IRS guidance on nonprofit excise taxes leaves questions unanswered
The Internal Revenue Service’s recently issued guidance on excise taxes for nonprofits that have executives earning over $1 million answers some lingering questions, but leaves others for later guidance.
The IRS released Notice 2009-09 on December 31, despite the partial government shutdown, as it was allowed make exceptions for work related to the Tax Cuts and Jobs Act (see IRS offers guidance on excise taxes for nonprofit executive comp). The notice offers some interim guidance on a provision of the Tax Cuts and Jobs Act that imposes a 21 percent excise tax on excess payments and remuneration over $1 million for top officials at nonprofits, as well as on certain excess parachute payments paid to top officials contingent upon a separation from employment.
“When the statute was passed a year ago as part of the Tax Cuts and Jobs Act, organizations knew that this tax was coming down,” said Marc Berger, national director of nonprofit tax services at BDO USA. “It’s an excise tax, not an income tax, focusing on compensation received by employees of certain tax-exempt organizations in excess of a million dollars.”
He emphasized that the tax isn’t imposed on the employee, but on the organization itself. Berger sees a few points that stand out in the IRS notice, one of which makes administration of the statute clearer and the other leaving matters a little less clear than what organizations originally thought when the legislation passed at the end of 2017. One of the areas where the recent IRS notice brings clarity is the fiscal year versus calendar year.
“The first point was what time frame you were focusing on with respect to the compensation received by an individual,” said Berger. “When you look at the statute, it focuses on the compensation received in the organization’s tax year. Many organizations use the calendar year as their fiscal tax year and some organizations have a different fiscal year end. It could be June 30, it could be September 30, or any other month or day. When the statute came out and was talking about the organization’s compensation paid in the tax year, it wasn’t clear. Many tax professionals were saying, ‘Well, if you’re on a fiscal year basis, you’re going to look for the compensation paid during the fiscal year.’ But the notice made it clear they will be focusing on compensation during a calendar year, and the calendar year that ends within the organization’s fiscal year. So if you’re a calendar year organization, it’s the calendar year, and there’s really no difference. But if you’re a June 30 fiscal year end organization, so your year runs from July 1 to June 30, you’ll use the calendar year end of that, December 31, that is, between July 1 and June 30. So if your year is July 1, 2018 to June 30, 2019, you’ll focus on calendar year 2018 compensation. That provided some clarity there.”
However, there is still some ambiguity for many organizations wondering if the tax even applies to them. “The one that stands out to me right now is which organizations are subject to the excise tax,” said Berger. “One main group is organizations that have a tax exemption under section 501(c) of the Internal Revenue Code. Another group of organizations is governmental organizations that don’t necessarily have a tax exemption under section 501(c) of the code, but they get an income tax exemption as a governmental entity under a different section of the code, section 115(1). For those governmental organizations, the notice will look like it’s on a case by case basis. Public colleges and universities are in most instances an arm of the state government, and many public universities have section 501(c)3 exemptions. If they do, then they would be subject to the excise tax. But many public universities don’t feel the need to have an exemption under section 501(c)3 because they get their income tax exemption under section 115.”
The legislative history of the provision seems to imply that the excise tax would apply to public colleges and universities that pay seven-figure salaries to football or basketball coaches. “They seemed to be the highest paid employees at large public colleges and universities,” said Berger. “It seemed to imply that the excise tax was to apply to those public colleges and universities that had highly paid employees. The notice seems to say that it’s almost on a case by case basis how each particular university falls under treatment as a governmental entity. That’s the one point that makes things a little unclear, and to me that’s whether a public college or university is subject to the tax.”
The notice states that the IRS intends to issue proposed regulations on this new section of the code. “But until they do, they published the notice for organizations to utilize until those proposed regulations are released,” Berger noted.
So far, he hasn’t heard many objections from clients about the new excise tax, but there is demand for ways to plan for and structure compensation arrangements to minimize the tax liability. He sees two ways for organizations to try to minimize their tax liability.
“In determining how much compensation you take into account and whether the tax applies, there are two general buckets,” said Berger. “The first one is wages subject to withholding, like each employee’s base salary that shows up on their W-2 in Box 1 for their federal income, the wages subject to federal income tax. The other bucket brings into account potential deferred compensation that has vested. In many instances it’s that deferred compensation that has vested that can push an individual over the million-dollar limit, so it’s the ability to structure payouts and when certain amounts vest and therefore become taxable. I think organizations are looking to see if there’s a way that those deferred compensation arrangements can be structured in order to minimize the tax.”
Tax practitioners and their clients are not only dealing with those ambiguities, but also with the uncertainties surrounding the ongoing government shutdown that’s leaving approximately 70,000 IRS employees on furlough. “I know I can’t call them for any advice or discussion on any current cases that I might have with them because there’s nobody there to answer the call,” said Berger. “As we get a little further into the year, generally some people start filing their personal income tax returns as early as late January and early February. I am hoping that they will reopen soon.”