Give Back That Bonus!
Oh, and by the way, you still owe taxes on it.
So, you still work for AIG, having decided not to desert a sinking ship. For this you received a retention bonus, but the politicians have decided to make a scapegoat out of you. Last week the House passed a bill that would tax your bonus at 90%--which, since you live in high-tax New York City, means you'd end up paying more than 100% when you add up all the taxes. In McCarthyite fashion, your state attorney general, Andrew Cuomo, says he has a list of names, as the Washington Post reports:
New York Attorney General Andrew M. Cuomo had subpoenaed AIG for a list of Financial Products employees and how much money each had received.
Now, the firm's chief operating officer, Gerry Pasciucco, had set a 5 p.m. Monday deadline for staffers to indicate whether they planned to return their retention payments, and if so, what percentage. His e-mail included what appeared to be a tacit ultimatum from Cuomo.
"We have received assurances from Attorney General Cuomo that no names will be released by his office before he completes a security review which is expected to take at least a week," Pasciucco wrote."To the extent that we meet certain participation targets, it is not expected that the names would be released at all."
In light of all this, you do the right thing and give the bonus back.
That's the upshot of blogger Richard Belzer's analysis of the tax implications of giving back a bonus.
The good news is that the House bonus-confiscation bill specifically excludes "any amount if the employee irrevocably waives the employee's entitlement to such payment, or the employee returns such payment to the employer, before the close of the taxable year in which such payment is due," provided that the employee does not receive "any benefit from the employer in connection with the waiver or return of such payment."
That means you won't be taxed at 90% on the money you held only briefly. But you will be taxed. As Belzer explains:
All compensation, including the retention bonuses, received by employees for services is included in the recipient's gross income, and in determining his adjusted gross income (AGI). If a bonus recipient gives it back, does the bonus vanish from the employee's income?
No. Because the recipient was entitled to receive the amount of the bonus, and actually received it, it cannot be excluded from gross income or AGI.
This is true under existing law, irrespective of whether the House-passed bill is ever enacted. Belzer notes a couple of ways in which you may be able to reduce the tax on your relinquished bonus:
A recipient could donate all or a portion of the bonus to charity. The amount donated would be deductible on the employee's 2009 return to the extent it does not exceed 50% of his AGI (as increased by the amount of the bonus). Any excess may be carried over and deducted in the succeeding 5 years, always subject to the 50% limit.
This may work if the law doesn't change, but the House bonus-confiscation bill makes no provision for deductions, so if it becomes law, a bonus donated to charity would still be taxable at 90%. Giving the money to charity instead of returning it to AIG would also seem to constitute a refusal of Cuomo's offer you can't refuse.
Another option may be to deduct the amount of the bonus returned to the employer as an unreimbursed business expense, incurred to avoid litigation or public disparagement that could harm the employee's current or future employability. Understandably, the instructions for IRS Form 2106 do not address a situation like this, and it is entirely possible that it has never previously occurred.
Assuming that the IRS were to agree, then the employee would be able to deduct the portion of the bonus exceeding 2% of AGI (again, as increased by the amount of the bonus). The proportion of the bonus that would be deductible depends on the relative size of the bonus to total AGI. No matter the ratio, the employee's tax bill would go up in proportion to the size of the bonus even though he did not keep it.
But wait. Because you're "rich," you don't get to deduct all your deductible income:
Regardless of whether a bonus recipient donates the money to charity, or claims a deduction for the return of the bonus, if his AGI in 2009 exceeds $166,800 (if single, or married and filing a joint return), his itemized deductions (other than for medical expenses, investment interest, and certain losses) are reduced by the lesser of (1) 3% of the difference between his AGI and $166,800, or (2) 80% of his otherwise allowable itemized deductions. For many bonus recipients, this will mean that a significant portion of the bonus is not deductible.
And it's even worse than that. Belzer does not note that unreimbursed business expenses, while deductible from the ordinary income tax, are subject to the alternative minimum tax. Thus you will pay at least 26%, and probably 28%, of the bonus you no longer have in AMT.
Add it all up, and the cost of returning your bonus is somewhere north of 130%. Suddenly that 90% rate doesn't sound so bad.