 55-446, C.B. 1955-2, 531, is modified to the extent that it may be interpreted as requiring delivery of an individual notice to each employee of the percentage of the total amount accrued as bonuses to which he is entitled in order to properly deduct the payments under section 162 of the Code.

The instant ruling has no bearing on situations such as those considered in Revenue Ruling 54-608, C.B. 1954-2, 8, since the taxpayer in the instant case has incurred a minimum liability, the amount of which is fixed at the end of its taxable year.