June 11, 2020
On June 5, 2020, the U.S. Internal Revenue Service (the IRS) issued proposed regulations on Section 4960 of the Internal Revenue Code of 1986, as amended (the “Proposed Regulations”). The Proposed Regulations are “intended to provide comprehensive guidance” on Section 4960, enacted as part of the Tax Cuts and Jobs Act, which imposes an excise tax (currently 21%) upon an “applicable tax-exempt organization” (ATEO) and “related organizations” on remuneration in excess of $1 million and for “excess parachute payments,” in each case, paid to the organizations’ “covered employees.” Section 4960 is effective for taxable years beginning after December 31, 2017.
The Proposed Regulations are largely based on Notice 2019-09, which provided initial guidance on the application of Section 4960. In general, the Proposed Regulations restate certain statutory definitions and define various terms appearing in Section 4960 and provide rules for determining: (1) the amount of remuneration paid for a taxable year (including for purposes of identifying covered employees); (2) whether a parachute payment is paid; (3) whether excess remuneration is paid and in what amount; (4) whether an excess parachute payment is paid and in what amount; and (5) the allocation of liability for the excise tax among related organizations.
The IRS published the Proposed Regulations in the Federal Register today, June 11, 2020. Written or electronic comments on the Proposed Regulations are due by August 10, 2020. The Proposed Regulations will apply to taxable years beginning on or after the date the final regulations are published in the Federal Register. Until the applicability date of the final regulations, taxpayers may rely either on the earlier guidance provided in Notice 2019-09 or, alternatively, on the guidance provided in the Proposed Regulations.
The Proposed Regulations provide clarifications and exceptions intended to ensure that certain employees of nonexempt organizations that provide services as employees to a related ATEO are not treated as “covered employees” of the ATEO. An ATEO’s “covered employees” are generally defined to include any employee of the ATEO that is one of the five highest-compensated employees of the ATEO for the taxable year, or was a covered employee of the ATEO (or any predecessor) for any preceding taxable year beginning after December 31, 2016.
The following are some key clarifications and exceptions provided in the Proposed Regulations for determining who is a covered employee:
Grandfathering of Certain Compensation
The Proposed Regulations provide that any vested remuneration, including vested but unpaid earnings accrued on deferred amounts treated as paid before January 1, 2018, will not be subject to the excise tax under Section 4960. Likewise, under the Proposed Regulations, for an employee who has vested deferred compensation for years in which he or she was not a covered employee, any vested remuneration that would have been treated as remuneration paid for a taxable year before such employee was a covered employee, is not remuneration subject to Section 4960. Notably, however, any earnings on such vested remuneration or vested deferred compensation that accrue or vest after the effective date of Section 4960 (January 1, 2018 for a calendar year employer) or in a taxable year in which the employee is a covered employee, as applicable, is treated as remuneration paid and may be subject to Section 4960.
Coordination with Section 162(m)
In situations where an ATEO’s covered employee is also a covered employee of a related “publicly held corporation” (as defined in Section 162(m)), Section 4960 provides that remuneration for which a deduction is not allowed under Section 162(m) is not treated as remuneration paid to a covered employee. An issue highlighted in the Proposed Regulations is that, in certain circumstances, it may not be known for some period of time whether remuneration paid to a covered employee from a related organization will be subject to the deduction disallowance under Section 162(m). For example, under Section 4960, nonqualified deferred compensation is treated as paid as it vests, whereas under Section 162(m), nonqualified deferred compensation is treated as paid when it is actually or constructively received. While the Proposed Regulations do not address the coordination of Sections 4960 and 162(m) in these circumstances, they do describe various approaches that could be adopted under future regulations. Treasury and the IRS are requesting comments on these approaches and any other approach that might be helpful in coordinating Sections 4960 and 162(m). Note that for purposes of Section 4960, all remuneration paid to a covered employee from a related publicly held corporation is taken into account for determining the ATEO’s five highest-compensated employees.
The Proposed Regulations provide helpful clarifications and exceptions for ATEOs and related organizations in determining which employees are covered employees. However, the Proposed Regulations illustrate the need for additional guidance with respect to shared employees, specifically those shared with nonexempt corporations, and the coordination between different tax provisions, notably Section 162(m). As noted above, until the final regulations are published, taxpayers may rely either on the earlier guidance provided in Notice 2019-09 or, alternatively, on the guidance provided in the Proposed Regulations.
 In general, ATEOs include any organization exempt from tax under Section 501(a), any farmer’s cooperative organization described in Section 521(b)(1), any organization that has income excluded under Section 115(1), and any political organization described in Section 527(e)(1).
 Related organizations with respect to an ATEO include entities that control or are controlled by the ATEO and entities under common control with the ATEO. “Control” generally means ownership of more than 50% of the equity of a corporation or partnership. For nonprofit organizations, control means that more than 50% of the directors of the organization are representatives of, or controlled by, the controlling entity.
 Any individual who qualifies as a covered employee for a taxable year after 2017 will always be characterized as a covered employee.
 Note that remuneration paid to shared employees of an ATEO and any of its related organizations is generally aggregated. For example, if a nonexempt company has a foundation, and a company employee provides services to the foundation (such as serving as an officer), the remuneration paid by the company and the foundation to the shared employee is aggregated for purposes of Section 4960.
 For a calendar-year employer.