IRS Taking Hard Look at Executive Bonuses, Deductions
The Internal Revenue Service is scrutinizing companies that give bonuses to top executives when they haven’t met previously agreed-upon performance goals.
Publicly traded companies can earn tax benefits by tying bonus pay to executive performance. Deductions are limited to $1 million for the company’s top five executive officers — unless shareholders approve plans to link the compensation to specific performance targets. Boards are allowed to change the targets from prior years for tax-deductible compensation without an OK from the shareholders.
The Wall Street Journal reported that the IRS has found abuses of the bonus-payout deductions in its study of executive-pay practices at 24 large companies. Businesses are changing the performance goals, or paying the bonuses even when executives failed to meet the targets outlined in the bonus plans, said IRS attorney Catherine Livingston Fernandez.
Companies say that bonus targets sometimes must be lowered or overlooked in a tough economy. For example, AT&T Wireless Services Inc. said in its 2003 proxy statement that a slowdown in the cellular-phone industry, among other factors, are to blame for the original bonus performance targets in 2002 "no longer providing meaningful incentives."
Companies could lose part of their executive-pay tax breaks or face other penalties if abuses are found, said Fernandez, who is head of the executive-compensation branch for the IRS's Office of Chief Counsel. IRS examiners "have discretion to resolve this whatever way they see fit," she said.
Fernandez suggested that abuses appear to be common enough to make bonus compensation a routine part of corporate audits.
The study of executive pay is part of an IRS pilot project, designed to look at tax compliance for eight kinds of management compensation, which can include personal use of corporate jets, generous severance packages, deferred compensation or stock options.
Mary B. Hevner, a Washington attorney who represents one-third of the concerns being audited over executive-pay practices, said tax examiners "have proposed a lot of adjustments to my clients." So far, she told the Journal, none has lost an executive-pay deduction because the companies adequately explained why bonus plans were changed.
"My big clients are very careful about complying with the rules," she said, adding that other companies could face hefty penalties because they don't want "to let the IRS run [their] business."