Accruing expenses at year-end: the tax rules and compliance steps
An expense you owe on December 31 is not always deductible for that year. For accrual-basis taxpayers two tests must be met, and some amounts owed to owners are deductible only when they are paid. Here is the checklist.
Prepared by Prem Tax and Accounting Corp. Last checked against official sources on October 21, 2026.
Who this applies to
This page is for businesses that use the accrual method (or a hybrid that accrues expenses). If you use the cash method, you deduct an expense when you pay it. A cash-method payment made in advance is generally deductible only in the year it applies to, unless it qualifies for the 12-month rule: it must not create a benefit that lasts beyond the earlier of 12 months after the benefit begins or the end of the next tax year.
The two tests
- The all-events test: all events have occurred that fix the fact of the liability, and the amount can be figured with reasonable accuracy.
- Economic performance: the goods or services have actually been provided to you, or the property has actually been used.
| Kind of expense | When economic performance generally occurs |
|---|---|
| Services you receive | As the services are performed |
| Goods you buy | As the goods are provided to you |
| Rent and use of property | As you use the property |
| Interest | As time passes, not when paid |
| Pay to employees | As the employee does the work (subject to the deferred pay rules below) |
| Income, property and employment taxes | Generally when paid (you can elect to treat taxes as a recurring item) |
| Workers' compensation, tort liabilities, insurance, warranty and service contracts, refunds and awards | As you make the payments |
The recurring-item exception (8½ months)
A recurring expense can be treated as incurred in the year the all-events test is met, even though economic performance comes later, if all of these are true:
- Economic performance occurs by the earlier of 8½ months after year-end or the date you file a timely return (with extensions).
- The item is recurring in nature, and you treat similar items the same way every year.
- The item is not material, or accruing it in the earlier year gives a better match against income.
- It is not a workers' compensation or tort liability.
Example: you receive office supplies and the bill in December and pay in January. You can deduct them for the earlier year, because the liability was fixed and the supplies were provided in December.
Year-end bonuses and vacation pay
- Bonuses: an accrued bonus to an employee can be deducted for the year it was earned if it is fixed by year-end and paid within 2½ months after year-end (by March 15 for a calendar-year employer). Paid later, it is treated as deferred pay and deducted when paid.
- Vacation pay: deductible for the year earned if you pay it during the year or, if it is vested, within 2½ months after year-end. Paid later, deduct it in the year you pay it.
- Payroll taxes follow the pay. The employee reports the bonus in the year it is paid.
Owners and related parties: the trap
Business expenses and interest owed to a related person who uses the cash method are not deductible until you pay them and the person includes the amount in income. For an S corporation, any person who owns any of its stock is treated as related. The relationship is tested at the end of the tax year.
- An S corporation that accrues a year-end bonus, salary, rent or interest to a shareholder cannot deduct it until it is paid, even if it is paid within 2½ months.
- To deduct an owner's bonus for the year, pay it by December 31, through payroll.
- The same rule can apply to family members and other entities you own.
Example (numbers made up)
An accrual-basis S corporation declares two bonuses on December 20: $20,000 to the owner-employee and $5,000 to a non-owner employee. The owner's bonus is paid January 10 and the employee's bonus is paid February 15.
| Bonus | Deductible for | Why |
|---|---|---|
| Owner-employee, $20,000, paid January 10 | The year it is paid | The owner is related to the S corporation, so the deduction waits for payment. Paid by December 28, it would have been deductible for the year earned. |
| Non-owner employee, $5,000, paid February 15 | The year it was earned | It was fixed by year-end and paid within 2½ months (by March 15). |
Compliance checklist
Cut off the year
Record goods and services received and sales delivered by year-end. Use dated documents: receipts, delivery slips and contracts.
Support each accrual
Keep the invoice, contract or board resolution, and the calculation. A bonus needs a decision made by year-end with a fixed amount or formula.
Find owner and family accruals
List amounts owed to shareholders, family members and related entities. Pay by year-end or accept that the deduction waits.
Test economic performance
For each item ask: were the services performed and the goods delivered by year-end?
Document recurring items
Apply the recurring-item rule consistently, and keep proof of the later payment or performance within 8½ months.
Check the follow-up
In January, confirm that accrued bonuses and vacation pay were paid by March 15 and that accrued items were performed.
Report by payment date
W-2 wages and Form 1099-NEC amounts are for payments made in the calendar year, not accrued amounts.
Keep the same method
Use the same method every year. Changing it needs Form 3115. See accounting methods.
Common questions
Can I deduct a December bill that I pay in January?
On the accrual method, yes, if you owed it by year-end and the goods or services were provided by year-end (or the recurring item rule applies). On the cash method, no: you deduct it when you pay it.
What is the March 15 date for bonuses?
It is the 15th day of the third month after your year-end. For a calendar-year employer that is March 15. Compensation paid after that date is presumed to be deferred compensation, so the accrued deduction is generally not allowed for the year earned.
Can my S corporation deduct a year-end bonus for me?
Only when it is paid. Amounts an S corporation owes to a person who owns any of its stock are deductible only in the year they are paid and included in that person's income. So pay the owner's bonus by December 31 if you want the deduction for the year.
Do I have to accrue expenses?
Only if you use the accrual method (or a hybrid that accrues expenses). Cash-method businesses deduct expenses when paid.
Do my W-2s and 1099s follow the accrual dates?
No. Wages and payments to contractors are reported for the calendar year in which they are paid, not the year they were accrued.
Official sources
- IRS Publication 538: Accounting periods and methods
- Treasury Regulation 1.404(b)-1T (the 2½-month period)
- Internal Revenue Code section 267 (related persons, including S corporation shareholders)
- IRS: Form 1099-NEC and independent contractors (FAQ)
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