In Rev. Rul. 2011-29, the Internal Revenue Service (the “IRS”) reviewed the question of whether certain bonuses, which are payable by an accrual basis taxpayer for a tax year, can meet the “fact of liability” requirement for that year, even though the amount or recipient of any particular bonus is unknown until the next year. The “fact of liability” requirement is found in Treas. Reg. Sec. 1.461-1(a)(2)(i), promulgated under section 461 of the Internal Revenue Code (the “Code”). In addition to the fact of liability requirement, that Treas. Reg. Sec. also contains an “amount of liability requirement” and an “economic performance requirement”. The Revenue Ruling does not consider the latter two requirements.
The bonuses at issue work as follows. The employer pays bonuses to a group of employees, for services rendered during a taxable year, pursuant to a program that defines the terms and conditions under which the bonuses are paid for that year. The employer communicates the general terms of the bonus program to employees when they become eligible to participate. The total amount of bonuses payable under the program to all employees as a group is determinable either (1) through a formula that is fixed prior to the end of the taxable year, or (2) through other corporate action, such as a resolution of the employer’s board of directors or compensation committee, made before the end of the taxable year, that fixes the bonuses payable to the employees as a group. To be eligible for a bonus, an employee must perform services during the taxable year and be employed on the date that the bonus is actually paid. Under the program, bonuses are paid after the end of the taxable year in which the employee performed the services, but before the 15th day of the 3rd calendar month after the close of that year. Any bonus amount allocable to an employee who is not employed on the date on which bonuses are actually paid is reallocated among other eligible employees.
According to the Revenue Ruling, the “fact of liability” is established when: (a) the event fixing the liability, whether that be the required performance or other event, occurs, or (b) payment is unconditionally due. Here, the employer’s liability to pay a total amount of bonuses to the group of eligible employees is fixed at the end of the tax year in which the services are rendered. Any bonus allocable to an employee, who is not employed on the date on which bonuses are actually paid, is reallocated to other eligible employees. Thus, the total amount of bonuses the employer pays to its group of eligible employees is not reduced by the departure of an employee before actual payment. As such, the “fact of liability” for the total amount of bonuses is established by the end of the tax year in which the services are rendered. This obtains, even though the identity of the ultimate recipients and the amount, if any, each employee will receive cannot be determined prior to the end of that year.