SEC Disclosure and Taxation of Executive Security Benefits: Legal Requirements and Key Considerations

Many companies are reevaluating their corporate security practices and considering enhancements to the security protections they provide to their executives and other senior leaders. Companies exploring such security practices should keep in mind that executive security protections may be considered disclosable compensation under Securities and Exchange Commission disclosure rules and trigger special income tax consequences for purposes of both income imputation and employer tax deductions.

We have summarized below, at a high level, rules regarding the Securities and Exchange Commission’s (SEC’s) disclosure and federal income taxation of executive security arrangements.

SEC RULES REGARDING PERQUISITE DISCLOSURE

Item 402 of Regulation S-K requires public companies to disclose detailed information regarding their executive compensation practices in registration statements, periodic reports, and proxy statements. Executive security arrangements may be considered compensatory perquisites, or “perks,” that must be publicly disclosed under the SEC’s rules.

For example, in the All Other Compensation column of the Summary Compensation Table, public companies generally must identify and quantify the total value of the perquisites provided to each named executive officer who receives at least $10,000 worth of perquisites for the year. With respect to any perquisite that exceeds the greater of $25,000 or 10% of the total value of all perquisites reported, the company is required to identify the type and quantify the amount of such perquisite in a footnote to the Summary Compensation Table.

In its 2006 adopting release, the SEC provided a two-step process for determining whether an item is a perk:

1. First, an item is not a perk “if it is integrally and directly related to the performance of the executive’s duties.” In the adopting release, the SEC was clear that whether an item is “integrally and directly related” to an executive’s duties must be analyzed narrowly, stating that in order for the item not to be considered a perk under this test, it must be needed by the executive to do his or her job (e.g., a laptop). Conversely, an item that provides a convenience to both the company and the executive may be considered a perk if it is not critical to job performance.
2. Otherwise, an item is a perk “if it 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, unless it is generally available on a non-discriminatory basis to all employees.” The example given by the SEC in the adopting release is providing helicopter service to an executive for commuting purposes. Although this service would get the executive from Point A to Point B more swiftly and efficiently, it is not critical to the executive’s ability to perform their job, “clearly bestows a personal aspect,” and “is not generally available to all employees on a non-discriminatory basis.”

APPLICABILITY TO EXECUTIVE SECURITY BENEFITS

Under the 2006 adopting release and current SEC guidance, the SEC’s position is that a company’s expenditures to ensure the personal security of a named executive officer are perquisites for which disclosure is required. Based on current SEC guidance, the fact that a personal benefit (such as a security arrangement) serves a business purpose or conveniences the company does not affect the characterization of the benefit as a perquisite if the benefit is not integrally and directly related to the executive’s job performance.[1]

As such, under the current SEC disclosure framework, the following arrangements are generally considered perks:

• The use of a company aircraft or vehicle for commuting purposes or for the executive’s personal travel or travel by the executive’s family members, notwithstanding company policy
• Providing for security (such as bodyguards, chauffeurs, or other security services) for personal or family travel
• Home security arrangements, such as alarm systems or security guards stationed at the executive’s residence

On the other hand, business travel is generally considered to be integrally and directly related to the performance of the executive’s job. Therefore, corporate aircraft usage and security provided during the pendency of business travel generally would not be considered a perk.

Other security arrangements are not easily categorizable as perquisites for which disclosure would be required. Whether the following security protections must be disclosed as perquisites is debatable and likely depends on the facts and circumstances. For example, while engaging bodyguards to escort an executive between the company’s office and parking lot or to protect an executive during a public work conference likely would not be deemed a perquisite, extending that security for the pendency of family vacations or commuting to a residence likely would.

RECENT SEC ENFORCEMENT ACTIONS RELATING TO PERKS

The SEC has brought a number of enforcement actions against companies for failure to properly disclose executive perquisites. Accordingly, when in doubt as to whether an executive security arrangement is a disclosable perquisite, some companies choose to disclose the benefit in the Summary Compensation Table for the sake of caution and include a footnote or narrative disclosure explaining the company’s view that the arrangement is not personal and instead is necessary, appropriate, and in furtherance of the company’s commercial business interests.

For additional discussion regarding SEC disclosure of executive perquisites, see our April 30, 2024 blog post and our July 11, 2023 LawFlash.

TAXATION OF EXECUTIVE SECURITY BENEFITS

Pursuant to the current US Department of the Treasury regulations relating to taxation of fringe benefits, if a private sector employer establishes an “overall security program” and can show that there is a bona fide business-oriented security concern with respect to the employee, then a significant portion of the value of certain personal security benefits may be excluded from the employee’s income.

Such a security concern exists only if the facts and circumstances establish a specific basis for concern regarding the safety of the employee existing at the time the security protection is provided. The basis for this concern must be specific to the particular employee, and a generalized concern for the employee’s safety is insufficient to establish a bona fide concern. Once such a security concern is determined to exist, the employer must periodically evaluate the situation for purposes of determining whether the concern persists with respect to the employee.

The regulations provide examples of factors indicating a specific basis for concern regarding the safety of a particular employee, including threats of death, kidnapping, or serious bodily harm with respect to the employee or a similarly situated employee because of either employee’s status as an employee of the employer or a recent history of violent terrorist activity (such as bombings) that may affect the employee or a similarly situated employee. For these purposes, a “similarly situated employee” may be an employee of the same employer or, presumably, of an unrelated employer.

The most common way to establish an overall security program that supports the exclusion from federal income taxation of excludable security benefits is by hiring an outside security consultant to conduct an independent security study. Under the applicable Treasury regulations, an independent security study with respect to a private sector employer exists if

• a security study is performed with respect to the employer and the employee or a similarly situated employee, by an independent security consultant—to be considered independent, the security consultant must be an outside firm or person, as opposed to another employee of the same employer;
• the security study is based on an objective assessment of all facts and circumstances;
• the recommendation of the security study is that a 24-hour overall security program (as described below) is not necessary and such recommendation is reasonable under the circumstances; and
• the employer applies the specific security recommendations contained in the security study to the employee on a consistent basis.

The regulations do not specifically require that a security study be obtained either before security is provided (although in most cases the security study is obtained in the year that the security protection is first provided to the employee) or each time a new security threat arises. Most of the independent security studies we have seen summarize the nature of the threat to the particular employee, in partial support of the study’s recommendation against 24-hour protection, and all of the security studies we have seen explain in detail the appropriate security protection that should be provided in response to the threat.

Also, it is advisable for any independent security study to include the locations and the typical period of time during which security protections will be necessary. Many companies periodically request updates to their security studies, especially when the covered employees change their work locations and/or residences.

Once a security study is obtained, the study can be used subsequently by the employer to justify the security protection extended either to the employee (or employees) cited in the study or to any similarly situated employee for whom the bona fide security concern exists.

If the employer satisfies the security study requirements with respect to employees, then a significant portion of the value of security protections can generally be excluded from the employees’ federal taxable income as “working condition fringes.” This exclusion is available for either in-kind security protections or cash reimbursements (although reimbursement arrangements are rarely established and are not recommended for items such as charter air service purchased directly by an executive due to Federal Aviation Administration limitations on such reimbursements, outside the context of time-share leases), provided that the employer must verify that the payment is actually used to purchase the security protections. An additional exclusion for cybersecurity and identity theft protections (which are often also added as part of home office security protections) applies under a long-standing Internal Revenue Service (IRS) moratorium on audits of these particular protections.

Alternatively, an overall security program can be established without the use of an independent security consultant if the employer can show that a bona fide business-oriented security concern exists with respect to the employee and security protections are provided to the employee on a 24-hour basis, whether the employee is at work, at home, or conducting business or personal travel. Employers rarely use this 24-hour security method to establish an overall security program due to the high cost and invasive nature of the security involved.

Importantly, even when a security study is in place (or where 24/7 security protection is provided), the value of some benefits still must be imputed as income to the protected executive. There are several special rules for imputing income, as, for example:

• The value imputed as income for a personal trip by the protected executive (or for a personal trip by a spouse or dependent child accompanying the executive) on an airplane owned or leased by the company is taxable, although the taxable amount is reduced by nearly half as compared to the amount that would be imputed absent the overall security program (and the amount allowed as a deduction to the company for personal flights by top executives would be correlatively reduced since the company’s deduction is limited to the amount imputed).
• The value imputed as income for any ride in a chauffeured car can be calculated based on the IRS’s vehicle-valuation rules, referencing only the value of the car without the cost of additional security protections, and the entire value of the chauffeur’s services may be excluded, provided that the chauffeur is trained in defensive driving.

HOW WE CAN HELP

Our lawyers stand ready to assist clients with respect to disclosure and taxation of executive compensation, including executive security arrangements and other perquisites and fringe benefits.