December 31, 2018; Accounting Today
Remember that tax bill passed by Congress in 2017? Built into that bill was the imposition of an excise tax for nonprofit organizations paying employees in excess of $1 million. (If you need a reminder, please read this, which NPQ published almost exactly one year ago.) Now, the IRS has released Notice 2019-09, a document meant to provide “interim guidance” regarding this new legislation (known as section 4960), while the Treasury Department and the IRS further develop its application.
As noted in Accounting Today, the IRS document was released despite the partial government shutdown. (Apparently, the IRS is allowed to make exceptions to the shutdown for work related to publishing tax information.) The IRS document offers some preliminary answers to questions that have been posed about section 4960 in such areas as what counts as an applicable tax-exempt organization, how to define covered employees, a definition of excess remuneration, what excess parachute payments are, and more.
The new excise tax is imposed on the amount any Applicable Tax-Exempt Organization (ATEO) pays a covered employee in excess of $1 million during the tax year. This is considered “excess remuneration.” For the tax year beginning after December 31st, the rate for the excise tax is 21 percent. Later definitions in the publication clarify that the applicable amount of the remuneration includes some benefits, including parachute payments. Interestingly, it does not include any compensation paid by the organization to a board director for performing services in that role, as that is defined as self-employment income, not wages.
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It appears that the IRS is making some preliminary clarifications based on what might be used by ATEOs as workarounds. For example, they are defining a “common-law employer” as the entity providing the compensation. This terminology means that the ATEO cannot avoid liability by having the employee paid by a number of different related organizations or by using a third-party payor arrangement like a payroll agent or a certified professional employer organization. Even if the pay is technically coming from another party, the common-law employer in these cases is still the ATEO.
As pointed out a year ago, it is important to remember that it is the ATEO that is liable for the excise tax on what is considered to be “excess compensation,” not the employee. An ATEO is defined in four ways, including any organization exempt under section 501(a) of the tax code. The most common nonprofit designation, 501c3, is in fact a subset of that section, so most nonprofit organizations are included. A clear and simple explanation of this distinction can be found here. According to the IRS publication, some governmental agencies are also liable.
Despite the fact that the amount over $1 million in remuneration is considered excessive and therefore liable for the excise tax under section 4960, the IRS states in the report that this does not automatically imply that the amount of pay is in fact unreasonable when determining if it is liable for taxation as an “excess benefit transaction.” Essentially, an excess benefit transaction is when someone was paid by a tax-exempt organization more than their services were worth.
All in all, this is a very long and detailed document that’s clearly intended to plug any loopholes ATEOs may try to use to avoid liability. Postponing or deferring actual payment, distributing pay among several related organizations, involving a third-party employer…none of these change the ATEO’s liability under this new tax law, according to these preliminary guidelines released by the IRS. As we said a year ago, nonprofit organizations and their boards are encouraged to seriously consider the implications of this tax law, and to seek counsel regarding how to address it.—Rob Meiksins