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New Guidance for Tax-Exempt Organizations: Proposed IRC 4960 Regulations

August 10, 2020

On June 11, 2020, the Internal Revenue Service released proposed regulations under code section 4960, which imposes an excise tax (21 percent for 2020) on remuneration in excess of $1,000,000 and any excess parachute payment paid by an applicable tax-exempt organization (ATEO) to any covered employee. These rules affect many tax-exempt organizations and, in certain circumstances, entities that are treated as related to those organizations. The policy objective behind the imposition of this excise tax is to level the playing field since parallel rules and taxes that apply to taxable entities have been in place for many years.

EXCESS REMUNERATION
As mentioned, 4960 applies to ATEOs which include any organization exempt from taxation under section 501(a), a farmers' cooperative organization described in section 521(b)(1), has income excluded from taxation under section 115(1), and a political organization described in section 527(e)(1).

If you qualify as an ATEO, it is important to identify your covered employees. A covered employee is defined as any employee (including any former employee) of an ATEO if the employee is one of the five highest-compensated employees of the organization for the taxable year or was a covered employee of the organization (or predecessor) for any preceding taxable year after December 31, 2016.

Whether an excise tax applies is a function of the amount of remuneration, an ATEO pays to a covered employee. Under 4960, remuneration is defined as wages, except that such term does not include designated Roth contributions but does include amounts required to be included in gross income under section 457(f). Remuneration is treatedas paid when there is no substantial risk of forfeiture (within the meaning of section 457(f)). Excluded from the definition of wages, however, is any remuneration paid to a licensed medical professional (including a veterinarian) for the performance of medical or veterinary services.

Notably, remuneration paid to a covered employee by an ATEO includes any remuneration paid with respect to employment of the employee by any related person or governmental entity. A person or governmental entity is treated as related to an ATEO if such person or governmental entity:

  • Controls, or is controlled by, the ATEO;
  • Is controlled by one or more persons who control the ATEO;
  • Is a supported organization during the taxable year with respect to the ATEO;
  • Is a supporting organization during the taxable year with respect to the ATEO; or,
  • In the case of an ATEO which is a voluntary employees' beneficiary association (VEBA) under section 501(c)(9), establishes, maintains, or makes contributions to  the VEBA.

EXCESS PARACHUTE PAYMENTS
An excess parachute payment is an amount equal to the excess of any “parachute payment” over the portion of the base amount allocated to such payment. The parachute rules under 4960, in general, follow the golden parachute rules that apply to taxable corporations under section 280G and for purposes of determining the “base amount.” Under 280G, the base amount is an individual's annualized compensation over the “base period,” which is the individual's last five taxable years.

A parachute payment is any payment in the nature of compensation to (or for the benefit of) a covered employee if the payment is contingent on the employee's involuntary separation from employment with the employer, and the value of the payments that are contingent on the separation equals or exceeds three times the base amount.

Certain payments are excluded as parachute payments under section 4960 and do not include payments:

  • Under qualified plans;
  • Made under or to an annuity contract described in section 403(b) or a plan described in section 457(b);
  • Made to a licensed medical professional (including a veterinarian) to the extent the payment is for the performance of medical or veterinary services by the professional; or
  • Made to an individual who is not a highly compensated employee as defined in section 414(q).

EFFECTIVE DATE
The guidance provided in these proposed regulations generally is consistent with the earlier guidance in Notice 2019-09. However, in certain instances, these proposed regulations modify the guidance provided in Notice 2019-09. Until the applicability date of the final regulations, taxpayers may rely on the guidance provided in Notice 2019-09 or, alternatively, on the guidance provided in these proposed regulations, including for periods prior to June 11, 2020.

NEXT STEPS
Tax-exempt organizations should, if they have not already, take the following steps to assess the current or future impact of section 4960, and comply with these new and complex rules:

  • Identify whether the organization is an ATEO or is related to one;
  • Determine which employees (current and past) are covered employees;
  • Calculate the amount of covered employee remuneration (including remuneration from related organization and deferred compensation);
  • Assess whether the remuneration to a covered employee is greater than $1,000,000; and
  • Evaluate whether excess parachute payments have been or may be made.

Anthony P. DaSilva, Jr. is a shareholder at Boston law firm Davis Malm. He has over two decades of experience counseling clients on the tax and regulatory issues impacting compensation and benefits arrangements. DaSilva is a trusted advisor to public, private and non-profit businesses on issues involving executive compensation, benefits, fringes and perquisites, deferred compensation and ERISA.