AGENCY:

Internal Revenue Service (IRS), Treasury.

ACTION:

Notice of proposed rulemaking.

SUMMARY:

This document sets forth proposed regulations under section 4960 of the Internal Revenue Code (Code), which imposes an excise tax on remuneration in excess of $1,000,000 and any excess parachute payment paid by an applicable tax-exempt organization to any covered employee. The regulations affect certain tax-exempt organizations and certain entities that are treated as related to those organizations. This document also provides notice of a public hearing on these proposed regulations.

DATES:

Written or electronic comments and requests for a public hearing must be received by August 10, 2020. Requests for a public hearing must be submitted as prescribed in the “Comments and Requests for a Public Hearing” section.

ADDRESSES:

Commenters are strongly encouraged to submit public comments electronically. Submit electronic submissions via the Federal eRulemaking Portal at https://www.regulations.gov (indicate IRS and REG-122345-18) by following the online instructions for submitting comments. Once submitted to the Federal eRulemaking Portal, comments cannot be edited or withdrawn. The IRS expects to have limited personnel available to process public comments that are submitted on paper through mail. Until further notice, any comments submitted on paper will be considered to the extent practicable. The Department of the Treasury (Treasury Department) and the IRS will publish for public availability any comment submitted electronically, and, to the extent practicable, on paper to its public docket.

Send paper submissions to: CC:PA:LPD:PR (REG-122345-18), Room 5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, Washington, DC 20044.

FOR FURTHER INFORMATION CONTACT:

Concerning these proposed regulations, William McNally at (202) 317-5600 or Patrick Sternal at (202) 317-5800; concerning submission of comments and/or requests for a public hearing, Regina Johnson, (202) 317-5177 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

I. Section 4960—Enactment and Essential Statutory Provisions

This document sets forth proposed regulations under section 4960 of the Internal Revenue Code (Code) amending part 53 of the Excise Tax Regulations (26 CFR part 53). Section 4960 was added to the Code by section 13602 of the Tax Cuts and Jobs Act, Public Law 115-97, 131 Stat. 2054, 2157 (TCJA). Section 4960(a) generally provides that an applicable tax-exempt organization (ATEO) that for a taxable year pays to a covered employee remuneration in excess of $1 million or any excess parachute payment is subject to an excise tax on the amount of the excess remuneration plus excess parachute payments paid during that taxable year at a rate equal to the rate of tax imposed on corporations under section 11 (21 percent for 2020).

ATEO is defined in section 4960(c)(1) as any organization which for the taxable year is exempt from taxation under section 501(a), is a farmers' cooperative organization described in section 521(b)(1), has income excluded from taxation under section 115(1), or is a political organization described in section 527(e)(1).

Covered employee is defined in section 4960(c)(2) as any employee (including any former employee) of an ATEO 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 predecessor) for any preceding taxable year beginning after December 31, 2016.

Remuneration is defined in section 4960(c)(3)(A) as wages (as defined in section 3401(a)), except that such term does not include any section 402A(c) designated Roth contribution and includes amounts required to be included in gross income under section 457(f). The flush language of section 4960(a) provides that for purposes of applying section 4960(a)(1) and (2), remuneration is treated as paid when there is no substantial risk of forfeiture (within the meaning of section 457(f)(3)(B)) of the rights to such remuneration. Section 4960(c)(3)(B) provides that remuneration does not include any remuneration paid to a licensed medical professional (including a veterinarian) for the performance of medical or veterinary services.

Section 4960(c)(4)(A) provides that remuneration paid to a covered employee by an ATEO includes any remuneration paid with respect to employment of such employee by any related person or governmental entity. Section 4960(c)(4)(B) provides that a person or governmental entity is treated as related to an ATEO if such person or governmental entity: Controls, or is controlled by, the ATEO; is controlled by one or more persons which control the ATEO; is a supported organization (as defined in section 509(f)(3)) during the taxable year with respect to the ATEO; is a supporting organization described in section 509(a)(3) during the taxable year with respect to the ATEO; or, in the case of an ATEO which is a voluntary employees' beneficiary association (VEBA) under section 501(c)(9), establishes, maintains, or makes contributions to the VEBA.

Excess parachute payment is defined in section 4960(c)(5)(A) as an amount equal to the excess of any parachute payment over the portion of the base amount allocated to such payment. Section 4960(c)(5)(D) provides that rules similar to the rules of section 280G(b)(3) apply for purposes of determining the “base amount.” Section 280G(b)(3) provides that the “base amount” is an individual's annualized compensation over the “base period,” which is the individual's last five taxable years.

Parachute payment is defined in section 4960(c)(5)(B) as any payment in the nature of compensation to (or for the benefit of) a covered employee if the payment is contingent on the employee's separation from employment with the employer and the aggregate present value of the payments in the nature of compensation to (or for the benefit of) the individual that are contingent on the separation equals or exceeds 3-times the base amount. Section 4960(c)(5)(C) provides that a parachute payment does not include any payment: Described in section 280G(b)(6) (relating to exemption from payments under qualified plans); made under or to an annuity contract described in section 403(b) or a plan described in section 457(b); made to a licensed medical professional (including a veterinarian) to the extent the payment is for the performance of medical or veterinary services by the professional; or made to an individual who is not a highly compensated employee as defined in section 414(q).

The statute grants the Secretary authority to prescribe regulations as may be necessary to prevent avoidance of the tax under section 4960, including regulations to prevent avoidance of the tax through the performance of services other than as an employee or by providing compensation through a pass-through or other entity to avoid the tax.

Section 4960, added to the Code by section 13602(a) of TCJA, is effective for taxable years beginning after December 31, 2017.

II. Notice 2019-09

On December 31, 2018, the Treasury Department and the IRS issued Notice 2019-09 (2019-04 I.R.B. 403), setting forth initial guidance on the application of section 4960. The notice provides that taxpayers may rely on that guidance, and that, until further guidance is issued, in order to comply with the requirements of section 4960, taxpayers may base their positions upon a reasonable, good faith interpretation of the statute (including consideration of the legislative history, as appropriate). The notice also provides that certain interpretations of section 4960 are not consistent with a reasonable, good faith interpretation of the statutory language, and that the Treasury Department and the IRS intend to embody those positions as part of forthcoming proposed regulations. For further information about continued reliance on the guidance in Notice 2019-09, see part VII of the Explanation of Provisions section, titled “Proposed Applicability Dates.”

The notice provides that any future guidance will be prospective and requests comments on the topics addressed in the notice, as well as comments on any other issues arising under section 4960. The Treasury Department and the IRS considered each of the comments received in drafting these proposed regulations. These proposed regulations are based in large part on Notice 2019-09, with changes as appropriate based on comments received.

Explanation of Provisions

I. Scope of Proposed Regulations

These proposed regulations are intended to provide comprehensive guidance with regard to section 4960. These proposed regulations restate certain statutory definitions and define various terms appearing in section 4960. These proposed regulations also provide rules for determining: The amount of remuneration paid for a taxable year (including for purposes of identifying covered employees); whether a parachute payment is paid; whether excess remuneration is paid and in what amount; whether an excess parachute payment is paid and in what amount; and the allocation of liability for the excise tax among related organizations. These definitions and rules are proposed to apply solely for purposes of section 4960.

II. Definitions

A. Applicable Tax-Exempt Organization

Commenters requested clarification of the status of governmental entities as ATEOs. As defined in section 4960(c)(1), “ATEO” includes an organization that has income excluded from taxation under section 115(1) or an organization that is exempt from taxation under section 501(a). For example, Federal instrumentalities exempt from tax under section 501(c)(1) and public universities with IRS determination letters recognizing their tax-exempt status under section 501(c)(3) are governmental entities exempt from tax under section 501(a), and thus are ATEOs.

A governmental entity that is separately organized from a state or political subdivision of a state may meet the requirements to exclude income from gross income (and thereby have income excluded from taxation) under section 115(1). See Rev. Rul. 77-261 (1977-2 C.B. 45). However, a state, political subdivision of a state, or integral part of a state or political subdivision, often referred to as a “governmental unit” (as in sections 170(b)(1)(A)(v) and 170(c)(1)) does not meet the requirements to exclude income from gross income under section 115(1) because section 115(1) does not apply to income from an activity that the state conducts directly, rather than through a separate entity. See Rev. Rul. 77-261; see also Rev. Rul. 71-131 (1971-1 C.B. 28) (superseding and restating the position stated in G.C.M. 14407 (1935-1 C.B. 103)).

Instead, under the doctrine of implied statutory immunity, the income of a governmental unit generally is not taxable in the absence of specific statutory authorization for taxing that income. See Rev. Rul. 87-2 (1987-1 C.B. 18); Rev. Rul. 71-131; Rev. Rul. 71-132 (1971-1 C.B. 29); and G.C.M. 14407. Section 511(a)(2)(B), which imposes tax on the unrelated business taxable income of state colleges and universities, is an example of a specific statutory authorization for taxing income earned by a state, a political subdivision of a state, or an integral part of a state or political subdivision of a state. Thus, under section 4960(c)(1), a governmental entity (including a state college or university) that does not have a determination letter recognizing its exemption from taxation under section 501(a) and that does not exclude income from gross income under section 115(1) is not an ATEO. However, such a governmental entity may be liable for excise tax under section 4960 if it is a related organization under section 4960(c)(4)(B) with respect to an ATEO.

A governmental entity that sought and received a determination letter recognizing its tax-exempt status under section 501(c)(3) may relinquish this status pursuant to the procedures described in section 3.01(12) of Rev. Proc. 2020-5 (2020-1 I.R.B. 241, 246) (or the analogous section in any successor revenue procedure). However, an entity that excludes all or part of its income from gross income under section 115(1) is an ATEO regardless of whether it has a private letter ruling to that effect.

One commenter requested that proposed regulations specify that certain Federal instrumentalities are not subject to section 4960 excise tax because their enabling statute exempts them from all existing and future Federal taxes, reasoning that Congress did not specifically override the enabling statute in enacting section 4960. This reasoning, if accepted, would exempt many or most Federal instrumentalities from tax under section 4960, both as ATEOs and as related persons or governmental entities. Section 4960 explicitly designates as ATEOs all organizations exempt from taxation under section 501(a). Federal instrumentalities organized under an Act of Congress before July 18, 1984, and exempt from Federal income tax under such Act, are exempt organizations under section 501(a) because they are described in section 501(c)(1). A section 501(c)(1) organization is also a “person or governmental entity” that may be a related organization under section 4960(c)(4). Other Code provisions, such as section 511(a)(2)(A) (which extended unrelated business income tax to exempt organizations), specifically exclude section 501(c)(1) organizations (or particular section 501(c)(1) organizations).^[1] In contrast, a similar exclusion was not included in section 4960 even though section 4960 applies to section 501(c)(1) organizations through reference to entities exempt under section 501(a). Thus, the Treasury Department and the IRS consider Federal instrumentalities to be subject to section 4960, and these proposed regulations do not adopt the commenter's suggestion. However, the Treasury Department and the IRS request comments regarding the application of section 4960 to these Federal instrumentalities.

These proposed regulations also address the status of foreign organizations as ATEOs. A foreign organization that otherwise qualifies as an ATEO will be treated as an ATEO unless it is described in section 4948(b) and the regulations thereunder. Section 4948(b) excludes foreign organizations from the application of excise taxes under chapter 42 (which includes section 4960) if they receive substantially all of their support (other than gross investment income) from sources outside the United States. Section 53.4948-1(a)(1) defines a “foreign organization” for this purpose as an organization not described in section 170(c)(2)(A) (that is, not created or organized in the United States or in any possession thereof, or under the law of the United States, any State, the District of Columbia, or any possession of the United States).

One commenter asked whether a foreign organization can be a related organization. Section 4960(c)(4)(B) does not distinguish between domestic and foreign organizations for purposes of determining status as a related organization to an ATEO. However, the Treasury Department and the IRS are considering whether section 4948(b) should apply to exempt a foreign organization (that otherwise meets the definition of “related organization”) from liability for tax under section 4960(c)(4)(C). For example, in the context of the section 4958 excise tax on excess benefit transactions, an organization is excepted from status as an applicable tax-exempt organization if it is described in section 4948(b) (see § 53.4958-2(b)(2)); thus, the tax under section 4958 does not apply to a disqualified person with respect to such a foreign organization. The Treasury Department and the IRS request comments on whether a foreign related organization described in section 4948(b) may be liable for tax under section 4960(c)(4)(C). The Treasury Department and the IRS also request comments on whether, for purposes of determining excess remuneration and allocating liability among the ATEO and related organizations, remuneration paid by a foreign related organization described in section 4948(b) should be taken into account even if the foreign related organization is exempt from liability for section 4960 tax.

B. Applicable Year

1. In General

Section 4960(a)(1) refers to remuneration paid “for the taxable year,” but does not specify which taxpayer's taxable year is referenced, what it means for remuneration to be paid “for” a taxable year, or how to measure remuneration if an ATEO and a related organization have different taxable years. These proposed regulations provide that remuneration is paid for a taxable year if it is paid during the “applicable year,” which is defined in these proposed regulations as the calendar year ending with or within an ATEO's taxable year.

Commenters were unsure whether “taxable year” refers to the taxable year of the ATEO, the related organization, or the covered employee. In addition, commenters noted that a tax-exempt organization's “taxable year” for purposes of section 4960 is not always obvious because generally a tax-exempt organization does not pay taxes and because section 4960 does not include its own definition of “taxable year.” The Treasury Department and IRS developed the applicable year concept to resolve this ambiguity. Prescribing a single period resolves this issue and also reduces the administrative burdens that would arise if ATEOs and related organizations liable for the excise tax were required to allocate remuneration paid during a single calendar year to multiple non-calendar taxable years. Moreover, this approach reduces administrative burdens by aligning more closely with the calendar year reporting of compensation on Form W-2, “Wage and Tax Statement,” and on Part VII and Schedule J of Form 990, “Return of Organization Exempt From Income Tax.” Finally, the concept of an applicable year aligns with the period for identifying highly compensated employees under section 414(q), as required for determining whether certain payments are excess parachute payments.

Remuneration paid during an applicable year is also used for identifying the five highest-compensated employees for a taxable year and thus the covered employees of the ATEO for the taxable year (who will remain covered employees for all future taxable years). Generally, status as an ATEO will not change during the taxable year, in which case the full twelve months of the applicable year is used as the measuring period. However, for the taxable year in which the ATEO becomes an ATEO (for example, if the ATEO is formed mid-year), or taxable year in which the ATEO ceases to be an ATEO (for example, due to corporate dissolution or revocation of exemption), adjustments to the standard applicable year may be necessary.

2. Rules Addressing the First Taxable Year an Organization Becomes an ATEO

For the taxable year in which an organization becomes an ATEO, the applicable year begins on the date the organization becomes an ATEO and ends on December 31 of that calendar year (“short applicable year”). For a calendar year taxpayer, the short applicable year is taken into account for the taxable year ending on the same date. For fiscal year taxpayers, the short applicable year is taken into account for the taxable year in which the short applicable year ends. If the ATEO has any related organizations, only the compensation paid (or treated as paid) by the related organizations during the short applicable year is taken into account for purposes of determining the amount of remuneration paid by the ATEO for that year.

3. Rules Addressing the Taxable Year in Which ATEO Status Terminates

For ATEOs with a calendar year taxable year, termination of ATEO status generally results in a short applicable year. The applicable year starts with January 1 and ends on the date of termination of ATEO status. For ATEOs with a fiscal year taxable year, termination of ATEO status may result in two applicable years being taken into account for the taxable year in which termination occurs. If the termination of ATEO status occurs on or before December 31 of the calendar year ending within the taxable year of the termination, then the applicable year for that taxable year starts January 1 and ends on the date of termination of status. If the termination of ATEO status occurs after December 31 of the calendar year ending within the taxable year of the termination, then the ATEO has two applicable years for the taxable year: The full calendar year ending within the taxable year in which the termination of ATEO status occurs and the period starting on January 1 of the calendar year in which termination of ATEO status occurs and ending on the date of termination. While liability for the tax for both applicable years is aggregated and reported for the taxable year of termination of ATEO status, covered employees and the amount of the tax for each applicable year are determined separately for each applicable year. For example, if an ATEO with no related organizations paid a covered employee $1.1 million of remuneration in the first applicable year (the full 12-month applicable year) and $500,000 in the second applicable year (the short applicable year ending on the date of termination of ATEO status), the ATEO would be liable for excise tax only on the $100,000 of excess remuneration it paid in the first (full) applicable year and would not be treated as paying any excess remuneration for the second (short) applicable year.

C. Employee

Section 4960(a) imposes a tax on excess remuneration and any excess parachute payment paid by an ATEO for the taxable year with respect to employment of a covered employee. Section 4960(c)(2) defines a “covered employee” as an employee (including any former employee) of the ATEO who meets certain other conditions. Accordingly, the tax imposed by section 4960(a) applies only with respect to a current or former employee of the ATEO.

Because the tax under section 4960(a)(1) applies to remuneration paid to a covered employee, and section 4960(c)(3)(A) defines “remuneration” as including wages under section 3401(a) (related to Federal income tax withholding) other than any designated Roth contribution as defined in section 402A(c), these proposed regulations define “employee” consistent with the definition of “employee” for purposes of Federal income tax withholding in section 3401(c) and the regulations thereunder. Specifically, the proposed regulations cross-reference the definition of “employee” in § 31.3401(c)-1, which includes common-law employees, officers or elected or appointed officials of governments, or agencies or instrumentalities thereof, and certain officers of corporations. These proposed regulations reiterate certain rules from § 31.3401(c)-1 that are particularly relevant to section 4960, including the rules that a member of a board of directors of a corporation is not an employee of the corporation (in the capacity as a director), and that an officer is an employee of the entity for which the officer serves as an officer (unless the officer performs no services or only minor services and neither receives, nor is entitled to receive, any remuneration, as discussed in part II.E. of this preamble, titled “Covered employee”). Accordingly, the Treasury Department and the IRS did not adopt one commenter's suggestion that an officer of an ATEO not be presumptively treated as an employee of the ATEO. For further discussion of this definition of “employee” and other proposed rules intended to address employees of non-ATEO related organizations performing limited or temporary services for the related ATEO (in particular, while also receiving compensation from the non-ATEO related organization), see part II.E.2. of this preamble, titled “Volunteer Services and Similar Exceptions.”

D. Employer

Section 4960(b) provides that the employer is liable for the tax imposed under section 4960(a). Similar to the definition of “employee,” these proposed regulations define “employer” consistent with the definition of “employer” for purposes of Federal income tax withholding in section 3401(d) and the regulations thereunder, without regard to the special rules in section 3401(d)(1) and (2). Accordingly, control of the payment of wages is not relevant for determining whether an entity is the employer for section 4960 purposes. Further, these proposed regulations provide that a person or governmental entity does not avoid status as an employer of an employee by using a third-party payor to pay remuneration to that employee. Third-party payors include a payroll agent, common paymaster, statutory employer under section 3401(d)(1), or certified professional employer organization under section 7705 (under the Code, an “employer” for subtitle C purposes only). Further, consistent with existing principles for determining the employer, under certain facts and circumstances, a management company may also be acting as a third-party payor for the employees of its ATEO client, rather than as the common law employer of the employees. Thus, as set forth in these proposed regulations, remuneration that is paid by a separate organization to an individual for services the individual performed as an employee of the ATEO, whether related to the ATEO or not, is deemed remuneration paid by the ATEO for purposes of section 4960. These proposed regulations also specify that calculation of the excise tax is separate from any arrangement that an ATEO and any related organization may have for bearing the cost of the excise tax under section 4960.

In addition, these proposed regulations provide that the sole owner of an entity that is disregarded as separate from its owner under § 301.7701-2(c)(2)(i) is treated as the employer of any employee of the disregarded entity, notwithstanding that the entity is regarded for subtitle C purposes under § 301.7701-2(c)(2)(iv).

E. Covered Employee

1. In General

Consistent with section 4960(c)(2), these proposed regulations define “covered employee” to mean any individual who is one of the five highest-compensated employees of the ATEO for a taxable year or was a covered employee of the ATEO (or any predecessor) for any preceding taxable year beginning after December 31, 2016. These proposed regulations provide that whether an employee is one of the five highest-compensated employees of an ATEO is determined separately for each ATEO and not for the entire group of related organizations. As a result, a group of related ATEOs can have more than five highest-compensated employees for a taxable year. Similarly, an employee may be a covered employee of more than one ATEO in a related group of organizations for a taxable year. Once an employee is a covered employee of an ATEO, the employee continues to be a covered employee for all subsequent taxable years of that ATEO. One commenter suggested a minimum dollar threshold for determining the five highest-compensated employees. These proposed regulations do not set a minimum dollar threshold for an employee to be a covered employee because there is no minimum threshold provided in the statute. Thus, an employee need not be paid excess remuneration or an excess parachute payment or be a highly compensated employee within the meaning of section 414(q) to be a covered employee of an ATEO for a taxable year and all future taxable years. (Note, however, that if an ATEO never pays a covered employee excess remuneration or an excess parachute payment, then there would be no section 4960 excise tax with respect to the covered employee.)

Commenters suggested that the Treasury Department and the IRS provide a rule of administrative convenience under which a covered employee is no longer considered a covered employee of an ATEO after a certain period of time has elapsed during which the employee was not an active employee of the ATEO. These proposed regulations do not adopt that suggestion because such a rule would be inconsistent with the statute.

The Treasury Department and the IRS considered using certain existing reporting standards for determining the amount of compensation paid to an employee for purposes of identifying the five highest-compensated employees for a taxable year under section 4960, such as the Securities and Exchange Commission standards that are used for section 162(m) purposes or the standards that are used for Form 990 reporting purposes. These proposed regulations generally use remuneration paid during the applicable year for purposes of identifying an ATEO's five highest-compensated employees for a taxable year because remuneration is an appropriate representation of compensation earned by an employee and it is more administrable to use a single standard for identifying covered employees and computing the tax, if any, imposed by section 4960(a)(1). However, these proposed regulations provide that while remuneration for which a deduction is disallowed under section 162(m) is generally not taken into account for purposes of determining the amount of remuneration paid for a taxable year, it is taken into account as remuneration paid for purposes of determining an ATEO's five highest-compensated employees. This rule is needed to ensure proper coordination between the rules under section 162(m) and the rules under section 4960.

These proposed regulations also provide that, for purposes of determining whether an employee is one of an ATEO's five highest-compensated employees for a taxable year, remuneration paid by the ATEO during the applicable year is aggregated with remuneration paid by any related organization during the ATEO's applicable year, including remuneration paid by a related for-profit organization or governmental entity, for services performed as an employee of such related organization. For a description of proposed rules intended to address certain situations in which an employee of a non-ATEO performs limited or temporary services for a related ATEO, see part II.E.2. of this preamble, titled “Volunteer Services and Similar Exceptions.”

Consistent with section 4960(c)(3)(B), these proposed regulations provide that for purposes of identifying an ATEO's five highest-compensated employees for a taxable year, remuneration paid during the applicable year for medical services is not taken into account. See H. Rept. 115-466, at 494 (2017) (“[f]or purposes of determining a covered employee, remuneration paid to a licensed medical professional which is directly related to the performance of medical or veterinary services by such professional is not taken into account, whereas remuneration paid to such a professional in any other capacity is taken into account.”). For a discussion of the proposed rules addressing identification of remuneration paid for medical or veterinary services, see section II.F. of this preamble, titled “Medical Services.”

2. Volunteer Services and Similar Exceptions

Many commenters expressed concern that the rules for identifying an ATEO's five highest-compensated employees provided in Notice 2019-09 would subject a non-ATEO to the excise tax on remuneration it pays to an employee who performs limited or temporary services for a related ATEO and who typically receives remuneration only from the non-ATEO. In this scenario, the allocation rules in Notice 2019-09 would allocate the entire excise tax to the non-ATEO. In addition, because the individual would continue to be treated as a covered employee of the ATEO for all subsequent taxable years, the non-ATEO would continue to be subject to the excise tax on any excess remuneration it paid to that employee for his or her remaining period of service as an employee of the non-ATEO, even if the individual ceased performing services as an employee of the ATEO (for example, upon “returning” to the non-ATEO after a temporary assignment at the ATEO). The commenters criticized this result, suggesting that the individual typically is performing services for the ATEO solely as a “volunteer” and that application of the excise tax would force significant changes to existing structures to avoid the tax, including possible dissolution of the ATEO or utilization of ATEO funds to procure separate services from other individuals with no employment relationship at the related non-ATEO. They argued that Congress did not intend to impose the excise tax under section 4960 in these circumstances.

Commenters suggested several modifications to the guidance provided in Notice 2019-09 in order to avoid these results. After consideration of the comments received, the Treasury Department and the IRS propose exceptions to the definition of “employee” and “covered employee” and the rules for identifying the five highest-compensated employees to address these concerns. These exceptions are intended to ensure that certain employees of a related non-ATEO providing services as an employee of an ATEO are not treated as one of the five highest-compensated employees of the ATEO, provided that certain conditions related to the individuals' remuneration or hours of service are met. To avoid manipulation of the rules through the deferral of compensation, in determining whether an employee is one of the five highest-compensated employees, a grant of a legally binding right to vested remuneration is considered to be remuneration paid, and any grant of a legally binding right to nonvested remuneration by the ATEO (or a related ATEO), for example, under a deferred compensation plan or arrangement, disqualifies the ATEO from claiming a relevant exception.

Remuneration paid to an individual who is never an employee of the ATEO is not taken into account for purposes of section 4960. For example, an individual who, under all the facts and circumstances, performs services for the ATEO solely as a bona fide independent contractor is not an employee of the ATEO and thus is not considered for purposes of determining the ATEO's five highest-compensated employees. Similarly, an individual who, under all the facts and circumstances, performs services solely as a bona fide employee of a related organization, including a related organization that provides services to the ATEO, is not an employee of the ATEO and thus is not considered for purposes of determining the ATEO's five highest-compensated employees.

In addition, these proposed regulations provide that for purposes of determining an ATEO's five highest-compensated employees for a taxable year, an employee is disregarded if neither the ATEO nor any related organization pays remuneration or grants a legally binding right to nonvested remuneration for services the individual performed as an employee of the ATEO or any related organization. This clarifies that if none of the ATEO's employees received remuneration from the ATEO or from a related organization, then the ATEO has no covered employees (instead of requiring that some employee be treated as a covered employee). Note, however, that employees who had been properly classified as covered employees in any prior taxable year would continue to be covered employees.

This rule also addresses concerns commenters expressed regarding situations in which the ATEO (and its related organizations) may not provide an employee a salary or monetary compensation but may provide other nontaxable benefits. The Treasury Department and the IRS note that benefits excluded from gross income are not considered remuneration, including expense allowances and reimbursements under an accountable plan (see § 1.62-2) and most insurance for liability arising from service with an ATEO, such as directors and officers liability insurance (see § 1.132-5(r)(3)). The Treasury Department and the IRS request comments on whether certain taxable benefits, such as employer-provided parking in excess of the value excluded under section 132, should be disregarded for purposes of determining whether an individual receives remuneration for services for this purpose and, if so, what standards should apply to identify those benefits.

Several commenters suggested that an employee who works for an ATEO for a small percentage of the employee's total hours worked for the ATEO and all its related organizations should be disregarded for purposes of determining that ATEO's five highest-compensated employees. To accommodate those situations in which an employee of a related non-ATEO provides limited services as an employee of the ATEO without any payment of compensation by the ATEO, these proposed regulations also provide a “limited-hours” exception for purposes of determining the five highest-compensated employees of the ATEO. Under this exception, an employee of an ATEO is disregarded for purposes of determining the ATEO's five highest-compensated employees for a taxable year if neither the ATEO nor any related ATEO pays remuneration or grants a legally binding right to nonvested remuneration to the employee for services performed for the ATEO and the employee performs only limited services for the ATEO. For purposes of the requirement that an employee not be paid remuneration by the ATEO, the ATEO is not deemed to pay remuneration for services performed for the ATEO that is paid by a related organization that also employs the individual, so long as the ATEO does not reimburse the payor and is not treated as paying remuneration paid by a related organization for services performed for the related organization (although, as discussed in section III.A of this preamble, titled “In General,” for other purposes, this remuneration generally is treated as paid by the ATEO).

In addition, an employee qualifies for this exception only if the hours of service the employee performs as an employee of the ATEO comprise 10 percent or less of the employee's total hours of service for the ATEO and all related organizations during the applicable year. For example, an employee of an ATEO and a related organization who works on average 10 hours per month as an employee of the ATEO (or 120 hours for the applicable year) and works on average 165 hours per month as an employee of the related organization (or 1,980 hours for the applicable year) is not counted among the ATEO's five highest-compensated employees for the taxable year, regardless of the amount of the employee's total remuneration, provided the ATEO does not pay the employee any remuneration. In addition, these proposed regulations provide a safe harbor under which an employee who performs fewer than 100 hours of services as an employee of an ATEO (and all related ATEOs) during an applicable year is treated as having worked less than 10 percent of the employee's total hours for the ATEO (and all related ATEOs).

Commenters have raised concerns that an employee of a taxable organization who performs more significant services for a related ATEO as an employee of the ATEO, but with no remuneration paid by the ATEO, may be treated as one of the ATEO's five highest-compensated employees solely based on the remuneration the employee receives from his or her regular, permanent employment with the related taxable organization. The Treasury Department and the IRS understand that the common practice of a taxable organization donating services of their employees to a related ATEO, without the ATEO incurring any expense for these services, is often premised on a desire to assist the ATEO in furthering its exempt purposes without the ATEO inadvertently paying compensation that may be subject to excise tax under sections 4941, 4945, or 4958. Furthermore, in these situations, the ATEO is not expending any of its funds for the employee's services. Regarding the reason for enacting section 4960, the House Report referenced payment of excessive compensation using tax-exempt funds, as well as aligning the tax treatment between for-profit and tax-exempt employers. Specifically, the House Report provided:

The Committee believes that tax-exempt organizations enjoy a tax subsidy from the Federal government because contributions to such organizations generally are deductible and such organizations generally are not subject to tax (except on unrelated business income). As a result, such organizations are subject to the requirement that they use their resources for specific purposes, and the Committee believes that excessive compensation (including excessive severance packages) paid to senior executives of such organizations diverts resources from those particular purposes. The Committee further believes that alignment of the tax treatment of excessive executive compensation (as top executives may inappropriately divert organizational resources into excessive compensation) between for-profit and tax-exempt employers furthers the Committee's larger tax reform effort of making the system fairer for all businesses.

H. Rep. 115-409, 115th Cong., 1st Sess. 333 (Nov. 13, 2017). Accordingly, these proposed regulations also provide a “nonexempt funds” exception for employees of controlling taxable organizations that perform more substantial services as an employee of the ATEO under certain circumstances.

Under the nonexempt funds exception, an employee is disregarded for purposes of determining an ATEO's five highest-compensated employees for a taxable year if neither the ATEO, nor any related ATEO, nor any taxable related organization controlled by the ATEO pays the employee of the ATEO any remuneration for services performed for the ATEO or grants a legally binding right to nonvested remuneration to the employee. As under the limited hours exception, for purposes of the requirement that an employee not be paid remuneration by the ATEO, the ATEO is not deemed to pay remuneration that is paid by a related organization that also employs the individual, so long as the ATEO does not reimburse the payor and is not treated as paying remuneration paid by a related organization for services performed for the related organization. In addition, to prevent indirect payment of remuneration by the ATEO, related ATEOs, or taxable related organizations controlled by the ATEO, the related taxable organization paying the employee remuneration must not provide services for a fee to the ATEO, related ATEOs, or their controlled taxable related organizations.

Further, the employee must have provided services primarily to the related taxable organization or other non-ATEO (other than a taxable subsidiary of the ATEO) during the applicable year. For purposes of this exception, an employee is treated as having provided services primarily to the related taxable organization or other non-ATEO (other than a taxable subsidiary of the ATEO) only if the employee provided services to the related non-ATEO for more than 50 percent of the employee's total hours worked for the ATEO and all related organizations (including ATEOs) during the applicable year. For example, an individual who works 40 total hours per week, 15 of which are for an ATEO and 25 of which are for a related taxable organization, would primarily provide services for the related taxable organization. The determination is made for each applicable year, so an employee who provides services full-time for 3 1/2 months of an applicable year to an ATEO and the remaining 8 1/2 months to the related taxable organization would be considered as providing services primarily to the related taxable organization.

The “limited services” exception set forth in Q/A-10(b) of Notice 2019-09 provides that an employee is not one of an ATEO's five highest-compensated employees for a taxable year if, during the applicable year, the ATEO paid less than 10 percent of the employee's total remuneration during the applicable year for services performed as an employee of the ATEO and all related organizations. However, if an employee would not be treated as one of the five highest-compensated employees of any ATEO in an ATEO's group of related organizations because no ATEO in the group paid at least 10 percent of the total remuneration paid by the group during the applicable year, then this exception does not apply to the ATEO that paid the employee the most remuneration during that applicable year. These proposed regulations adopt a substantially similar rule that has been modified to simplify the structure of the exception and to clarify that the exception does not apply if the ATEO has no related ATEOs.

Several other comments were received relating to the issue of employees of a non-ATEO providing temporary or limited services to a related ATEO. Several commenters suggested that “volunteers” should be excluded from the definition of “employee.” The term “employee” for Federal tax purposes generally is understood to refer to a common-law employee. Whether a service provider is a common-law employee generally turns on whether the service recipient has the right to direct and control the service provider, not only as to the result to be accomplished by the work but also as to the details and means by which that result is accomplished. See, e.g., § 31.3121(d)-1(c)(2). The determination does not depend on whether or how the individual is compensated or by which person. The Treasury Department and the IRS do not adopt the suggestion to modify the common-law standard for determining employee status solely for purposes of section 4960 or to use a definition other than the common law standard. Nonetheless, the limited hours and nonexempt funds exceptions provided in these proposed regulations exclude certain employees that some may view as “volunteers” from status as one of an ATEO's five highest-compensated employees, and, as discussed in section II.C. of this preamble, titled “Employee,” these proposed regulations exclude certain “volunteer” officers, consistent with employment tax regulations.

A commenter suggested that the definition of “employee” under Notice 2019-09 be modified so that officer status is not presumptive of common-law employee status. Another commenter suggested that officers who are not paid directly by the ATEO and who perform only minor services for the ATEO be excluded either from the definition of “employee” or from the five highest-compensated employees. Under section 4960(c)(3)(A), whether an amount is remuneration generally is based on whether an amount is wages as defined in section 3401(a). Section 31.3401(c)-1(f) provides that an officer generally is treated as an employee, but provides an exception under which an employee of the corporation does not include an officer who performs no services, or performs only minor services, and who neither receives, nor is entitled to receive, any remuneration. Because the definition of “remuneration” is tied to the definition of “wages” under section 3401(a) and § 31.3401(c)-1(f) provides that officers generally are treated as employees, the Treasury Department and the IRS do not agree that it is appropriate to provide categorically that officers are not employees. However, consistent with § 31.3401(c)-1(f), these proposed regulations define “employee” to exclude any officer who as such does not perform any services or performs only minor services and who neither receives, nor is entitled to receive, any remuneration.

A commenter suggested that an exception to the definition of “employee” for purposes of section 4960 that would align with the “volunteer” exception used for purposes of reporting employee compensation on the Form 990. Under this exception, an employee of a for-profit entity would not be considered an employee of the ATEO if the ATEO does not control the for-profit entity, the for-profit entity does not provide management services for a fee to the ATEO, and the employee provides only “volunteer” services to the ATEO (that is, services for which the ATEO pays no compensation to the employee). The Treasury Department and the IRS decline to adopt this approach because the considerations underlying the Form 990 definition of “employee” are different than those underlying section 4960. However, the limited hours and nonexempt funds exceptions provided in these proposed regulations are similar to the Form 990 “volunteer” exception and will cover many of the same employees.

Commenters suggested that an individual not be treated as one of an ATEO's five highest-compensated employees if the compensation paid directly by the ATEO (regardless of the compensation paid by one or more related organizations) did not meet a certain threshold amount or if the employee did not receive from the ATEO more than a threshold percentage of total compensation from the ATEO and its related organizations. Commenters also suggested that, for purposes of determining an ATEO's five highest-compensated employees, the amount paid to an employee should include only the amount paid by an ATEO (or by an ATEO and related ATEOs) and not by any of its related organizations (or not by any of its related non-ATEOs). The Treasury Department and the IRS do not adopt these suggestions because of concerns that these standards would permit taxpayers to restructure compensation arrangements so that a related organization pays compensation on behalf of an ATEO or break up operations into multiple ATEOs, each paying below the threshold, in order to control the identification of the ATEO's covered employees (and, in particular, would permit taxpayers to ensure that any individuals being paid overall remuneration in excess of $1 million are not identified as covered employees).

Commenters also suggested that, for purposes of determining an ATEO's five highest-compensated employees, the amount paid to an employee should be measured only by reference to compensation paid to the employee for services rendered as an employee of the ATEO (regardless of the payor). The Treasury Department and the IRS do not adopt this suggestion because an arrangement between entities for compensating employees of two or more of the entities may not accurately reflect the relative value of the services an employee provides to each of the entities. In addition, due to the highly factual nature of the analysis and the potential for differing conclusions, such a rule would not result in a predictable standard for taxpayers or the IRS to apply. However, the limited hours and nonexempt funds exceptions set forth in these proposed regulations are intended to address the concerns of these commenters.

Finally, a commenter suggested that a rule be provided under which an ATEO is permitted to choose one of several permissible methods to determine its five highest-compensated employees. A standard that would permit an ATEO to select among various identification methods would create administrative burdens and complexities not only in implementing that ATEO's election, but also in coordinating among related ATEOs (and their related non-ATEOs) with differing identification methods, applying changes in methods selected by ATEOs, and determining the consequences of corporate transactions involving ATEOs (for example, a merger of two ATEOs using two different identification methods). In addition, the Treasury Department and the IRS anticipate that the definitions of “employee” and “five highest-compensated employees” in these proposed regulations will address the issues raised by commenters concerning employees of non-ATEOs performing limited or temporary services for a related ATEO. For these reasons, these proposed regulations do not adopt this suggestion. However, the Treasury Department and the IRS continue to invite comments on any modifications to these proposed regulations with respect to identifying an ATEO's five highest-compensated employees that are consistent with the statutory provisions, treat similarly situated taxpayers consistently, do not permit improper avoidance of the provisions, and are administrable and not overly burdensome.

F. Medical Services

Section 4960(c)(3)(B) provides that remuneration for purposes of section 4960 does not include the portion of any remuneration paid to a licensed medical professional (including a veterinarian) that is for the performance of medical or veterinary services by such professional. Section 4960(c)(5)(C)(iii) provides a substantially similar exception from the definition of “parachute payment.” Commenters requested clarification of the types of services that for this purpose are medical or veterinary services.

These proposed regulations define “medical services” as the diagnosis, cure, mitigation, treatment, or prevention of disease in humans or animals; services provided for the purpose of affecting any structure or function of the human or animal body; and other services integral to providing such medical services, that are directly performed by a licensed medical professional. This standard is consistent with the statement in the Conference Report to TCJA, H. Rept. 115-466, at 494 (2017) that the exception applies only to remuneration “directly related” to the performance of medical services (including veterinary services). This standard is based on the definition of “medical care” under section 213(d)(1)(A) and § 1.213-1(a), which is a developed area of Federal tax law. Under these proposed regulations, only the remuneration paid by the employer to a licensed medical professional for the actual provision of medical services (or administrative tasks integral to such services) is disregarded for purposes of determining the amount of remuneration paid to the licensed medical professional for the applicable year (and the amount of any parachute payment under section 4960(c)(5)(C)(iii)). The proposed regulations provide that certain administrative tasks, such as creating patient records, are so integral to performing medical services that they constitute the performance of medical services. Further, the proposed regulations provide that, for purposes of section 4960, remuneration paid to a licensed medical professional for teaching or research services does not qualify for the exclusion from remuneration under section 4960(b)(3)(B) (or the exclusion from amounts treated as a parachute payment under section 4960(c)(5)(C)(iii)) except to the extent those services constitute medical services.

The Conference Report to TCJA states that “[a] medical professional for this purpose includes a doctor, nurse, or veterinarian.” H. Rept. 115-466, at 494 (2017). To further clarify the standard, these proposed regulations provide that a “licensed medical professional” is an individual who is licensed under state or local law to perform medical services. In addition to doctors, nurses, and veterinarians, as listed in the legislative history, a licensed medical professional generally would include dentists and nurse practitioners and may include other medical professionals, depending on the applicable state or local law.

For a discussion of other issues related to remuneration for medical or veterinary services, including a proposed rule for allocating remuneration received for a combination of medical and non-medical services, see part III of this preamble, titled “Remuneration.”

G. Predecessor Organization

Section 4960(c)(2)(B) provides that a covered employee includes any employee who was a covered employee of the ATEO (or any predecessor) for any preceding taxable year beginning after December 31, 2016. Because, under section 4960(c)(2), a covered employee must be (or have been) an employee of an ATEO, the predecessor must also have been an ATEO. Thus, an individual who is a covered employee of an ATEO (or of an ATEO predecessor of an ATEO) for one taxable year remains a covered employee of that ATEO (and any successor ATEOs) for subsequent taxable years.

These proposed regulations define “predecessor” by reference to several enumerated categories of organizational changes, including acquisitions, mergers, other reorganizations, and changes in tax-exempt status. A predecessor ATEO ordinarily is an ATEO that has transferred, by any of several legal means, its assets and operations to another pre-existing or newly created ATEO (the successor of the predecessor ATEO). This definition generally is consistent with the proposed regulations under section 162(m), 84 FR 70356 (December 20, 2019), with certain differences discussed in this section of the preamble. Section 162(m)(1) disallows a deduction for compensation in excess of $1 million paid by publicly-held corporations to certain executive officers, and the proposed regulations under section 162(m) define certain similar terms, including predecessor organization.

These proposed regulations provide that if an acquiror ATEO acquires at least 80 percent of the operating assets or total assets (determined by fair market value on the date of acquisition) of a target ATEO, then the target ATEO is a predecessor of the acquiror ATEO (the 80 percent asset transfer rule). However, the proposed regulations provide that only the target ATEO's covered employees that commence the performance of services for the acquiror ATEO (or an organization related to the acquiror) during the period beginning 12 months before and ending 12 months after the date on which all events necessary for the acquisition have occurred become the acquiror ATEO's covered employees (the 24-month services rule). For acquisitions of assets that occur over time, these proposed regulations generally provide that only acquisitions that occur within a twelve-month period are taken into account for purposes of applying the 80 percent asset transfer rule, though the period is extended during any period in which there is a plan to acquire the target's assets. The acquisition may be by gift or for bona fide consideration.

The 24-month services rule differs from the corresponding rule in the proposed regulations under section 162(m) in that for section 162(m), the proposed rule relates to hiring by the publicly held corporation (including its affiliated group), whereas the rule in these proposed regulations relates to hiring by an ATEO or any related organization. This difference reflects a structural difference in the two statutes, but the two rules are meant to have substantively similar effects.

These proposed regulations provide that a predecessor of an acquiror ATEO includes an ATEO that is acquired (target), or the assets of which are acquired, by another ATEO (acquiror) in most corporate reorganization transactions defined in section 368. Accordingly, the covered employees of a target are also covered employees of the acquiror. For nonprofit corporations, such reorganizations would commonly include mergers described in section 368(a)(1)(A). These proposed regulations also treat as a predecessor an organization that merely changes its form or place of organization as described in section 368(a)(1)(F).

The categories of organizational changes in these proposed regulations resulting in a predecessor and a successor are not mutually exclusive. For example, these proposed regulations treat a restructuring ATEO that changes its organizational form or place of organization as a predecessor of the surviving organization. Many or most such transactions, though not all, result in the same treatment under one or more of the 80 percent asset transfer rule, section 368(a)(1)(F), or Rev. Proc. 2018-15, 2018-9 I.R.B. 378.^[2]

ATEOs generally are defined as organizations exempt from tax under one of several Code sections. For purposes of section 4960(c)(2)(B), an ATEO may be a predecessor of itself due to its moving in and out of status as an ATEO. Specifically, these proposed regulations provide that a predecessor of an ATEO includes an ATEO that, after ceasing to be an ATEO, again becomes an ATEO effective for a taxable year (or part of the taxable year) ending before the date that is 36 months following the due date (disregarding any extensions) for the filing of the ATEO's information return under section 6033, such as Form 990 (or Federal income tax return in the case of section 115 instrumentalities or section 521 farmers' cooperatives), for the most recent taxable year during which the organization was an ATEO. The 36-month limitation is included for reasons similar to those underlying the proposed definition of “predecessor” for purposes of section 162(m)(3)(C). See Prop. § 1.162-33(c)(2)(ii)(C) and (H). These proposed regulations also provide that a predecessor of an ATEO includes any predecessor of its predecessor (thus, there may be a chain of predecessors).

ATEOs, which are defined in section 4960(c)(1), differ in their organizational structures and basis for tax exemption and in the types of reorganizational changes that they may undergo. For instance, predecessor rules involving transfers of stock generally will apply only to a limited class of ATEOs because ATEOs generally are not stock corporations. These proposed regulations specify that, in the case of an election to treat as an asset purchase either the sale, exchange, or distribution of stock pursuant to regulations under section 336(e) or the purchase of stock pursuant to regulations under section 338, the ATEO is treated as the same organization before and after the transaction for which the election is made. Comments are requested on the application of these rules to ATEOs and whether any other types of transactions involving ATEOs should be analyzed to determine if the predecessor rules do or should apply.

H. Related Organization

Section 4960(c)(4)(A) provides that remuneration paid to a covered employee by an ATEO includes any remuneration paid with respect to employment of the employee by any related person or governmental entity.^[3] Similar to the comment that only remuneration paid by the ATEO or related ATEO should be considered for purposes of determining an ATEO's five highest-compensated employees (described in paragraph II.E.1. of this preamble, titled “In General”), one commenter requested that, for purposes of applying the definition of “remuneration,” the phrase “any related person or governmental entity” be limited to the employer ATEO and any related ATEOs, but not any related non-ATEOs. Because section 4960(c)(4)(B) does not include this limitation in the definition of a “related organization,” these proposed regulations do not adopt this suggestion. Rather, these proposed regulations include in the definition of “remuneration” any remuneration paid by the employer ATEO, related ATEOs, and related non-ATEOs (including for-profit entities, nonprofit entities that are not ATEOs, and governmental entities that are not ATEOs).

Section 4960(c)(4) does not provide a definition of “control” for purposes of identifying related organizations. For purposes of defining “control” within the meaning of section 4960(c)(4)(B)(i) and (ii), two commenters suggested using the control standard under § 1.414(c)-5, with one of the commenters suggesting replacement of the “at least 80 percent” standard with a “more than 50 percent” standard to align with the Form 990 instructions. Such a standard is similar to the definition of “control” under section 512(b)(13)(D).

Consistent with Notice 2019-09, Q/A-8, for this purpose, these proposed regulations generally utilize the definition of “control” set forth in section 512(b)(13)(D) and § 1.512(b)-1(l)(4). That standard (and its “greater than 50 percent” threshold) generally aligns the definition of “related organization” for purposes of section 4960 with the definition of “related organization” for purposes of the annual reporting requirements on Form 990, reducing the burden on organizations in identifying related organizations, calculating compensation and remuneration from related organizations, and determining liability (if any) under section 4960. Use of a “greater than 50 percent” standard also aligns more closely with other exempt organization control tests and prevents abuse that may occur in the section 4960 context if a higher percentage threshold for control were adopted.

Following the standard in section 512(b)(13)(D), these proposed regulations define control of a stock corporation as ownership (by vote or value) of more than 50 percent of its stock, control of a partnership as ownership of more than 50 percent of its profits or capital interests, and control of a trust with beneficial interests as ownership of more than 50 percent of its beneficial interests. Consistent with the rule set forth in section 512(b)(13)(D)(ii), these proposed regulations provide that the attribution rules of section 318 apply in determining constructive or indirect ownership of stock in a stock corporation and that similar principles apply in determining constructive or indirect ownership of partnership interests or beneficial interests in a trust. For example, under section 318(a)(1), an individual is considered to own stock owned by the individual's spouse, child, grandchild, or parent. In general, the principles of section 318 are not readily applicable to nonstock organizations, which do not have ownership interests like other entities. However, some of the principles may be applied by analogy (such as proportional ownership under section 318(a)(2)), as set forth in these proposed regulations and examples. Similar rules apply in determining an indirect excess benefit transaction through a controlled entity in § 53.4958-4(a)(2)(ii)(B) for purposes of imposing the excise tax in section 4958 on excess benefit transactions. The Treasury Department and the IRS request comments on other circumstances for which clarifying regulations or examples would be helpful or whether a different standard should be considered.

Since most tax-exempt organizations are nonstock organizations, these proposed regulations also set forth a rule of “control” in the context of nonstock organizations to determine if the nonstock organization is a related organization. For this purpose, the proposed regulations define a “nonstock organization” as a nonprofit organization or other organization without owners, including a governmental entity. Similar to several other provisions and regulations dealing with controlled tax-exempt organizations (§ 1.512(b)-1(l)(4)(i)(b), § 53.4958-4(a)(2)(ii)(B)(1)(iii), and § 1.414(c)-5(b)),^[4] these proposed regulations provide that a person controls a nonstock organization under either a “removal power” test or a “representative” test.

Under the removal power test, a person controls a nonstock organization if the person has the power, directly or indirectly, to remove more than 50 percent of the trustees or directors of the nonstock organization and designate new trustees or directors. These proposed regulations specify that power to remove at regular intervals (for example, at the end of a board member's term of years) is sufficient for removal power to exist.

Under the representative test, a person or governmental entity generally controls a nonstock organization if more than 50 percent of the nonstock organization's directors or trustees are also trustees, directors, officers, agents, or employees of the person or governmental entity. Unlike the representative test in § 1.512(b)-1(l)(4)(i)(b), § 53.4958-4(a)(2)(ii)(B)(1)(iii), and § 1.414(c)-5(b), these proposed regulations expressly include an officer of the person or governmental entity as a representative for purposes of determining control of the nonstock organization.

One commenter suggested the representative test is overbroad, resulting in deemed control by the person because of the person's mere capacity to influence the nonstock organization, even if the person has no intent or interest in doing so, and even if the person has no knowledge of the nonstock organization (a phenomenon referred to here as “accidental control”). For example, according to the commenter, the representative test could unintentionally include an employer as a controlling person of an ATEO that two of the employer's employees established well before they became employees of the employer.

The representative test has an established history in tax law relating to tax-exempt organizations, appearing with minor variations in § 1.512(b)-1(l)(4)(i)(b), section 4911(f)(2)(B)(i), § 53.4958-4(a)(2)(ii)(B)(1)(iii), § 1.414(c)-5(b), and the instructions to the Form 990 (for 2008 and subsequent years) defining “related organizations.” The test may result in accidental control in some situations but is designed as a bright-line rule to avoid disputes over intent. However, to address the issue raised by the commenter, these proposed regulations permit a nonstock organization (or its putative controlling person or governmental entity) to qualify for an exception from control status if a director or trustee of the nonstock organization who is also a lower-level employee of the person or governmental entity (that is, not a trustee, director, or officer, or employee with the powers of a director or officer, of the person or governmental entity) is not acting as a representative of the person or governmental entity in his or her service with the nonstock organization. A nonstock organization that is relying on this exception must report that it is relying on the exception on the applicable Form 990 and provide details supporting the application of the exception.

III. Remuneration

A. In General

Consistent with section 4960(c)(3)(A), these proposed regulations define “remuneration” as wages under section 3401(a) (amounts generally subject to Federal income tax withholding), but excluding designated Roth contributions under section 402A(c) and including amounts required to be included in gross income under section 457(f). Remuneration does not include certain retirement benefits, including payments: That are contributions to or distributions from a trust described in section 401(a); under or to an annuity plan which, at the time of the payment, is a plan described in section 403(a); described in section 402(h)(1) and (2) if, at the time of the payment, it is reasonable to believe that the employee will be entitled to an exclusion under that section for the payment; under an arrangement to which section 408(p) applies; or under or to an eligible deferred compensation plan which, at the time of the payment, is a plan described in section 457(b) that is maintained by an eligible employer described in section 457(e)(1)(A) (governmental employer). See section 3401(a)(12). Remuneration also does not include an excess parachute payment but does include a parachute payment that is not an excess parachute payment.

In addition, these proposed regulations include in remuneration any amounts includible in gross income as compensation under section 7872 and related regulations. For example, under § 1.7872-15(e)(1)(i), a below-market split-dollar loan between an employer and employee generally is a compensation-related loan and any imputed transfer from the employer to the employee generally is a payment of compensation. Although section 7872(f)(9) provides that no amount shall be withheld under Chapter 24 of the Code with respect to any amount treated as transferred or retransferred under section 7872(a) or received under section 7872(b), those amounts are “remuneration . . . for services performed by an employee for his employer” within the meaning of section 3401(a) and are not specifically excluded from wages under section 3401(a). Thus, these amounts are remuneration as defined in section 4960(c)(3)(A). This analysis applies by analogy to other remuneration for services performed by an employee that is included in wages under section 3401(a) but is nonetheless not subject to income tax withholding under section 3402.

One commenter requested that remuneration be read to include amounts paid by any related person or governmental entity only with respect to employment of the employee by the ATEO and not with respect to employment of the employee by the related person or government entity. Neither the statute nor the legislative history indicates that this was the intended reading. In defining “remuneration,” section 4960(c)(4)(A) provides that “remuneration of a covered employee by an [ATEO] shall include any remuneration paid with respect to employment of the employee by any related person or governmental entity.” In addition, the legislative history indicates an intent to align the tax treatment of certain executive compensation payments made by for-profit employers and tax-exempt employers. The commenter's reading would be inconsistent with this intent, since section 162(m)(1) requires aggregation of amounts paid and proration of the resulting amount disallowed as a deduction if a covered employee of one member of an affiliated group is paid compensation by other members of the affiliated group. See § 1.162-27(c)(1)(ii) and Prop. § 1.162-33(c)(1)(ii). For these reasons, these proposed regulations do not limit the application of section 4960(c)(4)(A) to remuneration paid solely with respect to employment by the ATEO or for services rendered to the ATEO.

B. Remuneration Related to Medical Services

Remuneration that is paid to a licensed medical professional for medical services is excluded from the definition of “remuneration” for purposes of section 4960. (See part II.F. of this preamble, titled “Medical Services” for a further discussion of the scope of this exception.) When an employer compensates an employee for both medical services (including related services, such as medical recordkeeping) and other services, the employer must allocate remuneration paid to the employee between remuneration paid for medical services and remuneration paid for other services. These proposed regulations permit taxpayers to use a reasonable, good faith method to allocate remuneration between these two categories of services. For this purpose, taxpayers may rely on a reasonable allocation set forth in an employment agreement allocating remuneration between medical services and other services. If some or all of the remuneration is not reasonably allocated in an employment agreement, taxpayers must use another reasonable method of allocation. For example, allocating remuneration to medical services in the proportion that time spent providing medical services (determined based on records such as patient, insurance, Medicare/Medicaid billing records, or internal time reporting mechanisms) bears to the total hours the covered employee worked for the employer (including hours worked as an employee for all employers in a related group of organizations) would be a reasonable method. The Treasury Department and the IRS request comments providing examples of other reasonable methods of allocating remuneration between medical services and other services (or reasonable methods in particular circumstances).

C. When Remuneration Is Treated as Paid

These proposed regulations address when remuneration is treated as paid for purposes of section 4960. The flush language at the end of section 4960(a) provides that, for purposes of section 4960(a), remuneration is treated as paid when there is no substantial risk of forfeiture of the rights to the remuneration within the meaning of section 457(f)(3)(B). Although section 4960(a) cross-references the definition of “substantial risk of forfeiture” in section 457(f)(3)(B), the rule under section 4960(a) providing that remuneration is treated as paid upon when there is no substantial risk of forfeiture of the rights to the remuneration is neither limited to remuneration that is otherwise subject to section 457(f) nor limited to amounts paid pursuant to a nonqualified deferred compensation arrangement. Rather, for purposes of section 4960(a), this timing rule applies to all forms of remuneration.

To make clear when remuneration that is never subject to a substantial risk of forfeiture is treated as paid, these proposed regulations provide that remuneration that is a “regular wage” within the meaning of § 31.3402(g)-1(a)(ii) is treated as paid at actual or constructive payment. A “regular wage” is defined in § 31.3402(g)-1(a)(ii) as remuneration “paid at a regular hourly, daily, or similar periodic rate (and not an overtime rate) for the current payroll period or at a predetermined fixed determinable amount for the current payroll period.” Remuneration that is not a regular wage but that is never subject to a substantial risk of forfeiture is treated as paid on the first date the service provider has a legally binding right to the payment.

With respect to payments that are at some time subject to a substantial risk of forfeiture, these proposed regulations refer to remuneration as “vested” when it is no longer subject to a substantial risk of forfeiture, and this remuneration is treated as paid when it vests. The Treasury Department and the IRS issued proposed regulations under section 457(f) in 2016 (81 FR 40548 (June 22, 2016)), upon which taxpayers may rely for periods before they are finalized. Under proposed § 1.457-12(e)(1), an amount of compensation is subject to a substantial risk of forfeiture only if entitlement to the amount is conditioned on the future performance of substantial services, or upon the occurrence of a condition that is related to a purpose of the compensation if the possibility of forfeiture is substantial. See Prop. § 1.457-12(e)(3) for examples of the rules relating to substantial risk forfeiture. The Treasury Department and the IRS anticipate that the final regulations under section 4960 will adopt the definition of “substantial risk of forfeiture” in proposed § 1.457-12(e)(1). Any changes to the proposed regulations under section 457(f) when finalized will be taken into account for purposes of section 4960, and further guidance may be issued, if appropriate.

Although requested by commenters, these proposed regulations do not provide a short-term deferral rule (such as the rules provided in § 1.409A-1(b)(4) and proposed § 1.457-12(d)(2)) that would change the date remuneration is treated as paid depending on the timing of vesting in relation to the timing of actual payment (typically of cash) to the employee. Allowing a short-term deferral similar to that allowed in § 1.409A-1(b)(4) and proposed § 1.457-(12)(d)(2) would permit the employer to determine the taxable year in which the amount is treated as paid and would be inconsistent with the statute. The Treasury Department and the IRS are concerned that providing this type of exception to the timing rule under section 4960 would permit ATEOs and related organizations to spread remuneration across multiple applicable years by delaying actual payment of an amount that is already vested and thus potentially avoid the tax. However, the Treasury Department and the IRS invite comments regarding any burdens that could be avoided through a short-term deferral rule and how such a rule could be designed to avoid permitting inappropriate avoidance of the tax.

While a short-term deferral exception might allow an employer to choose the taxable year in which a payment is made in order to avoid the excise tax, the Treasury Department and the IRS understand that for routine salary and other similar payments made for the final pay period of a calendar year, most employers do not distinguish between the amounts earned in the initial year and the amounts earned in the subsequent year that are both paid in the subsequent year. Because these regulations provide that remuneration that is a regular wage within the meaning of § 31.3402(g)-1(a)(1)(ii) is treated as paid when actually or constructively paid, the employer will not need to determine amounts that vested in the initial year for purposes of section 4960. Thus, if a pay period ends December 26, 2020, but the salary for that period is not actually paid until January 2, 2021, then the salary is treated as paid in 2021 and the employer need not treat any amount as vested in 2020. But if the employee also vested in a bonus on December 26, 2020, that is actually paid on January 2, 2021, the bonus is treated as paid in 2020.

These proposed regulations provide that the amount of remuneration treated as paid generally is the present value of the remuneration on the date on which the covered employee vests in the right to payment of the remuneration. The employer must determine the present value using reasonable actuarial assumptions regarding the amount, time, and probability that the payment will be made. These proposed regulations do not provide rules for the determination of present value. However, an employer may determine the present value using the rules set forth in proposed § 1.457-12(c)(1). The Treasury Department and the IRS anticipate that final regulations covering the determination of present value for purposes of section 4960 will be issued when final regulations under section 457(f) are issued. In addition, to reduce the administrative burden for determining the present value of remuneration under a nonaccount balance plan described in § 1.409A-1(c)(2)(i)(C) scheduled to be paid within 90 days after vesting (which would result in minimal discounting), the employer may treat the amount that is to be paid as the present value of the amount on the date of vesting. For example, an employer is not required to discount an annual bonus of $10,000 that vests on December 31, 2020, and is scheduled to be paid on February 15, 2021, to reflect the delay in actual payment, but instead may treat $10,000 of remuneration as paid in 2020. Until actually or constructively paid or otherwise includible in gross income of the employee, any amount treated as paid at vesting is referred to as “previously paid remuneration.”

D. Earnings and Losses

These proposed regulations provide specific rules for the treatment of earnings and losses on previously paid remuneration, intended to minimize administrative burden. These proposed regulations provide that net earnings on previously paid remuneration are treated as vested (and therefore paid) on the last day of the applicable year in which they are accrued unless otherwise actually or constructively paid before that date. For example, the present value of vested remuneration accrued to an employee's account under an account balance plan described in § 1.409A-1(c)(2)(i)(A) (under which the earnings and losses attributed to the account are based solely on a predetermined actual investment or a reasonable market interest rate) is treated as paid on the date accrued to the employee's account and, until subsequently actually or constructively paid, is treated as previously paid remuneration. In addition, at the end of each applicable year in which there is this type of previously paid remuneration allocable to a covered employee, the present value of any net earnings accrued on that previously paid remuneration (the increase in present value due to the application of a predetermined actual investment or a reasonable market interest rate) is treated as remuneration paid in that applicable year.^[5]

Similarly, the present value of a vested, fixed amount of remuneration under a nonaccount balance plan described in § 1.409A-1(c)(2)(i)(C) is treated as paid on the date of vesting and subsequently treated as previously paid remuneration until actually or constructively paid. In addition, at the end of each applicable year in which there is this type of previously paid remuneration allocable to a covered employee, the net increase in the present value of that amount during the year due solely to the passage of time constitutes earnings and is treated as remuneration paid. For this purpose, earnings and losses from one plan or arrangement are aggregated with earnings and losses from any other plan or arrangement in which the employee participates that is provided by the same employer, resulting in an individual amount of remuneration paid by each employer and separate carryover of any net losses (but no carryover of gains, since any net gain would be treated as remuneration for the taxable year). For purposes of determining earnings and losses, previously paid remuneration is reduced by the amount actually or constructively paid under the plan or arrangement granting the rights to such remuneration. These proposed regulations further illustrate the operation of these rules through examples.

E. Request for a Grandfather Rule

Commenters requested a “grandfather” rule for section 4960 similar to the grandfather rule under section 13601 of TCJA, which amended section 162(m). Section 13601(e) of TCJA provides that the amendments to section 162(m) are effective for taxable years beginning after December 31, 2017, unless remuneration is provided pursuant to a written binding contract that was in effect on November 2, 2017, and that was not modified in any material respect on or after December 31, 2017. Section 13602(c) of TCJA added section 4960 to the Code, but it did not provide for a grandfather rule and there is no indication in the legislative history that Congress intended to adopt one. In addition, notwithstanding the suggestion of one commenter, the Treasury Department and the IRS do not agree that the regulatory authority provided in section 4960(d) to prevent avoidance of the tax is applicable to the adoption of a grandfather rule. A rule permitting the exclusion of certain amounts from remuneration would not prevent taxpayer abuse of failing to report and pay the applicable tax. Accordingly, these proposed regulations do not provide a grandfather rule.

However, these proposed regulations provide rules that have the effect of grandfathering certain compensation. The proposed regulations provide that any nonqualified deferred compensation that vested prior to the first day of the first taxable year of the ATEO beginning after December 31, 2017, is not considered remuneration for purposes of section 4960. Specifically, these proposed regulations provide that any vested remuneration, including vested but unpaid earnings accrued on deferred amounts, that is treated as paid before the effective date of section 4960 (January 1, 2018, for a calendar year employer) is not subject to the excise tax imposed under section 4960(a)(1). All earnings on that remuneration that accrue or vest after the effective date, however, are treated as remuneration paid for purposes of section 4960(a)(1).

Similarly, for an employee who has vested deferred compensation from years prior to the taxable year in which the employee first became a covered employee, these proposed regulations provide that vested remuneration (including vested but unpaid earnings) that would have been treated as remuneration paid for a taxable year before the taxable year in which an employee first became a covered employee under section 4960 is not remuneration subject to the excise tax imposed by section 4960(a)(1) for the first taxable year in which the employee becomes a covered employee or any subsequent year. However, subsequent earnings that accrue on those vested amounts while the employee is a covered employee may be subject to the excise tax imposed under section 4960(a)(1).

One commenter requested that, for determining when remuneration is paid for purposes of section 4960, taxpayers be permitted to allocate ratably over the vesting period benefit amounts accruing under section 457(f) plans and subject to “cliff vesting” (generally referring to amounts accruing based on services performed over a period of time with the right to the entire amount vesting only at the end of that period). The commenter reasoned that the vesting period may span many years (including years prior to the date that section 4960 first applies to the employer) and therefore only the amount accrued for each year, regardless of whether it is vested, should be treated as paid for purposes of section 4960. Additionally, the commenter observed that treating amounts that cliff vest as paid at vesting increases the likelihood that remuneration treated as paid to the employee will exceed the $1 million threshold for that taxable year. Nonetheless, because the flush language of section 4960(a) provides explicitly that remuneration is treated as paid at vesting as determined under section 457(f)(3)(B) and there is nothing in section 457(f)(3)(B) that would permit such a ratable allocation rule, this suggestion is not incorporated into these proposed regulations.

One commenter requested relief from sections 409A and 457(f) so that affected taxpayers can delay vesting or payment of amounts that, as of November 2, 2017, were subject to a legally binding obligation to be paid in the future, to the extent necessary to avoid application of section 4960. Because the timing of payment of remuneration under section 4960 is based on the vesting date, the delay in an actual or constructive payment date generally will not affect when that remuneration is treated as paid for purposes of section 4960. However, an extension of a vesting period may have consequences both with respect to when remuneration is treated as paid under section 4960 and under section 457(f) and section 409A. The regulations under section 409A and the proposed regulations under section 457(f) impose limitations on the extension of the vesting period applicable to deferrals of compensation. Under those rules, in general, an amount will not be considered subject to a substantial risk of forfeiture beyond the date or time at which the recipient otherwise could have elected to receive the amount of compensation, unless the present value of the amount subject to a substantial risk of forfeiture is materially greater than the present value of the amount the recipient otherwise could have elected to receive absent such risk of forfeiture. See § 1.409A-1(d)(1) and proposed § 1.457-12(e)(2). With respect to section 4960, the statute does not provide for a grandfathering rule or otherwise provide an exception to the application of section 457(f)(3)(A) and its definition of a “substantial risk of forfeiture” for purposes of determining the timing of payments. In addition, it is not appropriate to waive the otherwise applicable definition of “substantial risk of forfeiture,” which only recognizes extensions of vesting periods for which there is a rational economic basis (disregarding tax consequences) for purposes of section 4960. Accordingly, these proposed regulations do not adopt this suggestion.

F. Remuneration Paid to a Covered Employee for Which a Deduction Is Disallowed Under Section 162(m)

Consistent with section 4960(c)(6), these proposed regulations provide that remuneration for which a deduction is disallowed under section 162(m) is not treated as remuneration paid to a covered employee. Thus, remuneration that is paid to a covered employee of an ATEO who is also a covered employee of a related “publicly held corporation” or an applicable individual of a related “covered health insurance provider” (as defined in section 162(m)(2) and (m)(6)(C), respectively), for which a deduction is disallowed under section 162(m), generally is not treated as remuneration for purposes of section 4960 However, that remuneration is taken into account for purposes of determining the ATEO's five highest-compensated employees. See section II.E.1. of this preamble, titled “In General.”

In some circumstances, it may not be known at the time remuneration is treated as paid to a covered employee of the ATEO whether a deduction for such remuneration will be disallowed under section 162(m). For example, for purposes of section 4960(a)(1), nonqualified deferred compensation is treated as remuneration paid when the right to it vests (see section III.C of this preamble, titled “When Remuneration is Treated as Paid”). Whether a deduction for payment of the compensation would be precluded by section 162(m) may not be known until a subsequent taxable year, since the timing of an employer's otherwise available deduction for a payment of deferred compensation is delayed until the amount is includible in the employee's gross income, which is generally when the amount is actually or constructively paid to the employee.

A second example includes the situation in which a covered employee of an ATEO becomes a covered employee of a related publicly held corporation or an applicable individual of a related covered health insurance provider after the taxable year for which an amount has been treated as excess remuneration under section 4960(a), but before the taxable year in which the remuneration is deductible (subject to the disallowance under section 162(m)). This may occur because, at the time the remuneration is treated as paid, the covered employee of the ATEO did not meet the definition of “covered employee” under section 162(m)(3) or “applicable individual” under section 162(m)(6)(F) or because the related organization did not meet the definition of “publicly held corporation” under section 162(m)(2) or “covered health insurance provider” under section 162(m)(6)(C). Further, the present value of a future payment that is contingent on a separation from employment may be taken into account for purposes of determining whether an excess parachute payment is made, but when the payment is made in a subsequent taxable year, the corresponding deduction may be disallowed under section 162(m). (See section IV. of this preamble, titled Excess Parachute Payments). In these circumstances if, after including an amount in remuneration under section 4960, it is determined that section 162(m) disallows a deduction for that remuneration for a subsequent taxable year, a taxpayer may file a refund claim for the excise tax paid as a result of including the amount in remuneration, provided the period for making a refund claim has not expired.

In certain circumstances, however, it may not be known until after the period for making a refund claim has expired whether an amount that has been treated as excess remuneration is subject to the deduction disallowance under section 162(m). These proposed regulations do not address the coordination of sections 4960 and 162(m) in these circumstances, but instead this preamble describes possible approaches for future regulations coordinating these provisions and requests comments.

One possible approach is to permit the employer to exclude an amount from remuneration if the amount may reasonably be expected to be disallowed as a deduction under section 162(m) for a subsequent taxable year. Under this approach, for purposes of determining whether it is reasonably expected that an amount will be disallowed under section 162(m), the employer would be required to assume that remuneration is paid pursuant to the terms of the plan or arrangement under which the compensation is deferred, as in effect on the last day of the taxable year for which the amount is treated as remuneration paid. The Treasury Department and the IRS anticipate that this approach would permit this assumption only with respect to an organization that was a publicly held corporation or covered health insurance provider at the time the remuneration was treated as paid for purposes of section 4960 and only with respect to an employee that for that taxable year was a covered employee or applicable individual under section 162(m). In other words, the organization could not assume either that it would become a publicly held corporation or covered health insurance provider by the time the amount became deductible but for the application of section 162(m) or that an individual who was not a covered employee or applicable individual under section 162(m) would become one by the time the amount became deductible but for the application of section 162(m). The Treasury Department and the IRS request comments on this approach, including:

• Whether it should be assumed that no other remuneration will be paid to the covered employee in the year the amount is otherwise deductible but for section 162(m) and, if not, how to account for other payments subject to section 162(m). For example, how to address ordering of payments subject to the deduction limitation under section 162(m).
• Whether, in determining when amounts will be paid as part of applying this approach, the potential for payment to be accelerated based on death, disability, change in control, unforeseeable emergencies, or other events outside of the control of the individual should be disregarded.
• Whether this approach should be available when a plan or arrangement provides for different forms of payment and, if so, whether it should be assumed that amounts will be paid in the most rapid form in these circumstances (for example, if a plan may pay either a lump sum or installments depending on the particular payment event, whether it should be assumed that the amount will be paid in a lump sum).
• Whether the assumption provided in proposed § 1.457-12(c)(1)(ii)(C)(2), which provides that a separation from employment will occur no later than five years from the vesting date, should be adopted to determine when the deduction limitation under section 162(m) is reasonably expected to apply and, if not, what assumptions should be used with respect to payments due upon separation from employment.
• Whether, in circumstances in which payments are made upon the occurrence of an event other than separation from employment and that payment event has not yet occurred, it is reasonable to assume that the section 162(m) deduction limitation will apply to amounts that are payable upon the occurrence of such a payment event and when such a payment event should be deemed to occur.

Comments are also requested on how to treat an amount that is reasonably determined to be subject to the deduction limitation under section 162(m), but for which the deduction is not subsequently limited. For example, a taxpayer may reasonably determine that the amount that is treated as paid for a taxable year for purposes of section 4960 will exceed the section 162(m) threshold for the taxable year when it is paid, but the amount that is ultimately included in the employee's gross income (together with any other amount that is potentially subject to section 162(m) for the year) may not exceed the 162(m) threshold in that year due to, for example, investment losses.

A second possible approach to address these circumstances is to permit an employer to offset remuneration subject to section 4960 in a later taxable year by an amount equal to the amount that was treated as excess remuneration under section 4960 in a previous taxable year for which the deduction is subsequently disallowed under section 162(m). This approach would only benefit employers that pay excess remuneration in subsequent years.

The Treasury Department and the IRS request comments on these potential approaches, including how each might be offered as an alternative, and any other approach that may be helpful in coordinating sections 4960 and 162(m).

IV. Excess Remuneration

In general, the excise tax imposed under section 4960(a)(1) is based on the remuneration paid (other than any excess parachute payment) by an ATEO for the taxable year with respect to employment of any covered employee in excess of $1 million. These proposed regulations refer to this amount as “excess remuneration.” Consistent with section 4960(a)(1), the $1 million threshold is not adjusted for inflation. An amount subject to tax under section 4960(a)(2) as an excess parachute payment is not subject to tax under section 4960(a)(1) as excess remuneration.

As provided in section 4960(c)(4)(C), if an individual performs services as an employee for two or more related organizations during the applicable year, one or more of which is an ATEO, each employer is liable for its proportional share of the excise tax. These proposed regulations provide rules for allocating liability for the excise tax among the employers. For this purpose, remuneration that is paid by a separate organization (whether related to the ATEO or not) for services performed as an employee of the ATEO is treated as remuneration paid by the ATEO. For a further discussion of when amounts are treated as paid on behalf of an ATEO, see part VI of this preamble, titled “Calculation, Reporting, and Payment of the Tax.”

V. Excess Parachute Payments

A. In General

Section 4960(a)(2) imposes an excise tax on any excess parachute payment. Section 4960(c)(5)(A) provides that “excess parachute payment” means an amount equal to the excess of any parachute payment over the portion of the base amount allocated to such payment. Section 4960(c)(5)(B) provides that “parachute payment” means any payment in the nature of compensation to (or for the benefit of) a covered employee if the payment is contingent on the employee's separation from employment with the employer and the aggregate present value of the payments in the nature of compensation to (or for the benefit of) the individual that are contingent on the separation equals or exceeds an amount equal to 3-times the base amount. Under section 4960(c)(5)(C), certain retirement plan payments, certain payments to licensed medical professionals, and payments to an individual who is not a “highly compensated employee” (HCE) as defined in section 414(q) are not excess parachute payments.^[6]

The excess parachute payment rules under section 4960 are modeled after section 280G, but section 4960(c)(5)(B) defines “parachute payment” differently than section 280G(b)(2). The section 4960 definition refers to payments contingent on an employee's separation from employment, whereas the section 280G definition refers to payments contingent on a change in the ownership or effective control of a corporation (or in the ownership of a substantial portion of the assets of the corporation). While these proposed regulations incorporate many of the concepts found in the rules under § 1.280G-1, with modifications to reflect the statutory differences between sections 280G and 4960, they do not incorporate other rules under § 1.280G-1 because those rules address issues that do not arise under section 4960. In addition, many provisions in these proposed regulations do not have parallel rules under § 1.280G-1 because they address issues that arise under section 4960, but not under section 280G.

The following sections provide an overview of the guidance in these proposed regulations for purposes of calculating the excise tax imposed under section 4960(a)(2), noting certain similarities and differences between these proposed regulations and the rules under § 1.280G-1.

B. Definitions Related to Excess Parachute Payments

These proposed regulations define “excess parachute payment” and the term “parachute payment” for purposes of section 4960. Any payment in the nature of compensation made by an ATEO (or its predecessor or related organization) to a covered employee that is contingent on the employee's separation from employment is taken into account for purposes of the parachute payment calculation, assuming no exclusion applies. Those combined payments constitute a parachute payment if the aggregate present value of all such payments made to an individual equals or exceeds 3-times the individual's base amount. A parachute payment is an excess parachute payment to the extent it exceeds one-times the individual's base amount allocated to the payment.

These proposed regulations define a “payment in the nature of compensation” based on § 1.280G-1, Q/A-11 and Q/A-14. In general, any payment arising out of an employment relationship is a payment in the nature of compensation. A payment in the nature of compensation is reduced, however, by any consideration paid by the covered employee in exchange for the payment.

C. Payments Contingent on a Separation From Employment

1. In General

Although section 4960 does not define what it means for a payment to be contingent on a separation from employment, these proposed regulations generally treat a payment as contingent on an employee's separation from employment only if there is an involuntary separation from employment. If the payment is subject to a substantial risk of forfeiture (defined in a manner consistent with section 457(f)) at the time of an involuntary separation from employment, and the separation causes the risk of forfeiture to lapse, the payment is contingent on separation from employment.

2. Requirement of Involuntary Separation From Employment

Separation from employment (whether voluntary or involuntary) is often used in compensation arrangements as a trigger to pay vested compensation. For example, it is typical for a nonqualified deferred compensation plan to provide that a payment or a series of payments will be made or begin upon a separation from employment, including separation from employment resulting from death or disability. The vested amounts that are to be paid after a separation from employment generally are not treated as contingent on a separation from employment because the amounts will never be subject to forfeiture or otherwise not paid (even if an employee does not voluntarily or involuntarily terminate employment during the employee's lifetime, the payments will be made upon the employee's death). In these cases, the separation from employment functions only as a payment timing event and is neither a contingent event that may not occur nor a precondition to entitlement to the payment.

3. Definition of “Involuntary Separation from Employment”

If an amount is payable solely upon an involuntary separation from employment, then it is a payment contingent on an event that may not occur and that is a precondition to entitlement to the payment. The definition of an “involuntary separation from employment” set forth in these proposed regulations is modeled after the definition of an “involuntary separation from service” in § 1.409A-1(n)(1), which also was the model for the definition of an “involuntary severance from employment” under proposed § 1.457-11(d)(2). A separation from employment for good reason is treated as an involuntary separation from employment for purposes of section 4960 if certain conditions are met. For this purpose, these proposed regulations generally adopt the standards set forth in § 1.409A-1(n)(2) and proposed § 1.457-11(d)(2)(ii).

In addition, these proposed regulations generally adopt the standards of the regulations under section 409A for purposes of determining whether there has been a separation from employment, except that a bona fide change from employee to independent contractor status is treated as a separation from employment. However, the IRS may assert, based on all the facts and circumstances, that there was not a bona fide change from employee to independent contractor status. Specifically, these proposed regulations adopt the standards of § 1.409A-1(h)(1)(ii), providing that an anticipated reduction in the level of services of more than 80 percent is treated as a separation from employment, an anticipated reduction in the level of services of less than 50 percent is not treated as a separation from employment, and the treatment of an anticipated reduction between these two levels will depend on the facts and circumstances. The measurement of the anticipated reduction in the level of services is based on the average level of bona fide services performed over the immediately preceding three years (or shorter period for an employee employed for less than three full prior years). However, the proposed regulations do not adopt the rule of § 1.409A-1(h)(1)(ii), under which an employer may modify the level of the anticipated reduction in future services that will be considered to result in a separation from employment. Finally, because the section 409A regulations do not provide a standard for determining when an involuntary change of status from employee to independent contractor results in a separation from employment, the Treasury Department and the IRS request comments on whether additional guidance is needed on this issue.

4. When a Payment Is Contingent on Separation From Employment

In defining when a payment is contingent on separation from employment, these proposed regulations do not focus solely on whether the payment would not have been made but for a separation from employment, but instead also take into consideration whether the separation from employment accelerates the lapse of the substantial risk of forfeiture with respect to the right to payment or accelerates the right to payment. Generally, if the lapse of a substantial risk of forfeiture is accelerated or payment is accelerated as a result of an involuntary separation from employment (such as a payment that otherwise would have vested and been paid had the employee remained employed for a subsequent period of time), then the value of the accelerated payment plus the value of the lapse of the substantial risk of forfeiture is treated as contingent on a separation from employment (since the employer would not have provided the increased value in the absence of an involuntary separation from employment). However, if the lapse of the substantial risk of forfeiture is dependent on an event other than the performance of services, such as the attainment of a performance goal, and if that event does not occur prior to the employee's separation from employment, but the payment vests due to the employee's involuntary separation from employment, then the full amount of the payment is treated as contingent on the separation from employment.

A payment the right to which is not subject to a substantial risk of forfeiture within the meaning of section 457(f)(3)(B) at the time of an involuntary separation from employment generally is not contingent on a separation from employment (since the right to the payment is not triggered by the separation from employment). However, the increased value of an accelerated payment of a previously vested amount resulting from an involuntary separation from employment is treated as a payment contingent on a separation from employment. These proposed regulations adopt the rules of § 1.280G-1, Q/A-24(c) for purposes of determining the value of accelerated vesting.

If a covered employee involuntarily separates from employment before the end of a contract term and is paid damages for breach of contract pursuant to an employment agreement, those damages are treated as a payment that is contingent on a separation from employment. For purposes of these proposed regulations, “employment agreement” means an agreement between an employee and employer that describes, among other things, the amount of compensation or remuneration payable to the employee for services performed during the term of the agreement.

A payment under an agreement requiring a covered employee to refrain from performing services (for example, a covenant not to compete) is a payment that is contingent on a separation from employment if the payment would not have been made in the absence of an involuntary separation from employment. For example, if a covenant not to compete including one or more payments contingent on compliance in whole or in part with the covenant not to compete is negotiated as part of a severance arrangement arising from an involuntary separation from employment, generally the payment(s) will be treated as contingent on a separation from employment regardless of whether the payment(s) may be considered reasonable compensation for services provided. Similarly, if a covenant not to compete negotiated as part of an employment agreement provides for a benefit upon an involuntary separation, then the benefit is contingent on a separation from employment regardless of whether the payment may be considered reasonable compensation for services provided. This treatment is different from the treatment of payments made under a covenant not to compete in §§ 1.280G-1, Q/A-9, Q/A-40(b), and Q/A-42(b), under which payments made under a covenant not to compete may be treated as reasonable compensation for services (and thus excluded from the calculation of parachute payments) even if the payments would not have been made in the absence of a change in control. The Treasury Department and the IRS have concluded that the different treatment is warranted because in these cases a covenant not to compete is integrally related to the involuntary separation from employment, whereas a covenant not to compete generally is not integrally related to a change in ownership or control.

Actual or constructive payment of an amount that was previously includible in gross income is not a payment contingent on a separation from employment. For example, a payment of deferred compensation after an involuntary separation from employment that vested based on years of service completed before the involuntary separation from employment generally is not a payment that is contingent on a separation from employment because the separation from employment may affect the time of, but not the right to, the payment (although the value of an acceleration of the payment may be contingent on a separation from employment). Similarly, medical benefits that vested based on years of service completed before an involuntary separation from employment but that are provided after the involuntary separation from employment generally are not treated as payments that are contingent on a separation from employment. In contrast, a payment under a window program described in § 1.409A-1(b)(9)(vi) is contingent on a separation from employment.

Unlike Q/A-25 and Q/A-26 of § 1.280G-1, these proposed regulations do not provide a presumption that a payment made pursuant to an agreement entered into or modified within twelve months of a separation from employment is a payment that is contingent on a separation from employment. However, as discussed further below, if the facts and circumstances demonstrate that either the vesting or the payment of an amount would not have occurred but for the involuntary nature of the separation from employment, the amount will be treated as a payment contingent on a separation from employment.

In addition, these proposed regulations do not provide a rule similar to the one found in § 1.280G-1, Q/A-9 (exempting reasonable compensation for services rendered on or after a change in ownership or control from the definition of “parachute payment”), that would exclude reasonable compensation for services provided after a separation from employment. In most cases, the issue of whether payments made after a separation from employment are reasonable compensation for services will not arise because the employee will not provide services after the separation from employment. However, if the employee continues to provide services (including as a bona fide independent contractor) after an involuntary separation from employment, payments for those services are not contingent on the involuntary separation from employment to the extent those payments are reasonable and are not made due to the involuntary nature of the separation from employment. Nonetheless, as discussed previously in this section of this preamble, these proposed regulations provide that an agreement under which the employee must refrain from performing services (for example, a covenant not to compete) is not treated as an agreement for the performance of services. See the discussion in section V.B.4 of this preamble.

Notwithstanding the foregoing, if the facts and circumstances demonstrate that either vesting or payment of an amount (whether before or after an involuntary separation from employment) would not have occurred but for the involuntary nature of the separation from employment, the amount will be treated as contingent on a separation from employment. For example, an employer's exercise of discretion to accelerate vesting of an amount shortly before an involuntary separation from employment may indicate that the acceleration of vesting was due to the involuntary nature of the separation from employment and was therefore contingent on the employee's separation from employment. Similarly, payment of an amount in excess of an amount otherwise payable (for example, increased salary) shortly before or after an involuntary separation from employment may indicate that the amount was paid because the separation was involuntary and was therefore contingent on the employee's separation from employment.

The Treasury Department and the IRS request comments on whether there are types of payments made in connection with separation from employment other than those described in the preceding paragraphs and the extent to which the final regulations under section 4960 should be modified to ensure appropriate classification of those payments as contingent or not contingent on separation from employment.

D. Three-Times-Base-Amount Test

Section 4960(c)(5) provides rules for determining the tax on any excess parachute payment imposed under section 4960(a)(2). Section 4960(c)(5)(B) provides that a payment is a parachute payment only if the aggregate present value of the payments in the nature of compensation to (or for the benefit of) an individual that are contingent on a separation from employment equals or exceeds an amount equal to 3-times the base amount. Section 4960(c)(5)(D) provides that rules similar to the rules of section 280G(b)(3) apply for purposes of determining the base amount, and section 4960(c)(5)(E) provides that rules similar to the rules of section 280G(d)(3) and (4) apply for purposes of present value determinations. Section 280G(b)(3) provides that “base amount” means an individual's annualized includible compensation for the base period. Section 280G(d)(2) defines “base period” as the period consisting of the five most recent taxable years of the service provider ending before the date on which the change in ownership or control occurs or the portion of such period during which the individual performed personal services for the corporation. Section 280G(d)(3) provides that any transfer of property is treated as a payment and is taken into account at its fair market value. Section 280G(d)(4) provides that present value is determined using a discount rate equal to 120 percent of the applicable Federal rate determined under section 1274(d), compounded semiannually.

These proposed regulations provide that the “base amount” is the average annual compensation as an employee of the ATEO (including services performed as an employee of a predecessor or related organization) for the taxable years in the “base period” and that the base period is the five most recent taxable years during which the individual was an employee of the ATEO (or predecessor or related organization) or the portion of the five-year period during which the employee was an employee of the ATEO (or predecessor or related organization).

These proposed regulations provide rules for determining whether a payment is an excess parachute payment, including rules for applying the 3-times-base-amount test. Under the proposed regulations, payments in the nature of compensation that are contingent on a separation from employment are parachute payments if the aggregate present value of the payments equals or exceeds 3-times the employee's base amount. In addition, reasonable actuarial assumptions must be used to determine the aggregate present value of payments to be made in years subsequent to the year of separation from employment, and a special rule for the valuation of an obligation to provide health care benefits is proposed. These proposed regulations also provide that the discount rate to be used in determining aggregate present value is 120 percent of the applicable Federal rate under section 1274(d), compounded semi-annually. These proposed regulations further provide rules for determining the present value of a payment to be made in the future that is based on uncertain future events.

The rules proposed for determining the base amount, base period, and present value, including determining the present value of payments that are contingent on uncertain future events, are based on the rules under § 1.280G-1, Q/A-30 through Q/A-36 (substituting an involuntary separation from employment for a change in control). These proposed regulations describe when a payment in the nature of compensation is considered made for purposes of section 4960(a)(2), based on the rules found in § 1.280G-1, Q/A-11 through Q/A-14. Similar to § 1.280G-1, Q/A-11, a payment in the nature of compensation generally is considered made in the same taxable year as the year in which the amount is includible in the employee's gross income or, in the case of fringe benefits and other benefits excludible from income, in the year of receipt. In the case of taxable non-cash fringe benefits, these proposed regulations generally incorporate the income recognition timing rules found in Announcement 85-113 (1985-31 I.R.B. 31). Under these rules, for taxable non-cash fringe benefits provided in a calendar year, payment is considered made on any date or dates the employer chooses during the year (but not later than December 31) or, if provided during the last two months of the calendar year, during the subsequent year (subject to limitations).

These proposed regulations provide that the transfer of section 83 property generally is considered a payment made in the taxable year in which the property is transferred or would be includible in the gross income of the covered employee under section 83, disregarding any election made by the employee under section 83(b) or (i). This rule is consistent with the rules provided under § 1.280G-1, Q/A-12(a). In addition, similar to the rules provided under § 1.280G-1, Q/A-13(a), these proposed regulations generally provide that stock options and stock appreciation rights are treated as property transferred on the date of vesting (regardless of whether the option has a “readily ascertainable value” as defined in § 1.83-7(b)). For purposes of determining the timing and amount of any payment related to an option or a stock appreciation right, the principles of § 1.280G-1, Q/A-13 and Rev. Proc. 2003-68 (2003-2 C.B. 398) apply.

E. Computation of Excess Parachute Payments

Consistent with section 4960(c)(5)(A), these proposed regulations provide that an “excess parachute payment” is an amount equal to the excess of any parachute payment over the portion of the base amount allocated to the payment. The portion of the base amount allocated to any parachute payment is the amount that bears the same ratio to the base amount as the present value of the parachute payment bears to the aggregate present value of all parachute payments to be made to the covered employee. The rules on allocation of the base amount provided in these proposed regulations are based on § 1.280G-1, Q/A-38.

VI. Calculation, Reporting, and Payment of the Tax

Some ATEOs (and any related non-ATEO organizations) will not be affected by section 4960 because they do not pay any employee sufficient remuneration to trigger the tax. There can be no excess remuneration under section 4960(a)(1) if an ATEO (together with any related organization) does not pay more than $1 million of remuneration to any employee for a taxable year, and there can be no excess parachute payment under section 4960(a)(2) if the employer does not have any HCEs under section 414(q) ^[7] for the taxable year. In these cases, no excise tax under section 4960 is owed.

These proposed regulations provide rules regarding the entity that is liable for the excise tax under section 4960 and how that excise tax is calculated. These proposed regulations provide that the employer, as determined under section 3401(d), without regard to paragraph (d)(1) or (d)(2), is liable for the excise tax imposed under section 4960. Pursuant to section 4960(d), a payment by the employer may be treated as remuneration or a parachute payment if, based on the facts and circumstances, the payment is structured such that it has the effect of avoiding the tax applicable under section 4960. For example, the excise tax under section 4960 would apply if it would otherwise apply with respect to an individual who is an employee of the ATEO or related organization but who is incorrectly classified as an independent contractor. Similarly, the excise tax under section 4960 would apply to an amount paid to a limited liability company or other entity owned all or in part by an employee (or owned by another entity unrelated to the ATEO or related organization) for services performed by an employee of the ATEO or related organization if the arrangement would otherwise have the effect of avoiding the tax applicable under section 4960. For a further discussion of the definition of “employer” under these proposed regulations, see section II.D. of this preamble, titled “Employer.”

A. Calculation of Tax on Excess Remuneration

An individual may perform services as an employee of an ATEO and as an employee of one or more related organizations during the same applicable year, in which case remuneration paid for the taxable year is aggregated for purposes of determining whether excess remuneration has been paid. To address these cases, these proposed regulations provide rules for allocating liability for the excise tax among the related employers. As provided in section 4960(c)(4)(C), in any case in which an ATEO includes remuneration from one or more related organizations as separate employers of the individual in determining the excise tax imposed by section 4960(a), each employer is liable for its proportional share of the excise tax. In contrast, a payment for the services of an individual who performs services only as an employee of an ATEO, that is made by one or more other organizations (whether those organizations are related to the ATEO or not), is treated as remuneration paid by the ATEO and thus is aggregated with any remuneration paid directly by the ATEO (and the related liability is not allocated to the other organizations). If a covered employee is employed by one employer when the legally binding right to the remuneration is granted and employed by a different employer at vesting, then the covered employee's employer at vesting is treated as paying the remuneration, provided the employment relationship is bona fide and not a means to avoid tax under section 4960. The Treasury Department and the IRS request comments on whether there is a more appropriate approach to allocating liability for the excise tax where services performed for more than one employer during a vesting period are credited towards a vesting requirement based on the performance of services.

Consistent with the discussion of short applicable years in part II.B. of this preamble, titled “Applicable year,” a related organization may become related (or may cease to be related) during the applicable year, in which case only remuneration the related organization pays (or is treated as paying due to vesting) to the ATEO's covered employee during the portion of the applicable year that it is a related organization is treated as paid by the ATEO for the taxable year, as provided in section 4960(c)(4)(A).

If an employee is a covered employee of more than one ATEO, these proposed regulations provide that each ATEO calculates its liability under section 4960(a)(1), taking into account remuneration paid to the employee by the organizations to which it is related. These proposed regulations also provide that, rather than owing tax as both an ATEO and a related organization for the same remuneration paid to a covered employee, each employer is liable only for the greater of the excise tax it would owe as an ATEO or the excise tax it would owe as a related organization with respect to that covered employee. These proposed regulations also provide rules for determining liability when a related organization has a termination of ATEO status.

In order to calculate its liability for the tax on excess remuneration, an ATEO may take the following steps:

Step 1: Calculate total remuneration paid (other than any excess parachute payment) to each covered employee, including remuneration from all related organizations. The total tax liability for the ATEO and related organizations with respect to each covered employee is 21 percent (for 2020) of the total remuneration paid to the covered employee that exceeds $1 million;

Step 2: Calculate the share of the liability for each employer of the covered employee as the portion of the total tax liability that bears the same ratio to the total tax liability as the ratio of the amount of remuneration paid by the employer to the total remuneration calculated in step 1;

Step 3: Inform each related organization of its share of the liability calculated in step 2;

Step 4: Obtain information on the ATEO's share of the liability as a related organization for any covered employee of another ATEO. If the ATEO is a related organization with respect to more than one other ATEO, treat the ATEO's highest share of the liability as a related organization as its liability as a related organization for the covered employee; and

Step 5: Compare the ATEO's liability as an ATEO in step 2 to its share of the liability as a related organization under step 4 for each of the ATEO's covered employees. The ATEO's share of the liability is, and the ATEO reports, the greater of the share calculated under step 2 or step 4.

B. Calculation of Tax on an Excess Parachute Payment

With respect to the calculation of, and liability for, the tax on excess parachute payments, these proposed regulations differ in one respect from the guidance provided in Q/A-1 of Notice 2019-09. Notice 2019-09 provided that an ATEO or related organization may be liable for the tax on an excess parachute payment based on the aggregate parachute payments made by the ATEO and its related organizations, including parachute payments based on separation from employment from a related organization. These proposed regulations provide that only an excess parachute payment paid by an ATEO is subject to the excise tax on excess parachute payments. However, consistent with the provision in section 4960(c)(5)(D) that rules similar to section 280G(b)(3) apply for purposes of determining the base amount under section 4960, payments from related organizations that are not ATEOs are considered for purposes of determining the base amount and total payments in the nature of compensation that are contingent on the covered employee's separation from employment with the employer. See § 1.280G-1, Q/A-34. Generally, this means that a covered employee's base amount calculation includes remuneration from all ATEOs and related organizations, and that a covered employee's parachute payment calculation includes all payments (made from all ATEOs and related organizations) that are contingent on the employee's involuntary separation from employment. However, only ATEOs are subject to the excise tax on excess parachute payments they make to a covered employee. A non-ATEO that pays an amount that would otherwise be an excess parachute payment is not subject to the excise tax. These proposed regulations further provide that, based on the facts and circumstances, the Commissioner may reallocate excess parachute payments to an ATEO if it is determined that excess parachute payments were made by a non-ATEO for the purpose of avoiding the tax under section 4960.

In order to calculate its liability for the tax on excess parachute payments, an ATEO may take the following steps:

Step 1: Determine whether a covered employee is entitled to receive payments in the nature of compensation that are contingent on an involuntary separation from employment (contingent payments) and are not excluded from the definition of “excess parachute payment”;

Step 2: Calculate the total aggregate present value of the contingent payments, taking into account the rules that apply when an involuntary separation from employment accelerates the timing of a payment or the vesting of a right to a payment;

Step 3: Calculate the covered employee's base amount with respect to the base period;

Step 4: Determine whether the contingent payments are parachute payments. Contingent payments are parachute payments if their total aggregate present value equals or exceeds an amount equal to 3-times the covered employee's base amount;

Step 5: Calculate the amount of excess parachute payments. A parachute payment is an excess parachute payment to the extent the payment exceeds the base amount allocated to the payment; and

Step 6: Calculate the amount of excise tax imposed under section 4960(a)(2). The excise tax is the amount equal to the product of the rate of tax under section 11 (21 percent for 2020) and the sum of any excess parachute payments paid by an ATEO or related organization during a taxable year to the covered employee.

C. Reporting and Payment of the Tax

On April 9, 2019, the Treasury Department and the IRS issued final regulations under sections 6011 and 6071 (§§ 53.6011-1 and 53.6071-1, T.D. 9855, 84 FR 14008) to address reporting and the due date for paying the section 4960 tax. Those final regulations provide that the excise tax under section 4960 is reported on Form 4720, “Return of Certain Excise Taxes Under Chapters 41 and 42 of the Internal Revenue Code,” which is the form generally used for reporting and paying chapter 42 taxes. Those final regulations provide that the reporting and payment of any applicable taxes are due when payments of chapter 42 taxes are ordinarily due (the 15th day of the 5th month after the end of the taxpayer's taxable year—May 15 for a calendar year employer), subject to an extension of time for filing returns and making payments ^[8] that generally applies.

These proposed regulations provide that each employer liable for section 4960 tax, whether an ATEO or a related organization described in section 4960(c)(4)(B), is responsible for separately reporting and paying its share of the tax. These proposed regulations also provide that an employer may elect to prepay the excise tax imposed under section 4960(a)(2) for excess parachute payments in the year of separation from employment or any taxable year prior to the year in which the parachute payment is actually paid. This prepayment rule for the tax applicable to excess parachute payments is similar to the rule in § 1.280G-1, Q/A-11(c), under which a disqualified employee may elect to prepay the excise tax under section 4999 based on the present value of the excise tax that would be owed by the employee when the parachute payments are actually made.

Some commenters requested clarification as to whether the section 4960 excise tax is subject to quarterly payments of estimated tax under section 6655. Because section 6655 has not been amended to include section 4960, no quarterly payments of estimated section 4960 excise tax are required under section 6655.

VII. Proposed Applicability Date

These regulations are proposed to apply to taxable years beginning on or after the date the final regulations are published in the Federal Register. The Treasury Department and the IRS understand that the date during a calendar year on which final regulations are issued may affect the time an ATEO and its related organization(s) will have to familiarize themselves with the regulations and to respond with adjustments to compensation structures or other adjustments. The Treasury Department and the IRS will take this into account when issuing the final regulations, but also request comments on the burdens anticipated and the timeframe expected to be necessary to implement the final regulations (taking into account that the statutory provisions are already effective).

The guidance provided in these proposed regulations generally is consistent with the guidance provided in Notice 2019-09. However, in certain instances these proposed regulations modify the guidance provided in Notice 2019-09. Until the applicability date of the final regulations, taxpayers may rely on the guidance provided in Notice 2019-09 or, alternatively, on the guidance provided in these proposed regulations, including for periods prior to June 11, 2020.

Taxpayers may also base their positions upon a reasonable, good faith interpretation of the statute that includes consideration of any relevant legislative history. Whether a taxpayer's position that is inconsistent with Notice 2019-09 or these proposed regulations constitutes a reasonable, good faith interpretation of the statute generally will be determined based upon all of the relevant facts and circumstances, including whether the taxpayer has applied the position consistently and the extent to which the taxpayer has resolved interpretive issues based on consistent principles and in a consistent manner. Notwithstanding the previous sentence, the preamble to Notice 2019-09 describes certain positions that the Treasury Department and the IRS have concluded are not consistent with a reasonable, good faith interpretation of the statutory language, and these proposed regulations reflect this view. Specifically, the following positions will continue to be treated as inconsistent with a reasonable, good faith interpretation of the statutory language:

(1) Remuneration paid by a separate employer that is a related for-profit or governmental entity (other than an ATEO). The position that remuneration paid by a separate employer that is a related for-profit or governmental entity (other than an ATEO) is taken into account in determining whether a covered employee has remuneration in excess of $1 million, but that the related entity is not liable for its share of the excise tax under section 4960, is not consistent with a reasonable, good faith interpretation of the statutory language. There is no statutory support for such an exception for for-profit and governmental entities. Section 4960(c)(4)(B), which defines “related organizations,” applies to any “person or governmental entity” that meets any of the relationship tests in section 4960(c)(4)(B)(i) through (v). Unlike the definition of an “ATEO” under section 4960(c)(1)(C), which applies only to a governmental entity that excludes income from taxation under section 115(1), section 4960(c)(4)(B) applies to any “governmental entity” that is related to an ATEO. Similarly, a for-profit entity is a “person” under generally applicable tax principles. In addition, excepting for-profit entities from liability as related organizations would be inconsistent with section 4960(c)(6), which coordinates the tax on excess parachute payments with the section 162(m) deduction limitation (which only applies to for-profit entities). Finally, section 4960(c)(4)(C), which describes the liability for the excise tax, refers to any case in which remuneration from more than one employer is taken into account, stating that “each such employer” shall be liable, without qualification as to the employer's status as an ATEO.

(2) Continued treatment of a covered employee as a covered employee. The position that a covered employee ceases to be a covered employee after a certain period of time is not consistent with a reasonable, good faith interpretation of the statute. Although commenters requested that the Treasury Department and the IRS provide a rule of administrative convenience under which a covered employee is no longer considered a covered employee of an ATEO after a certain period of time during which the individual was not an active employee of the ATEO, neither Notice 2019-09 nor these proposed regulations adopt that suggestion because it is inconsistent with the statute.

(3) Remuneration for medical services for purposes of determining the five highest-compensated employees. The position that remuneration for medical services is taken into account for purposes of identifying the five highest-compensated employees is not consistent with a reasonable, good faith interpretation of the statute. As the Conference Report to TCJA states, “[f]or purposes of determining a covered employee, remuneration paid to a licensed medical professional which is directly related to the performance of medical or veterinary services by such professional is not taken into account, whereas remuneration paid to such a professional in any other capacity is taken into account.” H. Rept. 115-466, at 494 (2017).

(4) Covered employees of a group of related organizations. The position that a group of related ATEOs may have only five highest-compensated employees among all of the related ATEOs is not consistent with a reasonable, good faith interpretation of the statute. Section 4960 does not provide for such treatment. Further, to the extent section 4960 is analogous to the compensation deduction limitation under section 162(m), § 1.162-27(c)(1)(ii) provides that each related subsidiary within an affiliated group of corporations that is itself a publicly held corporation is separately subject to the deduction limitation, just as each ATEO within a group of related organizations is separately subject to section 4960.

Special Analyses

I. Regulatory Planning and Review

Executive Orders 13771, 13563, and 12866 direct agencies to assess costs and benefits of available regulatory alternatives and, if regulation is necessary, to select regulatory approaches that maximize net benefits (including potential economic, environmental, public health and safety effects, distributive impacts, and equity). Executive Order 13563 emphasizes the importance of quantifying both costs and benefits, of reducing costs, of harmonizing rules, and of promoting flexibility. The Executive Order 13771 designation for any final rule resulting from the proposed regulation will be informed by comments received. The preliminary Executive Order 13771 designation for this proposed rule is “regulatory.”

The proposed regulations have been designated as subject to review under Executive Order 12866 pursuant to the Memorandum of Agreement (April 11, 2018) between the Treasury Department and the Office of Management and Budget (OMB) regarding review of tax regulations. The Office of Information and Regulatory Affairs (OIRA) has designated the proposed rulemaking as significant under section 1(c) of the Memorandum of Agreement. Accordingly, OMB has reviewed the proposed regulations.

A. Background

1. The Excise Tax Under Section 4960

Section 4960 was added to the Code by TCJA. Section 4960(a) subjects excess remuneration above $1 million and excess parachute payments that an ATEO pays to a covered employee to an excise tax equal to the rate of tax imposed on corporations under section 11 (21 percent for 2020). Before TCJA, compensation paid by tax-exempt organizations was not subject to an excise tax, although section 4958 applies an excise tax to penalize excess benefit transactions in which an “applicable tax-exempt organization” (as defined in section 4958) provides a benefit to a disqualified person that exceeds the reasonable fair market value of the services received.

Section 4960 defines an “ATEO” as any organization which is exempt from taxation under section 501(a), is a farmers' cooperative organization described in section 521(b)(1), has income excluded from taxation under section 115(1), or is a political organization described in section 527(e)(1). Covered employees of an ATEO include the five highest-compensated employees of the organization for the taxable year and any employee or former employee who was a covered employee of the organization (or predecessor) for any preceding taxable year beginning after December 31, 2016.

“Remuneration” means “wages” as defined in section 3401(a) (excluding designated Roth contributions) and includes amounts required to be included in gross income under section 457(f). Section 4960 excludes from remuneration any amount paid to a licensed medical professional for medical or veterinary services provided. Remuneration also includes payments with respect to employment of a covered employee by any person or government entity related to the ATEO. A person or governmental entity is treated as related to the ATEO if that person or governmental entity controls, or is controlled by, the ATEO, is controlled by one or more persons which control the ATEO, is a “supported organization” (as defined in section 509(f)(3)) during the taxable year with respect to the ATEO, is a supporting organization described in section 509(a)(3) during the taxable year with respect to the ATEO, or in the case of an organization which is a voluntary employees' beneficiary association (VEBA) under section 501(c)(9), established, maintains, or makes contribution to such VEBA.

2. Notice 2019-09 and the Proposed Regulations

Notice 2019-09 provides taxpayers with initial guidance on the application of section 4960, including that taxpayers may base their positions on a reasonable, good faith interpretation of the statute until further guidance is issued. These proposed regulations are largely based on Notice 2019-09 with changes in part addressing comments received.

The Treasury Department and the IRS received 14 comments in response to Notice 2019-09. The comments primarily discussed the treatment of employees of a related person who also provide services to the ATEO, suggesting various exceptions for such situations. Comments also addressed the possibility of a grandfather rule for compensation under prior arrangements, treatment of deferred compensation as remuneration, the definition of “control,” and which organizations are ATEOs.

B. Baseline

The Treasury Department and the IRS have assessed the benefits and costs of the proposed regulations relative to a no-action baseline reflecting anticipated Federal income tax-related behavior in the absence of these regulations.

C. Affected Entities

The proposed regulations affect an estimated 261,000 ATEOs and 77,000 non-ATEO related organizations of ATEOs that in historical filings report substantial executive compensation.^[9] Of the roughly 261,000 such ATEOs based on filings for tax year 2017, 239,000 are section 501(a) exempt organizations (including 23,000 private foundations), 19,000 are section 115 state and local instrumentalities, 2,000 are section 527 political organizations, 600 are exempt farmers' cooperative organizations described in section 521(b)(1), and 200 are federal instrumentalities.

D. Economic Analysis

This section describes the key economic effects of the provisions of these proposed regulations.

1. Clarifications

Most provisions of the proposed regulations clarify aspects of the excise tax imposed by section 4960, minimizing the burdens entities bear to comply with section 4960, and have little other economic impact. Clarifications reduce uncertainty, lowering the effort required to infer which organizations, employees, and payments are subject to the excise tax and the potential for conflict if entities and tax administrators interpret provisions differently. Examples of provisions of the proposed regulations that are primarily clarifications include the definition of “control,” treatment of deferred compensation and vesting, and which organizations are ATEOs.

2. “Volunteer” Exceptions

Several commenters expressed concern that highly-paid employees of a non-ATEO performing services for a related ATEO without receiving compensation from the ATEO may be subject to the excise tax. To avoid the excise tax, individuals might cease performing such services, or ATEOs might dissolve their relationships with related non-ATEOs, reducing donations from related non-ATEOs.

The proposed regulations include exceptions to the definitions of “employee” and “covered employees” (specifically to the rules for determining the five highest compensated employees for purposes of identifying covered employees) to address such situations. With respect to the first exception, the regulations define “employee” consistent with section 3401(c), in particular adopting the rule that a director is not an employee in the capacity as a director and an officer performing minor or no services and not receiving any remuneration for those services is not an employee.

The general rule provides that 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 grant of a legally binding right to remuneration) from the ATEO or a related organization cannot be among the ATEO's five highest-compensated employees.

Under the exceptions, 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. 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. 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. Likewise, 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.

Consider, for example, a corporate employee making $2 million per year who spends 5 percent of her time (roughly one day each month) working for the corporation's foundation, a related ATEO, without receiving compensation from the ATEO and who would be a covered employee of the ATEO absent the exceptions. The value of the employee's services provided to the ATEO is roughly five percent of her salary, or $100,000. Without the exceptions, her compensation in excess of $1 million from the corporation, which is a related party of the foundation, is subject to a 21 percent excise tax, or $210,000 in excise tax liability. The exceptions remove that liability and the incentive it provides to stop providing such services or to dissolve the relationship between the ATEO and the related organization.

The exceptions in the proposed regulations may have a substantial impact on donations relative to a no-action baseline, although the magnitude of the potential impact depends on how often the exceptions apply and on how responsive organizations and employees are to the excise tax, both of which are uncertain.

The exceptions apply only in particular circumstances: The employee must be employed by a related organization (typically an organization that controls or is controlled by the ATEO), the employee must be highly compensated, and the employee's work for the ATEO must be sufficiently minimal. Historically, many ATEOs report employees with compensation from related organizations. An estimated 8,500 ATEOs filing Form 990 in tax year 2017 reported both compensation of $500,000 or more for any person and any compensation from related organizations. These ATEOs are estimated to have an average of 18 non-ATEO related organizations based on information reported on Form 990 Schedule R, yielding an estimated 154,000 non-ATEO related organizations, of which half, or 77,000, are estimated to employ a covered employee of the ATEO. The fraction of the 154,000 non-ATEO related organizations with employees to whom the exceptions apply (and who are thus not covered employees of the ATEO) is uncertain, but perhaps half the related organizations, or 77,000, have such an employee.

This entity count omits a substantial number of private foundations which may have employees who receive no compensation from the ATEO but who are highly compensated by related organizations, because while the ATEO count used in these estimates includes approximately 100 private foundations that have historically reported employee compensation of $500,000 or more on Form 990-PF, Form 990-PF (unlike Form 990) does not include information on employee compensation received from related organizations. The exceptions are particularly likely to apply to donations to foundations related to non-ATEO businesses, as companies are highly likely to be related organizations of a company's foundation, many family foundations are controlled by the same family that controls a private business, and executives of the related business often provide services to the foundation without payment from the foundation. Because of these facts, looking at pre-TCJA tax forms may underestimate the number of entities potentially affected by the exceptions. In the U.S. in 2015, there were about 2,000 company foundations responsible for $5.5 billion in giving, and 42,000 family foundations.^[10] It is reasonable to assume that about half of these foundations, or 22,000, have a related business with an employee to whom the exceptions apply.

Under reasonable assumptions about the response of donated services to the excise tax, the exceptions restore substantial donations (transfers) of services that the excise tax would otherwise eliminate. Totaling both private foundations and other ATEOs, roughly 99,000 related organizations are estimated to have employees to whom the exceptions apply. If the excise tax would have reduced services that are donated under the exceptions by an average of just over $5,000 per related organization, the total transfer reduction exceeds $500 million.

Absent the exceptions, organizations may also avoid the excise tax by dissolving the relationship between the ATEO and non-ATEO, which may affect donations of money as well as services. Considering only corporate foundations and setting aside other ATEOs, if such dissolutions would lead to a two percent reduction in the $5.5 billion in corporate giving that would otherwise take place through related foundations, the reduction exceeds $100 million. The Treasury Department and the IRS request comments on the impact of the exceptions on the dissolution of relationships between ATEOs and related organizations.

It is plausible that the proposed regulations restore substantial economic activity relative to a no-action baseline, under which the excise tax would discourage highly-compensated employees of related non-ATEOs from providing services to a related ATEO without compensation from the ATEO and discourage relationships between ATEOs and non-ATEOs.

3. Summary

This analysis suggests that the proposed regulations will reduce compliance burden on affected entities by providing clarifications and, through the exceptions, increase services provided to ATEOs without compensation from the ATEO by a small but potentially economically significant amount ($100 million or more), relative to a no-action baseline. The Treasury Department and the IRS request comments on the economic impact of these proposed regulations. In particular, comments that provide data, other evidence, or models that provide insight are requested.

II. Paperwork Reduction Act

The collections of information in these proposed regulations are in proposed § 53.4960-1(d), (h), (i)(2) and (j); § 53.4960-2(a), (c) and (d); and § 53.4960-4(a) and (d). This information is required to determine an ATEO's “covered employees” as defined in section 4960(c)(2); to calculate remuneration in excess of $1 million as described in section 4960(c)(3); to determine remuneration from related organizations and allocation of liability as described in section 4960(c)(4); and to determine any excess parachute payments to covered employees described in section 4960(c)(5).

The IRS intends that the burden of the collections of information will be reflected in the burden associated with Form 4720, under OMB approval number 1545-0047. The burden associated with Form 4720 is included in the aggregated burden estimates for OMB control number 1545-0047. For purposes of the Paperwork Reduction Act, the Treasury Department and the IRS have not estimated the burden, including that of any new information collections, related to the requirements under the proposed regulations.

The expected burden for ATEOs as described in section 4960(c)(1) and related organizations as described in section 4960(c)(4)(B) is listed below:

Estimated number of respondents: 337,888.

Estimated average annual burden hours per response: 0.20 hours (based on 66,509 total hours).

Estimated total annual burden: $3,569,632 (2020).

Estimated frequency of collection: Annual.

The Treasury Department and the IRS request comments on all aspects of information collection burdens related to the proposed regulations, including estimates for how much time it would take to comply with the paperwork burdens described above for each relevant form and ways for the IRS to minimize the paperwork burden. Proposed revisions (if any) to these forms that reflect the information collections contained in the final regulations will be made available for public comment at https://apps.irs.gov/​app/​picklist/​list/​draftTaxForms.html and will not be finalized until after these forms have been approved by OMB under the PRA. Comments on these forms can be submitted at https://www.irs.gov/​forms-pubs/​comment-on-tax-forms-and-publications.

An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless it displays a valid control number assigned by the Office of Management and Budget.

Books or records relating to a collection of information must be retained as long as their contents may become material in the administration of any internal revenue law. Generally, tax returns and return information are confidential, as required by 26 U.S.C. 6103.

III. Regulatory Flexibility Act

Pursuant to the Regulatory Flexibility Act (RFA) (5 U.S.C. chapter 6), it is hereby certified that these proposed regulations would not have a significant economic impact on a substantial number of small entities.

The Regulatory Flexibility Act (5 U.S.C. 601 et seq.) (RFA) generally defines a “small entity” as (1) a proprietary firm meeting the size standards of the Small Business Administration (SBA) (13 CFR 121.201), (2) a nonprofit organization that is not dominant in its field, or (3) a small government jurisdiction with a population of less than 50,000. (States and individuals are not included in the definition of “small entity.”) The Treasury Department and IRS estimate that these proposed regulations will affect 324,000 small entities, 73,000 of which are proprietary firms meeting the size standards of the SBA and 251,000 of which are nonprofit organizations that are not dominant in their fields or small government jurisdictions with a population of less than 50,000.

The Treasury Department and IRS estimated the number of ATEOs, based primarily on Form 990 data for filers with at least one employee (and thus having a burden, at a minimum, of maintaining annual lists of covered employees), as 261,118, and the number of non-ATEO related organizations employing at least one covered employee of an ATEO as 76,770, for a total of 337,888 affected entities. The SBA defines a small business as an independent business having fewer than 500 employees. (See A Guide for Government Agencies, How to Comply with the Regulatory Flexibility Act, Appendix B ^[11] ). Tax data available to Treasury Department and IRS include employee counts for only half the affected entities, as employee counts are included on Form 990, but not on other forms including Form 990-EZ and 990-PF. An examination of tax data from 2016 shows that for filers for whom employee counts were available and who had at least one employee, 96.5 percent had fewer than 500 employees. Similarly, there are no bright lines in the available data to distinguish small nonprofit organizations that are not dominant in their field. An examination of non-tax data shows that a similar proportion, approximately 96 percent, of all incorporated cities, towns, and villages in 2014 had a population of less than 50,000, which may serve as a proxy for small government jurisdictions generally.^[12] By applying the 96 percent estimate to all entities affected by section 4960, the Treasury Department and IRS estimate that 324,000 small entities are affected by these regulations.

Section 4960 imposes the excise tax on ATEOs and their related organizations to the extent they pay certain compensation to a covered employee. Because covered employee status is permanent, every ATEO must determine its five highest-compensated employees for the taxable year—even if the ATEO is not subject to the tax for that taxable year—and maintain a list of covered employees. Accordingly, the proposed rules likely will affect a substantial number of small entities, especially nonprofit entities that are not dominant in their fields.

The Treasury Department and the IRS estimate that vast majority of ATEOs, particularly small ATEOs, can determine their five highest-compensated employees for the taxable year under the method provided in the proposed rule very quickly and at negligible cost using information already collected in the normal course of business. The time necessary to determine an ATEO's five highest-compensated employees is positively correlated with the size of the entity (that is, the smaller the entity, the less time such a determination should take). Larger ATEOs may take more time, but it is estimated that this determination will take less than seven hours. The burden for making this determination is estimated to fall on the small number of larger ATEOs. Putting these two groups together, the total estimated cost for all 261,118 ATEOs to make these determinations is $1,255,760 per year, averaging $4.81 per ATEO. Thus, the Treasury Department and the IRS have determined that the proposed rules regarding an ATEO's covered employees are unlikely to have a significant economic impact on affected small entities.

Notwithstanding this certification, the Treasury Department and the IRS invite comments from the public on both the number of entities affected (including whether specific industries are affected) and the economic impact of this proposed rule on small entities.

Pursuant to section 7805(f) of the Code, this proposed rule has been submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small entities.

IV. Unfunded Mandates Reform Act

Section 202 of the Unfunded Mandates Reform Act of 1995 requires that agencies assess anticipated costs and benefits and take certain other actions before issuing a final rule that includes any Federal mandate that may result in expenditures in any one year by a state, local, or tribal government, in the aggregate, or by the private sector, of $100 million in 1995 dollars, updated annually for inflation. In 2019, that threshold is approximately $164 million. This rule does not include any Federal mandate that may result in expenditures by state, local, or tribal governments, or by the private sector in excess of that threshold.

V. Executive Order 13132: Federalism, Congressional Review Act

Executive Order 13132 (titled “Federalism”) prohibits an agency from publishing any rule that has federalism implications if the rule either imposes substantial, direct compliance costs on state and local governments, and is not required by statute, or preempts state law, unless the agency meets the consultation and funding requirements of section 6 of the Executive Order. This proposed rule does not have federalism implications that are not required by the statute and does not impose substantial direct compliance costs on state and local governments or preempt state law within the meaning of the Executive Order.

Comments and Requests for a Public Hearing

Before these proposed regulations are adopted as final regulations, consideration will be given to comments that are submitted timely to the IRS as prescribed in this preamble under the ADDRESSES section. The Treasury Department and the IRS request comments on all aspects of these proposed regulations. Any electronic comments submitted and, to the extent practicable, any paper comments submitted will be made available at https://www.regulations.gov or upon request.

A public hearing will be scheduled if requested in writing by any person who timely submits electronic or written comments. Requests for a public hearing are also encouraged to be made electronically. If a public hearing is scheduled, notice of the date and time for the public hearing will be published in the Federal Register. Announcement 2020-4, 2020-17 IRB 1, provides that until further notice, public hearings conducted by the IRS will be held telephonically. Any telephonic hearing will be made accessible to people with disabilities.

Drafting Information

The principal authors of these regulations are William McNally of the Office of Associate Chief Counsel (Employee Benefits, Exempt Organizations and Employment Taxes, Executive Compensation branch) and Patrick Sternal of the Office of Associate Chief Counsel (Employee Benefits, Exempt Organizations and Employment Taxes, Exempt Organizations branch). However, other personnel from the Treasury Department and the IRS participated in their development.

Statement of Availability

IRS Revenue Procedures, Revenue Rulings, Notices, and other guidance cited in this preamble are published in the Internal Revenue Bulletin (or Cumulative Bulletin) and are available from the Superintendent of Documents, U.S. Government Publishing Office, Washington, DC 20402, or by visiting the IRS website at https://www.irs.gov.

List of Subjects

26 CFR Part 1

• Income taxes
• Reporting and recordkeeping requirements

26 CFR Part 53

• Excise taxes
• Foundations
• Investments
• Lobbying
• Reporting and recordkeeping requirements

Proposed Amendments to the Regulations

Accordingly, the Department of the Treasury and the Internal Revenue Service propose to amend 26 CFR parts 1 and 53 as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation for part 1 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * * *.

Par. 2. Section 1.338-1 is amended by revising paragraph (b)(2)(i) to read as follows:

PART 53—FOUNDATION AND SIMILAR EXCISE TAXES

Par. 3. The authority citation for part 53 is revised to read in part as follows:

Authority: 26 U.S.C. 7805; 4960.

Par. 4. Sections 53.4960-0 through 53.4960-5 are added to read as follows:

Footnotes