Disputed Employee Benefit Deductions IRS Offers Settlement

The IRS has issued a settlement initiative covering audit disputes for certain accelerated deductions claimed by employers for accrued employee benefits. This includes vacation pay and severance pay for tax years ending on or before July 22, 1998. Under this settlement program, employers generally will be able to deduct half the expenses in the tax year they originally claimed them and the remaining half in the year the benefits were paid or were able to be included in the employees’ incomes.

Offer involves vacation and severance pay.
The audit issue involves deductions taken by employers for benefits, like vacation or severance pay, that employees may earn in one year but receive in a later year. Tax regulations generally consider vacation pay to be deferred compensation that is deductible by employers in the year paid to the employees. Other benefits may be deducted by an employer in the year they are able to be included in the employee’s income. However, the regulations provide an exception that allows employers to deduct accrued benefits received by employees within 2 1/2 months of the end of the year in which the benefits are earned.

Prior to July 22, 1998, companies sometimes purchased letters of credit, bonds, or other financial instruments to fund the payment of vacation and severance benefits within 2 1/2 months after the close of the tax year, and then claimed deductions for the accrued benefits. The Tax Court, in Schmidt Baking Company v. Commissioner, upheld such a deduction. The IRS Restructuring and Reform Act of 1998, which overruled the result in Schmidt Baking, disallows the deductions for tax years ending after July 22, 1998, but left unresolved outstanding audit disputes for earlier tax years.

Take advantage of the settlement program.
Employers currently under audit on this issue who are interested in accepting the IRS offer should contact the IRS agent handling their audit by October 1, 1999. The IRS advises employers that are not now being audited, but that are concerned that this could be an issue for them, to refer to the revenue procedure for specifics on taking advantage of this settlement initiative.

Cite: IRS Rev. Proc. 99-26, CCH Employee Benefits Management 475,178.

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