Executive Compensation Excise Tax: Who, What, and How Much?

Compensation November 12, 2019 By: Dan S. Brandenburg

A provision included in the 2017 tax reform law requires nonprofit organizations, including associations, to pay an excise tax on “excess” executive compensation. Here’s a primer on the key elements of the new requirement.

The Tax Cuts and Jobs Act of 2017 added a new 21 percent excise tax on tax-exempt organizations, including associations, that pay what the law defines as “excess tax-exempt organization executive compensation.” The new provision, Section 4960 of the Internal Revenue Code, is effective for taxable years that began after December 31, 2017.

For most nonprofits, the biggest impact will be the need to keep track of whether they have any employees whose compensation may be subject to this tax on the employer. On December 31, 2018, the IRS issued Notice 2019-09 explaining how the new excise tax is to be applied and providing helpful guidance.

Requirements and Definitions

Under the new provision, applicable nonprofits must pay an excise tax equal to 21 percent of compensation in two categories:

  • annual taxable compensation paid to covered employees in excess of $1 million
  • excess “parachute payments” made to covered employees as severance when they leave the organization. This applies to payments that total at least three times the employee’s average annual compensation over the previous five years. The taxable amount of the severance is the amount that exceeds the employee’s average annual compensation (called the “base amount”).

The tax on excess parachute payments applies even if the executive who received it earned less than $1 million a year. There is no grandfathering rule that applies to severance payments that were earned before the effective date of the new provision.

Section 4960 was intended to put nonprofits on equal tax footing with taxable organizations that are subject to similar taxes on executive compensation. There is an important difference, however, where parachute payments are concerned: Under Section 4960, the nonprofit employer must pay the excise tax, while under Section 280G, which applies to taxable employers, the individual receiving the parachute payments must pay the tax.

A covered employee under the new provision is defined as one of a nonprofit organization’s five highest-compensated employees. Once an employee meets that definition, he or she remains covered by the excise tax provision, even if the employee is no longer among the five highest-paid executives. As a result, a nonprofit must determine whether it has covered employees, and identify who they are, every year.

When considering these questions, organizations should generally use an employee’s calendar year wages—compensation or remuneration generally means wages subject to federal income tax withholding. As a result, certain forms of remuneration, like payments from tax-qualified pension or profit-sharing plans, are excluded. In addition, some compensation should be excluded because it is not wages—for example, compensation a nonprofit pays to non-employees for services as members of the board of directors.

Payment Deadlines

The excise tax is reported and paid using IRS Form 4720. It is due on the 15th day of the fifth month after the end of the employer’s taxable year. An employer may request an automatic extension of time to file the form, although filing for an extension does not change the deadline for paying the tax. To avoid interest and penalties, an employer must pay the tax due by the original due date.

When the IRS published Notice 2109-09, the agency said it intended to issue proposed regulations for the new excise tax requirement. None have yet emerged, and in the meantime, many open questions remain. But until formal regulations are adopted, the notice provides helpful guidance for associations and their counsel.

Dan S. Brandenburg

Dan S. Brandenburg is a partner at the Wagner Law Group in Washington, DC.