By Stephen Kirkland, CPA, CMC, CFC, CFF (Guest Author)
It has been more than 40 years since Elvis Presley faked his own death so that he could become a deserted-island based tax advisor. Back then, the IRS was auditing hundreds of C corporations, looking to see if they were over-compensating their shareholders. Elvis wanted to help.
Later, privately-owned C corporations started to become less common as more businesses elected S status. Elvis got all shook up to see the IRS begin to focus its sights on underpaid shareholder-employees at S corporations. He was on it like a hound dog.
In 1996, Section 4958 was added to the Internal Revenue Code and the IRS began imposing excise taxes on over-compensated employees at tax-exempt organizations. Elvis thought it took hearts of stone to do that, because universities and hospitals, among others, were hurt for not using comparability data to set compensation amounts for key employees. The excessive portion of the pay, known as an excess benefit, was subject to two excise taxes. That’s double trouble. One excise tax, equal to 25% of the excess benefit, was imposed on the overpaid individuals. And a 10% excise tax was imposed on the decision-makers who allowed the excessive compensation to be paid.
It was only a matter of time before municipalities, which were hungry for cash, began looking for overpaid employees at tax-exempt hospitals. A number of those hospitals were unsuccessful in court, which led to them losing their property tax exemptions, which can be a big pain for hospitals. The excess compensation was considered to be profit-sharing, which is forbidden under most property tax exemptions. At least one hospital also lost its sales tax exemption. Elvis could feel his temperature rising.
Elvis began providing compensation comparability to his clients to help them avoid these excise taxes and the bad publicity that came with it. As years went by, he was heartbroken to see compensation disputes also become more common in business valuations. But there were a whole lot of business owners getting divorced and baby boomers selling or transferring some of their shares.
Compensation amounts also became a heavily litigated topic at old-economy companies that had been passed down from the founders to the second and third generations. Family members not active in the businesses were often surprised when they learned how their siblings and cousins were able to afford all those blue suede shoes. Suspicious minds assumed the insiders were over-compensated. And, yes, Elvis could see that spurned shareholders will sue their family members in a heartbeat.
More recently, the digital economy has given rise to startups that sometimes become very valuable within a few years. Elvis discovered that when companies become flush with cash, the founders often want to be paid for the long hours they worked before their businesses could pay them competitive wages and benefits. However, the investors do not always agree that the company owes these founders tutti frutti compensation for years gone by. These disputes can quickly escalate to litigation that is disruptive, expensive and time-consuming.
For all of these reasons, Elvis could not help falling in love with the idea of providing his clients plenty of compensation comparability data. He said, “Keep the tax authorities and investors happy and nobody has to do the jailhouse rock.” And Elvis made sure his clients paid reasonable compensation amounts as they went, or they accrued an appropriate amount of deferred compensation.
Now Elvis is retired and living in Las Vegas where he is enjoying his latest flame.
This month we welcome our guest contributor Stephen Kirkland. Stephen is regarded as one of the country’s premier reasonable compensation experts. He shares with us a brief history of Reasonable Compensation through the eyes of “The King”.