In the last couple of years, the IRS has engaged in an audit initiative involving executive compensation and fringe benefits. The focus began with large corporations and has now moved to smaller companies, too.
Because executives often receive more than a paycheck for their work, companies need to understand IRS regulations for reporting compensation. Not properly reporting executive perks to the IRS can land both you and your company in hot water.
According to their website, the IRS recognizes a shift in salary packages for company leaders: “Executive compensation has evolved dramatically in recent years, in creativity, complexity, and dollar value. Stock options, deferred compensation, fringe benefits, and other ‘non-cash’ alternative forms of compensation are becoming increasingly popular and making up larger and larger parts of executives’ overall compensation packages.”
During an audit, the IRS may scrutinize both the employers that pay compensation and the executive-employees who receive it. The IRS Audit Technique Guides used by examiners, such as “Executive Compensation – Fringe Benefits” provide information you can use to ensure proper tax is paid on common perks provided to executives.
Errors to Avoid
Potential taxable fringe benefits include property or service that an executive receives in lieu of, or in addition to, regular taxable wages. The IRS points out that some employers go off track when they classify these benefits “under expense accounts other than compensation,” in order to avoid income and employment taxes.
For example, some companies permit their top-level executives to use company provided credit cards at will and do not require them to submit business expense reports. This can lead to a failure to properly include these taxable fringe benefits in the report of the executives’ wages. During an audit, IRS employees look for personal expenses paid by credit card on behalf of executives, so it is important to keep accurate records and require expense reports at all levels.
The text box below provides other examples of benefits the IRS will examine carefully and companies should be careful to report correctly.
Think Like an Auditor
Understanding how IRS engages in an audit will help you to better understand how to set up your reporting to avoid issues. The IRS audit guide recommends auditors begin a fringe benefit examination with a three-step process:
1. Assume a particular benefit is taxable to the executive.
2. Then, look to see if there is any statute that allows the benefit to be excluded from taxation. For example, does it qualify as a tax-free “working condition fringe benefit?”
3. Finally, if there is no statute that excludes the entire amount, determine the value of the benefit to include in the executive’s gross compensation. “Fringe benefits are generally valued at the amount the employee would have to pay for the benefit in an arm’s length transaction,” the IRS explains.
If you do get audited, you may have to undergo a rigorous IRS review. Here are some of the steps the IRS recommends auditors take in examining executive compensation and fringe benefits:
• Request a list of corporate executives and officers to identify the highly compensated employees. Determine who is responsible for approving and processing payments to them.
• Review the minutes of meetings concerning executive compensation. Look for decisions and instructions about the treatment of fringe benefits. Identify all payments to, or on behalf of, executives and officers.
• Inspect employment contracts and severance agreements to identify salaries and benefits.
• Examine loan agreements between the corporation and executives and officers.
• Check samples of monthly expense reports submitted by executives.
• Search accounts payable records for the names, titles, and Social Security numbers of executives, in order to determine if payments made to them were included on their Forms W-2 or 1099.
• Examine any documents filed with the Securities and Exchange Commission, such as Form 10-K, to identify compensation issues.
• Ask for a list of payroll codes or other accounting codes which might be used for executive expenses, in order to identify payments which may be taxable.
• Look at certain items on the tax return to see if fringe benefits have been claimed. For example, under Travel and Entertainment, Schedule M-1, Rent, and the line item “Other Deductions.”
When it comes to executive compensation, getting the details right and staying in compliance can be a daunting task. Consult with our tax advisors to ensure your company’s executive compensation plans are in line with the Internal Revenue Code and the regulations set forth by the IRS.
Under the IRS Microscope: Executive Fringe Benefits
• Athletic Skyboxes and Cultural Entertainment Suites;
• Awards/ Bonuses;
• Club Memberships;
• Corporate Credit Cards;
• Employee Discounts;
• Employer-Paid Parking;
• Executive Dining Room;
• Financial Planning;
• Loans;
• Paid Vacations;
• Relocation Costs;
• Transportation/ Company Cars/ Chauffeurs;
• Spousal/ Dependent Travel;
• Private Jet Use;
• Transfer of Property (such as real estate, stock, computers and furniture.)
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Our firm provides the information in this e-newsletter for general guidance only, and does not constitute the provision of legal advice, tax advice, accounting services, investment advice or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal or other competent advisors. Before making any decision or taking any action, you should consult a professional advisor who has been provided with all pertinent facts relevant to your particular situation. Tax articles in this e-newsletter are not intended to be used, and cannot be used by any taxpayer, for the purpose of avoiding accuracy-related penalties that may be imposed on the taxpayer. The information is provided “as is,” with no assurance or guarantee of completeness, accuracy or timeliness of the information, and without warranty of any kind, express or implied, including but not limited to warranties of performance, merchantability and fitness for a particular purpose.
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