Pension, Pay Audits Could Cost Billions

The fallout of all those corporate accounting scandals has finally settled on the desk of the nation’s tax collector, and companies that aren’t ready to face IRS scrutiny could pay a heavy price.

Since the Internal Revenue Service instituted two intense corporate audit initiatives a year ago, the agency has identified dozens of companies violating tax-code provisions for executive compensation and pension plans. In pension plans alone, an undisclosed number of companies in a pool of 40 initially audited by the IRS could be on the hook for a combined $2 billion to $3 billion in corrections and adjustments, says one source familiar with the audits.

“It’s a huge amount of money. Some of the (cases) they described were corrections in the hundreds of millions of dollars,” says Chris Lipski, a partner with Ernst & Young’s human capital practice in Cleveland who’s working with several companies being audited.

It’s all part of an IRS pledge to beef up compliance and enforcement in light of behemoth executive pay package scandals at companies such as Tyco International and WorldCom, where executives played fast and loose with tax laws. Increased public attention on pension plans in light of recent instances of underfunding is behind the retirement-plan audits.

In October 2003, the IRS started a yearlong pilot to more closely examine executive compensation programs at public and private companies with $10 million or more in annual revenue. As a first step, the IRS’ large and medium-size business division targeted 24 companies for audits. The agency has not publicly named them.

What they’ve found so far: corporate executives who didn’t file individual tax returns, repay corporate loans or declare as income fringe benefits like private use of company jets, says Andrew Liazos, a Boston-based partner at McDermott Will & Emery, who has been briefed by the IRS. The agency also found irregularities in long-term compensation payouts, golden parachutes and compensation-related performance goals, among other things, according to Monique Guesnon, a PricewaterhouseCoopers human resource services manager. She is working with at least five clients who are auditing their own executive compensation plans in light of tougher IRS audits of executive pay.

According to IRS documents, the agency is already incorporating seven of eight compliance areas initially targeted in the pilot into routine audits. An eighth issue, offshore employee leasing, wasn’t found to be common among large and medium-sized businesses, but it is being looked into by the IRS’ small-business division.

Also in late 2003, the IRS launched a separate 12-month pilot project to scrutinize corporate pension programs, specifically targeting defined-contribution and defined-benefit plans with more than 2,500 participants. For the first 40 companies it examined, audits lasted 200 to 300 days, compared with five days for a typical qualified plan review, according to industry sources. Among the problems pension plan audits have uncovered: ineligible participants; calculation errors affecting contributions, deferrals and benefits; and lack of proper documentation.

To minimize the impact of these new-generation audits, companies should undertake their own comprehensive compliance reviews, say accountants, lawyers and other industry experts. In the case of pension plans, a little preventive medicine could go a long way. The IRS has begun a voluntary compliance program to which companies can apply if they’re initiating an internal pension plan review. Once a company is enrolled in the voluntary program, the IRS won’t start an audit, and if the business ends up owing taxes, it won’t incur additional penalties, according to IRS documents.

To give the audit initiatives teeth, the IRS is expanding resources and training staff, by some estimates adding as many as 200 agents. “If they’re spending money and hiring people and finding errors, they’re serious,” Liazos says.

–Michelle V. Rafter