Insights and Resources
Excess compensation paid by exempt organizations final regs. released
TAX ALERT |
Authored by RSM US LLP
The Treasury Department and IRS recently released an advance copy of final regulations (T.D. 9938) under section 4960, providing exempt organizations and their related entities with definitive guidance addressing the computation of excise tax on remuneration paid in excess of $1 million and excess parachute payments to covered employees. The final regulations will apply to tax years beginning after December 31, 2021.
If the final regulations are not published by the Federal Register ahead of Jan. 20, 2021, they may be further delayed and require additional approval by the incoming administration before being published.
The 2017 tax law (Pub. L. 115-97), commonly referred to as the Tax Cuts and Jobs Act (TCJA), added section 4960, which imposes an excise tax on exempt organizations (and certain related entities) that provide “excessive executive compensation.” Congress indicated its intent to create parity between tax-exempt employers and taxable employers by imposing limitations on executive compensation paid by tax-exempt employers that are similar to those imposed on taxable employers. Specifically, the provisions in section 4960 are similar to and modeled after the disallowed deduction under section 162(m) and the parachute payment provisions of section 280G.
These regulations generally adopt and clarify the guidance provided in the proposed regulations released in June 2020. Read our prior RSM Tax Alert. The substantive changes contained in the final regulations generally are limited to expanding the nonexempt funds exception to the definition of covered employees. In addition, the final regulations add a number of examples to clarify provisions originally included in the proposed regulations.
The final regulations retain the three volunteer exceptions to the definition of a covered employee as set forth in the proposed regulations: limited services, limited hours, and nonexempt funds. These exceptions serve to exclude certain remuneration paid by a related organization if certain conditions are met, including the employee not receiving remuneration for services rendered to the applicable tax exempt organization (ATEO). The final regulations adopt without change the limited services and limited hours exceptions and provide two taxpayer favorable modifications to the nonexempt funds exception.
The final regulations expand the application of the nonexempt funds exception by establishing a two year testing period (rather than the one year period originally proposed) and narrowing the scope of what entities are related organizations for this purpose. The nonexempt funds exception generally provides relief for an employee of a related non-ATEO that performs a significant portion of his/her services as an employee of the ATEO if the following criteria are met:
- None of the ATEO, any related ATEO, or any taxable organization controlled by the ATEO pays remuneration to the employee for services rendered to the ATEO;
- No related organization that pays remuneration to the employee provides services for a fee to the ATEO, any related ATEO, or any taxable organization controlled by the ATEO; and
- The employee spends less than 50% of his/her total work hours during the applicable year and the preceding applicable year for the ATEO and its related ATEOs.
Solely for purposes of this exception, the final regulations narrow the definition of a related organization by providing that the section 318(a)(3) downward attribution rules do not apply. The definition of a related organization for other purposes of section 4960 does not change. The preamble explains that without this modification, the definition of a related organization would be unduly restrictive and not permit the exception to apply in situations where it was intended to function. The preamble illustrates this concern as follows: assume a single person controls two taxable corporations and an ATEO. Section 318 attribution results in the ATEO controlling both taxable corporations even though there is no actual control or ownership by the ATEO of either taxable entity. As a result, no shared employee of both the taxable corporation and the ATEO could qualify for the nonexempt funds exception. By eliminating the downward attribution, the final regulations permit a shared employee that otherwise meets the criteria discussed above to satisfy the nonexempt funds exception.
Timing of remuneration
The final regulations adopt the general timing rule that treats remuneration as paid when it has vested (i.e., is not subject to a substantial risk of forfeiture) without including an exception for short-term deferrals. Despite commenters continuing to request the inclusion of a short-term deferral rule, Treasury and the IRS stated that doing so would be inconsistent with the statutory language. Therefore, the complexity in differentiating W-2 wages from section 4960 remuneration related to year-end payments and bonuses continues to apply as there is no matching between the year of inclusion for the excise tax and the income tax.
Although comprehensive, the final regulations leave open a few items to be addressed in future guidance. First, a federal instrumentality (e.g., described in section 501(c)(1)(A)(i)) with an enabling statute that specifically provides exemption from all current and future federal taxes may treat itself as not subject to section 4960 either as an ATEO or a related organization. However, if it is related to an ATEO, the ATEO must include remuneration paid by the instrumentality in determining its covered employees and the amount of remuneration subject to tax. The final regulations reserve paragraphs to resolve this issue in further guidance
Second, the final regulations do not address the coordination between sections 162(m) and 4960, acknowledging that the timing differences between the two sections make it a complex analysis to ensure that remuneration disallowed as a deduction under section 162(m) is not subject to an excise tax under section 4960. Therefore, the preamble permits taxpayers to use a reasonable, good faith approach to coordinate these provisions in circumstances where it is not known whether section 162(m) will result in a disallowed deduction by the due date of the Form 4720 (for payment of the section 4960 excise tax).
The final regulations will be effective for tax years beginning on or after the date they are published in the Federal Register; however, the regulations will be applicable to tax years beginning after December 31, 2021. Until the applicability date, taxpayers may rely on a reasonable good-faith interpretation of section 4960, including guidance provided in Notice 2019-09 or the proposed regulations. Alternatively, taxpayers may choose to apply the final regulations to tax years beginning after December 31, 2017.
Call us at +1 213.873.1700, email us at email@example.com or fill out the form below and we'll contact you to discuss your specific situation.
This article was written by Anne Bushman, Alexandra Mitchell, Karen Field, Morgan Souza and originally appeared on 2021-01-15.
2020 RSM US LLP. All rights reserved.
The information contained herein is general in nature and based on authorities that are subject to change. RSM US LLP guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. RSM US LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer.
RSM US Alliance provides its members with access to resources of RSM US LLP. RSM US Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each is separate and independent from RSM US LLP. RSM US LLP is the U.S. member firm of RSM International, a global network of independent audit, tax, and consulting firms. Members of RSM US Alliance have access to RSM International resources through RSM US LLP but are not member firms of RSM International. Visit rsmus.com/about us for more information regarding RSM US LLP and RSM International. The RSM logo is used under license by RSM US LLP. RSM US Alliance products and services are proprietary to RSM US LLP.
Vasquez & Company LLP is a proud member of the RSM US Alliance, a premier affiliation of independent accounting and consulting firms in the United States. RSM US Alliance provides our firm with access to resources of RSM US LLP, the leading provider of audit, tax and consulting services focused on the middle market. RSM US LLP is a licensed CPA firm and the U.S. member of RSM International, a global network of independent audit, tax and consulting firms with more than 43,000 people in over 120 countries.
Our membership in RSM US Alliance has elevated our capabilities in the marketplace, helping to differentiate our firm from the competition while allowing us to maintain our independence and entrepreneurial culture. We have access to a valuable peer network of like-sized firms as well as a broad range of tools, expertise and technical resources.
For more information on how Vasquez & Company LLP can assist you, please call +1 213.873.1700.
Subscribe to receive important updates from our Insights and Resources.