The 2017 Tax Cuts and Jobs Act (TCJA) added Section 4960 to the IRS tax code which imposed an excise tax equal to the corporate tax rate (currently 21%) on the amount of remuneration in excess of $1 million and any excess parachute payment paid by an applicable tax-exempt organization to a covered employee.
In response to a demand for further guidance on Section 4960, the IRS and the Treasury Department issued Notice 2019-09. The 92-page Notice was released January 1, 2019 and provides interim guidance in a question and answer format to clarify the application of Section 4960.
General Information
Section 4960 is effective for the first taxable year beginning after December 31, 2017. The taxable year to be used to determine the tax is the calendar year ending within the tax year of the employer.
The Section 4960 excise tax must be paid and reported by filing Form 4720 by the 15th day of the 5th month after the end of the employer’s taxable year. An employer may request an automatic extension of time to file Form 4720; however, an employer must pay the tax due by the original due date of Form 4720 to avoid interest and penalties.
Applicable Tax Exempt Organizations and Related Organizations
Applicable Tax-Exempt Organizations (ATEOs) are liable for the Section 4960 tax. Notice 2019-09 defines ATEOs as any organization that for the taxable year:
- is exempt from taxation under Section 501(a);
- is a farmers’ cooperative organization described
in Section 521(b)(1); - has income excluded from taxation under Section 115(1); or
- is a political organization described in Section 527(e)(1).
In addition, government entities, for-profit entities, and other related organizations can be liable for the tax if they are the common-law employer of the covered employee(s).
Remarkably, public colleges and universities (excluding colleges and universities liable for the tax as related organizations) that often pay high salaries to athletic coaches are not included in the definition of ATEOs. TCJA’s Joint Committee on Taxation has acknowledged this, as these entities were intended to be the subjects of the Section 4960 tax. To reflect this original intent, amendments to Section 4960 might be forthcoming.
Covered Employees
The term “covered employee” means any employee (including any former employee) of an ATEO, if the employee:
- is one of the five highest-compensated employees of the organization for the taxable year of the ATEO; or
- was a covered employee of the ATEO (or any predecessor) for any of the ATEO’s preceding taxable years beginning after December 31, 2016.
Excess Remuneration
According to Notice 2019-09, remuneration includes wages subject to federal income tax withholding. It does not include certain Roth contributions and certain retirement benefits.
For each covered employee, excess remuneration is the excess for a taxable year of the remuneration that is paid (other than any excess parachute payment) by an ATEO, including remuneration paid by a related organization, over $1 million for the taxable year.
Medical and Veterinary Services
Remuneration paid to a licensed medical professional which is directly related to the performance of medical or veterinary services by such professional is not subject to the excise tax, whereas remuneration paid to such a professional in any other capacity is. A licensed medical professional is defined as a doctor, nurse, or veterinarian.
Excess Parachute Payments
A “parachute payment” is any payment in the nature of compensation to (or for the benefit of) a covered employee if:
- such payment is contingent on such employee’s separation from employment with the employer, and
- the aggregate present value of the payments in the nature of compensation to (or for the benefit of) such individual which are contingent on such separation equals or exceeds an amount equal to three times the base amount.
Example 1. A is a covered employee with respect to M, an ATEO. A’s base amount is $200,000. Payments in the nature of compensation that are contingent on a separation from employment totaling $800,000 are made to A on the date of the separation from employment. The payments are parachute payments because they have an aggregate present value at least equal to three times A’s base amount of $200,000 (3 x $200,000 = $600,000).
An “excess parachute payment” is an amount equal to the excess of the total amount of any parachute payment over the portion of the base amount allocated to such payment.
Excess parachute payments in the form of property transferred in connection with the performance of services, such as stock options and stock appreciation rights, are considered payments made at the later of the date the property is transferred to the covered employee or the date the property becomes substantially vested.
The Treasury Department and the IRS intend to issue further guidance regarding Section 4960 in the form of proposed regulations. Until further guidance is issued, taxpayers may rely on the interim guidance.
For details on Section 4960, including information on how to calculate the tax, see IRS Notice 2019-09.
For more information about this article and compensation strategies, please contact Chérie Williams at cwilliams@windes.com or at 844.4WINDES (844.494.6337).