Because of the Tax Cut and Jobs Act of 2017, there have been many changes to employment and income taxes. Among these changes is the excise tax on tax-exempt employers, particularly for their highly compensated, ‘covered’ employees. This article will discuss this excise tax and provide some useful insights for tax-exempt organizations.
A Quick Recap
Section 4960 of the Internal Revenue Code imposes a 21 percent excise tax on the remuneration paid by tax-exempt employers in two situations in particular.
- Remuneration amounts over $1 million paid to a ‘covered’ employee for a given tax year
- Remuneration classified as separation or ‘parachute’ payment given to a highly compensated employee that is equal to or exceeds three times the average base pay of that employee in the last five years.
Tips for Tax-Exempt Employers
To make sure bases are covered, taxes are managed, and regulations are followed, here are a few insights that can help tax-exempt organizations regarding excise taxes.
Identify and Track the Covered Employees in the Organization
‘Covered’ employees are typically defined as the top five highest-paid people in the organization. They are the ones affected by the excise tax for tax-exempt employers. Even if they are not paid in excess of $1 million in compensation, the ‘parachute’ payments may still trigger the excise tax if the amount is over $120,000 and is three times the average W-2 compensation of the employee in the last five years. The tax is applied to anything that exceeds the base amount, not just the amount exceeding three times the average compensation.
The $1 million threshold does not account for inflation. This means employers that pay less than $1 million at the moment may still trigger the excise tax in the future.
Take Note of Related Organizations
According to the Code, the aggregation of compensation from related employers is required. ‘Related’ here means that another entity controls over 50 percent of the board of a tax-exempt organization. This means a shared employee may be considered for the excise tax of the tax-exempt entity. The entity controlling the tax-exempt organization could end up paying the excise tax if the parameters are met for the employee.
Be Aware of Unintuitive Timing
Compensation is typically considered as paid after it becomes vested. Deferred compensation or bonuses can count towards the excise tax even before payment is actually made to the employee. This can be avoided by stating a condition for the employee to stay on until the payment date.
Results are Affected by Deferred Compensation
Speaking of deferred compensation, even if an employee’s regular compensation is less than $1 million, large unpaid balances or vesting of large balances until the employee leaves can still trigger the excise tax.
Specify Doctor and Veterinarian Services
When dealing with doctors and veterinarians, compensation for services must be separated from compensation for teaching, research, and administrative duties. The former is exempt from the excise tax, while the latter category is not.
The above article is for general information purposes only and should not be relied upon as specific legal advice. This article, or contacting Apex, does not in any way form an attorney-client relationship. If you have any questions or would like to learn more, please contact Maha Jafarey at firstname.lastname@example.org.