Not For Profit/Exempt Organizations Blog

Repeal of Unrelated Business Income Tax on Qualified Transportation Fringe Benefits

Late on Friday, December 20, 2019, President Trump signed into law government funding legislation for the 2020 fiscal year that includes a provision repealing Section 512(a)(7), commonly referred to as the “parking tax.”[1]

Section 512(a)(7) was enacted pursuant to the 2017 U.S. tax legislation known as the “Tax Cuts and Jobs Act.”  The provision required tax-exempt employers to increase their unrelated business taxable income (“UBTI”) by amounts paid or incurred for qualified transportation fringe benefits provided to employees, including the provision of parking and public transportation benefits.  Despite certain guidance passed at the end of 2018, the provision caused concern amongst tax-exempt organizations because of the prospect of increased tax liability, the lack of clarity for determining the taxable amount of such benefits, and the additional administrative burdens triggered for certain organizations.

Pursuant to the new legislation, Section 512(a)(7) was repealed with retroactive effect to the date of its enactment.  As a result, organizations should file an amended Form 990-T to claim a refund for any taxes paid related to such qualified transportation fringe benefits.  Organizations are encouraged to consult their own tax advisors as to whether a state tax refund is available as well.[2]

[1] See Division Q of H.R. 1865, the “Further Consolidated Appropriations Act, 2020.”

[2] In New York State, amounts paid or incurred by tax-exempt organizations for qualified transportation benefits were not subject to tax, as the New York State tax code was decoupled from the changes made to the federal UBTI rules at the end of 2018.  Thus, no New York State tax would have been due with respect to these amounts.

New York State Codifies the Johnson Amendment

On October 23, 2019, Governor Andrew M. Cuomo, signed legislation incorporating the federal Johnson Amendment into New York law. As previously described, the Johnson Amendment denies tax-exempt status under section 501(c)(3) of the Internal Revenue Code (the “Code”) to (and imposes excise taxes on) any organization that engages in political campaign activities. The new legislation amended section 1116 of New York Tax Law, which will now deny tax-exempt status for N.Y tax purposes to any organization that engages in political campaign activities, either on behalf or in opposition of any candidate for public office. Continue Reading

Proskauer’s 24th Annual Trick or Treat Seminar

Proskauer’s 24th Annual Trick or Treat Seminar was held on Wednesday, October 31 and discussed timely topics and best practices specifically tailored to the not-for-profit community.

The seminar discussed:

  • Protect Yourself: A Practical Guide to Strategic Risk Management and Insurance
  • How to Solicit a Donor in Fifteen Minutes: The Ultimate Cheat Sheet
  • Compensation and Benefits Update: New Excise Taxes, Litigation, and Other Developments
  • Time to Care: Developments and Trends in Family and Personal Leave

Amanda Nussbaum welcomed everyone and briefly discussed recent tax law changes and areas of focus for the Internal Revenue Service and introduced the presenters.

Here are some key points from each presentation:

John Failla discussed insurance risk management issues affecting nonprofit organizations.  John explained how nonprofits can employ enterprise risk management techniques to identify and prioritize emerging risks.  He discussed the importance and benefits of reviewing insurance contracts with counsel at least annually.  Finally, John discussed the top ten insurance pitfalls that nonprofit organizations face, including cyber and privacy risks, computer crime and social engineering, liability from the acts of volunteers, sexual abuse and employment practices liability coverages, and the need for procedures and training to ensure compliance with notice, cooperation and consent requirements in insurance policies.

David Pratt discussed a range of opportunities, including charitable lead trusts created during life and at death, leaving IRAs, 401(k)s and other qualified plans, as well as tax deferred annuities to charity to avoid the income taxes that would otherwise be imposed.  He focused on using insurance in charitable planning as a wealth replacement tool and as a way to leave money to charity, particularly with policies that are very often forgotten about (i.e., low hanging fruit).  David also discussed how donors have appreciated securities and low basis real estate, and how these assets can be used in connection with charitable giving.  Finally, David discussed how charitable giving, in general, is a way for a donor to decide what charities he or she may want to give to, rather than paying taxes and letting the government decide.

Seth Safra discussed compensation and benefits developments.  First, Seth discussed recent developments and open issues related to the 21% excise tax on compensation in excess of $1 million and on certain separation pay.  Next, Seth discussed the March 31, 2020, deadline to restate preapproved section 403(b) plans and to update individually designed 403(b) plans for qualification requirements.  Finally, Seth discussed benefits litigation, including cases before the Supreme Court that will address standing for claims related to pension investments and whether receiving a disclosure is sufficient to establish “actual knowledge” for purposes of ERISA’s statute of limitations; lessons learned from recent section 403(b) litigation decisions and settlements; and ongoing litigation related to actuarial factors used to calculate pension benefits.

Laura Fant discussed recent trends and developments in the area of employee leave.  She first covered the latest updates regarding the federal Family and Medical Leave Act (“FMLA”), including updates to the model certification and designation forms and recent Department of Labor opinion letters and case law addressing FMLA leave.  She then turned to the topic of paid sick leave, including recent changes to the rules governing the New York City Earned Safe and Sick Time Act.  Laura also discussed the new trend of “personal time” laws – that is, laws requiring employers to provide a certain amount of leave that can be used by employees for any reason.  Maine and Nevada have already passed such laws, with other jurisdictions, including New York City, considering similar legislation.  Laura then provided an update on the New York Paid Family Leave Law and talked about the nationwide trend of paid family and medical leave laws being enacted, including in Connecticut, Massachusetts, and Washington, D.C.  Finally, Laura gave an overview of other leave-related developments in New York, including time off for victims of domestic and related violence and paid time off to vote.

Deadline Approaching for 403(b) Sponsors to Review Plan Documents for Compliance

Section 403(b) plans must be maintained pursuant to a written plan document that meets detailed requirements set forth in IRS regulations.  If a plan contains a defect as to form (e.g., a provision does not comply with the regulations or a required provision is missing), the plan can be at risk for losing its qualification for favorable tax treatment.  The IRS allows a “remedial amendment period” to correct form defects in individually designed plans that were timely adopted, but the remedial amendment period ends March 31, 2020 (subject to a short extension for recently incurred plan defects).

It is not uncommon for the IRS to identify possible defects in well-drafted plan documents that were adopted in good faith.  The “remedial amendment period” offers employers an opportunity to review existing language in light of developments over the last several years and to clean up or improve the language retroactively without penalty.

After March 31, 2020, retroactive correction will no longer be permitted outside of the IRS Employee Plans Compliance Resolution System (EPCRS).  Because the March 31, 2020 deadline is not likely to be extended by the IRS, sponsors of individually designed section 403(b) plans are encouraged to review their 403(b) plan documents and consult with their advisers to determine if there are any provisions that should be cleaned up by March 31, 2020.

Parsonage Exclusion Found by Seventh Circuit to Be Constitutional

On March 15, 2019, the U.S. Court of Appeals for the Seventh Circuit held in Gaylor v. Mnuchin that the tax exemption for “ministers of the gospel” (defined below) under Section 107(2) of the Internal Revenue Code (the “Code”) does not violate the Establishment Clause[1] of the First Amendment and, therefore, is constitutional, overruling the district court decision.[2]

In Gaylor, the Freedom From Religion Foundation (the “FFRF”)[3] sued the Treasury Department after the Internal Revenue Service (the “IRS”) denied the refund claims of FFRF’s co-presidents who sought to exclude the portion of their salaries paid in the form of a housing allowance. The central issue in the case on appeal was whether the district court was correct in holding that the exclusion for housing allowances under Section 107(2) is a law “respecting an establishment of religion.”

Overview of Section 107

Section 107, commonly referred to as the “parsonage exclusion,” excludes from gross income housing furnished to a “minister of the gospel” (or, “minister”) as part of his or her compensation. For the purposes of this Code section, a “minister of the gospel” is “a duly ordained, commissioned, or licensed minister of a church or a member of a religious order”[4] and applies to religious leaders of any denomination.[5] The housing may be provided in kind under Section 107(1), in which case the rental value of the home including utilities are excluded,[6] or in the form of an allowance under Section 107(2), in which case the allowance is excluded to the extent it is considered “reasonable compensation” for the minister’s services[7] and is actually used in the taxable year in which it is received to pay for rent, the purchase of a home or expenses directly related to providing a home.[8] A cap on the exclusion under Section 107(2) equal to the fair rental value of a home, including furnishings, appurtenances and utilities, was added by Congress in response to constitutional concerns over the holding in Warren v. Commissioner, where the Tax Court determined that the language of the statute did not impose any such restriction.[9]

Consistent with exemptions under the “convenience-of-the-employer” doctrine for secular employees whose jobs have housing requirements, Congress enacted Section 107 to provide a housing exemption for ministers whose homes are often used as part of, or located in a certain area for, their ministry. While Section 107(1) was generally accepted by the FFRF to put ministers on equal footing as other employees who may exclude certain employer provided in kind housing under Section 119(a)(2),[10] the FFRF argued that the exemption under Section 107(2) for housing allowances is “different” and “better” than those for secular employees under the Code. Section 107(2) differs primarily from Section 119(a)(2) in that it excludes housing allowances as well as in kind housing and it does not require ministers to use their homes as a part of their ministry or to live in certain proximity to their “work” (i.e., their congregation).

Exclusion under Section 107(2) Found Constitutional

The court found that Section 107(2) does not violate the Establishment Clause as it has a secular legislative purpose, its principal effect is neither to endorse nor to inhibit religion and it does not cause excessive government entanglement.[11] The court additionally analyzed whether Section 107(2) is consistent with the “historical practices and understandings” of the Establishment Clause, following the mandate of Town of Greece v. Galloway.[12]

Although the primary housing exclusion provided under Section 119(a)(2) only excludes in kind housing, the court noted that there are “myriad” provisions in the Code that provide in cash and in kind housing exemptions for various categories of employees[13] and that limiting the parsonage exclusion to in kind housing tended to discriminate against ministers of smaller or poorer denominations.[14] Furthermore, Section 107(2) was found to avoid “excessive entanglement” with religion that would result if the IRS needed to inquire into the use of a minister’s home and what activities constitute “worship.” Although the IRS nonetheless must determine who qualifies as a “minister of the gospel” under Section 107,[15] the court reasoned that it involves less entanglement than the alternative of applying the requirements of Section 119(a)(2), which would force the IRS to determine what the “business” of a church is and how far the “premises” of the church extend.

Notably in determining whether Section 107(2) has the primary effect of advancing or inhibiting religion, the court declined to apply Justice Brennan’s plurality opinion in Texas Monthly that a tax exemption for religious publications violated the Establishment Clause because “[e]very tax exemption constitutes a subsidy that affects nonqualifying taxpayers,”[16] concluding that the Brennan plurality opinion was not binding under the Marks test.[17] As the Texas Monthly plurality was not binding, the court felt bound by Walz and Amos to conclude that tax exemptions do not constitute sponsorship of a religion.[18]

Turning to the historical significance test of Town of Greece, the court also found that Section 107(2) is constitutional because of the tradition throughout American history to provide tax exemptions for religion, particularly for church-owned properties. In other words, a tax exemption for parsonage is not what has been historically understood as constituting an “establishment of religion” and therefore is not a violation of the Establishment Clause.[19] The court dismissed both the district court’s finding that Section 107(2) is distinguishable from historical tax exemptions for religion since it is an income and not a property tax exemption, and the position of FFRF that a historical analysis of the Establishment Clause is only applicable when determining the constitutionality of legislative prayer.

Future of Section 107(2)

The ruling by the Seventh Circuit in Gaylor v. Mnuchin does not necessarily settle the constitutionality of Section 107(2). Whether the FFRF will appeal the case or whether the Supreme Court will review it is uncertain.


[1] The Establishment Clause of the First Amendment states that “Congress shall make no law respecting an establishment of religion,” U.S. Const. amend. I, and has been held to not only forbid Congress from establishing a state religion but also to limit the government’s ability to “favor one faith over another” or to show “adherence to religion generally,” McCreary County v. ACLU, 545 U.S. 844 (2005), and thus to generally obligate “governmental neutrality between religion and religion, and between religion and nonreligion,” Epperson v. Arkansas, 393 U.S. 97, 104 (1968).

[2] Gaylor v. Mnuchin, 278 F. Supp. 3d 1081 (W.D. Wis. 2017).

[3] The FFRF is a non-profit educational organization under Section 501(c)(3) of the Code that promotes “the constitutional principle of separation of state and church” and “educate[s] the public on matters relating to nontheism.” What is the Foundation’s Purpose?, Freedom From Religion Foundation, (last visited March 28, 2019).

[4] Treas. Reg. Section 1.1402(c)-5(a)(1).

[5] See, e.g., Salkov v. Comm’r, 46 T.C. 190 (1996) (holding that a Jewish cantor was a “minister of the gospel”).

[6] Treas. Reg. Section 1.107-1(a).

[7] See Rev. Rul. 78-448 (rental allowance cannot exceed reasonable compensation for services where the minister performs only occasional and insubstantial services for a church).

[8] See Treas. Reg. Section 1.107-1(c).

[9] See Pub. L. No. 107-181, § 2(a), 116 Stat. 583 (2002); Warren v. Commissioner, 114 T.C. 343 (2000), appeal dismissed, 302 F3d 1012 (9th Cir. 2002). In Warren, the IRS challenged the position of Richard Warren, a minister of the gospel within the meaning of Section 107, that the exclusion under Section 107(2) was not limited to the fair rental value of a home. Concerns that the Tax Court’s broad interpretation of Section 107(2) in its holding for Warren violated the Establishment Clause prompted Congress to add the fair rental value cap in 2002. This legislative change made the government’s appeal of the case moot, and the appeal was dismissed by the Ninth Circuit accordingly.

[10] Section 119(a)(2) exempts in kind lodging that an employee must accept as a condition of employment and that is furnished on the business premises of, and is for the convenience of, the employer. Treas. Reg. Section 1.119-1(b).

[11] The aforementioned conclusions are based off of the “Lemon” test, first articulated in Lemon v. Kurtzman, 403 U.S. 602 (1971). Lower courts have generally applied the Lemon test, amongst other tests, when analyzing an Establishment Clause question, although there are some doubts about its continuing vitality.

[12] 572 U.S. 565, 576 (2014).

[13] See, e.g., Section 162 (housing provided to an employee away on business for less than a year); Section 134 (housing provided to current or former members of the military); Section 912 (housing provided to government employees living abroad).

[14] See, e.g., Larson v. Valente, 456 U.S. 228, 244 (1982).

[15] Even so, the IRS has specifically said it will not issue rulings or determination letters regarding whether an individual is a “minister of the gospel” for Federal tax purposes. See Rev. Proc. 2019-3.

[16] Texas Monthly, Inc. v. Bullock, 489 U.S. 1, 14 (1989) (Brennan J., plurality opinion).

[17] The Marks test references Marks v. United States, which held that when “a fragmented Court decides a case and no single rationale explaining the result enjoys the assent of five Justices, the holding of the Court may be viewed as that position taken by those Members who concurred in the judgments on the narrowest grounds.” 430 U.S. 188, 193 (1977).

[18] See Walz v. Tax Comm. Of City of N.Y., 397 U.S. 664, 675 (1970) (“The grant of a tax exemption is not sponsorship since the government does not transfer part of its revenue to churches but simply abstains from demanding that the church support the state.”); Corp. of the Presiding Bishop of the Church of Jesus Christ of Latter-Day Saints v. Amos, 483 U.S. 327, 337 (1987) (“We do not see how any advancement of religion achieved by the [exempt religious organization] can be fairly attributed to the Government, as opposed to the Church.”).

[19] This “historical significance” test developed under Town of Greece v. Galloway, 572 U.S. 565 (2014) and requires that the Establishment Clause be interpreted “by reference to historical practices and understandings.”

Five Excise Tax Tips For Tax-Exempt Employers

As we have previously discussed, the 2017 tax reform act created a new excise tax under section 4960 of the Internal Revenue Code that will affect many tax-exempt employers.  The tax is 21% of certain compensation and can be triggered if an employee receives more than $1 million of compensation or an employee receives certain post-termination payments (“parachute” payments).  The tax can apply even if the tax-exempt employer never pays $1 million in compensation.  Two key dates are fast approaching for this new tax:

  • April 2nd is the deadline to submit comments on Notice 2019-9, which provides interim guidance under section 4960. Employers affected by the tax or its administrative complexity should consider submitting comments (we can help); and
  • May 15th is the deadline for calendar year organizations to file excise tax returns for 2018. As with Form 990, a 6-month extension is available if Form 8868 is filed by the May 15th

With that in mind, here are five tips for tax-exempt employers:

  1. Identify and Track Your Covered Employees. The excise tax affects “covered employees,” which are generally defined as the employer’s top five highest-paid employees.  Although payments to employees making under $120,000 (indexed) per year are exempt from the “parachute” payment tax, there is no compensation to be on the covered employee list.  So every tax-exempt employer technically has covered employees; and they must be tracked until they have received all of their compensation from the tax-exempt entity and any related organizations.
  2. Beware of Related Organizations. IRS Notice 2019-9 requires aggregation of compensation from a wide net of “related employers” (described below).  Under the initial aggregation rules, the tax can be triggered even if no compensation is actually paid by a tax-exempt entity (and even if the employee is no longer working for the tax-exempt entity), and the tax obligation is generally allocated among the payers.  Consequently, related for-profit companies could owe an allocation of the tax, and tax-exempt employers that pay only a small part of the employee’s total compensation can still owe a share of the tax.  Also, payments by a third-party vendor (such as a professional employer organization) are generally treated as paid by the employer.
  3. Timing is Not Intuitive. For excise tax calculations, compensation is taken into account when it is earned.  Consequently, a bonus or deferred compensation can count toward the excise tax before it is included in the employee’s income or payment is actually made.
  4. Deferred Compensation Affects the Results. Deferred compensation balances can trigger excise taxes even if the employee’s regular compensation is far less than $1 million.  As explained below, this issue comes up in two ways: (i) large unpaid deferred compensation balances can push an employee over the $1 million threshold, and (ii) vesting of large balances when employment terminates can trigger a tax on “parachute” payments.
  5. Allocation Required for Doctors and Veterinarians. Compensation to doctors and veterinarians must be allocated between (i) compensation for medical and veterinary services and (ii) compensation for teaching, research, and administrative services.  Compensation in the first category is exempt from the excise tax, but compensation in the second category must be taken into account.

Each tip is discussed in more detail below.  The excise tax and IRS guidance are discussed in more detail here.

  1. Tracking Covered Employees. Tax-exempt entities should track covered employees, even if they never pay anyone $1 million in compensation.  Tracking covered employees is important for two reasons:
    • First, separate from the $1 million issue, the tax applies for “excess parachute” payments, even if the covered employee makes less than $1 million (although there is an exemption for payments to employees making less than $120,000 (indexed for inflation)). For this purpose, a “parachute” payment includes almost any payment or benefit that is contingent on separation from service, including tax-exempt benefits.  For example, parachute payments include accelerated vesting of deferred compensation, severance pay, and subsidized health benefits.  The tax is triggered if an individual’s parachute payments equal or exceed 3 times his or her “base amount” (generally his or her average W-2 compensation over the last five years).  If triggered, the tax applies on the entire excess over the base amount—not just the excess over 3 times the base amount.
    • Second, the $1 million threshold is not indexed for inflation. With inflation, many employers that currently pay less than $1 million will eventually get to the $1 million threshold.

Because covered employees from any year since 2017 continue to be covered in perpetuity, it is important to keep track of who they are.  For example, an employee who is among the five highest paid in 2017 or 2018 could trigger an excise tax years down the road due to severance or deferred compensation, even if the employee ceases to be among the highest paid.

For a more extreme example, suppose a for-profit company controls the board of a related tax-exempt foundation (see Related Employers, below).  Suppose that an officer of the foundation is or later becomes an executive of the for-profit company.  If compensation from the for-profit company exceeds the $1 million threshold, the tax can be triggered—even if the threshold is not reached until years later.

  1. Related Employers. Section 4960 requires aggregation of compensation from related employers.  Under Notice 2019-9, “related” is generally determined based on owning more than 50% of the organization’s stock (measured by voting rights or value) or capital or profits interests (or, if the organization is a trust, beneficial interests in the trust), or controlling more than 50% of the organization’s board.  Once related employers are identified, compensation from all of the related employers must be aggregated to determine whether the tax applies (and, if so, the amount), and each related employer that is tax-exempt will have to create its own list of covered employees.

For example, suppose a for-profit company controls more than 50% of the board of a tax-exempt foundation, and the company’s treasurer also serves as an officer of the foundation.  If the foundation is treated as a common law employer of the treasurer (even if the for-profit company is also a common law employer), the treasurer could be a covered employee of the foundation.  To make this determination, compensation paid by the for-profit company would have to be taken into account.  Depending on the circumstances, the for-profit company could have to pay an excise tax even though it is not tax-exempt; and if the foundation pays (or is deemed to pay) part of the treasurer’s compensation, the foundation would have to share part of the burden.  As noted above, this could occur even if the treasurer is no longer working for the foundation when he or she gets over the $1 million threshold.

A special rule for tax-exempt entities that pay less than 10% of an individual’s compensation does not appear to change the result here.  The 10% rule allows a tax-exempt entity to omit from its covered employee list anyone to whom it pays less than 10% of total compensation, if another tax-exempt entity pays at least 10% of the total compensation.  This rule is relevant only for constructing the tax-exempt entity’s list of covered employees.  It is not a complete shield from the excise tax: all compensation still counts for determining whether the excise tax applies, and an entity that pays less than 10% can still owe an allocation of the tax.

  1. Timing. For purposes of the section 4960 rules, compensation is generally treated as paid when it becomes vested—even if the compensation is not paid or included in the employee’s income at that time.  For example, bonuses earned in 2018 but paid in early 2019 would count toward compensation paid for 2018, even though the bonus typically would not be included in income until 2019.  This result can be avoided by conditioning the bonus on remaining employed until the payment date.
  2. Deferred Compensation. There are two ways deferred compensation accounts can trigger the excise tax, even if the employee’s ordinary compensation is far less than $1 million:
    • First, an accumulated deferred compensation balance counts toward the $1 million threshold in the year of vesting, even if payments to the employee do not reach the $1 million threshold. For example, suppose an employee who is paid $300,000 per year accumulates a deferred compensation balance of $800,000 that is conditioned on remaining employed by the organization until age 55.  When the employee turns 55, the $800,000 balance would be added to the employee’s other $300,000 of compensation for the year.  Consequently, the employee’s total compensation for the year would be $1.1 million, triggering an excise tax of $21,000 (21% of the $100,000 excess over the $1 million threshold).
    • Second, any part of the balance that becomes vested upon an involuntary termination can count as a parachute payment. For example, suppose an employee’s average compensation is $200,000.  Suppose that, on an involuntary termination of employment, the employee becomes entitled to $100,000 of severance and a $500,000 deferred compensation account becomes vested.  In this case, the $600,000 (severance plus deferred compensation) could trigger the excise tax—even though the employee’s total compensation is less than $1 million.  Fortunately, Notice 2019-9 includes a special rule for valuing deferred compensation when the only vesting condition is the requirement to continue working for a specified period.  Depending on the amount of time left until the vesting date, this rule can help to mitigate or avoid the excise tax from accelerated vesting.  (A similar rule applies for purposes of valuing acceleration of vesting under the section 280G golden parachute rules.)  But even with the special rule, vesting of deferred compensation can cause unexpected results.
  1. Doctors and Veterinarians.  Section 4960 has an exclusion for compensation paid to medical and veterinary professionals, but only to the extent the compensation is “for the performance of medical or veterinary services.”  In contrast, compensation for teaching, research, and administration counts toward the $1 million cap.  Hospitals and other tax-exempt entities that employ medical and veterinary professionals will need to allocate the employees’ compensation between compensation for medical/veterinary services and other compensation.  Notice 2019-9 gives employers flexibility to establish a reasonable allocation methodology.

The allocation is important for purposes of establishing the covered employee list, determining whether an excise tax is due on compensation in excess of $1 million, and determining whether any post-termination pay will trigger the excise tax on excess parachute payments.

IRS Releases Interim Guidance on New Excise Tax on Executive Compensation Paid by Tax-Exempt Organizations

On December 31, 2018, the Department of the Treasury (“Treasury”) and the Internal Revenue Service (the “IRS”) released Notice 2019-09 (the “Notice”), which provides interim guidance under Section 4960 of the Internal Revenue Code.

Very generally, Section 4960 imposes a 21% excise tax on certain tax-exempt entities (and certain related organizations) that pay remuneration in excess of $1 million to certain highly-paid individuals or that make certain “excess parachute payments” to this class of highly-paid individuals.

The Notice indicates that Treasury and the IRS intend to issue proposed regulations under Section 4960, which will be prospective only. The Notice also provides that until Treasury and the IRS issue additional guidance, however, taxpayers may rely on good faith, reasonable interpretations of Section 4960, and that the guidance issued in the Notice will be considered reliance upon a good faith, reasonable interpretation of Section 4960. The Notice also provides several examples of interpretations of Section 4960 that would not be considered by Treasury and the IRS as good faith, reasonable interpretations.

Overview of Section 4960

Section 4960 imposes on an employer an excise tax equal to the corporate tax rate (currently 21%) on the sum of (1) remuneration paid in excess of $1 million, except for remuneration paid for medical and veterinary services, by an applicable tax-exempt organization (an “ATEO”) or a related organization for the taxable year with respect to the employment of any covered employee, and (2) any excess parachute payment paid by an ATEO to a covered employee.

Below is a high-level summary of key issues in the guidance issued in the Notice on each of the bolded terms above and general considerations regarding compliance.

What is an “Applicable Tax-Exempt Organization”?

Section 4960 provides that an ATEO is any organization that:

  • is exempt from tax under Section 501(a) (which would generally include an organization exempt from tax under Section 501(c)(3), a religious or apostolic organization exempt from tax under Section 501(d), or a trust forming part of a stock bonus, pension or profit sharing plan under Section 401(a));
  • is a farmers’ cooperative organization described in Section 521(b)(1);
  • has income excluded from tax under Section 115(1) (which generally excludes income derived from any public utility or from the exercise of any essential governmental function and accruing to a state, any political subdivision of a state, or the District of Columbia); or
  • is a political organization described in Section 527(e)(1).

Commentators questioned whether certain governmental units, or quasi-governmental units, such as public universities, are included in the definition of an ATEO because many public universities claim to be tax-exempt under the doctrine of implied statutory immunity (rather than under Section 115(1) or any of the Sections listed above).

The Notice explains that 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). However, a state, political subdivision of a state, or integral part of a state or political subdivision, often referred to as a “governmental unit,” 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. 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.

Some governmental units that may not be tax-exempt under Section 115(1) may be exempt from tax under Section 501(a). The Notice clarifies that such an organization will be an ATEO if it received a determination letter from the IRS that recognizes its tax-exemption under Section 501(a), even if the governmental unit could claim that the determination letter it received was protective and not necessary because the governmental unit is exempt from tax under other authority, such as under the doctrine of implied statutory immunity. The Notice provides that a governmental unit may relinquish its Section 501(c)(3) status using procedures described in Revenue Procedure 2018-5 to avoid being an ATEO. Therefore, if a governmental unit (including a state college or university) is not tax-exempt under Section 115(1) and also is not tax-exempt under Section 501(a) (including Section 501(c)(3)), it would not be an ATEO.

Who is the “Employer”?

Section 4960 imposes an excise tax on employers (and not employees). The Notice clarifies that it is the common-law employer (as generally determined for federal tax purposes) on which the excise tax is imposed, and a common law employer cannot avoid liability for the excise tax by entering into a third-party payor arrangement, such as using a payroll agent or professional employer organization.

The Notice also provides that the excise tax is based on remuneration paid to a covered employee by an ATEO and also by “any related person or governmental entity.” Some commentators suggested that only other ATEOs should be treated as related. The Notice, however, states that the phrase “any related person or governmental entity” includes all related organizations, regardless of whether the related organization is a tax-exempt organization, a governmental entity or a taxable organization. The Notice specifically states that a taxpayer’s interpretation that does not include taxable organizations and governmental entities as related organizations would not be a good faith, reasonable interpretation of Section 4960.

Section 4960 provides that if a covered employee is employed by both an ATEO and one or more employers related to the ATEO, then all employers are liable for their portion of the excise tax. The Notice confirms that if an ATEO has a covered employee who receives compensation not only from the ATEO, but also from related organizations that employ the covered employee, which can include a tax-exempt organization, a governmental entity or a taxable organization, the related organizations may also be liable for their portion of the excise tax as allocated in accordance with the Notice.

What is a “Related Organization”?

Section 4960 provides that the following persons and governmental entities are treated as organizations related to ATEOs:

  • organizations that control or are controlled by the ATEO;
  • organizations that are controlled by one or more persons which control the ATEO;
  • organizations that are a “supported organization” (as defined in Section 509(f)(3)) during the taxable year with respect to the organization;
  • organizations that are a “supporting organization” (as described in Section 509(a)(3)) during the taxable year with respect to the organization; and
  • if the ATEO is a voluntary employees’ beneficiary association, organizations established, maintained, or that make contributions to such voluntary employees’ beneficiary association.

Section 4960 does not define the term “control” for purposes of determining an ATEO’s related organizations. The Notice clarifies for taxable entities that control is defined as ownership of more than 50% of the stock of a corporation based on vote or value, profits interests or capital interests of a partnership, and beneficial interests in a trust. For nonprofit organization or other organizations without owners or persons with beneficial interests (a “nonstock organization”), the Notice defines control as more than 50% of the directors or trustees of the ATEO or nonstock organization being either representatives of or being controlled by the other entity, or more than 50% of the directors or trustees of the nonstock organization being either representatives of or being controlled by one or more persons that also control the ATEO.

The Notice clarifies that if an employer becomes or ceases to be a related organization of an ATEO during the calendar year ending with or within the ATEO’s taxable year, only the remuneration that the related organization paid to a covered employee with respect to services performed during the portion of the calendar year when the employer was a related organization is included for purposes of calculating the excise tax liability.

Who is a “Covered Employee”?

Section 4960(c)(2) defines a “covered employee” as any current or former employee of an ATEO who (1) is one of the five highest-compensated employees of the ATEO for the taxable year, or (2) was a covered employee for any taxable year beginning after December 31, 2016 (i.e., once an individual becomes a covered employee of an ATEO, the individual will always remain a covered employee). There is no minimum dollar threshold for an employee to be determined to be a covered employee.

The Notice clarifies that the five highest-compensated employees are determined based on remuneration paid for services performed as an employee of the ATEO, including remuneration for services performed as an employee of an organization related to the ATEO during a calendar year ending with or within the ATEO or related organization’s taxable year. Importantly, these related organizations could include not only other tax-exempt organizations, but also for-profit or governmental entities. However, if an ATEO pays less than 10% of an employee’s total remuneration for services performed for the ATEO and all related organizations during a calendar year, under the Notice, the employee is not considered to be one of that ATEO’s five highest-compensated employees (and, thus, may not be required to be added to the list of covered employees for that ATEO). However, if the ATEO and no other related ATEOs pay 10% or more of the employee’s compensation and the employee would otherwise be a covered employee then, under the Notice, this exception would not apply to the ATEO that pays the employee the most remuneration during that year (and that ATEO could be subject to the excise tax).

Whether an employee is one of an ATEO’s five highest-compensated employees is determined separately for each ATEO and not for the entire group of related organizations. Therefore, each ATEO will have its own set of five highest-compensated employees. It is possible that a group of related organizations may have more than five covered employees. The Notice specifically states that a taxpayer’s interpretation that a group of related organizations with more than one ATEO has a single set of five highest-compensated employees would not be a good faith, reasonable interpretation of Section 4960.

While commentators asked for a rule that would allow an individual who becomes a covered employee of an ATEO to cease being a covered employee after a certain number of years, the Notice does not provide any such relief. To the contrary, the Notice states that a covered employee will never cease to be a covered employee and that a taxpayer’s contrary interpretation will not be a good faith, reasonable interpretation of Section 4960.

What is the Applicable “Taxable Year”?

Section 4960(a)(1) provides that relevant period during which remuneration is measured to determine if it exceeds $1 million is the “taxable year.” However, Section 4960 does not indicate whose taxable year is relevant (i.e., the employer’s or employee’s taxable year). The Notice clarifies that the taxable year used to calculate amount of remuneration paid to determine if there is an excise tax is the calendar year ending with or within the employer’s taxable year.

Because Section 4960 applies to tax years beginning on or after January 1, 2018, if an employer that uses a calendar year as its taxable year, the excise tax described in Section 4960 could apply to all remuneration paid in 2018. For an employer with a non-calendar fiscal year, the results will be different. For example, if an employer uses a taxable year that begins on July 1, any remuneration that was paid between January 1 and June 30, 2018, was paid in a taxable year that is not covered by Section 4960. For 2018, only remuneration that was paid between July 1 and December 31, 2018, will be subject to Section 4960.

What is “Remuneration”?

Section 4960 defines remuneration to mean wages as defined in Section 3401(a), but excluding designated Roth contributions and including nonqualified deferred compensation required to be included in gross income under Section 457(f).

The Notice clarifies that remuneration does not generally include qualified retirement benefits (such as benefits from a 403(b), 401(k) or qualified pension plan) because these payments are excluded from the definition of wages in Section 3401(a). Remuneration also generally does not include director’s fees because director’s fees are generally treated as self-employment income and not wages under Section 3401(a).

Section 4960 states that remuneration is deemed paid when the right to the remuneration is no longer subject to a substantial risk of forfeiture. The Notice uses the definition of “substantial risk of forfeiture” under Section 457(f) (which is interpreted in proposed Treasury Regulations issued in 2016). In general, these proposed Treasury Regulations provide that remuneration 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 remuneration if the possibility of forfeiture is substantial. The Notice clarifies that this rule is not limited to remuneration that is otherwise subject to Section 457(f) or nonqualified deferred compensation under Sections 457(f) or 409A. When remuneration is no longer subject to a substantial risk of forfeiture, its present value is treated as remuneration regardless of when the amount is actually paid.

Employers that are ATEOs (and their related organizations) may now have to consider when amounts are no longer subject to a substantial risk of forfeiture, which may not have been relevant before the enactment of Section 4960. For example, if an employee becomes entitled to a bonus in December, but the bonus is not paid until the following January, the bonus will be treated as paid in December because that is when it is no longer subject to a substantial risk of forfeiture. Likewise, if an employer agrees to pay an employee 12 months’ salary as severance upon an involuntary termination of employment, when the employee involuntarily terminates employment, the present value of all 12 months of severance payments will be treated as remuneration that is paid upon the employee’s involuntary termination of employment because the amounts will no longer be subject to a substantial risk of forfeiture.

The Notice specifically states that the $1 million excess remuneration threshold is not adjusted for inflation.

Who is a Licensed Medical or Veterinary Professional and How Do You Determine What Amounts are Paid for “Medical and Veterinary Services”?

Section 4960 excludes from remuneration and excess parachute payments amounts paid to a licensed medical or veterinary professional for the performance of medical or veterinary services.

The Notice defines licensed medical and veterinary professionals to include individuals who are licensed under state or local law to perform medical or veterinary services (which includes dentists and nurse practitioners).

The Notice defines medical and veterinary services to mean direct medical care as described under Section 213(d), which includes the diagnosis, cure, mitigation, treatment, or prevention of disease, including services for the purpose of affecting any structure or function of the human body ( Section 213(d) applies by analogy for veterinary services). Activities related to medical services, such as administrative, teaching, and research services are not considered medical or veterinary services unless the medical or veterinary professional performs direct medical or veterinary care while performing those activities. When an employer pays remuneration for both direct medical or veterinary services and other non-direct medical or non-direct veterinary services, the employer must allocate the remuneration between the two categories of services.

The Notice specifically states that amounts paid to a licensed medical or veterinary professional for the performance of medical or veterinary services should not be taken into account when determining the employer’s five highest-compensated employees and that a contrary interpretation would not be a good faith, reasonable interpretation of Section 4960.

What are “Excess Parachute Payments”?


Section 4960 imposes an excise tax on any excess parachute payment paid by an ATEO or a related organization to a covered employee. This excise tax is reminiscent of the concepts contained in Section 280G with respect to excess parachute payments paid in connection with a change of control, except that instead of the parachute payments being paid in connection with a change of control, Section 4960 applies to amounts that are contingent on and paid in connection with an involuntary separation from employment.

Contingent on the Employee’s Separation from Employment

The Notice generally treats payments as contingent on a covered employee’s separation from employment if the facts and circumstances indicate that the employer would not make the payment in the absence of an involuntary separation from employment (including payments made in connection with a window program). Section 4960 gave no indication that separation from employment meant an involuntary separation from employment.

The Notice provides that an involuntary separation from employment means a separation from employment due the independent exercise of the employer’s unilateral authority to terminate the employee’s services, other than due to the employee’s implicit or explicit request, if the employee was willing and able to continue performing services. Thus, an involuntary separation from employment may include a termination because an employer chooses not to renew an employment contract when it expires. The Notice also provides that a termination by an employee for “good reason” may be treated as an involuntary separation from employment. A payment does not fail to be contingent on a separation from employment merely because the payment is conditioned upon the execution of a release of claims, noncompetition or nondisclosure provisions, or other similar requirements.

Parachute Payments

Under Section 4960, parachute payments include any payments in the nature of compensation to (or for the benefit of) a covered employee if (i) the payments are contingent on the employee’s separation from employment with the employer, and (ii) the aggregate present value of the payments equals or exceeds three times the covered employee’s “base amount.”

The “base amount” is determined by applying the current rules of Section 280G, which generally will provide that a covered employee’s base amount is the individual’s average annual taxable income from the organization over the five-year period immediately preceding the year in which the separation from service occurs (or any shorter period of service with the organization if less than five years).

Section 4960 provides that the following payments generally are excluded when determining the amount of a parachute payment:

  • payments to or from certain retirement plans (including defined contribution plans, defined benefit plans, Section 403(b) plans and Section 457(b) plans);
  • payments to a licensed medical professional (including a veterinary professional) to the extent that such payments are for the performance of medical or veterinary services by such professional; and
  • payments to an individual who is not a highly compensated employee (as defined in Section 414(q), the threshold for which is $125,000 for 2019, subject to annual adjustment).

Payment in the Nature of Compensation

The Notice clarifies that any payment is considered a payment in the nature of compensation if the payment arises out of an employment relationship. This includes payments made under a covenant not to compete, wages and salary, bonuses, severance pay, fringe benefits, life insurance, pension payments and other deferred compensation. Payments are considered made in the taxable year in which they are includible in the covered employee’s gross income or when received for non-taxable benefits.

If a payment is accelerated or a substantial risk of forfeiture lapses as a result of an involuntary separation from employment, the additional value arising due to the acceleration is treated as a payment contingent on a separation from employment, but only the value arising due to the acceleration is treated as contingent on a separation from employment.

Paying the Excise Tax

Taxpayers report and pay the excise tax imposed under Section 4960 using Form 4720, Return of Certain Excise Taxes Under Chapter 41 and 42 of the Internal Revenue Code. Each ATEO and related organization must file a separate Form 4720 to report its share of the excise tax liability. Form 4720 is due by the 15th day of the fifth month after the end of the employer’s taxable year, which may be extended by filing a Form 8868, Application for Automatic Extension of Time to File an Exempt Organization Return. There is not a requirement for the employer to pay estimated taxes.

Inclusion of Qualified Transportation Fringe Benefits in UBTI: Guidance, Relief, and Rumors of Possible Repeal

December 10, 2018 saw significant activity with respect to Section 512(a)(7) of the Internal Revenue Code (the “Code”), which requires tax-exempt employers to increase their unrelated business taxable income (“UBTI”) by amounts paid or incurred for qualified transportation fringe benefits provided to employees, including the provision of parking and public transportation benefits. Section 512(a)(7) was enacted pursuant to the 2017 U.S. tax legislation known as the “Tax Cuts and Jobs Act,” and caused concern amongst tax-exempt organizations because of the prospect of increased tax liability, the lack of clarity for determining the taxable amount of such benefits, and the additional administrative burdens triggered for certain organizations.

Guidance issued by the Internal Revenue Service (“IRS”) and a new New York State law, all as of December 10, 2018, may help alleviate some of these concerns.

Notice 2018-99: IRS Issues Guidance Regarding Parking Provided by Tax-Exempt Organizations

On December 10, 2018, the IRS released Notice 2018-99 and Notice 2018-100, which together provide guidance and relief for tax-exempt organizations with respect to determining the amount of UBTI attributable to qualified parking expenses and other qualified transportation fringe benefits. Pursuant to Section 512(a)(7), tax-exempt employers are required to increase their UBTI by amounts paid or incurred for qualified transportation fringe benefits provided to employees. The tax imposed by Section 512(a)(7) applies whether the tax-exempt employer pays for these benefits at its own expense or allows employees to deduct money from their compensation to pay for the benefits on a pre-tax basis.

Notice 2018-99 provides interim guidance for determining the amount of qualified parking expenses subject to UBTI. The Notice generally provides that organizations may use “any reasonable method” to calculate their UBTI with respect to such parking expenses. However, the Notice also includes a specific safe harbor that tax-exempt employers may use until further guidance is issued to calculate the amount of parking expenses that should be included in UBTI, as well as several examples that illustrate use of this safe harbor. For purposes of these rules, the Notice provides that tax-exempt employers may aggregate multiple parking facilities within the same geographic location (i.e., in the same city). The safe harbor delineates four steps:

  • First, a tax-exempt organization would calculate its expenses related to parking explicitly (or effectively) reserved for employees (whether it is on property the employer owns or leases, at or near the employer’s business, or at a location from which the employee commutes to work).
  • Next, the tax-exempt organization would identify the remaining parking spots in the facility that are not explicitly reserved for employees, and determine whether their “primary use” is for the general public. To the extent more than 50% of actual or estimated use of parking spots in the parking facility during typical business hours is for use by the general public, then the “primary use” of the parking facility may be considered to be for the general public, and accordingly, the amount of parking expenses allocated to these non-reserved parking spaces will not be included as UBTI.
  • Third, to the extent the “primary use” of the parking facility is not for the general public (i.e., more than 50% of the actual or estimated use of the facility is for employees, even if spaces are not explicitly reserved), then the tax-exempt organization would identify any such spots that are specifically reserved for non-employee or general public use. Amounts allocable to these spots would not be included as UBTI.
  • Finally, if there are any remaining parking spots not addressed in steps 1-3, the tax-exempt organization would reasonably determine the typical use of those remaining spots, based on actual or estimated usage, and amounts allocable to spots that are typically used by employees would be included as UBTI.

Pursuant to the Notice, tax-exempt organizations are permitted to reduce their UBTI with respect to parking arrangements by reducing the number of explicitly reserved employee parking spots at any time on or prior to March 31, 2019, with retroactive effect to January 1, 2018.

The Notice further provides that UBTI generated under Section 512(a)(7) is not considered a separate unrelated trade or business for purposes of the rules requiring separate computation of UBTI for each separate unrelated trade or business under Section 512(a)(6). This position was previously stated in Notice 2018-67, which was issued in August of 2018.

Notice 2018-100: IRS Provides Penalty Relief for Tax-Exempt Organizations with Respect to Section 512(a)(7)

In coordination with Notice 2018-99, and also on December 10, 2018, the IRS issued Notice 2018-100, which waives tax penalties for tax-exempt organizations that failed to make estimated income tax payments, to the extent the underpayment was attributable to the changes to the qualified transportation fringe benefit rules in Section 512(a)(7). Notably, however, this relief only applies to tax-exempt organizations that were not required to file Form 990-T for the previous taxable year.

New York Law Declines to Tax Tax-Exempt Organizations for Qualified Transportation Fringe Benefits

Relatedly, New York Governor Andrew Cuomo signed a bill on December 10, 2018 that decouples the New York State tax code from the changes made to the federal UBTI rules. This move exempts amounts paid or incurred by tax-exempt organizations for commuter benefits from an additional 9% New York State tax.


Finally, there continues to be momentum in Congress to amend or repeal Section 512(a)(7). On December 10, 2018, Chairman of the House Ways and Means Committee, Kevin Brady (R-TX) introduced an amendment to H.R. 88 that would repeal Section 512(a)(7), retroactive to the date of enactment. Other bills proposed by different members of Congress have contained similar provisions.

IRS Announces Relief from the “Once-In-Always-In” Requirement for Excluding Part-Time Employees Under 403(b) Plans

Last week, the IRS released Notice 2018-95 to provide transition relief to 403(b) plans that improperly excluded certain employees.  Specifically, Notice 2018-95 targets employers that may have erroneously excluded part-time employees from eligibility to make elective deferral when the employees should have been eligible to participate under the “once-in-always-in” requirement (“OIAI”).  According to the OIAI requirement, once an employee becomes eligible to make elective deferrals, an employer may not exclude the employee from eligibility in any later year on the basis that the employee does not work sufficient hours to participate.  Notice 2018-95 consequently provides transition relief for employers that sponsored 403(b) plans and did properly follow the OIAI requirement applied to their part-time employees.

For plans that did not properly apply the OIAI requirement, Notice 2018-95 establishes relief regarding plan operations and plan language, as well as a “fresh-start opportunity.”  Notice 2018-95 also makes it clear that if a 403(b) plan excludes part-time employees for purposes of making elective deferrals, the plan must explicitly include the OIAI requirement in the plan document prior to April 1, 2020, which may require many 403(b) plans to be amended.

Employers sponsoring 403(b) plans that exclude part-time employees for purposes of elective deferral eligibility should carefully consider how the OIAI requirement affects their plans and whether any changes will be necessary to either their procedures or plan documents.

We have provided more detailed information regarding the relief offered under Notice 2018-95 on our Employee Benefits & Executive Compensation Blog, available at the following link:

IRS Announces Transition Relief From The Once-In-Always-In Requirement For Excluding Part-Time Employees Under 403(b) Plans


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