Executive compensation compliance initiative.

• Author: Neuhauser, Derrick P.

As part of an increased effort to examine executive compensation, the IRS recently announced a compliance audit initiative intending to highlight the compensation arrangements of senior corporate executives and directors. The initiative includes reviewing the returns of the top 15 highest-paid employees (who are typically the executives) and the directors; see Massey, Lutz and LaGarde, Tax Clinic, "IRS Audit Initiative Targets Executive Compensation," TTA, March 2004, p. 131. It is not the size of the compensation packages that concerns the IRS, but the way they are constructed. New laws, cases and rulings have fostered creative and complex compensation arrangements. According to Keith Jones, IRS Director, Field Specialists, as a result, the complexity and the creativity of compensation design has grown tremendously.

Besides reviewing returns, the Service will also match W-2 income to corporate returns. If it finds any discrepancies or other problems, it will expand the scope of the review beyond the 15-highest-paid employees.

Subsequent to a November 2003 IRS Webcast about the audit program, additional details have emerged. During a January 2004 panel discussion with the American Bar Association, Alan Tawshunsky, IRS Assistant Chief Counsel, laid out a more institutionalized compliance and examination program. According to Mr. Tawshunsky, the initiative for uncovering noncompliance is a basis for focusing future examination resources on more technical issues. For perspective, Mr. Tawshunsky said that the idea was not just to look at 24 test companies, but to build a knowledge base. Further, the IRS also wants to develop an infrastructure for conducting these types of examinations on a wider basis. It can be expected that the initiative will be a highly publicized and coordinated effort.

This executive compensation compliance initiative will focus on eight issues: (1) nonqualified deferred compensation; (2) stock-based compensation; (3) the $1 million cap on deductible compensation; (4) golden parachutes; (5) split-dollar life insurance; (6) transfers of compensatory options to related parties; (7) offshore deferred compensation arrangements; and (8) executive perks.

The tax law has not changed; the Service is just refocusing on executive compensation, which, in recent years, has become more complicated to administer. Tax directors, chief financial officers and human resources officers should pay close attention to the areas the IRS has outlined. They can still address 2003 compliance issues and, in some instances, noncompliance from previous years.

Nonqualified Deferred Compensation

The IRS will focus on the tinting of employer deductions and executive...