Accruing a bonus at year end: the 180-day rule

Accruing a bonus at year end is one of the oldest tools in owner-manager tax planning. The corporation records the bonus as an expense in the year just ended, which reduces corporate taxable income for that year, and the money physically leaves the company in the following year. Done properly it is entirely legitimate. Done a week too late it costs you the deduction for a full year.

What the rule actually says

Subsection 78(4) of the Income Tax Act deals with unpaid employee remuneration. If an expense for salary, wages or other remuneration from an office or employment is still unpaid 180 days after the end of the tax year in which it was incurred, the amount is deemed not to have been an expense incurred in that year and is not deductible. If the amount is paid later, it is deemed to be an expense incurred in — and deductible in — the tax year in which it is actually paid.

In plain terms: pay it inside 180 days and the deduction stays where you put it. Pay it outside 180 days and the deduction slides forward to the year of payment. The CRA has also confirmed that a payment made on the 180th day counts as made within the time limit.

Why owners use an accrued bonus

There are three common reasons an owner-manager declares a bonus rather than simply leaving profit in the company:

• Bringing corporate income back under the small business limit. A bonus is deductible to the corporation, so it reduces active business income that would otherwise be taxed at the general rate.
• Creating RRSP room and CPP contributions. Salary and bonus are earned income for RRSP purposes; dividends are not. That trade-off is the heart of the bonus versus dividend decision.
• Timing personal income. The bonus is deductible to the company in the year accrued, but it is employment income to the recipient in the year it is received. That can shift personal income into a lower-income year.

Which of those matters most depends on your marginal rate, your RRSP plans and how much income the corporation is earning. Our salary versus dividends guide walks through the comparison.

What a properly documented accrual looks like

An accrual is only an expense if the corporation actually became liable for it by year end. A number typed into the trial balance after the fact is not a liability. Three things should exist:

1. A directors’ resolution or written authorization declaring the bonus, dated on or before the year end, naming the employee and the amount.
2. A recorded liability in the year-end accounts, usually accrued wages payable, that reconciles to the resolution.
3. Evidence of payment inside the 180-day window — a payroll register, the bank entry, and the source-deduction remittance.

Bonuses also have to be reasonable in the circumstances. In practice the CRA rarely challenges the reasonableness of remuneration paid to an active owner-manager of a Canadian-controlled private corporation, but a bonus paid to a family member who does no work for the business is a different matter. A bonus paid to a family member has to reflect work genuinely done for the business.

The payroll side people forget

The deduction date and the payroll date are not the same thing. The corporation deducts the bonus in the year of accrual, but the bonus is employment income to the employee in the year it is paid, and payroll obligations follow the payment:

• Source deductions — income tax, and CPP where applicable — must be withheld when the bonus is paid and remitted on the corporation’s normal remittance schedule for that period.
• The T4 slip reports the bonus in the calendar year of payment, which is often the year after the corporate deduction. See the slip filing deadlines.
• Cash has to be there. A bonus of any size can create a large withholding remittance in a single month.

A common mistake is to accrue the bonus, pay it within 180 days, and then forget to remit the withholding — which turns a clean planning move into a penalty.

What happens if you miss the deadline

Nothing dramatic happens automatically, which is exactly why it gets missed. The corporation must add the unpaid bonus back in computing income for the year of accrual, and claim it in the year of payment. The consequences are cash-flow ones: more corporate tax in the earlier year, possibly instalment interest if the earlier year’s tax was understated, and an amended return if the original one already claimed the deduction.

If the bonus was never really going to be paid, a cleaner alternative may be to leave the profit in the corporation and pay a dividend later, or to look at whether the money is already out through a shareholder loan.

A simple checklist

• Diarise the 180-day date the moment the resolution is signed.
• Do not schedule payment in the final week of the window.
• Confirm the corporation will have the cash for the bonus and the withholding.
• Keep the resolution with the year-end file, not loose in a drawer.
• Check the bonus against the rest of your year-end checklist before filing.

The 180-day rule is not complicated, but it is unforgiving. It is worth deciding on the bonus before the year end rather than three months after it, when the deduction is already committed and the deadline is running.

This article is general information, not tax advice for your specific situation. Tax rules and CRA administrative positions change — confirm anything that affects a decision with the CRA or with us first.