RE: Excise Tax on Executive Compensation Paid by Tax- Exempt Organizations (Notice 2019-09)

April 2, 2019

The Honorable David J. Kautter
Assistant Secretary for Tax Policy Department of the Treasury
1500 Pennsylvania Avenue, N.W.
Washington, D.C. 20220

Mr. William M. Paul
Acting Chief Counsel Internal Revenue Service
1111 Constitution Ave, N.W.
Washington, D.C. 20224

RE: Excise Tax on Executive Compensation Paid by Tax- Exempt Organizations (Notice 2019-09)

The Association for Advanced Life Underwriting (AALU) appreciates the opportunity to provide comments to the Department of the Treasury and the Internal Revenue Service in response to the request for public comment on Notice 2019-09 addressing the imposition of a 21% excise tax on certain tax-exempt entities (and related organizations) that pay remuneration in excess of $1 million to certain covered individuals.

Since 1957, AALU has been the leading organization of financial professionals who provide life insurance and retirement planning solutions for individuals, families, and businesses. Our more than 4,000 members nationwide are financial security professionals who focus on life insurance, annuities, and investments for estate planning, retirement, charitable giving, deferred compensation, and employee benefit planning services.

We appreciate the efforts of the Department and Service to provide additional guidance concerning the tax on excess tax-exempt organization executive compensation enacted as 26 U.S.C. § 4960 in the Tax Cuts and Jobs Act (TCJA). However, we are concerned the proposed guidance would apply the excise taxes created by Section 4960(a)(1) far more broadly than intended or provided for by the TCJA. We appreciate the opportunity to comment, and ask that the following issues are addressed in the final guidance.

Definition of Covered Employee

Section 4960(c)(2) defines a “covered employee” as “any employee (including a former employee)” of an applicable tax-exempt organization (ATEO) who “is one of the 5 highest compensated employees of the organization for the taxable year” or “was a covered employee” in any year starting in 2017.

The statutory definition of “covered employee” is ambiguous, with room for different interpretations. The Notice interprets any ambiguity presented by the undefined term “5 highest compensated employees of the organization” to require that an ATEO calculate its five highest- compensated employees by “including remuneration for services performed as an employee of a related organization.” In effect, the Notice treats “compensation” and “remuneration” as the same term, while it is unclear whether these definitions are identical in the statute.

This interpretation of who constitutes a covered employee under Section 4960 could have broad consequences for many organizations, permanently sweeping in many individuals who receive little to no compensation from an ATEO. That is, an individual who receives $10,000 in compensation from an ATEO while receiving $1.5 million in compensation from a for-profit related entity would trigger new tax liability under Section 4960. And if that taxable entity is not currently subject to the disallowance of deduction under 26 U.S.C. § 162(m), the tax liability for the related organization could be substantial. The consequence of this kind of broad expansion of who constitutes a “covered employee” could mean that many senior executives may avoid providing services to related non-profit organizations in order to avoid triggering new tax liabilities for their employers. This is almost certainly not the result intended by Section 4960.

This problem is compounded under the Notice’s interpretation that covered employees include an ATEO’s officers, whether compensated or not. In fact, at a March 20, 2019 D.C. Bar event, IRS representatives stated that Section 4960 was not intended to displace the minor services exception, citing Revenue Ruling 74-390 and expressly welcoming comments on this point. Failing to clarify that the limited services exception applies might lead some unpaid officers and directors to reconsider their charitable service to avoid creating potential tax liability for their employer.

The guidance did create a “limited service exception” in what appears to be an effort to address these issues. Unfortunately, the exception—which lacks any clear statutory basis—would not address the consequences described above.

Example: The Notice carves out an individual from being considered a covered employee if “the ATEO paid less than 10 percent of the employee’s total remuneration for services performed as an employee of the ATEO and all related organizations.” However, as written the limited services exception does not apply if an individual receives less than 10% of her compensation from just a single ATEO with the remaining 90% coming from related for-profit entities.

Recommendation 1: Clarify that unpaid officers and directors who perform only “minor services” for an organization are not considered employees for purposes of Section 4960.

Recommendation 2: The final guidance should clarify that the definition of “covered employee” is restricted to that set forth in Section 4960(c)(2), including only compensation “of the organization” for purposes of determining the ATEO’s “5 highest compensated employees,” and not the compensation of any “related organizations.” The most coherent definition of “covered employee” in Section 4960 should not include compensation from “related organizations” when determining an ATEO’s “5 highest compensated employees.”

The Notice unadvisedly conflates the requirements for determining the amount of excess remuneration under Section 4960(c)(3) with the initial question of who is considered a “covered employee,” which should be answered exclusively by Section 4960(c)(2).

Recommendation 3: If the final guidance nonetheless extends the definition of covered employee to include compensation from related organizations in the calculation of the “5 highest compensated employees,” the limited service exception should be clarified to exclude any employee from an ATEO’s five highest compensated employees when the ATEO paid less than 10 percent of the employee’s total remuneration for services performed as an employee of the ATEO and all related organizations. That is, when there is a single ATEO that provides less than 10% of overall compensation to an employee while related non-exempt organizations provide more than 90%, the limited services exception should still apply and no new tax liability should be triggered under Section 4960.

Inclusion of Payments from Deferred Compensation Retirement Plans in Definition of Remuneration

 In the Notice, “remuneration” is defined by Section 4960(c)(3) to include not just wages (as defined in Section 3401(a)) but also deferred compensation accumulated even prior to enactment of the new law when it is included in gross income under Section 457(f). Thus, even when employees make nowhere near $1 million per year, tax liability could suddenly be triggered for their employer when their supplemental retirement plan vests.

Example: An ATEO without any related organizations pays its CEO $400k in annual compensation while also contributing $125,000 per year to a Section 457(f) deferred compensation retirement plan. After ten years, her Section 457(f) plan vests with a value of $1.25 million. Although the CEO’s annual earnings are well below $1 million dollars, with all three elements of Section 4960(a)(1) met, the exempt organization will be liable for $136,500 in new tax liability – excess remuneration ($400k + 1.25 million – $1 million) x .21.

Even if the ATEO had a binding legal obligation on November 2, 2017 to pay the CEO her retirement benefits of $1.25 million on December 31, 2019, the full accumulated retirement benefit of $1.25 million will still be included 2019. What is more, any attempt to restructure the plan to delay vesting or payment will generally be ignored and/or result in significant additional tax liability under Sections 457(f) and/or 409A.

For-profit entities have the ability to defer and spread annual income into retirement years through the use of nonqualified deferred compensation arrangements. However, for executives of tax- exempt entities, the present value of amounts deferred into retirement are all included in income at the time of vesting which is typically in the final few years of service. This bunching of the recognition of retirement benefits is unique to tax-exempt entities, making the application of the million-dollar limitation in this context unfairly onerous. What is more, many tax-exempt organizations have binding legal obligations to pay out large retirement benefits that have accumulated over the last 30 years or more in upcoming retirement years and no grandfathering has been provided to address the retroactive application of the new law to these existing accrued obligations. To make matters worse, no relief has been provided from existing onerous tax regulations that ignore or impose significant tax penalties on attempts to restructure these existing obligations.

Tax law should never be applied retroactively, as it can have significant and unintended consequences. Deferred compensation retirement plans are binding contracts, and employers are required to make certain payments at specific times. Without a grandfather clause for contracts in effect before the passage of the TCJA, employers will face a new tax on payments they are already committed to pay.

Recommendation 4: Grandfather amounts vested and/or paid from binding legal obligations in effect on November 2, 2017, which have not been materially modified, except to the extent such modification represented a good faith attempt to address and comply with Section 4960. Allow tax- exempt employers, to delay vesting and payment under Sections 457(f) and 409A without penalties to the extent necessary to avoid application of 4960

We appreciate the opportunity to comment, and appreciate your consideration of our concerns. We are always happy to answer any questions.


Marc Cadin
Chief Executive Officer