Bonus Pay Assumed in Asset Sale

Technical topics regarding tax preparation.
#1
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S Corp with a 10/31/19 year end is the seller in a asset sale to close Dec 2019. Purchaser to assume non ownership bonus pay liability on date of asset sale that was due as of 10/31/2019 and will pay bonus inside 2 1/2 month window. Can seller deduct at 10/31/19 for tax purposes?
 

#2
Nilodop  
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Nope, fails economic performance test. See regs. 1.461-4(d)(5) and 1.461-4(g)(1)(ii)(C).
 

#3
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Cash Funds received by the seller will be reduced at closing date in December 2019 to cover bonus. Bonus will be paid later in month by seller. Sorry for the confusion, liability is not being discharged.
 

#4
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Or are you saying, seller should pay bonus out of own funds prior to close and not have it mixed in with Asset sale.
 

#5
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It's a liability being assumed by buyer, as you properly describe above.
Buyer will deduct the expense. I would assume proceeds to seller are decreased for this item. This is how the economics pan out for seller.
~Captcook
 

#6
Joan TB  
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Hasn't seller already deducted it when the liability was recorded?? So how would buyer ALSO be allowed the deduction? Are you saying that seller has to REVERSE the accrual so that buyer can deduct it? That is the only way it isn't "double-dipped". Are there rules that make this different from other liabilities - even though payment will occur within the 2-1/2 month window?
 

#7
Nilodop  
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Cash Funds received by the seller will be reduced at closing date in December 2019 to cover bonus. Bonus will be paid later in month by seller. Sorry for the confusion, liability is not being discharged.


So effectively seller is paying it twice? Once in a lower net sale price, again in cash?
 

#8
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No, buyer is paying after close with the funds. Hasty post, should have proof read. We are owed a deduction as some point, buyer is contractually obligated to pay it to employees. I was not sure if I could lean on 2 1/2 month rule when we are obligating purchaser to do.
 

#9
Nilodop  
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Why do the regs. I cite in #2 not apply to you?
 

#10
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I was not thinking that. I was thinking payment was the key and that was not correct given your cite.
 

#11
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I don’t follow the 1.461-4(d)(5) reference. Please explain. Why would that defer the deduction?
 

#12
Doug M  
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Give us the journal entry to record the sale of the business as if it was fully paid in cash in December 2019
 

#13
Nilodop  
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I don’t follow the 1.461-4(d)(5) reference. Please explain. Why would that defer the deduction?

Uh-oh, when this member asks an "innocent" question, it sometimes often usually almost always means he disagrees and is correct, so let me take another look.

OK, took said other look. I'm wrong, incorrect, and in error. Because the economic performance occurs, and therefore the bonus liability is incurred,
as the amount of the liability is properly included in the amount realized on the transaction by the taxpayer.
, which will be at the closing of the deal in December, 2019, just like it says in reg. 1.1001-2(a).

Give us the journal entry to record the sale of the business as if it was fully paid in cash in December 2019. OK, not sure why, but it's like this:
Dr cash 900
Dr accrued bonus 100
Cr sale price of business 1,000
 

#14
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OK, not sure why


I’m not either…

Let’s say price is $1k, all cash. But then seller says, I’d like you to assume $100 of accrued payroll. Buyer says okay. Price is still $1k, but only $900 will be paid in cash. Buyer does this: (1) debit assets $1k (2) credits payroll liability $100 (3) credits cash $900.

Seller – assuming accrual basis, which I believe he is in OP’s case - will have already debiting payroll expense $100 and credited payroll liability $100. As Nilodop says, seller’s entry to record the sale will be (1) debit cash $900 (2) debit payroll liability $100 (2) credit sale price of business $1k (i.e. the amount realized). With this last credit, we can see that the seller is including the assumption of the payroll liability, by the buyer, as an amount realized.

There is a lot going on with these entries and a lot of possibilities. The question is whether or not the seller can deduct his $100 payroll accrual. If he can, then this case is open and shut. If he can’t, then his initial accrual either wouldn’t be made or it would be made, but it would be an M1 adjustment since his accrued expense wouldn’t be deductible. In that case, I would call foul on the seller being forced to treat the payroll liability assumption as an amount realized. (And we wonder, for kicks and giggles, about a seller who is on the cash basis).

If we are talking about routine current year bonuses, that get paid within 2.5m months of year-end, this is not “deferred compensation” as we know that phrase. As such, the Sec 404 rules should not come into play. Now, if this is something like compensation earned in prior periods (i.e. phantom stock, stock appreciation rights, etc.), we have a problem, I do believe.

See PLR (or TAM) 8939002. This was issued before the Regs that Nilodop cited, but is nonetheless instructive.

And take a look at this one:

https://www.irs.gov/pub/irs-wd/0009013.pdf

I can’t say I agree with Conclusion #2.
 

#15
Wiles  
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Am I missing something here. If he accrues and deducts the $100 he has $1k gain on the $900. If he doesn’t he has a $900 gain on the $900. Either was there is a net of $900. One has $100 more capital gain.
 

#16
Nilodop  
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The pre-tax economics don't change. The type of taxable income does.
 

#17
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The type of taxable income does.


Exactly. That is known as the “character” of the income.

If you walk into a restaurant and the waiter says:

“Hey Jeff, do you want your usual - $900 LTCG? Or, would you prefer our special - $1,000 LTCG and a $100 ordinary deduction?”

I would pick the special…yummy.

This is why in these situations if a seller is cash basis and has accrued items he can’t deduct, or is accrual and has accrued items he can’t deduct…it makes more sense for the seller to pay them in cash before the transaction closes as opposed to having the buyer assume them. I say this despite Conclusion #2 in PLR 200009013.

In OP’s case, though, I think we are in agreement that he can deduct the accrual.
 

#18
Nilodop  
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Jeff-O has said he does not agree with conclusion #2 in the PLR. He implies that he still doesn't by saying despite Conclusion #2 in PLR 200009013.. So what is JeffO getting at?

I'd say he sees this reg quote in the PLR:
Pursuant to § 1.404(a)-12(b)(2) of the Income Tax Regulations, and provided that they otherwise meet the requirements for deductibility, contributions or compensation deferred under a nonqualified plan or arrangement are deductible in the taxable year in which they are paid or made available, whichever is earlier.
.

And the ruling describes the facts this way:
The Plan also provides that in the event of a sale or other change of control of X representing 80 percent or more of the Company’s outstanding voting shares, participants have the right to surrender all SAR’s immediately prior to the sale, at which time the SAR’s would otherwise terminate.
and this way:
Thus, as of June 15, 1999, all outstanding SAR’s had been awarded more than a year earlier and were therefore immediately exercisable. By resolution of the X Board of Directors, all SAR’s were deemed and treated as surrendered and all participants were paid for their SAR’s on the day immediately preceding the change of control: June 29, 1999. Participants will include the SAR payments in income for the taxable year ending December, 1999.
.

But the PLR also extracts this from the regs.
... a contribution paid or incurred with respect to a nonqualified plan, method or arrangement, providing for deferred benefits is deductible in the taxable year of the employer in which or with which ends the taxable year of the employee in which the amount attributable to the contribution is includible in the gross income of the employee.


So the older awards (SARs) were made available by terms of the plan on June 29, 1999, the last day of the S corp. year, and the Board confirmed that requirement in a resolution, and further even caused actual payment to be made on June 29, 1999.

Apparently that #2 conclusion is the result of an interpretation by IRS that, since the employees' taxable years end on Dec 31, 1999, the deduction has to be in the employer's taxable year ending on that date ("in which or with which ends the taxable year of the employee"). But Jeff must be saying that the June 29, 1999 year (an S corp. year) is also a taxable year of the employer ending in the employees' Dec 31, 1999 year, and it's the year when the cash was paid, so that's the correct deduction year.

As I said in my mea culpa post #13, Jeff-Ohio is almost always correct.

As an aside, is "made available" (in above context) the same as "constructively received"? (The plan says the employee can cash out commencing one year from the date of the award.) I think not.
 


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