IRS Issues Interim Guidance on Executive Compensation Excise Tax
By Lisa W. Heller, Senior Tax Manager
The IRS has issued long-awaited interim guidance on a provision in the new tax law affecting tax-exempt organizations that pay their top people over $1 million, or that provide generous severance packages.
Under new Section 4960 of the Internal Revenue Code, created as part of the 2017 tax act (P.L. 115-97), an excise tax of 21% is imposed on the amount of remuneration in excess of $1 million, and on any excess parachute payment, paid by an applicable tax-exempt organization (“ATEO”) to a covered employee. The ATEO, not the covered employee, is responsible for reporting and paying this tax to the IRS. Section 4960 applies to taxable years beginning after December 31, 2017.
Notice 2019-09 (12/31/2018) provides interim guidance with respect to the application of Section 4960, pending the issuance of proposed regulations. The Notice indicates that any future guidance under Section 4960 will be prospective in nature and will not apply to taxable years beginning before the issuance of that guidance. In the meantime, taxpayers may rely on the guidance provided in the Notice when applying Section 4960.
The Notice states that until further guidance is issued, taxpayers may use a good-faith, reasonable interpretation of the statute to comply with the requirements of Section 4960. Positions reflected in the Notice will constitute a good-faith, reasonable interpretation of the statute. The Notice also describes certain positions that IRS and the Treasury Department do not consider a good-faith, reasonable interpretation of the statutory language. If a taxpayer’s position is inconsistent with the Notice, then all relevant facts and circumstances, including consideration of the legislative history, will be considered in determining whether the position is in good faith and reasonable.
The 92-page Notice provides preliminary answers as to many aspects of Section 4960, including (but not limited to) what counts as an ATEO, who is a covered employee, how to compute excess remuneration, what is an excess parachute payment, and how to report and pay the resulting tax. Some key answers provided in the Notice include the following:
- There are four broad categories of ATEOs, including organizations exempt from tax under Section 501(a), farmers’ cooperative organizations described in Section 521(b)(1), governmental entities whose income is excluded from taxation under Section 115(1), and political organizations described in Section 527(e)(1). Based on this interim guidance, many state colleges and universities fall outside the scope of this excise tax. Therefore, any state college or university that does not fall into the specific definition of an ATEO, and that pays a multimillion dollar salary to an employee (such as an athletic coach), is not subject to the tax.
- The excise tax is imposed on remuneration paid (other than any excess parachute payment) by an ATEO for the taxable year to any covered employee in excess of $1 million. The $1 million threshold is not adjusted for inflation. For purposes of Section 4960, remuneration is defined as wages subject to federal income tax withholding, but excluding designated Roth contributions, and including amounts required to be included in gross income under Section 457(f). Remuneration includes a parachute payment that is not an excess parachute payment, and it does not include certain retirement benefits or certain directors’ fees.
- Remuneration is treated as paid when there is no substantial risk of forfeiture of the rights to the remuneration. Therefore, ATEOs cannot delay the actual payment of the remuneration to its covered employees to avoid the excise tax.
- An excess parachute payment is, in general, a payment of compensation contingent on an employee’s separation from employment, where the amount equals or exceeds three times a calculated base amount. An excess parachute payment needs not exceed $1 million to be subject to the excise tax.
- The excise tax is determined based on excess remuneration paid and excess parachute payments made in the calendar year ending with or within the taxable year of the employer. ATEOs with fiscal tax years will compute the tax based on remuneration paid and excess parachute payments made in the calendar year ending within the organization’s tax year (e.g., amounts paid during the calendar year ended December 31, 2018, for a tax year ended June 30, 2019).
- The Notice states that the “common-law employer” pays the compensation and is responsible for any Section 4960 excise tax. The Notice specifies that the ATEO is considered the common-law employer, and therefore cannot avoid liability under Section 4960 by paying its people through any number of related organizations, or by using a third party payor arrangement, such as a payroll agent, common paymaster, statutory employer, certified professional employer organization, or any similar arrangement.
- The excise tax is paid and reported by filing Form 4720 by the fifteenth day of the fifth month after the end of the employer’s taxable year (e.g., May 15 for a calendar tax year). An employer may file for an extension of time to file Form 4720, but the extension filing does not extend the time to pay the tax. Estimated tax payments are not required for the excise tax.
- Any excess remuneration and excess parachute payment, which is subject to the excise tax, is not automatically considered an excess benefit transaction under Section 4958. Rather, the ATEO should make a separate determination as to whether all compensation paid, whether to covered employees or to others, meet the rebuttable presumption of reasonableness for purposes of Section 4958.
IRS is requesting comments on the guidance provided in the Notice. The deadline for all comments is April 2, 2019. Because of this deadline date, it is clear that we cannot expect proposed regulations on Section 4960 any earlier than the second half of 2019. IRS and the Treasury Department have not given a timeframe as to when we can expect proposed regulations on this topic. We will keep you posted as additional information becomes available.
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