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Federal Excise Taxes on Executive Compensation

November 8, 2018

On November 5, 2018 the Internal Revenue Service released proposed regulations addressing the filing requirements related to the Tax Cuts and Jobs Act’s federal excise taxes on an exempt organization’s executive compensation in excess of $1,000,000 and excess parachute payments. The proposed regulations provide that IRS Form 4720, Return of Certain Excise Taxes, is to be used for reporting the excise taxes and that Form 4720 must be filed by the 15th day of the fifth month after the end of the organization’s taxable year. Thus, an organization reporting on a calendar-year basis that incurred excise tax during the calendar year ending December 31, 2018, must file a Form 4720 and pay the tax due by May 15, 2019. As of the date of this notice, the IRS has not yet updated the Form 4720 to account for these new excise taxes, but we urge exempt organizations to plan ahead for compliance.

Background

Excess Compensation. Beginning January 1, 2018, new Internal Revenue Code section 4960 generally imposes on most tax-exempt organizations an excise tax equal to 21% of any compensation in excess of $1 million paid to the organization’s covered executives. A covered executive generally is an individual who is one of the five highest compensated employees of the organization for the taxable year or was a covered executive for any preceding taxable year beginning after December 31, 2016. The excise tax is due even if the total compensation paid to the covered executive (including the amount in excess of $1 million) is reasonable.

For purposes of this new excise tax on excess compensation, compensation means wages as defined for federal income tax withholding purposes, and compensation is deemed to be paid when there is no substantial risk of forfeiture of the rights to such compensation.

Excess Parachute Payments. In addition, such tax-exempt organizations are now required to pay an excise tax equal to 21% of certain excess parachute payments paid to their executives (regardless of whether or not the executive’s compensation exceeds $1 million). A parachute payment is a payment to a covered executive if the payment is contingent on separation from employment and the aggregate present value of all such payments equals or exceeds three times a base amount (defined below). An excess parachute payment is the amount by which any parachute payment exceeds the portion of the base amount allocated to the payment.

The base amount is the average annualized compensation includible in the covered executive’s gross income for the five taxable years ending before the date of the separation from employment. Parachute payments do not include payments under a qualified retirement plan, a simplified employee pension plan, a simple retirement account or a tax-deferred annuity.

Exception for Medical Services.  The excise taxes do not apply to compensation or excess parachute payments paid to a licensed medical professional for the provision of medical or veterinary services.

The Proposed Regulations

The proposed regulations provide that IRS Form 4720, Return of Certain Excise Taxes, is to be used for reporting and paying the excise taxes and that such form must be filed by the 15th day of the fifth month after the end of the organization’s taxable year during with the excise tax liability was incurred.

Items to Note:

  • As of the date of this notice, Form 4720 has not been updated by the IRS to account for these new federal excise taxes. We expect that an updated form will be released shortly.
     
  • It is interesting to note that because this new burden is imposed as an excise tax, quarterly estimated payments are not required.  This is to be contrasted with other tax burdens on exempt organizations arising out of the Tax Cuts and Jobs Act, which treat certain payments by exempt organizations as unrelated business taxable income that are subject to the unrelated business income tax and the related estimated payment obligation.

We will update as necessary if any changes are made to the proposed regulations.

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