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Tax Reform Impact for Tax-Exempt Organizations

The Tax Cuts and Job Act was signed into law on Friday, December 22nd. The following outlines the implications for "excessive pay" in tax-exempt organizations, effective for employer tax years beginning after 12/31/2017. 

What you need to know:

1.  A tax-exempt employer must pay a 21% excise tax on annual remuneration (not including “excess parachute payments”) above $1M with respect to an employee (or former employee) who at any time was 1 of the 5 highest paid employees in any tax year after 2016 (a “covered employee”). Once a person is considered a covered employee, they remain a covered employee even in years they are not one of the 5 highest paid. 
  • The tax rate is tied to the corporate income tax rate; if that tax rate changes, the excise tax rate for tax-exempt organizations will also change.
  • For this purpose, deferred compensation that becomes taxable under Code Section 457(f) but is paid in a subsequent year is includable for purposes of the $1M test when taxable under Code Section 457(f).
2.  The excise tax also applies to “excess parachute” payments regardless of the $1M threshold; these are amounts contingent on termination of employment that where the total exceeds the average of the individual’s W-2 pay for the 5 calendar years preceding the year employment terminates.
  • However, the application of the excise tax on excess parachute payments does not apply if the total amount contingent on termination does not exceed 3 times the 5-year average (this rule is similar to the golden parachute rules applicable to change-in-control situations that exempt amounts if the total is less than 3 times the average).
  • In addition, amounts payable under qualified plans, Code Section 403(b) annuities and Code Section 457(b) plans are not considered payments contingent on termination of employment.
3.  Employers will need to be mindful of payment timing of compensation and vesting timing of amounts subject to Code Section 457(f) to avoid inadvertent exposure to this excise tax. 

For more information please contact:

Katrina Gerenz, katrina.gerenz@mclagan.com
Gayle Appelbaum, gayle.appelbaum@mclagan.com
Bryan Lemke, bryan.lemke@mclagan.com
Todd Leone, todd.leone@mclagan.com