Heads Up! Even Nonprofits without Millionaire Execs Should Know Excise Tax Changes

April 24, 2019; Lexology

A Lexology article cautions nonprofits paying far less than $1 million to their CEOs that there are circumstances under which the new salary excise tax included in the 2017 federal tax law will affect them. Their piece breaks down the nonprofit-specific provisions to the tax code in terms of how they may come into play for organizations that may not be expecting it.

Much of what Venable LLP has to say in this piece comes from IRS guidance provided in Notice 2019-9. Among other things, they caution that “even if a nonprofit organization does not pay any of its employees annual remuneration in excess of $1 million, the organization could be subject to the excise tax if it has a deferred compensation plan in which benefits are spread out over a period of years, and then vest all at once.”

For example, a nonprofit organization that pays its chief executive officer an annual salary of $700,000 per year and contributes $50,000 per year to a deferred compensation plan that vests after 10 years could be liable for a tax of $42,000 in the year of vesting (21 percent of the excess of $1.2 million (salary of $700,000 + vested deferred compensation of $500,000) over $1 million, or $200,000). Thus, even though the nonprofit organization never paid its chief executive a salary of more than $700,000, it incurred liability for the excise tax when the chief executive’s deferred compensation vested. Importantly, Code Section 4960 does not provide a “grandfather” rule that would exempt remuneration paid under a deferred compensation plan that was entered into prior to the enactment of Code Section 4960.

(Most of us only wish we had such problems, or don’t but wonder what the salary ratios in those organizations look like overall—but, moving on…)

These provisions also apply to “excess parachute payments,” which refers to a severance that amounts to more than three times an employee’s average salary over the last five years.

Those considered to be “covered employees” include any nonprofit’s five highest-compensated employees for the current taxable year, with no minimum threshold.

Some additional guidance from the IRS notice referenced earlier:

• Each employer within a related group of tax-exempt organizations will need to make its own separate determination of who is a covered employee in every year (even in years when the employer is not subject to the excise tax).

• Once an individual is classified as a covered employee, the individual remains a covered employee indefinitely, even if the individual is no longer one of the employer’s five highest-compensated employees.
• In identifying its five-highest compensated employees, an employer must include remuneration paid to the employee by any “related” organizations.

So, long story short, while many organizations are too small to feel the effects of this provision, under some circumstances even more modest ones may have to crunch some numbers to ensure the entities paying the bill are covered.

In sum, in addition to nonprofit organizations that pay remuneration in excess of $1 million, Code Section 4960 can potentially affect many other nonprofit organizations, including those organizations that use deferred compensation plans to attract and retain executives, and those that pay severance packages to departing employees. Furthermore, the $1 million threshold is not adjusted for inflation, so over time it will encompass an ever-increasing number of nonprofit organizations. In addition, the requirement to track covered employees indefinitely introduces new record keeping requirements for many nonprofit organizations.

Again, for most of us this advice will be immaterial, but the change in regulation is worth noting.—Ruth McCambridge