Proposed Regulations on 21 Percent Tax on Excess Compensation Released

July 10, 2020

Treasury and the IRS recently released proposed regulations addressing the section 4960 excise tax.

Beginning in 2018, section 4960 imposed a 21 percent excise tax on remuneration in excess of $1,000,000 and severance paid due to an involuntary separation from service paid to the five highest-paid employees by an applicable tax-exempt organization (“ATEO”). For this purpose, remuneration includes payments made to such employees by related organizations or governmental organizations.

Notice 2019-19, issued over 18 months ago, provided interim guidance, including definitions of ATEO, covered employee, and remuneration, and clarified the effective date of the new tax and how to allocate it between related organizations.

The proposed regulations are generally consistent with Notice 2019-9, although important exceptions apply for volunteers and certain regular wages.


Many tax-exempt organizations use volunteers for governance, management and other specialized services, some of whom are highly paid executives of related for-profit organizations. Because the excise tax applies to all remuneration paid to employees of the ATEO by the ATEO and related entities, the excise tax could apply to payments for services other than those rendered to the ATEO.

To avoid this result, the proposed regulations provide three exceptions to avoid classification as one of the five most highly compensated employees and, thus, the application of the excise tax to the individual’s compensation:

  • Limited Hours Exception: The ATEO and any related ATEO do not pay compensation for services performed as an employee of the ATEO and the individual does not spend more than 100 hours or 10 percent of total hours or days worked as an employee for the ATEO and all related entities performing services for the ATEO.
  • Nonexempt Funds Exception: The ATEO and any related ATEO or taxable organization don’t pay compensation for services performed as an employee of the ATEO, the individual spends less than 50 percent of total hours or days worked as an employee for the ATEO and all related entities performing services for the ATEO and no related organization that paid remuneration to the employee provided services for a fee to the ATEO or any related ATEO or taxable corporation.
  • Limited Services Exception: The ATEO did not pay 10 percent or more of the employee’s total remuneration for services performed as an employee of the ATEO and all related organizations and the ATEO had at least one related organization and either a related ATEO paid at least 10 percent of the remuneration or no related ATEO paid at least 10 percent of the total remuneration and the ATEO paid less to the employee than at least one related ATEO

In addition, directors and individuals having the title of officer, but who provide only minor services and are not entitled to receive any remuneration for the services provided to the ATEO are not treated as employees of the ATEO

Related Entities

In general, a related entity is one that controls or is controlled by the ATEO, one that is controlled by the same persons that control the ATEO, a supported or supporting organization and, in the case of a VEBA, the entity making contributions or maintaining the VEBA.  Control is generally more than 50-percent control of equity, a partnership profits or capital interest, a trust beneficial interest and, in the case of a nonstock organization, control of either the directors or trustees of the organization.  Employees are deemed representatives of their employer, although non-officers and those who do not possess the authority commonly exercised by an officer are not treated as representatives if they do not act as such and that fact is reported to the IRS.  In this way, employees who are active with ATEOs as other than an employee of their employer will not cause the employer and ATEO to be related.

Split Dollar Life Insurance

Many tax-exempt organizations use split dollar life insurance as an arrangement to provide deferred compensation to employees of tax-exempt organizations without running afoul of the rules of section 457(f).  With enactment of the excise tax, such arrangements became even more popular. The proposed regulations note that taxable income recognized as part of a split dollar life insurance arrangement, including compensation equal to imputed interest for premium payments where the insurance policy is owned by the individual.


Remuneration includes amounts vested, even if those amounts would not be currently taxed to an individual.  This makes the calculation of amounts subject to the tax difficult as amounts can be subject to the excise tax before payment.   However, the proposed regulations treat regular wages (e.g., salary) different than bonuses, allowing regular salary to be included in income with paid.  This eliminates the need to include amounts earned at the end of the year and paid in the first pay period of the subsequent year.  The rules do not apply to bonuses which vest in one year and are paid within the first 2 and ½ months of the following year.

Effective Date

The regulations are proposed to apply to tax years beginning after December 31 of the calendar year in which the final regulations are issued. Therefore, for earlier tax years, an exempt organization may rely on one of the following:

  • A reasonable, good-faith interpretation of section 4960 that includes consideration of any relevant legislative history. The preamble to Notice 2019-09 describes certain positions that the Treasury Department and the IRS have concluded are not consistent with such a reasonable, good faith interpretation.
  • The proposed regulations in their entirety.
  • Notice 2019-09.

The proposed regulations can be viewed here.

If you have questions or concerns on how this may affect your organization, please contact Amanda Adams or Deb Walker.

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