Awards and Bonuses

You can deduct the cost of any bonuses you pay to your employees, as long as the bonus represents pay for services rather than a gift, and it's reasonable in view of the employee's services and performance.

If you're a cash method taxpayer, you must have paid the bonus before the end of your tax year in order to deduct in that year; for example, you'd have to have paid the bonus by December 31, 2013, in order to deduct it in 2013.

If you're using the accrual method, you can deduct the bonus for 2013 as long as you established the total amount of bonuses to be paid and the employee's right to the bonus before the end of the year. You do not need to have determined the specific amount that each employee will receive as long as the right to receive the bonus and the total amount to be paid is determined before year-end.

However, don't delay too long. If a bonus is paid more than two and one-half months following the close of the employer's tax year in which it was earned, it is presumed to have been paid under a deferred compensation plan or arrangement. Unless the presumption is rebutted, it may not be deducted until it is actually or constructively paid. Therefore, it may not be deducted by an accrual-basis taxpayer in the year in which it was earned.

Warning There is an exception to the accrual bonus rules for related taxpayers. If your bonus-achieving employee is your spouse, child, brother or sister, parent or grandparent, you may only deduct the payment in the year in which the employee reports the payment as income. This means that if the recipient is using the cash method (as most individuals do), you may only deduct the bonus in the year you pay it, after all.

Awards. Employee achievement awards of tangible personal property that are awarded to an employee because of the employee's length of service (including retirement), productivity, or safety achievement, made under a written plan that does not discriminate in favor of highly compensated employees, and which average $400 or less during the year, are deductible as "qualified" plan awards.

Other awards are considered "nonqualified." No more than $1,600 in total awards, both qualified and nonqualified, can be deducted for any one employee per year.