Which payments are not deductible in the year of accrual and only taken as a tax deduction when paid, unless the payment is made within 2fi months following the year of accrual?

Question

Options

• ARetained earning
• BAccrued compensation
• CPaid-In capital
• DBond compensation

• A
  3% (1)
• B
  80% (28)
• C
  6% (2)
• D
  11% (4)

Explanation

Accrued compensation (B) is correct because under tax law's matching principle for related-party transactions, an accrual-basis employer cannot deduct compensation owed to cash-basis employees (who only recognize income when paid) until the payment is actually made - with one exception: if the payment is made within 2½ months after the close of the tax year, the employer may deduct it in the year it was accrued.

Why the distractors are wrong:

• A. Retained earnings is a stockholders' equity account representing accumulated undistributed profits - it is never a deductible expense.
• C. Paid-in capital represents shareholder investment in the company, an equity concept with no connection to deductibility rules.
• D. Bond compensation is not a recognized tax category; bond interest is generally deductible when accrued under normal accrual rules and does not carry the 2½-month payment requirement.

Memory tip: Think of the "2½-month safe harbor" as a grace period - the IRS gives accrual-basis employers a short window after year-end to actually pay accrued employee compensation and still claim the deduction for the prior year. Miss that window, and the deduction shifts to the year of actual payment.

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