Tax

IRS Unveils Amnesty for Tax-Shelter Abuse

Executives who employed a tax-saving scheme to hide stock-option gains have something to smile about.
Craig SchneiderFebruary 23, 2005

The Internal Revenue Service yesterday announced an amnesty program for executives and companies that used “abusive tax shelters” to hide gains related to stock options.

Corporate executives who engaged in the scheme will have until May 23 to accept an IRS settlement offer to resolve their tax issues. The offer also extends to corporations that issued the options to executives and directors as part of their compensation, according to an IRS release. To date, the IRS has identified 42 companies, many more executives, and unreported income of more than $700 million as being involved in the shelter scheme.

In the transactions, executives—often aided by their employers— transferred stock options or restricted stock, to family-controlled entities. The family partnerships often were created for the sole purpose of receiving the options and avoiding compensation income tax, explained IRS officials.

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The shelters used to defer option-compensation taxes for up to 30 years, according to the service. Often, the scheme resulted in the corporation deferring a legitimate deduction for the same compensation. Professional service firms and financial institutions aggressively promoted the stock option transactions over the last decade during the boom years of the U.S. stock market.

“These transactions raise questions not only about compliance with the tax laws, but also, in some instances, about corporate governance and auditor independence,” said IRS Commissioner Mark Everson. “These deals were done for the personal benefit of executives, often at the expense of shareholders.”

Under the terms of the settlement, executives who took part in the scheme must report 100 percent of the compensation and must pay interest and a 10 percent penalty, according to the IRS. That’s one-half of the maximum 20 percent applicable penalty.

Corporations and executives must also pay the appropriate employment taxes. The parties will be allowed to deduct their out-of-pocket transaction costs, which are typically promoter and professional fees. Companies also will be allowed a deduction for the compensation expense reported by the executives, the IRS noted.

The IRS will contact the senior managements of the companies and ask them to refer the issue to board audit committees for review.

Tax laws require executives to include the difference between the amount they pay for the stock and its value when the option is exercised as income and pay taxes on that amount. Corporations are entitled to a deduction for the compensation when the options are exercised.

In many of the cases the IRS looked at, an executive’s “inappropriate attempt” to defer tax on was coupled with a corporate deferral of an otherwise legitimate tax deduction, the IRS noted.

The agency also noted that it will continue to pursue executives and companies who took part in the transactions and don’t come forward now to join the settlement.

“We believe a new climate under Sarbanes-Oxley, together with the tougher independence standards for auditors recently proposed by the Public Company Accounting Oversight Board make this sort of thing less likely going forward,” Everson said. “However, we want to give executives and corporations a chance to clean up past transactions.”