The Tax Cuts and Jobs Act of 2017 ("TCJA") is mostly known as the legislation that cut the top corporate tax rate from 35% to 21%. It also introduced a new excise tax under Code Section 4960, which imposes an excise tax equal to the corporate income tax rate on "applicable tax-exempt organizations" ("ATEOs") that pay covered employees compensation that either exceeds $1 million or is an excess parachute payment (i.e., certain payments made contingent on an employee's separation from employment). On June 5, 2020, the IRS released proposed regulations under Code Section 4960. (Prior to the proposed regulations, the IRS issued Notice 2019-09, which provided interim guidance on the Code Section 4960 excise tax. See our prior Legal Update on Notice 2019-09 here.)
The proposed regulations, which at 177 pages long, reflect how simple Code Section 4960 will be to comply with, are intended to provide comprehensive guidance on the application of Code Section 4960. The proposed regulations generally incorporate the guidance in Notice 2019-09; however, in response to comments received on Notice 2019-09, the proposed regulations do modify or clarify the initial guidance in certain respects, including which governmental entities will be treated as ATEOs; the definition of covered employees and the rules for identifying the five highest-compensated employees; and the calculation of, and liability for, the excise tax on excess parachute payments.
Notably, under the proposed regulations, certain employees of a related for-profit employer providing services to an ATEO will no longer be treated as one of the ATEO's five highest-compensated employees, provided that certain conditions related to the individuals' remuneration or hours of service are met. These exceptions were specifically requested by various stakeholders to avoid an extension of the Code Section 4960 excise tax to executives of for-profit companies that volunteer or perform limited services at a related ATEO. While we weren't in the drafting room, we'd guess that the IRS felt significant pressure to avoid any disincentive for executives to volunteer for an ATEO, given that many ATEOs are performing critical medical and social services during the current pandemic. Regardless, we're grateful for the pragmatism on this point.
Additionally, in the preamble to the proposed regulations, the IRS addresses the possibility of a "grandfather" rule for Code Section 4960 similar to the grandfather rule under the TCJA amendments to Code Section 162(m), but declines to adopt such a rule because it would be inconsistent with the statute. They do note, however, that the proposed regulations include rules that have the effect of grandfathering certain compensation. For example, any vested remuneration, including vested but unpaid earnings accrued on deferred amounts, that is treated as paid before the effective date of Code Section 4960 (i.e., the first taxable year of the ATEO beginning after December 31, 2017) is not subject to the excise tax imposed under Code Section 4960.
Stay tuned for our upcoming Legal Update that will take a deeper dive into the proposed regulations.
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