Excess Employee Compensation Under the New Tax Reform Law: Will Your Tax-Exempt Organization Be Affected?

Most Americans are now aware that new tax reform legislation, titled the 2017 Tax Cuts and Jobs Act, was signed into law late last year. There has been significant news coverage of the provisions of the law that relate to individual taxpayers and corporations, but little about the law’s effect on tax-exempt organizations. One provision in the new law will impact those tax-exempt organizations that pay any employee wages in excess of $1 million. This article will summarize what we know about this provision and the questions that have yet to be answered by official guidance.

New Excise Tax on Excess Compensation

Internal Revenue Code (IRC) section 162(m) has long disallowed a deduction for corporate taxpayers that compensate certain employees in excess of $1 million per year. However, this law had no effect on tax-exempt organizations that were not subject to tax on related income; therefore, there was no excess-compensation-related economic impact for tax-exempt organizations.

The 2017 Tax Cuts and Jobs Act, with the addition of Section 4960 to the IRC, now stipulates that tax-exempt organizations are subject to excise tax for compensation paid to covered employees that exceeds $1 million per individual. This new tax is in effect for tax years beginning after December 31, 2017. Though the Internal Revenue Service (IRS) and the Department of the Treasury likely are working to provide further guidance for Section 4960, we currently know the following:

  1. The excise tax rate is 21%– the same as the corporate income tax rate.
  2. As defined in Section 4960, a tax-exempt organization includes entities exempt from tax under Section 501(a) and political organizations exempt under Section 527(e)(1).
  3. “Compensation” is defined as wages (excluding designated Roth contributions) that include income (reportable in the employee’s Form W-2 because there is not a substantial risk of forfeiture) from nonqualified deferred compensation plans under Section 457(f).
  4. Wages paid to a licensed medical professional for services performed while providing medical care are not included in the calculation of the amount subject to excise tax.
  5. Compensation paid by related organizations is aggregated when determining if an individual is remunerated in excess of $1 million per annum. The liability for the excise tax will be pro rata across the organizations, and it is possible that an organization that pays less than $1 million to the covered employee will be subject to a portion of the excise tax.

The Need for Further Guidance

Though policy makers have released the above guidance, there are many questions for which tax-exempt organizations and tax practitioners will continue to seek clarity. The following are some areas requiring further consideration:

  • A “covered employee,” according to Section 4560, is an individual who “is one of the [five] highest compensated employees of the organization for the taxable year”. At present, there is no guidance specifying if licensed medical professionals working in direct patient care are excluded as one of the five highest compensated employees. The IRC simply states that wages paid for medical services are not subject to excise tax, but provides no further clarification.
  • Also of note, the definition of a covered employee includes language referring to the taxable year, not the calendar year. Historically, compensation for reportable employees of tax-exempt organizations has been reported on the calendar year. If excise tax is to be calculated based on taxable year compensation, then compensation amounts will not align to either the individual’s Form W-2 or Form 990 reporting for fiscal year filers.
  • If a tax-exempt organization has a taxable corporation as a related organization, how is the pro-rata share of the excise tax calculated? Will the taxable corporation be subject to excise tax and be required to file an excise tax return, in addition to the income tax return?

What Should Tax-Exempt Organizations Be Doing Now?

Clearly, there is a need for more guidance and clarification, and tax-exempt organizations are advised to keep a close eye on the matter. In addition, it is recommended that tax-exempt organizations perform an internal review of compensation policies sooner, rather than later, as the law applies starting with calendar year 2018. Keep in mind that the law does not prohibit compensating an employee in excess of $1 million and should not be used as the final determinant of a compensation package. Organizations should begin planning for the excise tax, being aware of upcoming deferred compensation payouts or other unusual payouts to its highest compensated employees.

If you have any questions about the new tax reform law, or would like more information about how it will affect tax-exempt organizations and employee compensation or would like to request a speaker on this topic for your organization or event, contact one of our executives below at (800) 270-9629.

 

Access additional tax reform insights here.


Debbie Ernsberger

Debbie Ernsberger

Principal

Amy DeLong

Amy DeLong

Senior Manager

Emily Smithson

Emily Smithson

Manager

Related Posts
The term “one size fits all” may be desirable in certain circumstances.  But, in many cases, the phrase more often translates to “just kind of fits.”  This is particularly true...
Read More

Finding the Right Fit: 4 Considerations When Choosing a Healthcare Auditor

Large data breaches impacting millions regularly make news headlines; and, increasingly, small businesses are becoming frequent targets of cyberattacks.  In response, states across the country are beginning to introduce laws...
Read More

A Matter of Time: States Adopt New Cyber Security Requirements

PYA ranks on INSIDE Public Accounting’s list of Top 100 Accounting Firms for the third consecutive year.  PYA, a national accounting and management consulting firm, has been ranked as a...
Read More

PYA Again Among IPA’s Top 100 Largest Accounting Firms

FVS Consulting Digest recently published an article, “The Opioid Crisis: The Important Role of CPAs,” co-authored by PYA Senior Manager Valerie Rock.  The article outlines the crucial role CPAs play...
Read More

The Opioid Crisis: The Important Role of CPAs

Several PYA employees were acknowledged for their achievements in mid-year promotions.   PYA, a professional services firm, has announced that Matt Neilson is the latest principal to join its executive team.  In addition,...
Read More

PYA Announces Several Mid-Year Promotions

In the nonprofit world, organizations are fueled and sustained by generous contributions and grants, which are used to support the organization’s mission.  Although such funding can often be the deciding...
Read More

“Threading the Needle”—Accounting Standards Update Closes Hole in Nonprofit Grant Guidance

Certain employees of governmental and not-for-profit organizations may qualify for a program that offers student loan forgiveness with zero tax liability.   The Public Service Loan Forgiveness (PSLF) Program gives full-time...
Read More

Tax-Free Student Loan Forgiveness for Eligible Public Servants

The Patient Protection and Affordable Care Act (ACA) became law eight years ago, establishing §501(r) of the Internal Revenue Code (IRC)—a section most tax-exempt hospitals have become quite familiar with...
Read More

Attention Hospitals – Does Your Financial Assistance Policy Make the Grade?

PYA, a national professional services firm headquartered in Knoxville, has been awarded a 2018 Top Workplaces honor by the Knoxville News Sentinel. The award is a result of employee feedback...
Read More

Knoxville News Sentinel Names PYA a Winner of the Greater Knoxville Area 2018 Top Workplaces Award

Share This Insight

If you received value from this article, please share it with your network (e.g., Facebook, Twitter, LinkedIn). Icons below for your convenience.

Stay Current

PYA Population Health Ascend

PYA Healthcare Blog

PYA Thought Leadership Services

The Healthcare Loop