On Monday, January 11, Treasury and the IRS released final regulations under section 4960. Section 4960, enacted as part of the Tax Cuts and Jobs Act (TCJA), imposes an excise tax on remuneration in excess of $1 million and any excess parachute payment paid by an applicable tax-exempt organization (ATEO) to any covered employee. The excise tax and the final regulations can affect not only ATEOs, but also certain entities that are treated as related to those organizations.
In June 2020, Treasury and the IRS published proposed regulations under section 4960. The final regulations retain the basic approach and structure of the proposed regulations, with certain revisions. For prior coverage of the proposed regulations, click here.
Changes to the proposed regulations include:
- A modification to the nonexempt funds exception to covered employee status that expands the measurement period from one applicable year to two applicable years (that is, the current applicable year and the preceding applicable year are treated as a single measurement period). This allows organizations more flexibility for determining whether an employee provided services to the ATEO and all related ATEOs for not more than 50% of the employee's total hours worked as an employee of the ATEO and all related organizations. Therefore, in situations where an employee "rotates" to an ATEO for a period that extends longer than six months, or when an employee unexpectedly provides services beyond six months in an applicable year, that employee could still be excluded as a covered employee.
- A modification to the attribution rules as they apply for purposes of determining eligibility for the nonexempt funds exception (by generally disregarding the application of so-called "downward attribution").
- Certain modifications to the examples illustrating the scope and application of the limited hours exception to covered employee status.
- A clarification that remuneration paid to a covered employee of an ATEO by certain related foreign organizations that have not received substantial support from United States sources (as described under section 4948(b)) is taken into account for purposes of determining liability for the tax, but the foreign organization is not subject to the tax.
- A clarification that, in accordance with section 7872, certain de minimis amounts of foregone interest are not remuneration for purposes of section 4960.
- A rule permitting taxpayers to use a reasonable, good faith method to allocate remuneration between medical services that are excluded from section 4960 and other services.
- Certain modifications to the rules for determining when remuneration is treated as paid, but not the inclusion of additional short-term deferral rules.
- Specific rules for the treatment of earnings and losses on previously paid remuneration that are intended to minimize administrative burdens.
- A clarification that any vested remuneration, including vested but unpaid earnings accrued on deferred amounts, that is treated as paid before the effective date of section 4960 (January 1, 2018, for a calendar year employer) is not subject to the excise tax imposed under section 4960(a)(1). All earnings on those vested amounts that accrue or vest after the effective date, however, are treated as remuneration paid for purposes of section 4960(a)(1).
The final regulations reserve on the question of whether a federal instrumentality for which an enabling act provides for exemption from all current and future federal taxes is subject to tax under section 4960. Until further guidance is issued, such an instrumentality may treat itself as not subject to tax under section 4960 as an ATEO or related organization. However, if that federal instrumentality is a related organization of an ATEO, remuneration paid by the instrumentality must be taken into account by that ATEO.
The final regulations also reserve on the coordination of sections 4960 and 162(m) in circumstances where there is a difference in timing between vesting and payment of remuneration. Until future guidance is issued, taxpayers generally may use a reasonable, good faith approach with respect to the coordination of sections 4960 and 162(m) in circumstances in which it is not known whether a deduction for the remuneration will be disallowed under section 162(m) by the due date (including any extension) of the relevant Form 4720.
The final regulations will apply to taxable years beginning after December 31, 2021 (with the first applicable year generally being the 2022 calendar year). Until the applicability date, taxpayers may rely on the guidance provided in Notice 2019-09 in its entirety or on the proposed regulations in their entirety. Alternatively, taxpayers may choose to apply the final regulations to taxable years beginning after December 31, 2017 provided they apply the final regulations in their entirety and in a consistent manner. Until the applicability date of the final regulations, taxpayers may also base their positions upon a reasonable, good faith interpretation of the statute that includes consideration of any relevant legislative history.