Tax Connections Newsletter – Winter 2024
Robert Swenson

Can You Deduct 2024 Bonuses This Year?

You may be familiar with the rule that permits a business to deduct employee bonuses this year if it pays them within 2½ months after the end of the tax year. It is an attractive year-end planning technique that benefits your business and your employees: You enjoy a tax deduction this year, while your employees need not report the income until next year.

These tax benefits are not always available, however, so it is important to understand the requirements. Here is a quick review.

Accrual-basis taxpayers only; no related parties

If your business uses the cash method of accounting, you must deduct bonuses in the year they are paid, even if they are earned in the previous year. To accelerate bonus deductions into this year, your business must be on the accrual method of accounting.

Favorable tax treatment is limited to bonuses paid to unrelated parties. For a corporation, a related party is an individual who owns more than 50% of the company. For S corporations, partnerships and limited liability companies, related parties include any of their shareholders, partners or members.

Fixed and determinable

Even if the first two requirements are met, you cannot deduct a bonus this year unless it is fixed and determinable as of December 31. Generally, this means that:

  • The recipient has earned the bonus;
  • All events have taken place that establish the company’s liability to pay it; and
  • The amount of the bonus can be determined with reasonable accuracy.

Many companies get tripped up by the “fixed and determinable” requirement because their bonus plans condition payment on the recipient’s continued employment through the payment date. If employees who leave the company before the payment date forfeit their bonuses, the company’s liability is not established by year end.

There may be a way to avoid this problem, however. Under IRS guidance, it is possible to deduct bonuses earned this year, even if there is a risk of forfeiture. The solution can be to use a properly designed bonus pool. For this strategy to work, the aggregate amount in the pool must be fixed by the end of the year. Additionally, any forfeited bonuses must be reallocated among the remaining employees.

Handle with care

If you wish to accelerate deductions for bonuses paid next year, consult your CPA to make sure that you meet the requirements. It is critical to design your bonus plan carefully to avoid any language that suggests bonuses are not fixed by the end of the year, such as retaining discretion to modify or cancel them or conditioning payment on board approval.

Are New Business Start-Up Costs Deductible?

If you started a new business during the COVID-19 pandemic, you are not alone. According to U.S. Census Bureau data, from 2019 to 2022 new business applications increased by 44%.

Many of these businesses were formed by people who found themselves unemployed in the early months of the pandemic or by entrepreneurs who saw business opportunities in the remote working environment. Although the surge has leveled off a bit, the current rate of new business creation remains substantially higher than before the pandemic.

Starting a new business is not cheap, and many expenses are incurred long before the business officially opens. Here are answers to frequently asked questions about deducting start-up costs for federal income tax purposes.

What are start-up costs?

Start-up costs include those incurred:

  • In connection with creating an active trade or business; and
  • In investigating the creation or acquisition of an active trade or business.

Generally, start-up costs are capital expenses that cannot be recovered until you sell or otherwise dispose of the business — although the cost of certain assets may be recovered through depreciation. However, you can elect to deduct up to $5,000 in eligible start-up costs after the business is up and running and amortize any remaining start-up costs over 180 months (15 years).

Note that the $5,000 deduction is reduced dollar-for-dollar (but not below zero) to the extent that your total start-up costs exceed $50,000. For example, if you have $53,000 in eligible start-up costs, you can deduct $2,000 in the year the business goes active. The remaining $51,000 must be amortized over 15 years. If your eligible start-up costs are $55,000 or more, you must amortize the full amount.

What can be deducted or amortized?

Start-up costs qualify for deduction/amortization if they would be currently deductible as business expenses by an active business and are paid or incurred before your business becomes active. Eligible costs include amounts paid for:

  • Researching potential markets, products, labor supplies and transportation facilities;
  • Advertising the opening of your business;
  • Wages for employees being trained, as well as for instructors;
  • Travel and related expenses for finding customers, suppliers and distributors; and
  • Fees for consultants or other professional services.

Eligible start-up costs do not include interest expense, taxes, or research and experimental costs (although these costs may be recovered under separate tax code provisions). Also, if you are acquiring an existing business, deductible/amortizable start-up costs are limited to costs associated with a general business search or with a preliminary investigation of a target business to decide whether to purchase it. Costs incurred in connection with purchasing a specific business are capital expenses.

Keep in mind that expenses that would not otherwise be currently deductible by an active business — such as the cost of real estate, equipment, furniture or other depreciable assets — are not considered start-up costs.

When can you take the deduction?

You can deduct start-up costs on your tax return for the year in which the business becomes active. Amortization begins in the month the business becomes active.

Under current rules, the election to deduct/amortize start-up costs is deemed to be made automatically. However, you can affirmatively opt out and elect to capitalize these expenses.

Are organizational costs deductible?

The costs associated with organizing a corporation or partnership are not considered start-up costs. However, similar rules apply.

Indeed, you can elect to deduct up to $5,000 in qualifying organizational costs in the year your business becomes active, reduced to the extent your total organizational costs exceed $50,000. As with start-up costs, nondeductible organizational costs may be amortized over 180 months.

What if you are unsuccessful?

If you fail to acquire or launch a business, investigative costs associated with evaluating investment options or identifying potential targets are considered nondeductible personal expenses. Costs associated with starting or acquiring a specific business, however, may be deducted as capital losses.

Get a head start

If you are starting a new business, learn which start-up costs are deductible or amortizable. That way, you will be ready to claim those costs once your business opens its doors. Your tax advisor can help with the details.

For more information, contact Rob Swenson at [email protected] or 312.670.7444. Visit ORBA.com to learn more about our Tax Services.

Forward Thinking