As an update on an important matter that we raised during McDermott’s May 8 Tax Symposium, it is critical to promptly assess whether to report any excise taxes imposed under Section 4960 as the deadline for filing Form 4720 is May 15, 2019 for calendar year taxpayers. Section 4960 of the Internal Revenue Code imposes a 21% excise tax on compensation over $1 million paid to the five highest paid employees of a tax exempt organization, including a private foundation (PF). For purposes of applying Section 4960, the Internal Revenue Service includes compensation paid by related taxable organizations, which may include publicly held or privately held corporations that control who sits on the PF’s board of trustees.
Set forth below are the key issues relevant to establishing a reasonable, good faith position under Notice 2019-9 that the Section 4960 excise tax should not apply to volunteer officers of a PF who receive all of their compensation from taxable organizations related to such PF. What is important to understand is that the Section 4960 excise tax only applies if volunteer officers are treated as employees of the related PF. Whether an employee relationship exists is a facts and circumstances test, and having someone serve as an officer to meet state law nonprofit corporation requirements does not result, by itself, in employee status.
We have also provided steps that companies may follow in developing the facts necessary to establish such reasonable, good faith position pending the issuance of proposed regulations. Please feel free to contact us for assistance in developing such position or with any questions concerning Section 4960.
KEY ISSUES
- Notice 2019-9 provides that only a “common law” employer is subject to excise tax under Section 4960 (Notice 2019-9, Q&A-3).
- Whether an entity is the common law employer of an individual is determined based on the facts and circumstances, and focuses largely on the entity’s ability to exert control over the individual and the services provided by such individual to the entity.
- Under Sections 3401 and 3121, an officer can also be considered a common law employee of an entity.
- Section 3401 and 3121 regulations provide that an officer who only performs minor services and neither receives nor is entitled to receive remuneration, directly or indirectly, is not an employee of the PF.
- Title does not determine officer status for tax purposes—whether an individual is an “officer” for tax purposes should be based on facts and circumstances.
- Section 280G regulations require regular and continuing services for someone to be an officer regardless of title, and Section 280G concepts are incorporated into Section 4960 in determining the amount of compensation that is subject to the 21% excise tax upon an involuntary termination.
- A director (as opposed to an officer) of the PF should not automatically be considered a “common law” employee of a PF. Such a determination can only be made after reviewing the facts and circumstances of the service relationship.
- It appears that the issue of highly paid executives of public companies or large private companies serving as PF officers on a non-compensated basis was not formally considered before the issuance of Notice. The IRS National Office is seeking more information regarding these type of situations and seems willing to clarify its position on this issue, perhaps through the issuance of a safe harbor.
STEPS TO ESTABLISH THE REASONABLE, GOOD FAITH POSITION
- Distinguish between services provided as director and services provided by officers. It is common for senior executives of companies related to a PF to serve in both a volunteer director and a volunteer officer position. Services provided solely as a director do not generally rise to the level of being a common law employee of a PF. Accordingly, in determining the quantitative and qualitative services provided by a senior executive to a PF for purposes of this analysis, identify and exclude services appropriately classified as provided as a director.
- Document the actual responsibilities and day-to-day activities conducted by the volunteer officers. To review their qualitative roles, first review the PF’s bylaws and any board-delegated duties to specific “officers.” Just because someone has the title of an officer does not automatically make such individual a covered employee for purposes of the Section 4960 excise tax. Instead, what makes such “officer” an employee is a facts and circumstances test that looks to the responsibilities delegated to such person (under the state corporation code, bylaws or resolutions) and the level and importance of the services actually provided by such individual.
- Document the number of hours per week (or month or year) the officers spend on their officer duties at the PF, as opposed to their role as employees of the related corporation. In many situations, individuals who are listed as “officers” of the PF only spend a few hours, at most, on PF business annually, and these individuals’ involvement is largely limited to satisfying state law nonprofit corporation and governance requirements. The day-to-day work and officer-like responsibilities are often carried out by other volunteer staff members or even paid employees of the PF.
While there is no specific percentage at which an individual is automatically included or excluded as an officer, if the individual spends on average less than 5% of his or her time on PF matters, that is generally a helpful fact. The lower the percentage, the stronger the fact. In addition, make sure the weekly hours disclosed on Form 990-PF accurately reflect the officer’s level of involvement.
- Document the analysis. Until we have further guidance from the IRS, it is important to fully analyze and document the above analysis to form the basis for your reasonable good faith interpretation.
