Athletic Coaches and the Tax Act

A position was taken by some advisers that where a state sponsored college or university was not subject to income tax based on IRC §115(1) and not §501(c) therefore the excise tax should not apply. On Dec. 31, 2018, the IRS issued interim guidance that addresses how excise tax will apply in various situations that commonly arise for tax-exempt employers. These announcements together with the Blue Book issued on Dec. 20, 2018 by the Joint Tax Committee provide clear guidance. Overall, the IRS has interpreted Section 4960 in a manner that is unfavorable to tax-exempt employers, particularly nonprofit health systems and state sponsored colleges and universities. Establishing internal systems to determine which employees are covered by this excise tax is likely to be challenging. Key highlights of Notice 2019-09 addressing Non Profit Organization executive compensations include:

• The 21% excise tax applies to governmental entities exempt from tax under Section 115 of the Code, as well as other governmental entities that have applied and received recognition of tax-exempt status as Section 501(c)(3) organizations (“dual-qualified” organizations). Only governmental entities that fit neither of these categories can avoid the excise tax (g., a state college with no IRS determination letter). An ''applicable tax-exempt organization'' is an organization exempt from tax under section 501(a), an exempt farmers' cooperative, a Federal, State or local governmental entity with excludable income, or a political organization. The Blue Book on p.263 specifically indicates “Applicable tax-exempt organizations are intended to include State colleges and universities. Fn.1251 (1251 A technical correction may be necessary to reflect this intent.)” For purposes of the timing of application, for example, if a state university recognized under §§501(c) or 115(1) pays its covered employee head football coach $5 million per year, it would face an $840,000 excise tax (21% of $4 million) during each year of the contract.
• In order to reduce complexities associated with multi-corporate tax-exempt systems having entities with different tax years, the Notice clarifies that the excise tax is determined on a calendar year basis, not based on the taxable year of the employer. This is an important development for non-fiscal year employers, as it should reduce the administrative burden that might otherwise arise if these employers were required to allocate compensation paid during a single calendar year to multiple fiscal years.

The IRS issued final regulations in June 2016 and further direction with the Tax Cut and Jobs Act, the Bluebook and Notice 2019-09 that provide a roadmap for a successful solution to the excise tax conundrum. A solution applies an actuarially based methodology to provide benefits for selected non-profit executives on a tax efficient basis. If you already have a plan in place it is most likely a 457(f) plan for the executive, management and professional employees. This is not meant to replace a plan in existence, rather it compliments it as there are decided differences. Most significant for the participants is the opportunity to provide for their families, a pre-retirement death benefit without risks of forfeiture and with enormous flexibility. This is not an ERISA plan, it does not need a Trustee and the participant and plan sponsor will avoid the claims of creditors while providing for the participant's loved ones. Because this is not a qualified plan and it is not considered as deferred comp by the IRS, the plan can be self-funded and the benefit amounts can vary on a participant by participant basis. Because it follows the “top hat” rules it does not require any form of ongoing or annual filings with any regulatory agencies. A one-time e-filing with Department of Labor is the only regulatory filing. It is two pages long and does not require the listing of participants or amounts contributed.

Non-profit organizations have limited opportunities to recruit, retain and reward highly prized Executives, because of regulatory, economic, human resources, communication and compliance requirements. New rules provided by the IRS offer the opportunity to use a planning tool that will provide a current benefit for the top five executives not otherwise available in ERISA based plans, deferred compensation and split dollar insurance planning.