Accrued expenses to Owner/Shareholder

[Snaggletooth]

It is my belief that for an accrual-based taxpayer, any expenses pertaining to the year in question may be accrued and deducted.

Except for expenses associated with a majority shareholder. For example, a bonus to the shareholder cannot be expensed unless actually paid by the end of the year.

I cannot support my position with Code/Regs. Can anyone help?

[kathyc2]

It would depend on the type of expense you are talking about. If the item would be taxable to shareholder such as payroll or rent, then no accrual. If it's a reimbursement for mileage and not income to shareholder, then it's fine. See IRC 267(a)(2).

[Roland Slugg]

As reported in another reply above, the law pertaining to your Q is Code §267(a)(2). The specific related taxpayers affected are listed in §267(b). There are thirteen of them listed, of which the one at §267(b)(2) is probably the most common of them all and the one you have in mind. Be sure to review the constructive ownership rules as well, listed in §267(c). There are also related Regs, but they say the same things the Code does.

The most common accrued but unpaid expenses are: (1) compensation, (2) rent, and (3) interest. It would be easy to focus on a large, year-end bonus payable to the 100% shareholder, and advise the company to be sure and pay it on or before the corporation's FYE. However, it might be easy to overlook the owner's normal salary for the last month or half-month of the fiscal year, including it right along with the other employees' accrued salaries/wages for that pay period. Most companies pay everyone once or twice a month, on a regular schedule, and the actual paychecks come out three to five days after each PP ends. A corporation with a FYE of, say, September 30th, might have accrued wages as of that date that were actually paid on October 5th. If the more-then-50% shareholder's salary is part of that routine, monthly accrual, then it's not deductible until the following fiscal year. It would be very easy to miss this, and I would speculate that it often is.

[Snaggletooth]

Good Responses

Thanks to Kathy and Roland. I have read 267(a)(2) and it seems to allow an accrual of expenses paid to a related party so long as the recipient can include the revenue in his(her) taxable year. Not sure this is the message Kathy and Roland are trying to get through to me.

I guess the most common case where this would NOT be allowed could be a corporate owner for a corporation whose year ends on December 31. A year-end bonus payable on January 10th would seemingly not be deductible because the owner would not have this on his W-2 until the following year.

Am I on the right track? Not sure I am...

[kathyc2]

Thanks to Kathy and Roland. I have read 267(a)(2) and it seems to allow an accrual of expenses paid to a related party so long as the recipient can include the revenue in his(her) taxable year. Not sure this is the message Kathy and Roland are trying to get through to me.

I guess the most common case where this would NOT be allowed could be a corporate owner for a corporation whose year ends on December 31. A year-end bonus payable on January 10th would seemingly not be deductible because the owner would not have this on his W-2 until the following year.

Am I on the right track? Not sure I am...

Yes. Like Roland pointed out, it's not just bonus but regular payroll. From an accounting perspective, you can handle accrued payroll a couple of different ways. On the books you can accrue all payroll and then make a M1 adjustment for the shareholder/related party portion of the accrual. Or, if financial statements are on OCBOA- tax basis, you can just ignore accruing the shareholder/related party portion.

Another thing to look out for is if accounts payable has anything for the shareholder. If it does, and it would be income to shareholder such as rent, you need to either back it out or make a M1 adjustment.

[Roland Slugg]

Not sure this is the message Kathy and Roland are trying to get through to me.

Am I on the right track? Not sure I am...

No, Snagg, I don't think you understand it correctly yet. Perhaps the easiest way to remember this is that accrued but unpaid expenses, that will be reported as income by a cash-basis, over 50% shareholder only when received by him, are not deductible by the corporation until the day they are paid. And that day can not be in a recently ended fiscal year, even if paid on the first day of the new fiscal year. For such expenses the accrual-basis corporation is treated as if it is on the cash basis.

For example, Corp X has on its books as of its 9/30/2016 FYE the following expenses due to S, who owns (directly or via the §267(b) and (c) related party rules) more than 50% of X's shares: Accrued salary of $10,000 for the month of September 2016, an authorized bonus of $50,000, $5,000 rent for the month of September of the building owned by S and occupied by X, and one year's interest of $8,000 on a $200,000 note representing a loan from S to X. The salary is paid to S on October 5, 2016 right along with all other X employees via the payroll run covering the month of September; the rent is paid on October 10, 2016 as part of the monthly accounts payable run; the interest is paid on October 25, 2016; and the $25,000 bonus is paid on December 5, 2016 along with bonuses for several other key employees for whom bonuses were authorized and accrued as of the September 30, 2016 FYE. None of the four payments to S described above can be deducted by X until its fiscal year beginning on October 1, 2016 and ending on September 30, 2017.

Seem harsh? Yes, it is, but there is an easy way to deal with it without having to make a special, early payroll run just for the owner or pay the other amounts on a special, early day. Corp X just needs to issue a promissory note on (or before) 9/30/2106 for the accrued amounts. Payments by the issuance of a promissory note constitute receipt by the payee and, thus, are taxable to him on the date the note is issued. The note should be a real, printed, signed document, but all the payments can still be made in their usual way and at their normal times. The recording of the note and the satisfaction thereof via the various payments can then simply be recorded on the company's books via journal entries.