1. Recent Developments in Benefits/Executive Compensation Affecting Tax Exempt Organizations  
Tax Cuts and Jobs Act of 2017
Venable LLP
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Washington, DC 20001
February 15, 2018

2. Executive Compensation
“Excessive” Compensation
Excise tax on annual remuneration in excess of $1M for covered employees

3. Executive Compensation(cont’d)
“Excessive” Compensation
Definition of Covered Employee
A covered employee is an employee (including any former employee) of an applicable tax- exempt organization if the employee is one of the five highest compensated employees of the organization for the taxable year or was a covered employee of the organization (or a predecessor) for any preceding taxable year beginning after December 31, 2016.
This definition means far more than five employees may be covered. For example, suppose that two tax-exempt organizations, A and B (with no overlapping employees), merge. The individuals who were the top five of each of A and B will continue to be covered employees forever, even if they are not among the top five of the merged organization.
Similarly, an individual who has unusually high compensation in one year (e.g., as a result of bonuses or deferred compensation) may become a covered employee, and will then remain one even if their compensation in subsequent years is much lower.

4. Executive Compensation(cont’d)
“Excessive” Compensation
Definition of Remuneration –
In general, all compensation reported on the Form W-2 is counted, both in determining whether someone is a covered employee and in determining whether the $1 million cap has been exceeded. However, there are three exceptions:
Roth contributions
Section 457(b) plans of governmental employers (but not private tax-exempts)
Compensation attributable to medical services of licensed medical professionals, such as doctors, nurses, or veterinarians
Note that only compensation attributable to medical services is covered by the second exemption. For example, if a doctor is acting as a hospital administrator, the compensation for administrative services is not exempt.

5. Executive Compensation(cont’d)
“Excessive” Compensation
Timing of Remuneration –
Remuneration is treated as paid when there is no substantial risk of forfeiture (when “vested”).
In most, but not all, instances, this means that the amount is included in remuneration at the same time as it is included in income under section 457(f).
However, amounts are included in Form W-2 wages when paid, not when included in income under 457(f). How can the statement that remuneration means amounts included in Form W-2 income be reconciled with the statement that it is treated as paid when vested?

6. Executive Compensation(cont’d)
“Excessive” Compensation
Differences from the “reasonable compensation” rules
Employees of nonprofits are already subject to a “reasonable compensation” standard, which prevents them from receiving compensation which is not reasonable, considering factors such as the size of the organization and the degree of responsibility. However, the new excess compensation rules are separate from this. Thus, even over $1 million is reasonable for a particular executive (e.g., because the organization is competing with profit-making employers offering more than $1 million for the employee), it will nevertheless be subject to the excise tax if it goes over the $1 million figure.
This can be a particular problem when an executive has built up an organization. In many instances, an executive will initially accept a salary well below market rates, because the organization is small and not able to pay more. However, once the organization becomes much larger (often due to that executive’s own fund-raising and the like), it wants to pay the executive extra to compensate for the low salary in the early years. While such compensation may be reasonable, it may in some instances cause the executive to go over the $1 million cap.

7. Executive Compensation(cont’d)
“Excessive” Compensation
Special problems for medical professionals –
In some instances, a hospital, for example, may want to promote a doctor or nurse to become overall administrator of the hospital. Or a medical school may want to hire a doctor as a professor. In either instance, the compensation of the doctor or nurse involved is no longer exempt from being part of “remuneration” for purposes of the excise taxes.
Issues:
The individual may immediately become subject to the excise tax on excess compensation.
The individual may become a covered employee as a result of the change, meaning the individual is subject to the rules for all future years.
As a result, many organizations may find that they have trouble recruiting the most qualified individuals for nonmedical positions.

8. Executive Compensation(cont’d)
“Excessive” Compensation
Deferred Compensation
Deferred compensation is included in remuneration in the year it becomes vested, which typically means no later than the final year of employment. Given that this is often the year in which the executive has the highest level of compensation, receiving the deferrals may trigger the tax.
Example: A has been putting aside $15,000 in deferred compensation per year for the past 30 years. The value of that today (including earnings) is $850,000. A’s current compensation is $500,000. If A takes the deferred compensation, plus the current compensation, in the final year of employment, A will have a total of $1,350,000 in remuneration, triggering the excise tax.
For an executive with substantial deferrals, consideration may be given to delaying vesting by requiring the executive to continue performing services (e.g., as a consultant) after termination of employment. To avoid having the entire amount subject to the cap in one year, vesting might be spread out over a period of years as a consultant. However, for this to be effective, the amount of services to be performed as a consultant must be substantial relative to the payment. At the same time, the compensation as a consultant must not be so high that it, together with the amount taken into account under the 457(f) plan, gives rise to the excise tax.

9. Executive Compensation(cont’d)
“Excessive” Compensation
Bonuses, vacation, sick leave, and similar plans
Section 457(f) provides exceptions under which certain types of plans are exempt from being taxed when they become vested.
Any 457(b) plan.
Any bona fide vacation leave, sick leave, compensatory time, severance pay, disability pay, or death benefit plan.
Any plan paying solely length of service awards to bona fide volunteers (or their beneficiaries) on account of qualified services performed by such volunteers.
Any plan (such as a bonus plan) in which amounts are paid within 2½ months after the end of the year in which they become vested.
The excise tax on excess compensation does not include those exceptions.
Section 457(b) plans of nongovernmental employers are included in remuneration. Are they counted when vested, or when distributed?
Are accrued vacation and the like included in remuneration when they become vested, not when actually paid?

10. Executive Compensation (cont’d)
“Excessive” Compensation
Governmental plans issues
Applies only to governmental instrumentalities, not integral parts of government
Distinction between the two is unclear under IRS guidance

11. Executive Compensation (cont’d)
“Excessive” severance benefits
A severance payment to a covered employee is a “parachute payment” subject to the tax if the aggregate present value of all severance payments equals or exceeds three times the base amount.
The base amount is the average annualized compensation includible in the covered employee’s gross income for the five taxable years ending before the date of the employee’s separation from employment.
Exclusions similar to those on the excise tax on excess compensation apply to the definition of compensation for this purpose.
If a severance payment is found to be a parachute payment, then all amounts in excess of the base amount (not just the amounts in excess of three times the base amount) are subject to the tax.
Example: A is a covered employee and has a base amount of $300,000. If A receives a severance payment of $899,999, none of it will be subject to the excise tax. However, if A receives a severance payment of $901,000, then $601,000 of it will be subject to the excise tax.
The same amount will not be counted for purposes of the excise tax on excess compensation and the excise tax on excess severance benefits. However, the same severance payment can give rise to both taxes. Suppose the facts are the same as in our prior example. A receives a severance payment of $901,000, plus $900,000 in regular compensation. The $200,000 in severance which is not subject to the excise tax on excess severance benefits will be added to the $900,000 in regular compensation to determine whether the excise tax on excess compensation applies. Accordingly, A’s compensation for the year is $1.1 million, and the excise tax on excess compensation will apply to $100,000 of it. This will be in addition to the excise tax on the $601,000 in excess severance benefits.

12. Transportation fringe benefits
Parking and transit passes –
Can still be provided tax-free to the employee, but employer must treat as UBTI
Alternatively, employer can eliminate the pre-tax benefit, in jurisdictions that permit it

13. Fringe Benefits (cont’d)
Provisions of general application that also affect nonprofits
Moving expense reimbursements - employee tax exclusion repealed (reinstituted in 2025)
Qualified plan loans - A participant terminating employment with an outstanding qualified plan loan will now have an extended period (through the tax return due date for the year in which loan is due) within which to contribute the outstanding loan amount to an IRA and avoid default

14. Contact Venable LLP 600 Massachusetts Avenue Washington, DC 20001
Carol Calhoun
Counsel
Venable LLP
600 Massachusetts Avenue
Washington, DC 20001