IRS targets execs' shelters

CHICAGO — In a crackdown against what they called "abusive" tax shelters, IRS officials announced yesterday that they are targeting nearly 200 corporate executives for failure to pay millions in taxes on stock-option profits.

Commissioner Mark Everson said the Internal Revenue Service's investigation has so far identified 42 companies with unreported executive income of more than $700 million.

"These are household names," he said. "It was pervasive. It was widespread."

Citing federal tax-privacy laws, IRS officials declined to identify any of the companies or executives.

Everson said they are from a range of industries and locations.

In the tax shelters, IRS officials said, companies would grant stock options to executives, who would transfer them to family partnerships or similar entities owned by the executives and their relatives.

The partnerships would pay the executives with long-term notes, sometimes up to 30 years in duration, and then exercise the options, frequently selling the shares immediately. The executives did not pay taxes on the profit between the exercise price and the market price at the time of the exercise, as is required in option exercises, arguing the taxes could be deferred until the note was due.

The IRS ruled in 2003 that these transactions were "abusive."

It said it was allowing the executives the chance to pay the taxes until May 23, plus interest and a 10 percent penalty, half the maximum penalty that could be imposed.

Those that don't participate face stiffer penalties, the IRS said.

"We want to give people an incentive to put it behind them," Everson said.

In addition, in about half the cases, Everson said, companies did not take deductions that are available to them from the option exercises, which he called a questionable corporate-governance decision.

"Shareholders pay a higher tax bill than they might have — that's where the conflict comes in," he said.

Everson said the shelters typically were recommended by law firms, bankers and companies' independent auditors. Critics say the potentially lucrative fees from providing that kind of advice can compromise auditors' independence.

Those sorts of potential conflicts of interest came into sharp focus two years ago at Sprint, when Chief Executive William Esrey and President Ronald LeMay were forced out amid controversy over apparently similar tax shelters related to profits from option exercises.

The shelters were developed by the company's former auditors, Ernst & Young, which has defended its tax advice. Later in 2003, Ernst & Young agreed to pay the IRS $15 million in connection with its marketing of tax shelters.

The tax shelters targeted yesterday were only some of many that exploded onto the scene in the late 1990s as option grants and a booming stock market created countless executive millionaires.

"They were largely constructed at a time when the environment was different," Everson said, adding that in the new corporate-governance climate, "This sort of thing is less likely going forward."

In a statement, Securities and Exchange Commission Chairman William Donaldson commended yesterday's IRS action, saying, "It is important that leaders in our capital markets avoid inappropriate conflicts of interest."