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Group Seeks Changes to Mitigate Inequities of Executive Comp Tax

JUN. 7, 2019

Group Seeks Changes to Mitigate Inequities of Executive Comp Tax

DATED JUN. 7, 2019
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June 7, 2019

The Honorable David J. Kautter
Assistant Secretary for Tax Policy
U.S. Department of the Treasury
1500 Pennsylvania Ave NW
Washington, DC 20220

Re: Comments on Interim Guidance under Section 4960 (Notice 2019-09)

Dear Mr. Kautter:

The Council of Michigan Foundations ("CMF") is grateful for the opportunity to submit comments on Notice 2019-09 relating to the new excise tax on excess compensation paid by tax-exempt organizations under Internal Revenue Code Section 4960. The Council of Michigan Foundations is a Section 501(c)(3) membership association encompassing more than 300 charitable grantmaking organizations, including corporate, family, independent and community foundations.

We are asking that the Treasury Department and the Internal Revenue Service clarify when and to what extent the remuneration paid to an employee of a related person or governmental entity ("related organization") is subject to this tax. The Notice currently provides that the remuneration is subject to the tax even in situations when the employee is providing only limited or even volunteer service to the applicable tax-exempt organization ("ATEO").

The guidance found in the Notice is based on an assumption that all remuneration received by an individual from a related organization is related to service to the ATEO and therefore taxable. There also appears to be an assumption in the code section and in the Notice that remuneration paid by the related organization is paid in an effort to avoid the new tax under IRC 4960, a tax that did not exist when many of the relationships between related organizations and ATEOs were established. These assumptions can have unintended consequences to the effective management of ATEOs.

Those consequences could include an ATEO paying excise tax in a situation where the ATEO provides only nominal remuneration — for nominal service performed on behalf of the ATEO — due to the aggregation of the remuneration paid by the ATEO and the related organization. Similarly, the remuneration paid by related organizations may be subject to tax even in situations where the employee serves as a volunteer officer, director or in another capacity to an ATEO.

The application of Notice 2019-09 could result in the loss of talent and expertise provided to an ATEO by skilled employees of a related organization as those related organizations find that they are now subject to possibly large excise taxes due to the service of the employee to an ATEO.

Example: The chief financial officer of a related organization also serves as a volunteer officer of the foundation of the related organization. The chief financial officer does this in order to lend his/her expertise to the management of the foundation's assets. The related organization could now find itself paying excise tax under IRC Section 4960 for the chief financial officer's compensation even though that person serves the ATEO in a volunteer officer capacity. This could lead the related organization to prohibit the chief financial officer from serving the ATEO thus depriving the ATEO of the expertise of this volunteer.

You will find attached some suggested regulatory language to Section 4960(a). We chose Section 4960(a) for these suggestions due to the flow of the entire Section, but the suggested language could be modified as regulations to Section 4960(c)(2). By explanation, the rationale for each section of the proposed language is as follows:

  • Paragraph A(i) is merely an affirmation that directors are not considered employees for federal tax purposes. Rather, they are considered independent contractors. Therefore, their remuneration should be excluded from a tax directed at a "covered employee." This paragraph is suggested to provide certainty that remuneration of directors as independent contractors remains consistent with other provisions of the tax code.

  • Paragraph (A)(ii) is offered as a limited and reasonable exception to the general tax treatment that officers are considered employees. As many commentators have noted, employees of related organizations will often serve as directors — and as officers with limited duties and responsibilities — to related ATEOs like corporate foundations on a limited time basis. Their primary work responsibilities remain dedicated to the for-profit related organization which is the sole or principle source of their remuneration. The availability of their talents, expertise and experience to the ATEO even on a limited basis can be invaluable to the success of the ATEO. Since a director (see paragraph (i)) is not considered an employee, it would be a harsh result to apply the excise tax of IRC 4960 to a situation where a director also has an officer title with the ATEO but is still serving in a limited or narrow role to the ATEO. For this reason, we suggest some form of "de minimis" exception for persons in these situations. We offer a cap of 10 percent as Notice 2019-09 has used that percentage in other similar circumstances.

  • Paragraph (A)(iii) is offered to make the application of IRC 4960 consistent with the current reporting on IRS Form 990, Part VII, Section A. This section of the Form 990 is used to report the compensation received by officers, directors, trustees, key employees and independent contractors and is based on IRC §6033(b)(6) and (7) and the regulations thereunder. Page 31 of the 2018 Form 990 instructions provides a "volunteer exception" noting that the nonprofit need not report compensation received from a related organization by a volunteer officer, director or trustee, if the related organization is a for-profit organization and other conditions are met. The proposed paragraph (iii) is substantially similar to the language and conditions from the 2018 Form 990 instructions and would allow the reporting and treatment of remuneration to be consistent between the two code sections.

  • Paragraph (B) is offered to reflect the situation where an employee of a related organization dedicates a part of his/her services to a related organization and a part to the ATEO. It is not consistent with the intent of IRC 4960 to subject  all of the employee's remuneration including that portion that is not for the benefit of the ATEO to the excise tax. This paragraph would subject to the excise tax only the remuneration received by that employee of the related organization that is for services performed for the ATEO.

We would also note in support of proposed paragraphs (A)(ii) and (iii) that the general 20-factor test for determining common law employee status makes no reference to whether a person is an "officer." Further, Rev. Rul. 74-390 provides, in part, that "In determining whether services actually performed by a corporate officer in that capacity may be considered to be of a minor or nominal nature the character of the services, the frequency and duration of their performance, and the actual or potential importance or necessity of the services in relation to the conduct of the corporation's business, are the primary elements to be considered. Thus, occasional, routine signing of documents, presiding over or attendance at infrequent meetings, and similar isolated or [non-continuous] acts having no significant bearing or effect on the day-to-day functioning of the corporation in the conduct of its business, will be considered, as a general rule, to be services of a minor or nominal nature." Additionally, Treas. Reg. Sections 31.3401(c)-1(f) and 31.3121(d)-1(b) define employee to exclude officers who perform minor services and receive no remuneration.

With respect to Paragraph (A)(iii), if Treasury disagrees that there should be consistency between code sections 4960 and section 6033(b)(6) and (7), we offer an alternative paragraph (iii) that creates a "qualified volunteer" exception where the remuneration of the employee of a related organization is not subject to the tax if the employee's services to the ATEO are not a requirement of his/her employment to the related organization. This alternative would prevent the concern arising from the assumption that employment at related organizations would be used as a way to avoid the excise tax as the service by the employee to the ATEO cannot be a condition of employment.

Lastly, we offer a proposed regulation for Section 4960(c)(2)(B) to remove from the definition of covered employee, an employee of a related organization who was a covered employee if that employee has no ongoing role with the ATEO. The rationale for this is that Section 4960 is intended to tax excess remuneration of employees of ATEOs and to prevent the shifting of the payment of that remuneration to a related organization. However, if that once-covered employee is no longer affiliated with the ATEO, the tax should no longer apply to the remuneration of that individual.

Thank you for your time and consideration of our comments and proposed language. Please feel free to contact me or our attorneys, Duane Tarnacki (dtarnacki@clarkhill.com) or Robin Ferriby (rferriby@clarkhill.com), if you would like to discuss this letter further.

Sincerely,

Kyle Caldwell
President & CEO
Council of Michigan Foundations
Grand Haven, MI

Cc:
Elinor Ramey
Stephen LaGarde

enclosure


Proposed Regulation for Section 4960(a)

(A) The tax imposed under Section 4960(a) will not apply to any remuneration and excess parachute payment paid by a related person or governmental entity to an employee of such related person or governmental entity in any of the following situations:

(i) The employee of the related person or governmental entity serves only as a director of the applicable tax-exempt organization;

(ii) During a tax year or portion of a tax year during which the employee of a related person or governmental entity is an officer of an applicable tax-exempt organization, the employee:

(a) receives from the applicable tax-exempt organization 10% or less of the total remuneration the employee receives from the related person or government entity and the applicable tax-exempt organization; and

(b) serves as an officer of the applicable tax-exempt organization on average less than the greater of:

(i) four hours per week, and

(ii) 10% of the employee's total number of hours worked (including any paid time off credited to the employee) for both the related person or government entity and the applicable tax-exempt organization.

(iii) The employee of a related person serves as a volunteer to the applicable tax-exempt organization and the related person is not an applicable tax-exempt organization, is not owned or controlled directly or indirectly by the applicable tax-exempt organization or one or more related applicable tax-exempt organizations, and does not provide management services for a fee to the applicable tax-exempt organization.

(B) If the remuneration and any excess parachute payment of an employee of a related person or governmental entity is subject to the tax imposed under Section 4960(a) and the employee performs services for the related person or governmental entity in addition to those that directly benefit the applicable tax-exempt organization, only the remuneration or that portion of the excess parachute payment reasonably allocated to the services performed by the employee that directly benefit the applicable tax-exempt organization are subject to the tax imposed under Section 4960(a).

Alternative for (iii) above

(iii) The employee of the related person or governmental entity serves as a "qualified volunteer" to the applicable tax-exempt organization. A "qualified volunteer" means a person who serves in any capacity to the applicable tax-exempt organization who:

(a) Receives no remuneration from the applicable tax-exempt organization (other than reimbursement of expenses reasonably incurred in connection with the services provided by the person to the applicable tax-exempt organization) and

(b) Whose service to the applicable tax-exempt organization is not a requirement of employment by the related person or governmental entity.

Proposed Regulation for Section 4960(c)(2)(B)

The employee of the related person or governmental entity who was a covered employee of an applicable tax-exempt organization because the person was a covered employee for the organization (or any predecessor) for any preceding taxable year beginning after December 31, 2016 will no longer be a covered employee if the person no longer serves the applicable tax-exempt organization in any capacity.

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