TCJA’s Excise Tax: Remuneration in Excess of $1,000,000 and Excess Parachute Payments
The Tax Cut and Jobs Act (“TCJA”) imposes a 21 percent excise tax on certain compensation paid to covered employees of certain tax exempt and governmental employers, effective the first tax year beginning after December 31, 2017. The Internal Revenue Service (“IRS”) has now issued interim guidance in IRS Notice 2019-09, to help you comply with these rules. Until further guidance is issued, you can rely on a good faith, reasonable interpretation of the statute. The interim guidance can be used as an interpretation, or other approaches can be used, as long as Notice 2019-09 does not specify that a particular interpretation of the rules is not reasonable or made in good faith.
The excise tax applies to two amounts:
- Compensation in excess of $1,000,000 paid to a covered employee, or
- Severance payments in excess of three times a covered employee’s base amount paid on account of an involuntary separation from service
Which employers are subject to this excise tax?
Applicable tax-exempt organizations (“ATEOs”) and related entities are subject to this tax. An ATEO is, among other things, an entity that is recognized as exempt under Section 501(a) or a governmental entity excluding income under the provisions of Section 115(1). Not all governmental entities exclude income under Section 115(1), as many are not subject to federal tax under the doctrine of implied statutory immunity and do not need this exclusion to avoid federal tax. A state university who is recognized as tax exempt would be subject to the rules as an ATEO, although a state university without this status would not be. The guidance explains that Rev. Proc. 2018-5 provides rules on how a governmental entity may relinquish its tax-exempt status to avoid being an ATEO.
An entity related to an ATEO may be either tax-exempt or taxable, depending on whether or not they are controlled by or controlling the ATEO, or controlled by persons who control the ATEO.
Who is a covered employee?
Covered employees are the five most highly compensated employees of the ATEO for the taxable year, or one of those individuals in any year beginning after December 31, 2016. In some cases, there will be more than five employees whose compensation is subject to the rules, including individuals who are no longer one of the five most highly compensated. For determining these individuals, compensation includes amounts paid or vested in the taxable year of an employee that ends with or within the taxable year of the employer. Compensation directly related to medical or veterinary services is not included, although other amounts paid to these licensed professionals would be included. While only a common-law employee of an ATEO or related entity can be one of the five highest paid employees, compensation from a related entity is included in compensation for this determination. Similarly, compensation paid by an unrelated entity for services to the ATEO or related entity is included.
What is compensation?
Compensation paid or vesting during the calendar year ending with or within the employer’s year is remuneration subject to the rules. Only the net present value of an amount payable in the future is considered compensation for this purpose. If amounts are paid within 90 days of being vested, the employer can choose to include the amount to be paid and not the net present value of that amount.
Net earnings on vested amounts become part of compensation on of the last day of the calendar year. Net earnings are decreased by losses in an account or in other deferred accounts, or carried over from a prior year if the amount has not previously been used to decrease earnings.
What are severance payments?
Severance payments are amounts that would not be paid if severance had not occurred. The guidance states that these amounts are only payments or vesting related to involuntary termination. It also includes amounts that are paid before termination if the payment would only have been made or vested if involuntary termination was imminent. Conveniently, many of the computations needed to determine the payments contingent on separation from service use the rules applicable to golden parachute payments for taxable corporations. Similarly, the rules applicable to nonqualified deferred compensation are used to determine whether an involuntary separation from service exists.
How is the excise tax reported?
The excise tax is reported and paid on Form 4720, and is due 4 and a half months after the end of the employer’s taxable year. No quarterly estimated tax payments are required as this is an excise and not an income tax.
The guidance highlights that this excise tax is separate from the excise tax for unreasonable or excessive compensation in Section 4958 or the Section 4941 excise tax, which is a tax on self-dealing for compensation paid to disqualified persons. Although, in some cases, both excise taxes could be due – the fact that tax is due under Section 4960 does not automatically mean that the corresponding tax under Sections 4941 or 4958 is applicable as well.
If your business needs guidance and a practical approach to navigate this information, our dedicated team of experts at Cherry Bekaert can explain these details specific to your situation, and help you determine which actions are best for your business.