Executive Compensation

March 13, 2024

3523 / Did the TARP program place any limitations on the deductibility of executive compensation of program recipients?

<div class="Section1">The Emergency Economic Stabilization Act of 2008 added new rules to limit the deductibility of compensation paid to certain executives of companies participating in the federal government’s Troubled Assets Relief Program (“TARP”).<a href="#_ftn1" name="_ftnref1">1</a> These companies generally may not deduct more than $500,000 in compensation, including deferred compensation.<a href="#_ftn2" name="_ftnref2">2</a></div> <div class="Section1"> In effect, the compensation in excess of the limit is taxed twice. It is taxed once when the employee pays tax on the compensation, and it is taxed again to the extent the employer cannot deduct the compensation in excess of the limitation. Most large recipients under the program have sought to make their reimbursement of advances under the program to remove these special deduction limitations. </div> <div class="refs"> <hr align="left" size="1" width="33%" /> <a href="#_ftnref1" name="_ftn1">1</a>. As of June 2023, there were 991 recipient organizations under the TARP program originally, see “Bailout Recipients” on ProPublica website at https://projects.propublica.org/bailout/list/index for a list and current status of the recipients under the program. <a href="#_ftnref2" name="_ftn2">2</a>. IRC § 162(m)(5), as added by EESA 2008. </div>

March 13, 2024

3525 / Did the Dodd-Frank Act place any limitations on the deductibility of executive compensation?

<div class="Section1">The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (DFA) added new law to prohibit any covered financial institution (those not already covered by TARP restrictions) from offering any type of incentive-based compensation arrangement that encourages inappropriate risk by providing “excessive compensation, fees or benefits,” or would lead to “material loss” to the covered financial institution.</div> <div class="Section1"> A “covered financial institution” is one that has assets greater than $1 billion and is: <blockquote>(1) a depository institution or depository holding institution; (2) a broker-dealer; (3) a credit union; (4) an investment advisor; (5) the Federal National Mortgage Association; (6) the Federal Loan Mortgage Corporation; or (7) any other financial institution that federal regulators determine should be treated as a covered financial institution.</blockquote> Many of these new prohibition rules could look very much like those already in place for TARP-covered financial institutions. It is important to see the final regulations for the details of the operation of this broad and vague compensation limiting prohibition. However, in 2017, the President ordered a review of all of Dodd Frank with regard to regulations, existing or yet to be issued.<a href="#_ftn1" name="_ftnref1">1</a> As of the date of this publication, most of the focus has been on current regulations already issued, like the CEO pay ratio regulations. </div> <div class="refs"> <hr align="left" size="1" width="33%" /> <a href="#_ftnref1" name="_ftn1">1</a>. Executive Order 13772 (Feb. 3, 2017). </div>

March 13, 2024

3524 / Do the health care reform laws place any limitations on the deductibility of executive compensation?

<div class="Section1">Yes. The Affordable Care Act (ACA) has added rules to limit the deductibility of compensation paid to certain executives of certain “health care insurers” as defined under the law (and applying the controlled group rules). The definition of “health care insurers” includes insurance companies, health maintenance organizations, and any other entity that receives premiums for providing “health insurance coverage.” The ACA places a $500,000 limit on the deduction of compensation that otherwise would be deductible to each employee during an applicable tax year. This limit includes any deferred compensation amounts earned in that tax year, even if it will not be paid until a later year. The deduction then would not be available when the deferred compensation is later paid if it is used up.</div> <div class="Section1"> In effect, the compensation in excess of the limit is taxed twice. It is taxed once when the employee pays tax on the compensation, and it is taxed again to the extent the employer cannot deduct the compensation in excess of the limit. This limit is effective for compensation earned in 2013 and later tax years, but includes compensation earned in 2010 or later tax years and deferred until later than 2012. </div>

March 13, 2024

3519 / What are the limits on an employer’s ability to deduct compensation paid to an employee?

<div class="Section1">Editor’s Note: The Tax Cuts & Jobs Act of 2017 changed the rules governing the deductibility of compensation, including nonqualified deferred compensation, under Code Section 162(m) for certain companies as to “performance-based compensation” and the $1 million cap, except as to amounts under narrowly crafted grandfathering provisions. See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3520">3520</a> for details.<div class="Section1"> An employer may deduct all ordinary and necessary business expenses including “a reasonable allowance for salaries or other compensation for personal services actually rendered.”<a href="#_ftn1" name="_ftnref1">1</a> “Reasonable” compensation is “such amount as would ordinarily be paid for like services by like enterprises under like circumstances.”<a href="#_ftn2" name="_ftnref2">2</a> A salary that exceeds what is customarily paid for such services is considered unreasonable or excessive. Items other than wages may be considered in determining whether compensation is excessive. For example, the amount of loans forgiven on key person insurance policies for two top executives when the policies were transferred to them was used in determining whether their compensation was unreasonable.<a href="#_ftn3" name="_ftnref3">3</a> Compensation generally is the total amount of compensation paid to an employee, rather than that paid to all employees as a group.<a href="#_ftn4" name="_ftnref4">4</a> The issue of reasonable compensation has been almost exclusively a problem in connection with employee-shareholders of closely-held companies. If the IRS finds compensation to be unreasonable, it may reclassify it as a dividend if it had been paid to an employee-shareholder.<a href="#_ftn5" name="_ftnref5">5</a> The fact that the corporation had never declared a dividend was a factor in determining whether amounts paid to an individual who was president, director, and sole shareholder were actually disguised dividends.<a href="#_ftn6" name="_ftnref6">6</a> Bonuses that are disproportionately high in relation to salaries actually may be dividends in disguise, especially if the employee receiving the “bonus” is the company’s sole or majority shareholder.<a href="#_ftn7" name="_ftnref7">7</a> This even includes the value of qualified and nonqualified pension-like benefits, although valuing them for this purpose is not entirely clear.<a href="#_ftn8" name="_ftnref8">8</a> </div><div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.     IRC § 162(a)(1) as amended by PL 115-97. <a href="#_ftnref2" name="_ftn2">2</a>.     Treas. Reg. § 1.162-7(b)(3). <a href="#_ftnref3" name="_ftn3">3</a>.     Avis Indus. Corp. v. Comm., TC Memo 1995-434. <a href="#_ftnref4" name="_ftn4">4</a>.     L. Schepp Co., 25 BTA 419 (1932). <a href="#_ftnref5" name="_ftn5">5</a>.     See Treas. Reg. § 1.162-7(b)(1). <a href="#_ftnref6" name="_ftn6">6</a>.     Eberl’s Claim Serv., Inc. v. Comm., 249 F.3d 994 (10th Cir. 2001). <a href="#_ftnref7" name="_ftn7">7</a>.     Rapco, Inc. v. Comm., 85 F 3d 950 (2d Cir. 1996),96-1 USTC ¶ 50,297 (2d Cir. 1996); Labelgraphics, Inc. v. Comm., TC Memo 1998-343, aff’d, 2000-2 USTC ¶ 50,648 (9th Cir. 2000). But see Exacto Spring Corp. v. Comm., 196 F.3d 833, 99-2 USTC ¶ 50,964 (7th Cir. 1999). <a href="#_ftnref8" name="_ftn8">8</a>.     See, e.g., The Thousand Oaks Residential Care Home v. Comm., TC Memo 2013-10. </div></div>

March 13, 2024

3530 / What are “excess parachute payments” and how are they taxed?

<div class="Section1">Editor’s Note: The 2017 tax reform legislation changed the rules governing the taxability of certain compensation amounts paid by the employer (not the employee), including certain “excess parachute payments,” for certain tax-exempt entities. See Q <a href="javascript:void(0)" class="accordion-cross-reference" id=""></a> for details of coverage for purposes of the 21 percent excise tax penalty.<div class="Section1"> Agreements providing a generous package of severance and benefits to top executives and key personnel in the event of a takeover or merger are commonly referred to as “golden parachutes.” “Excess parachute payments,” as defined in IRC Section 280G, are subject to the following two tax sanctions: (1) no employer deduction is allowed; and (2) the recipient is subject to a 20 percent penalty tax.<a href="#_ftn1" name="_ftnref1">1</a> Note that this tax penalty is not the same 20 percent penalty imposed by plans covered by and failing IRC Section 409A requirements ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3540">3540</a>). A “parachute payment” is defined in the IRC as any payment in the nature of compensation to a disqualified individual that is (1) contingent on a change in the ownership or effective control of the corporation or a substantial portion of its assets and the present value of the payments contingent on such change equals or exceeds three times the individual’s average annual compensation from the corporation in the five taxable years ending before the date of the change, or (2) pursuant to an agreement that violates any generally enforced securities laws or regulations.<a href="#_ftn2" name="_ftnref2">2</a> The present value of the payments contingent on the change in ownership or control is to be determined as of the date of the change, using a discount rate equal to 120 percent of the applicable federal rate.<a href="#_ftn3" name="_ftnref3">3</a> A transfer of property will be treated as a payment and taken into account at its fair market value.<a href="#_ftn4" name="_ftnref4">4</a> A “disqualified individual” is any employee, independent contractor, or other person specified in the regulations who performs personal services for a corporation and who is an officer, shareholder, or highly compensated individual of the corporation. For this purpose, “highly compensated individual” only includes an individual who is a member of the group consisting of the highest paid 1 percent of the employees of the corporation or, if less, the highest paid 250 employees of the corporation. A payment generally will not be considered contingent if it is substantially certain at the time of the change that the payment would have been made whether or not the change occurred. If a payment is made under a contract entered into or amended within one year of a change in ownership or control, it is presumed to be a parachute payment, unless it can be shown “by clear and convincing evidence” that the payment was not contingent on the change in ownership or control.<a href="#_ftn5" name="_ftnref5">5</a> The term “parachute payment” does not include: <blockquote>(1)   any payment to a disqualified individual with respect to a “small business corporation” as defined in IRC Section 1361(b) (which does not have more than one class of stock and not more than 100 stockholders, all of whom are generally individuals but none of whom are nonresident aliens), (2)   any payment to a disqualified individual with respect to a corporation if, immediately before the change, no stock was readily tradable on an established securities market or otherwise and shareholder approval of the payment was obtained after adequate and informed disclosure by a vote of persons, who, immediately before the change, owned more than 75 percent of the voting power of all outstanding stock of the corporation, or (3)   any payment to or from a qualified pension, profit sharing or stock bonus plan, a tax sheltered annuity plan, or a simplified employee pension plan.<a href="#_ftn6" name="_ftnref6">6</a></blockquote> IRC Section 280G applies to agreements entered into or amended after June 14, 1984.<a href="#_ftn7" name="_ftnref7">7</a> See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3531">3531</a> for a discussion of how to calculate the nondeductible portion of a parachute payment. Section 409A Impact Because Section 280G and Section 409A both can cover a plan providing severance/separation benefits in the case of a change in control, and Section 280G and Section 409A have separate definitions of what constitutes a change in control (Section 409A imposing a narrower definition), it is necessary to carefully coordinate the plan provisions when both IRC sections might apply ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="537">537</a>). </div><div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.   IRC §§ 280G, 4999. <a href="#_ftnref2" name="_ftn2">2</a>.   IRC § 280G(b)(2). <a href="#_ftnref3" name="_ftn3">3</a>.   IRC § 280G(d)(4). <a href="#_ftnref4" name="_ftn4">4</a>.   IRC § 280G(d)(3). <a href="#_ftnref5" name="_ftn5">5</a>.   IRC § 280G(b)(2)(C). <a href="#_ftnref6" name="_ftn6">6</a>.   IRC §§ 280G(b)(5) and (6). Based upon the Conference Report to the Tax Reform Act of 1984 that enacted the 280G tax, true nonqualified deferral plans are probably excluded since they are compensation earned prior to the change of control. Nonqualified supplemental plans would generally be included, except for one case, supplemental plans installed to replace an executive’s qualified plan benefits lost under a prior employer’s qualified plan since they were also deemed as earned prior to change of control in the report. <a href="#_ftnref7" name="_ftn7">7</a>.   Treas. Reg. § 1.280G-1, Q&A 47. </div></div>

March 13, 2024

3526 / Did the Temporary Pension Contribution Relief Act place any limitations on the deductibility of executive compensation?

<div class="Section1">Editor’s Note: The 2017 tax reform legislation changed the rules governing the deductibility of compensation, including deferred compensation, for certain companies, except to the extent amounts are grandfathered. See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3520">3520</a> for details.<div class="Section1"> Although not a deduction limitation, the Preservation of Access to Care for Medicare Beneficiaries and Pension Relief Act of 2010 (“BPRA”) indirectly affects an employer’s compensation deductions (and it affects the employer’s cash and accounting in other ways). The law added new rules to permit employers to amortize any qualified pension contribution shortfalls – from the required amount – over a longer time period. A public or private company must give up portions of its annual pension contribution relief permitted under the BPRA, based on “excess compensation” paid to employees (not just executives) of companies. Under the BPRA, there is a formula for calculating the permitted relief reduction in the annual pension contribution; the formula requires the employer to offset certain amounts (i.e., to make an add-back adjustment), primarily stock redemptions, dividends, and so-called “excess compensation.” Under the BPRA, “excess compensation” is defined as all taxable compensation of an employee from the employer during a year exceeding $1 million, including all nonqualified deferred compensation as defined by Section 409A, which includes a broad segment of an employee’s compensation under current law. The definition of “excess compensation” also includes certain amounts that are not currently taxable to an employee. The BPRA requires an employer to include in “excess compensation” employer contributions made to any trust (or similar arrangement) to fund any nonqualified deferred compensation plan, even though these employer contribution amounts are not currently taxable. Although it is not yet clear, this requirement could include premium payments made to EOLI/COLI or annuities acquired in connection with an employer’s nonqualified deferred compensation plan. Although excess compensation cannot ever exceed the permitted temporary reduction, it could cancel the benefit of the reduction for a year. Moreover, there is some concern that, subject to getting the IRS interpretation from further guidance on the statutory language, the formula and its operation with regard to excess compensation actually could cost the employer a $2 increase in pension contribution for each $1 of excess compensation. In summary, a public or private employer seeking to take advantage of the temporary qualified pension contribution relief law will need to evaluate both the alternative schedules of pension contribution relief offered by the BPRA, and also then consider the potential impact of various scenarios of excess compensation, taking account of both taxable compensation and non-taxable employer contributions to nonqualified plans on that schedule. </div></div>

March 13, 2024

3531 / How is the nondeductible amount of a parachute payment calculated?

<div class="Section1">Editor’s Note: The 2017 tax reform legislation changed the rules governing taxability to the employer (not the employee) of certain compensation, including certain “excess parachute payments,” for certain tax-exempt entities. See Q <a href="javascript:void(0)" class="accordion-cross-reference" id=""></a> for details.<div class="Section1"> The amount of a parachute payment that is nondeductible and subject to the excise tax (i.e., the “excess parachute payment,” see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3530">3530</a>) is the amount of the payment in excess of the portion of the base amount allocable to that payment. The “base amount” is the average of the individual’s annual compensation paid by the corporation undergoing the change in ownership and includable in the gross income of the individual in the most recent five taxable years ending before the date on which the change in ownership or control occurs. If the individual has been employed by the corporation for fewer than five years, then the base amount is figured using the annual compensation for the years actually employed. Compensation of individuals employed for a portion of a taxable year should be annualized (i.e., $30,000 in compensation for four months of employment with the corporation would be $90,000 on an annual basis). To determine the “excess parachute payment,” the base amount is multiplied by the ratio of the present value of the parachute payment to the present value of all parachute payments expected; the result is then subtracted from the amount of the parachute payment. <table border="1" align="center"> <tbody> <tr> <td rowspan="2" width="67">excess parachute payment</td> <td rowspan="2" width="13">=</td> <td style="text-align: center;" rowspan="2" width="120">parachute payment</td> <td rowspan="2" width="13">–</td> <td width="119">present value of the parachute payment</td> <td rowspan="2" width="13">×</td> <td rowspan="2" width="107">base amount</td> </tr> <tr> <td width="119">present value of all parachute payments expected</td> </tr> </tbody> </table> The present value is to be determined at the time the contingency occurs, using a discount rate of 120 percent of the applicable federal rate. Any amount the taxpayer can prove is “reasonable compensation” will not be treated as a parachute payment.<a href="#_ftn1" name="_ftnref1">1</a> See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3519">3519</a> for a general discussion on standards for “reasonable compensation.” <hr> Planning Point: The original documentation should allow the sponsor the option to pay the maximum amount payable (2.99 x average annual compensation) without equaling or exceeding the total amount that would make some portion “excess compensation,” which would cause loss of a portion of the deduction. This option often may result in the participant ultimately receiving a larger dollar amount than if the participant had received “excessive compensation,” after consideration for income taxes in both cases. In addition, the sponsor will have retained its compensation deduction for the payment. <hr> </div><div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.   IRC § 280G(b)(4); Treas. Reg. § 1.280G-1, Q&A 40-44. </div></div>

December 15, 2020

3521 / What was the pre-2018 exception for performance-based compensation to the rules for deduction executive compensation?

<div class="Section1">Prior to 2018, specifically excluded from the definition of applicable employee remuneration were commission payments, which generally were defined as any remuneration paid on a commission basis solely due to income generated directly by the employee’s performance.<a href="#_ftn1" name="_ftnref1">1</a> The 2017 tax reform legislation repealed the exception that allows a corporation to deduct compensation in excess of $1 million to the top executive employees of a public company if that compensation is performance based. As a result, public companies are now only entitled to deduct $1 million in compensation.<a href="#_ftn2" name="_ftnref2">2</a> <hr> Planning Point: Companies that offer a deferred compensation program should be advised that the Section 409A performance-based compensation definition has not changed. <hr> Planning Point: State law implications should also be examined by companies in light of the now firm $1 million cap on the deductibility of compensation. Most states calculate state taxable income based upon the company’s federal taxable income at some point (either before or after NOL and other special federal-level deductions). The impact will vary based on how closely a state conforms its tax rules to the IRC. Some states may conform to the IRC on a rolling basis (i.e., the new changes will immediately flow through to the state level), while others may conform at a fixed date. If the state uses the IRC as in effect at a fixed date (before the passage of tax reform), corporations in these states may have to separately track their starting point (for measurement of the amount of compensation paid during the one-year period) for state tax purposes. <hr> Certain other performance-based compensation (e.g., stock options and stock appreciation rights) payable solely on the attainment of at least one performance goal also was excluded, but only if (1) the goals were set by a compensation committee of the corporation’s board of directors, made up solely of at least two outside directors, (2) the terms under which the compensation would be paid were disclosed to the corporation’s shareholders and approved by a majority vote prior to the time of payment, and (3) the compensation committee certified that the performance goals had been attained before payment was made.<a href="#_ftn3" name="_ftnref3">3</a> A plan would not be considered performance-based compensation, however, if payment would be made when the employee was terminated or retired regardless of whether or not the goal was met.<a href="#_ftn4" name="_ftnref4">4</a> Amounts paid under a binding contract in effect on February 17, 1993, and not modified before the remuneration is paid, also are excluded.<a href="#_ftn5" name="_ftnref5">5</a> If a contract entered into on or before February 17, 1993 is renewed after this date, it becomes subject to the deduction limitation.<a href="#_ftn6" name="_ftnref6">6</a> The IRS has concluded that a proposed supplemental executive retirement plan (“SERP”) ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3540">3540</a>) affecting employees subject to pre-1993 employment contracts did not provide for increased compensation or the payment of additional compensation under substantially the same elements and conditions covered under the employment agreements and thus was not considered a material modification of those agreements pursuant to Treasury Regulation Section 1.162-27(h)(1)(iii)(C).<a href="#_ftn7" name="_ftnref7">7</a> The IRS has released guidance clarifying that the CFO of a smaller reporting company will be treated as a covered employee for purposes of Section 162(m) if the CFO is one of the business’ two most highly compensated employees. In a notice released in 2007, the IRS had stated that a covered employee does not include an employee for whom disclosure is required because the employee is the company’s CFO. A 2015 CCA, however, clarified this rule in the case of smaller reporting companies. The new guidance provides that, in the case of a smaller reporting company, the principal financial officer is a covered employee if he or she is also one of the two most highly compensated employees (other than the CEO) at the end of the tax year. Disclosure is not required only because of the individual’s status as CFO, however.<a href="#_ftn8" name="_ftnref8">8</a> Under the 2017 tax reform legislation, however, the CFO of a company is now generally treated as a covered employee. Revenue Ruling 2008-13 In Revenue Ruling 2008-13, the IRS took the new position that agreements providing for vesting acceleration on performance-based equity or cash awards following an executive’s termination without cause, without good reason, or due to retirement, or if the plan or agreement does not pay remuneration solely on account of the attainment of one or more performance goals and regardless of actual performance, will cause the plan to fail the requirements of Section 162(m), even if the accelerated vesting and payout is never triggered under the plan. In effect, the IRS said that provisions in a plan for vesting and payment accelerations upon terminations without cause, for good reason, or due to involuntary retirement are not permissible payment events under Section 162(m) regulations. The provisions alone thereby cause loss of the compensation deduction, even if the acceleration of vesting and payment never occurs. Under the ruling, the IRS gave employers until January 1, 2009, to modify performance-based plans and agreements with “covered employees” to comply for years after 2009. <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.   IRC § 162(m)(4)(B). <a href="#_ftnref2" name="_ftn2">2</a>.   IRC § 162(m). <a href="#_ftnref3" name="_ftn3">3</a>.   IRC § 162(m)(4)(C). <a href="#_ftnref4" name="_ftn4">4</a>.   Rev. Rul. 2008-13, 2008-10 IRB 518. <a href="#_ftnref5" name="_ftn5">5</a>.   IRC § 162(m)(4)(D); Treas. Reg. § 1.162-27(h)(1)(iii). <a href="#_ftnref6" name="_ftn6">6</a>.   Treas. Reg. § 1.162-27(h)(1)(i). <a href="#_ftnref7" name="_ftn7">7</a>.   Let. Rul. 9619046. <a href="#_ftnref8" name="_ftn8">8</a>.   IRS CCA 201543003. </div></div>

July 14, 2020

3528 / Are there any exceptions to the application of the 21 percent excise tax on certain individuals who provide services for tax-exempt organizations?

<div class="Section1">In order to be covered by the new regulations, the individual receiving remuneration from the ATEO must be an employee, not an independent contractor. The typical facts-and-circumstances analysis is used to determine whether independent contractor status is appropriate.</div> <div class="Section1"> The proposed regulations also contain exceptions designed to exempt certain individuals who provide minimal services for the ATEO. This new rule is meant to exclude “employees” who donate services to tax-exempt organizations. Under the exceptions, (1) a director is not an employee in the capacity as a director and (2) an officer performing minor or no services and not receiving any remuneration for those services is not an employee. Employees of a related non-ATEO are not considered for purposes of determining the five highest-compensated employees if they are never employees of the ATEO. In addition, individuals who receive no remuneration (or a legally binding right to remuneration) from the ATEO or a related organization cannot be among the ATEO’s five highest-compensated employees.<a href="#_ftn1" name="_ftnref1">1</a> Under the limited hours exception, an ATEO’s five highest-compensated employees also exclude an employee of the ATEO who receives no remuneration from the ATEO and performs only limited services for the ATEO, which means that no more than 10 percent of total annual hours worked for the ATEO and related organizations are for services performed for the ATEO.<a href="#_ftn2" name="_ftnref2">2</a> An employee who performs fewer than 100 hours of services as an employee of an ATEO and its related ATEOs is treated as having worked less than 10 percent of total hours for the ATEO and related ATEOs.<a href="#_ftn3" name="_ftnref3">3</a> Under the non-exempt funds exception, an employee who is not compensated by an ATEO, related ATEO, or any taxable related organization controlled by the ATEO and who primarily (more than 50 percent of total hours worked) provides services to a related non-ATEO is also disregarded. Similarly, an employee is disregarded if an ATEO paid less than 10 percent of the employee’s total remuneration for services performed for the ATEO and all related organizations. However, in the case of related ATEOs, if neither the ATEO nor any related ATEO paid more than 10 percent of the employee’s total remuneration, then the ATEO that paid the highest percent of remuneration does not meet this exception. Basically, this exception only applies in the case of multiple ATEOs paying compensation to the same employee. An employee is disregarded for purposes of determining an ATEO’s five highest-compensated employees for a taxable year even though the ATEO paid remuneration to the employee if, for the applicable year, all of the following requirements are met: (1) Remuneration requirement. 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 (2) Related organization requirement. The ATEO had at least one related ATEO and one of the following conditions apply: a. Ten percent remuneration condition. A related ATEO paid at least 10 percent of the remuneration paid by the ATEO and all related organizations; or b. Less remuneration condition. No related ATEO paid at least 10 percent of the total remuneration paid by the ATEO and all related organizations and the ATEO paid less remuneration to the employee than at least one related ATEO.<a href="#_ftn4" name="_ftnref4">4</a> </div> <div class="refs"> <hr align="left" size="1" width="33%" /> <a href="#_ftnref1" name="_ftn1">1</a>. Prop. Treas. Reg. § 53.4960-1(d)(2)(i). <a href="#_ftnref2" name="_ftn2">2</a>. Prop. Treas. Reg. § 53.4960-1(d)(2)(ii)(A)(2). <a href="#_ftnref3" name="_ftn3">3</a>. Prop. Treas. Reg. § 53.4960-1(d)(2)(ii)(C). <a href="#_ftnref4" name="_ftn4">4</a>. Prop. Treas. Reg. § 53.4960-1(d)(iv). </div>

September 30, 2019

3529 / Did the 2017 tax reform legislation make any changes to the rules for calculating unrelated business taxable income (UBTI) in the tax-exempt entity context?

<div class="Section1">Editor’s Note: The Taxpayer Certainty and Disaster Relief Act of 2019<a href="#_ftn1" name="_ftnref1">1</a> repealed the expansion of the UBTI definition. The repeal was made retroactive to the date of enactment, so it is essentially as though the new provision never existed. However, organizations can file an amended Form 990-T to claim a refund for taxes paid under the repealed provision. The rules discussed below reflect the rule as it would have stood had the repeal not happened.</div> <div class="Section1"> The 2017 tax reform legislation created a new IRC Section 512(a)(6) requirement that tax-exempt entities now separately compute unrelated business taxable income (UBTI) for each trade or business, so that losses from one business can no longer be used to offset gains in another business. In interpreting this new rule, several questions arose that the IRS began to address in Notice 2018-67. Notice 2018-67 makes clear that the IRS will not penalize entities for using any reasonable good faith interpretation of the statute in calculating UBTI, and requests comments on implementation of the new rules. The Notice proposes that entities distinguish between their trades and businesses by using the codes provided by the North American Industry Classification System (NAICS) in order to aggregate certain business lines. The notice also requests comments on the IRS’ proposal to create a separate category of “business” for gains and losses generated from partnership investments. Notice 2018-67 contains a safe harbor for organizations to rely upon in the meantime. Under the safe harbor rule, organizations can aggregate income from a single partnership that conducts multiple trades or businesses if the holdings are qualified partnership interests. Gains and losses from all qualifying partnership interests can also be aggregated under the safe harbor. A “qualifying partnership interest” for this purpose is an investment that satisfies one of the following tests: De minimis test where the organization has no more than a 2 percent interest in the profits and capital of the partnership, or Control test, where the organization has no more than a 20 percent interest in the partnership and does not exert any control or influence over the partnership. A transition rule allows aggregation of all income from a single partnership as one trade or business if the interest was acquired before August 21, 2018 (although aggregation across partnerships is not addressed). <hr /> Planning Point: After enactment of the 2020 law, UBTI now will not include amounts paid for (1) qualified transportation fringe benefits, (2) parking facilities used in connection with qualified parking or (3) on-premise athletic facilities, if the amounts are not paid in direct connection with an unrelated trade or business regularly conducted by the organization. With respect to other fringe benefits, an IRS official has commented on the link between the IRC Section 274 expensing rules and the Section 512 UBTI. The official noted that tax-exempts should look to the Section 274 allowances to determine whether they are offering a fringe benefit that would become subject to the UBTI. <hr /> </div> <div class="refs"> <hr align="left" size="1" width="33%" /> <a href="#_ftnref1" name="_ftn1">1</a>. Part of PL 116-94. </div>