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:: Executive Compensation - Fringe Benefits Audit Techniques
Guide (02-2005)
NOTE: This
guide is current through the publication
date. Since changes may have occurred after
the publication date that would affect the
accuracy of this document, no guarantees are
made concerning the technical accuracy after
the publication date.
Issue Description
Corporate executives often
receive extraordinary fringe benefits that
are not provided to other corporate
employees. Any property or service that an
executive receives in lieu of or in addition
to regular taxable wages is a fringe benefit
that may be subject to
taxation. In 1984, the Internal Revenue Code
(“Code”) was amended to include the
term “fringe benefits” i n the definition of
gross income found in §61. A fringe benefit
provided in connection with the performance
of services, regardless of its form, must be
treated as compensation includible in income
under §61.
Whether a particular fringe
benefit is taxable depends on whether there
is a specific
statutory exclusion that applies to the
benefit. For example, when §61 was amended
to include the term “fringe benefits”, §132
was added to provide exclusions for certain
commonly provided fringe benefits that had
previously not been addressed in the Code.
Section 132 provides exclusions for working
condition fringes, deminimis fringes,
noadditional cost services, qualified
employee discounts, qualified moving
expenses, qualified transportation fringes,
and qualified retirement planning services.
Although it is clear that
fringe benefits are taxable, employers may
not treat them as
wages for income and employment tax
purposes. Employers may classify a taxable
fringe benefit under expense accounts other
than compensation, resulting in a failure to
subject the fringe benefit to income and
employment taxes.
Because the tax treatment
of fringe benefits can vary depending on the
facts and
circumstances under which they are provided,
it may be helpful to follow a 3-Step
analysis when examining a particular item an
employer gives or makes available to an
executive.
-
First, identify the
particular fringe benefit and start
with the assumption that its
value will be taxable as
compensation to the employee.
-
Second, check to
see if there are any statutory
provisions that exclude the fringe
benefit from the executive’s gross
income.
-
Third, value any
portion of the benefit that is not e
xcludable for inclusion in the
executive’s gross income. Fringe
benefits are generally valued at the
amount the
employee would have to pay for the
benefit in an arm’s length
transaction.
Potential Issues
There are several potential
issues regarding fringe benefits; however,
this paper is
designed to outline those more commonly
provided to executives. There are both
income and employment tax issues related to
fringe benefits.
-
Is the expense
deductible by the corporation?
-
Is the amount
excludible from gross income of the
executive?
-
Is the executive
receiving personal benefit from the
corporation?
-
Does the benefit
exceed the §162(m) limitation?
The following discusses
some of the most common fringes provided to
executives.
Athletic
Skyboxes/Cultural Entertainment Suites -
In the case of a skybox or other private
luxury box leased for more than one event,
the amount allowable as a deduction under
Code §274(l)(2) with respect to such events
shall not exceed the sum of the face value
of a non-luxury box seat ticket(s) for the
number of seats in the luxury box. Luxury
boxes rented by related parties or
individuals are treated as a single lease in
determining whether a luxury box is leased
for more than one event. See Notice 87-23,
1987-1 C.B. 467, 469. The remaining amount
for attendance at the event is limited to
ordinary and necessary business expenditures
that also satisfy all the requirements under
§274(a), (d), and (n) for deducting
entertainment expenses. Similarly, a
purchase of a skybox is the purchase of a
facility subject to §274(a). Catered events
may need examination to verify the deduction
limitations of IRC §274(n) have been
correctly applied. If the purchased or
leased skybox is used personally by the top
executives of the corporation, the value of
the benefit may be taxable income to the
executives.
Awards/Bonuses
- A Company may utilize a number of methods
to provide
compensation for services rendered by the
executives. Additional attention must be
given to executive payment arrangements and
plans used to determine bonuses and or
awards. Generally, all payments in whatever
form, are payments in the nature of
compensation if they arise out of an
employment relationship or are associated
with the
performance of services. Payments in the
nature of compensation include (but are not
limited to) wages, salary, bonuses,
severance pay, fringe benefits, pension
benefits and
other deferred compensation. Awards and /or
bonuses paid to key executives should be
carefully reviewed to determine if they
should be included as remuneration under
§162 (m). Corporations have begun providing
non-cash awards and bonuses to executives.
Attention should be given to payments made
on behalf of executives. It may be necessary
to review invoices for the “ship to” address
for large ticket items that appear to be
personal in nature.
Club Memberships
– Effective since calendar year 1994, §
274(a)(3) provides that no deduction is
permitted for club dues. This includes all
types of clubs, including social, athletic,
sporting, luncheon clubs, airline and hotel
clubs and “business” clubs for all amounts
paid or incurred after 1993. Regulations §
1.274-2(a)(2)(iii) and (e)(3) (ii)(b)
clarifies that the purposes and activities
of a club, and not its name, determine
whether it is covered under the disallowance
provision. The employer has the choice of
either including the value of the club
membership in the employee’s income or
forgoeing any deduction for the club dues.
IRC § 274(e)(2). Put another way, the
company can deduct the cost if it treats the
club dues as compensation includable in
gross income and wages. However, if the
employer’s deduction for club dues is
disallowed by § 274(a)(3), Regulations §
1.132-5(s) provides that the amount, if any,
of an employee’s working condition fringe
benefit relating to the emplo yer provided
membership in the club is determined without
regard to the application of § 274(a) to the
employee. To be excludible as a working
condition fringe, however, the amount must
otherwise qualify for deduction by the
employee under § 162(a). Note that the
requirements of § 274(d) must still be met
(i.e., time, place and business purpose must
be established. See Regulations §
1.132-5(s)(3) for examples applying these
rules.
Although many corporations
are aware of the law regarding the
deductibility of club
dues and membership fees, they will often
make such e xpenditures and disguise the
deduction. Club memberships have been
distributed to departing executives through
severance agreements. The value of a club
membership distributed to executives upon
departure is wages. Close scrutiny should be
afforded employment contracts and
severance agreements for executives.
Corporate Credit
Card - Many companies provide
corporate credit cards to executives and
other employees. The difference between the
rank and file credit card accounts and those
maintained for executives is generally the
method of reimbursement. Top level
executives are permitted to use the card at
will. A monthly statement may be mailed
directly to the corporation and the account
may be paid in full without the submission
of a business expense report. Lower level
executives are generally required to submit
an expense report and are reimbursed for
business related
expenses. Personal expenses paid on behalf
of executives are taxable fringe benefits
that should be included in wages.
The determination of
whether the corporation has an accountable
plan within the
meaning of §62(c) and the regulations
thereunder should be made at the beginning
of
the examination. If executives are not
required to substantiate that the expenses
charged to the corporate credit card were
for business expenses, the reimbursement is
considered to have been made under a
non-accountable plan and the entire
reimbursement is taxable to the executive,
and wages for employment tax purposes.
See Regulations § 1.62-2.
Executive Dining
Room – Meals furnished on the
employer’s business premises and
for the convenience of the employer are
excludable from income under IRC §119. In
the case of an employer-operated eating
facility, the rules of IRC §132(e)(2) must
be
met in order for the income to be excludable
as a de minimis fringe. The four tests
outlined in Treasury Regulation
§1.132-7(a)(2) must be met in order for the
value of the meals to be excluded from an
employee’s gross income. This income
exclusion is
available to highly compensated employees
only if the “direct operating cost” test of
Regulations §1.132-7(a)(1)(i) is satisfied.
The nondiscrimination rules under § 1.132-8
must also be met. The fringe benefit rules
incorporate the § 410(b) standards in
determining whether the benefit is provided
on a nondiscriminatory basis. See
Regulations § 1.132-8(d). For purposes of
applying these nondiscrimination rules, a
highly compensated employee (“HCE”) for 2003
is an employee who meets either of the
following tests:
-
The employee was a
5% owner at any time during the year
or the
preceding year.
-
The employee
received more than $ 90,000 in pay
for the preceding
year. (See Notice 2002-71, 2002-45
I.R.B. 830. This amount is
unchanged from 2002. See Notice
2001-84, 2001-53 I.R.B. 642.).
The employer can choose to
ignore test (2) if the employee was not also
in the top 20% of employees when ranked by
pay for the preceding year. The definition
of HCEs for fringe benefit purposes
incorporates the standard under § 414(q).
Loans - No
Cost/Low Cost/ Disguised Compensation - A
number of companies have made loans or
extended credit to their executives. These
loans have either been at no cost or low
cost. In some instances, the terms have been
such that the loan is really disguised
compensation. Factors that are indicative of
a bona fide loan are 1) existence of a
promissory note, 2) cash payments according
to a specified repayment schedule, 3)
interest is charged, and 4) there is
security for the loan.
Loans to executives should
be reviewed to determine if they are bona
fide and to
determine if the terms are being followed.
Is there a written document detailing the
terms of the loan, payment over a certain
number of years or is payment on demand; is
the interest rate at market or at a below
market rate of interest; is the loan listed
on the
company’s balance sheet as a receivable? Are
the terms of the loan being followed –
payments are to be made monthly and the
executive is not making payments, etc. The
loan terms could include forgiveness of part
or the entire loan if the executive remains
with the company for a certain number of
years, etc.
I.R.C. §7872 deals with the
treatment of loans with below market
interest rates; it
specifically applies to what it terms
compensation-related loans, which include
belowmarket loans directly or indirectly
between an employer and an employee. In
general, § 7872 operates to impute interest
on below market loans. In the case of
employer/employee loans, the employer is
treated as transferring the foregone
interest
to the employee as additional compensation
and the employee is treated as paying
interest back to the employer. Different
rules apply depending on whether a loan is a
demand loan (7827(a)) or a term loan
(7872(b)). A demand loan is a below market
loan if it does not provide for an interest
rate at least equal to the applicable
federal rate. A term loan is a below-market
loan if the present value of all amounts due
on the loan is less than the amount of the
loan (i.e., the yield to maturity is lower
than the applicable federal rate). With
respect to demand loans, the imputed
interest payments and deemed transfer of
additional compensation are treated as being
made annually. With respect to term loans,
the lender is treated at the time of the
loans as transferring the difference between
the loan amount and the present value of all
the future payments under the loan as
additional compensation. The term loan is
then treated as having original issue
discount equal to the amount of the deemed
transfer of additional
compensation and, thus, subject to the
original issue discount provisions of § 1272
et.
Seq. There is a de minimis exception from
the application of the § 7872 imputation
rules if loans between the parties in
aggregate do not exceed $10,000.
(7872(d)(3)).
The de minimis exception does not apply if
one of the principal purposes of the loan is
tax avoidance.
Personal loans to officers
and directors of public companies are banned
by the
enactment of the Sarbanes-Oxley Act of 2002,
which became effective on July 30,
2002. Personal loans outstanding on the date
of enactment are not prohibited, provided
there is no material modification or renewal
of the loan on or after the date of
enactment. Neither loans nor an extension of
credit can be renewed after the date of
enactment of Sarbanes-Oxley. This law does
not apply to private companies.
Some loans to executives are essentially
disguised compensation based on the terms
of the loan. Sections 61(a)(1) and 61(a)(12)
define gross income to include
compensation for services and income from
discharge of indebtedness. Reg. §1.61-
12(a) provides that if an individual
performs services for a creditor, who in
consideration for the services, cancels the
debt, the debtor realizes income in the
amount of the debt as compensation for
services. Discharge of indebtedness income
by an employee from an employer under these
circumstances is payment in the nature of
compensation, and thus is includible in
gross income and wages for employment tax
purposes.
Issues have been raised
regarding loan forgiveness (remain in the
employ of the
corporation for a period of four years),
unusual repayment methods (stock in lieu of
cash), and extreme repayment dates
(repayment by the executive’s trust upon the
death of the executive and his spouse).
Loans are often used to disguise
compensation; therefore, the underlying
intent must be examined and addressed.
Outplacement
Services – Outplacement services
provided solely for executives are
not excludable from gross income. The
service must be provided to all classes of
employees; however, the le vel of service
afforded the executives can differ greatly
from that provided to lower level employees
(Revenue Ruling 92-69, 1992-2 C.B. 51). The
services must also meet the requirements of
a working condition fringe benefit outlined
in IRC §132.
Qualified Employee
Discounts – This exclusion applies
to a price reduction an
employer gives an executive on qualified
property, §132(c)(4), or services offered to
customers in the ordinary course of the line
of business in which the employee performs
substantial service. It does not apply to
discounts on real property or discounts on
personal property of a kind commonly held
for investment (such as stocks and bonds)
§132(c). There are specific rules that must
be followed if the employee is highly
compensated (see Notice 2002-71, 2002-45
I.R.B. 830). Treasury Regulation
§1.132-1(b)(1) does not allow company
discounts for directors and independent
contractors. It has become quite common for
former officers to be retained on a
contractual basis by the corporation upon
retirement and continue to receive
discounts. Qualified employee discounts must
be provided on a nondiscriminatory basis.
See generally Regulations § 1.132-8. This
regulation incorporates § 410(b)
nondiscrimination standards, and the §
414(q) definition of HCE. See Regulations §
1.132-8(d) and (f).
Security-related
Transportation - Regulations §
1.132-5(m)(1) provides that if a bonafide
business-oriented security concern exists,
and an overall security program exists, then
the employee may exclude the excess of the
value of the transportation provided by the
employer over the amount that the employee
would have paid for the same mode of
transportation absent the bona fide security
concern. With respect to air
transportation, the phrase “same mode of
transportation” means comparable air
transportation.
A bona fide
business-oriented security concern exists
only if the facts and
circumstances establish a specific basis for
concern regarding the safety of the
executive (§1.132-5(m)(2)(i)). A generalized
concern for the executive’s safety will not
trigger application of the security
exclusion (§1.132-5(m)(2)(i)). Under §
1.132-
5(m)(2)(i), the employer must demonstrate
the existence of a bona fide security
concern. A bona fide security concern exists
if the facts and circumstances
demonstrate a specific basis for concern
regarding the safety of the employee.
Examples of specific bases for a bona fide
security concern include a specific threat
to
harm the employee or a recent history of
violent terrorist activity in the geographic
area
in which the transportation is provided.
Section 1.132-5(m)(2)(ii)
provides that an overall security program
must be established. In order to establish
the existence of an overall security
program, the employer must generally
establish that security is provided to the
employee on a 24-hour basis.
However, under
§1.132-5(m)(2)(iv), an overall security
program is deemed to exist if the following
conditions are satisfied:
-
A security study is
performed with respect to the
employer and the employee (or a
similarly situated employee of the
employer) by an independent security
consultant;
-
The security study
is based on an objective assessment
of all facts and
circumstances;
-
The recommendation
of the security study is that an
overall security program (as
defined in paragraph (m)(2)(iii) of
this section) is not necessary and
the
recommendation is reasonable under
the circumstances; and
-
The employer
applies the specific security
recommendations contained in the
security study to the employee on a
consistent basis.
An independent security
study could conclude, for example, that
security during air
travel is necessary, but security on a
24-hour basis is unnecessary.
The expenses incurred for
security services will normally be deducted
under “Other
Deductions”. A review of the W-2/1099 forms
and employment agreements may
provide information related to security
services.
Upon examination it has
been found that homes of executives have
been fortified with
special rooms or other security devises. It
is important to evaluate the level of
security
afforded top executives and their families
to determine that security studies are being
followed.
Spousal/Dependent
Life Insurance – Group term life
insurance premiums paid to
insure the lives of a spouse or dependent of
an executive are included in the gross
income of the executive (Treasury Regulation
§1.61-21(b)(1)) . The “cost” of dependent
group term life insurance must be determined
under Table I of §1.79-3(d)(2) of the
regulations. Employers attempt to classify
such payments as a deminimis fringe benefit;
however, the Government takes a very narrow
view of this provision (PLR 200033011).
Split-Dollar Life insurance provided for an
executive’s spouse should be examined. For
further guidance, refer to the ATG titled
“Split Dollar Life Insurance”.
Transportation
- If an employer provides a car or other
road vehicle for an executive’s use, the
amount excludable as a working condition
fringe benefit is the amount that would be
allowable as a deductible business expense
if the executive paid for its use
(§1.132-5(b)). The executive’s personal use
of the vehicle is taxable. The value is
generally determined by reference to fair
market value unless one of the special
valuation methods is used (§1.61-21(b)(4)).
The three special valuation rules for
automobiles are:
-
Automobile lease
valuation rule – §1.61-21(d)(2);
-
Vehicle
cents-per-miles rule – §1.61-21(e);
and
-
Commuting valuation
rule – §1.61-21(f).
There are specific
requirements that must be met in order to
use these special valuation
rules. For example, the employer must
provide the employee with a vehicle for
commuting for bona fide noncompensatory
business reasons in order to use the
commuting valuation rule.
Chauffeurs
- The taxable benefit with respect to a
chauffeur is determined separately
from the taxable benefit of the use of a
vehicle. In order to determine the taxable
benefit, the business use percentage must be
determined. See §1.61-21(b)(5). If the
chauffeur’s services are obtained for
security reasons refer to § 1.132-5(m).
Employer-paid
parking - The term “qualified
transportation fringe” (§132(f)) includes:
1) transportation in a commuter highway
vehicle between the executive’s residence
and place of employment; 2) any transit
pass; and 3) qualified parking. The value of
parking provided to an executive on or near
the business premises of the employer is
excludable from gross income if the
statutory monthly limit is not exceeded
(§132(f), 1.132-9, and Notice 94-3
(providing valuation rules)).
Transportation expenses may
be deducted under Other Deductions and
Depreciation
on the tax return. A review of benefit
packages, employment contracts, and W-2/1099
forms may indicate potential issues in this
area.
Transfer of
Property - Income provided or
granted to employees or executives
includes all remuneration granted for the
exchange of services. Remuneration may also
take the form of property. Property may
include real and personal property other
than
money or an unfunded and unsecured promise
to pay money in the future. Property
may also include a beneficial interest in
assets (including mone y) which can be
transferred or set aside from the claims of
the creditors of the transferor, such as in
a
trust or escrow account. See Regulation
§1.83-(3)(e).
Property other than cash
may be represented in a number of forms. It
may include stock or personal property
including real estate, furniture, equipment,
personal computers and or cellular phones.
Employee Use of
Listed Property - Special
recordkeeping rules apply to computers
except for those used exclusively at the
business establishment and owned or leased
by the person operating the business.
Detailed records are required to establish
business use of computers that can be taken
home or are kept at home by the executives.
There are no record keeping exceptions like
“no personal use” available for computers.
See Code §280F(d)(4)(B) and §274(d)(4), and
cf. Reg. §1.274-6T(a)(2) and§
1.280F-6T(b)(3)(ii).
Similar recordkeeping
problems arise for cellular and car phones
placed in service after 1989. Code
§280F(d)(4)(A)(v) as adopted under OBRA ’89
identifies these items as listed property.
This requires documentation of business
usage in order for the purchase and
operational cost to be an allowable
deduction and not included as income to the
executive.
In addition, the taxable
income in connection with the transfer of
tangible property must be determined
utilizing one of the prescribed methods
listed in Regulation §1.482-3. It has become
common place for corporations to purchase
homes for relocating executives or to
provide low or no interest loans for the
purchase of homes. Executives generally
maintain a home office that may be furnished
by the corporation. Sometimes upon
termination of employment the furnishings
and equipment are transferred to the
executive as part of their severance
package.
Relocation
Exepenses – The value of relocation
benefits may be includable in gross
income. Section 82 provides that there shall
be included in gross income (as
compensation for services) any amounts
received as payment for or reimbursement of
expenses of moving from one residence to
another which is attributable to
employment. However, § 132(g) provides an
exclusion for qualified moving expense
reimbursements. Under § 132(g), an employee
may exclude the amount paid or reimbursed by
the employer that would be deductible under
§ 217. Under § 217, only the costs of moving
personal belongings and traveling to the new
location are deductible. Costs such as meals
and lodging in temporary quarters are not
deductible under § 217. In addition, other
costs paid by the employer, such as
brokerage fees, property taxes, insurance,
fix-up expenses, and reimbursement for
losses with respect to the sale of the prior
home are includable in gross income.
Non-commercial Air
Travel - If an executive (or family
member) uses the employer’s aircraft for
personal reasons, the use must be valued and
included in taxable wages (§1.61-21(g)). The
valuation will depend on whether the flight
is primarily business or personal and
whether o r not the executive is a “control
employee” (§1.61-21(g)(8)). The value of the
flight is determined by reference to fair
market value unless the special valuation
rules known as the Standard Industry Fare
Level formula (”SIFL”) are elected (§
1.61-21(g)(5)). There is a lower SIFL
inclusion amount if the air travel is a
security related benefit meeting the
requirements of §1.132.5(m)(2)(iii).
Even though the amounts
attributable to the personal use of the
aircraft exceed the
amounts treated as compensation to the
executive, the employer’s deduction is not
limited, unless deduction is limited by the
recently enacted amendment to § 274(e)(2),
discussed below. The courts have
consistently held that the taxpayer’s
deductions for
operation of the aircraft were in no way
limited by the value reportable as
compensation for personal use of the
aircraft. Midland Financial Co. v.
Commissioner, T.C. Memo 2001-203;
National Bancorp of Alaska, Inc. v.
Commissioner, T.C. Memo 2001-202;
Sutherland Lumber-Southwest, Inc. v.
Commissioner, 114 T.C. 197, aff’d
255 F.3d 495 (8th Cir. 2001). The Service
acquiesced to Sutherland
(AOD 2002-02).
Section 274(e)(2) was
recently added by the Jobs Act of 2004 to
provide that the
employer's deduction is limited to the
amount included i n the executive's income.
The
amendment was expressly intended to reverse
Sutherland Lumber. It applies with
respect to individuals who are subject to
the reporting requirements under § 16(a) of
the Securities Act of 1934 (the president,
principal financial officer, principal
accounting officer, any vice president in
charge of a principal business unit, or any
other officer who performs a policy making
function). Under § 274(e)(2), with respect
to covered executives, a corporation may not
deduct the expense of operating aircraft in
excess of the amount included in the
executive's income, which is generally based
on the SIFL valuation methodology. New §
274(e)(2) applies to expenses incurred after
October 22, 2004.
The deduction on the return
for this expense will normally be found
under “Travel and
Entertainment” or “Officer Compensation”. A
review of the flight log, flight schedules,
W-2/1099 forms, Compensation Committee
Minutes, and employment contracts will
usually provide the information needed to
compute the amount to be included in taxable
wages. Corporations will normally include a
portion of the imputed amount in wages;
however, these amounts are often computed
incorrectly. It has been found that
departing executives may enter into
consulting contracts that contain provisions
“allowing the worker the same travel status
and privileges as other senior company
executives”. This has been interpreted to
mean that such workers are allowed to
utilize
the service of the corporate aircraft rather
than travel by commercial means.
Employer-paid
vacations – The value of
employer-provided vacations generally is
includable in gross income and wages. The
value of a vacation is generally not
excludable as a working condition fringe
benefit because vacation expenses are
personal expenses. A working condition
fringe is any property or service provided
to an employee of an employer to the extent
that, if the employee paid for the property
or
service, the amount paid would be allowable
as a deduction under §§ 162 or 167
(§1.132-5(a)). In general no deduction shall
be allowed under § 162 for personal, living,
and family expenses. An example of personal
expenses would include expenses
incurred in traveling away from home (which
include transportation expenses, meals,
and lodging) and any other transportation
expenses not deductible under §162
(§1.262-1(a) and 1.262-1(b)(5)).
However, special rules
exist for air travel provided in connection
with trips that are part business and part
personal. See Regulations §
1.61-21(b)(6)(iii). In addition, a portion
of the cost of air travel may be e xcludable
if there is a security related concern
within the meaning of § 1.132-5(m).
This expense may be
deducted under Other Deductions, Travel and
Entertainment, or
Employee Benefits. A review of the flight
logs for the corporate jet may reveal
vacation trips taken by executives and their
families.
Spousal or
Dependent Travel – No deduction
under §274(m)(3) shall be allowed for travel
expenses paid or incurred for a spouse,
dependent, or other individual
accompanying the executive on business
travel unless –
-
the spouse,
dependent, or other individual is an
employee of the taxpayer,
-
the travel of the
spouse, dependent, or other
individual is for a bona fide
business purpose, and
-
such expenses would
otherwise be deductible by the
spouse, dependent, or
other individual.
If the employer elects to
treat the travel of the spouse as
compensation and tax the
executive accordingly, the employer can
deduct the travel expenses. IRC § 274(e)(2).
The amounts must be reported in the
executive’s W-2 as originally filed. The
employer
must also withhold taxes with respect to the
amounts included in gross income.
(§1.132-5(t); 1.274-2(f)(2)(iii)). The
limitations set out in §162(m) must be
considered when spousal travel is included
in executive compensation.
If an employer’s deduction
under § 162(a) is disallowed by § 274(m)(3),
the amount of the employee’s working
condition fringe benefit relating to the
employer-provided travel is determined
without regard to § 274(m)(3). However, to
be excludable as a working condition fringe,
the amount must otherwise be deductible
under § 162 by the employee if incurred by
the employee. The amount will be excludable
as a working condition fringe if it can be
shown that spouse’s presence has a bona fide
business purpose and if the employee
satisfies the substantiation requirements
under § 274(d). If the spouse’s travel is
not excludable as a working condition
fringe, then the employee must include the
value of the spouse’s travel in gross
income. See Regulations §§ 1.132-5(t);
1.61-21(a)(4).
A deduction for this
expense would normally be found under Travel
and Entertainment
or Employee Benefits. A review of the flight
logs and schedules may indicate when
spouses or other related parties accompany
the employee on trips or vacations. It may
also be necessary to issue an IDR asking for
specific information related to travel.
Wealth Management
– As part of their employment agreement or
as a separate written or oral agreement,
many executives are provided either a sum of
money for financial planning or the services
of the accounti ng firm used by the company.
The use of financial planning services is a
service that an executive receives in lieu
of
compensation and is a taxable fringe
benefit, receiving a sum of money for
financial
planning is also compensation unless the
requirements of § 132(m) are met.
Qualified
Retirement Planning - Beginning
with the year 2002, §132(a)(7) excludes from
gross income qualified retirement planning
services. The services are defined in
§132(m) as any retirement planning advice or
information provided to an employee and his
spouse by an employer maintaining a
qualified employer plan. The employer may
not discriminate in favor of highly
compensated executives. The
nondiscrimination rule states that the
exclusion is allowable for highly
compensated employees only if the retirement
planning services are available on
substantially the same terms to each member
of the group of employees normally provided
education and information regarding the
employer’s qualified employer plan (which is
defined as a plan, contract, pension or
account described in §219(g)(5)). For the
purposes of CIC taxpayers, this would be
stock bonus, pension or profit sharing plans
with a qualified trust, not the executive’s
nonqualified deferred compensation.
You can identify this issue
by requesting information about services
provided by the
company to the executives for income tax
preparation, financial planning, or other
accounting services. A review of the
executive’s employment agreements and
benefits
will also assist in identifying this issue.
A cursory review of the corporation’s
outside
accounting expense account(s) may lead to
identification of this issue.
An Employer May Pay
the Employee’s Share of FICA Taxes
An employer may pay the
employee FICA tax imposed by §3101 owed with
respect to a fringe benefit. The payment of
the employee’s FICA tax constitutes a
payment of
additional wages for FICA and income tax
withholding purposes. (§31.3401(a)-1(b)(6)).
Rev. Proc. 81-48, 1981-2 CB
623, and Revenue Ruling 86-14, 1986-1 CB
304, provide a formula for purposes of
calculating an employee’s FICA wages when
the employer pays the FICA tax without
deducting the amount of the tax from the
employee’s pay. For example: In 2004, an
employer pays an employee $300 weekly and
arranges to pay the employee FICA tax
without deducting the amount of the tax from
the $300. The rate of FICA tax is 7.65%. The
amount of wages, social security wages, and
Medicare wages is $324.85 as computed using
the formula shown below.
W = S/1-R
W = The employee’s total
FICA wages after the increase reflecting the
pyramiding effect referred to in § 2.04 of
the revenue procedure.
S = Stated pay (the pay before taking into
account the increase in wages).
R = Rate employee FICA tax.
W = 300/1-.0765
W = $324.85
How to Identify
SEC Items such as Form 10-K
(Items 10, 11, and 12) and Form 4 can be
used to
identify executive compensation issues. The
Form 4, Statement of Changes in
Beneficial Ownership, may indicate whether
stock was used for loan repayments.
(Sarbanes-Oxley Act restricts the use of
loans after July 30, 2002).
The following line items on
the income tax return frequently contain
taxable fringe
benefits; the list is not all inclusive :
-
Other Deductions
-
Cost of Goods Sold
-
Depreciation
-
Employee Benefits
-
Schedule M-1
-
Travel and
Entertainment
-
Rent
Request a listing of the
executives and officers from the taxpayer to
identify the highly
compensated executives. A representative
group of executives may be selected for an
in-depth examination. At a minimum the
selection should include the SEC §16b
executives (CEO and the other four highest
compensated officers) for publicly traded
companies.
The following steps should
aide in the examination of Executive Fringe
Benefits:
-
Determine the
department responsible for approving
and processing payments to
executives and officers.
-
Review the
Executive Compensation Committee
Minutes, reports, etc.
-
Review loan
agreements between the corporation
and executives/officers.
-
Identify all
payments to, or on behalf of, the
executives/officers.
-
Inspect the
employment contracts and/or
severance agreements to identify
salaries and benefits paid to the
executives.
-
Sample monthly
expense reports submitted by
executives. Determine if there is
an Accountable Plan and if the plan
meets the requirements of IRC 62(c).
-
Search for the
executive’s name, SSN, or title in
Accounts Payable. This search
may identify payments to executives
that were not included on a Form W-2
or
Form 1099.
-
Request a listing
of the specific Payroll Codes or
other accounting codes that
relate to expenses/expenditures for
executives. These codes can be used
to
identify payments to the
executives/officers that may be
taxable as compensation.
Attachments
Information
Document Request Forms – The
attached IDRs are samples containing items
that should be considered when examining
executive fringe benefits. The requirements
of the Team Coordinator, Team Manager, or
Taxpayer will dictate the format and manner
in which these items should be requested.
Articles –
A list of articles that may be of use when
examining executive fringe benefits. The
articles have been selected because they
provide insight into the world of executive
pay. The listing will be updated
periodically as new information is reported.
Executive
Compensation Articles
Oink, CEO Pay is
Still Out of Control, Here’s Why,
Fortune, April 14, 2003 By Jerry
Useem
A Rigged Market for
CEOs, Washington Post April 30,
2003 by Steven Pearlstein
Big Kozlowski,
Fortune, December 6, 2002, by Nicholas
Varchaver
CEO Perks That Will
Drive You Berserk, Fortune, July
21, 2002 by Andy Serwer and Grainger David
Getting Paid In
Planes, Perks, and Automobiles,
Fortune, July 9, 2002 by Jeremy
Kahn
The Great CEO Pay
Heist, Fortune, June 11, 2001 by
Geoffrey Colvin
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