In case you were wondering (in your spare time), the IRS now has a techniques guide for auditing equity compensation. The “guide” is actually an instruction to internal IRS auditors on how to evaluate equity compensation during an “examination” (fancy word for “audit”). The guide, published in August 2015, is available on the IRS web site. I’ll try to summarize some of the more interesting points in today’s blog.

The Angles of Audit

Before I dive into what the guide says, I want to cover a thought that came to me as I was reading the guide. Stock Plan Administrators and their vendors are focused on tax compliance relative to the company’s corporate tax obligations (reporting, withholding, etc.). However, it’s important to remember that as compliant as we may be from a issuer standpoint, there is still audit exposure potential from the individual angle of tax compliance. An employee may get audited, even if the company is not being audited. The company’s documentation may be requested from the IRS as part of that audit. It’s important that issuers are aware that there are a variety of audit angles that could attract attention to their equity compensation record-keeping and disclosures at any given time, and the IRS guide seems to support that thought – providing detailed information on the types of transactions and potential tax issues that could arise. With that detail comes guidance on how to source documents attached to equity compensation. According to a blog dedicated to explaining the guide by Porter Wright Morris & Arthur LLP,

“Interestingly, the Guide devotes a fair amount of detail to explaining where auditors may find these documents, encouraging them to review Securities and Exchange Commission (“SEC”) filings as well as internal documents. As such, the Guide serves as an important reminder to employers to be mindful that the IRS (or other third parties) someday could seek to review their corporate documents. ”

Documents Galore

Let’s cut to the chase. Where are auditors instructed to look?

• SEC documents – This is an obvious one, but it’s where the IRS recommends their auditors start. Disclosures such as the 10K (Form 10-K), proxy statement (DEF 14A) and Section 16 reports of changes in beneficial ownership (Form 4) are places to identify types of plans and awards, as well as detailed compensation data for named executive officers and directors. The IRS recommends comparing data from these disclosures to individual Form W-2s and 1099-MISCs to verify proper tax withholding and reporting. If discrepancies surface, the IRS recommends expanding the audit (yikes).

• Internal Documents – Types of internal documents subject to scrutiny include employment contracts, and meeting minutes from Board of Director and Compensation Committee meetings.

The Porter et al blog summarized this into some key awareness factors for employers:

“Employers should be aware of these instructions. Often times, it is easy for someone to prepare internal documents using jargon or short-hand that is familiar among people at the company but that may be difficult to explain to a third party or worse could be misleading. The Guide demonstrates that internal documents may not be restricted to internal personnel. Instead, the IRS very well could review these internal documents. As such, employees and advisers who prepare these documents should be mindful of both the information contained in the documents and how they present that information.”

Takeaways

When preparing documentation or disclosures (including supporting documents for those disclosures), it’s good to look at the process as if a third party will eventually come in and evaluate the information. The Porter blog made a great point – often times records are maintained in manner that internal parties may easily understand, or there’s someone on hand who can “interpret” that scrawl made by a board member. However, once that information is subject to review by an auditor, questions can arise. Companies should be aware of the IRS audit instructions relatives to equity compensation and maintain their records in a way that will make it easy to explain if audited.

-Jenn