Regulatory updates continue as the IRS recently issued interim guidance on the Tax Cuts and Jobs Act (TCJA). Specifically, new regulations impose a 21% excise tax on “excess” executive compensation at applicable tax-exempt organizations (ATEOs). This guidance is designed to provide companies with a reasonable interpretation of the statute until such time as the IRS can issue final regulations. This excise tax applies to employee compensation that is larger than $1 million and large parachute payments that are three times the “base” amount. However, even if an ATEO does not pay employees anywhere near this amount, they must still comply with Code Section 4960 to calculate the “base” amount for future payments.
Highest Paid Employees:
As mentioned above, many ATEOs will not have employees who reach the $1 million threshold. However, these organizations should still determine their five highest paid employees and mark them as “covered employees.” These individuals may, in future years, be paid an amount subject to the 21% excise tax. For example, parachute payments that are three times the covered employee’s “base” amount would be subject to excise tax.
Calendar Year Determination Year:
Since the TCJA and applicable code sections went into effect starting on January 1, 2018, the interim guidelines determine compensation and payments on the basis of a calendar year. For ATEOs who use a taxable or fiscal year, the IRS uses the calendar year that ends within the fiscal year. Therefore, if an executive receives the full $1 million over the course of 2018, but the organization runs a taxable year that ends halfway through the calendar year, then only half that compensation is included for purposes of compliance with the TCJA.
ATEOs and Related Entities:
In addition to compensation received directly from an ATEO, the IRS takes into account compensation received from “related entities.” These are entities where 50% or more of the ownership of beneficial interests, partnerships, stock corporations, trusts, etc. are under “common control.”
Exclusions for Medical and Veterinary Services:
Compensation paid for certain skilled employees, including medical and veterinary professionals, is excluded from the total that would be used to determine compensation for excise tax purposes. This applies only to specific services that are related to their field. These services are narrowly defined to include diagnosis, cure, mitigation, treatment, and prevention. They do not include teaching and research or administrative activities. The IRS expects employees to allocate their compensation on a “reasonable” basis between excluded and non-excluded activities.
In putting together the interim guidance for applying the TCJA, the IRS acknowledges that it relied heavily on existing guidelines regarding golden parachutes and $1 million compensation limitations. However, not all the regulations currently applying to those situations apply to ATEOs.