United States: IRS Notice Provides Guidance For Exempt Organizations On Excise Tax

Nicole M Elliott is a Partner in our Washington DC office.

Christopher J Armstrong is a Partner in our Washington DC office.

HIGHLIGHTS:

  • The Internal Revenue Service (IRS) released IRS Notice 2019-09 (Notice) offering guidance under Section 4960 of the Internal Revenue Code as added by the Tax Cuts and Jobs Act.
  • Section 4960 applies to certain tax-exempt organizations, and imposes an excise tax on excess executive compensation and excess parachute payments.
  • Section 4960 imposes additional burdens on tax-exempt organizations to assess, track and potentially pay the excise tax. Notice 2019-09 provides some additional clarity for taxpayers.

The Tax Cuts and Jobs Act (TCJA) added Section 4960 to the Internal Revenue Code (IRC). The new section applies to any "applicable tax-exempt organizations" and imposes an excise tax on excess executive compensation (remuneration) and excess parachute payments. Such excess amounts are taxed at the corporate tax rate of 21 percent. Like many provisions in TCJA, the new provision is effective for taxable years beginning after Dec. 31, 2017.

The IRS released IRS Notice 2019-09 on Dec. 31, 2018, and the much-awaited details provide informal guidance on this new provision. While waiting for the proposed regulations and final regulations, taxpayers can rely on the Notice as a reasonable interpretation of the law. Comments on Notice 2019-09 are due by April 2, 2019.  

Notice Background and Highlights

The Notice leans heavily on guidance issued previously by the IRS under Section 162(m) (an older provision regarding excess compensation for certain publicly traded companies) and Section 280G (an older provision regarding golden parachute payment when there is a change in control of a company such as a merger or acquisition). As with Section 162(m) and Section 280G, new Section 4960 imposes additional burdens on tax-exempt organizations to assess, track and potentially pay the excise tax.

Those entities subject to Section 4960 include an organization that is exempt from tax under Section 501(a) or has income excluded from tax under Section 115(1) (which generally exempts from taxation income of state or political subdivision). Section 4960 taxes remuneration paid to a "covered employee" that exceeds $1 million or is considered an "excess parachute payment." A "covered employee" is one of the five highest-compensated employees in the current taxable year and any covered employee in any preceding taxable year beginning after Dec. 31, 2016. As noted below, the determination of who is a covered employee is based on remuneration paid during the calendar year by the exempt organization and any related organization. An "excess parachute payment" is defined as the excess of the total amount of any parachute payment (generally a payment contingent on the employee's separation) over the portion of a base amount (calculated by looking at past compensation) allocated to the payment.

Highlights of Notice 2019-09 are as follows:

  • Remuneration and payments determined on a calendar-year basis, using the calendar year that ends with or within the organization's taxable or fiscal year. This clarification helps interpret the existing statute which was unclear.
  • As expected, the Notice confirms that organizations must track their five highest-paid employees because once that employee is designated as a "covered employee," the employee remains a covered employee and may be paid in future years amounts that then become subject to the tax.
  • The Notice indicates that certain state colleges and universities are not subject to Section 4960. This has been the most controversial part of Section 4960. While legislative history indicates Congress intended its application to these entities who are exempt from taxation, the law as written does not appear to apply as broadly.
  • In conformity with the statute, for purposes of determining remuneration, amounts paid to a medical professional that are for the performance of medical service are not to be taken into account. The Notice clarifies that medical services do not include administration, teaching or research services.
  • Only employees of exempt entities might be "covered employees." However, a related organization may also employ the entity's covered employee, which could cause the related organization to be subject to the Section 4960 excise tax. The Notice provides some clarification that related organizations can include for-profit organizations and governmental organizations based on a 50 percent control test. These rules could catch many taxpayers off guard and it will be important to determine which entity is the common-law employer.
  • Clarifies that payment of the excise tax is due the 15th day of the fifth month after the year by filing IRS Form 4720.

Conclusion and Takeaways

While the guidance provides welcome clarification, the new provision does impose additional burdens on affected entities. Holland & Knight is prepared to answer any questions that organizations may have about Section 4960, and we can review policies and procedures to ensure compliance and exposure for this new tax.

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.

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