Section 4960 of the Internal Revenue Code imposes a 21% excise tax on compensation exceeding $1 million paid by an applicable tax-exempt organization ("ATEO") and related organizations to covered employees (generally the five highest paid employees of the organization for the taxable year). In 2019, the IRS issued interim guidance, Notice 2019 09, followed by proposed regulations in 2020.
On January 19, 2021, the IRS issued final regulations that largely track Notice 2019 09 and the proposed regulations, with several clarifications and modifications. The final regulations apply to tax years beginning after December 31, 2021.
ATEOs and Related Organizations
Consistent with the proposed regulations, ATEOs include every organization that: (1) is exempt from tax under IRC Section 501(a); (2) is a farmers' cooperative organization under IRC Section 521(b)(1); (3) has income excluded from taxation under IRC Section 115(1); or (4) is a political organization described in IRC Section 527(e)(1). Like the proposed regulations, the final regulations require that remuneration for each covered employee include not only remuneration from the ATEO but also remuneration from all related organizations. Organizations can be related based on various factors, including voting rights, partnership interests, or control over the organization's board or governing body. An organization is considered a related organization based on a controlled group analysis using a 50% threshold.
The final regulations contain two notable exceptions to ATEO status. First, Section 4960 does not apply to governmental entities that claim exemption from federal income tax based on sovereign immunity—including many public universities—but only if the entity is not also tax-exempt under Section 501(a). Foreign organizations described in IRC Section 4948(b) are also excluded from ATEO status if they are exempt from tax under IRC Section 501(a) or are taxable foundations described in IRC Section 4948(b).
The final regulations confirm that a covered employee of an ATEO remains a covered employee for all subsequent tax years, even after the employment relationship has terminated. The proposed regulations created two exceptions for ATEOs affiliated with for profit organizations under which certain individuals are not treated as covered employees—the "limited hours" exception and the "non exempt funds" exception.
The final regulations adopted the limited hours exception in substantially the same form as set forth in the proposed regulations. Under this exception, an individual is not a covered employee if the hours the employee works for the ATEO make up 10% or less of the total time he or she works for the ATEO and all related organizations during the year. An individual is deemed to automatically satisfy the limited hours exception if that individual works no more than 100 hours for the ATEO and all related organizations during the year.
The final regulations adopted a modified version of the nonexempt funds exception. Under this exception, an individual is not a covered employee if the individual does not perform services for the ATEO and its related ATEOs exceeding 50% of his or her total hours worked for the ATEO and all of its related organizations for the current year and the preceding year. In addition, no related organization that paid remuneration to the individual may provide paid services to the ATEO, any related ATEOs, or any taxable related organizations controlled by the ATEO and/or related ATEOs.
In the case of remuneration other than regular wages (e.g., deferred compensation), the proposed regulations provided that the amount of remuneration treated as paid by the employer is generally the present value of such remuneration that vested during the applicable year. The final regulations clarify that if the amount of this remuneration is scheduled to be actually or constructively paid within 90 days of vesting, the employer may instead use the future amount that will be paid.
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