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Sunday, January 06, 2019

Rules Issued on Excess Remuneration Paid by Exempt Organizations

The 2017 Tax Act imposed a penalty on excess compensation paid to employees of an applicable exempt organizations (“ATEO”). Code §4960 imposes an excise tax of 21 percent on compensation paid to a covered employee in excess of $1 million and on any excess parachute payments paid to a covered employee.  A “covered employee” is any employee (or former employee) who is one of the five highest - compensated employees of the organization for the taxable year or was a covered employee of the organization (or any predecessor) for any preceding taxable year.

The IRS has issued Notice 2019-9, which contains interim rules on how the excise tax will apply. Some interesting aspects of the new statute and rules are summarized below:

  • Related Entity Aspects:
    • Any remuneration paid to a covered employee by a related entity is included in the calculation of the covered employee’s total remuneration for the year.
    • A payment from a related entity, including a related entity that is an ATEO, for services rendered to the common-law employer, is considered a payment to the employee from the common-law employer. Calculation of the excise tax is separate from any arrangement that an ATEO and any related organization may have for bearing the cost of the excise tax.
    • Remuneration paid by a separate organization on behalf of the ATEO, whether related to the ATEO or not, for services performed as an employee of the ATEO is treated as remuneration paid by the ATEO.
    • An employee may be a covered employee of more than one ATEO and that each ATEO employer calculates its liability under Code Sec. 4960(a)(1) taking into account the organizations to which it is related. However, an employer is liable only for the greater of the excise tax it would owe as an ATEO or the excise tax it would owe as a related organization with respect to that covered employee.
  • Determining Compensation Aspects:
    • Wages include all remuneration for services performed by an employee for the employer, except for fees paid to a public official, and other specifically excluded types of remuneration.
    • Remuneration is treated as paid when there is no substantial risk of forfeiture of the rights to such remuneration (i.e., when the compensation is vested). Remuneration in which the covered employee vested before the effective date of Code §4960 is treated as paid before that effective date. The definition of substantial risk of forfeiture under Prop Reg § 1.457-12(e)(1) is the definition of substantial risk of forfeiture within the meaning of Code §457(f)(3)(B) for purposes of Code §4960(a). Under Prop Reg § 1.457-12(e)(1), an amount of compensation is subject to a substantial risk of forfeiture only if entitlement to the amount is conditioned on the future performance of substantial services, or upon the occurrence of a condition that is related to a purpose of the compensation if the possibility of forfeiture is substantial.
    • For purposes of determining when remuneration is treated as paid, the timing rule in Code Sec. 4960(a) applies,and the timing rule for wage inclusion under Reg § 31.3402(a)-1(b) is not relevant. Under Notice 2019-9, Q/A-13, the amount of remuneration treated as paid at vesting is the present value of the remuneration in which the covered employee vests.
  • Who Is a Covered Employee:
    • Once an employee is a covered employee, he or she continues to be a covered employee for all subsequent tax years. There is no minimum dollar threshold for an employee to be a covered employee.
    • Remuneration paid for medical services is not taken into account for purposes of identifying the five highest-compensated employees.
    • Whether an employee is one of the five highest-compensated employees is determined separately for each ATEO, and not for the entire group of related organizations. Therefore, each ATEO has its five highest-compensated employees. Thus, a related group of entities may have more than five covered employees.
    • Only an ATEO’s common law employees (including officers) can be one of an ATEO’s five highest compensated employees. There is a limited services exception from highest compensated employee status under which, unless an ATEO pays at least 10% of the total remuneration paid by the ATEO and all related organizations to an employee during the calendar year, the employee is not treated as one of the ATEO’s five highest compensated employees.
  • Misc.:
    • Certain governmental entities are not ATEOs. A governmental entity (including a state college or university) that is not recognized as exempt from taxation under Code §501(a) and does not exclude income from gross income under Code §115(1) is not an ATEO described in Code §4960(c)(1). A governmental entity that sought and received a determination letter recognizing its tax-exempt status under Code §501(c)(3) may relinquish this status pursuant to the procedures described in Rev Proc 2018-5.
    • For purposes of calculating the remuneration upon which the tax is calculated, remuneration does not include certain retirement benefits or certain directors' fees.
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