INSIGHT: The Brave New World for Tax Exempts Under the New Excise Tax

Section 4960, which was amended by the 2017 tax act, imposes a 21 percent excise tax on (1) the amount of remuneration in excess of $1 million that is paid by a tax-exempt organization to certain of its highly compensated employees, as well as (2) any excess parachute payments paid by the organization to this same category of employees. The new excise tax became effective for taxable years commencing after Dec. 31, 2017. Consequently, the first year for tax-exempt organizations to understand the impact of the changes and their new tax reporting requirements under Section 4960 is for calendar year 2018. On Dec. 31, 2018, the Treasury Department and the Internal Revenue Service issued Notice 2019-09 as a piece of interim guidance to assist taxpayers in applying the provisions of Section 4960. The Notice is intended to cover only certain, select issues under Section 4960 for which taxpayers have indicated they have a more immediate need for receiving direction.

In the interim, the Treasury and the IRS are drafting proposed regulations for Section 4960 (that will incorporate the guidance included in the Notice), which when released, will only apply prospectively to future taxable years. Until such proposed regulations are released, the Notice directs taxpayers to base any tax position taken with respect to Section 4960 upon a good faith, reasonable interpretation of the statute, and the notice expressly identifies that the guidance it provides does constitute such good faith positions (and contrary positions are typically not good faith).

As discussed in more detail below, the Notice provides insight into each of the following topics:

• Which entities are ‘’applicable tax-exempt organizations”;
• How a “taxable year” is determined for the excise tax’s application;
• Who is the “employer” for purposes of assessing the excise tax;
• What entities constitute “related organizations” for purposes of calculating the excise tax;
• Who is a “covered employee” required to be evaluated for purposes of applying the excise tax;
• How is “remuneration” defined for purposes of the excise tax calculation;
• What constitutes an ‘’excess parachute payment” for purposes of the excise tax; and
• How does liability under Code Section 4960 get reported.

WHICH ENTITIES ARE APPLICABLE TAX-EXEMPT ORGANIZATIONS?

As a general matter, Section 4960 applies to organizations that are exempt from taxation. More specifically, Section 4960(c)(1) defines an “applicable tax-exempt organization“ (ATEO) as any organization that for the taxable year:

• Is exempt from taxation under Section 501(a);
• Is a farmers’ cooperative organization described in Section 521(b)(1);
• Has income excluded from taxation under Section 115(1); or
• Is a political organization described in Section 527(e)(1).

Although the above definition is relatively straightforward, the Notice did provide clarification on the application of Section 4960 to governmental entities. Specifically, a governmental entity (which can include a state college or university) that:

• Is not recognized as exempt from taxation under Section 501(a) (e.g., has not received a determination letter recognizing its tax-exempt status from the IRS), or

• Does not exclude income from gross income under Section 115(1)

will not fall within the scope of Section 4960. If the governmental entity meets neither of these requirements, then it will be classified as an ATEO and thereby subject to the excise tax.

DEFINING A TAXABLE YEAR FOR MEASUREMENT PURPOSES

For application of the excise tax to remuneration, Section 4960(a)(1) refers to remuneration paid “for the taxable year,” but does not specify which taxpayer’s taxable year is used for the measurement period (i.e., either the employee covered by the excise tax or the employing tax-exempt organization). Q&A–2 of the Notice outlines that the excise tax imposed on applicable excess remuneration (i.e, remuneration in excess of $1 million) and excess parachute payments is determined based on any such amounts paid that are made in the calendar year ending with or within the taxable year of the employer.

The preamble to the Notice notes that a calendar year measurement period was chosen to reduce the administrative burdens by aligning the reporting for Section 4960 with the calendar year reporting requirement of compensation on Form W-2, Wage and Tax Statement and Form 990, Return of Organization Exempt From Income Tax. Further, this approach will eliminate the need for taxpayers to allocate such remuneration payments that are paid in a single calendar year to multiple non-calendar (i.e., fiscal) taxable years.

NOTE: Because Section 4960 applies to taxable years after Dec. 31, 2017, if applicable excess remuneration or an excess parachute payment was paid during the 2018 calendar year before a fiscal year ATEO’s taxable year commenced (e.g., the taxable year runs October 1 to September 30), any such amounts paid (i.e., prior to October 1) would not be subject to Section 4960. Consequently, non-calendar fiscal year ATEOs potentially will have an additional period during 2018 where certain applicable payments made were not subject to Section 4960.

When is remuneration paid for a taxable year?

Because tax-exempt organizations are subject to Section 457, certain taxation nuances can result with respect to when remuneration is taxed versus when it is paid. Under Section 457(f), remuneration that is no longer subject to a substantial risk of forfeiture is required to be taxed in the year in which the risk of forfeiture lapses. Notwithstanding this, in many situations, such taxed amounts are not necessarily “paid” at the same time as vesting. Given this scenario, remuneration previously taxed to the covered employee in an earlier taxable year would be subject to the excise tax under Section 4960 in a different year simply because it is released for payment in a later taxable year.

To account for this taxation nuance, Q&A–13 of the Notice synchronizes “payment” with the vesting and taxation event. According to the Notice, “remuneration is treated as paid on the first date that the right to the remuneration is not subject to a substantial risk of forfeiture within the meaning of section 457(f)(3)(B).“ Note that the wording does not state that the arrangement must be subject to Section 457. Instead, the ATEO is required to apply the meaning of a substantial risk of forfeiture contained in Section 457(f)(3)(B) for purposes of determining whether a substantial risk of forfeiture exists. Therefore, an amount of remuneration is treated as “paid” upon vesting and hence taxation. As such, the taxable year (i.e., calendar year) in which vesting occurs is the year in which the remuneration is considered paid for purposes of Section 4960 and thereby included in the amounts for purposes of the excise tax calculation.

NOTE: The guidance clarifies that the remuneration treated as paid upon vesting is the present value (as of the vesting date) of the future payments to which the covered employee has a legally binding right. Further, the present value of the right to future payments as of the vesting date includes any earnings that have accrued as of the vesting date. The determination of the present value calculation for Section 4960 borrows heavily from the Proposed Treasury Regulations under Section 457 (proposed regulations) as well as the final regulations under Section 409A. As such, the recognition of the remuneration for income tax reporting purposes to the employee and inclusion in the Section 4960 calculation are then coordinated.

NOTE: The proposed regulations via the short term deferral exception under Prop. Treas. Reg. 1.457-12(d)(2), allow tax-exempt organizations to potentially delay taxation to an employee up until March 15 of the calendar year following the calendar year which includes the vesting date. Depending on the size of the payment and whether payment will be made later than 90 days following vesting, some employers will receive a potential tax preference by being able to use the short-term deferral exception for payment to the covered employee, but alternatively, present valuing the payment in order to reduce the amount potentially subject to the excise tax. For example, an amount of deferred compensation which first vests on Jan. 1, 2020, and is eligible for under the short-term deferral exception can be paid to the participant by March 15, 2021, and still be compliant with Sections 457(f) and 409A. However, given that an approximately 14-month delay in payment is possible to the executive, the organization may receive some benefit with the present value of the payment being lower for excise tax calculation purposes than the amount actually paid to the executive.

Finally, the Notice clarifies that any remuneration that was vested but was not actually or constructively paid prior to the employer’s taxable year beginning in calendar year 2018 will not be subject to Section 4960. Alternatively, earnings that accrued after Dec. 31, 2017, on such vested but unpaid amounts will be considered remuneration for purposes of the excise tax; these amounts are considered paid at the end of the calendar year in which the earnings accrue (rather than in the year actually paid). This approach synchronizes with the general taxation rule under Section 457(f) as well as the reporting approach seen on Form 990.

WHO IS THE EMPLOYER?

Section 4960(b) provides that the “employer” shall be liable for the tax. The Notice clarifies that the “employer” is the common-law employer, as determined generally for federal tax purposes. Further, the common-law employer is not permitted to avoid treating a payment as remuneration under Section 4960 simply because the payment is made by a third-party payor such as a payroll agent, common paymaster, statutory employer, or any other certified professional employer organization.

Notwithstanding the above, for purposes of determining what remuneration is paid by the employer, Section 4960(c)(4) further requires the taxpayer to include within such remuneration any amounts paid by a related organization or a governmental entity (as discussed below in “What Entities Constitute Related Organizations”) to the covered employee with respect to his/her services rendered to the common-law employer. The Notice provides that such payments by the related organization or government entity are considered a payment to the covered employee by the common-law employer for purposes of calculating the applicable remuneration and determination of the excise tax.

Equally, the Notice further clarifies that a related organization or government entity includes any related organization to the ATEO, regardless of whether such entity is a tax-exempt organization, a governmental entity or a for-profit entity. With respect to this, even though the related organization may not itself have been an entity subject to Section 4960 (i.e., would not be an ATEO in its own right), Q&A-14 of the Notice states that for all amounts paid to the covered employee, that are includable within the total remuneration subject to Section 4960, each entity that contributed to that total remuneration will be responsible for paying a proportionate amount of any excise tax due (based on their allocable amount of the remuneration).

NOTE: The natural impact of this allocation of excise tax among related entities is that if an ATEO and one or more of its related organizations are both subject to Section 4960, each entity may end up paying Section 4960 excise tax on more than just its own covered employees. Additionally, Q&A-14 does provide limited relief if the relevant employer is subject to Section 4960 on its own but also due to being a related organization for the same remuneration to a covered employee. In this situation, the Notice states that the employer will not be liable for the excise tax under Section 4960 in both capacities. Instead, it will only be liable for the greater of the excise tax it owes on the covered employee as an ATEO OR the excise tax it would owe as a related organization with respect to that same covered employee.

It is worth noting that the Notice expressly states that any tax position taken by an employer subject to Section 4960, that its related organizations that are for-profit entities or governmental entities are not subject to any applicable portion of any excise tax due, shall not be considered a good faith, reasonable interpretation of the statute.

WHAT ENTITIES CONSTITUTE RELATED ORGANIZATIONS?

From a straight tax perspective and based on similar rules and concepts used under the tax code in the executive compensation and employee benefits area, there are not many surprises on how the Treasury and the IRS defined related organizations.

Section 4960(c)(4)(B) provides that a person or governmental entity is related to the ATEO if such person or governmental entity:

• Controls, or is controlled by, the ATEO;

• Is controlled by one or more persons that control the ATEO;

• Is a supported organization (as defined in Section 509(f)(3)) during the taxable year with respect to the ATEO;

• Is a supporting organization (as described in Section 509(a)(3)) during the taxable year with respect to the ATEO; or

• In the case of an organization that is a voluntary employees’ beneficiary association (a “VEBA” as described in Section 501(c)(9)), establishes, maintains, or makes contributions to such VEBA.

As stated in the Preamble of the Notice, the definition of control is to be interpreted in accordance with Section 512(b)(13)(D) (which is generally a “more than 50 percent” test on a number of ownership aspects). The Treasury and the IRS specifically chose to not adopt the Section 414(b) and (c) tests for control (which is generally a “more than 80 percent” test on a number of ownership aspects). Instead, use of the control test under Section 512(b)(13)(D) is believed to be more closely aligned with other exempt organization control tests and is anticipated to prevent certain abuses that may occur in the application of Section 4960. Meaning, with a lower control requirement of 50 percent needed to demonstrate control, more organizations will be deemed related than if the higher 80 percent threshold was utilized.

In short, the Notice clarifies that the definition of “related organization” for purposes of Section 4960 generally aligns with the definition of related organization for purposes of the annual reporting requirements on Form 990. This commonality in approaches is expected to reduce the burden on organizations in identifying related organizations, calculating compensation from related organizations, and determining liability under Section 4960.

Keeping in mind that Section 4960 does generally apply to tax-exempt organizations, Q&A-8 of the Notice does specifically address “control” as it pertains to nonstock organizations (which is typically what tax-exempt organizations tend to be). In the case of a nonprofit organization or other organization without owners or persons having beneficial interests (i.e., nonstock organizations), including a governmental entity, control means that:

• More than 50 percent of the directors or trustees of the ATEO or the nonstock organization are either representatives of, or are directly or indirectly controlled by, the other entity; or

• More than 50 percent of the directors or trustees of the nonstock organization are either representatives of, or are directly or indirectly controlled by, one or more persons that control the ATEO.

For this purpose, a “representative” means a trustee, director, agent, or employee, and control includes the power to remove a trustee or director and designate a new trustee or director.

Additionally, Q&A-14 addresses the situation when an employer ceases to be a “related organization” with respect to a tax-exempt organization subject to Section 4960 (e.g., due to a corporate transaction) during the calendar year ending with or within the taxable year of the tax-exempt organization subject to Section 4960. When such a situation occurs, the employer still qualifies as a “related organization” but only the remuneration paid by the related organization to a covered employee with respect to services performed during that portion of the calendar year that the employer is a related organization is included for purposes of calculating liability for the excise tax under Section 4960.

NOTE: Any remuneration with respect to the employer that is a related organization for which a covered employees is still subject to a substantial risk of forfeiture (i.e., not vested) while the employer is a related organization with regard to the ATEO will not be required to taken into account for purposes of Section 4960.

WHO ARE THE COVERED EMPLOYEES?

Pursuant to Section 4960(c)(2), a “covered employee” means any employee who:

• Is one of an ATEO’s five highest-compensated employees for the current taxable year; OR

• Who was a covered employee of the ATEO (or any predecessor) for any preceding taxable year beginning after Dec. 31, 2016.

Consequently, once an employee is a covered employee, he or she continues to be a covered employee for all subsequent taxable years. There is no articulated rule that allows once designated “covered employees” to ever be removed from the list of covered employees. As a result of this, an group of “covered employees” will almost always exceed five at some point in the future based on this perpetual tracking requirement.

Importantly, the Notice reinforces that there is no minimum dollar threshold for an employee to be a covered employee. In light of this, an employee need not be paid excess remuneration or an excess parachute payment nor be a highly compensated employee within the meaning of Section 414(q) to be a covered employee for a taxable year and all future years.

NOTE: Even if an ATEO has no liability under Section 4960 for one particular taxable year, the ATEO still needs to determine and track its five highest-compensated employees for that particular taxable year, as those employees will then continue to be covered employees in all future years and accordingly, may eventually be paid excess remuneration or excess parachute payments in a later taxable year thereby making them required to be reported.

How Are the ATEO’s Five Highest-Compensated Employees Determined for a Taxable Year?

Notice 2019-09, Q&A–10 provides that whether an employee is one of an ATEO’s five highest-compensated employees is based on remuneration “paid” in the calendar year ending with or within the employer’s taxable year. Although Treasury and the IRS acknowledged that they had considered using certain existing reporting standards for determining the amount of compensation paid (such as the Securities and Exchange Commission standards that are used for Section 162(m) purposes or the standards that are used for Form 990 reporting purposes) that may recognize accruals of remuneration over time, the interim guidance concluded that these other standards were not appropriate for purposes of Section 4960.

Instead, Treasury and the IRS indicate that using the standard of remuneration “paid” for purposes of identifying an ATEO’s five highest-compensated employees will result in a more fair representation of compensation earned by an employee as well as being more administrable since it then synchronizes to a single standard both identifying covered employees and computing the excise tax, if any, imposed by Section 4960(a)(1) (which as discussed above, already uses this standard).

Covered Employees Determined Separately for each ATEO Instead of on a Controlled Group Basis

Perhaps the most controversial provision of the guidance is the articulated requirement that each ATEO within a controlled group must separately identify its own “five highest-compensated employees.” By not acknowledging existing controlled group relationships of related ATEOs, the result is that a controlled group can potentially have significantly more than five highest-compensated employees (which can already exceed five based on former covered employees never being removed from the list of covered employees). Therefore, this interpreted requirement that each ATEO within a controlled group separately determine its own set of “covered employees” can exponentially increase the potential amount of excise tax due by dramatically expanding the number of employees required to be “covered” within a tax-exempt controlled group for purposes of Section 4960.

Although a significant number of professionals pointed out that not even Section 162(m) (applicable to public companies and its subsidiaries) sweep in more than five highly-compensated employees, Treasury and the IRS have expressly indicated in the Notice that any taxpayer position taken that a group of related organizations with more than one ATEO has a single set of five highest-compensated employees will be inconsistent with a good faith, reasonable interpretation of Section 4960.

Covered Employees and Multiple Related Organizations

Notice 2019-09, Q&A–9 expressly provides that only an ATEO’s common law employees (which includes officers) can be one of an ATEO’s five highest-compensated employees. As previously discussed under “Who is the Employer?,” to identify its five highest-compensated employees, the ATEO must include remuneration paid for the taxable year to the covered employee by any related organization (including for profit organizations or governmental entities).

However, to prevent circumstances in which an employee to whom the ATEO paid minimal remuneration displaces an employee who would otherwise be a covered employee of the ATEO, Q&A–10(b) of the Notice articulates a limited services exception under which, unless an ATEO pays at least 10 percent of the total remuneration paid by the ATEO and all related organizations to an employee during the calendar year, the employee will not be treated as one of the ATEO’s five highest-compensated employees. However, if no ATEO pays at least 10 percent of an employee’s total remuneration during a calendar year, this exception does not apply to the ATEO that paid the most remuneration to the employee during the calendar year.

NOTE: The above guidance appears to be targeting large tax-exempt controlled groups (with multiple related organizations and ATEOs) which may try to avoid the application of Section 4960 as pertains to a certain employee by configuring or allocating such employee’s remuneration across multiple entities in an effort to manipulate who is included or excluded from the list of “covered employees” for a given ATEO. Consequently, the 10 percent threshold rule above is designed to prevent manipulation and ensure individuals who otherwise would qualify as “covered employees” are appropriately captured for purposes of the excise tax.

WHAT IS REMUNERATION?

For purposes of tying the separate provisions of the guidance together, recall that under the heading “Defining a Taxable Year for Measurement Purposes” and “Who are Covered Employees?,” the ATEO must evaluate only remuneration “paid.” As previously discussed, remuneration is treated as “paid” when there is no substantial risk of forfeiture on the rights to the remuneration (and hence taxation results even if such amounts are not yet constructively made available to the employee).

As a general matter, Section 4960(c)(3)(A) generally defines “remuneration” as wages under Section 3401(a) (i.e., wages subject to federal income tax withholding), but excluding designated Roth contributions under Section 402A(c) and including amounts required to be included in gross income under Section 457(f). Additionally, because “excess parachute payments” (as discussed in more detail below under the heading “What Are Excess Parachute Payments?”) are also separately subject to the Section 4960 excise tax, they should not be counted twice for purposes of the excise tax (i.e., once for the excess remuneration rule and once for the excess parachute payment rule). As such, Q&A–12 of the Notice clarifies that the definition of remuneration specifically includes only a parachute payment (i.e., amounts paid contingent on the covered employee’s separation from employment) that is not an excess parachute payment.

Further, the Notice provides that the definition of remuneration does not include certain tax-qualified retirement benefits (e.g., those payable under a Section 401(a) or 403(b) plan or a governmental Section 457(b) plan) due to their exclusion from the definition of wages under Section 3401(a). Finally, as provided for under Section 4960(c)(3)(B), remuneration expressly excludes any portion paid to a licensed medical professional (including a veterinarian) that is directly related to the performance of medical services by such professional.

What Qualifies as Remuneration for Medical Services?

For purposes of determining whether remuneration received for “medical services” can be excluded from remuneration that is subject to the excise tax, the Notice directs that an analysis of the services should be evaluated under Section 213(d). According to Section 213(d), medical care consists of services for the diagnosis, cure, mitigation, treatment, or prevention of disease, including services for the purpose of affecting any structure or function of the body.

Compensation received for this medical care would constitute remuneration for medical services only if those services are provided by a licensed medical professional (that is an individual who is licensed under state or local law to perform those medical services). Equally, for a veterinarian or other licensed veterinary professional, Section 213(d)(1)(A) applies by analogy to determine whether a given activity constitutes veterinary services.

Further, the Notice clarifies that certain activities, even if related to medical services, such as administrative, teaching, and research services, will not be considered “medical services” whose remuneration can be excluded for the excise tax calculation. Notwithstanding this, to the extent a licensed medical professional provides direct medical care to a patient in the course of these activities (such as teaching or instructing an intern during hospital rotations), then he or she would be performing medical services, and remuneration allocable to those services would be permitted to be excluded for purposes of Section 4960.

The more challenging aspect with respect to medical services is when a covered employee is compensated for both medical services and other services for the same taxable year. In these situations, the employer must allocate remuneration paid to such employee between medical services and such other services. The ATEO is permitted to use any reasonable, good faith method to allocate remuneration between medical services and other services.

For example, if the covered employee is subject to an employment agreement that explicitly provides for such an allocation, then the ATEO may rely on the allocation provided for in an employment agreement. If some or all of the remuneration is not reasonably allocated in an employment agreement, the ATEO must develop and use a reasonable method of allocation. The Notice indicates that appropriate allocation methodologies can be developed using such things as patient records, insurance records, Medicare/Medicaid billing records, or internal time reporting mechanisms that allow the ATEO to determine the time spent providing medical services. Similar concepts would be applied with respect to veterinary services.

Is the $1 Million Threshold Adjusted Over Time?

The Preamble to the Notice specifically provides that the $1 million excess remuneration threshold will not be adjusted for inflation.

WHAT ARE EXCESS PARACHUTE PAYMENTS?

Unlike any remuneration paid that exceeds $1 million, excess parachute payments are subject to the Section 4960 regardless of the $1 million threshold. Pursuant to Section 4960(c)(5)(B), an excess parachute payment exists if:

• Any payments in the nature of compensation being made to the covered employee are contingent on such covered employee’s separation from employment with the ATEO (i.e., the employer); AND
• The aggregate present value of all the compensatory payments paid to such covered employee that are contingent on such covered separation from employment equals or exceeds an amount equal to three times the base amount.

Therefore, even if the total excess parachute payment does not reach $1 million, if it meets the definition of an excess parachute payment, it is still subject to the 21 percent excise tax.

As a general matter, the Notice provides that any payment in the nature of compensation means the payment is received as a result of the employment relationship, including holding oneself out as available to perform services and refraining from performing services. Thus, for example, payments made under a covenant not to compete or a similar arrangement are payments in the nature of compensation.

Given the broad scope, a payment in the nature of compensation includes (but is not limited to) wages and salary, bonuses, severance pay, fringe benefits, life insurance, and other deferred compensation (including any amount characterized by the parties as interest or earnings thereon). Notwithstanding this, Section 4960(c)(5)(C) expressly excludes from consideration, for purposes of excess parachute payments, any amounts paid from tax-qualified retirement plans, certain payments made to licensed medical professionals (as discussed above under “What Is Remuneration?”), and payments to individuals who are not highly compensated employees as defined in Section 414(q).

As a side note, as was originally assumed from the references to Section 280G in the text of Section 4960, the excess parachute payment rules are modeled after certain key concepts provided under Section 280G and its applicable regulations. Keeping in mind that application of Section 280G is contingent on a change in control of a corporation (instead of contingent upon a separation from employment as pertains in the Section 4960 context), the Notice does incorporate many of the Q&As of the Section 280G regulations but modifies those provisions to reflect the new intent under Section 4960.

When is an Amount Contingent on Such Covered Employee’s Separation from Employment?

The Notice provides that payments are treated as “contingent on a separation from employment” if such payments to the covered employee are contingent on an involuntary separation from employment (whereby an involuntary separation from employment is not an event that is guaranteed to occur and hence qualifies as a substantial risk of forfeiture). Said another way, payments that solely vest upon an involuntary separation from employment would then be vesting contingent upon or due to such involuntary separation from employment (or lapse of the substantial risk of forfeiture). Alternatively, if an employee may voluntarily separate from service and still be entitled to a payment, then the payment either is not subject to a substantial risk of forfeiture or the forfeiture condition is not related to the separation from employment.

Therefore, if a right to compensatory amounts springs forth because of the separation from service, then those amounts are said to be “contingent on such covered employee’s separation from service“ and are required to be included in the excess parachute payment calculation. Examples of such contingent amounts include, but are not limited to:

• Severance pay,

• Accelerated vesting on nonqualified deferred compensation due to the separation from employment (but only the additional value due to the acceleration),

• Continuation of employer-paid portion of health care (post-separation), and

• Outplacement allowance.

NOTE: A payment of nonqualified deferred compensation made after an involuntary separation from employment that vested (and was taxed) prior the involuntary separation from employment would not be a payment that is contingent upon a separation from employment. Only additional amounts that have vesting accelerated because of the involuntary separation from employment would qualify as such payments.

How is Base Amount Defined?

The covered employee’s base amount is equal to the covered employee’s average annualized compensation includible in the covered employee’s gross income for the five taxable years ending before the date of the covered employee’s separation from employment (this calculation is comparable to the calculation used for determining the base amount under Section 280G). If the covered employee does not have five full years of completed service, then any such short period (which is annualized) and completed years are instead used for the calculation.

NOTE: It is extremely important to note that the base amount is defined by the amounts previously “includible” in gross income. As such, nontaxable fringe benefits received in prior years by the covered employee would not be included in the base amount calculation to “boost” this portion of the calculation (and hence reduce any excess parachute payment). However, any fringe benefit (whether taxable or not) that is received due to it being “contingent on the separation from employment” would be required to be included in the definition of payments provided “contingent on the separation from employment” (which would inherently increase the amount which constitutes an excess parachute payment).

Which Separations From Employment Events Are Involuntary?

Notice 2019-09, Q&A-22 provides that an involuntary separation from employment means a separation from employment due to any of the following:

• The independent exercise of an employer’s unilateral authority to terminate the covered employee’s services, other than due to the employee’s implicit or explicit request, if the employee was willing and able to continue performing services; OR

• An employer’s failure to renew a contract at the time the contract expires, provided that the covered employee was willing and able to execute a new contract providing terms and conditions substantially similar to those in the expiring contract and to continue providing services; OR

• An employee’s voluntary separation from employment for good reason as defined in Prop. Treas. Reg. 1.457-11(d)(2)(ii).

The determination of whether a separation from employment is involuntary will be based on all the facts and circumstances. Further, the guidance also clarifies that if a payment is made subject to an execution of a release of claims or restrictive covenants agreement (i.e., a condition to receiving payment), that requirement will not mean the payment fails to be a continent payment on a separation from employment.

REPORTING SECTION4960 LIABILITY

Applicable excise tax due under Section 4960 is reported on Form 4720, Return of Certain Excise Taxes Under Chapters 41 and 12 of the Internal Revenue Code. As discussed in “Who is the Employer?,” each employer (who paid remuneration to the covered employee) is responsible for reporting and remitting its share of any Section 4960 excise tax, whether an ATEO or a related organization. Form 4720 is due when the respective organization files its annual return, plus any extensions. For tax-exempt organizations, this is generally the Form 990, Return of Organizations Exempt from Income Tax, which is due the 15th day of the fifth month of the organization’s fiscal year (for calendar year taxpayers this is May 15th with a possible extension date until November 15th of the same calendar year).

With respect to excess parachute payments, the employer may elect to prepay the excise taxes due in the year of separation of employment. Note that this is an election and is not mandatory.

NEXT STEPS

For calendar year ATEOs, the first year in which these interim rules apply is 2018, which has a corresponding May 15, 2019, tax return filing due date. All ATEOs are encouraged to consult with their tax and legal counsel with respect to application of the interim guidance and their specific fact situations as pertains to their first reporting year for excise tax purposes. Specifically, ATEOs operating within large controlled groups (such as health systems) are encouraged to:

• Identify all ATEOs within a specific controlled group;

• Identify the covered employees for each ATEO within the controlled group; and

• Identify if any entity within the controlled group that is not an ATEO contributed any portion of a given covered employee’s remuneration such that a portion of excise tax must be allocated back to those entities.

By doing the preliminary mapping of the above, a controlled group will be able to identify which entities within the group are subject to the new reporting and remittance requirements to better coordinate the necessary tax filings.

Mary K. Samsa is a partner with Akerman, LLP in their Chicago office. With more than 20 years of experience, Mary Samsa focuses her practice on executive compensation matters and tax-qualified retirement programs for a wide range of organizations, including Fortune 500 companies, privately held companies, multinational organizations and nonprofit entities, including health systems and educational institutions.