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IRS Taking a Look at Executives' Pay

Hundreds of millions of dollars in underpayments of income tax may be at stake, experts say.

December 30, 2003|Kathy M. Kristof | Times Staff Writer

Spurred by a congressional investigation into executive compensation at Enron Corp., tax authorities for months have been quietly scrutinizing the salaries and fringe benefits of top officers at other big companies.

Two dozen such audits are underway, said Keith Jones, director of field specialists at the Internal Revenue Service, and more are planned.

"In the past five years, compensation has grown in complexity, creativity and dollar value," Jones said. "Our issue is not with how much executives are paid. Our issue is whether the rules are being followed and the proper amount of tax is being paid."

Tax authorities are barred by law from disclosing the names of audit targets. Jones said the audits were being performed at an array of companies.

Launched without fanfare last summer, the audits focus on corporations rather than individuals. The IRS is increasingly reviewing executive tax returns as part of the corporate audit process to determine whether companies and their executives are taking consistent tax positions, experts said. Dozens of executives, officers and directors may be placed under the microscope at each corporation audited, the experts added.

"The audits are active. They're very real and very serious," said David Fuller, a tax lawyer with McDermott, Will & Emery in Washington. "The IRS is asking corporate tax directors to give them the personal returns of their executives, officers and directors."

As part of the initiative, the IRS has assembled a team of examiners. They are getting special training and long lists of questions aimed at ferreting out issues that the government believes to be troublesome.

"We feel that there is enough error and disagreement in this area that we should be spending more time with it," Jones said. "Is it our No. 1 issue? No. That's abusive tax shelters. But is it an area where we want to devote more resources? Absolutely."

It is too early to tell what the audits may uncover, but experts believe that hundreds of millions of dollars in tax underpayments may be at stake.

The IRS is looking at eight general types of compensation typically provided to upper executives:

* Nonqualified deferred compensation, such as supplemental retirement plans.

* Stock options, which are rights to buy company shares at a set price in the future.

* Family limited partnerships, which are estate-planning tools often used to pass assets to children at a discount to current market value.

* Fringe benefits, such as company-paid cars and housing, corporate jets and other perks.

* Split-dollar life insurance, which is life insurance that can benefit both the company and the policyholder's heirs.

* Golden parachutes, which are lucrative payments to executives who are fired or leave under certain other specified circumstances.

* Offshore employee-leasing arrangements, which the IRS believes are illegal tax shelters that pay individuals from offshore affiliates for work done in the U.S.

* So-called 162(m) deductions, which restrict companies from deducting pay over $1 million that does not meet performance criteria.

The two areas of special interest are perks such as private planes, housing and deferred compensation plans, and stock option arrangements that may allow for the underpayment of taxes on the gains.

The biggest ticket item is likely to be stock options that were put into trusts and family limited partnerships, allowing executives to transfer the tax liability on the gains to children and organizations that would be in a significantly lower tax bracket than the executive. The IRS has labeled these deals as "listed transactions," which puts companies on notice that tax officials believe the deals to be so abusive that they must be immediately reported to authorities.

Hundreds of such arrangements are believed to have been entered into over the last three years, involving hundreds of millions of dollars in stock gains.

"The amounts are astronomical," said one compensation expert who asked not to be named. "The stock deals were heavily marketed to people with huge stock gains. If you figure that just 10% of the Fortune 500 got into them, you'd be talking about hundreds of millions of dollars in tax."

Tax officials also are taking a closer look at fringe benefit arrangements, primarily because of the "Enron effect," said Andrew Liazos, chairman of the compensation practice at McDermott, Will & Emery in Boston.

A 3,000-page report on the Enron collapse issued in February chronicled a series of perks provided to executives that were not available to the rank and file -- and may not have been properly taxed, Liazos said.

That has prompted the IRS to examine deferred-compensation agreements and to look at whether executives are properly paying tax on the value of their personal use of company cars, planes and apartments.

"This area is evolving," Liazos said. "But, I guess the message that should be clear is if you have these arrangements, you want to start thinking about whether your house is in order."

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