IRS offers to settle on tax shelter schemes

Proposal targets companies, officials who shielded $700 million

February 23, 2005|By Meredith Cohn | Meredith Cohn,SUN STAFF

In an effort to rein in corporate tax-avoidance schemes, the Internal Revenue Service said yesterday that it is offering settlements to 42 companies and about 200 of their executives who it claims channeled hundreds of millions of dollars worth of stock options through improper tax shelters.

The IRS did not identify the companies but said they included household names in various industries across the country.

With help from their employers, the executives were able to transfer options to family trusts or partnerships that sheltered a total of at least $700 million from taxes. In about half of the cases, companies also did not take legitimate deductions for the compensation, which meant shareholders had to foot a higher tax bill, the IRS said.

"This covers a wide range of leading public companies," IRS Commissioner Mark W. Everson said. "These deals were done for the personal benefit of executives, often at the expense of shareholders."

The IRS crackdown is an outgrowth of two of the biggest business stories of the past decade. The first was the surge in stock option grants that accompanied the rapid rise and fall of the dot-com Internet companies in the late 1990s. That was followed by a spate of white-collar prosecutions in recent years that revealed accounting frauds and insider deals to concoct or conceal profit, sometimes engineered by supposedly independent auditing firms.

Professional service firms and financial institutions aggressively promoted abusive stock option transactions, the IRS said yesterday.

The 2002 Sarbanes-Oxley legislation, which raised requirements for corporate accountability, helped cut down on the kind of abuse the IRS is targeting, the agency said.

"We believe a new climate under Sarbanes-Oxley, together with the tougher independence standards for auditors recently proposed by the Public Company Accounting Oversight Board, make this sort of thing less likely going forward," Everson said in a statement. "However, we want to give executives and corporations a chance to clean up past transactions."

Everson said executives, companies and others who used the shelters will get 90 days to accept a settlement offer from the IRS, claim the proper income and pay interest. The executives would also have to pay a 10 percent penalty. That is half the amount they would pay if they were caught by the IRS during audits or through other means.

Everson said a similar settlement initiative last year that targeted individuals, most of whom sold a business and then sought to avoid taxes, prompted hundreds of taxpayers to come forward. A tally of taxes recovered from the "Son of BOSS" settlement -- a variant of another scheme called the Bond and Option Sales Strategy -- will be available in the next several weeks, the agency said.

IRS officials said enforcement is at an all-time high, with audits last year reaching 1 million individuals, up from 620,000 in the late 1990s.

The agency also has declared about 30 transactions abusive in recent years. The stock option scheme described yesterday was declared abusive in 2003, but officials said no companies had come forward to report back taxes owed.

The IRS has investigated similar tax-avoidance schemes from stock option gains in the past.

One such case led to the ouster in 2003 of William T. Esrey, Sprint Corp.'s chairman and chief executive, and Ronald T. LeMay, the company's president and chief operating officer. The IRS later collected $15 million from Ernst & Young, Sprint's outside auditor, for marketing such tax shelters.

Under the scheme being targeted, an executive would transfer stock options to a related party, such as a family limited partnership or trust, which would agree to defer payment to the executive. The related entity would later exercise the options and sell the stock. The executive would claim no tax was owed until the date of the deferred payment, typically 15 to 30 years, although the executive would retain access to the proceeds.

"It is important that leaders in our capital markets avoid inappropriate conflicts of interest such as those described in the IRS' executive stock option initiative," U.S. Securities and Exchange Commission Chairman William H. Donaldson said in a statement. "The IRS' settlement initiative is a step forward in the effort to protect the integrity of our capital markets."

William J. McDonough, chairman of the Public Accounting Oversight Board, said the IRS effort and coordination among regulators will help "bolster confidence of investors and the public."

The board, a private-sector, nonprofit corporation created in 2002 to oversee auditors of public companies, has proposed new rules in an effort to ensure their independence and ethical behavior.

"The state of ethics in corporate America is better today than it was a few years ago," said R. Edward Freeman, academic director of the Business Roundtable Institute for Corporate Ethics. "But if you're focusing on not getting caught by the IRS, then you're missing the point. We need to build ethics into the way we do business, and I think it's starting to happen."

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