IRS Audit Activity Involving Executive Compensation and Benefits

Transcription

1 IRS Audit Activity Involving Executive Compensation and Benefits ABA Tax Section (EO Committee) Midyear Meeting January 21, 2011 Ralph E. DeJong, Esq. McDermott Will & Emery LLP Robert W. Friz PricewaterhouseCoopers LLC Executive Compensation Still a Major Area of Concern Broader context is qualification for federal tax-exempt status, particularly for charitable hospitals Executive pay and benefits still make headlines Sen. Grassley wanted tighter rules, but PPACA ultimately included non-pay-related exemption requirements for hospitals 2

2 Executive Compensation Still a Major Area of Concern (Cont d) Form 990, as revised, provides more detail, but confusion continues Double counting deferred compensation Disparate reporting practices Comparing pre-2009 and post-2007 Forms 990 Difficult to link numbers and narrative explanations 3 IRS Executive Compensation Activity 2004 soft contact questionnaires included questions on executive compensation Frequent unreported items Generally addressed through prospective changes in 990 reporting 2007 report on IRS findings Primarily focused on 990 reporting noncompliance Some concern as to loans 4

3 IRS Executive Compensation Activity (Cont d) 2006 Hospital questionnaires included an executive compensation section Conflicts of interest involving approval body Comparability data 2009 report on hospital project Nearly all hospitals responding used rebuttable presumption process 20 hospitals were audited, but pay was found to be reasonable 5 IRS Executive Compensation Activity (Cont d) 2008 compliance check questionnaires, sent to 400 public and private colleges and universities, included questions on executive compensation, types of executive benefits, and review and approval process 2010 interim report on colleges and universities project, noting follow-up audits being conducted at more than 30 of the 400 institutions involved 6

4 IRS Executive Compensation Activity (Cont d) employment audit program 2,000 employers per year for three years Includes roughly 1,500 EOs Focus on employee (vs. independent contractor) status, executive fringe benefits, executive pay, and payroll tax compliance Combined Annual Wage Reporting (CAWR) Project IRS analysis of employment tax reporting by EOs for 4,000 organizations from FY Included focusing on reporting of officer compensation on Form 990 with no Form W-2 reporting 7 What Are the Risks? Challenge to exempt status based on private inurement or more than insubstantial private benefit Corporate income tax liability Financial reporting considerations, including FIN 48 (ASC ) Intermediate sanctions excise taxes on disqualified person who received an excess benefit from a 501(c)(3) or (c)(4) entity Automatic excess benefit transaction for any economic benefit (to a disqualified person), if the organization did not clearly indicate its intent to treat the benefit as compensation at the time of payment 8

5 What Are the Risks? (Cont d) Penalties for failing to report, withhold as to, and pay employment taxes as to, economic benefits that should have been treated as taxable compensation 9 Key Audit Issues / Observations Automatic Excess Benefit Transactions - accountable vs. non-accountable plans Accountable Plan Requirements Business connection Substantiation Return of any amounts in excess of substantiated expenses 10

6 Key Audit Issues / Observations (cont d) Automatic Excess Benefit Transactions - accountable vs. non-accountable plans Non-accountable plan reimbursements generally implicate Form W-2 and Form 941 reporting Withholding and payment of employment taxes Form 1040 reporting 11 Key Audit Issues / Observations (cont d) Automatic Excess Benefit Transactions Intent to treat reimbursements as compensation for services Written contemporaneous substantiation Reasonable cause exception 12

7 Key Audit Issues / Observations (cont d) Automatic Excess Benefit Transactions Key IRS focus areas Expense reimbursements not satisfying the strict accountable plan rules Fringe benefits that may not be covered by a statutory exclusion Loans to disqualified persons Existence of a bona-fide loan Imputed income issues for below-market loans 13 Audit Issues Generally Identify who is at risk, whose issues are implicated, to whom the audit is directed, and who is the client Note the disparate interests, in a 4958 case, of the entity and the recipient Potential conflict of interest for legal counsel that previously advised as to any item being challenged Application of attorney-client and attorney work product privileges Consultant reports and/or reasonableness opinions prepared at direction of counsel 14

8 Audit Issues Generally (Cont d) Counsel s correspondence and/or risk assessments Drafts of final reports, opinions and correspondence Statute of limitations Which years are open? Normally a three-year period running from filing deadline for 990 on which item is adequately reported If the contested issues have not been adequately reported on 990, a six-year period applies An audit typically begins with a request to extend the limitations period on open years being examined 15 Audit Issues Generally (Cont d) Who defends? Check for applicable liability insurance and rights of carrier to defend Bear in mind strategic options Requesting technical advice Showing reasonable cause Requesting abatement of certain taxes 16

9 Issues Arising in Executive Pay Audits Reasonableness of total compensation process by which review and approval occurred Whether rebuttable presumption applies Comparability of data used by approval body Particular types of pay or benefits Nonaccountable expense allowances (including any remaining flexible benefit allowance programs) Club memberships Use of employer-owned housing 17 Issues Arising in Executive Pay Audits (Cont d) Personal use of other employer property (particularly corporate credit cards and employer-owned or leased cars) Spouse/companion travel Broader business expense reimbursement (particularly issue of adjacent personal time/activity) Other fringe benefits such as gift cards, tangible gifts, and posttermination or lifetime health benefits 18

10 Key Audit Issues / Observations Form 990 Focus Areas 19 Key Audit Issues / Observations Form 990 Focus Areas 20

11 Key Audit Issues / Observations Form 990 Focus Areas 21 Key Audit Issues / Observations Form 990 Focus Areas 22

12 IRS Requests for Information ( IDRs ) Describe process used to determine pay and benefits of officers, directors, trustees, and key employees and five highest-paid other employees Provide employment and other agreements between organization and those individuals Provide minutes for all Board and committee meetings at which executive compensation was discussed Provide all compensation consultant reports 23 IRS Requests for Information ( IDRs ) (Cont d) Provide any correspondence, including s, between the organization and the compensation consultant Describe each executive benefit provided Provide all relevant governance documents, including bylaws, committee charters, and governing policies 24

13 Typical Disputed Issues in Executive Compensation Audit Application of rebuttable presumption Whether use of for-profit data was appropriate Whether compensation consultant was independent Did market data represent similarly situated organizations? Whether reasonable compensation starts at the market median Whether 990 data of other organizations should be used to challenge or defend compensation as reasonable 25 Typical Disputed Issues in Executive Compensation Audit (Cont d) Whether use of employer-owned property was sufficiently business-related 26

14 Preparing for Possible Audit Do meeting minutes clearly describe compensation and benefits considered and approved, approval process, rebuttable presumption and basis for reasonableness conclusion? Are all elements of pay and benefits, and all uses of employer property, identified and known to the Board or applicable committee? Is the authority of the applicable committee to review and approve compensation, and to qualify for the rebuttable presumption, clear? 27 Preparing for Possible Audit (Cont d) Has organization identified and resolved all conflicts and dualities of interest involving members of the applicable committee, so that an actual or perceived conflict does not become a sticking point? Is the compensation consultant sufficiently independent? Has the organization reported everything on the 990 in a manner that will cause the statute of limitations to run? Whether or not the compensation consultant has opined on reasonableness, has the Board or applicable committee reached its own supportable and well-articulated conclusion as to the reasonable of compensation? 28

15 Preparing for Possible Audit (Cont d) Is the full Board at least aware of all executive compensation? Is the organization aware of when the initial contract exception (to 4958 excise taxes) might apply, and is the 990 reporting consistent with the position? For any known excess benefit transactions, has a thorough correction been made (that will serve as a good defense to an exemption challenge), and is the 990 Schedule L reporting clear and consistent? 29 Preparing for Possible Audit (Cont d) Has the organization clearly stated which economic benefits are intended at all times to constitute compensation (by contract, approval as compensation, or reporting on an appropriate federal tax form), so as to avoid automatic excess benefit transaction treatment?