Compensation today is more complicated than in the past. It’s no longer confined to a paycheck and a fringe benefit or two.
Today, employers seeking to attract and retain the best talent, craft arrangements to minimize income taxes for employees while saving on employment taxes to the extent allowed by law.
To further complicate matters, what is desirable from an employee perspective and what can be done from a tax perspective keep changing. To know what employees want, employers have to ask and listen. To know what tax rules are requires employers to be proactive.
Fortunately, from time to time the IRS posts audit technique guides that tell its agents what to look for during an audit, and we can review the guides, too, so we know what not to do.
Here are three key guides related to compensation:
- Equity-based compensation. This guide, which was posted recently, covers various stock-related compensation arrangements. Examples of equity-based compensation include stock transfers, stock options, stock warrants, restricted stock, restricted stock units, phantom stock plans, stock appreciation rights, and other awards whose value is based on the value of the employer’s stock. When the IRS examines these arrangements in closely-held businesses, it is going to look at employment contracts and minutes from board of directors meetings to see what is said about them. It’s also going to make sure that the terms of the arrangements are satisfied (i.e., that stock has been transferred to employees). If the corporation loans money to an employee to facilitate a stock purchase, the IRS is going to check on whether there has been any loan cancellation, which is additional compensation for the employee.
- Nonqualified deferred compensation. This guide, which came out in June of this year, addresses salary reduction arrangements, bonus deferral plans, supplemental executive compensation plans, and excess benefit plans. It also covers phantom stock plans, which are a form of a nonqualified deferred compensation plan.
- Executive compensation fringe benefit guide. This guide, which came out a decade ago, is a comprehensive look at all types of compensation paid to owners and other top management. It covers such perks as skyboxes, executive dining rooms, loans, and even chauffeurs. The guide is helpful in listing the various types of perks that can be provided. However, some matters in the guide may be outdated, or superseded by the other guides.
Bottom line: Business owners and their CPAs or other financial advisors should familiarize themselves with all compensation options. When fixing compensation arrangements for owners, executives, and other staff, it is important to keep in mind all of the following factors:
- Cost and what the company can afford
- Tax implications for employees and the company
- IRS view on various fringe benefits and compensation arrangements
