United States: New Tax Law Brings Penalties For Top Paid Non-Profit Executives

Last Updated: January 4 2018
Article by Tyrone P. Thomas, Alden J. Bianchi and David R. Lagasse

The "intermediate sanctions" rules under Section 4958 of the Internal Revenue Code have long governed the payment of compensation to executives of public charities. While these rules are highly prescriptive, if followed, they offer taxpayers a significant advantage in the form or a rebuttable presumption of reasonableness. While there was concern among tax-exempts that the tax bill might reduce or even eliminate the presumption of reasonableness, that turned out not to be the case. But the final version of the legislation for the first time imposed a tax on certain excess compensation and excess parachute payments, which we discuss in more detail below.

How are public charities regulated under U.S. tax law?

U.S. tax law has long recognized and provided special, beneficial tax treatment of public charities in the form of an exemption from income tax under Code § 501(c). To qualify for this exemption, a public charity must, among other things, operate so that none of its income or assets inure to the benefit of any of its board members, trustees, officers, or key employees. These types of individuals are commonly referred to colloquially as "insiders" and technically under applicable law and regulations as "disqualified persons." Thus, the prohibition precludes any of the income or assets of a charity from unfairly or unreasonably benefiting, either directly or indirectly, individuals who have close relationships with their organizations and the ability to exercise control over them.

What is the most common type of private inurement?

The most common type of private inurement is the payment of excessive compensation to insiders. Violation of these rules can result in the revocation of a charity's tax-exempt status and/or in the imposition of intermediate sanctions as explained below.

What are the intermediate sanctions rules?

The "intermediate sanctions" rules under Code § 4958 prohibit the payment of excessive compensation or other benefits (called "excess benefits") to certain individuals responsible for running tax-exempt organizations. Penalties under the intermediate sanctions rules can be significant.

What happens if the intermediate sanctions rules are violated?

If an excess benefit is paid or provided to a "disqualified person" (i.e., any person who is in a position to exercise substantial influence over the institution), he or she can be liable for an initial excise tax of 25% on the value of the excess benefit. This tax is imposed in addition to the individual's other income taxes. A disqualified person is also liable for an additional excise tax of 200% if the excess benefit is not repaid to the organization, along with an amount equivalent to what the organization would have lost for the time value of money. In addition, any manager of an organization (officers, board members, trustees, etc.) who knowingly participates in an excess benefit transaction may be subject to a 10% tax on the excess benefit, up to $20,000, unless the participation was not willful and was due to reasonable cause.

What steps are required to comply with the intermediate sanctions rules?

Final regulations issued under Code § 4958 provide a safe harbor in the form of a rebuttable presumption of reasonableness where the following procedural requirements are met:

  • An "authorized body" (e.g., board or a board appointed committee) of the institution, none of whom have a "conflict of interest" with respect to the proposed transaction or transfer, must approve the compensation before it is paid.
  • The board or committee must obtain and rely on "appropriate data" as to comparability of the compensation prior to making its determination.
  • The board or committee must "adequately document" the basis for its determination "concurrently" with the making of that determination. (The final intermediate sanctions rules prescribe specific requirements as to what must be documented and by when).

The final intermediate sanctions regulations establish a procedure which, if followed, creates "a rebuttable presumption" that compensation payable to a disqualified person (i.e. the person whose compensation or other financial arrangement is under discussion) is reasonable under the circumstances.

Though not required, it behooves a public charity to follow this procedure so as to gain the benefit of this presumption. Establishing a rebuttable presumption of reasonableness shifts the burden of proof with respect to the reasonableness of compensation from the tax-exempt organization to the IRS in the event that the compensation is renewed. In addition, to the extent that a member of the authorized body relies upon a reasoned, written opinion of counsel, in-house counsel, accountants with relevant tax expertise, or independent valuation experts, he or she will not be subject to the separate tax imposed upon an organization manager. Proposed changes to the rules governing the rebuttable presumption of reasonableness were not included in the final legislation.

What changes to executive compensation can public charities expect under the Tax Cuts and Jobs Act?

Section 13602 of the Tax Cuts and Jobs Act imposes a 21% excise tax on compensation in excess of $1,000,000 paid to insiders, which include any current or former employee who would have been one of the charity's five highest paid employees for the tax year or in a prior tax year beginning after 2016.

Under the provision, a tax-exempt organization is liable for the excise tax on:

  • Any remuneration (other than an excess parachute payment) in excess of $1 million paid to a covered employee by an applicable tax-exempt organization for a taxable year (compensation is paid when the rights to the compensation are no longer subject to a substantial risk of forfeiture), and
  • Any excess parachute payment paid by a tax-exempt organization to a covered employee.

Notably, the excise tax applies as a result of an excess parachute payment, even if the employee's remuneration does not exceed $1 million.

An excess parachute payment is a payment that exceeds the portion of the "base amount" (i.e., the amount by which the current net present value of the payments exceed three times the average annual compensation of the employee for the five tax years before the employee's separation from employment). The tax on excess parachute payments is imposed only on highly compensated employees. These rules are effective commencing in 2018.

How does the Tax Cuts and Jobs Act affect tax reporting on non-profit executive compensation?

Most tax-exempt organizations are required to annually file Form 990, an informational tax return that provides an overview of the organization's activities, governance and financial information. Schedule J of Form 990 is used to report compensation information for disqualified persons – certain officers, directors, individual trustees, key employees and highly compensated employees – as well as provide information on the organization's compensation practices.

Part II of Schedule J requires a comprehensive disclosure of the various components of executive compensation, including base compensation, incentive compensation, retirement and deferred compensation, nontaxable benefits, and other reportable compensation. Since the reporting rules for ineligible nonqualified deferred compensation (often referred to as "golden handcuff" plans to provide significant retention incentives for senior executives) require disclosure for both the year in which funds are deferred and the year in which the right to payment is substantially vested, there is in essence double reporting of this information.

Column F of Schedule J Part II addresses this in part by providing for separate disclosure of compensation that has already been reported in Column B of Schedule J Part II of prior 990s. However, as the excise tax penalty of the Tax Cuts and Jobs Act focuses solely on the year amounts are paid, irrespective of whether the amounts are the result of a series of prior year deferrals that were subject to a risk of forfeiture, it raises question whether the significant amounts of previously disclosed compensation in Column F is relevant for executive compensation tax reporting.

Organizations which may be liable for excise taxes under the Tax Cuts and Jobs Act will have to reconcile this standing with their responses to Line 25a-25b of Form 990, which requests disclosure of excess benefit transactions. To date, these responses in the Form 990 have been governed by compliance with the intermediate sanctions rules. Organizations which report such excess benefit transactions must provide further detailed information on the nature of the excess benefit transaction under Form 990 Schedule L.

How does the Tax Cuts and Jobs Act impact unrelated business taxable income paid by tax-exempts?

The new law increases unrelated business taxable income ("UBTI") by the amount of certain fringe benefit expenses for which a deduction is disallowed, effective for amounts paid or incurred after 2017. Thus, for example, a tax-exempt organization's UBTI will be increased in the amount the organization pays or incurs for any qualified transportation fringe benefit (even if paid through an employee's pre-tax salary reduction), as well as any on-premises athletic facility.

Considerations for Next Steps

Going forward the Boards of tax-exempt institutions (or the committees endowed with authority for executive compensation decisions) will need to carefully evaluate conditions for both current and deferred compensation that would cause their senior leadership to exceed the new compensation threshold for excise taxes. In some instances, this may require significant restructuring and planning of governing compensation philosophies, performance incentive plans and non-qualified deferred compensation arrangements. There will also be need to assess the effect of the new tax rules on availing the safe harbor threshold for intermediate sanctions and accurate reporting on Form 990. Counsel should advise on both the process and requirements for these decisions.

For more coverage of the new tax bill's impact on the workplace click here.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Tyrone P. Thomas
Alden J. Bianchi
Similar Articles
Relevancy Powered by MondaqAI
Poyner Spruill LLP
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Poyner Spruill LLP
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions