Vacation Pay and Unpaid Salaries

Regardless of your method of accounting, you can deduct only what you actually paid to your employees during your tax year.

If you're on the accrual method, you may be able to deduct vacation pay or unpaid salaries before the payment is actually made, so long as the employee's right to the payment is fixed and unconditional, and the employee has done the work on which the payment is based.

For example, if the employee's pay period ended on December 31 and your paychecks are issued a week later, you could deduct the amount for that last pay period of the year. Accrued vacation pay must be paid within two and one-half months to come under this rule.

There is an exception to the rule for employees who are related to you. If your 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 vacation pay or unpaid salaries in the year you pay it, after all.