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DEDUCTING ACCRUED SALARIES - THE DO'S AND DON'TS

January 26, 2004

A quick overview: taxpayers can deduct accrued employee compensation within 2 1/2 months after the end of the tax year, except when they can't, unless they are cash basis taxpayers, when they can't anyway, or unless they are accrued to related parties, for which they have to be on a cash basis.

Got that? OK, we can't blame you; let's take it a bit slower.

RULES FOR NON-RELATED PARTIES

Accrual-basis taxpayers can normally deduct salaries accrued at year-end if they are paid within 2 1/2 months. If salaries are paid later than 2 1/2 months after year-end, they are only deductible when paid. Among the common items affected by this are bonus plans and accrued vacation pay arrangements.

RELATED PARTIES

If compensation is accrued to a "related" individual, the deduction can only be taken in the year the compensation is actually paid. For this purpose, "related" means:

C CORPORATIONS: 50% owners and their siblings, spouses, ancestors and lineal descendants.

S CORPORATIONS AND PARTNERSHIPS: Any owners, and their siblings, spouses, ancestors and lineal descendants. Oh, and their sublings, spouses, ancestors and lineal descendants, too.

"Attribution" rules can limit deductions further - for example, if you own a trust that owns corporate stock, you may be considered "related" for these purposes.

CASH BASIS?

Cash basis taxpayers don't have to worry about this sort of complication; if it hasn't been paid, it's not deductible.

WHAT ABOUT QUALIFIED PLAN CONTRIBUTIONS?

That's a different matter. Both cash-basis and accrual-basis taxpayers can deduct qualified plan contributions for a year that are paid by the due date of that year's tax returns. You can give yourself more time to pay the plan contribution simply by extending the return. Be careful if you do this - if you file an extension, you need to file the extended return after its original due date or the extension may be invalidated.

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