Law Firm Seeks Clarification in Executive Comp Excise Tax Regs

August 7, 2020

 

Commissioner Charles P. Rettig
Internal Revenue Service
1111 Constitution Avenue NW
Washington, D.C. 20224

Re: Comments on Proposed Regulations Under Section 4960

Dear Commissioner Rettig:

Enclosed please find comments on the Proposed Regulations under section 4960 with respect to the excise tax on executive compensation paid by tax-exempt organizations.

Although there may be clients of our firm who might be affected by the federal tax principles addressed by these comments, we have not been engaged by any client to make a government submission with respect to, or otherwise to influence the development or outcome of one or more specific issues addressed by, these comments.

Thank you in advance for considering our comments. If you have any questions or would like to discuss, please feel free to contact us.

Very truly yours,

Reynolds T. Cafferata
of RODRIGUEZ, HORII, CHOI & CAFFERATA LLP

Andrew S. Atkin
Of Counsel
RODRIGUEZ, HORII, CHOI & CAFFERATA LLP
Washington, DC

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COMMENTS ON PROPOSED REGULATIONS UNDER SECTION 4960

In the following comments, we make two suggestions regarding the Proposed Regulations under section 4960. First, we recommend that example five under the Limited hours exception (Prop. Reg. 53.4960-1(d)(3)(v)) be modified to avoid the potential for confusion. Second, we recommend that the related organizations requirement under the Nonexempt funds exception (Prop. Reg. 53.4960-1(d)(2)(iii)(A)(3)) be modified so that it does not cause the loss of the Nonexempt funds exception in situations where there does not appear to be any possibility for abuse.

1. Example Five under the Limited Hours Exception (Prop. Reg. 53.4960-1(d)(3)(v)) Should be Modified.

Example five under the Limited Hours Exception (Prop. Reg.53.4960-1(d)(3)(v)) provides in part:

(A) Facts. ATEO 5 and CORP 3 are related organizations. ATEO 5 has no other related organizations and does not control CORP 3. Employee D is an employee of CORP 3. As part of Employee D's duties at CORP 3, Employee D serves as an officer of ATEO 5. Only CORP 3 paid remuneration (or granted a legally binding right to nonvested remuneration) to Employee D and ATEO 5 did not reimburse CORP 3 for any portion of Employee D's remuneration in any manner. During 2021, Employee D provided services as an employee for 2,000 hours to CORP 3 and 200 hours to ATEO 5.

We believe that the statement in the second sentence of the example that ATEO 5 “does not control CORP 3” should be eliminated from this example. We make this recommendation because this example is meant to clarify the Limited hours exception and under this exception it is irrelevant whether ATEO 5 controls CORP 3. As such, the Limited Hours exception would apply even if such control does exist. Readers however may be confused that control between ATEO 5 and CORP 3 does matter given the existence of this language in the example.

We believe that the statement in example five that ATEO 5 “does not control CORP 3” was included in this example because the facts in example five are carried forward for application in other examples in the proposed regulations, including example eight under the Nonexempt funds exception (Prop. Reg. 53.4960-1(d)(3)(viii)). With respect to example eight, it is relevant that the ATEO 5 does not control CORP 3. We therefore recommend that the statement regarding lack of control be eliminated from example five and moved to example eight.

2. The Related Organizations Requirement Under the Nonexempt Funds Exception (Prop. Reg. 53.4960-1(d)(2)(iii)(A)(3)) Should be Modified.

The related organizations requirement under the Nonexempt funds exception (Prop. Reg. 53.4960-1(d)(2)(iii)(A)(3)) provides that the Nonexempt funds exception will only apply if:

[n]o related organization that paid remuneration or granted a legally binding right to nonvested remuneration to the individual provided services for a fee to the ATEO, to any related ATEO, or to any taxable related organization controlled by the ATEO (or by one or more related ATEOs, either alone or together with the ATEO).

We believe that the related organizations requirement is unduly restrictive and will lead to the inapplicability of the Nonexempt funds exception in situations where such result is not appropriate.

For example, consider the following situation. Individual is the sole shareholder of two for profit corporations (CORP 1 and CORP 2). Individual also has the power to appoint a majority of the board of an Applicable Tax Exempt Organization (ATEO 1). Individual is a paid employee of CORP 1. CORP 1 one provides administrative services for a fee to Corp 2 but does not provide any services to ATEO 1. The other requirements of the Nonexempt funds exception are met.

Under these facts, it does not appear that the Nonexempt funds exception will apply because Corp 1 is providing services to a fee to Corp 2. This is because the related organizations requirement prohibits the payment of services by the related organization employing the individual to any “taxable related organization controlled by the ATEO.” Under Prop. Reg. 53.4960-1(i)(2)(vii)(B)(2), for purposes of determining whether an ATEO controls an organization, if a person controls the ATEO, the ATEO is treated as owning a percentage of the stock owned by the person in accordance with the percentage of directors of the ATEO that are controlled by that person. Thus, in our example, ATEO 1 will be deemed to control CORP 2. Therefore, the payment of services for a fee from CORP 1 to CORP 2 will cause the Nonexempt funds exception not to apply.

This result seems inappropriate because it is difficult to see how the sharing of services between two for profit corporations in which the applicable tax exempt organization has no ownership interest could be used to circumvent the Section 4960 excise tax. Yet, under the current text of the related organizations requirement, this appears to be the mandated result. From our experience, it is fairly common for a for profit corporations to provide services to a related corporation and for the related corporation to pay the other for services provided to it. Thus, unless the related organizations requirement is modified, individuals who own more than one for profit corporation and who also control an applicable tax exempt organization will likely not be able to meet the Nonexempt funds exception. We therefore recommend that the related organizations requirement be modified so that it only prohibits the provision of services for a fee to a for profit entity if the applicable tax exempt organization actually owns a controlling interest in the for profit entity, as opposed to merely being attributed such ownership interest under Prop. Reg. 53.4960-1(i)(2)(vii)(B)(2).