When Personal Security Is a Perk: SEC Reporting and Income Tax Implications for Corporate Security Benefits
Executive protection is no longer reserved for heads of state. As public scrutiny and threats against corporate leaders intensify, more companies are paying for residential security systems, bodyguards, private air travel, secure ground transportation, and cybersecurity for senior executives. While many companies initially assume that such protection is simply a business expense, the reality is that company-paid security packages may be treated as taxable compensation to the executive unless certain requirements for exclusion are met. But, that is not all: for public companies, such benefits are also generally required to be disclosed as a perquisite to the executive under Securities and Exchange Commission (SEC) disclosure rules.
Tax Considerations
Security Can Be a Tax-Free “Working Condition Fringe” Under Certain Circumstances
The default rule is that the value of executive security benefits is taxable income to the executive.1 However, the value of all or a portion of such benefits can be excluded from an executive’s income as a working condition fringe if (i) there is a bona fide business-oriented security concern and (ii) the employer establishes an “overall security program” to address such risk.2
For there to be a bona fide business-oriented security concern, the concern must be specific to the executive based on the facts and circumstances at the time the security is provided. A generalized “executives are high-profile” worry is not enough. Factors that support pre-tax treatment could include specific threats of death, kidnapping, or serious bodily harm directed at the executive (or a similarly situated employee) because of his or her status, or a recent history of violent activity that may affect the executive or a similarly situated employee. A “similarly situated employee” may be an employee of the same employer or of an unrelated employer.
An “overall security program” can be established in one of two ways:
- 24-Hour Protection. The company may provide security to the executive 24 hours per day across all contexts (residence, commute, work, and travel).
- Independent Security Study. More commonly, companies engage an independent third-party consultant to perform a security study and recommend appropriate protections short of full-time coverage.
Independent Study Requirements
To qualify, an independent security study must meet several requirements:
- Independence and Objectivity. The study must be conducted by an independent third party and based on an objective assessment of all relevant facts and circumstances, rather than generalized assumptions.
- Specific, Individualized Analysis. The study must evaluate risks with respect to a particular executive (or similarly situated employee) and reflect a tailored analysis of the individual’s circumstances, rather than general concerns. Best practice is typically to request an update to the study if the company wishes to provide security services to a new employee, since there is no specific guidance on what constitutes a “similarly situated employee.”
- Detailed Recommendations. The study should explain in detail the appropriate security protections to be provided in response to the threat and identify the locations and typical time periods during which protection should be provided.
- Consistency in Implementation. The company must apply the study’s recommendations on a consistent basis. The consistency requirement would not be met if, for example, the security study found that the employee should be provided security at his workplace and for ground transportation, but the company decided to provide security to the employee only while commuting to and from work, but not for any other ground transportation. In such a case, the Internal Revenue Service (IRS) may conclude that an overall security program does not exist, and the value of the secured ground transportation to and from work may become fully taxable.
- Ongoing Evaluation. The program cannot be “set it and forget it” because the IRS regulations specifically provide that the company must periodically reassess whether the security concerns continue to exist. Because threats and circumstances change, the company should periodically request updates to the study, including when the executive changes roles, residences, or work locations.
Some Benefits May Still be Taxable
Even with a study and reasonable program in place, some value may still need to be imputed to the executive related to these services. The IRS regulations include several examples.3 For instance, the regulations provide that when, as a part of an overall security program, a company provides an executive with a car that includes safety features (such as bulletproof glass), the executive may exclude as a working condition fringe the value of the special security features of the vehicle, but not the value of the entire car. Therefore, companies must carefully consider each type of security provided to an executive and determine the imputed income related to each security element; companies should not assume that an independent study will eliminate all potential tax implications.
SEC Disclosure Rules
Public companies also need to consider whether executive security benefits are a disclosable perquisite in the company’s annual meeting proxy statement, a determination that must be made separately from the determination of whether the benefit is taxable. Under Item 402 of Regulation S-K, companies must disclose detailed information, including the value of items that are considered executive perks. Typically, when people think of “executive perks” they think of country club dues, executive apartments, or company-provided cars. But, the SEC definition is actually much broader. Perks are any item that “confers a direct or indirect benefit [to the executive] that has a personal aspect, without regard to whether it may be provided for some business reason or for the convenience of the company.”4 The only narrow exception is for benefits that are “integrally and directly related to the performance of the executive’s duties.” For example, company-provided laptops and cell phones are typically excluded under this exception.
SEC guidance provides that security at an executive’s residence or during personal travel (even if required by the company) is considered a perk that must be disclosed. Security during business travel or at the executive’s place of work requires more thought, as there is an argument that such benefits are “integrally and directly related to the performance of the executive’s duties” since they are provided while working. However, because disclosure of executive perquisites appears to be a focus area for the SEC based on recent enforcement actions, companies may wish to err on the side of caution and disclose any security-related perquisites.
The Bottom Line
When developing an executive security program, companies should keep potential tax consequences in mind to avoid unexpected income for their executives. A properly designed program may be fully or partially excludable from income if the company takes proper steps to design the program in accordance with the fringe-benefit rules described above. Public companies must also consider whether such benefits must be disclosed as perquisites in their annual meeting proxy statements. Notably, even if security benefits qualify from exclusion from income under IRS rules, they may still be considered disclosable compensation under SEC rules.
Foley’s employee benefits and executive compensation practice group regularly advises public and private companies on the design, documentation, and tax treatment of executive security programs and perquisites, including coordinating independent security studies, structuring exclusions, calculating imputed income, and properly reporting arrangements for public companies under SEC proxy disclosure rules.
1 Treas. Reg. 1.61-21(a) and (b)
2 Treas. Reg. § 1.132-5.
3 Treas. Reg. § 1.132-5(m)(8)
4 https://www.sec.gov/files/rules/final/2006/33-8732a.pdf
