The 2020 Foundations Excise Tax Regulations – What You Need to Know
At first thought, most people recall The Tax Cuts and Jobs Act, which the President signed into law in late 2017, as legislation that changed the rate for standard deductions and capped certain other deductions, including charitable contributions. Rightly, the Act provides those of us working in the nonprofit charitable sector plenty to think about in terms of engaging donors so as not to lose their contributions.
Yet an equally important provision was included imposing an excise tax on certain excess compensation paid by some tax-exempt organizations to particular employees. Section 4960 of the IRS Code introduced a now 21% excise tax paid by an applicable tax-exempt organization on compensation over $1,000,000.
To date, the IRS has provided only interim guidance regarding Section 4960 as it considers public comments and drafts final regulations. Wading through the interim guidelines and other materials one finds a lot of tax code language and legalese, which can be more than a little overwhelming if, like me, you are not an expert in these matters. Add into the mix that the interim rules are somewhat ambiguous about exactly who and exactly what compensation is liable for taxation, and it is all more than a little confusing. If you ever need a case for obtaining good tax advice, this is it.
For many, the idea of $1,000,000 in compensation is merely a dream. Moreover, some might suggest that compensation in the seven-figure range has no business in the nonprofit sector. Perhaps yes—maybe no—and certainly worthy of debate. When I taught classes in fundraising, an inevitable question each semester was, “What constitutes a major gift?” It is relative, I would respond, as a $10,000 grant might keep an after-school program operating for a year whereas that same gift to a major university might literally get lost in rounding errors. The same is true with compensation: It is relative.
Yet here is the potential trap: Although you may receive minimal compensation for work at your foundation, the $1,000,000 threshold appears to include all your compensation. Perhaps in your “day job” you are the CEO of a for-profit company or an investment banker receiving high compensation for that work, which has nothing to do with your foundation participation. The IRS, however, will still count it toward the $1,000,000 threshold.
With Washington being Washington, we should remember that the provision sets a precedent and a bar, so should a future Congress find itself looking for more revenue, it is conceivable they would lower the threshold at which the excise tax kicks in, potentially exasperating the issues we’ve been discussing.
As funders and grant recipients, we need to recognize that Section 4960 might well serve as a disincentive to certain highly compensated employees to get involved with charitable activities that could trigger the excise tax. I certainly believe that altruism is alive and well for many in the philanthropic community, yet the prospect that the practice of unselfish concern for the well-being and welfare of others could be subject to taxes may dampen those good intentions. That would not be good for anyone.