The IRS and Treasury plan to issue new regulations to tax excessive executive compensation paid by tax-exempt organizations. The rule will apply to any employee earning over $1 million annually, expanding beyond the previous limit of the five highest-compensated employees.
The Internal Revenue Service (IRS) and the Department of the Treasury have announced their intention to issue proposed regulations aimed at taxing excessive executive compensation paid by tax-exempt organizations. This initiative, detailed in a notice issued on June 5, specifically addresses Section 4960 of the Internal Revenue Code, which imposes an excise tax on nonprofits paying employees over $1 million in remuneration or excess parachute payments in a tax year.
Under the new rule, the excise tax will apply to any employee whose compensation exceeds $1 million annually, a significant expansion from the previous requirement that the employee be among the five highest-compensated individuals. This change is set to take effect for tax years beginning after December 31, 2025. The regulations will also cover former employees who were among the top five highest-compensated and earned over $1 million in any tax year between December 31, 2016, and December 31, 2025. Taxation on parachute payments remains unchanged.
IRS Chief Executive Officer Frank J. Bisignano stated that the rule enhances accountability for tax-exempt organizations by broadening the scope of the tax. The Treasury and IRS are seeking public comments on the notice until August 4. The American Institute of CPAs (AICPA) has previously expressed concerns, urging for comprehensive guidance and transition relief to prevent unintended financial exposure for tax-exempt organizations. Retirement plan professionals are advised to be aware of these changes, as qualified retirement plan designs can potentially reduce the compensation counted towards the excise tax, offering an opportunity for advisors to assist nonprofit clients.
These regulatory changes will impact how tax-exempt organizations structure executive compensation and benefits, potentially increasing their financial exposure and requiring adjustments to retirement plan designs to mitigate excise tax liabilities.