While many workers eagerly await a gift from their employers this quarter in the form of a bonus, businesses may shudder at the costs incurred, raising the question, “Are employee bonuses deductible?” Take heart, because in many cases, employee bonuses don’t just serve as an extra incentive for workers but they are generally tax-deductible for businesses that operate as corporations. Read on to learn about the allowances and limitations for the employee bonus deduction.
When are employee bonuses deductible?
In general, the IRS allows businesses that operate as corporations to deduct amounts paid to employees for ordinary and necessary services they perform. This payment might be disbursed in the form of salaries, wages, commissions and bonuses, whether cash or property.
Regardless of the type of bonus, the IRS requires that deductible pay like bonuses be reasonable for the services provided. Extravagant bonuses will not likely pass muster with the IRS for tax deduction purposes. While “reasonable” is a hazy term that depends on each company and employee, a general test is to see whether similar businesses would compensate the worker with a bonus of a similar value. If a bonus or other pay is deemed to be unreasonable, the excess portion of the pay would be disallowed from the deduction the corporation claims.
Even when a business can claim the employee bonus deduction, and the employee claims the bonus in his or her income, this does not exempt the employer from withholding appropriate taxes from the bonuses as would be done for traditional compensation like salary and wages.
What constitutes qualifying cash and property bonuses?
Cash bonuses awarded to employees are generally regarded by the IRS as tax-deductible, as long as the bonus was given as additional compensation for the services of the employees—not as a business gift—and that the services were performed before the bonus was paid out. However, bonuses based on sales or earnings that were paid via an agreement made before the services were performed are also viewed as deductible in the eyes of the IRS.
Bonuses awarded in the form of property, such as company stock, are also generally deductible. However, estimating the value of such a bonus to the business can be less straightforward. The value of the employee bonus deduction is often not the value of the property when the corporation acquired it, but the fair market value of the property on the date it was transferred to the employee, minus any amount the employee paid for the property. This means that depending on the property transferred, the business must be willing to recognize any losses or gains in the transfer.
Lastly, you may only deduct a property bonus for the tax year in which the recipient employee included the bonus in his or her income. For more information on tax deductions and stipulations for bonuses and other employee pay, see IRS Publication 535.
MileIQ’s blog does not constitute professional tax advice. You should contact your own tax professional to discuss your situation.