Question

1. Kalvin, a cash basis taxpayer, is a 75% owner and president of Falcon Fish Market. Falcon, an S corporation, uses the accrual method of accounting. On December 28, 2019, Falcon accrues a bonus of $40,000 to Kalvin. The bonus is payable on February 1, 2020.

1. When is the bonus deductible?

2. How would your answer change if Falcon is a cash basis taxpayer?

Answer 1

a. Generally, an accrual basis corporation can deduct an expense in the tax year in which the payment is made to a cash basis tax payer. However, because Kalvin and Falcon are related parties, Falcon must wait to deduct the expense until 2020, the tax year Kalvin records the bonus as income. Falcon can deduct the expense on its tax return for the year ended 31 December, 2020 and Kalvin will record the bonus as an income on his 2020 tax return. Note that the effect of the related party rule is to always have the income and the corresponding deduction reported in the same year.

b. If both Kalvin and Falcon are cash basis tax payers, then Falcon will deduct the bonus when it is paid in 2020 and Kalvin will record the bonus as income in 2020.