The NASPP Blog

June 7, 2011

IRS Auditing Stock Compensation

In late 2009, the IRS announced a major audit initiative for executive compensation that will ultimately involve at least 6,000 companies (see “IRS Audits: Are You Ready to Rumble?” January 26, 2010). We’re now over a year into that project, so I thought it might be a good time to revisit the subject.

No Need to Be Surprised

If you’ve been wondering what the IRS might audit relating to stock compensation, it turns out that there’s no need to be surprised. The IRS explains what they are looking for relating to stock compensation on their website. Here are a few highlights of what you can expect IRS auditors to investigate:

  • In the case of restricted stock and units, whether there has been a transfer of property (e.g., does the employee have voting and/or dividend rights) and whether there is a substantial risk of forfeiture for the award.  According to Stephen Saxon in the March issue of PLANSPONSOR (“Saxon Angle: Audit Trials“), companies that offer accelerated vesting upon retirement should be especially wary of this issue for their retirement-eligible employees.
  • Whether ISOs and ESPPs meet the statutory requirements, especially the $100,000 and $25,000 limitations.
  • Whether income has been properly reported (on Form W-2 or Form 1099-MISC) and taxes withheld (if required) on all types of stock plan transactions.
  • Whether tax withholding for stock compensation has caused companies to exceed the $100,000 next-day deposit threshold that Rachel blogged about a couple of weeks ago (“Timely Tax Deposits,” May 26), and, if so, if companies complied with the deadline.
  • Recordkeeping practices relating to grants, exercises, and other stock plan transactions.
  • Compliance with Section 162(m)–but that’s a topic for another blog. 

Things I Sure Hope Won’t Be a Problem

There are a few items highlighted in the IRS’s audit instructions that I sure hope won’t be a problem for any NASPP members–I know you are all too smart to fall for these traps:

  • Back-dated stock options.  No explanation needed on this one.
  • Transfers of options to a related party.  Under this strategy, an executive would “sell” stock options to a family member or trust in exchange for an unsecured, long-term, balloon payment obligation (essentially, the related party just “promises” to pay the executive for the stock option at some point in the future, a long ways in the future).  The idea was to get around the gift tax that could apply if the option were simply transferred to the family member/trust.  This type of a arrangement has been a no-go with the IRS for some time.
  • Not issuing stock upon same-day-sale exercises of an ISO or ESPP.  Although the tax code itself is not clear, the IRS’s audit instructions specifically state that if, rather than issuing stock on a same-day sale, the underlying shares are simply cancelled in exchange for the spread–in other words, a net exercise–the arrangement is subject to withholding for both income tax and FICA purposes. 
  • Issuing loans to executives for option exercises and then later forgiving or reducing the loans.  Public companies shouldn’t be issuing loans to executives at all, much less forgiving those loans.   

Last Chance to Qualify for Survey Results
This week is your last chance to participate in the NASPP’s 2011 Domestic Stock Plan Administration Survey (co-sponsored by Deloitte).  Issuers must complete the survey by this Friday, June 10, to qualify to receive the full survey results. Register to complete the survey today–we’ve already extended the deadline once, we can’t extend it again!

NASPP Conference Program Now Available
The full program for the 19th Annual NASPP Conference is now available.  Check it out today and register by June 24 for the early-bird discount–this deadline will not be extended.

NASPP “To Do” List
We have so much going on here at the NASPP that it can be hard to keep track of it all, so I keep an ongoing “to do” list for you here in my blog. 

– Barbara