The whole package: IRS zeros in on executive perks

In an environment of competitive salaries, fringe benefits arean important tool in a company’s efforts to hire and retain executives.At the same time, the IRS has increased its scrutiny of executivecompensation, with a particular focus on fringe benefits. How cancompanies and executives avoid tax issues with respect to fringebenefits? Know the rules and tie perks to efficiency, performance andbottom-line business goals.

The focus on fringe

In2004, in the wake of numerous corporate scandals, the IRS conducted apilot program to investigate 24 companies’ compliance with federalexecutive-compensation rules. The program uncovered numerous problemswith nonqualified deferred compensation, stock-based compensation,section 162(m) deductions, section 280G, and fringe benefits includingspousal travel and private use of corporate aircraft.

In an interview with HR Magazine,Keith Jones, IRS director of field specialists for the Large andMidsize Business Division, said most of the audited companies owed backtaxes and filed amended returns costing tens of millions of dollars.The investigation has led to a concerted effort to enforce complianceby companies of all sizes.

"We found that companies sometimeshave good [executive-compensation] plans, but the payroll departmentisn’t withholding the right amount of tax," Jones said. "As a result ofthe pilot program’s findings, executive-compensation reviews will nowbe embedded in our everyday procedures."

To evidence this newfocus, Jones mentioned more than 70 employment-tax specialists and5,000 field agents trained to evaluate compensation plans more closely.While the difficulty of accurately accounting for fringe benefits alsoincreases the difficulty of investigating fringe compensation, expertsagree that now is the time to take steps to prevent (or minimize theeffect of) an IRS audit of your executive-compensation plan.

Common perk problems

Mostof the IRS’s executive-compensation activities so far have centered onrecent changes to deferred-compensation legislation, which requirescompanies to rethink and revise their deferred-compensation packages.In addition, the Securities and Exchange Commission has issuedfar-reaching new rules for public companies to disclose executivecompensation. These changes provide public companies with a primeopportunity to get their heads around their totalexecutive-compensation plans.

A recent survey by CompensationResources Inc. identified the following "most popular" executive perks,as well as the percentage of responding companies that offered thesebenefits:

Executive perk offered	Percentage of companies offering
Cellular phone	76.0
Holiday parties or gatherings	66.7
Company car	50
Severance agreement	33.3
Financial counseling	16.7
Country-club membership	12.5
First-class air travel	12.5
Spousal travel	3.1

It’sno surprise many of these perks correspond to IRS concerns. In anarticle for CFO.com, Douglas Rogers, former IRS director for penaltiesand interest, outlined the following common fringe benefits sure tocatch an auditor’s eye:

Executive partnerships intowhich bonuses are paid (One advantage for the employer in sucharrangements is that the company avoids paying certain payroll taxes,including unemployment and FICA taxes, because the third-partypartnership is involved.)
Club memberships
Corporate credit cards
Outplacement services
Spousal and dependent life insurance
Spousal and dependent travel expenses
Transfer of property
Wealth-managementservices (The IRS generally views this benefit as taxable, becauseemployers award it in lieu of compensation.)

Evensomething as seemingly insignificant as company cell-phone or laptopusage can raise questions if ownership of the phone or computertransfers to the executive. The IRS regards both as compensation unlessthe employer maintains the company equipment, and the employee checksthe equipment in and out.

"Tax-favored" fringe benefits

Whenemployers properly accounted for them, the tax code allows certainexecutive fringe benefits without requiring the executives to reportadditional income. These benefits include:

Business-related working condition fringe benefits, including business-related magazine subscriptions, professional dues, and business travel and entertainment.
Convenience-related meals and lodging furnished on the employer’s business premises for the convenience of the employer.
De minimis fringe benefitsthat normally are taxed, if accounting for the items is unreasonable oradministratively impractical. These include occasional event tickets,cocktail parties or group meals, or occasional personal typing by acompany secretary.
Qualified moving expense reimbursements,including any amount an executive receives from an employer as paymentfor, or reimbursement of, expenses that are deductible as movingexpenses on the executive’s income-tax return.
Qualified parkingprovided to an employee on or near the employer’s business premises, oron or near a location from which the employee commutes to work. (If anemployee chooses cash compensation rather than the parking itself, thatamount counts as gross income.)

Other benefits, such asuse of a company car or club memberships, can be "prorated" accordingto the percentage of personal use versus business use and taxedaccordingly. You should document usage patterns as accurately as youcan.

Steering clear of audit trouble

According tothe Society for Human Resource Management’s (SHRM’s) Compensation andBenefits Forum, employers increasingly are tying perks to executiveperformance and efficiency — making them easier to distinguish fromtaxable wages.

"For example, in New York City, a limo serviceallows an executive to conduct business in comfort while maneuveringthrough traffic jams," said Professor David B. Balkin, Leeds School ofBusiness at the University of Colorado, Boulder, in an SHRM article."For these people, wasted time is also wasted money."

Inaddition to properly documenting executive compensation and withholdingtaxes on it, accounting and human resources departments must play anactive role in defining total compensation and appropriate use offringe benefits. SHRM recommends starting with the following questions:

Are the perks for senior executives useful and job-related? If they are reasonable in amount and positively affect performance, you can easily defend them.
Are perks really necessary to motivate the recipients? If not, consider replacing them with increasingly popular (and lucrative) pay-for-performance incentives.
If perks are intended to evoke status as part of the company’s image, are you going too far? Ask yourself, would you be embarrassed to disclose these perks? Would your shareholders or employees be enraged?

Executivescan help keep themselves and their companies from trouble byconsistently documenting business-related expenditures and by notmixing company business with personal or family affairs.

Withlaws and policies changing constantly, it may also pay to bring in athird party to audit your executive-compensation package in the sameway the IRS would. Often this process requires tax or legal expertisethat companies don’t have in-house. Private companies should considerevaluating themselves just as their publicly traded counterparts do.While public disclosure is not a requirement for a privately heldcompany, a careful self-assessment will make a tremendous difference inthe case of an income-tax audit.

RSM Resources