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:
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).
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.