Human Capital & Careers

IRS Offers Stock-Option Tax Settlement

''These transactions raise questions not only about compliance with the tax laws, but also, in some instances, about corporate governance and audit...
Stephen TaubMarch 7, 2005

The Internal Revenue Service has extended a May 23 deadline to executives and directors at 42 companies, and to the companies themselves, to settle charges that they participated in abusive tax avoidance transactions that resulted in more than $700 million of unreported income.

The IRS did not identify the companies or the individuals.

According to the agency, the transactions enabled executives to transfer stock options to family controlled partnerships and other related entities typically created solely to receive the options and avoid taxes, under terms of an agreement to defer payment to the executive. The partnership would exercise the options and sell the stock in the marketplace. The executive would then take the position that tax is not owed until the date of the deferred payment, perhaps 15 to 30 years later — even though he or she has access to partnership assets that are undiminished by taxes.

The IRS also noted that in many cases, the corporation deferred a legitimate deduction for the same compensation. “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 W. Everson, in a statement. “These deals were done for the personal benefit of executives, often at the expense of shareholders.”

Under the terms of the proposed settlement, participating executives must report 100 percent of the compensation, pay interest, and also pay a 10 percent penalty — half the 20 percent maximum for such cases. Companies and executives must also pay appropriate employment taxes. According to the IRS, the parties will be allowed to deduct their out-of-pocket transaction costs — that is, the professional fees charged by the firms that promoted these transactions in the first place.

The companies will still be allowed a deduction for the compensation expense reported by their executives and directors. The settlement offer described on the IRS website suggests no penalties for the companies themselves, though it notes that “the IRS will contact senior management and ask that the matter be referred to the board of directors’ audit committee for appropriate review.”

The IRS also warned that it will continue to pursue executives and companies who participated in these transactions and do not come forward now to participate in this settlement opportunity.