A Deeper Look at Tax Reform’s Evolving New Game Plan for Tax-Exempt Organizations


In the Bloomberg BNA Tax Management Compensation Planning Journal, Jackson Walker partner Greta E. Cowart co-authored an article on Notice 2019-09, which provides interim guidance regarding Section 4960 of the Internal Revenue Code. Here is a preview of the article:

Overview

The year 2019 started with Notice 2019-09, a lengthy piece of guidance providing further definition to the unpleasant surprise for tax-exempt organizations in the Tax Cuts and Jobs Act enacted in late 2017 (the ‘‘2017 tax act’’).[1] The 2017 tax act surprised tax-exempt organizations when it imposed a 21% excise tax on compensation in excess of $1 million and on certain ‘‘parachute payments.’’ Organizations, including public universities, state and local government entities, charitable organizations, public utilities, farmers’ cooperatives, and other organizations that operated without an expectation of retaining profits to pay tax expenses may now find themselves subject to either complying with the new compensation limit, or adjusting planned use of financial resources in order to free funds to pay the tax.[2] While the 2017 tax act’s changes to the compensation limit for companies with publicly traded securities included a transition rule, surprisingly, the addition of this compensation limit to entities that had not faced this type of hard line limit did not provide for any explicit transition rule for existing contracts.[3] Because there is no statutory transition rule, the entities subject to this new excise tax may have an immediate unplanned expense.

Notice 2019-09 provides some relief in the parachute payment area by recognizing the impact of special substantial risk of forfeiture requirements applicable to the tax-exempt organization under §457(f).[4]

Section 13602 of the 2017 tax act added §4960 to the Code, which imposes a tax on what it deems to be excess executive compensation in tax-exempt organizations. Section 4960 borrowed concepts from restrictions applicable to for-profit companies, such as the compensation limit under §162(m), the golden parachute limitations under §280G, and the related tax under §4999. However, these rules differ in many respects and the penalties are revised to fit the different type of organization with an excise tax applicable to the entity for either a violation of the compensation limit or for the excess departure payments upon an involuntary separation from service (because the change in control concepts under §280G and its tax on the individual do not fit as well).[5]

 

The tax falls on excess compensation paid in any tax year above $1 million, plus it can also apply to any of what it calls an ‘‘excess parachute payment’’ paid to a covered employee upon separation from employment with the entity subject to the tax. The $1 million dollar threshold does not apply to any amounts that are excess parachute payments.[6]

As a practical matter, tax-exempt organizations will need to watch the payments triggered by an involuntary separation from employment to keep that amount at a multiple of 2.99 or less. Organizations who compensate covered employees at an annual amount that exceeds the $1 million dollar limit will need to budget for the excise tax on the compensation the tax-exempt organization pays the executive above the annual limit. Affected tax-exempt and governmental employers will also need to maintain lists of which individuals are amongst the ‘‘High Five’’ in each calendar year after December 31, 2016, because the excise tax follows the change to §162(m) by adopting a ‘‘once-in-always-in’’ rule.

While some terminology in §4960 is similar to that used in §162(m) and §280G, the terminology in §4960 is defined in different ways from the restrictions on a company that has publicly-traded securities or that is subject to §280G’s golden parachute rules. Thus, one needs to carefully review the §4960 definitions and anti-avoidance rules to fully appreciate their scope and application.


[1] Pub. L. No. 115-97.
[2] See potential limitations on the application of §4960, as added by the 2017 tax act, to state and local government run universities explained further in ‘‘Organizations Subject to the Compensation Limit and Excise Tax’’ below. All section references are to the Internal Revenue Code of 1986, as amended (the Code), and the regulations thereunder, unless otherwise specified.
[3] 2017 tax act, §13601(e).
[4] This article is an update to Tax Reform’s Radical New Game Plan for Tax-Exempt Organizations, 46 Comp. Plan. J. No. 3 (March 2, 2018).
[5] Notice 2019-09, Q&A 20(a).

To download the PDF, view “A Deeper Look at Tax Reform’s Evolving New Game Plan for Tax-Exempt Organizations.” For more insights on tax and accounting, visit the Bloomberg Tax website.


Meet Greta

Greta E. Cowart has counseled employers for more than 30 years on best practices in human resources and employee relations issues related to benefits and executive compensation. In her practice, Greta routinely develops strategies for effective administration of claims and other disputes, including defense of grievances, and in litigation considering implications under ERISA, while also considering applicable labor and employment laws. Greta also provides fiduciary training and review of fiduciary operations to improve the documentation of the fiduciary process. Greta is a former chair of the Employee Benefits Committee of the ABA Section of Taxation, and has served on the U.S. Department of Health and Human Services CHIP Working Group.