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.
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