Unlock Cash Flow with the Year-end Bonus Accrual Deduction

What if you could legally use a time-warp to lower your tax burden? That’s essentially what happens with the bonus accrual tax deduction. This powerful maneuver lets qualifying businesses claim employee bonuses against last year’s income, even if you write the checks this year.

It’s like delaying the tax payment while still securing the benefit, but this powerful move requires precision. You must follow a strict set of IRS rules to make the time-warp work.

If you are an accrual-basis taxpayer, the first and most critical step is the payment deadline. To claim a bonus deduction for the prior tax year, you must pay the bonus within 2½ months after that year closes.

For a business that follows the calendar year, this means the bonuses must be paid by March 15.

Note on Accounting: This strategy is exclusively for businesses that use the accrual method of accounting. If your business uses the simpler cash method (deducting expenses only when money leaves your bank account), you must deduct the bonus in the year it is paid, period.

Even if you pay on time, the IRS needs proof that you were legally obligated to pay that money before the old year ended. This is tested using the “all-events test,” which asks:

A key question with bonuses is whether the liability for the bonus was truly fixed by December 31. This is where many businesses stumble.

The Problem of the Contingency: Many common bonus plans state that an employee must still be employed on the payment date (March 15) to receive the money.

The Impact: If an employee leaves in January and forfeits their bonus, the total amount the company is liable for decreases. Because the final amount is contingent on future employment, the IRS argues that the liability was not fixed in the previous year. You lose the deduction until the year of payment.

To pass the all-events test, the liability must be made legally binding before the year is over. This means your governing body (like the Board of Directors) must formally authorize and fix the aggregate bonus pool amount before December 31. This action legally binds the company to pay the entire amount, regardless of employee departures.

Fortunately, you can often keep the annual deduction even if some employees might leave. The IRS allows you to accelerate the deduction with a carefully designed bonus pool arrangement.

Imagine the bonus pool is a pie:

The Key Rule: The size of the total pie must be fixed and must be fully consumed. If an employee leaves and forfeits their slice, that slice cannot revert to the company’s treasury. Instead, it must be reallocated and shared among the remaining eligible employees.

Because the total aggregate amount remains fixed and must be paid out—even if the recipients change—the liability is considered fixed by the end of the year. This protects your deduction while allowing flexibility for employee turnover.

All the rules above are irrelevant if the bonus is paid to a related party (such as a shareholder). This rule is a common issue for small business owners, where employees are often also owners of the business or related to the owners.

If the employee receiving the bonus is related to the business (usually by ownership), the deduction is automatically deferred until the year the employee receives the cash.

Impact on Families: If you are an S Corporation and pay a bonus to any shareholder, you cannot accelerate the deduction. The same restriction applies to majority shareholders (owning more than 50%) of C Corporations.

This critical distinction ensures that you cannot use this strategy to shift income and deductions purely for tax avoidance within your own ownership circle. For a family business, this rule often means the bonus accrual deduction is off the table entirely.

The rules for C Corps offer different advantages compared to S Corps. If you’re weighing the pros and cons of a transition, don’t miss our comprehensive breakdown: The Big Switch: Weighing the Costs of Converting a C Corp to an S Corp

Claiming this deduction early helps your cash flow right now. By lowering the taxable income for the previous year, you reduce or defer tax payments, putting capital back into your business today. That capital can be used to invest in growth, hire staff, or provide stability for your employees and their families, which benefits your entire community.

When you file your return, do you qualify for this tax acceleration? If you’re unsure, we can review your plan and ensure your bonus structure is optimized. If you didn’t qualify this time, we can help you set up a compliant plan this year so you’re ready to accelerate the deduction when you file next year.

Don’t leave valuable cash on the table. Every decision you make now impacts your family, your team, and your community. We specialize in tax strategies that keep more money working for your business.

Click here to explore our full range of tax planning and compliance services and schedule a consultation today.