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IRS: Settlement Window for Stock Scam Open until late May
In its announcement Tuesday, the IRS said the
settlement offer also extends to corporations that issued
the options to executives and directors as part of their
compensation. To date, the tax officials have identified
42 corporations, many more executives and unreported
income of more than $700 million involved in the
transactions, according to the IRS news release.
According to the IRS, executives carrying out these
transactions transferred stock options to family
controlled partnerships and other related entities
typically created for the sole purpose of receiving the
options and avoiding taxes on compensation income
normally taxed to the executive. The objective was to
defer for up to 30 years taxes on the compensation and,
in many cases, resulted in the corporation deferring a
legitimate deduction for the same compensation, according
to the government.
“These transactions raise questions not only about
compliance with the tax laws, but also, in some
instances, about corporate governance and auditor
independence,” said IRS Commissioner Mark Everson, in the
news release. “These deals were done for the personal
benefit of executives, often at the expense of
shareholders.”
Under the terms of the settlement, participating
executives must report 100% of the compensation and must
pay interest and a 10% penalty – one-half of the
maximum 20% applicable penalty. Corporations and
executives must also pay appropriate employment taxes.
The parties will be allowed to deduct their out of pocket
transaction costs, typically promoter and professional
fees. Corporations will be allowed a deduction for the
compensation expense reported by the executive. Where
corporations have been identified, the IRS will contact
senior management and ask that the matter be referred to
the board of directors’ audit committee for appropriate
review.
Background
The IRS said that professional service firms and
financial institutions aggressively promoted these stock
option transactions in the late 1990s and early 2000s.
The IRS announcement said that the transaction first
involves the transfer of stock options by the executive
to a related entity, such as a family limited
partnership, under terms of an agreement to defer payment
to the executive. Next, the partnership exercises the
options and sells the stock in the marketplace. The
executive then takes the position that tax is not owed
until the date of the deferred payment, typically 15 to
30 years later, although the executive has access to the
partnership assets undiminished by taxes.
Tax laws require executives to include in income and pay
tax on the difference between the amount they pay for the
stock and its value when the option is exercised, the IRS
warned. Corporations are entitled to a deduction for the
compensation when the options are exercised.
In many cases examined by the IRS, the executive’s
inappropriate attempt to defer tax on the compensation
was paired by the corporation with also deferring an
otherwise legitimate tax deduction for that compensation.
The IRS also issued
a Fact Sheet
describing the transaction fundamentals, the corporate
governance issues and the tax and penalty costs to
executives and companies who participate and those that
don’t.