South Florida Hospital News
Wednesday June 26, 2019
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April 2019 - Volume 15 - Issue 10

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Excise Tax on Executive Compensation and Excess Parachute Payments

IRC §4960 Background
One of the most substantial changes of the TCJA affecting tax-exempt organizations was the creation of IRC §4960. This new code section applies to “applicable tax-exempt organizations (“ATEO”)” and imposed a new 21% excise tax on excess executive compensation and excess parachute payments.
 
Organizations subject to IRC §4960 must determine excess compensation and excess parachute payments made to a “covered employee”. A covered employee is defined as any employee who is one of the 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 December 31, 2016. Therefore, once an employee is a covered employee, they will continue to be a covered employee for all subsequent taxable years.
 
IRS Notice 2019-09
On December 31, 2018, over a year after the release of the TCJA, the IRS released Notice 2019-09, which provided 92 pages of much anticipated informal guidance regarding IRC §4960. The Notice provided some clarity for tax-exempt organizations, as further outlined below.
 
Excess Remuneration
In general, the excise tax imposed under §4960(a)(1) is based on the remuneration paid (other than any excess parachute payment) by an ATEO for the taxable year with respect to employment of any covered employee in excess of $1 million. The regulations indicates that excise tax imposed on excess remuneration and excess parachute payments is determined based on the remuneration paid and excess parachute payment made in the calendar year ending with or within the taxable year of the employer. It is important to note that “remuneration” is defined as wages under §3401(a) (wages subject to federal income tax withholding), but excluding designated Roth contributions under §402A(c) and including amounts required to be included in gross income under §457(f). Furthermore, §4960 states that remuneration is considered paid only when there is no substantial risk of forfeiture. Net earnings on previously paid remuneration is treated as paid at the close of the calendar year in which they accrue.
 
Medical Services
IRC §4960(c)(3)(B) and (c)(5)(C)(iii) exclude from remuneration the portion of any compensation that is paid for the performance of medical services by a licensed medical professional. The notice defines “licensed medical professionals” as an individual who is licensed under state or local law to perform medical services.
 
When a covered employee is compensated for both medical services and other services, the employer must allocate remuneration paid. The Notice permits taxpayers to use any reasonable, good faith method to allocate remuneration. Additionally, the Notice clarified that medical services do not include administration, teaching or research services.
 
Excess Parachute Payments
IRC §4960(a)(2) imposes an excise tax on “any excess parachute payment.”, which is further defined as an amount equal to the excess of any parachute payment over the portion of the base amount allocated to such payment. Parachute payments are payments made in the nature of compensation to a covered employee contingent upon voluntary separation from the employer, in which the aggregate present value of the payments equals or exceeds three times the base amount. According to §280G(b)(3), the term “base amount” refers to the average of an individual’s annualized compensation over the previous five taxable periods (or less) prior to separation.
 
Effective Date
IRC §4960 is effective for the first taxable year beginning after 12/31/2017. Therefore, calendar year entities will be subject to the 21% excise tax for excess remuneration for their covered employees for calendar year 2018. However, organizations with fiscal year-ends will only be subject to the 21% excise tax on remuneration paid in excess of $1 million on covered employees for the period included for their first able year beginning after 12/31/2017.
 
Reporting the Liability Under §4960
Employers are to report their liability and applicable payment by completing Federal Form 4720, Return of Certain Excise Taxes by the 15th day of the 5th month after the end of the taxpayer’s taxable year. An employer may file Form 8868 to request an automatic extension of time to file the Form 4720.

For more information, contact Johanna Orellana, Senior, WithumSmith+Brown, CPAs, at jorellana@withum.com or Hayley Shulman, CPA, Manager, at hshulman@withum.com or visit withum.com.

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