Tax Exempt Orgs: 457(f) Plans and 4960 Parachutes
2019.01.22 457(f) Landmine Lurks for All Tax-exempt Organizations … Even the Small Ones! “Maybe not today. Maybe not tomorrow, but someday” … you are likely to have a golden parachute problem. It’s not often that Casablanca and tax law intersect, but the above warning is apropos for any tax exempt organization that has a 457(f) plan. Plans of that kind are typically structured to avoid immediate income taxation for executives by deferring benefit payments until their termination of employment. No one would think this could trigger golden parachute penalties for the organization. In the wake of IRS Notice 2019-09, however, tax-exempt organizations should think again.
Today’s challenge for 457(f) plans has its genesis in Code Section 4960, which was enacted as part of the Tax Cuts and Jobs Act of 2017. This new Code section imported Code Section 280G’s golden parachute rule into the world of tax-exempt organizations. There is, however, one huge twist in Code Section 4960: the three times pay (3x) limit found in Code Section 280G only applies to amounts paid in connection with changes in corporate control. By contrast, Section 4960’s 3x limit applies to most forms of severance pay that tax-exempt organizations provide to exiting executives, not just payments relating to changes in corporate control. Here are a few sobering observations drawn from Notice 2019-09:
1. A tax-exempt organization with an employee earning more than $125,000 in 2019 (indexed for future years) could become subject to Section 4960’s golden parachute excise tax.
2. Once an employee is classified as an HCE for any year, that employee will always be considered an HCE for Section 4960 purposes.
3. Section 4960’s 3x limit is exceeded if an HCE receives “contingent payments” exceeding three times the HCE’s average W-2 income for the five calendar years ending before the year in which employment terminates. This five-year average establishes what is called “Base Amount” for Section 4960 purposes.
4. Section 4960 is structured in a manner that can trigger shockingly high excise taxes.
5. There is not yet any grandfathering for amounts already accrued under existing 457(f) plans.
6. Rolling risks of forfeiture have long been an effective tax planning device under Section 457(f) plans. Now, however, their use could “roll-up” parachute payments to levels that trigger Section 4960 problems.
The above is intended merely to provide tax exempt organizations with a generalized alert to one of many planning issues that their directors and executives should consider. It is critical for them to make executive compensation decisions that carefully navigate the intersection of Code Sections 457, 4958, and 4960 (as well as 409A!). Otherwise, the organization, the executives, or both will become subject to significant excise tax surprises.
Copyright © Joseph Poerio. All rights reserved.