The IRS has finalized regulations under Section 4960 of the Internal Revenue Code, which impose an excise tax on applicable tax-exempt organizations (ATEOs) for compensation to a covered employee that either exceeds $1 million or is an excess parachute payment. The final regulations largely track the proposed regulations released last summer, which we previously blogged about here, including provisions around compensation paid by related organizations.
Background. In general, a covered employee is an employee is who is one of the five highest-compensated employees of the ATEO for the taxable year, or was a covered employee of the organization for any preceding taxable year beginning after December 31, 2016.
Company-related foundations have paid particular attention to the fact that the amount of compensation paid by an ATEO under Section 4960 includes amounts paid to a covered employee by a related organization. This raised the concern that a corporate officer serving the foundation in a volunteer capacity could nonetheless trigger the excise tax based on pay received from the corporation for services performed in that capacity.
As we noted in our previous post, the proposed regulations provided exceptions that largely address this concern—and the final regulations largely have adopted them. More specifically:
Limited hours exception: This exception disregards an individual for purposes of determining the five highest compensated employees if:
- neither the ATEO nor any related ATEO paid compensation for services performed for the ATEO, and
- the individual performed services for the ATEO and other related ATEOs for no more than 10 percent of the total hours worked as an employee for the ATEO and all related organizations.
There is a safe harbor here for employees who perform no more than 100 hours of service for the ATEO and all related ATEOs during the applicable year. This exception works for situations where an individual provides fairly limited volunteer services to an ATEO.
Nonexempt funds exception: This exception disregards an individual for purposes of determining the five highest compensated employees if:
- neither the ATEO, nor any related ATEO or taxable related organization controlled by the ATEO, paid remuneration to an individual for services performed as an employee for an ATEO;
- the individual performed services as a employee of the ATEO and all related ATEOs for less than 50 percent of total hours worked as a employee of the ATEO and all related organizations; and
- no related organization that paid remuneration to the individual provided services for a fee to the ATEO, any related ATEO or any taxable related organization controlled by the ATEO.
The final regulations differ from the proposed regulations by making the determination of the 50 percent threshold over a two-year period, rather than one. Solely for purposes of this exception, the final regulations narrow the definition of a related organization by providing that the section 318(a)(3) downward attribution rules do not apply. This exception would cover situations where an individual provides more substantial services for an ATEO.
The final regulations will be applicable to tax years beginning after December 31, 2021. Until the applicability date, taxpayers may rely on a reasonable good-faith interpretation of section 4960, including guidance provided in Notice 2019-09 or the proposed regulations. However, taxpayers may choose to apply the final regulations to tax years beginning after December 31, 2017, so long as they apply the final regulations in their entirety and in a consistent manner.