IRS notices on Section 4960 compliance

Background

IRC Section 4960 was enacted as part of the Tax Cuts and Jobs Act of 2017 and imposes a 21% excise tax on applicable tax-exempt organizations (ATEOs) that pay covered employee remuneration in excess of $1 million and on excess parachute payments. The excise tax imposed by IRC Section 4960 is effective for tax years beginning after Dec. 31, 2017.

In general, remuneration for purposes of IRC Section 4960 is defined as gross wages under IRC Section 3401(a) with certain adjustments for income no longer subject to a substantial risk of forfeiture, such as amounts required to be included in income under IRC Section 457(f), and excludes, for example, designated Roth IRA contributions under IRC Section 402A(c) and remuneration paid to licensed medical professionals for the performance of medical services.

Notice trigger

Based on the questions on the compliance check information request, it appears that the IRS is using the information reported in Form 990, Part VII, “Compensation of Officers, Directors, Trustees, Key Employees, Highest Compensated Employees, and Independent Contractors,” to flag organizations that reported individuals with compensation in excess of $1 million and determine whether each organization filed Form 4720 to remit excise taxes under IRC Section 4960. If the IRS does not have a record of a Form 4720 being filed, the exempt organization will be asked to file the form, to provide a copy of the form if it has been filed, or to provide an explanation of why it is not required to be filed.

What’s important to know

Section 4960 compliance notices are automatically generated, and the IRS appears to be casting a wide net in its efforts to identify noncompliance. However, reporting an individual with compensation of more than $1 million does not automatically mean the organization has an excise tax liability under IRC Section 4960 because remuneration as defined by IRC Section 4960 is not always the same as compensation reported in Part VII of Form 990.

Following are some of the reasons why remuneration under IRC Section 4960 might be different from compensation reported in Part VII of the Form 990.

• Remuneration for qualified medical professionals excluded. Remuneration for purposes of IRC Section 4960 does not include the portion of any remuneration paid to a licensed medical professional that is for the performance of medical or veterinary services by such professional.
• Not a covered employee. A covered employee, for purposes of IRC Section 4960, is any individual who is one of the five highest-compensated employees of the applicable exempt organization for a taxable year or an individual who was a covered employee of the ATEO (or any predecessor) for any preceding taxable year beginning after Dec. 31, 2016. Such individuals may be reported in Part VII of the Form 990 but may not be considered covered employees for purposes of IRC Section 4960.
• Substantial risk of forfeiture versus payment. For purposes of IRC Section 4960(a), remuneration generally is treated as paid when there is no substantial risk of forfeiture of the rights to the remuneration within the meaning of Section 457(f)(3)(B). As such, remuneration (with the exception of regular wages such as base salary or a regular hourly wage) is treated as paid for purposes of Section 4960 when it no longer is subject to a substantial risk of forfeiture (when vested) rather than when it is actually or constructively paid.

Additionally, in 2018, the first year that the law was applicable, fiscal year filers might not have a reporting requirement even if employees had annual compensation for the 2018 calendar year in excess of $1 million. Remuneration under IRC Section 4960 is calculated based on excess remuneration paid during the calendar year ending with or within the employer’s taxable year beginning after Dec. 31, 2017. For example, for an exempt organization with a fiscal year beginning July 1, 2018, and ending June 30, 2019, the calendar year ending with or within the employer’s taxable year beginning after Dec. 31, 2017, is calendar year 2018; however, remuneration paid before July 1, 2018, was not subject to the excise tax under Section 4960. Thus, the first year in which Section 4960 was applicable included only a portion of 2018 calendar year remuneration from the period July 1, 2018, through Dec. 31, 2018.

Looking ahead

Organizations that reported compensation of more than $1 million to any individual but that did not file Form 4720 might receive a Section 4960 compliance notice from the IRS. Taxpayers should work with their tax adviser to carefully consider the applicability of Section 4960 and whether they have an IRC Section 4960 excise tax liability when responding to the IRS.