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
A recent Accounting Standards Update (ASU) addresses land easements and their accounting under the new lease standards.  In January 2018, the Financial Accounting Standards Board (FASB) issued ASU 2018-01 Leases:...
Read More

Land Easements—Guidance for Implementing New Lease Accounting Standards

According to its tagline, Atlanta Business RadioX spotlights “the city’s best businesses and the people who lead them.”   PYA is pleased to share that one of its own, Consulting Principal...
Read More

PYA’s Lori Foley Shared Insight in Live Radio Interview

Many Americans have a 401(k) retirement savings plan as a benefit of employment with their employers.  They contribute a percentage of their compensation to their 401(k) each pay period with...
Read More

Taking Distributions from Your 401(k): What You Need to Know

The recent Tax Cuts and Jobs Act (TCJA) imposes a limit on deductions for business interest for taxable years beginning in 2018.  The limit, like other aspects of the law,...
Read More

IRS Sheds Light on New Limit on Business Interest Expense Deductions

Stakeholders seeking clarity were behind the latest Accounting Standards Update (ASU) issued by the Financial Accounting Standards Board (FASB).  In response to questions raised, the FASB released ASU 2018-03: Technical...
Read More

Measuring Fair Value: New ASU Offers Clarity

The Tax Cuts and Jobs Act (TCJA) of 2017 brings sweeping changes for many businesses. Along with a reduced corporate tax rate and the elimination of the Alternative Minimum Tax...
Read More

Looking Ahead: Net Operating Loss Rules under the New Tax Act

Are you feeling unease about the impending Tuesday, April 17 tax filing deadline? Fear not –the Internal Revenue Service (IRS) permits a taxpayer to file an extension to allow time...
Read More

The Tax Deadline Looms: Need More Time?

Engage. Share. Encourage. The American Healthcare Lawyers Association (AHLA) is hosting AHLA Day April 19, 2018, and these impactful words are setting the tone. AHLA receptions will be held across...
Read More

Join PYA in Celebrating Our Health Lawyer Colleagues During AHLA Day

Medicare cards are getting a much-needed facelift.  The Centers for Medicare & Medicaid Services has announced its intention to remove Social Security numbers from the cards in an effort to...
Read More
Medicare card scam

New Medicare Cards in the Mail—Don’t Fall Prey to Scammers

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