# Tax on Excess Tax-Exempt Organization Executive Compensation > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/fr%3A2021-00772 ## Record - **Collection:** Federal Register - **Document type:** Rule - **Published:** January 19, 2021 - **Citation:** 86 FR 6196 ## Text DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Parts 1 and 53 [TD 9938] RIN 1545-BO99 Tax on Excess Tax-Exempt Organization Executive Compensation AGENCY: Internal Revenue Service (IRS), Treasury. ACTION: Final regulations. SUMMARY: This document sets forth final regulations under section 4960 of the Internal Revenue Code (Code), which imposes an excise tax on remuneration in excess of $1,000,000 and any excess parachute payment paid by an applicable tax-exempt organization to any covered employee. The regulations affect certain tax-exempt organizations and certain entities that are treated as related to those organizations. DATES: Effective Date: These final regulations are effective on January 15, 2021. Applicability Dates: For dates of applicability, see § 53.4960-6. FOR FURTHER INFORMATION CONTACT: William McNally at (202) 317-5600 or Patrick Sternal at (202) 317-5800 (not toll-free numbers). SUPPLEMENTARY INFORMATION: Background This document amends the Foundation and Similar Excise Tax Regulations (26 CFR part 53) by adding final regulations under section 4960. Section 4960 was added to the Code by section 13602 of the Tax Cuts and Jobs Act, Public Law 115-97, 131 Stat. 2054, 2157 (TCJA). Section 4960(a) generally provides that an applicable tax-exempt organization (ATEO) that pays to a covered employee remuneration in excess of $1 million for a taxable year or any excess parachute payment is subject to an excise tax on the amount of the excess remuneration (as described in section IV of the Summary of Comments and Explanation of Revisions, titled “Excess Remuneration”) plus excess parachute payments paid during that taxable year at a rate equal to the rate of tax imposed on corporations under section 11 (currently 21 percent). Section 4960 is effective for taxable years beginning after December 31, 2017. An ATEO is defined in section 4960(c)(1) as any organization that for the taxable year is exempt from taxation under section 501(a) as well as certain other tax-exempt organizations. A covered employee is defined in section 4960(c)(2) as any employee (including any former employee) of an ATEO if the employee is one of the five highest-compensated employees of the organization for the taxable year or any preceding taxable year beginning after December 31, 2016. Section 4960(c)(4)(A) provides that remuneration paid to a covered employee by an ATEO includes any remuneration paid with respect to employment of such employee by any related person or governmental entity. Section 4960(c)(4)(B) defines a related person or governmental entity as an entity that controls, or is controlled by, the ATEO; is controlled by one or more persons that control the ATEO; or is a supported or supporting organization as described in sections 509(f)(3) and 509(a)(3), respectively. An excess parachute payment is defined in section 4960(c)(5)(A) as an amount equal to the excess of any parachute payment over the portion of the base amount (as described in section V.D. of the Summary of Comments and Explanation of Revisions, titled “Three-Times-Base-Amount Test”) allocated to such payment; section 4960(c)(5)(B) defines a parachute payment as any payment in the nature of compensation to a covered employee if the payment is contingent on the employee's separation from employment with the employer and the aggregate present value of such payments exceeds 3-times the base amount. On December 31, 2018, the Department of the Treasury (Treasury Department) and the Internal Revenue Service (IRS) issued Notice 2019-09 (2019-04 I.R.B. 403), setting forth initial guidance on the application of section 4960. On June 11, 2020, the Treasury Department and the IRS published proposed regulations on section 4960 in the Federal Register (REG-122345-18, 85 FR 35746) (the proposed regulations). The statutory provisions and the initial guidance provided by Notice 2019-09 are described in detail in the proposed regulations. The Treasury Department and the IRS received written comments on the proposed regulations. No public hearing was requested or held. All written comments received in response to the proposed regulations are available at www.regulations.gov or upon request. Comments received that are outside of the scope of the proposed regulations generally are not addressed in this preamble but may be considered in connection with future guidance projects. After consideration of the relevant comments received, the proposed regulations under section 4960 are adopted as final regulations as modified by this Treasury Decision. The major areas of comment and the revisions to the proposed regulations are discussed in the Summary of Comments and Explanation of Revisions. With respect to provisions in the proposed regulations on which no comments were received or for which comments were received prior to the issuance of the proposed regulations, the preamble to the proposed regulations may provide additional information. Summary of Comments and Explanation of Revisions These final regulations provide guidance on the excise tax imposed by section 4960 and the entities that are subject to the tax. I. Scope of Final Regulations These final regulations retain the basic approach and structure of the proposed regulations, with certain revisions. These final regulations restate certain statutory definitions and define various terms set forth in section 4960. These final regulations also provide rules for determining: The amount of remuneration paid for a taxable year for purposes of identifying covered employees and calculating the excise tax; whether excess remuneration has been paid and in what amount; whether a parachute payment has been paid and in what amount; the allocation of liability for the excise tax among related organizations; and the date of applicability of these final regulations. These definitions and rules apply solely for purposes of section 4960. II. Definitions A. Applicable Tax-Exempt Organization These final regulations adopt the definition of “applicable tax-exempt organization” or “ATEO” as set forth in the proposed regulations. Consistent with section 4960(c)(1), the proposed regulations provided that an “applicable tax-exempt organization” or “ATEO” includes an organization that is exempt from tax under section 501(a); is a farmers' cooperative organization described in section 521(b)(1); has income excluded from taxation under section 115(1); or is a political organization described in section 527(e)(1). In response to comments on Notice 2019-09 regarding the applicability of the excise tax imposed by section 4960 to certain Federal instrumentalities, section II.A. of the Explanation of Provisions of the proposed regulations, titled “Applicable Tax-Exempt Organization,” stated that the Treasury Department and the IRS consider all Federal instrumentalities described in section 501(c)(1) to be included in the statutory ATEO definition as an organization exempt from tax under section 501(a) and thus subject to section 4960. However, the Treasury Department and the IRS requested comments regarding the application of section 4960 to Federal instrumentalities. One commenter requested that these final regulations confirm that Federal instrumentalities described under section 501(c)(1)(A)(i), for which the enabling acts provide for exemption from all current and future Federal taxes are not subject to tax under section 4960. These final regulations do not address this issue but reserve § 53.4960-1(b)(3) and § 53.4960-4(a)(5) for future rules to address these Federal instrumentalities. The Treasury Department and the IRS will continue to consider whether section 4960 should apply to Federal instrumentalities for which the enabling acts provide for exemption from all current and future Federal taxes. Until further guidance is issued, a Federal instrumentality for which an enabling act provides for exemption from all current and future Federal taxes may treat itself as not subject to tax under section 4960 as an ATEO or related organization. However, if that Federal instrumentality is a related organization of an ATEO, remuneration it pays must be taken into account by that ATEO. B. Applicable Year Section 4960(a)(1) refers to remuneration paid “for the taxable year,” but does not specify which taxpayer's taxable year is referenced, what it means for remuneration to be paid “for” a taxable year, or how to measure remuneration if an ATEO and a related organization have different taxable years. The proposed regulations provided that remuneration is treated as paid for a taxable year if it is paid during the applicable year, and that the applicable year is defined as the calendar year ending with or within an ATEO's taxable year. The proposed regulations provided rules for determining the applicable year of an organization with respect to the taxable year in which the organization becomes an ATEO or ceases to be an ATEO, including rules addressing short applicable years that may arise in these situations and rules addressing related organizations with different taxable years. No comments were received on those proposed rules, and these final regulations adopt those rules without change. C. Employee Section 4960(a) imposes a tax on excess remuneration and any excess parachute payment paid by an ATEO for the taxable year with respect to employment of a covered employee. Section 4960(c)(2) defines a “covered employee” as an employee (including any former employee) of the ATEO who meets certain other conditions. Accordingly, the excise tax imposed by section 4960(a) applies only with respect to a current or former employee of the ATEO. The proposed regulations defined “employee” by reference to the definition of “employee” for purposes of Federal income tax withholding in section 3401(c) and the regulations thereunder. Specifically, the proposed regulations cross-referenced the definition of “employee” in § 31.3401(c)-1, which includes common-law employees, officers or elected or appointed officials of governments, or agencies or instrumentalities thereof, and certain officers of corporations. The proposed regulations restated certain rules from § 31.3401(c)-1 that are particularly relevant to section 4960, including the rules that a member of a board of directors of a corporation is not an employee of the corporation (in the member's capacity as a director), and that an officer is an employee of the entity for which the officer serves as an officer (unless the officer performs no services or only minor services and neither receives, nor is entitled to receive, any remuneration for such services). For further discussion, see section II.E. of this Summary of Comments and Explanation of Revisions, titled “Covered Employee.” No comments were received on those proposed rules, and these final regulations adopt those provisions of the proposed regulations without change. One commenter requested clarification regarding the source of the remuneration that is considered for purposes of applying the minor services exception to the rule that treats a corporation's officer as an employee. The minor services exception in Prop. § 53.4960-1(e)(1) incorporated the standard in § 31.3401(c)-1 and provided that “an officer of a corporation who as such does not perform any services or performs only minor services and who neither receives, nor is entitled to receive, any remuneration is not considered to be an employee of the corporation solely due to the individual's status as an officer of the corporation.” The commenter stated that it is unclear whether an individual qualifies for the exception if he or she receives remuneration from a related person or governmental entity for services performed for an organization other than the ATEO and also volunteers his or her time as an officer of the ATEO (and performs no services or only minor services for the ATEO). The commenter recommended that these final regulations clarify that the relevant remuneration for purposes of meeting the minor services exception is only remuneration paid by the ATEO. The minor services exception applies if an individual is not paid (nor is entitled to be paid) remuneration based “solely” on the individual's status as an officer. Thus, the source of the remuneration is not relevant, but rather the standard is whether the individual received any remuneration for the minor services as an officer regardless of the source of the remuneration. Therefore, the Treasury Department and the IRS have concluded that this clarification of the minor services exception in these final regulations is unnecessary. For a discussion of how this definition of “employee” and other rules address employees of non-ATEO related organizations performing limited or temporary services for the related ATEO (in particular, while also receiving compensation from the non-ATEO related organization), see section II.E.5. of this Summary of Comments and Explanation of Revisions, titled “Volunteer Services and Other Exceptions.” D. Employer Section 4960(b) provides that the employer is liable for the tax imposed under section 4960(a). Similar to the definition of “employee,” the proposed regulations defined “employer” by reference to the definition of “employer” for purposes of Federal income tax withholding in section 3401(d) and the regulations thereunder, without regard to the special rules in section 3401(d)(1) and (2). Accordingly, control of the payment of wages would not be relevant for determining whether an entity is the employer for section 4960 purposes. Further, the proposed regulations provided that a person or governmental entity does not avoid status as an employer of an employee by using a third-party payor to pay remuneration to that employee. Third-party payors include a payroll agent, an agent under section 3504, a common paymaster, a statutory employer under section 3401(d)(1), or a certified professional employer organization under section 7705 (which is an “employer” only for purposes of subtitle C of the Code). Similarly, consistent with existing principles for determining the employer, under certain facts and circumstances, a management company may also be acting as a third-party payor for the employees of its ATEO client, rather than as the common law employer of the employees. Thus, the proposed regulations provided that remuneration that is paid to an individual by a separate organization for services the individual performed as an employee of the ATEO would be remuneration paid by the ATEO to its employee for purposes of section 4960, whether or not the separate organization is related to the ATEO. In addition, the proposed regulations provided that the sole owner of an entity that is disregarded as separate from its owner under § 301.7701-2(c)(2)(i) would be treated as the employer of any employee of the disregarded entity, notwithstanding that the entity is regarded for subtitle C purposes under § 301.7701-2(c)(2)(iv). No comments were received on these provisions of the proposed regulations, and these final regulations adopt them without change. E. Covered Employee 1. In General Section 4960(c)(2) defines “covered employee” as any individual who is one of the five highest-compensated employees of the ATEO for a taxable year or was a covered employee of the ATEO (or any predecessor) for any preceding taxable year beginning after December 31, 2016. Thus, once an employee is a covered employee of an ATEO, the employee continues to be a covered employee for all subsequent taxable years of that ATEO. The proposed regulations provided that whether an employee is one of the five highest-compensated employees of an ATEO is determined separately for each ATEO and not for an entire group of related organizations. As a result, a group of related ATEOs could have more than five “five highest-compensated employees” for a taxable year. Similarly, an employee could be a covered employee of more than one ATEO in a related group of organizations for a taxable year. No comments were received on these provisions of the proposed regulations, and these final regulations adopt them without change. 2. Aggregation of Remuneration Paid by the ATEO and Its Related Organizations for Purposes of Determining the Five Highest-Compensated Employees For purposes of determining whether an employee is one of an ATEO's five highest-compensated employees for a taxable year, the proposed regulations provided that remuneration paid by the ATEO during the ATEO's applicable year is aggregated with remuneration paid by any related organization during the ATEO's applicable year, including remuneration paid by a related taxable organization or governmental entity, for services performed as an employee of that related organization. Remuneration for which a deduction is disallowed under section 162(m) generally is not considered for purposes of determining whether excess remuneration is paid for a taxable year, but that remuneration is considered for purposes of determining an ATEO's five highest-compensated employees. One commenter suggested that, for purposes of determining an ATEO's five highest-compensated employees, these final regulations should consider only remuneration paid (directly or indirectly) by an ATEO for services provided by an employee to the ATEO, rather than aggregating all remuneration paid to the individual for services the individual provides as an employee of the ATEO and as an employee of any related organization, including a related non-ATEO (for example, a taxable organization). The commenter reasoned that aggregating remuneration for purposes of determining covered employee status is not required by the statutory text and is unnecessary to comply with Congressional intent to achieve parity between ATEOs and publicly held corporations that are subject to the section 162(m) deduction disallowance for compensation paid to a covered employee in excess of $1 million. The commenter also reasoned that because only an ATEO can have a “covered employee” under section 4960(c)(2), the reference to the “five highest-compensated employees of the organization” (emphasis in comment) in section 4960(c)(2)(A) should be read to include only compensation paid by the ATEO, directly or indirectly (for example, by reimbursing another entity), for services provided by the employee to the ATEO, regardless of the payor. The commenter asserted that the language in section 4960(c)(4)(A), which provides that “remuneration of a covered employee by an [ATEO] shall include any remuneration paid with respect to employment of such employee by any related person or governmental entity” (emphasis in comment) should not override a plain reading of section 4960(c)(2), which refers only to employment with the ATEO. The commenter further reasoned that section 4960(c)(4)(A) applies after a determination of the ATEO's covered employees has already been made, and thus it is circular to read section 4960(c)(4)(A) as requiring inclusion of remuneration paid to a covered employee of an ATEO by a related person or governmental entity for purposes of determining an ATEO's highest-compensated employees (and, thus, its covered employees). While the Treasury Department and the IRS acknowledge that alternative interpretations as to whether sections 4960(c)(2) and (c)(4)(A) take into account remuneration paid by a related organization for purposes of determining an ATEO's covered employees may be reasonable, for the reasons set forth below, these final regulations adopt the relevant provisions of the proposed regulations without change and do not adopt the commenter's recommendation. Section 4960 does not define the “five highest-compensated employees” of an ATEO. The ambiguity in this term is highlighted by the fact that the only provision in the statute that references “compensation” is section 4960(c)(2), which defines “covered employee” as one of the “5 highest compensated employees”; the statute otherwise uses the defined terms “remuneration” and “parachute payment” for purposes of determining the excise tax imposed by section 4960. In addition, there is no discussion in the legislative history describing how Congress intended an ATEO to determine its five highest-compensated employees. The Treasury Department and the IRS have concluded that the commenter's suggested interpretation—that only remuneration paid by the ATEO for services performed for the ATEO should be considered for purposes of determining who is a covered employee—would raise significant tax administration issues and the potential for abuse in circumstances in which an individual provides services to, and receives compensation from, the ATEO and one or more related organizations during the applicable year. In these cases, it may be difficult to determine the proper allocation of the compensation among the organizations to which the individual provides the services and whether the allocation was properly based on the value of the services provided. Due to the highly factual nature of this analysis and the potential for differing conclusions on one or more of these issues, the commenter's suggested rule would result in an unpredictable standard to be applied by taxpayers and the IRS and would raise the potential for abusive mischaracterizations of the nature of the services and compensation provided. The commenter further asserted that the requirement to aggregate compensation paid by the ATEO and all related organizations is not required to ensure parity with the rules for identifying covered employees under section 162(m). Under §§ 1.162-27(c)(2)(ii) and 1.162-33(c)(1)(ii)(B), the amount of compensation used to identify the covered employees who are the three most highly compensated executive officers (other than the principal executive officer and the principal financial officer) for the taxable year is determined pursuant to the executive compensation disclosure rules under the Securities Exchange Act of 1934. Under 17 CFR 229.402(a)(2), the amount of compensation paid to an employee by a publicly held corporation is measured by reference to remuneration paid by the registrant and remuneration paid by the registrant's subsidiaries, and is not limited to remuneration for services provided to the registrant. Although the provisions of sections 4960 and 162(m) are similar in many respects, there is no indication in the legislative history that sections 162(m) and 4960 are intended to apply in the same manner in all situations. Further, the section 162(m) and section 4960 statutory language and the application of the rules differ significantly in many respects that would not allow that strict parity. Regardless of the conclusion that the sections 162(m) and 4960 rules do not allow for strict parity, the Treasury Department and the IRS have concluded that the aggregation of compensation paid by all related entities in identifying covered employees is more analogous to the rules under section 162(m) than considering only remuneration for services provided to the ATEO. Thus, while the Treasury Department and the IRS considered several alternatives for determining the ATEO's five highest-compensated employees, including the alternative proposed by the commenter, the Treasury Department and the IRS ultimately concluded that including remuneration paid by all related organizations is appropriate and that it is more administrable to use a single standard for identifying covered employees and computing the excise tax, if any, imposed by section 4960(a)(1). However, to mitigate the effect of requiring the aggregation of remuneration paid by an ATEO and all related organizations for purposes of determining the ATEO's covered employees, these final regulations retain the limited hours, nonexempt funds, and limited services exceptions (discussed in section II.E.5. of this Summary of Comments and Explanation of Revisions, titled “Volunteer Services and Other Exceptions”). 3. Remuneration for Medical Services Consistent with section 4960(c)(3)(B) and the proposed regulations, these final regulations provide that for purposes of identifying an ATEO's five highest-compensated employees for a taxable year, remuneration paid during the applicable year for medical services is not taken into account. For a discussion of the rules for determining the remuneration paid for medical or veterinary services and for allocating remuneration to medical and non-medical services, see section II.F. of this Summary of Comments and Explanation of Revisions, titled “Medical Services.” 4. Covered Employee Status Continues for All Subsequent Taxable Years In accordance with section 4960(c)(2), the proposed regulations provided that a covered employee includes any employee (including any former employee) of an ATEO who was a covered employee of the organization (or a predecessor) for any preceding taxable year beginning after December 31, 2016. In response to the proposed regulations, one commenter suggested that the Treasury Department and the IRS reconsider the rule that an individual who is a covered employee of an ATEO (or of a predecessor ATEO) for one taxable year remains a covered employee of that ATEO (and any successor ATEOs) for all subsequent taxable years. The commenter suggested that an ATEO should be relieved of the burden of continuing to include an employee among its covered employees when a consolidation or restructuring of a tax-exempt organization results in changes to the employee's job responsibilities and compensation, if it no longer furthers the purpose of the statute to include the employee among its covered employees. The commenter asserted that the requirement that an individual remain a covered employee for all subsequent years, even after the employment relationship has ended, creates a potentially excessive administrative burden for the ATEO. These final regulations do not adopt this suggestion because that rule would be inconsistent with the statutory language. 5. Volunteer Services and Other Exceptions The proposed regulations provided certain exceptions to the definition of “covered employee” and the rules for identifying the five highest-compensated employees of an ATEO. Several commenters supported the inclusion of the exceptions provided in Prop. § 53.4960-1(d)(2)(ii), (iii), and (iv). These final regulations adopt these exceptions with certain modifications in response to comments as discussed later in this section. The exceptions to the definition of “covered employee” in the proposed regulations were provided in response to comments on Notice 2019-09 expressing concern that the rules for identifying an ATEO's five highest-compensated employees in the notice would subject a non-ATEO to the excise tax on remuneration it pays to an employee who performs limited or temporary services for a related ATEO and who typically receives remuneration only from the non-ATEO. The exceptions were intended to ensure that certain employees of a related non-ATEO providing services as an employee of an ATEO are not treated as one of the five highest-compensated employees of the ATEO, and thus considered a covered employee, if certain conditions related to the individuals' remuneration or hours of service are met. To avoid manipulation of the rules through the deferral of compensation, in determining whether an employee is one of the five highest-compensated employees, the proposed regulations provided that a grant of a legally binding right to vested remuneration is considered to be remuneration paid, and any grant of a legally binding right to nonvested remuneration by the ATEO (or a related ATEO), for example under a deferred compensation plan or arrangement, disqualifies the ATEO from claiming a relevant exception. No comments were received on those proposed rules, and these final regulations adopt those rules without change. a. No Remuneration and Non-Employment Exceptions The proposed regulations provided that the remuneration paid to an individual who is never an employee of an ATEO is not considered for purposes of section 4960. For example, an individual who, under all the facts and circumstances, performs services for an ATEO solely as a bona fide independent contractor is not an employee of the ATEO, and thus is not considered for purposes of determining the ATEO's five highest-compensated employees. Similarly, an individual who, under all the facts and circumstances, performs services solely as a bona fide employee of a related organization, including a related organization that provides services to the ATEO, is not an employee of the ATEO, and thus is not considered for purposes of determining the ATEO's five highest-compensated employees. No comments were received on those provisions of the proposed regulations, and these final regulations adopt them without change. The proposed regulations further provided that, for purposes of determining an ATEO's five highest-compensated employees for a taxable year, an employee is disregarded if neither the ATEO nor any related organization pays remuneration or grants a legally binding right to nonvested remuneration for services the individual performed as an employee of the ATEO or any related organization. Thus, if none of an ATEO's employees received remuneration from the ATEO or from a related organization, then the ATEO has no covered employees. Benefits excluded from gross income are not considered remuneration, including expense allowances and reimbursements under an accountable plan (see § 1.62-2) and most insurance for liability arising from service with an ATEO, such as directors and officers liability insurance (see § 1.132-5(r)(3)). These final regulations adopt these provisions of the proposed regulations without change. In section II.E.2. of the Explanation of Provisions of the proposed regulations, titled “Volunteer Services and Similar Exceptions,” the Treasury Department and the IRS requested comments on whether certain taxable benefits, such as employer-provided parking in excess of the value excluded under section 132, should be disregarded for purposes of determining whether an individual receives remuneration for services and what standards should apply to identify those benefits. No comments were received on this issue. Because taxable fringe benefits that are wages within the meaning of section 3401(a) are included in the statutory definition of remuneration, these final regulations adopt the provisions of the proposed regulations providing that these amounts are considered for purposes of determining an ATEO's five highest-compensated employees and for purposes of applying the exceptions from covered employee status. For a discussion of comments received on the exclusion of taxable fringe benefits from the definition of remuneration for purposes other than the determination of the five highest-compensated employees, see section III.A. of this Summary of Comments and Explanation of Revisions, titled “In General” under “Remuneration.” b. Limited Hours Exception These final regulations adopt the “limited hours” exception as provided in the proposed regulations for purposes of determining an ATEO's five highest-compensated employees. Under this exception, an employee of an ATEO is disregarded for purposes of determining the ATEO's five highest-compensated employees for a taxable year if neither the ATEO nor any related ATEO pays remuneration or grants a legally binding right to nonvested remuneration to the employee for services performed for the ATEO and the employee performs only limited hours of service for the ATEO. For purposes of this exception, an ATEO is not treated as paying an amount paid to an individual by a related organization that employs the individual, so long as the ATEO does not reimburse the payor. An employee qualifies for this exception only if the hours of service the employee performs as an employee of the ATEO and all related ATEOs comprise 10 percent or less of the employee's total hours of service for the ATEO and all related organizations during the applicable year. For purposes of this rule, an employee who performs fewer than 100 hours of service as an employee of an ATEO (and all related ATEOs) during an applicable year is treated as having worked no more than 10 percent of the employee's total hours for the ATEO (and all related ATEOs). One commenter recommended that these final regulations replace the 10 percent hours of service threshold in the limited hours exception with the 50 percent hours of service threshold that is used for the nonexempt funds exception (discussed later in this section) because the 10 percent threshold fails to capture many common arrangements between ATEOs and taxable related organizations controlled by the ATEO (“controlled taxable related organizations”) that are not structured to avoid the excise tax imposed by section 4960. These final regulations do not adopt this suggestion because the limited hours exception was intended to address arrangements in which services are sufficiently limited so that the arrangements resemble volunteer arrangements. This exception therefore has a much lower hours of service threshold than the nonexempt funds exception but may be used by a broader group of ATEOs. Further, the Treasury Department and the IRS have concluded that adopting the commenter's suggestion would be inconsistent with the legislative intent of section 4960. As explained in section II.E.2 of the Explanation of Provisions of the proposed regulations, titled “Volunteer Services and Similar Exceptions,” the legislative history indicates that Congress intended to tax excessive compensation paid to covered employees from tax-exempt funds. 1 Consistent with this intent, the proposed regulations provided a nonexempt funds exception, which applies if certain criteria are satisfied, but does not apply if an ATEO's controlled taxable related organization pays remuneration to an employee of the ATEO. The Treasury Department and the IRS reasoned that a controlled taxable related organization that pays remuneration to an employee for services provided to an ATEO uses the ATEO's funds to do so, either because the controlled taxable related organization's assets are, effectively, the ATEO's assets, or because the payment reduces the related organization's assets, which in turn reduces the value of the ATEO's interest in the related organization. The Treasury Department and the IRS consider the funds of an ATEO's controlled taxable related organization as, in substance, equivalent to tax-exempt funds, and thus the use of such funds to compensate an individual for services provided to an ATEO is in substance the use of tax-exempt funds. 2 1 H. Rep. 115-409, 115th Cong., 1st Sess. 333 (Nov. 13, 2017). 2 In a similar context, § 53.4958-4(a)(2) treats excessive compensation paid to a disqualified person with respect to an applicable tax-exempt organization by a controlled entity of the organization as excessive compensation paid by the organization, and thus as an excess benefit transaction. One commenter expressed concern about the “cliff” nature of the proposed limited hours exception (as well as the nonexempt funds and limited services exceptions), noting that exceeding the thresholds even slightly may result in the employee being a covered employee for the applicable year and all subsequent applicable years. The commenter recommended that these final regulations allow a 3-year (or longer) measurement period to qualify for the limited hours exception or the other exceptions, primarily to prevent the ATEO from inadvertently failing to satisfy the exception. A 3-year measurement period would reduce the potential for inadvertent failures for an employer intending to be at or below the threshold for every applicable year. However, for an employer that intends to meet the limited hours exception during only one applicable year, the suggested 3-year standard would effectively raise the 10 percent hours of service limit to 30 percent and create a new “cliff” at that 30 percent threshold. In addition, permitting a 3-year measurement period would create additional complexity and burdens for taxpayer compliance and tax administration. For these reasons, the Treasury Department and the IRS do not adopt this suggestion. However, the modification to the nonexempt funds exception described later in this section, expanding the measurement period to two applicable years, is intended to address some of the commenter's concerns with respect to inadvertent failures to meet the requirements of the nonexempt funds exception. Another commenter recommended that Example 5 in the provisions of the proposed regulations, which illustrated the application of the limited hours exception (Prop. § 53.4960-1(d)(3)(v)), be modified to eliminate from the facts that ATEO 5 does not control CORP 3, as control of another corporation by an ATEO is irrelevant for purposes determining whether the requirements of this exception are met, and thus irrelevant to the conclusion in that example. The commenter further suggested that this fact be moved to Example 8 in the proposed regulations, which illustrated the application of the separate nonexempt funds exception (Prop. § 53.4960-1(d)(3)(viii)), since control of another corporation by an ATEO is relevant for determining whether the requirements of that exception are met, and thus relevant to the conclusion in that example. The Treasury Department and the IRS agree with the commenter's suggestion, and modified Example 5 in these final regulations describing the limited hours exception (§ 53.4960-1(d)(3)(v)) accordingly. However, because of changes to the nonexempt funds exception as described later in this Summary of Comments and Explanation of Revisions, these final regulations replace Example 8 (§ 53.4960-1(d)(3)(viii)) with a new example. c. Nonexempt Funds Exception As previously discussed, the proposed regulations also provided a “nonexempt funds” exception for employees of a related non-ATEO organization who may perform a large portion of their overall services as an employee of the ATEO under certain circumstances. Under the nonexempt funds exception, an employee is disregarded for purposes of determining an ATEO's five highest-compensated employees for a taxable year provided that none of the ATEO, any related ATEO, or any controlled taxable related organization, pays the employee of the ATEO any remuneration or grants a legally binding right to nonvested remuneration to the employee. When applying these requirements for the nonexempt funds exception, the ATEO is not treated as paying remuneration that is paid by a related organization that also employs the individual, so long as the ATEO does not reimburse the payor. Further, to prevent indirect payment of remuneration by the ATEO, a related ATEO, or controlled taxable related organization, no related organization that paid remuneration to the individual may provide services for a fee to the ATEO, related ATEO, or any controlled taxable related organization. To satisfy the nonexempt funds exception, the proposed regulations also stated that the employee must have provided services primarily to a taxable related organization or other non-ATEO (other than a controlled taxable related organization of the ATEO) during the applicable year. For this purpose, an employee is treated as having provided services primarily to the taxable related organization or other non-ATEO (other than a controlled taxable related organization of the ATEO) only if the employee provided services to the taxable related organization or other non-ATEO for more than 50 percent of the employee's total hours worked for the ATEO and all related organizations (including ATEOs) during the applicable year. One commenter expressed concern that, for purposes of the nonexempt funds exception, the requirement limiting the employee's hours worked for the ATEO and all related ATEOs to not more than 50 percent of the total hours worked for the ATEO and all related organizations during an applicable year was too restrictive and may result in inadvertent failures. The Treasury Department and the IRS acknowledge the issues presented by this comment. These final regulations modify the exception by expanding the measurement period from one applicable year to two applicable years (that is, the current applicable year and the preceding applicable year are treated as a single measurement period) for purposes of determining whether an employee provided services to the ATEO and all related ATEOs for not more than 50 percent of the employee's total hours worked as an employee of the ATEO and all related organizations during the applicable year and the prior applicable year. This modification provides additional flexibility for situations in which an employee “rotates” to an ATEO for a period that extends longer than six months, or when an employee unexpectedly provides services beyond six months in an applicable year. Another commenter recommended that the nonexempt funds exception be modified to prohibit the provision of services for a fee to a taxable entity only if the ATEO actually owns a controlling interest in the taxable entity, as opposed to being attributed the ownership interest under the section 318 attribution principles, which were incorporated into the definitions of a related organization and control. The commenter asserted that the related organizations requirement under the proposed nonexempt funds exception (Prop. § 53.4960-1(d)(2)(iii)(A)(3)), which incorporates the section 318 attribution principles, is unduly restrictive, and would have unintended results, as illustrated by the following example. An individual who is the sole shareholder of two taxable corporations (Corporation 1 and Corporation 2) also controls an ATEO (by having the power to appoint a majority of the ATEO's board of directors); Corporation 1 provides administrative services for a fee to Corporation 2; employee of Corporation 1 provides services only to Corporation 1 and does not provide any services to the ATEO. Under these facts, Corporation 2 is deemed to be controlled by the ATEO because, for purposes of determining whether an ATEO controls an organization under Prop. § 53.4960-1(i)(2)(vii)(B)(2), if a person controls an ATEO, the ATEO is treated as owning a percentage of the stock owned by that person in accordance with the percentage of directors of the ATEO that are controlled by that person. Because the related organizations requirement prohibits the payment of a fee by a related organization to a controlled taxable related organization for services performed by an employee of the controlled taxable related organization, and because Corporation 1 is providing services for a fee to Corporation 2, which is deemed to be controlled by the ATEO, no employee of Corporation 1 could meet the requirements of the proposed nonexempt funds exception. The commenter suggested that this result is inappropriate because the sharing of services between two taxable corporations in which an ATEO has no actual ownership interest would not circumvent the legislative intent of section 4960. The Treasury Department and the IRS agree with the commenter's recommendation. Accordingly, these final regulations modify the attribution rules as they apply for purposes of determining eligibility for the nonexempt funds exception by disregarding the application of downward attribution in applying section 318(a)(3) to corporations and other entities and in applying section 318 principles to nonstock organizations. This modification applies only for purposes of applying the nonexempt funds exception and does not apply for purposes of determining whether an organization is a related organization generally. d. Limited Services Exception The proposed regulations provided a “limited services” exception, under which an employee is not considered for purposes of determining an ATEO's five highest-compensated employees for a taxable year if, during the applicable year, the ATEO paid less than 10 percent of the employee's total remuneration during the applicable year for services performed as an employee of the ATEO and all related organizations. However, if an employee would not be considered for purposes of determining the five highest-compensated employees of any ATEO in an ATEO's group of related organizations because no ATEO in the group paid at least 10 percent of the total remuneration paid by the group during the applicable year, then this exception does not apply to the ATEO that paid the employee the most remuneration during that applicable year. No comments were received on that proposed rule, and these final regulations retain that rule without change. F. Medical Services Section 4960(c)(3)(B) provides that remuneration for purposes of section 4960 does not include the portion of any remuneration paid to a licensed medical professional (including a veterinarian) that is for the performance of medical or veterinary services by such professional. Section 4960(c)(5)(C)(iii) provides a substantially similar exception from the definition of “parachute payment.” The proposed regulations provided rules relating to medical services and licensed medical professionals. No comments were received on those rules in the proposed regulations, and these final regulations adopt the rules in the proposed regulations without change. For further discussion of these rules, see section II.F. of the Explanation of Provisions of the proposed regulations, titled “Medical Services.” These final regulations also adopt the rule in the proposed regulations that a “licensed medical professional” is an individual who is licensed under state or local law to perform medical services. In addition to doctors, nurses, and veterinarians, a licensed medical professional generally would include dentists and nurse practitioners and may include other medical professionals, depending on the applicable state or local law. For a discussion of other issues related to remuneration for medical or veterinary services, including a rule for allocating remuneration received for a combination of medical and non-medical services, see section III.B. of this Summary of Comments and Explanation of Revisions, titled “Remuneration Related to Medical Services.” G. Predecessor Organization Section 4960(c)(2)(B) provides that a covered employee includes any employee who was a covered employee of the ATEO (or any predecessor) for any preceding taxable year beginning after December 31, 2016. Because a covered employee, under section 4960(c)(2), must be (or have been) an employee of an ATEO, the predecessor must also have been an ATEO at the time the individual was employed by the predecessor to be a covered employee. Thus, an individual who is a covered employee of an ATEO (or of an ATEO predecessor of an ATEO) for one taxable year remains a covered employee of that ATEO (and any successor ATEOs) for subsequent taxable years. The proposed regulations defined “predecessor” by reference to several enumerated categories of organizational changes, including acquisitions, mergers, other reorganizations, and changes in tax-exempt status. A predecessor ATEO ordinarily is an ATEO that has transferred, by any of several legal means, its assets and operations to another pre-existing or newly created ATEO (the successor of the predecessor ATEO). No comments were received with respect to the proposed rules. These final regulations adopt the definition of predecessor as provided in the proposed regulations without change. For further information concerning these rules, see section II.G. of the Explanation of Provisions of the proposed regulations, titled “Predecessor Organization.” H. Related Organization Section 4960(c)(4)(A) provides that remuneration paid to a covered employee by an ATEO includes any remuneration paid with respect to employment of the employee by any related person or governmental entity, 3 and includes in the definition of “remuneration” any remuneration paid by the employer ATEO, related ATEOs, and related non-ATEOs (including taxable entities, nonprofit entities that are not ATEOs, and governmental entities that are not ATEOs). Section 4960(c)(4)(B) defines a “related organization” of an ATEO as a person or governmental entity that controls, or is controlled by, the ATEO; is controlled by one or more persons that control the ATEO; is a supported organization or a supporting organization (as defined in sections 509(f)(3) and 509(a)(3), respectively) during the taxable year of the ATEO, or, in the case of an ATEO that is a voluntary employees' beneficiary association described in section 501(c)(9) (VEBA), establishes, maintains, or makes contribution to the VEBA. 3 The proposed and final regulations refer to related persons and governmental entities collectively as related organizations. Section 4960(c)(4) does not define “control” for purposes of identifying related organizations. To determine which persons are related organizations under section 4960(c)(4)(B), the proposed regulations generally adopted the definition of “control” set forth in section 512(b)(13)(D) and § 1.512(b)-1(l)(4). Section II.H. of the Explanation of Provisions of the proposed regulations, titled “Related Organization,” explained that this standard (and its “greater than 50 percent” threshold) was intended to align the definition of “related organization” for purposes of section 4960 with the definition of “related organization” for purposes of the annual reporting requirements on Form 990, “Return of Organization Exempt From Income Tax,” and with other exempt organization control tests. One commenter recommended that these final regulations instead define “control” based on the controlled group rules in section 414(b) and (c) and the regulations thereunder, which include an 80 percent control test. The commenter suggested that the section 414(b) and (c) controlled group test was more appropriate for a number of reasons: The purpose of section 414(b) and (c) is to treat related parties as a single employer (the same purpose as section 4960(c)(4)(C)), whereas the purpose of section 512(b)(13) is to tax abusive transactions; the regulations under section 512(b)(13) do not reflect statutory revisions; the control definition under section 512(b)(13) is overinclusive; and using the Form 990 test for control does not reduce administrative burdens because the Form 990 rules for identifying an ATEO's highest-compensated employees and calculating compensation differ significantly from the section 4960 rules. These final regulations do not adopt the suggestion in this comment. Instead, these final regulations adopt the rules in the proposed regulations, which align the definition of control with the definition in the Form 990 instructions, which, in turn, is generally based on the section 512(b)(13) standards. The Treasury Department and the IRS have concluded that this definition of control is more appropriate and administrable because the Form 990 control definition and the section 512(b)(13) rules are familiar to and used by exempt organizations. Similarly, an 80 percent control threshold, while used in section 414(b) and (c), as well as in regulations under section 162(m), generally is not a standard used for purposes of tax administration related to exempt organizations, whereas the 50 percent control threshold is a control test familiar to exempt organizations. See, for example, the instructions to Form 990; §§ 1.509(a)-4(g)(1)(i); 1.509(a)-4(j)(1); 56.4911-7(b); 53.4941(d)-1(b)(5); 53.4943-3(b)(3)(ii); 53.4958-4(a)(2)(ii)(B); and 53.4968-3(b). In addition, section 509(a)(3) supporting organizations and their section 509(f)(3) supported organizations are defined as related organizations under section 4960(c)(4)(B); the adoption of an 80 percent control threshold would be incongruous with the lower standards of control for such organizations under § 1.509(a)-4 (particularly in the case of Type III supporting organizations, for which control is not required). Further, the legislative history states that the purpose for enacting section 4960 is to deter “excessive compensation,” 4 indicating an intent to deter arguably abusive practices, and the Treasury Department and the IRS have determined that use of a higher control threshold would allow potentially abusive compensation arrangements among organizations that are related to a lesser degree. 5 For these reasons, and the reasons set forth in section II.H. of the Explanation of Provisions of the proposed regulations, titled “Related Organization,” these final regulations adopt the rules regarding the overall definition of “control” in the proposed regulations without change. 4 H. Rep. 115-409, supra, at 333. 5 The imposition of excise tax under section 4960 is not determinative as to whether the remuneration paid to the covered employee is excessive or unreasonable compensation for purposes of sections 4941 or 4958. Similarly, there is no presumption, inference, or basis for concluding that remuneration paid to a covered employee that is not subject to excise tax under section 4960 is reasonable compensation for purposes of determining liability for excise tax under sections 4941 or 4958. To determine control of a nonstock organization, the proposed regulations provided rules similar to other regulations dealing with control of tax-exempt organizations (§§ 1.512(b)-1(l)(4)(i)(b), 53.4958-4(a)(2)(ii)(B)(1)(iii), and 1.414(c)-5(b)) 6 that provide that a person is considered to control a nonstock organization under either a “removal power” test or a “representative” test. No comments were received addressing the “removal power” test, and the final regulations adopt these rules from the proposed regulations without change. Comments were received on the “representative” test, and in particular the manner in which the proposed regulations would address certain situations involving “accidental control.” 6 See also the representative test in section 4911(f)(2)(B)(i) for determining affiliated organizations. Under the representative test, a person or governmental entity generally controls a nonstock organization if more than 50 percent of the nonstock organization's directors or trustees are also trustees, directors, officers, agents, or employees of the person or governmental entity. Unlike the representative test in §§ 1.512(b)-1(l)(4)(i)(b), 53.4958-4(a)(2)(ii)(B)(1)(iii), and 1.414(c)-5(b), the proposed regulations expressly included an officer of the person or governmental entity as a representative for purposes of determining control of a nonstock organization. In response to Notice 2019-09, a commenter raised the issue of “accidental control” presented by the representative test in which, for example, control of an organization by an employer may be found because a few lower-level employees of the employer serve on the board of directors of the organization. The proposed regulations addressed this issue by permitting a nonstock organization (or its putative controlling person or governmental entity) to qualify for an exception from control status if the employees of the person or governmental entity that are directors or trustees of the nonstock organization are not trustees, directors, officers, or employees with the powers of a director or officer, of the person or governmental entity and are not acting as representatives of the person or governmental entity in their service with the nonstock organization. A nonstock organization that relies on this exception must report its reliance on this exception on the applicable Form 990 and provide supporting details. Another commenter on the proposed regulations stated that compliance with this exception to avoid “accidental control” under the representative test places additional reporting burdens on exempt organizations and recommended that these final regulations remove “employees” altogether from the list of deemed representatives and instead focus the representative test on the actual decision-makers in the organization. The commenter suggested that an expansive list of deemed representatives, including employees, is more justifiable with an 80 percent control threshold. These final regulations do not adopt the commenter's suggestions. The Treasury Department and the IRS have concluded that a rule that treats as non-officers any employees not defined as officers under the organization's organizing documents may be subject to abuse because employees frequently function as officers, even if they do not have that title. Further, a rule that treats any employee without the title of officer as a non-officer would be inconsistent with other Code provisions addressing exempt organizations, which generally treat as an officer any person with similar powers. See, for example, sections 4946(b)(1), 4955(f)(2)(A), 4958(f)(2), 4965(d)(1), and 4966(d)(3)(A). In addition, an employee of an organization (such as a department head) may serve ex officio on the board of another organization, and, in substance, serve in a representative capacity. Similarly, the facts of other arrangements in which an employee serves on another organization's board may demonstrate that the employee is serving as a representative of the employer. Finally, the percentage threshold of control is not necessarily relevant to the determination of whether the individual is serving in a representative capacity—an employer with less than a specific threshold percentage may still have reasons to have an employee represent its interests on another organization's board of directors. For these reasons, these final regulations adopt without change the representative rules in the proposed regulations. The proposed regulations also addressed the status of foreign organizations as ATEOs, excluding them from ATEO status if described in section 4948(b) and the regulations thereunder. The Treasury Department and the IRS requested comments on whether a foreign related organization described in section 4948(b) should be exempt from tax imposed by section 4960(c)(4)(C) and, if so, whether remuneration paid by such an organization should nonetheless be taken into account for purposes of determining excess remuneration and allocating liability among the ATEO and related organizations that are subject to the excise tax imposed by section 4960. No comments were received on these issues. However, the Treasury Department and the IRS have concluded that it is appropriate to address these issues in these final regulations. Chapter 42 of the Code applies generally to private foundations and other tax-exempt organizations and the excise taxes in chapter 42 generally are payable by exempt organizations and in some cases by persons associated with them. However, under section 4948(b), sections 507 and 508 and chapter 42 do not apply to a foreign organization that has not received substantial support (other than gross investment income) from United States sources. Section 509(d) defines support for purposes of chapter 42 as including gifts, gross receipts from an activity that is not an unrelated trade or business under section 513, net income from unrelated business activities, gross investment income, tax revenues levied for the benefit of the organization, and the value of services or facilities furnished by a governmental unit without charge—a breadth of items that support a tax-exempt organization. Section 4948(b) is thus concerned with foreign private foundations (including entities treated as private foundations for purposes of chapter 42) and other tax-exempt organizations that have received sufficient support from United States sources to warrant subjection to taxation and various prohibitions under chapter 42. Therefore, the Treasury Department and the IRS have determined that it is appropriate to exclude from taxation under section 4960 as a related organization any foreign organization that is both described in section 4948(b) and is either exempt from tax under section 501(a) 7 or a taxable private foundation. 8 Such organizations excluded from the excise tax imposed by section 4960 are referred to as “section 4948(b) related organizations.” 7 Some types of exempt organizations are limited to domestic organizations, such as section 501(c)(10) fraternal organizations. 8 A private foundation that loses its exemption under section 501(c)(3) remains a taxable private foundation until its private foundation status is terminated under section 507. See sections 509(b) and 4940(b). While chapter 42 taxes are inapplicable to section 4948(b) related organizations, those organizations' activities that otherwise would have resulted in chapter 42 taxes may have other consequences. For example, section 4948(c) in certain circumstances imposes loss of exemption on an exempt organization described in section 4948(b) that engages in activities that would result in chapter 42 taxes for domestic organizations. Therefore, the Treasury Department and the IRS have determined that the remuneration paid to a covered employee of an ATEO by a section 4948(b) related organization must be taken into account by the ATEO and any related organizations subject to the excise tax imposed by section 4960 for purposes of determining an ATEO's (and related organizations') liability under section 4960 and the ATEO's five highest-compensated employees, even though the section 4948(b) related organization is not subject to the excise tax imposed by section 4960 on the excess remuneration that is otherwise allocable to that organization. These final regulations also clarify that for purposes of applying the exclusion from status as an ATEO or a related organization, whether the foreign organization meets the requirements of section 4948(b) is determined at the end of the organization's taxable year. III. Remuneration A. In General Consistent with section 4960(c)(3)(A), the proposed regulations defined “remuneration” as wages under section 3401(a) (meaning generally amounts subject to Federal income tax withholding), but excluding designated Roth contributions under section 402A(c) and including amounts required to be included in gross income under section 457(f). Remuneration does not include certain retirement benefits, including payments that are contributions to or distributions from a trust described in section 401(a); payments under or to an annuity plan described in section 403(a) at the time of payment; payments described in section 402(h)(1) and (2) if, at the time of the payment, it is reasonable to believe that the employee will be entitled to an exclusion under that section for the payment; payments under an arrangement to which section 408(p) applies; or payments under or to an eligible deferred compensation plan described in section 457(b) and maintained by an eligible employer described in section 457(e)(1)(A) (governmental employer) at the time of payment. See section 3401(a)(12). Remuneration includes a parachute payment, but excess remuneration does not include a parachute payment that is an excess parachute payment. These final regulations adopt these rules provided in the proposed regulations without change. One commenter recommended that, for purposes of computing the excise tax, section 4960(c)(4)(A) should be interpreted to include only remuneration related to the employment of an employee by an ATEO, which would include remuneration paid by a related person or related governmental entity with respect to an ATEO or by any other third party, but only if the payment related to the employee's employment by the ATEO. The commenter stated that this suggested interpretation would ensure that all remuneration with respect to a covered employee's employment by an ATEO, including remuneration paid by a related organization of an ATEO with respect to services performed for the ATEO, would be included in computing the tax under section 4960(a). The commenter asserted that the suggested interpretation would avoid the unintended result, caused by the proposed regulations, of subjecting to the excise tax remuneration that is paid by persons who are not ATEOs for an individual's services that are unrelated to an ATEO. The Treasury Department and the IRS have concluded that the more natural reading of the statute is that remuneration paid to a covered employee of an ATEO includes remuneration paid by a related organization with respect to services performed as an employee for the related organization. In addition, adoption of the commenter's suggestion could raise the potential for abuse because it relies on an ability to identify the specific recipient of services that an employee provides to multiple entities and determine the relative value of the services or allocate the compensation to the entities under a reasonable allocation method. Specifically, given the facts and circumstances analysis that in many cases may be difficult and burdensome to administer, adoption of the suggestion could provide an opening for related taxpayers to coordinate their activities to mischaracterize the employer of an individual with respect to some or all services provided to a related organization, or to misallocate portions of the total remuneration paid by the related taxpayers to the individual as paid for services provided as an employee of a related organization, so that all the related entities avoid any liability under section 4960 while still providing what would otherwise be excess remuneration to the individual as an employee of an ATEO. While this type of identification and allocation may be needed for other tax purposes, including in some cases the allocation of liability under section 4960, those applications do not involve a situation such as this in which all the entities may benefit from the mischaracterizations through the avoidance of the potential liability. Thus, the interpretation provided in these final regulations also is consistent with the exercise of authority in section 4960(d) to prevent avoidance of the tax imposed by section 4960 by providing compensation through a third party. Further, adoption of the commenter's suggestion could raise issues regarding the role of section 4960(c)(6), the statutory provision coordinating the application of section 162(m) and section 4960, given the impact that adoption of the suggestion would have on the scope of circumstances to which that provision may apply. For these reasons, these final regulations do not limit the application of section 4960(c)(4)(A) to remuneration paid solely with respect to employment by an ATEO or for services provided to an ATEO, as suggested by the commenter. The commenter also suggested that these final regulations not treat remuneration paid by a related organization as paid by the ATEO if a covered employee is not employed by an ATEO at any time during an applicable year. For example, in circumstances in which a covered employee of an ATEO performs services for a related non-ATEO but provides no services for the ATEO during an applicable year, the commenter suggested that compensation for those services not be treated as remuneration under section 4960. These final regulations do not adopt this suggestion. Section 4960(c)(2)(B) provides that once an individual is a covered employee of an ATEO (or any predecessor), the employee remains a covered employee for all subsequent years. Section 4960(c)(4)(A) provides that “remuneration of a covered employee by an [ATEO]” includes “any remuneration paid with respect to employment of such employee by any related person or governmental entity.” The Treasury Department and the IRS have concluded that the better interpretation of section 4960(c)(2)(B) and (c)(4)(A), when read together, is that compensation paid to a covered employee by a related organization during an applicable year is remuneration for purposes of section 4960, even if the covered employee does not perform services as an employee of the ATEO during the applicable year. In addition, the commenter's suggestion also raises administrability issues similar to those that would arise if only remuneration for services provided to the ATEO were taken into account. If an employee provides services to different members of a group of related organizations from year to year, it may be difficult to determine what remuneration is allocable to services provided to each group member. Therefore, the commenter's suggestion would be similarly difficult and burdensome to administer and could raise the potential for abuse. The same commenter also suggested that these final regulations apply the substance of the limited hours and nonexempt funds exceptions for purposes of determining remuneration paid. These final regulations do not adopt this suggestion because the Treasury Department and the IRS have concluded that the statute does not provide the authority to apply these exceptions to the definition of remuneration. The statute does not define compensation for purposes of identifying the five highest-compensated employees, and thus the statute permits flexibility in the rules for determining the five highest-compensated employees. In contrast, section 4960(c)(3)(A) defines remuneration as wages within the meaning of section 3401(a) (with certain specified modifications) paid by an ATEO and section 4960(c)(4)(A) provides that “remuneration of a covered employee by an [ATEO] shall include any remuneration paid with respect to employment of such employee by any related person or governmental entity.” These statutory provisions do not provide the flexibility to adopt the commenter's suggestion to include the exceptions applicable to the determination of a covered employee in the definition of remuneration. Another commenter requested that these final regulations limit the scope of the definition of remuneration to include only regular employee wages, as defined in section 3401(a), and to exclude taxable fringe benefits from the section 4960 definition of remuneration. The commenter asserted that certain taxable fringe benefits, such as paid parking above the excludable limit and reimbursement of childcare expenses, are not the type of remuneration that was intended to be taxed under section 4960. The commenter further suggested that the inclusion of taxable fringe benefits in remuneration would have an adverse effect on certain employers' ability to attract and retain key employees. These final regulations do not adopt this commenter's suggestion because it would be inconsistent with the statutory provisions. Section 4960(c)(3)(A) defines remuneration as amounts that are “wages” within the meaning of section 3401(a). Section 3401(a) defines “wages” as all remuneration for services performed by an employee for his employer, including the cash value of all remuneration (including benefits) paid in any medium other than cash, with certain specific exclusions. Taxable fringe benefits, including parking above the excludable limit and reimbursement of childcare expenses, are not excluded from wages under section 3401(a). In addition, section 4960(c)(3) specifically excludes other type of wages, such as designated Roth contributions and remuneration for medical services, indicating a legislative intent for all other types of wages to be included. For these reasons, the Treasury Department and the IRS have determined that providing further exclusions such as those suggested would be inconsistent with the statute and these final regulations do not adopt this suggestion. The proposed regulations clarified that remuneration includes any amount includible in gross income as compensation under section 7872 and the regulations thereunder. For example, under § 1.7872-15(e)(1)(i), a below-market split-dollar loan between an employer and employee generally is treated as a compensation-related loan, and thus any imputed transfer from the employer to the employee generally is a payment of compensation. Although section 7872(f)(9) provides that no amount shall be withheld under chapter 24 of the Code with respect to any amount treated as transferred or retransferred under section 7872(a) or received under section 7872(b), those amounts are “remuneration . . . for services performed by an employee for his employer” within the meaning of section 3401(a) and are not specifically excluded from wages under section 3401(a). Thus, those amounts are remuneration as defined in section 4960(c)(3)(A). ATEOs that are private foundations or section 509(a)(3) supporting organizations should consider, before entering into these arrangements, that loans (including transactions treated as loans for Federal tax purposes, such as split-dollar arrangements) to certain employees may constitute an act of self-dealing under section 4941 or an excess benefit transaction under section 4958(c)(3). A commenter recommended that these final regulations, or alternatively the preamble to these final regulations, confirm that remuneration does not include amounts that are not includible in gross income pursuant to the $10,000 de minimis exception under section 7872(c)(3). Under that exception, the foregone interest attributable to any day on which the aggregate outstanding amount of loans between the borrower and lender does not exceed $10,000 is not includible in gross income. These final regulations adopt the commenter's suggestion and clarify that, in accordance with section 7872, these de minimis amounts are not remuneration for purposes of section 4960. Other than this comment that resulted in this clarification, no further comments were received on those provisions of the proposed regulations, and these final regulations adopt them without further changes. B. Remuneration Related to Medical Services Remuneration that is paid to a licensed medical professional for medical services is excluded from the definition of “remuneration” for purposes of section 4960. (See section II.F. of the Summary of Comments and Explanation of Revisions, titled “Medical Services,” for a further discussion of the scope of this exception.) When an employer pays remuneration to an employee for both medical services (including related services, such as medical recordkeeping) and other services, the employer must allocate that remuneration between remuneration paid for medical services or for other services. These final regulations adopt the proposed regulations, with minor clarifications, and permit taxpayers to use a reasonable, good faith method to allocate remuneration between these two categories of services. For this purpose, taxpayers may rely on a reasonable allocation set forth in an employment agreement allocating remuneration between medical services and other services. If some or all of the remuneration is not reasonably allocated in an employment agreement, taxpayers must use another reasonable method of allocation. For example, allocating remuneration to medical services based on the portion of the total hours the employee worked for the employer providing medical services (determined based on records such as patient, insurance, Medicare/Medicaid billing records, or internal time reporting mechanisms) would be a reasonable method. In section III.B. of the Explanation of Provisions of the proposed regulations, titled “Remuneration Related to Medical Services,” the Treasury Department and the IRS requested comments on other reasonable methods of allocating remuneration between medical services and other services. One commenter recommended that an employer be permitted to make a reasonable, good faith allocation between remuneration for providing medical services and remuneration for providing nonmedical services, not only with respect to current remuneration but also with respect to contributions and earnings under a deferred compensation plan. These final regulations adopt this recommendation and clarify that an employer may make a reasonable, good faith allocation between remuneration for medical and nonmedical services, regardless of the form of compensation, and that an employer may apply the same principles with respect to contributions and earnings under a deferred compensation plan. C. When Remuneration Is Treated as Paid The proposed regulations addressed when remuneration is treated as paid for purposes of section 4960. The flush language at the end of section 4960(a) provides that, for purposes of section 4960(a), remuneration is treated as paid when there is no substantial risk of forfeiture of the rights to the remuneration within the meaning of section 457(f)(3)(B). Although section 4960(a) cross-references the definition of “substantial risk of forfeiture” in section 457(f)(3)(B), the rule under section 4960(a) providing that remuneration is treated as paid when there is no substantial risk of forfeiture of the rights to the remuneration is neither limited to remuneration that is otherwise subject to section 457(f) nor limited to amounts paid pursuant to a nonqualified deferred compensation arrangement. The proposed regulations provided that, for purposes of section 4960(a), all forms of remuneration except for “regular wages” as described in the next paragraph are treated as paid when the remuneration is not subject to a substantial risk of forfeiture. These final regulations adopt this payment timing rule provided in the proposed regulations with certain modifications, as discussed in further detail in this section. To clarify when remuneration that is never subject to a substantial risk of forfeiture is treated as paid, the proposed regulations provided that remuneration that is a “regular wage” within the meaning of § 31.3402(g)-1(a)(ii) is treated as paid at the time of actual or constructive payment. A “regular wage” is defined in § 31.3402(g)-1(a)(ii) as remuneration “paid at a regular hourly, daily, or similar periodic rate (and not an overtime rate) for the current payroll period or at a predetermined fixed determinable amount for the current payroll period.” These final regulations adopt these rules provided in the proposed regulations without change. Because the final regulations provide that remuneration that is a regular wage within the meaning of § 31.3402(g)-1(a)(1)(ii) is treated as paid when actually or constructively paid, an employer will not need to determine amounts of regular wages that vested in the preceding year for purposes of section 4960. For example, if a pay period begins December 25, 2022, and ends January 7, 2023, and the salary for that period is not actually paid until January 14, 2023, then the salary for the pay period is treated as paid in 2023, and the employer need not treat any amount as remuneration paid in 2022 due to vesting in 2022. The proposed regulations treated an amount that is not regular wages as paid when it is no longer subject to a substantial risk of forfeiture within the meaning of section 457(f)(3)(B) and referred to such an amount as “vested.” The Treasury Department and the IRS issued proposed regulations under section 457(f) in 2016 (81 FR 40548 (June 22, 2016)), upon which taxpayers may rely for periods before the applicability date of the final section 457(f) regulations. Under Prop. § 1.457-12(e)(1), an amount of compensation is subject to a substantial risk of forfeiture only if entitlement to the amount is conditioned on the future performance of substantial services, or upon the occurrence of a condition that is related to a purpose of the compensation if the possibility of forfeiture is substantial. See Prop. § 1.457-12(e)(3) for examples of the rules relating to substantial risk forfeiture. These final regulations adopt the rules provided in the proposed regulations, including the definition of “substantial risk of forfeiture” in Prop. § 1.457-12(e)(1). Any changes to the proposed regulations under section 457(f) when finalized will be considered for purposes of section 4960, and further guidance may be issued, if appropriate, including any transition guidance that may be needed to take into account periods before and after the applicability date of the definition of substantial risk of forfeiture under the final section 457(f) regulations. In section III.C. of the Explanation of Provisions of the proposed regulations, titled “When Remuneration Is Treated as Paid,” the Treasury Department and the IRS invited comments regarding any burdens that could be avoided through a short-term deferral rule and how such a rule could be designed to avoid permitting inappropriate avoidance of the tax. One commenter recommended that these final regulations extend the rule for “regular wages” as defined in § 31.3402(g)-1(a) to amounts that are not treated as deferred compensation under § 1.409A-1(b)(4) or Prop. § 1.457-12(d)(2) because such amounts are paid within the “short-term deferral” period. The commenter suggested that other remuneration that falls outside the definition of “regular wages” be treated as remuneration when actually or constructively paid, including benefits under bona fide severance pay plans and death and disability plans, as well as annual bonuses, long-term incentive pay, business expense reimbursements, and noncash fringe benefits. The commenter noted that such amounts are treated as wages for other reporting purposes, including Federal Insurance Contributions Act (FICA) wage reporting, when actually or constructively paid, and thus the rules under the proposed regulations result in a timing mismatch. The commenter asserted that this recommendation would substantially reduce the administrative burden and potential for errors created by the broad timing rule in the proposed regulations, yet affect a limited range of remuneration. Another commenter recommended that these final regulations provide that the short-term deferral exception to the definition of deferred compensation for section 457(f) apply to section 4960 such that the year of inclusion for income tax purposes matches the year of inclusion for section 4960 purposes. The commenter interpreted the statutory reference to wages under section 3401(a) and amounts included in income under section 457(f) as providing not only a substantive rule but also a timing rule, meaning the amount must either be wages within the meaning of section 3401(a) paid during that year or be an amount included in income under section 457(f) during that year in order to be treated as remuneration paid in that year. According to the commenter, since amounts that meet the definition of a short-term deferral for purposes of section 457(f) are neither wages under section 3401(a) nor includible in income under section 457(f) in the year of vesting, those amounts should be treated as remuneration for purposes of section 4960 only in the year actually paid. Further, the commenter noted that applying a short-term deferral rule would simplify administration for employers because the determination of remuneration would more closely track the determination of wages for Form W-2, “Wage and Tax Statement,” reporting. The commenter acknowledged the concern stated in section III.C. of the Explanation of Provisions of the proposed regulations, titled “When Remuneration Is Treated as Paid,” that a short-term deferral rule would permit an ATEO to select the year in which remuneration would be subject to tax under section 4960, but observed that an individual may become a covered employee during the section 457(f) short-term deferral period after the year of vesting, and thus the proposed rule could actually result in amounts not being subject to the excise tax. The commenter also observed that treating short-term deferrals as remuneration in the year of vesting requires that those amounts be present-valued and that earnings be included in remuneration in the subsequent year, resulting in additional complexity for ATEOs. Finally, the commenter suggested that an employer be permitted to include an amount in remuneration in the year of vesting or include the amount in the year of payment, as is permitted for FICA tax purposes under § 31.3121(v)(2)-1(b)(3)(iii), and require that employers apply consistent treatment of amounts with respect to its selection of the timing of FICA taxation of short-term deferrals and timing of the treatment as remuneration for purposes of section 4960. These final regulations do not adopt the commenter's suggestions to apply a “short-term deferral” rule. Rather, these final regulations adopt the applicable provisions of the proposed regulations without change. Under section 4960(c)(3), an amount must either be wages under section 3401(a) or be includible in income under section 457(f) in order to be remuneration under section 4960. However, the rules under section 4960(c)(3) determine whether an amount is remuneration, not when the remuneration is considered to be paid. The flush language at the end of section 4960(a) provides that, for purposes of section 4960(a), remuneration is treated as paid when there is no substantial risk of forfeiture, as defined in section 457(f)(3)(B), of the rights to the remuneration. Section 3401(a) primarily focuses on whether, not when, amounts are includible in wages; the basic timing rule for wage inclusion appears in regulations under section 3402(a), not section 3401(a). Specifically, § 31.3402(a)-1(b) provides that wages are paid when actually or constructively paid and explains what it means for an amount to be constructively paid. Thus, the cross-reference to section 3401(a) (and not section 3402(a)) in section 4960(c)(3) establishes the scope of the term “remuneration” without regard to timing, but the flush language in section 4960(a) establishes the timing rule that applies to all forms of remuneration. In addition to being inconsistent with the statutory language addressing the timing of the payment of remuneration, allowing a short-term deferral rule similar to the rule in § 1.409A-1(b)(4) and Prop. § 1.457-12(d)(2) could permit an employer to determine the taxable year in which the amount is treated as paid, which could be used not only to manipulate the application of section 4960(a) to the remuneration paid, but also to manipulate the identification of covered employees. This application of the statutory language results in circumstances in which the amount of remuneration paid for purposes of section 4960 is not the same as the amount reported in any box on Form W-2 for an applicable year. However, as described later in this section, these final regulations address the administrative burden of calculating the present value of vested but unpaid amounts by expanding the ability to include at vesting the full amount that is to be paid in circumstances in which there is a short delay between vesting and payment. These final regulations adopt the rule set forth in the proposed regulations that provided that an amount of remuneration treated as paid generally is the present value of the remuneration on the date on which the covered employee vests in the right to payment of the remuneration. The employer must determine the present value using reasonable actuarial assumptions regarding the amount, time, and probability that the payment will be made. These final regulations do not provide rules for the determination of present value. However, an employer may determine the present value using the rules set forth in Prop. § 1.457-12(c)(1). The Treasury Department and the IRS anticipate that final regulations addressing the determination of present value for purposes of section 4960 will be issued when final regulations under section 457(f) are issued. Until actually or constructively paid or otherwise includible in gross income of the employee, any amount treated as paid at vesting is referred to as “previously paid remuneration.” To reduce the administrative burden of determining the present value of remuneration in certain circumstances that would involve minimal discounting, these final regulations adopt the rule provided in the proposed regulations that the employer may treat the entire amount to be paid on a future date (without making a present valuation determination) as the present value on the date of vesting. However, these final regulations do not limit the application of this rule to amounts that are paid under a nonaccount balance plan described in § 1.409A-1(c)(2)(i)(C), but instead this rule applies to any vested amount that is scheduled to be paid within 90 days. For example, an employer is not required to discount an annual bonus of $10,000 that vests on December 31, 2022, and is scheduled to be paid on February 15, 2023, to reflect the delay in actual payment, but instead may treat $10,000 as remuneration paid in 2022. D. Earnings and Losses These final regulations generally adopt the proposed regulations and provide specific rules for the treatment of earnings and losses on previously paid remuneration. In general, these rules are intended to minimize administrative burdens in determining the amount of earnings and losses treated as paid for an applicable year, as well as in determining the amount of earnings and losses across multiple compensation arrangements. The proposed regulations provided that net earnings on previously paid remuneration are treated as vested (and therefore paid) on the last day of the applicable year in which they are accrued unless otherwise actually or constructively paid before that date. For example, the present value of vested remuneration accrued to an employee's account under an account balance plan described in § 1.409A-1(c)(2)(i)(A) (under which the earnings and losses attributed to the account are based solely on a predetermined actual investment or a reasonable market interest rate) is treated as paid on the date accrued to the employee's account and, until subsequently actually or constructively paid, is treated as previously paid remuneration. In addition, at the end of each applicable year in which there is previously paid remuneration remaining in the covered employee's account balance, the present value of any net earnings accrued on that previously paid remuneration (the increase in present value due to the application of a predetermined actual investment or a reasonable market interest rate) is treated as remuneration paid in that applicable year. This remuneration is then treated as previously paid remuneration for subsequent applicable years until actually or constructively paid. Similarly, the proposed regulations provided that the present value of a vested, fixed amount of remuneration under a nonaccount balance plan described in § 1.409A-1(c)(2)(i)(C) is treated as paid on the date of vesting and subsequently treated as previously paid remuneration until actually or constructively paid. In addition, at the end of each applicable year in which previously paid remuneration remains as part of the covered employee's benefit under the plan, the net increase in the present value of that amount during the year due solely to the passage of time constitutes earnings and is treated as remuneration paid. For this purpose, earnings and losses from one plan or arrangement are aggregated with earnings and losses from any other plan or arrangement in which the employee participates that is provided by the same employer (but not across arrangements provided by related but separate employers). For purposes of determining earnings and losses, previously paid remuneration under a plan or arrangement is reduced by the amount actually or constructively paid under the plan or arrangement. These final regulations further illustrate the operation of these rules through examples. One commenter recommended that these final regulations permit, but not require, related employers to determine net earnings on previously paid remuneration on an aggregate basis by treating all earnings and losses on the previously paid remuneration of related employers as paid by the ATEO. The commenter explained that in groups of related taxable and tax-exempt organizations, related organizations often provide separate deferred compensation plans to their employees. Therefore, an individual employee who works (or has worked) for multiple related employers might have several deferred compensation plans, which often differ considerably, with some being nonaccount balance plans and others being account balance plans that may offer very different investment options. As a result, an individual employee might accrue significant earnings in a year under some deferred compensation plans but incur significant losses in others. The commenter therefore suggested that these final regulations permit aggregation of losses with earnings among related employers to avoid the inappropriate inflation of remuneration in certain circumstances. Any concerns about manipulation due to permitting aggregation could be addressed by requiring employers to aggregate (or not aggregate) earnings and losses consistently from year to year, with changes allowed only infrequently—for example, every 3 years—unless in response to changes in the composition of the group of related organizations. These final regulations do not adopt the commenter's suggestion to permit the aggregation of earnings and losses among related organizations. The commenter's suggestions would be feasible among related organizations only if they agreed to either aggregate or disaggregate arrangements as to all employees and also to coordinate and integrate their remuneration calculations across the separate plans and arrangements that each employer established to permit timely and accurate calculations for each covered employee (and employees that may become covered employees) who participated in more than one employer arrangement. Even if this was feasible for a particular year, the regulatory framework would need to account for the entry and departure of members of the group of related organizations and how the aggregation or disaggregation would account for those events. This regime would be complex and burdensome for taxpayers and the IRS to administer and is not warranted due to the limited potential benefits. In addition, the aggregation of earnings and losses across related employers would implicate the statutory allocation of the liability for the tax on excess remuneration under section 4960(c)(4)(C), since the aggregation of earnings and losses would impact the relative remuneration paid by the separate employers. E. Request for a Grandfathering Rule One commenter suggested that these final regulations provide for grandfathering of employee remuneration contracts executed on or before November 2, 2017, so that amounts paid under such contracts would not be treated as remuneration for purposes of section 4960. The commenter reasoned that the grandfathering of employee remuneration contracts executed on or before November 2, 2017, would help certain employers in overcoming challenges in hiring executives, and that the legislative history of the TCJA failed to consider the differences between tax-exempt employers and their taxable counterparts. The final regulations do not adopt the commenter's suggested rule. Section 13602(c) of TCJA, which added section 4960 to the Code, did not provide for a grandfathering rule and there is no indication in the legislative history that Congress intended that one be adopted by regulation. In contrast, section 13601 of TCJA amended section 162(m) of the Code and provided an explicit grandfathering rule. Under these circumstances, the Treasury Department and the IRS do not find it appropriate to provide a grandfathering rule. However, these final regulations provide rules that have the effect of grandfathering remuneration that vested before the taxpayer's first taxable year beginning after December 31, 2017. Section III.E. of the Explanation of Provisions of the proposed regulations, titled “Request for a Grandfather Rule,” explained that one of the consequences of treating remuneration as paid at the time the remuneration vests is that any remuneration that vested prior to the first day of the first taxable year of the ATEO beginning after December 31, 2017, is not considered remuneration for purposes of section 4960. One commenter recommended that the Treasury Department and the IRS explicitly reflect this rule in these final regulations. In response to this comment, these final regulations provide that any vested remuneration, including vested but unpaid earnings accrued on deferred amounts, that is treated as paid before the effective date of section 4960 (January 1, 2018, for a calendar year employer) is not subject to the excise tax imposed under section 4960(a)(1). All earnings on those vested amounts that accrue or vest after the effective date, however, are treated as remuneration paid for purposes of section 4960(a)(1). Similarly, for an employee who has vested compensation from years prior to the taxable year in which the employee first became a covered employee, these final regulations adopt the rule in the proposed regulations providing that vested remuneration (including vested but unpaid earnings) that would have been treated as remuneration paid for a taxable year before the taxable year in which an employee first became a covered employee under section 4960 is not remuneration subject to the excise tax imposed by section 4960(a)(1) for the first taxable year in which the employee becomes a covered employee or any subsequent year. However, subsequent earnings that accrue on those vested amounts when the employee is a covered employee are treated as remuneration paid for purposes of section 4960(a)(1). F. Remuneration Paid to a Covered Employee for Which a Deduction Is Disallowed Under Section 162(m) Section 4960(c)(6) provides that remuneration for which a deduction is disallowed under section 162(m) is not taken into account for purposes of section 4960. Thus, remuneration that is paid to a covered employee of an ATEO who is also a covered employee of a related “publicly held corporation” or an applicable individual of a related “covered health insurance provider” (as defined in section 162(m)(2) and (m)(6)(C), respectively), for which a deduction is disallowed under section 162(m), generally is not treated as remuneration for purposes of determining whether remuneration has been paid. However, that remuneration is taken into account for purposes of determining the ATEO's five highest-compensated employees. See section II.E. of this Summary of Comments and Explanation of Revisions, titled “Covered Employee.” As discussed in section III.F. of the Explanation of Provisions of the proposed regulations, titled “Remuneration Paid to a Covered Employee for Which a Deduction Is Disallowed Under Section 162(m),” the application of this provision raises significant issues stemming largely from the difference in timing between the payment of remuneration under section 4960 (when the right to the amount vests), and the availability of a deduction that may be restricted by section 162(m) (generally when the amount is paid). Section III.F. of the Explanation of Provisions of the proposed regulations, titled “Remuneration Paid to a Covered Employee for Which a Deduction Is Disallowed Under Section 162(m),” described two possible approaches for addressing these circumstances and requested comments on those approaches. The Treasury Department and the IRS continue to consider the issues raised by this provision in section 4960(c)(6) requiring coordination with section 162(m), including the comments submitted, but have not yet determined the appropriate manner of implementation. Accordingly, these final regulations do not address the coordination of sections 4960 and 162(m) in these circumstances, but instead reserve a section of these final regulations as a place for future guidance. Until that future guidance is issued, taxpayers may use a reasonable, good faith approach with respect to the coordination of sections 4960 and 162(m) in circumstances in which it is not known whether a deduction for the remuneration will be disallowed under section 162(m) by the due date (including any extension) of the relevant Form 4720. For this purpose, a reasonable, good faith approach must have a reasonable basis for anticipating that the compensation that a particular employee will be paid in the future may be subject to the deduction limitations of section 162(m). For example, it is not reasonable for this purpose to anticipate that an ATEO may become a public corporation by the date the compensation will be paid absent facts indicating that is a realistic potentiality. Additionally, until further guidance is issued, the two approaches regarding deferred compensation described in section III.F. of the Explanation of Provisions of the proposed regulations, titled “Remuneration Paid to a Covered Employee for Which a Deduction Is Disallowed Under Section 162(m),” will be treated as reasonable, good faith approaches. However, a third approach suggested by a commenter, under which section 162(m) would not disallow a taxpayer's deduction for remuneration that the taxpayer treated as excess remuneration under section 4960 in a previous taxable year, will not be treated as a reasonable, good faith approach, because such an approach would be inconsistent with section 162(m) and the regulations thereunder. IV. Excess Remuneration In general, the excise tax imposed under section 4960(a)(1) is based on the remuneration paid (other than any excess parachute payment) by an ATEO for the taxable year with respect to employment of any covered employee in excess of $1 million. Consistent with the proposed regulations, these final regulations refer to this amount as “excess remuneration.” The $1 million threshold provided in section 4960(a)(1) is not adjusted for inflation, and an amount subject to tax under section 4960(a)(2) as an excess parachute payment is not subject to tax under section 4960(a)(1) as excess remuneration. As provided in section 4960(c)(4)(C), if an individual performs services as an employee for two or more related organizations during an applicable year, one or more of which is an ATEO, each employer is liable for its proportionate share of the excise tax. These final regulations adopt the rules provided in the proposed regulations for allocating liability for the excise tax among the employers. For this purpose, remuneration that is paid by a separate organization (whether related to the ATEO or not) for services performed as an employee of the ATEO is treated as remuneration paid by the ATEO. For a further discussion of when amounts are treated as paid by an ATEO, see section VI of this Summary of Comments and Explanation of Revisions, titled “Calculation, Reporting, and Payment of the Tax.” V. Excess Parachute Payments A. In General The proposed regulations set forth rules with respect to excess parachute payments under section 4960. No comments were received on these rules, and these final regulations adopt them without change. Section 4960(a)(2) imposes an excise tax on any excess parachute payment. Section 4960(c)(5)(A) provides that “excess parachute payment” means an amount equal to the excess of any parachute payment over the portion of the base amount allocated to such payment. Section 4960(c)(5)(B) provides that “parachute payment” means any payment in the nature of compensation to (or for the benefit of) a covered employee if the payment is contingent on the employee's separation from employment with the employer and the aggregate present value of the payments in the nature of compensation to (or for the benefit of) the individual that are contingent on the separation equals or exceeds an amount equal to 3-times the base amount. Under section 4960(c)(5)(C), certain retirement plan payments, certain payments to licensed medical professionals, and payments to an individual who is not a “highly compensated employee” (HCE) as defined in section 414(q) are not excess parachute payments. 9 9 Under section 414(q), a “highly compensated employee” generally is defined as any employee who was a five-percent owner at any time during the year or the preceding year or who had compensation from the employer in the preceding year in excess of an inflation-adjusted amount. Notice 2019-59 (2019-47 I.R.B. 1091) and Notice 2020-79 (2020-46 I.R.B 1014), provide that the inflation-adjusted amounts for 2020 and 2021 are $130,000 and $130,000, respectively. See section 414(q) and the regulations thereunder for additional rules, including the availability of an election to treat no more than the top 20 percent of an employer's employees as highly compensated employees by reason of their compensation. The excess parachute payment rules under section 4960 are modeled after section 280G, but section 4960(c)(5)(B) defines “parachute payment” differently than section 280G(b)(2). The section 4960 definition refers to payments contingent on an employee's separation from employment, whereas the section 280G definition refers to payments contingent on a change in the ownership or effective control of a corporation (or in the ownership of a substantial portion of the assets of the corporation). While these final regulations incorporate many of the concepts found in the rules under § 1.280G-1, with modifications to reflect the statutory differences between sections 280G and 4960, they do not incorporate other rules under § 1.280G-1 because those rules address issues that do not arise under section 4960. In addition, many provisions in these final regulations do not have parallel rules under § 1.280G-1 because they address issues that arise under section 4960, but not under section 280G. The following sections provide a general overview of these final regulations for purposes of calculating the excise tax imposed under section 4960(a)(2), noting certain similarities and differences between these final regulations and the rules under § 1.280G-1. For more information concerning these rules, including additional similarities and differences with the rules under section 280G, see section V of the Explanation of Provisions of the proposed regulations, titled “Excess Parachute Payments.” B. Definitions Related to Excess Parachute Payments These final regulations define “excess parachute payment” and the term “parachute payment” for purposes of section 4960. Any payment in the nature of compensation made by an ATEO (or any predecessor or related organization) to a covered employee that is contingent on the employee's separation from employment is taken into account for purposes of the parachute payment calculation, assuming no exclusion applies. Those combined payments constitute a parachute payment if the aggregate present value of all such payments made to an individual equals or exceeds 3-times the individual's base amount. A parachute payment is an excess parachute payment to the extent it exceeds one-times the individual's base amount allocated to the payment. These final regulations define a “payment in the nature of compensation” based on § 1.280G-1, Q/A-11 and Q/A-14. In general, any payment arising out of an employment relationship is a payment in the nature of compensation. A payment in the nature of compensation is reduced, however, by any consideration paid by the covered employee in exchange for the payment. C. Payments Contingent on a Separation From Employment 1. In General Although section 4960 does not define what it means for a payment to be contingent on a separation from employment, these final regulations generally treat a payment as contingent on an employee's separation from employment only if there is an involuntary separation from employment. If the payment is subject to a substantial risk of forfeiture (defined in a manner consistent with section 457(f)) that lapses upon an involuntary separation from employment, and the separation causes the risk of forfeiture to lapse, the payment is contingent on separation from employment. 2. Requirement of Involuntary Separation From Employment Separation from employment (whether voluntary or involuntary) often is used in compensation arrangements as a trigger to pay vested compensation. For example, it is typical for a nonqualified deferred compensation plan to provide that a payment or a series of payments will be made or begin upon a separation from employment, including separation from employment resulting from death or disability. The vested amounts that are to be paid after a separation from employment generally are not treated as contingent on a separation from employment because the amounts will never be subject to forfeiture or otherwise not paid (even if an employee does not voluntarily or involuntarily terminate employment during the employee's lifetime, the payments will be made upon the employee's death). In these cases, the separation from employment functions only as a payment timing event and is neither a contingent event that may not occur nor a precondition to entitlement to the payment. 3. Definition of “Involuntary Separation From Employment” If an amount is payable solely upon an involuntary separation from employment, then it is a payment contingent on an event that may not occur and that is a precondition to entitlement to the payment. The definition of an “involuntary separation from employment” set forth in these final regulations is modeled after the definition of an “involuntary separation from service” in § 1.409A-1(n)(1), which also was the model for the definition of an “involuntary severance from employment” under Prop. § 1.457-11(d)(2). A separation from employment for good reason is treated as an involuntary separation from employment for purposes of section 4960 if certain conditions are met. For this purpose, these regulations generally adopt the standards set forth in § 1.409A-1(n)(2) and Prop. § 1.457-11(d)(2)(ii). These final regulations generally adopt the standards of the section 409A regulations for purposes of determining whether there has been a separation from employment, except that for purposes of section 4960 a bona fide change from employee to independent contractor status is treated as a separation from employment. Because the section 409A regulations do not provide a standard for determining when an involuntary change of status from employee to independent contractor results in a separation from employment, in section V.C.3. of the Explanation of Provisions of the proposed regulations, titled “Definition of `Involuntary Separation from Employment,' ” the Treasury Department and the IRS requested comments on whether additional guidance is needed on this issue. No comments were received in response to that request. Consistent with the proposed regulations, these final regulations provide that a separation from employment occurs in the case of a bona fide and involuntary change of status from employee to independent contractor in circumstances in which the change in status otherwise meets the requirements for an involuntary separation from employment. With respect to when an employee otherwise has terminated employment, these final regulations adopt rules based on the section 409A regulations. Specifically, these regulations adopt the standards of § 1.409A-1(h)(1)(ii), providing that an anticipated reduction in the level of services of more than 80 percent is treated as a separation from employment, an anticipated reduction in the level of services of less than 50 percent is not treated as a separation from employment, and the treatment of an anticipated reduction between these two levels will depend on the facts and circumstances. The measurement of the anticipated reduction in the level of services is based on the average level of bona fide services performed over the immediately preceding 3 years (or shorter period for an employee employed for less than 3 full prior years). However, these regulations do not adopt the rule in § 1.409A-1(h)(1)(ii), under which an employer may modify the level of the anticipated reduction in future services that will be considered to result in a separation from employment. 4. When a Payment Is Contingent on Separation From Employment In defining when a payment is contingent on separation from employment, these final regulations do not focus solely on whether the payment would not have been made but for a separation from employment, but also take into consideration whether the separation from employment accelerates the right to payment or the lapse of a substantial risk of forfeiture with respect to the right to payment. Generally, if the payment or the lapse of a substantial risk of forfeiture is accelerated as a result of an involuntary separation from employment (such as a payment that otherwise would have vested and been paid had the employee remained employed for a subsequent period), then the value of any accelerated payment plus the value of any lapse of the substantial risk of forfeiture is treated as contingent on a separation from employment (since the employer would not have provided the increased value in the absence of an involuntary separation from employment). However, if the lapse of the substantial risk of forfeiture is dependent on an event other than the performance of services, such as the attainment of a performance goal, and if that event does not occur prior to the employee's separation from employment, but the payment vests due to the employee's involuntary separation from employment, then the full amount of the payment is treated as contingent on the separation from employment. As discussed in section V.C.4. of the Explanation of Provisions of the proposed regulations, titled “When a Payment Is Contingent on Separation from Employment,” a payment the right to which is not subject to a substantial risk of forfeiture within the meaning of section 457(f)(3)(B) at the time of an involuntary separation from employment generally is not contingent on a separation from employment (since the right to the payment is not triggered by the separation from employment). However, the increased value of a payment accelerated due to the involuntary separation from employment, and the value of accelerated vesting due to the involuntary separation from employment, each generally are treated as a payment contingent on a separation from employment. In addition, a payment for damages due to the breach of an employment agreement that is related to an involuntary separation from employment generally constitutes a payment contingent on a separation from employment, and a payment for compliance with a noncompetition agreement or similar arrangement may, in certain situations, constitute a payment contingent on a separation from employment. Actual or constructive payment of an amount that was previously includible in gross income is not a payment contingent on a separation from employment. For example, a payment of deferred compensation after an involuntary separation from employment that vested based on years of service completed before the involuntary separation from employment generally is not a payment that is contingent on a separation from employment because the separation from employment may affect the time of, but not the right to, the payment (although the value of an acceleration of the payment may be contingent on a separation from employment). Unlike Q/A-25 and Q/A-26 of § 1.280G-1, these regulations do not provide a presumption that a payment made pursuant to an agreement entered into or modified within 12 months of a separation from employment is a payment that is contingent on a separation from employment. However, as discussed later in this section, if the facts and circumstances demonstrate that either the vesting or the payment of an amount would not have occurred but for the involuntary nature of the separation from employment, the amount will be treated as a payment contingent on a separation from employment. In addition, these final regulations do not provide a rule similar to § 1.280G-1, Q/A-9 (exempting reasonable compensation for services rendered on or after a change in ownership or control from the definition of “parachute payment”), which would exclude reasonable compensation for services provided after a separation from employment. In most cases, the issue of whether payments made after a separation from employment are reasonable compensation for services will not arise because the employee will not provide services after the separation from employment. However, if the employee continues to provide services (including as a bona fide independent contractor) after an involuntary separation from employment, payments for those services are not contingent on the involuntary separation from employment to the extent those payments are reasonable and are not made due to the involuntary nature of the separation from employment. Notwithstanding the foregoing, if the facts and circumstances demonstrate that either vesting or payment of an amount (whether before or after an involuntary separation from employment) would not have occurred but for the involuntary nature of the separation from employment, the amount will be treated as contingent on a separation from employment. For example, an employer's exercise of discretion to accelerate vesting of an amount shortly before an involuntary separation from employment may indicate that the acceleration of vesting was due to the involuntary nature of the separation from employment and was therefore contingent on the employee's separation from employment. In section V.C.4. of the Explanation of Provisions of the proposed regulations, titled “When a Payment Is Contingent on Separation from Employment,” the Treasury Department and the IRS requested comments on whether there are additional types of payments made in connection with separation from employment and the extent to which these final regulations under section 4960 should be modified to ensure appropriate classification of those payments as contingent or not contingent on separation from employment. No comments were received in response to this request, and no modifications have been made in the final regulations. D. Three-Times-Base-Amount Test Section 4960(c)(5) provides rules for determining the tax on any excess parachute payment imposed under section 4960(a)(2). Section 4960(c)(5)(B) provides that a payment is a parachute payment only if the aggregate present value of the payments in the nature of compensation to (or for the benefit of) an individual that are contingent on a separation from employment equals or exceeds an amount equal to 3-times the base amount. Section 4960(c)(5)(D) provides that rules similar to the rules of section 280G(b)(3) apply for purposes of determining the base amount, and section 4960(c)(5)(E) provides that rules similar to the rules of section 280G(d)(3) and (4) apply for purposes of present value determinations. Section 280G(b)(3) provides that “base amount” means an individual's annualized includible compensation for the base period. Section 280G(d)(2) defines “base period” as the period consisting of the 5 most-recent taxable years of the service provider ending before the date on which the change in ownership or control occurs or the portion of such period during which the individual performed personal services for the corporation. These final reg [Text truncated at 120,000 characters. The full text is on the page linked above.] --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A2021-00772. Public record. Not legal advice.