IRS Issues Proposed Regulations for Taxation of Nonprofit Executive Compensation

By Magdalena M. Czerniawski |  Robert Lyons  |  July 1, 2020

IRS Issues Proposed Regulations for Taxation of Nonprofit Executive Compensation

Section 4960 of the Internal Revenue Code, which was added as part of the Tax Cuts and Jobs Act of 2017 (December 2017), provides that an applicable tax-exempt organization (ATEO) is subject to an excise tax at the prevailing corporate rate (21% for 2020) for payments to a covered employee in excess of $1 million. While this calculation is fairly straightforward for remuneration, it becomes considerably more complicated in the case of excess parachute payments paid during the year. A year after the initial enactment, Notice 2019-09 was issued to provide interim guidance concerning the excise tax. On June 11, 2020, the Treasury Department issued proposed regulations that are fairly closely aligned with Notice 2019-09. Because the proposed regulations are very term specific, it is important to understand the definitions.

Definitions

Remuneration[1] paid to a covered employee[2] includes any amounts paid by the organization or a related organization. This precludes an applicable tax-exempt organization[3] from spreading compensation between separate related organizations to avoid the $1 million cap.

Code Section 4958 provides for an excise tax for excess benefits received by the employee where the benefit received exceeds the services provided. This is an excise tax on the employee and is not to be confused with excess executive compensation. In the latter case, the executive compensation may be both ordinary and necessary but if it exceeds $1 million it will be subject to the excise tax. The primary difference is that the excise tax associated with excess executive compensation is paid by the ATEO and not the executive. The excise tax is designed to “punish” the organization and not the executive. Having said that, the excise tax is applicable to the employer and not the employee. 

The proposed regulations define “employer” consistent with the definition for purposes of federal income tax withholding. As such, control of the payment of wages is not relevant for determining whether an entity is the employer for purposes of Section 4960. The regulations provide that a person does not avoid the status as an employer of an employee by using a third-party payor to pay remuneration. The regulations list payroll agents, common paymasters, statutory employers and certified professional employer organizations (PEOs) as examples. In addition, a management company may also be acting as a third-party payor for the employees of its ATEO client, rather than as the common law employer. Remuneration that is paid by a separate organization to an individual for services the individual performed as an employee of the ATEO, whether related to the ATEO or not, is deemed remuneration paid by the ATEO for purposes of Section 4960. The regulations ultimately look to who is receiving the benefit from the “fruits of the employee’s labor.”

In discussing remuneration, the regulations look to any compensation paid by the employer’s ATEO, related ATEOs and related non-ATEOs. This includes for-profit entities, nonprofit entities that are not ATEOs and governmental entities that are not ATEOs. Taken from the guidance in Notice 2019-09, the proposed regulations utilize the definition of “control” that is found in Section 512(b)(13)(D) (greater than 50% control). This standard, in part, is what an organization uses to identify reporting on Form 990 Schedule R.  Remuneration paid by these related organizations would be aggregated with the employer ATEO to determine levels of compensation.

The treatment of “ordinary” remuneration is fairly straightforward. If an individual is paid over $1 million, the organization (employer) will be subject to the excise tax. In the case of excess parachute payments,[4] the calculations can be very difficult because, in part, they rely on the organization’s historical information. Because of the complexity, the ATEO may find it beneficial to seek assistance from their accounting firm in order to make the calculation.

The reporting and payment of the tax is made on Form 4720, “Return of Certain Excise Taxes Under Chapter 41 and 42 of the Internal Revenue Code.” For a calendar year organization, Form 4720 is due on May 15. The due date for fiscal year filers is the 15th day of the fifth month. Form 4720 also allows for an extension of time, but not an extension for payment of tax.

Conclusion

As mentioned above, these calculations can be very complex, and organizations should seek guidance from their tax advisors.


Remuneration is defined as wages excluding designated Roth contributions and includes amounts required to be included in gross income under IRC 457(f) for deferred compensation plans.  Remuneration does not include any amounts paid to a licensed medical professional (including a veterinarian) for the performances of medical or veterinary services. 

[2] Covered employee includes current and former employees if the employee is one of the five highest compensated employees for the year or was a covered employee for any preceding taxable year beginning after December 31, 2016.

[3] Applicable tax-exempt organization (ATEO) includes organizations exempt from taxation under Section 501(a), farmers’ cooperatives and certain universities.  This category can also include related organizations.

[4] Excess parachute payment includes 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 over the base period, which is the individual’s last five taxable years.

Parachute payment is defined as any payment in the nature of compensation to or for the benefit of a “covered employee” if the payment is contingent on the employee’s separation from employment with the employer and the aggregate present value of the payments in the nature of compensation to the individual that are contingent on the separation equals or exceeds three times the base amount. 


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About Magdalena M. Czerniawski

Magdalena M. Czerniawski Linkedin Icon

Magdalena M. Czerniawski, CPA, MBA, is a Partner 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 ASC 740-10 (FIN 48), the reporting... READ MORE +


About Robert Lyons

Robert Lyons Linkedin Icon

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 +


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