IRS Initiates Tax Crackdown Targeting Employee Stock Option Plans

The Internal Revenue Service (IRS) building in Washington on June 28, 2023. (Madalina Vasiliu/The Epoch Times)

The IRS stated that it’s taking “swift and aggressive action” targeting compliance issues related to Employee Stock Ownership Plans (ESOPs), which are retirement arrangements through which employees become partial owners of their company by owning stock in it.

As part of its broader thrust to increase tax collections, the IRS stated in an Aug. 9 alert that it had identified numerous compliance issues associated with ESOPs, including certain arrangements that are potentially abusive and can amount to prohibited transactions.

Since an ESOP can borrow funds from employers or third parties to purchase shares of the employer, ESOPs can be complex arrangements. In light of this complexity, the IRS stated that it’s taking tougher enforcement strategies to make sure that employers who sponsor an ESOP are complying with tax laws.

Some of the compliance problems flagged by the IRS include valuation issues with employee stock, prohibited allocation of shares to disqualified people, and failure to follow tax rules for ESOP loans that cause such loans to be unlawful.

‘Swift and Aggressive Action’

IRS Commissioner Danny Werfel said that before recent legislation that included a massive $80 billion funding boost for the tax agency, the IRS was unable to keep up with increasingly complicated ways that some taxpayers might avoid paying taxes.

“The IRS is now taking swift and aggressive action to close this gap,” Mr. Werfel said in a statement. “Part of that includes alerting higher-income taxpayers and businesses to compliance issues and aggressive schemes involving complex or questionable transactions, including those involving ESOPs.”

Besides compliance issues related to ESOPs, the IRS has identified instances of tax advisers promoting potentially abusive arrangements related to such plans. For instance, certain schemes have come to the attention of the tax agency that involve a company’s establishing a “management” S corporation.

This S corporation’s stock is entirely owned by an ESOP with the primary intention of diverting taxable business earnings to the ESOP. The S corporation claims to extend loans to business proprietors equivalent to the business’s income, aiming to avoid taxation on those earnings.

“The IRS disagrees with how taxpayers interpret this transaction and emphasizes that these purported loans should be taxable income to the business owners,” the IRS said in a statement, meaning that it considers such arrangements to be potentially abusive.

Such transactions also play a role in whether the ESOP satisfies certain tax law requirements, with the possible consequence that the management company loses its status as an S corporation.

The IRS said that over the coming year, it will use a range of compliance tools—including more audits—to address ESOP-related compliance issues.

Besides vowing to crack down on compliance issues related to ESOPs through tougher enforcement, the IRS also asked people to report individuals who promote improper and abusive tax schemes, and to tell on tax return preparers who intentionally prepare improper returns.

“Businesses and individual taxpayers should seek advice from an independent and trusted tax professional instead of promoters focused on marketing questionable transactions that could lead to bigger trouble,” Mr. Werfel said.

Other Policy Shifts

In a recent move that represented a shift in IRS policy, the tax agency announced it would be putting an end to most unannounced agent visits to taxpayers’ homes.

The move, which was announced at the end of July and went into effect immediately, reversed decades of policy that saw IRS revenue officers knock on doors of taxpayers’ homes without forewarning in a bid to resolve delinquent tax matters.

The IRS said the reason for the change was to lower the risk that the surprise home visits could spiral out of control, posing a hazard to both taxpayers and agency field officers.

Unannounced door knocks at homes and businesses were found to be high-risk encounters, the IRS said, with agents routinely facing “hazards and uncertainty” when making surprise visits.

“These visits created extra anxiety for taxpayers already wary of potential scam artists,” Mr. Werfel said in a statement. “At the same time, the uncertainty around what IRS employees faced when visiting these homes created stress for them as well. This is the right thing to do and the right time to end it.”

Instead of unannounced door knocks, IRS agents will send letters to taxpayers to schedule in-person meetings.

There will still be rare unannounced visits, including those related to summonses and subpoenas.

Also, the IRS recently sent out a warning to taxpayers that it had identified a new tax scam that tries to trick people into believing the government owes them money.

Unlike some scams that involve online activity, the new scheme involves a physical mailing that comes in a cardboard envelope from a delivery service. Inside is a letter on IRS masthead that fraudulently claims that the notice relates to an unclaimed tax refund.

While dangling the prospect of obtaining unclaimed tax refund dollars, the letter asks taxpayers to provide sensitive personal information, including detailed photographs of driver’s licenses.

The IRS warned that the data the scammers are trying to obtain could be used to try to get a tax refund or other sensitive financial information.

The agency urged taxpayers to verify the authenticity of any communication they receive and seek official information directly from the IRS.

Prior Warnings

Every year, the IRS puts out a compilation of tax scams it calls the “Dirty Dozen” list as a warning to taxpayers. These scams target individuals and tax professionals, aiming to deceive and defraud unsuspecting victims.

One common scam on the list involves targeting people by promoting large refunds associated with the Employee Retention Credit. These promoters use misleading advertisements on the radio and the internet, providing inaccurate information about eligibility and computation of the credit. Some of these schemes are designed solely to collect personal information for the purpose of identity theft.

Another prevalent scam is phishing and smishing: Individuals receive fake communications posing as legitimate tax and financial organizations such as the IRS and state agencies. Unsolicited text messages (smishing) and emails (phishing) are used to trick recipients into divulging valuable personal and financial information, putting them at risk of identity theft.

The IRS states that taxpayers should note that the agency mostly communicates through regular mail and never initiates contact via email, text, or social media regarding tax bills or refunds.

Additionally, scammers try to deceive taxpayers by posing as helpful third parties offering assistance in creating IRS online accounts. These offers are fraudulent, as taxpayers can establish their own online accounts directly through the official IRS website.

The IRS cautions that falling victim to these scams can expose people to identity theft and other crimes involving fraud.