USA Reporting obligation?

[dragon-ash]

I recently took over as CFO of a small company run by four co-founders. At least for the first few years of the company, the CEO was essentially a one-man shop. Shortly after taking over, I found that the CEO's wife had been on the payroll for some years as part-time staff (no payroll tax etc being deducted), with the monthly amount ensuring that the wife would not be liable for any income tax. No work was actually being performed, but phantom payslips were being generated for the 'work'. None of the current Board members that were also on the board at the time were aware of this arrangement.

I put a kabosh to this straight away, but the CEO instead wanted that money added to his current pay, which the Board approved.

I'm pretty sure that if we were ever audited and this was identified, the tax authorities would say we owe tax on the phantom salary that was inappropriately expensed, and that instead, that payment should be treated as debt repayment to the CEO (who had loaned money to the company when cash was short).

What is my obligation here? Can I remain silent and hope it's not uncovered in an audit? Am I professionally / morally obliged to whistleblow on the company? Should I work for a CEO that would do this? The CEO's view is that 'I put money into the company when it was struggling so it's deserved', to which my rebuttle would be, 'there were some equity reconciliations that increased your stake in the company to over 40%, so...'.

I should point out, the former CFO's wife was also on the payroll but doing no actual work (obviously, the former CFO is no longer with the company). I've dug around and other than possibly a slight lean towards overly aggressive entertainment expense, the rest of the company seems fine; I haven't identified any other 'flashing red warning sign' issues.

 

[Dave In Capital]

If the Board approved the CEO's request for reclassification of the salary, and without wanting recourse for his actions, then that is an implicit consent of the alleged activities. In which case, there is no basis for establishing demonstrable harm to stakeholders. Thus, it's difficult to say that there are any potential legal considerations to be discussed in the independent auditor's report. The audit report might indicate an adverse opinion due to lack of controls, but the impact of that really depends on the stakeholders to decide. This doesn't appear to be a public company. So, persons of consequence other than the aforementioned might be lenders maybe. They might feel misled, but don't have much basis for seeking recourse until the organization defaults on whatever obligations due to those entities.

As far as the IRS, it's evasion if the wife failed to report it. I would have to infer that she didn't since you haven't mentioned 1099s. Even then, materiality is another concern. If it was pervasive and material, then it might be an issue. But based on the circumstances it sounds like the worst that will happen is a collection judgment.