Mitigation Alternatives to the Excise Tax on “Excess” Compensation

The 2017 Tax Cuts and Jobs Act (TCJA) added a 21% excise tax on “excess” executive compensation paid by tax-exempt organizations to certain employees. It is the organization, not the employee, that is responsible for paying this tax. Because this tax applies to individuals who are generally highly compensated, this can be a significant tax burden for organizations. However, there are some strategies organizations can use in an effort to mitigate the impact of this tax.

“Excess” Executive Compensation

This excise tax applies to “excess” compensation or income greater than $1,000,000 per year to a covered employee. A tax-exempt organization or other type of applicable business such as a farmer’s cooperative or a political subdivision is included in the excise tax imposed by the TCJA. Covered employees are the five highest-compensated employees of that organization or an individual who qualified as a covered employee in a preceding taxable year. Pursuant to these new rules, “once a covered employee, always a covered employee,” despite changes in pay.

While the IRS has not yet issued regulations on this point, exempt organizations are expected to apply, in good faith, a reasonable interpretation of the statute. The IRS did release a Notice in September 2019, and compliance with this notice is considered good faith. This Notice provided a bit of detail, including information that remuneration paid for medical and veterinary services were not included when calculating the five highest-paid individuals.

Excise Tax Mitigation Strategies

  • Use Tax-Qualified Retirement Plans: Since Code Section 4960 does not apply to payments made to or from tax-favored retirement plans, maximizing contributions to these plans may be part of your executive compensation strategy. The organization may
  • Split-Dollar Life Insurance: Under this arrangement, the employee would purchase a whole life insurance policy and the organization would make loans to the employee in the amount needed to pay the premium. The cash value of the plan then becomes a source of retirement income, and the death benefit can repay the premium loans. Loans are not wages and thus would not be considered remuneration.

It is important to ensure that any action taken complies with IRS Code Section 4960. This is a good time to take a step back and look at compensation practices to determine whether changes are needed to ensure compliance both with IRS Code as well as alignment with organizational goals and principles. The experienced employee benefits attorneys at Hall Benefits Law can help you create a new executive compensation committee, learn about industry best practices, or explore benefits and compensation packages that help your organization meet its goals. To learn more, call 678-439-6236 today, or visit the Hall Benefits Law website.

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Hall Benefits Law, LLC

HBL offers employers comprehensive legal guidance on benefits in mergers and acquisitions, Employee Stock Ownership Plans (ESOPs), executive compensation, health and welfare benefits, healthcare reform, and retirement plans. We counsel a wide spectrum of clients including small, mid-sized, and large companies, 401(k) investment advisors, health insurance brokers, accountants, attorneys, and HR consultants, just to name a few. HBL is passionate about advising clients, and we are dedicated to our mission: to provide comprehensive, personalized, and practical ERISA and benefits legal solutions that exceed client expectations.

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