June 10, 2020
IRS Releases Proposed Regulations on Excess Tax-Exempt Organization Executive Compensation
Posted by Katy Brown
On June 5, 2020, the IRS and Treasury Department released the much-anticipated Proposed Treasury Regulations under Internal Revenue Code (IRC) Section 4960, Tax on Excess Tax-Exempt Organization Executive Compensation. These proposed regulations generally follow the interim guidance in IRS Notice 2019-09 that provided an explanation of the excise tax that was enacted as part of the 2017 Tax Cuts and Jobs Act. The proposed regulations adopt some of the interim guidance, clarify certain open questions, provide additional details and explanations, and specifically request public comments on other areas.
This Tax Alert briefly highlights the areas to consider if this will apply to your organization. (For a more detailed analysis of the proposed regulations please see here.)
In general, IRC Section 4960 imposes a 21% excise tax on Applicable Tax-Exempt Organizations (ATEO) or their related organization if either:
- Your organization, combined with all related organizations, pays any covered employee over $1 million in compensation for services as an employee, or
- Your organization makes any payment to a covered employee contingent on their separation from employment. The separation payment is not based on a $1 million threshold, but rather a three-times base compensation threshold.
Generally, covered employees are the five highest-compensated employees for a given year, plus any covered employee of a prior year. The proposed regulations provide exceptions to the definitions of “employee” and “covered employee.” A director is not an employee in their capacity as a director. An officer is considered an employee unless one of the exceptions below apply.
When there are related organizations, it is important to consider who is an employee. If there is any question whether an officer or another individual who does perform services will be considered an employee, the following three exceptions may apply: 1) limited-hours exception, 2) non-exempt funds exception, and 3) limited-service exception.
1) Limited-hours exception: An employee of the ATEO who receives no remuneration from the ATEO and performs 10% or less of their total annual hours worked for the ATEO and any related ATEO. As a safe harbor, “10% or less” can be replaced with “100 hours or less” to qualify for this exception.
2) Nonexempt fund exception: An employee who is not compensated by the ATEO, a related ATEO, or any taxable related organization controlled by the ATEO, who spends less than 50% of their total annual hours worked for the ATEO and all related organizations, and the employer providing compensation does not provide services for a fee to the ATEO, a related ATEO, or any taxable related organization controlled by the ATEO.
3) Limited-service exception: An employee who receives 10% or less of their remuneration from the ATEO employer for services performed for the ATEO and all related organizations. (For this exception, there must be another related ATEO organization, who provided the highest percentage of remuneration, to count such an employee as their “covered employee.”)
For Section 4960 purposes, remuneration is defined as wages and amounts includable in gross income. This specifically includes non-qualified deferred compensation plans under Section 457(f). It specifically excludes designated Roth contributions. Also excluded are medical services directly performed by a licensed medical professional. Remuneration is treated as paid when the rights to compensation are not contingent on future performance.
In addition, the definition of “remuneration” includes any remuneration paid by the employer ATEO, related ATEOs, and related non-ATEOs (including for-profit entities, nonprofit entities that are not ATEOs, and governmental entities that are not ATEOs).
“Excess parachute payments” in Section 4960 are defined as an amount equal to the excess of any “parachute payment” over the portion of the base amount allocated to such payment. The “base amount” is an individual’s annualized compensation for the last five taxable years. “Parachute payment” is any payment contingent on the employee’s separation from employment and the aggregate present value of the payments equal or exceed three-times the base compensation amount. These payments are considered paid when the employee’s rights to compensation are no longer conditioned upon future performance (upon vesting), rather than when the cash is actually paid.
For More Information
If you think Section 4960 may apply to your organization, please see our more detailed summary with additional analysis and feel free to contact us with any questions.
Katy Brown is an exempt organizations specialist with 10 years of experience in the tax field. She has experience working with exempt organizations in a variety of capacities including consulting on formation, board governance and ongoing compliance requirements. Katy has also been brought on as an outside service provider of comprehensive tax compliance services.
She is a member of the California Society of CPAs, the AICPA and the Center for Volunteerism and Nonprofit Leadership, and she currently serves as a board member for the Clifford Brown Jazz Foundation. Katy earned a Bachelor of Arts from George Mason University, a Master of Arts from The University of Arizona and a Master of Science in Taxation from Golden Gate University.
Co Authors :
Matt Petroski is a nonprofit tax specialist with 18 years of experience in the industry. He recently joined Armanino after spending his career in PwC’s National Tax Services Exempt Organization Tax Services Practice. He has experience working with exempt organizations in a variety of capacities, including consulting on formation, board governance, other tax consulting, and as an outside service provider of comprehensive tax compliance services.
Matt received his BS from the University of Maryland where he was enrolled in the University Honors Program. He also received his JD/MBA and LLM in Taxation from Villanova University. Matt is a licensed member of the Pennsylvania and New Jersey bars and is a member of the ABA Tax Section.