---

Executive perks that are not properly reported to the IRS can land both you and your company in hot water. Over 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. Ensuring compliance with these regulations is crucial for any business, and understanding the role of tax services can help you navigate these challenges effectively.

Under the IRS Microscope: Executive Fringe Benefits

In the realm of executive compensation, certain perks can easily become red flags for IRS auditors if not properly reported. These perks are often referred to as fringe benefits and can include a variety of offerings:

• Athletic Skyboxes and Cultural Entertainment Suites: Exclusive access to events can be a significant benefit but must be reported accurately.
• Awards/Bonuses: Monetary or non-monetary awards require careful documentation.
• Club Memberships: Memberships to private clubs can be considered taxable benefits.
• Corporate Credit Cards: These can be misused, leading to underreported income.
• Employee Discounts: Generous discounts might require tax consideration.
• Employer-Paid Parking: Providing parking can sometimes be a taxable benefit.
• Executive Dining Room: Exclusive dining facilities need to be reported correctly.
• Financial Planning: This perk can be a gray area requiring clarity in tax reporting.
• Loans: Loans to executives are another area scrutinized by the IRS.
• Paid Vacations: These need proper documentation and reporting.
• Relocation Costs: Such costs can often be complex and require detailed reporting.
• Transportation/Company Cars/Chauffeurs: Vehicle perks are taxable unless properly excluded.
• Spousal/Dependent Travel: Travel expenses can be a significant benefit but also a liability if not reported.
• Private Jet Use: The personal use of company jets is scrutinized for compliance.
• Transfer of Property: Real estate, stock, computers, and furniture transfers need careful valuation and reporting.

Navigating the Complex Landscape of Executive Compensation

“Executive compensation has evolved dramatically in recent years, in creativity, complexity, and dollar value,” the IRS states on its website. For example, stock options, deferred compensation, fringe benefits, and other “non-cash” alternative forms of compensation are becoming increasingly popular and making up larger parts of executives’ overall compensation packages. This evolution makes it essential for businesses to use tax services that understand these complex packages and ensure they meet IRS standards.

When IRS auditors examine tax returns, they come well-armed. Over the last couple of decades, the IRS has developed a series of Audit Technique Guides designed to bring its examiners up to speed on business practices common to specific industries, such as construction and gas retail.

Several other audit guides have been published to focus on broad issues that affect many industries, such as “Executive Compensation – Fringe Benefits.” In this guide, the IRS instructs auditors on how to assess whether the proper tax was paid on common perks provided to executives.

Where Auditors Look for Errors

The IRS is aware that “corporate executives often receive extraordinary fringe benefits that are not provided to other corporate employees.” These potentially taxable fringe benefits include property or service that an executive receives in lieu of or in addition to regular taxable wages. That’s where problems can begin. Although it is clear that some fringe benefits are taxable, the IRS tells auditors that employers may classify them “under expense accounts other than compensation” to avoid income and employment taxes.

Take corporate credit cards, for example. Although many companies provide them to executives and other employees, the process for reimbursement is different. The IRS audit guide notes that some “top-level executives are permitted to use the card at will,” with monthly statements mailed directly to the corporation and the account paid in full without the submission of business expense reports. Lower-level employees are generally required to submit expense reports before being reimbursed for business-related expenses. Tax services can help ensure that these processes are followed correctly, preventing costly errors during an audit.

Auditors are instructed to look for personal expenses paid by credit card on behalf of executives and ensure these taxable fringe benefits were included in their wages.

The Three-Step Audit Process

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: This approach ensures that all potential tax liabilities are considered from the start.
2. Look to see if there is any statute which allows the benefit to be excluded from taxation: For example, does it qualify as a tax-free “working condition fringe benefit?” Understanding these exclusions can help businesses maintain compliance.
3. 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. Tax services are invaluable in accurately assessing these values and ensuring proper reporting.

Steps to Take if You Face an Audit

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: This step ensures that all agreements align with tax reporting.
• Examine loan agreements between the corporation and executives and officers: Loans need to be scrutinized for compliance.
• Check samples of monthly expense reports submitted by executives: Ensuring consistency and accuracy in these reports is vital.
• Search accounts payable records for the names, titles, and Social Security numbers of executives: This helps 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: These documents can provide insights into compensation issues.
• Ask for a list of payroll codes or other accounting codes which might be used for executive expenses: Identifying payments that may be taxable requires understanding how they are recorded.
• 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.”

Professional Guidance

When it comes to executive compensation, getting the details right and staying in compliance can be a daunting task. Consult with your tax advisor to ensure your company’s executive compensation plans align with the Internal Revenue Code and the regulations set forth by the IRS. Using professional tax services can make this complex process manageable and ensure that your business avoids costly mistakes.

Understanding the intricacies of executive fringe benefits and the potential pitfalls of non-compliance requires expertise. With the IRS’s increased focus on executive compensation, having a robust strategy for reporting and auditing these benefits is more critical than ever.

Navigating the complexities of tax regulations doesn’t have to be a solo journey. Whether it’s understanding the nuances of fringe benefits or ensuring that your executive compensation packages comply with IRS guidelines, having a dedicated team of professionals can make all the difference.

Contact Burton McCumber & Longoria today to learn how our comprehensive tax services can help your business stay compliant and optimize your executive compensation strategies.