Uh oh: IRS taking a closer look at companies’ stock option plans

Publicly traded companies that offer stock options may want to touch base with their tax accountants.

That’s because the IRS is launching an enforcement crackdown on employee stock ownership plans (ESOPs). The goal is simple: Make an example out of tax cheats and boost compliance by the majority that wants to comply with the law at all times.

The IRS says it’s focusing on ESOPs so that “high-income filers pay the taxes they owe,” IRS Commissioner Danny Werfel warns. “This means spotting aggressive tax claims as they emerge and warning taxpayers. Businesses and individual taxpayers should seek advice from an independent and trusted tax professional instead of promoters focused on marketing questionable transactions that could lead to bigger trouble.”

Bigger trouble, of course, meaning substantial fines and criminal prosecution.

What’s going to land tax filers in hot water?

The IRS acknowledges that ESOPs are frequently “complex” and it can lead to companies and individuals failing to pay taxes owed by accident. The flip side is also true as sometimes entities overpay in taxes.

Three common compliance issues the IRS will be checking are:

• under-valuing stock shares
• giving shares to disqualified individuals, and
• failure to follow tax law requirements for ESOP loans which makes said loans “prohibited transactions.”

The IRS is also onto “schemes” in which “a business creates a ‘management’ S corporation whose stock is wholly owned by an ESOP for the sole purpose of diverting taxable business income to the ESOP. The S corporation purports to provide loans to the business owners in the amount of the business income to avoid taxation of that income. The IRS disagrees with how taxpayers interpret this transaction and emphasizes that these purported loans should be taxable income to the business owners.” These transactions also impact whether the ESOP satisfies several tax law requirements which could result in the management company losing its S corporation status.”

The agency offers an ESOP compliance website (click here). Companies that spot mistakes made in past years would be wise to contact the IRS as soon as possible because the agency is inviting would-be whistleblowers who know about ESOP noncompliance to share what they know.