IRS audit initiative targets executive compensation.

• Author: Massey, Bart

According to a November 2003 IRS Webcast, the Service has begun an initiative to assess compliance and target abuses related to executive compensation and benefits; it intends to implement more structured reviews of compensation arrangements during future examinations of large corporate tax returns.

In describing some of the reasons for the new program, Cate Livingston Fernandez, branch chief of the IRS's Executive Compensation Branch, indicated compliance with executive compensation laws has not been aggressively reviewed for years, and "people may have forgotten some of the fundamentals." Through the new effort, the IRS expects to identify areas in which taxpayers repeatedly make errors and may need additional guidance, added Keith Jones, a director of field specialists at the IRS's Large and Mid-Size Business Division.

Targeted Areas

At the program's inception, the IRS selected 24 sample companies from five industry groups from which to gather compliance information on executive compensation issues. Auditors examining the businesses will focus on eight primary areas: nonqualified deferred compensation, stock-based compensation, the $1 million cap on compensation paid to public company officers, golden parachute arrangements, split-dollar life insurance, fringe benefits and the use of two listed transactions (family limited partnerships and offshore employee leasing).

Fernandez explained that the IRS, in reviewing nonqualified deferred compensation arrangements, will examine timing of deductions for deferred amounts (i.e., whether the deduction has been postponed until the employee has corresponding income). The Service will also examine whether a company's deferred compensation arrangement triggers currently taxable income under either the constructive receipt or economic benefit doctrine, and whether the company has properly applied payroll taxes.

For stock options, the IRS may look at a number of issues, such as 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. With issues such as the $1 million dollar cap under Sec. 162(m) and golden parachute payments, the Service will ensure proper compliance with statutory limits and regulations.

For split-dollar arrangements, the IRS will check whether a company has included amounts in income when an insurance product has...