Bonus before 15 March could maximise US tax benefit
January is an opportune time for businesses with either a US presence, US shareholders or US employees to consider how to maximise their tax position. The US Internal Revenue Service (IRS) generally allows business tax returns to be prepared on the cash or the accruals basis. However, one notable exception is the deductibility of payroll expenses for accrued basis taxpayers. As well as payroll amounts relating to the prior calendar year needing to be paid out within 2.5 months of the end of the accounting period, i.e., by 15 March to be allowable tax deductions against net profits of that year, they must also be ‘earned’ by the end of the calendar year and not dependent on subsequent events.
From the perspective of a US employee, where they are to receive deferred US-sourced compensation, it is important to ensure they do not fall foul of Section 409A of the Internal Revenue Code. These rules regulate the taxation of non-qualified deferred compensation and can be penal with additional taxes, interest and penalties. As well as being expensive for the employee, this can also be punitive to the employer even if they were unaware of their obligations and failed to report. The rules can be sidestepped by ensuring that deferred compensation, such as a bonus, is paid by 15 March, so long as the plan either requires payment within this window or is silent on timings.
Getting a bonus by 15 March could help motivate employees but there will be a matching cash flow disadvantage to the employer in bringing forwards a cash payment. However, in an owner-managed business with no other employees, this could net out. A notable advantage will be to simplify the employee’s tax reporting, eliminating the need for detailed calculations and reporting requirements associated with deferred compensation plans, streamlining the overall tax process for both the employee and the employer.
If you would like to know more about maximising tax benefits in the US, feel free to contact our international tax director Kelly Ricketts.