Athletic Coaches and the Tax Act

When the Tax Cut and Jobs Act became law in December of 2017 there was a question whether some of the highest salaried employees at non-profit organizations would be exempt from the $1M remuneration tax. In the majority of states (39 out of 50), the highest salaried employees are athletic coaches. Of the 50 U.S. states, a college football or men's basketball coach were the highest-paid employee in 2016. Further Checking the Office of President University of California website the top 20 salaried employees are athletic coaches.

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.

Using a patented actuarial methodology the University Plan Sponsor can provide this without requiring additional recordkeeping, reporting, limitation of covered employees, ERISA and qualified plan rules, employee cooperation, regulatory compliance issues and penalties.

This §457(e)11 plan provides:

• Economically efficient funding;
• Complies with all regulatory requirements without addition recordkeeping and reporting;
• Avoids the risk of forfeiture requirements under §457 (f) and §4960;
• A current death benefit while employed not otherwise available to other employees;
• A patented actuarial methodology to determine the covered participants, the value of the current benefits and the funding of the benefits; and
• Qualifies for exclusion of immediate remuneration recognition required under§457(f), §4960 and §162(m) and during funding.

What Is a §457(e)11 Plan?

A permissibly selective benefit plan, the bona fide death benefit only plan uses a multidisciplinary platform following deferred compensation, welfare benefit plan structures with an actuarially determined current benefit provided for employees and independent contractors. The participants are taxed on the economic benefit so long as the benefit is funded by the Plan Sponsor. A §457(e)11 Plan is a nonqualified ineligible non deferred compensation and non-compensation plan. (26CFR1.457-11, IRC 457 Examination Guidelines).

A Plan Sponsor must be a tax-exempt entity (TEE) (457[e][1]) A participant may be an employee or independent contractor of a TEE §457(e)(2), 1.457-2(d)

A 457(e)(11) Death Benefit Plan does not have to comply with risk of forfeiture or acceleration of income 457(f) requirements IRC §457(f)(11)(A)(1), Notice 87-13 and 88-68.

Payments by the Plan Sponsor to fund a §457 (e)(11) Death Benefit Plan are not taxable income nor are deferred compensation to the participant. In Office of Chief Counsel INFO 2003-0082 (UIL:457.09-05) (Feb. 25, 2003), the OCC interpreted Notice 88-68 to indicate the providing or accruing of the benefits is not a taxable event. It is only when the benefit it provided to the participant is there a taxable or nontaxable event. Providing the benefit thru a §457(e)11 plan does not affect to taxation to the participant, that is addressed under other provisions of the law. The participant by the funding of the benefit is taxed on the Table 2001 rates as economic benefit. As the death benefit is the only benefit provided by participating in the plan, to the extent the benefit qualifies as life insurance under §101(a) it should not be subject to income tax as received by a beneficiary identified in the plan.

The plan may be elective or non-elective and a salary reduction or non-salary reduction plan (IRS Notice 88-68 and Notice 87-13Q&A 26).

A §457(e)11 death benefit plan may be funded with life insurance (REG147196-07 06-21-2016).

How Does the §457(e)11 Work?

• Employer and Employee enter into mutually beneficial arrangement to provide death benefit during employment.
• Employer funds the life insurance over agreed upon period.
• Group arrangement uses a co-ownership format to provide coverage Plan Sponsor expenses contribution.
• Plan Sponsor has no interest in cash values nor death benefit Participant voluntarily requests wage reduction.
• Participant is taxed on the economic benefit using Table 2001.
• Participants benefit not deemed remuneration for §162(m) and §4960 purposes.
• Program provides death benefit only coverage during the years of employment. No distributions other than death benefit allowed. Plan Sponsor and Participant is restricted in access.
• Permanent Life Policies accrue on tax-free basis.
• Policies are reviewed annually.
• Economic Benefit costs stop once contributions are no longer made No Tax reporting upon termination of the Benefit Arrangement.
• After termination of benefit plan, co-ownership arrangement is evaporated.
• Insured may access cash values of policies, or use polices for their personal financial and estate planning.

Administration of the Plan

The §457(e)11 death benefit only is not a qualified plan nor deferred compensation or an ERISA plan. The DOL has specific administrative rules that requires the following:

• Name, address, including email address of plan administrator;
• Permits, but does not require, plan name to be stated;
• Does not require providing plan document; and
• Requires a box to be checked if it is an amended notice.

The website to enroll is https://www.askebsa.dol.gov/efile/Home/tophat.

The Plan Administrator will have to electronically enroll the plan at the time of implementation and will provide proof of filing to the Plan Sponsor.

Third-Party Validation

At the time of implementation, the 457(e)11 plan should receive from an independent third party validation:

• A well-reasoned legal memorandum indication that the plan complies with all applicable regulatory requirements;
• An actuarial report supporting the contribution and it reflecting the cost of the current death benefit thru age 67; and
• A report from actuarial firm should indicate that the amount of the funding of the policy meets required benchmark to qualify under §457(e)11 and Regs.Sec. 31.3121(v)(2)-1(b)(4)(iv)(C)(2) as a bona fide death benefit plan.

If the University or healthcare entity is not currently using this planning tool and no other benefit plan available to nonprofits provides this multidisciplinary tool to recruit, retain and rewards the nonprofits organization's highly prized employees and independent contractors are missing out on the opportunities and they may look elsewhere and desert the service provider. This is another leg of the stool to provide executive benefits in the most economically efficient manner while being regulatory compliant.

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Lawrence L. Bell, JD, LTM, CLU, ChFC, CFP®, AEP, a member of this newsletter's Board of Editors, has served as Tax Bar liaison to the IRS for 10 years. He has received patents in actuarial product fields dealing with COLI, GASB, FASB, IASB and OPEB solutions. To learn more, visit www.mycpo.net.