On June 11, the U.S. Department of the Treasury and the IRS published proposed regulations under IRC Section 4960. Section 4960 was added to the IRC by 2017 tax reform (also referred to as the Tax Cuts and Jobs Act (TCJA)) and imposes an excise tax on an applicable tax-exempt organization (ATEO) with respect to certain excessive compensation provided to certain executive employees of the ATEO.
Effective for each taxable year beginning after Dec. 31, 2017, an ATEO generally is liable for an excise tax (currently 21%) on the sum of any covered employee’s excess remuneration (remuneration exceeding $1 million, other than excess parachute payments) and any excess parachute payment paid to that covered employee.
An ATEO is any organization that is exempt from taxation under Section 501(a), that excludes income from taxation under Section 115(1), that is a farmers’ cooperative organization described in Section 521(b)(1), or that is a political organization described in Section 527(e)(1).
A covered employee of an ATEO is one of the five highest-compensated employees of the organization (or a predecessor) for the current taxable year or in any preceding taxable year beginning after Dec. 31, 2016. Generally, all compensation paid by the ATEO to an employee, directly or indirectly, must be counted toward determining whether that employee is a covered employee and toward determining remuneration and parachute payments paid to that covered employee. Payments from a related organization (as defined) of an ATEO also must be counted.
For an applicable year (the calendar year ending with or within the ATEO’s taxable year), remuneration generally means wages as defined for income tax withholding purposes but also includes amounts required to be included in gross income under Section 457(f). Remuneration is treated as paid in the year when the covered employee’s right to the amount no longer is subject to a substantial risk of forfeiture as defined under Section 457(f)(3)(B), regardless of when the amount actually is paid. (Section 457(f) governs deferred compensation arrangements of tax-exempt and governmental organizations.)
Generally, when the sum of all payments made due to involuntary separation from employment equals or exceeds three times the employee’s base amount (as defined), the amount in excess of the base amount is an excess parachute payment.
The TCJA excludes remuneration directly related to the performance of medical services by licensed medical professionals (direct medical services payments) for purposes of determining covered employees. In addition, the statute excludes direct medical services payments and payments to employees who are not highly compensated employees (based on indexed dollar thresholds that apply for qualified retirement plan purposes) from treatment as parachute payments.
On Dec. 31, 2018, Treasury and the IRS issued Notice 2019-09 to provide initial guidance under Section 4960. The notice permits taxpayers to rely on its guidance and to base their positions on a reasonable, good faith interpretation of the statute (including legislative history, as appropriate) until further guidance is issued. The notice also outlines certain interpretations of Section 4960 that are not consistent with a reasonable, good faith interpretation of the statute and indicates that forthcoming proposed regulations are expected to cover these interpretations.