08/16/2021

IRS Clarifies Rules on Excess Compensation Tax

What this means for nonprofits

Earlier this year, the Internal Revenue Service (IRS) issued final regulations on IRC Section 4960, which imposed an excise tax on tax-exempt organizations and related organizations that pay over $1 million of compensation or excess parachute payments to a covered employee.  The Tax Cuts and Jobs Act (TCJA) added a provision stating that, beginning in 2018, nonprofit organizations could be charged an excise tax if it pays more than $1 million to certain "covered" employees.

These final regulations generally mirror the proposed regulations released in 2020 and guidance provided in Notice 2019-09. The new regulations, which fall short of wholesale changes requested by nonprofits and other members of the tax community, went into effect on Jan. 15, 2021. However, technically, they don't apply until tax years beginning after 2021. Nonprofit organizations may want to analyze the final regulations with regard to their specific facts to identify any potential tax planning opportunities before 2022.

Who's Covered, What's Taxed

Under the law, the definition of "covered" employees includes an organization's five highest-compensated employees (HCEs) for the current tax year, based on remuneration paid in the calendar year ending with or within the fiscal year. It also includes any individual who was a covered employee for any preceding tax year beginning after 2016. Note: There's no minimum dollar threshold for covered HCEs for purposes of this calculation.

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