Deducting accrued vacation pay not paid.

Kiplinger Tax Letter, The, November, 1996

Firms can deduct accrued vacation pay before actually paying it. A firm bought an irrevocable letter of credit to cover vacation pay owed at end of prior year...did so within 21/2 months after end of the tax year. Deducted vacation pay on that year's return...not yet paid to employees.

Tax Court allows deduction because the letter of credit was bought within 21/2 months after the tax year ended (Schmidt Baking, 107 TC No. 16).

Employees probably are taxed in year letter of credit is bought, even if paid in a later year. IRS says employees are taxed...pay is added to W-2s. Indeed, the IRS also is likely to insist that withholding occur within the 21/2 months. Tax Court didn't say, but hints it agrees with IRS.