The IRS recently released an updated version of its Audit Technique Guide (ATG) for audits involving stock compensation: Equity (Stock) – Based Compensation Audit Techniques Guide, which provides guidance to IRS examiners. Financial advisors and tax professionals with clients that receive equity compensation should consider reviewing it.
Here is an outline of the updated ATG on stock compensation. The guide summarizes and confirms the tax treatment for different types of equity compensation and raise issues about how the IRS applies and interprets certain IRC sections and IRS regulations.
How The IRS Prepares For Audits
The ATG recommends that during the initial examination process, a good place to start is with a review of the company’s SEC filings and the taxpayer’s internal documents. The review of these documents may help to identify people who have received equity-based compensation and the key provisions in SEC filings and company documents.
What IRS Looks For In Stock Transfers And Awards
The ATG also lists, the hot IRS topics that are leading to tax errors in recognizing income, withholding, reporting, and underpayments. The IRS instructs its auditors to determine whether:
- Stock was actually transferred
- Stock options were transferred to a related person
- The purchase price was reduced for a note used to acquire employer stock
- Elections were punctually made under IRC §83(b) and records verify these timely elections
- A substantial risk or forfeiture exists to delay vesting according to the facts and circumstances
- Dividends were paid on restricted stock
For each of these, the IRS explains the issues and then covers ways in which examiners can root out potential tax errors.
What IRS Looks For With Stock Options
In addition to the items listed above, the ATG delves into even greater detail with stock options. The guide tells IRS auditors to determine the type of stock options granted and to then closely examine whether:
- Statutory stock options, which in IRS terminology includes ISOs and tax-qualified ESPPs, are following the specific IRC provisions for them, both in their grant terms and in the taxes incurred when shares are sold
- Reporting and filing rules were complied with, including those for Form W-2 and those required for ISOs and ESPPs under IRC Section 6039
- Appropriate amounts were promptly deposited for the withholding of FICA, FUTA, and federal income tax
The ATG also covers other types of equity-based compensation, instructing its examiners to look at the payout structure of phantom stock plans and of Stock Appreciation Rights (SARs) at exercise. The guide also contains a summary of the tax rules for Restricted Stock Units (RSUs) and a reminder that RSUs must follow IRC Sections 451 and 409A to avoid taxation at grant.