Audit Initiative Targets Executive Compensation

ccording to an IRS webcast, the service has begun an initiative to assess compliance and target abuses related to executive compensation and benefits. CPAs who represent public companies should become familiar with this initiative.

AREAS OF INTEREST
The IRS selected 24 sample companies from five industry groups to gather compliance information on executive compensation issues. Auditors examining these businesses will focus on nonqualified deferred compensation, stock-based compensation, the $1 million cap on deductions for compensation paid to public company officers, golden parachute arrangements, split-dollar life insurance, fringe benefits and the use of two “listed transactions” (those specifically identified by the IRS as tax-avoidance transactions or expected to produce the same or similar tax consequences).

IRS APPROACH
In reviewing nonqualified deferred compensation arrangements, the IRS will examine deduction timing for deferred amounts (that is, whether a deduction has been postponed until the employee has corresponding income). It also will review whether a company’s deferred compensation arrangement triggers currently taxable income and whether the company has properly applied payroll taxes.

For stock options the IRS may look at whether there has been proper income inclusion on option exercise (or on a disqualifying disposition of stock acquired from such exercise), participation rights in employee stock purchase plans and general statutory compliance. For the $1 million cap under IRC section 162(m) and golden parachute payments, the service will ensure proper compliance with statutory limits and regulations.

For split-dollar insurance arrangements, the IRS will check whether a company has included amounts in income when an insurance product has been transferred from an employer to an employee. When fringe benefits (such as the use of a corporate-owned aircraft or automobile or relocation benefits) have been provided to executives, the IRS will verify that the company properly treated the benefit as wages for employment taxes.

TAX SHELTERS
The service also plans to target the use of two types of listed transactions used for executive compensation. First, the IRS will scrutinize a taxpayer’s attempt to defer income by transferring compensatory options to a related party in exchange for a deferred payment obligation.

The service also will examine companies for tax schemes in which individuals use professional corporations or other taxable entities to attempt to avoid payroll and income taxes through the use of an employee-leasing arrangement in an offshore-tax-savings jurisdiction.

KEY EMPLOYEE FILINGS
In a typical audit the IRS examiners are expected to ask corporate tax departments to assist them in obtaining executives’ forms 1040, so they can be reviewed for consistency with the corporate return. The executives’ returns, however, will not be examined as part of the compliance effort; the examination’s focus would be the timing of the employer’s deductions and its reporting and withholding compliance.

For more information see the Tax Clinic, edited by Mark Garay, in the March 2004 issue of The Tax Adviser.

—Lesli Laffie, editor
The Tax Adviser