By John Huskins and J. Calvin Marks
One of the headline pieces of the Tax Cuts and Jobs Act of 2017 that impacts tax-exempt organizations is the excise tax on compensation paid to certain employees in excess of $1 million. The tax generally applies only to compensation paid to the five highest-compensated current and former employees, with no grandfathering provisions related to pre-existing contracts.
The tax, which is imposed on the organization and not the employee, is based broadly on “remuneration” paid to covered employees. Remuneration for this purpose is defined as wages with respect to Section 3401, which describes wages subject to withholding. So in general, the amount of compensation subject to the tax should be the same as Box 1 of Form W2. This means that there are some important exclusions that may provide valuable tax planning opportunities for organizations paying compensation to employees that may reduce the excise tax liability such as:
- Amounts deferred under qualified deferred compensation plans, including 401(k), 403(b), 457(b), SEPs, and Simple Retirement Accounts: Deferrals under Roth plans, which would ordinarily be considered “wages” for this purpose are also excluded, putting these deferrals on equal footing with contributions to traditional plans. The annual contribution limits for most of these plans limit their usefulness in shielding large amounts of income from tax, but for highly-compensated employees who are not otherwise fully utilizing their ability to contribute to these plans, this provides some valuable savings to the organization, along with the benefits of these plans to the employee. It’s also worth noting that although contributions to 457(b) plans are excluded from wages for this purpose, contributions to 457(f) plans are not.
- Group term life insurance: To the extent that a highly-compensated employee is willing to convert otherwise taxable wages to non-taxable group term life insurance, there may be significant savings for both the employee and the organization.
- Nontaxable benefits in general, including health insurance premiums, HSA contributions, education assistance programs, dependent care assistance programs, and employee achievement awards, among others: The annual limits that apply to many of these benefits undermine their value separately in reducing an organization’s tax liability, but in aggregate there may be a significant tax savings to be had.
Compensation paid by related organizations is aggregated for the purpose of the calculation of tax, and each organization paying compensation is liable for their proportionate share of compensation paid. As an excise tax rather than an income tax, organizations do not need to make quarterly estimated payments on their liability for this tax. Furthermore, a federal tax liability under this provision may not trigger a state tax liability, as states generally impose tax only on the unrelated business income of exempt organizations.
If you have any concerns about the impact of the provisions of the Tax Cuts and Jobs Act of 2017 on your organization, please contact John Huskins or J. Calvin Marks.
This article first appeared on the Johnson Lambert LLP, blog.