IRC Section 4960, the tax law governing exempt organization executive compensation, has already impacted the tax liabilities of many tax-exempt organizations, which could become more pronounced this year for some organizations.
The Tax Cuts & Jobs Act (TCJA) established the Section 4960 excise tax on excess compensation back in 2017. Under IRC Section 4960, applicable tax-exempt organizations and related organizations that pay over $1 million in compensation to any “covered employee” are subject to a 21% excise tax. Excess parachute payments are also subject to an excise tax at the same rate.
While the TCJA made the excise tax effective for tax years beginning in or after 2017, the IRS’s final regulations contained modifications applicable to tax years beginning in or after 2022.
Prior to 2022, organizations were permitted to use a reasonable, good-faith method based on existing guidance or the proposed regulations. But now that the final regulations are effective, leniency is no longer expected, and compliance is.
Last fall, the IRS’s Tax Exempt & Government Entities (TE/GE) Division released a letter detailing their priorities for fiscal year 2022, and supporting examinations of exempt organization executive compensation was among them. The TE/GE will focus on “high-income taxpayers with TE/GE issues, especially for private foundations and retirement plans.”
The TE/GE, in collaboration with the IRS’s Large Business and International (LB&I) and Small Business/Self-Employed (SB/SE) Divisions, will carry out joint audits, consisting of compliance checks and examinations of Form 4720, which is where private foundations report IRC Section 4960 excise tax when filing Federal Form 990-PF.
Which organizations are subject to the Section 4960 excise tax?
Applicable Tax–Exempt Organizations (ATEOs) and some related organizations may be subject to the tax.
ATEOs are organizations that are:
- tax-exempt under Section 501(a);
- farmers’ cooperative organizations, as described in Section 521(b)(1);
- organizations with income excluded from taxation under section 115(1); or
- political organizations, as described in Section 527(e)(1)
Generally, a related organization is a person or governmental entity that:
- controls the ATEO or is controlled by the ATEO;
- is controlled by one or more persons that control the ATEO;
- is a supported organization of the ATEO, as defined in IRC Section 509(f)(3); or
- is a supporting organization of the ATEO, as described in IRC Section 509(a)(3)
Who qualifies as a covered employee?
Covered employees are employees and former employees who are among the five highest-compensated employees for an organization’s taxable year beginning on or after December 31, 2016.
There are two exceptions under which individuals are not treated as covered employees:
- Under the “limited-hours” exception
- the hours (or days) the individual works at the ATEO (and related ATEOs) can only make up 10% or less of the total hours (or days) the individual works for the ATEO and all related organizations during the year
- an individual satisfies this requirement if they work no more than 100 hours for the ATEO and all related ATEOs during the year
- Under the “non-exempt funds” exception
- the threshold for hours (or days) worked for the ATEO and related ATEOs is less than 50% of the total hours (or days) the individual works for the ATEO and all related organizations for the current year and the preceding year
- no related organization may provide paid services to the ATEO, any related ATEO(s), or taxable related organization(s) controlled by the ATEO and/or related ATEOs
ARB’s Nonprofit Advisory Services Team helps tax-exempt organizations navigate the complexities of new and updated legislation and regulatory requirements. We can help you determine what the IRS’s final regulations to IRC Section 4960 mean for your organization’s specific circumstances, ensure compliance, and identify tax-planning opportunities that may help you reduce your organization’s Section 4960 liability. If you’re ready to learn more, contact me today.
Alyssa Hemingway joined ARB in 2016 and is a Senior Manager. She provides accounting and auditing, and advisory services primarily for nonprofit organizations. Alyssa specializes in compliance audits in accordance with Uniform Guidance and MAAP. Her career concentration has been in non-profit organizations, including education, conservation, healthcare, community, and welfare services. She advises our clients on internal control systems, accounting standards, gift acceptance, and organizational matters.