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


Amy DeLong

Amy DeLong

Senior Manager

Emily Smithson

Emily Smithson


Related Posts
The ink on the Tax Cuts and Jobs Act (TCJA), which swept in a tidal wave of changes to federal tax rules, had been dry for only seven weeks before...
Read More

New Budget Agreement Brings Additional Tax Changes

To help you organize and prioritize important 2018 deadlines, we’ve provided this summary of due dates for various tax-related forms, payments, and other actions.  Be aware that some deadlines have...
Read More

No Excuses—New Tax Deadlines You Need to Know

In the wake of passage of the Tax Cuts and Jobs Act (TCJA) late last year, the IRS has taken one of the first critical steps to institute the law’s...
Read More

IRS Issues Updated 2018 Withholding Tables

The Financial Accounting Standards Board (FASB) has set forth amended guidance aimed at simplifying and reclassifying certain features of financial instruments. Accounting Standards Update (ASU) No. 2017-11 – Earnings Per...
Read More

The Update on Down Round—FASB Reclassifies Earnings Per Share

Although the new tax reform was signed into law late 2017, the implications of that reform, now called the Tax Cuts and Jobs Act of 2017, won’t affect your 2017...
Read More

Tax Reform 2018

The new Tax Cuts and Jobs Act is bringing sweeping reform to the United States tax code. While recent tax reform has drawn considerable media attention to domestic corporate tax...
Read More

The Bottom Line: How Will Recent Tax Reform Impact You?

A Section 83(b) election could be one of the biggest tax-saving decisions for taxpayers who receive equity subject to vesting. It is common for start-up founders and key employees to...
Read More

83(b) Election for Start-Up Founders

In today’s business environment, cloud computing arrangements play a key role in the day-to-day operations of companies large and small. The Financial Accounting Standards Board’s (FASB) Accounting Standards Update (ASU)...
Read More

Clearing Up Cloud Computing Accounting

An on-demand webinar, presented by Mike Shamblin, CPA, and brought to you by PYA, helps lay the foundation for the new revenue recognition standard.  The webinar guides healthcare providers of...
Read More

PYA On-Demand Webinar Outlines the New Revenue Recognition Standard in Preparation for Implementation

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

* indicates required
Monthly eNewsletters
See more newsletter and alert options.

PYA Population Health Ascend

PYA Healthcare Blog

PYA Thought Leadership Services

The Healthcare Loop