Johnson $10M Payday Could Raise Red Flags For IRS

June 30, 2011 5:24 a.m.

Sen. Ron Johnson’s $10 million post-election windfall from his former company not only raises eyebrows among election lawyers, but the lump-sum payout also could raise serious red flags for the IRS, according to legal experts and accountants.

The Wisconsin Republican, a Tea Party favorite who defeated Sen. Russ Feingold (D-WI) last year, received a $10 million payment in deferred compensation from his former plastics company, Pacur, weeks after his $9 million self-financed 2010 campaign for Senate came to an end.Election lawyers and reporters have raised questions about the similar amounts and whether the company, not Johnson, was underwriting his campaign. The apparent lack of a written deferred compensation agreement signed and dated before the election is problematic, experts tell TPM.

The Supreme Court’s Citizens United ruling opened up the floodgates for companies to spend unlimited funds on independent campaign expenditures benefiting candidates, but corporations still cannot give directly from their treasuries to federal candidates’ campaigns.

Aside from election law violations, Johnson’s $10 million payday also may violate the Internal Revenue Code’s requirements that any deferred compensation agreement must be in writing – even if it’s between the top executive and the company he owns.

In January 2005, the IRS imposed new rules requiring any compensation deferment agreement to be formalized in a written document and imposing a severe 20 percent penalty on any agreements that do not comply with the new rules.

The new IRS rules were enacted, in part, in response to the Enron scandal when executives were attempting to speed up the payments under their deferred compensation plans in order to access the money before the company went belly up, and also, because there had been a history of perceived tax-timing abuses associated with compensation deferments.

The timing of a written agreement is also key, said Jeff Martin, manager of the national tax office of Grant Thorton, a major accounting firm.

“It would have to exist at the time that the compensation was deferred,” Martin told TPM.

And it would certainly be in Johnson’s interest to have a written agreement to guard against an IRS audit.

“A prudent lawyer structuring this transaction would want to confirm the contours of the package at the time it was committed,” said Scott Oswald, the managing principal of the Employment Law Group, “otherwise, the IRS could tax it differently than the parties determined at the time.”

“Deferred compensation needs to be structured in such a way that there isn’t even an inference of impropriety because of the executive’s duty of loyalty to the company,” Oswald added.

Johnson told the Milwaukee Journal-Sentinel, which first reported on the $10 million payment, that it was “an agreed-upon amount” that was determined at the end of his tenure with the company.

Agreed upon with whom?

“That would be me,” he said.

Johnson has subsequently declined to produce a written document or any proof that the deferred compensation was agreed to before the campaign when he stopped taking a salary from Pacur.

Asked by TPM before a Senate vote on Tuesday to clarify whether he worked out the agreement before or after his 2010 campaign, Johnson did not give a direct answer.

“It’s a private company,” he said. “We fully complied, fully disclosed [and] followed the law, complied with the spirit and letter of the law, and again it’s a private company. Those financial matters end up being more complex.”

His office has not responded to several inquiries from TPM.

While Johnson’s public statements could be difficult to defend in an IRS audit, the agency has not shown a great propensity to go after violations of the new 2005 law, Martin pointed out.

A bigger tax problem for Johnson could be the two loans he took out from Pacur in 2004 and 2007 for $1 to $5 million each. He reported the loans on his most recent personal financial disclosure report as having an interest rate of .69 percent – virtually interest free.

The IRS frowns on loans taken out from companies at below market rates and issues a chart of what is known as applicable federal rates, i.e. reasonable market rates, on a monthly basis. In 2007, the applicable federal rates on loans ranged from roughly 4 to 6 percent, and in 2004 they hovered between 2.5 percent to 5.5 percent.

Johnson’s interest rate of .69 percent “certainly would have to be lower than any definition of what the market rate would be,” Oswald said. “It would raise significant red flags.”

“Generally, executives should not be receiving loans at anything but the same rate that they would receive from a local bank or other financial institution,” he added.

The IRS could collect taxes on the difference between the actual interest rate and the market rate or it could determine that the loan does not meet the standard definition of a loan, and could tax the entire amount of the loan at normal income tax levels for the year it was taken out.

Real, bona fide loans must meet certain requirements laid out in a written document, such as the interest rate, payment schedule and specified collateral, Martin noted. The IRS is on the lookout for fake loans that are issued by a company to individuals but later forgiven without full payment.

Even though Johnson owned the company and controlled its decisions and finances, that’s no excuse for failing to document loans or deferred compensation agreements, Oswald said.

“Even when it’s a closely held corporation, it’s a separate entity” under the law, Oswald said. “And the individuals who work for the corporation have a fiduciary obligation to meet their duty of loyalty to the company … to treat it like a separate entity when there’s this kind of [financial deals] involved.”

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