Accrued Bonus 2.5 Month Rule: Deadlines, Related Parties, and 409A

The accrued bonus 2.5 month rule lets an accrual-basis business deduct a year-end bonus in the year it was accrued, but only if the employee actually receives payment by the 15th day of the third month after the tax year ends. For a calendar-year company, that means March 15. Pay one day later, and the deduction shifts to the following year.

The rule sits in Section 404 of the Internal Revenue Code, and it applies to every accrued employee bonus. A separate matching rule under Section 267 adds another layer when the bonus goes to an owner, a family member, or another related party.

How the Deadline Works

Section 404 treats a bonus accrued in one year and paid in the next as deferred compensation, which would normally be deductible only in the year the employee reports it as income.¹ The 2.5 month window is the exception. Treasury Regulations carve out bonuses paid by the 15th day of the third calendar month after the employer’s tax year closes, so the accrual-year deduction survives.

For a December 31 year-end, the deadline is March 15. For a June 30 fiscal-year entity, it’s September 15. The deadline is rigid. There is no extension, no reasonable-cause exception, and no rounding. A bonus accrued on December 31, 2025, and paid on March 16, 2026, cannot be deducted in 2025.

The Liability Has to Be Fixed Before Year-End

Meeting the payment deadline only matters if the accrual itself holds up. An accrual-basis taxpayer can deduct a bonus for the year only when the liability is fixed and the amount can be determined with reasonable accuracy by the last day of that year. The IRS calls this the all events test.² Economic performance must also have occurred, meaning the employee has already done the work.³

Two bonus structures typically satisfy the fixed-liability requirement:

A bonus calculated by a formula set before year-end using that year’s financial results, even if individual allocations happen later.
A board or compensation committee resolution before year-end that commits the company to pay at least a specified total amount to a defined group of employees.

In Revenue Ruling 2011-29, the IRS confirmed that an employer’s liability was fixed at year-end where the bonus pool could not revert to the company. Individual recipients were not identified until after December 31, but the minimum total payout was locked in by a pre-existing formula, and any amount forfeited by a departing employee was reallocated to others in the group.⁴

A purely discretionary bonus, where management can decide after year-end to pay nothing, fails the test. Without a formula or a binding commitment by December 31, the liability isn’t fixed and no current-year deduction is available regardless of when the check goes out.

The “Still Employed” Trap

Most accrued bonus deductions fall apart on this one clause. Many plans require the employee to be on the payroll on the payment date to receive the bonus. That contingency prevents the liability from being fixed at year-end, because the employer doesn’t yet know whether it owes anything. In Chief Counsel Advice 200949040, the IRS concluded that a plan conditioning payment on continued employment through payout means the liability only becomes fixed when the employee satisfies the condition, which is after year-end.

A plan can survive the trap by reallocating any forfeited amount to other eligible employees, keeping the total pool intact, as Revenue Ruling 2011-29 confirmed.⁴ A plan where forfeited amounts revert to the company cannot. If your plan has a continued-employment condition and no reallocation mechanism, the deduction gets pushed to the payment year even if you pay before March 15.

What “Actually Received” Means

Section 404(a)(11) sets a standard that surprises some employers: no amount is treated as paid until the employee actually receives it.¹ Constructive receipt does not count. That’s the opposite of the usual rule for cash-method income recognition, where funds credited to an account or made available for withdrawal can be treated as received.⁵

Recording the bonus on the books, crediting it internally, or cutting a check that sits in a drawer won’t satisfy the deadline. The employee needs the funds in hand or in their account. A check mailed close to March 15 that arrives on March 16 loses the accrual-year deduction. Direct deposit or wire transfer with a clear record of the settlement date is the safest way to prove timely receipt.

Related-Party Bonuses Face a Second Rule

Section 404 applies to every accrued bonus. When the recipient is a related party using the cash method of accounting, Section 267(a)(2) adds a matching requirement: the payer’s deduction is allowed only in the year the recipient includes the payment in income.⁶ The deduction and the income inclusion have to land in the same tax year.

For a calendar-year business paying a bonus to a related cash-method owner, both rules line up when payment happens by March 15. Miss that date, and Section 404 reclassifies the bonus as deferred compensation while Section 267(a)(2) independently blocks the deduction until the owner actually reports the income.

Who Is a Related Party

Section 267(b) lists the relationships that trigger the matching rule:⁶

An individual and their spouse, siblings (including half-siblings), parents, grandparents, children, and grandchildren, with legally adopted family members counted.
An individual and a corporation when the individual owns, directly or indirectly, more than 50% of the stock by value.
Two corporations in a controlled group, generally linked by 80% or greater common ownership.
A partnership and any partner who owns more than 50% of the capital or profits interest.
A personal service corporation and any employee-owner, regardless of ownership percentage.

Constructive Ownership Can Pull You In

You don’t have to hold the stock personally to be treated as an owner. Section 267(c) attributes ownership between family members and through entities, and attributed ownership then counts as actual ownership when applying the family attribution rules.⁶

Take a corporation owned 30% by a father and 30% by his daughter. Neither owns more than 50% outright. But each is treated as constructively owning the other’s stake through family attribution, putting both at 60% and making both related parties under Section 267(b)(2). Closely held businesses often cross the threshold this way without noticing.

Missing the Deadline

The Deduction Moves to a Later Year

Blowing past March 15 doesn’t kill the deduction permanently. It shifts under Section 404(a)(5), and the employer can deduct the bonus only in the year the employee receives it and reports the income.¹ A $50,000 bonus accrued on December 31, 2025, but paid in April 2026, becomes a 2026 deduction. A full year of tax benefit is lost.

The Employee May Owe a 409A Penalty

The employer’s timing problem is only half of it. A bonus paid outside the 2.5 month window may also fall under Section 409A’s rules for nonqualified deferred compensation. Treasury Regulations provide a short-term deferral exception for compensation paid by the 15th day of the third month after the year in which the right to payment is no longer subject to a substantial risk of forfeiture.⁷

Miss that window without a 409A-compliant plan, and the consequences hit the employee. The deferred amount is immediately includible in gross income, plus a 20% additional tax, plus an interest charge at the underpayment rate plus one percentage point running back to the year the compensation was first deferred.⁸ A late bonus can convert a routine payment into a tax penalty for the person who earned it.

Documentation That Backs Up the Deduction

An examiner reviewing a year-end bonus accrual will want to see the liability was fixed before December 31 and that payment cleared before the 2.5 month deadline. Useful records include:

A board resolution or written formula adopted before year-end showing the total pool, the calculation method, or a minimum committed amount that cannot revert to the company.
Plan terms that either omit any continued-employment condition or include a reallocation provision sending forfeited amounts to other eligible employees.
Bank records, direct deposit confirmations, or cleared-check dates showing the funds reached each recipient by the deadline. A payroll processing date alone won’t do it if the money wasn’t available to the employee by March 15.
Workpapers matching each accrued amount to the corresponding payment, recipient, and date.

Two related points sit alongside the timing rule and are worth knowing. Bonuses are supplemental wages subject to federal income tax withholding, Social Security, and Medicare tax when paid, so withholding lands in the quarter of payment rather than the quarter of accrual.⁹ And for closely held businesses paying owner-employees, the bonus must still qualify as reasonable compensation under Section 162. Meeting the March 15 deadline preserves the timing of the deduction, but it doesn’t shield an amount that is excessive for the services performed.

1
Office of the Law Revision Counsel. 26 USC 404 – Deduction for Contributions of an Employer
2
Internal Revenue Service. Publication 538 (01/2022), Accounting Periods and Methods
3
Office of the Law Revision Counsel. 26 USC 461 – General Rule for Taxable Year of Deduction
4
Internal Revenue Service. Revenue Ruling 2011-29
5
eCFR. 26 CFR 1.451-2 – Constructive Receipt of Income
6
Office of the Law Revision Counsel. 26 USC 267 – Losses, Expenses, and Interest With Respect to Transactions Between Related Taxpayers
7
eCFR. 26 CFR 1.409A-1 – Definitions and Covered Plans
8
Office of the Law Revision Counsel. 26 USC 409A – Inclusion in Gross Income of Deferred Compensation Under Nonqualified Deferred Compensation Plans
9
Internal Revenue Service. Publication 15 (2026), (Circular E), Employer’s Tax Guide