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DECEMBER 22, 2003
Exec Pay: "Everybody Should Be A Little Nervous" The IRS is going after the last bastion of accounting creativity -- executive pay For years, the Internal Revenue Service's policy on matters related to executive pay has been distinctly hands-off. Only rarely did corporate audits venture into executive pay packages. With that set to change, however, CEOs may soon have another thing to worry about. About six months ago, the agency quietly began what looks increasingly like an an all-out assault on tax-code violations in connection with gargantuan executive pay packages. The IRS says it intends to make executive pay a part of every corporate audit from now on. In audits of two dozen of the nation's biggest companies, its agents have already begun focusing on stock options, fringe benefits, and golden parachute payments. The goal: to get companies and executives who underpaid their taxes to cough up what's owed -- and to convince them to change their ways. "They're clearly sending a signal that it's no longer a kinder, gentler IRS," says David R. Fuller, a Washington tax attorney with clients targeted in the IRS sweep. "I don't see this blowing over." The IRS is inserting itself into the executive-compensation fray at a particularly auspicious moment. In the wake of Richard A. Grasso's resignation from the New York Stock Exchange over his $188 million pay package, the spectacle of L. Dennis Kozlowski allegedly squandering Tyco International (TYC ) assets for personal use, and the questionable tax strategies employed by top executives at Sprint (FON ), public anger over the issue has reached a fever pitch. THE CREATIVITY FACTOR But it isn't the size of the pay packages that has the IRS leveling its sights -- it's the way they're constructed. The bonuses, stock and option grants, deferred compensation, and litany of perks that make up a typical executive pay package leave a lot of room for imaginative taxpaying strategies, for both the company and the executive. New laws passed in the last decade, and the never-ending stream of court cases and IRS rulings, add to the opportunity for tax dodges. "The complexity -- the creativity -- has really grown," says Keith Jones, director of field specialists for the agency. "It's now higher on our radar screen than it was five years ago." OPEN SEASON So what are the taxmen looking for? In a word, everything. Stock-option grants and deferred-compensation contributions that are deducted too early by the company, excess company payments for life-insurance policies that are not declared as income by the executive, and company deductions that violate the $1 million cap on deductible compensation are all in the IRS crosshairs. Jones figures the compliance program will result in "adjustments and taxes paid" by both companies and individuals. How much, though, is open for debate. Donald C. Alexander, a former IRS commissioner, says he suspects noncompliance is minimal. But some executive compensation experts predict that violations will be numerous -- especially at many smaller companies, where lavish perks to lure executive talent may not always get the most rigorous tax treatment. Says Brent Longnecker, an executive-compensation consultant based in Houston: "Everybody should be a little nervous." By making such issues part of every corporate audit, the IRS hopes companies will put a higher priority on strict compliance. "To the extent that there are some pockets of noncompliance, this would be something that would get you walking the straight and narrow very quickly," says Robert Willens, a tax and accounting analyst at Lehman Brothers Inc. (LEH ). One thing seems certain: Companies that ignore the new IRS initiative will do so at their peril. Remember, it wasn't a squad of G-men who finally brought down Al Capone -- it was an army of pencil-packing IRS agents. Now the overpaid executive is the IRS' new public enemy No. 1.  By Louis Lavelle in New York
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