Ask the Experts!

The professionals at Advanced Underwriting Consultants (AUC) answer the tax questions posed by producers.  Here’s the question of the day.

Question: Is there a maximum amount a business can spend on an executive bonus plan?

Answer: Yes, if the business wants to deduct the bonus as a business expense.  The statutory source for the executive bonus plan idea is Revenue Code Section 162, which reads as follows:

Sec. 162. Trade or business expenses

    (a) In general

      There shall be allowed as a deduction all the ordinary and

    necessary expenses paid or incurred during the taxable year in

    carrying on any trade or business, including -

        (1) a reasonable allowance for salaries or other compensation

      for personal services actually rendered;

The IRS has consistently ruled that the compensation package as a whole for the participating executive must be reasonable based on the executive’s actual duties for the company.  How does the IRS decide whether a compensation package is reasonable?  It looks to what employees at similar companies get in compensation for comparable jobs.

Is it possible to predict with 100% certainty in advance whether the IRS will view a compensation package—including a bonus element—as reasonable?  No.  However, based on case law, the IRS generally takes a common sense approach to the issue.  For example, if a company pays $500,000 a year to a part-time janitor, it seems likely that the compensation will be considered excessive, and at least some of the deduction for compensation would be disallowed.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day.