Section 4960 Excise Tax Proposed Regulations
On June 11, the Federal Register included a proposed rule by the Internal Revenue Service (IRS) issuing proposed regulations under section 4960 of the Internal Revenue Code (Code). Section 4960 obligated certain tax-exempt organizations to pay taxes on compensation paid to employees when the compensation exceeded certain threshold amounts. Section 4960 originated from section 13602 of the Tax Cuts and Jobs Act (TCJA), and section 4960(d) required the IRS to issue implementing regulations. The proposed regulations help to explain what a credit union needs to do to comply with section 4960.
In the intervening time between the enactment of the TCJA and the issuance of the proposed rule, NAFCU has written several times about section 4960. This NAFCU Final Regulation explains the IRS’s interim guidance, issued at the end of 2018, about complying with section 4960 and provides a section-by-section analysis of the guidance. Also, a NAFCU Compliance Blog post addresses the requirement to report and pay the section 4960 excise tax on IRS Form 4720.
Section 4960 Requirements
Under section 4960, applicable tax-exempt organizations (ATEOs) must pay excise taxes on excess remuneration (remuneration in excess of $1 million) and excess parachute payments made to covered employees. An ATEO includes any organization that is exempt from taxation under section 501(a). Section 501(a) exempts from taxation organizations described under sections 501(c) and (d). Federally chartered credit unions are exempt from taxation under section 501(c)(1), and state-chartered credit unions are identified in section 501(c)(14)(A). Both are ATEOs under section 4960. Under the statute’s definitions, section 4960 could also apply to a credit union service organization (CUSO) as a related organization.
Reduced to its most basic level, the application of the excise tax sounds simple enough. First, determine the amounts of excess remuneration and excess parachute payments. Second, apply the applicable tax rate set forth in section 4960(a)—21% at the moment—to those amounts. Unfortunately, the express language of the statute left some things unclear. The statute defines remuneration in a way that incorporates the definition of wages under section 3401(a) of the Code and amounts included in gross income through section 457(f) nonqualified deferred compensation plans, but remuneration does not include section 402A(c) Roth contributions. Other definitions provide less clarity. For example, the statute defines excess parachute payment in a manner that may not be easily digestible: it “means an amount equal to the excess of any parachute payment over the portion of the base amount allocated to such payment.” The definition of excess parachute payment depends on what constitutes a parachute payment and a base amount, which are also terms defined in section 4960.
The IRS’s interim guidance was designed to address these issues and provide taxpayers with clarity about how to comply with section 4960. It included several examples in the form of questions and answers that explained what the defined terms in section 4960 really meant in the context of real-world examples.
No Grandfather Rule
Upon enactment of the TCJA, NAFCU asked the IRS, among other things, to evaluate its authority to grandfather certain employment contracts to establish parity with for-profit corporations under the new law. NAFCU asked the IRS to determine whether it had the authority under the TCJA to grandfather employment contracts entered into on or before November 2, 2017, because for-profit corporate executive nonqualified deferred compensation contracts entered into on or before this date were exempted from the deduction limit under section 162(m) of the Code. NAFCU, in the alternative, asked that the IRS support Congressional efforts to introduce a technical corrections bill to this effect. Through the interim guidance, Treasury and the IRS explained their conclusion that grandfathering contracts for ATEOs was inappropriate because the legislative history of the TCJA did not evidence an intent to grandfather contracts entered into before the effective date of section 4960. The proposed rule reiterates this position, but it clarifies that the proposal effectively grandfathers certain types of compensation: (1) nonqualified deferred compensation that vested prior to the first day of the first taxable year of the ATEO beginning after December 31, 2017; and (2) vested deferred compensation from years prior to the taxable year in which the employee first became a covered employee.
The Proposed Rule
The proposed rule, for the most part, is consistent with the interim guidance. The preamble to the proposed rule identifies the limited situations in which the IRS’s proposal may differ from the interim guidance. For example, the IRS proposed exceptions to the definitions of employee and covered employee to address concerns about the treatment of individuals who may perform limited services for an ATEO but are only paid by an organization other than that ATEO. Comments received in response to the interim guidance expressed concern that these individuals were essentially volunteers and that the possible application of the excise tax to these individuals might disincentivize organizations to continue these beneficial practices and relationships.
The section 4960 regulation will be located at sections 53.4960-0 through 53.4960.5 of the IRS’s rules and regulations. The organization of the regulation is very similar to the interim guidance. The proposed regulation starts out by defining applicable terms before examining how to determine the remuneration paid and whether there is a parachute payment in any applicable year. This part of the proposed regulation helps to answer the first question identified above—determining the amounts of excess remuneration and any excess parachute payments. The last part of the proposed regulation instructs taxpayers about how to calculate the liability for the excise tax. Like the interim guidance, the proposed regulation includes representative examples to demonstrate how these rules are designed to work.
For more information about the proposed rule, please look out for the forthcoming Regulatory Alert being prepared by the NAFCU Regulatory Affairs team. The proposed rule specifies that the IRS must receive comments to the proposed rule by August 10, 2020.
Section 4960 covers elements of benefits and tax law. Both are highly complex and require a large degree of specialization. Therefore, your credit union may wish to consult with benefits or tax counsel for a more detailed analysis about your credit union or CUSO’s specific obligations under section 4960.