IRS rules for a tax aimed at the highest-paid employees at nonprofits will likely calm some concerns in the sector about the scope of the levy since its creation in the tax overhaul.
A major problem area that the nonprofit sector saw with initial IRS guidance was that people with limited involvement in an organization could end up triggering the tax—individuals, for example, who work for corporations but volunteer at a related charity, or individuals who do limited work at a nonprofit. The proposed rules released last week (REG-122345-18), offer a number of exceptions to limit the 21% tax.
“They have created a number of exceptions that should provide comfort to at least the vast majority of arrangements that I’ve worked with,” said Spencer Walters, a partner at Ivin Phillips Barker Chartered in Washington.
As long as the nonprofit doesn’t pay the person, the proposed rules “limited-hours” exception says the tax will only be triggered if the individual spends more than 10% of their time, or more than 100 hours, at the nonprofit. The exception should cover a common situation: Corporate executives volunteer at a company foundation, with no compensation and for a limited number of hours, said Christopher Moran, an associate at Venable LLP in Baltimore.
The tax applies to a nonprofit’s five highest-paid employees earning $1 million a year or more. Lawmakers created it largely to rein in highly compensated coaches at private colleges or executives at nonprofit hospitals.
The exceptions help address what could have otherwise been unintended consequences in the rules, said Elinor Ramey, a partner at Steptoe & Johnson LLP and a former attorney-adviser at Treasury during the 2017 overhaul.
“There was no real expectation that corporate officers’ for-profit compensation should be taxed under this rule” she said.
The IRS believed Congress gave them some authority to offer exceptions in the Section 4960 rules, Janine Cook, deputy associate chief counsel at the IRS, said on a webinar Monday.
“We felt we had some room to deal with situations we don’t think were intended to be captured by this, but wanted to be careful not to administer so much tax planning that it unwittingly opens up something that could get abusive or undermine the code,” Cook said.
Avoid Major Disruption
The rules also create a non-exempt funds exception for employees of a controlling taxable organization that perform more substantial work at the applicable nonprofit. An employee won’t be considered one of the nonprofit’s five highest-compensated for a taxable year if neither the nonprofit, nor any related nonprofit, gives the employee any compensation for the service.
The limited-hours and non-exempt funds exceptions should be reviewed closely, Moran said. In some situations, a corporate foundation may reimburse the company for the time that the executives spend there, which could trigger tax, he said. Or, a corporate executive may not be paid by the related foundation, but may spend more than half of their time on foundation matters.
The agency seems to be taking a pretty broad definition of employee, likely because it makes the rules easier to administer, he said.
Changing the definition of employee would have opened a can of worms, said Veena Murthy, a principal at Crowe LLP who worked on the provision in her previous role as legislation counsel at the Joint Committee on Taxation.
“To change how an employee or employer is defined would have been extremely disruptive for purposes far beyond Section 4960, and I believe that Treasury and IRS recognized this, thank goodness,” Murthy said.