Guidance for Section 4960 exempt organization compensation excise tax

Overview

The 2017 tax reform legislation included new Section 4960, which imposes a 21% excise tax on remuneration in excess of $1 million and on any excess parachute payments paid by an ‘applicable tax-exempt organization’ and any related organizations to a ‘covered employee.’ The IRS recently issued Notice 2019-09, providing interim guidance to assist taxpayers in applying Section 4960 and to address issues on which stakeholders indicated that they would benefit from IRS guidance.

Until further guidance is issued in the form of proposed regulations, Notice 2019-09 indicates that a taxpayer may base its reporting position on a ‘good faith, reasonable interpretation of the statute,’ including consideration of the legislative history, where appropriate. The positions reflected in the 92-page Notice are deemed to constitute good faith, reasonable interpretations of the statute; the Notice also sets forth positions that would not meet this standard and, thus, may not be taken by taxpayers. The Notice requests comments by April 2, 2019, on issues under Section 4960, including six specific topics.

This Tax Insights discusses the interim guidance relating to the application and calculation of the excise tax.

The takeaway

The interim guidance in Notice 2019-09 is intended to assist taxpayers in applying Section 4960 while Treasury and the IRS develop further guidance. Exempt organizations are encouraged to consider the implications of the new excise tax as clarified by the Notice. Specific highlights include:

• Remuneration is reported based on the calendar year ending with or within the taxable year, similar to Form 990 reporting. However, remuneration must be calculated under the rules set forth in the Notice, and cannot be taken directly from Form W-2 box 1 or 5.
• A tax-exempt employer may have liability under Section 4960 directly for its covered employees and additionally as a related organization, subject to limited relief to avoid double counting remuneration of the same covered employee.
• Taxable or governmental entities may be required to file Form 4720 and pay a portion of the excise tax if they pay remuneration to an employee that is a covered employee of a related ATEO.
• Governmental entities can avoid being treated as ATEOs, but only if they also avoid being excluded from taxation under either Section 501(a) or Section 115(1), but nevertheless may be liable for the Section 4960 excise tax if they are a related organization to an ATEO.
• The ‘medical services’ exclusion is defined to align with Section 213(d). The remuneration of narrowly defined medical services generally is disregarded when determining whether an individual is a covered employee and whether a payment is an excess parachute payment.
• Within a related group of tax-exempt organizations, each tax-exempt employer must identify its covered employees separately.
• There is no minimum dollar threshold of remuneration for an employee to be a covered employee, and covered employee status never ends.
• Compensation that was vested prior to January 1, 2018, or the beginning of the employer’s first taxable year beginning after December 31, 2017, is not included as remuneration subject to the excise tax. However, earnings on these amounts after the effective date are included as remuneration for Section 4960 purposes.
• An excess parachute payment is one that is contingent on an involuntary separation from employment.

Next steps

Exempt organizations now will be challenged to understand and implement this interim guidance quickly in the new tax year so they can determine the tax impact and consider any operational changes going forward that might mitigate their excise tax exposure. In addition, organizations should determine whether there still are unanswered questions or comments that warrant submission to Treasury and the IRS by April 2, 2019. The Notice specifically requests comments on the following six topics:

• whether an employer should be allowed to rely on a written statement from a potential covered employee regarding whether the employee provided services to any other employer
• alternatives to remuneration calculations when a related organization has a change in status with regard to its relationship to an ATEO
• the value of remuneration based on underlying stock options or rights
• treatment of remuneration subject to Section 4960 in a prior year but denied deduction under Section 162(m) in the current year 
• the definition of a ‘predecessor’ organization and 
• reasonable methods of allocation of medical and non-medical services.