IRS Issues Interim Guidance on Excise Taxes for Nonprofit Executive CompensationBy Magdalena M. Czerniawski | Robert Lyons | January 9, 2019
On December 31, 2018, the Internal Revenue Service issued Notice 2019-09 offering interim guidance for nonprofit executive compensation under Section 4960 of the Internal Revenue Code. The Tax Cuts and Jobs Act (“TCJA” or “the Act”) introduced Section 4960, which imposes an excise tax of 21 percent (or current rate) on remuneration in excess of $1 million and any excess parachute payments paid by an applicable tax-exempt organization to a covered employee. The new section was added for taxable years starting after December 31, 2017.
While most organizations do not generally pay compensation over the $1 million-dollar threshold on a yearly basis, their executives might still be subject to this excise tax in the future. This is because the compensation definition under 4960 includes payout from Section 457(f) retirement plans.
The interim guidance is intended to assist organizations in making a “good faith” estimate of applicable employee remuneration. The notice states that taxpayers may base their positions upon a good faith, reasonable interpretation of the statute and that any future guidance will be prospective. The positions reflected in Notice 2019-09 constitute a good faith, reasonable interpretation of the statute.
The notice clarifies what constitutes a “taxable year” included in section 4960(a)(1). It stipulates that organizations should use the calendar year ending with or within the taxable year of the employer when determining the amount of remuneration. This is particularly helpful when related organizations have different year-ends. For fiscal-year filers, this would require using the calendar year-end that falls within the organization’s fiscal year. This would align the reporting with the methodology currently used in the Form 990 Return of Organizations Exempt from Income Tax and W-2 Wage and Tax Statement.
The notice also addresses the tax treatment applicable for common-law employers, which would affect leased employees or other third-party arrangements. Pursuant to the notice, a common-law employer, as determined generally for federal tax purposes, is liable for the excise tax imposed under Section 4960. Third party payors include, but are not limited to, payroll agents, common paymasters, statutory employers, or certified professional employer organizations (PEOs). Similarly, payment from a related entity for services rendered to the common-law employer is considered a payment from the common-law employer, who is therefore liable for excise tax.
Furthermore, the notice clarifies that the calculation of the excise tax is separate from any arrangement that an organization and a related entity may have for bearing the cost of the excise tax. The notice goes to great lengths to explain that the excise tax cannot be avoided by using multiple entities. In general, if an organization is reportable as a related party on Schedule R, Form 990, it will be aggregated for purposes of Section 4960.
A covered employee is defined as one of the organization’s five highest-compensated employees for the current taxable year or one who was a covered employee for any preceding taxable year beginning after December 31, 2016. Therefore, once an employee is a covered employee, he or she continues to be a covered employee for all subsequent taxable years. This is different from the limited five-year taint associated with “disqualified persons” reported on Form 990.
There is an exception for remuneration received for furnishing medical services. Licensed medical professionals including doctors and veterinarians are exempt only to the extent that the remuneration is for providing medical services. In the event a covered licensed medical professional provides both medical and administrative services, the income will have to be bifurcated to determine the application of Section 4960.
Whether an employee is included as one of the five highest is determined separately for each organization, and not for the entire group of related organizations. As such, each organization in the group has to test for its five highest covered employees, and a group of related organizations could have more than five highest paid employees for this purpose. However, the compensation from each related entity has to be taken into consideration when determining the threshold.
The excise tax is based on the remuneration paid by the organization for the taxable year with respect to employment of any covered employee in excess of $1 million. The $1 million is not adjusted for inflation, but it does require certain present value calculations. The remuneration includes wages and amounts required to be included in income under Section 457(f) retirement plans but excludes Roth contributions.
The notice discusses in detail compensation where there may be a “substantial risk of forfeiture.” This is applicable to certain cases involving payouts of deferred compensation arrangements under Section 457(f) of the Code. In the case of deferred compensation arrangements, the amount of remuneration treated as paid at vesting is the present value of the remuneration in which the covered employee vests.
In cases where related organizations are required to aggregate compensation to determined excess remuneration for the taxable year, each employer is liable for its proportionate share of the excise tax.
Excess Parachute Payments
Excess parachute payments are defined as an amount equal to the excess of any parachute payment over the portion of the base amount allocated to such payment. Section 4960 provides that the term parachute payment means any payment in the nature of compensation to a covered employee if:
- Such payment is contingent on separation from employment; and
- The aggregate present value of the payments in the nature of compensation to such individual which are contingent on such separation equals or exceeds an amount equal to three times the base amount.
- The notice provides steps to calculate the excess parachute payments.
Payment of Excise Tax
Once it has been determined that the organization is subject to tax under Section 4960, the tax is reported on Form 4720 Return of Certain Excise Taxes. This form is more commonly used to report excise tax associated with private foundations. The Form 4720 would be due by the fifteenth day of the fifth month following the close of the taxable year. The Form 4720 can be extended along with the organization’s Form 990.
The text of Notice 2019-09 is 92 pages long. The concepts of what constitutes a covered employee or what makes up excess remuneration are very complicated, especially when there are deferred compensation arrangements. If you have any questions on the application of Notice 2019-09 and new IRS Code Section 4960, please contact Magdalena Czerniawski or Robert Lyons in our Nonprofit Practice.
About Magdalena M. Czerniawski
Magdalena M. Czerniawski, CPA, MBA, is a Tax Director at Marks Paneth LLP and a member of the firm’s Nonprofit, Government & Healthcare Group. With over 15 years of nonprofit industry experience, she provides tax services to a wide array of nonprofits, including charitable organizations, schools, social welfare organizations, professional associations and private foundations. In addition to providing tax planning and advisory services, Ms. Czerniawski specializes in matters related to... READ MORE +
About Robert Lyons
Robert (Rob) Lyons, CPA, MST, is a Tax Director, Exempt Organizations in the Nonprofit, Government & Healthcare Group at Marks Paneth LLP. Mr. Lyons brings to this role the skills he has developed during more than 30 years of providing tax and consulting services to his clients in the nonprofit, higher education, and public sector industries. His experience includes handling substantial exempt organization tax issues. Mr. Lyons has testified in front of the House and Ways Committee in... READ MORE +