Decrease the Chance of an IRS Audit

IRS audits have exhibited higher focus on executive compensation and fringe benefits over the past few years. Knowing where auditors look for errors can help decrease the chance of an audit.

Fringe benefits are defined as benefits provided by employers which are exempt from taxations as long as certain criteria are met.  Some examples of fringe benefits include athletic skyboxes and suites, large bonuses, club memberships, private jet usage, and corporate credit cards. All employees with taxable fringe benefits must include the benefits’ market value in their taxable income for that year.

While there are clear guidelines that determine which fringe benefits are taxable and which are not, the IRS also says that some taxes can be avoided if benefits are classified under expense accounts other than compensation. This is where it can get confusing.

To decrease the chance of an IRS audit, it is helpful to be aware of the IRS audit examination process. First, the IRS instructs auditors to assume a benefit is taxable to the employee.  Next, they check for statutes that exclude the benefit from taxation.  If there is no statute that covers the entire benefit amount, its value is determined and included in the employee’s gross compensation.  The fringe benefit is valued at the amount that the employee would pay for it at an “arm’s length” transaction.

The IRS conducts a meticulous examination of employee compensation and fringe benefits if an audit is ordered. Auditors are instructed to identify highly compensated employees, salary amounts, and whoever approved and processed payment.  They may request a list of corporate executives, and inspect employee contracts.  Auditors may also examine payment processes by reviewing meeting minutes and loan agreements between the corporation and executives.

The IRS may inspect any compensation-related documents in order to determine if payments were included in employee compensation, and identify any compensation discrepancies.  These documents can be check samples, account payable records, or documents filed with the Securities and Exchange Commission. Auditors are also advised to examine payroll codes and tax returns to identify taxable payments and ensure that they were claimed.

In the face of a possible audit, ensuring compliance is key.  Stay detail-orientated and make sure compensation plans are in line with IRS regulations. Staying organized will help make the entire process less daunting.

If you have any questions, please contact us.