Does an Excise Tax Apply When Company Employees Serve as Directors and Officers of the Company Foundation?

This article originally appeared on the Wisconsin Philanthropy Network blog, and is republished here with permission.

In a prior blog post (July 2019), we addressed the potential for the new section 4960 excise tax (which was adopted as part of the 2017 tax reform bill) to apply when highly compensated company employees also served as directors and officers of the company foundation.  At that time, we argued that the tax should not apply based on available guidance, although there was some uncertainty because the IRS had not directly addressed it.  New proposed regulations would clarify that the excise tax will not apply in most cases. 

As background, the Tax Cuts and Jobs Act of 2017 subjected non-profit organizations to a 21% excise tax when certain “covered employees” of the organization are paid more than $1 million or receive excess parachute payments.  A “covered employee” is any of the five highest compensated employees of the organization for the taxable year, or was a covered employee in a prior year.

On its face, for most company foundations, this is not an issue—usually those foundations do not provide compensation.  However, the excise tax came with an aggregation rule that calculated the covered employee’s compensation as both what it received from the tax-exempt organization (the “applicable tax exempt organization” or “ATEO”) and any related organization, including any organization that controls or is controlled by the exempt organization.  Company foundations are oftentimes controlled by the for-profit company (or the shareholders of a closely-held company), and the wording of the statute seemed to indicate that the foundation had to take into account the compensation paid to foundation directors and officers by the Company (which can exceed the triggering amount).  Thus, the foundation would be subject to the excise tax on compensation paid by the company. 

Thankfully, the Department of the Treasury recently released proposed regulations with further exceptions to the “covered employee” rule, helping to ensure that the section 4960 tax does not apply to a company foundation in these circumstances.  The Regulations contain three exceptions:

• Limited Hours Exception: An individual who does not do substantial work for the ATEO is not a “covered employee” if i) the individual is not paid any compensation for their work for the ATEO, by the ATEO or other tax related exempt organizations and ii) the individual spends a minimal amount of time (not more than 10% of their total work hours) working for the ATEO (or spends no more than 100 hours annually).An IRS follow-up example provides that this exception does not apply if the ATEO reimburses the employing entity for the covered employee’s time.
• Nonexempt funds exception:An individual who provides up to (but still less than) 50% of their hours working for the ATEO is not considered a covered employee, as long as i) the employee works primarily for the related nonexempt organization, ii) the ATEO or related exempt organization do not pay directly or indirectly for the individual’s services, and iii) the business that pays the employee has a purely charitable relationship with the exempt organization (the business entity that is paying compensation is not being paid for services to the ATEO or organization related to or controlled by the ATEO).

  This exception is aimed at individuals who devote more hours to the ATEO than individuals falling within the limited hours exception, but still primarily work for a related nonexempt organization (such as employees of a company that devote some hours to the company foundation).

• Limited Services Exception: An individual can avoid being considered a covered employee of the ATEO if the organization does not pay 10% or more of the employee’s total remuneration for services performed and the ATEO has at least one related ATEO, and i) the related ATEO paid at least 10% of the total remuneration paid by the ATEO and all related organizations, or ii) no related ATEO paid 10% of the total remuneration, but the ATEO paid less than at least one related ATEO.

The proposed regulations also confirm that directors and officers who do not perform any services or perform only minor services are not treated as employees of the AETO for these purposes.

These are proposed regulations, and so an organization may rely on these regulations, Notice 2019-09, or its own reasonable, good faith interpretation of the statute until final regulations are issued.