EY Exempt Organization Tax Services Future Tax Leaders · 10/17/2019 · For benefit to be part of...

EY Exempt OrganizationTax Services Future TaxLeadersCompensation and benefit reporting

17 October 2019

Disclaimer

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► Views expressed in this presentation are those of the speakers and do not necessarily represent theviews of Ernst & Young LLP.

► This presentation is provided solely for the purpose of enhancing knowledge on tax matters. It doesnot provide tax advice to any taxpayer because it does not take into account any specific taxpayer’sfacts and circumstances.

► These slides are for educational purposes only and are not intended, and should not be relied upon,as accounting advice.

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Presenters

► Brenda GriesemerSenior Manager, Ernst & Young LLPPhoenix, AZ

► Jocelyne MillerExecutive Director, Ernst & Young LLPSan Diego, CA

► Kathy Pitts, moderatorExecutive Director, Ernst & Young LLPBirmingham, AL

Objectives

► Recognize the importance of accurate compensation andbenefits reporting for exempt organizations

► Identify who is required to be reported on Form 990 andSchedule J

► Identify components of compensation and benefitsrequired to be reported

► Recognize recent legislative changes related tocompensation

► Recognize strategies for explaining unusual ornonrecurring compensation components

Agenda

► Why is compensation and benefit reporting so important for exemptorganizations?

► Compensation reporting on the Form 990 and Schedule J► Who is reported?► What is reported?

► Tax reform guidance► Excise tax on excess compensation

► Tips for explaining unusual or nonrecurring compensationcomponents

Why is compensation and benefit reporting soimportant for exempt organizations?

Private inurement and private benefit

► Prohibition on private inurement► No part of net earnings may inure to benefit of any private

shareholder or individual► Potential loss of tax-exempt status (e.g., Section 501(c)(3))► Intermediate sanctions (Section 4958)

► Limitation on private benefit► Not mentioned in IRC Section 501(c)(3)► No more than an insubstantial part of activities are not in

furtherance of exempt purposes

Unreasonable compensation and intermediatesanctions

► Unreasonablecompensation occurswhen individuals or groupsare compensated beyondthe value of the workbeing performed.► Consider number of

hours reported for eachindividual.

► Intermediate sanctions isa tax-exempt law.► A tax-exempt organization

cannot benefit an insiderunreasonably or an excisetax is imposed.

Excess compensation and intermediatesanctions

► Section 501(c)(3) and (4):► Prohibition on private inurement for benefit of shareholders and

insiders► Inurement: any financial transaction, including excessive

compensation, that benefits an insider

► IRC Section 4958:► May complement revocation of exempt status, or be imposed in

lieu of► Imposed on “disqualified person”► 25% excise tax on “excess benefit transactions”► Compensation must be reasonable

Section 4958Review of intermediate sanctions requirements

► Excess benefit transaction – any transaction where aneconomic benefit is provided to a disqualified person(including compensation for services) if value of benefitexceeds value of services

► Disqualified person – any person, during prior five years,in position to exercise substantial influence overorganization (also family member and 35% shareholder)► CEO, president, CFO, treasurer, COO deemed disqualified

► Compensation reasonable if an amount ordinarily paidfor like services by a like enterprise (taxable or tax-exempt)

Section 4958Rebuttable presumption

► Compensation is presumed reasonable if:► Approved by board or committee of individuals with no conflict of interest► Approval based on “appropriate comparable data”► Adequate documentation of determination, completed before next meeting or 60

days following action► “Appropriate comparable data” includes:

► Current compensation surveys compiled by independent firms showingcompensation levels by similar organizations (taxable and nontaxable) forcomparable functions

► Written offers from similar organizations competing for services► “Compensation” includes all economic benefits (limited exceptions):

► Cash, noncash, salary, bonuses, severance, deferred compensation, liabilityinsurance premiums, payment of expenses, gross-up of tax, penalty or correctionunder Section 4958, payments to welfare benefit plans (e.g., medical, dental, lifeinsurance, disability)

► Questions related to compensation policies:► Form 990, Part VI, line 15

► Schedule J, Part I, line 3

Tip: board members should be made aware of the organization’s responsibilities related to thecompensation process

Board responsibility

Automatic excess benefit transactions

► For benefit to be part of reasonable compensation, clearly indicateintent to treat as compensation when it is paid

► To avoid automatic excess benefit transaction treatment,contemporaneous written substantiation required:► Benefit reported on federal tax return (e.g., Forms W-2, 1099, 990,

1040) for year in which transaction occurred:► Needs to be before initiation of Internal Revenue Service (IRS) exam► Reasonable-cause exception

► Other written contemporaneous evidence► Warning – remember accountable plan reimbursement requirements;

failure to enforce the requirements results in compensation thatmust meet intent-to-compensate documentation rules

Optics

► Federal, state and local government scrutiny► Watchdog groups► Charitable contributions► Media and other public attention► Competitors► Employee, union and independent contractor relations

Polling question 1

The potential loss of exempt status is the main reason whymost exempt organizations pay close attention tocompensation reporting.

A. TrueB. False

Compensation reporting on the Form 990

Exempt organization compensation reporting

► Reporting is required by the Internal Revenue Code (IRC),Treasury Regulations and IRS guidelines for a completeand accurate filing.

► Many state and local governments require exemptorganizations to submit a copy of their Form 990.

► The IRC requires that the Form 990 be made public,including compensation.

Compensation reporting on Form 990: twoplaces to look

► Part VII – Compensation of Officers, Directors, Trustees, KeyEmployees, Highest Compensated Employees and IndependentContractors► Lists current or former officers, directors, trustees, key and highest

compensated employees (HCEs), and independent contractors► Reports certain compensation information relating to such persons

► Schedule J – Compensation Information for Certain Officers,Directors, Trustees, Key Employees and Highest CompensatedEmployees► Reports compensation for certain officers, directors, individual trustees,

key employees and HCEs, and information on certain compensationpractices

Who is reported?

Form 990, Part VII

Current directors or trustees

► Disclose all current directors and trustees regardless of amount ofcompensation.

► A director/trustee is a member of the organization’s governing body, butonly if the member has voting rights.

► A member of an advisoryboard who does notexercise any governanceauthority over theorganization is notconsidered a directoror trustee.

► “Current” means having servedeven one day of the tax year.

► Consider election dates thatdon’t line up with tax year-ends.

Tip: advisory boards can be reported in a Schedule O disclosure

Current officers

► A person elected or appointed to manage the organization’s dailyoperations, such as a president, vice president, secretary or treasurer

► Refer to organizing documents► Include “officers of the board” and “officers of the corporation”► Consider state law

► Often, a domestic/foreign corporation annual report that is filed with the Secretary of Statewill list the officers

► Always include the organization’s top management official and top financialofficial► Top management official has ultimate responsibility for implementing the decisions of the

organization’s governing body or for supervising the management, administration oroperation of the organization (e.g., president, CEO or executive director)

► Top financial official has ultimate responsibility for managing the organization’s finances (e.g.,treasurer or CFO)

► Not everyone with “officer” in their title is automatically included► Disclose all current officers, regardless of compensation

Current key employee

► Key employee – an employee of the organization (other than an officer,director or trustee) who meets all three of the following tests:► $150,000 test – receives reportable compensation from the organization and all

related organizations in excess of $150,000 for the calendar year ending with orwithin the organization’s tax year (calendar year 2018 for taxpayers with a June30, 2019 tax year-end)

► Responsibility test – has wide control similar to an officer, director or trustee;control over 10% of the organization’s activities, assets, income or expenses; orhas authority or shares authority to control or determine 10% or more of theorganization's capital expenditures, operating budget or compensationfor employees (calendar year 2018 for taxpayers with a June 30, 2019 tax year-end)

► Top 20 test – is among the 20 employees (meeting the top two tests) with thehighest reportable compensation from the organization and related organizationsfor the calendar year ending with or within the organization’s tax year (calendaryear 2018 for taxpayers with a June 30, 2019 tax year-end)

► If there are more than 20 individuals who meet the $150,000 andresponsibility test, report only the 20 individuals who have the highestreportable compensation.

Current five highest-compensated employees

► The five highest-compensated employees (other than officers, directorstrustees or key employees) who received over $100,000 in reportablecompensation from the organization or any related organizations► Reportable compensation is W-2 Box 5 or 1099-MISC Box 7 wages► Related organizations are determined by completing Schedule R

Tip: before determining who must be reported on your organization’s Part VII, Schedule R needs to becompleted (definition of related organization and control)

Number of hours

► For each person listed in Part VII, report the average number of hours perweek in column B.► How to determine► Can be more than 40► Factor in considering reasonable compensation

Former officers, directors, trustees, keyemployees (ODTKE) and HCE► The organization reported (or should have reported, applying the

instructions in effect for such years) an individual on any of theorganization’s Forms 990, 990-EZ or 990-PF for any one or more of the fiveprior years in one or more of the following capacities:► Officer► Director or trustee► Key employee► Highest-compensated employee

And► The individual received reportable compensation, from the organization

and/or related organizations, in the calendar year ending with or within theorganization’s current tax year in excess of the threshold amount:► $100,000 for former officers, key employees and HCE► $10,000 for former directors or trustees for services rendered in their capacity as

a former director or trustee

Tip: if an individual served even one day of the tax year, they are considered current, not former

Who is considered for Schedule J?

► Schedule J is triggered for additional compensation reporting on individualslisted in Part VII who:► Are listed as a former officer, director, trustee, key employee or HCE► Have reportable compensation and other compensation greater than $150,000► Receive or accrue compensation from any unrelated organization or individual for services

rendered to the organization

► Not all individuals listed in Part VII will necessarily be required to be reportedin Schedule J

Matrix for Form 990, Part VII, Section A

Other considerations

► Disregarded entities (such as single-member LLCs that are not treated asseparate entities for federal income tax purposes) are treated as a division ofthe organization for purposes of Form 990*. An officer or director of thesingle-member LLC may qualify as a key employee or HCE.

► Management and/or employee leasing companies► Company could be listed as independent contractor► Organization should report employees of employee leasing company or a management

company as the organization's own employees if such persons are common-law employees ofthe filing organization

► Common paymaster or payroll agent► Treat amounts paid by a common paymaster or a payroll or reporting agent for services

performed for the organization as if paid directly by the organization

*Note: single-member LLCs are “regarded” for employment and some other tax purposes

Tip: know the details of any management company or leasing company situations

Other considerations

► Document the logic► Personnel org chart► Payroll runs of reportable compensation► Factors considered for the responsibility test► Board member start and term dates

Tip: keep good records of who you reported (or didn’t report) and why

Polling question 2

If an officer is no longer employed at the time of the Form990 filing, they will be considered a former officer.A. TrueB. False

What is reported in Part VII?

What is compensation for Form 990 purposes?

► Part VII requires disclosure of two categories ofcompensation:► “Reportable compensation” from filing organization and related

organizations► “Other compensation” from filing organization and related

organizations

► Schedule J, Part II requires organizations to break thesegeneral categories into more detail.

Reportable compensation

► For employees, Form W-2, box1 or 5 (whichever is greater)

► Form 1099-MISC, box 7 forservices to organization orrelated organization

► Actual amount paid forservices if Form W-2 orForm 1099-MISC not filed

Form W-2

Form 1099-MISC

Reportable compensation

► Schedule J, Part II breaks reportable compensation intocategories:► Base compensation

► Pay that makes up the normal work week► Bonus and incentive compensation, including but not limited to:

► Signing bonus► Management incentive plan

► Other reportable compensation, including but not limited to:► Current-year payments of amounts earned in a prior year► Payments under a severance plan► Deferred amounts and earnings or losses in a nonqualified defined

contribution plan subject to Section 457(f) when substantially vested► Awards based on longevity of service► Taxable benefits► Sick pay or PTO cash-out

Other compensation

► Compensation, other than reportable compensation, including:► Deferred compensation not currently reportable on Form W-2, box 1 or 5

or Form 1099-MISC, line 7:► Current-year deferrals under any retirement or other deferred compensation

plan, qualified or nonqualified, established, sponsored or maintained by or fororganization or a related organization

► Includes annual increase or decrease in actuarial value of defined benefit plan► Certain nontaxable benefits, including but not limited to:

► Educational assistance► Health insurance and medical reimbursement programs► Life, disability and long-term care insurance► Dependent care and adoption assistance

► Does not include disregarded benefits, such as fringe benefits, andpayments made pursuant to an accountable plan

Tip: not all components of compensation are run through payroll; consult with payroll and benefits

Schedule J, Part II, column (F)

► Payment reported in current-year column (B) – i.e.,reportable compensation – to the extent such paymentwas reported as deferred compensation on a prior Form990

► Example: Section 457(f) nonqualified plan amounts thatwere reported as deferred in column (C) in a prior yearbut have substantially vested in current year, thusrequiring them to be reported in column (B)(iii)

Determining where reportable and othercompensation goes on the Form 990

► Form 990 instructionsaddress PartVII/Schedule Jtreatment of 72different types ofcompensation

Form 990 compensation table

Polling question 3

What might be included as “reportable compensation” onPart VII of the Form 990?A. The greater of box 1 or box 5 on Form W-2B. Form 1099-MISC, box 7C. Actual amount paid for services (no W-2 or 1099-MISC filed)D. All of the above

Schedule J compensation questions

Form 990, Schedule J

► Schedule J serves as a supplement to Part VII.► Part I questions generally must be answered taking into

consideration all individuals listed in Part VII, Section A.► Part II compensation detail must be completed for:

► Former ODTKEs or HCEs reported on Part VII► Persons on Part VII whose sum of reportable compensation and

other compensation from organization and related organizationsexceeds $150,000

► Any person on Part VII who received or accrued compensationfrom an unrelated organization for services rendered to the filingorganization

Form 990, Schedule J

Tip: read each question closely to determine who needs to be considered in the answer

Form 990, Schedule J: Part I, line 1

► “Relevant” information to be disclosed for any checked items:► Type of benefit► Person or category of persons who received the benefit► Whether the benefit was treated as taxable

► If the organization followed its written policy, answer “yes” toSchedule J, Part I, line 1b.► If not, explain in Part III who determined the organization would provide

the benefit and explain the decision-making process


► Refers only to directors, trustees and officers► An accountable plan is a reimbursement or other

expense allowance arrangement that satisfies therequirements of IRC Section 62(c) by meetingrequirements of business connection, substantiation andreturning amounts in excess of substantiated expenses

► Organization can answer “yes” if it checked discretionaryspending account box on line 1a and requiredsubstantiation of expenses under rules for accountableplans for all listed benefits on line 1a other than fordiscretionary spending accounts


► Check only the boxes for any items used to establishcompensation of the CEO/executive director (topmanagement official)► For example, simply having a current written employment

contract for the CEO would not warrant checking that box. Usingwritten employment contracts (say from former or similaremployers) to establish your CEO’s compensation would warrantchecking that box

► Explain in Part III if organization relied on a relatedorganization that used one or more methods outlined inline 3 to establish top management official’scompensation

Polling question 4

All exempt organizations that pay for companion travel must report thedetails of such payments on Schedule J.A. TrueB. False

Form 990, Schedule J: Part I, lines 4–6

Tip: read each question closely to determine if it should be answered only with regard to the filingorganization or with regard to related organizations, too


► List in Part III the names of listed persons paid amountsduring year by filing organization or a relatedorganization under any arrangement described in lines4a (severance), 4b (supplemental nonqualified retirementplan) through 4c (equity-based compensation), andreport amounts paid during the year to each

► For 4b and 4c, also describe in Part III terms andconditions of arrangement in which one or more listedpersons participated during year, regardless of whetherany payments to listed person were made during year


► “Yes” if organization paid or accrued, with respect to alisted person, any compensation contingent upon anddetermined in whole or in part by:► Revenues (gross or net) of one or more activities of organization

or a related organizationOr

► Revenues (gross or net) of organization or a related organizationas a whole

► Net revenues mean gross revenues less certain expenses, butdoes not mean net income or net earnings

► Describe such arrangements in Part III


► “Yes” if the organization paid or accrued with respect toa listed person any compensation contingent upon anddetermined in whole or in part by:► Net earnings of one or more activities of organization or a related

organizationOr

► Net earnings of organization or a related organization as a whole► Describe such arrangements in Part III


Example:► A, a listed person, is an employee of organization B. As part of A’s

compensation package, A is to be paid a bonus equal to x% of B’s netearnings for a specified period of time. This arrangement is apayment contingent on net earnings of the organization for line 6purposes, regardless of whether the payment is contingent onachieving a certain net earnings target.

► However, if instead the bonus payment is a specific dollar amount tobe paid only if a net earnings target is achieved, the payment is notcontingent on the net earnings of the organization for this purpose.The same result would occur if the bonus were a percentage of abonus pool when the pool was determined without regard to netearnings.

Form 990, Schedule J: Part I, lines 7–9


► Answer “yes” if organization provided non-fixed payments not described onlines 5 and 6 for a listed person

► Describe such arrangements in Part III► Fixed payment is an amount of cash or other property specified in contract,

or determined by a fixed formula specified in contract, which is to be paid ortransferred in exchange for the provision of specified services or property

► A fixed formula can incorporate an amount that depends upon futurespecified events or contingencies, provided that no person exercisesdiscretion when calculating amount of a payment or deciding whether tomake a payment, such as a bonus

► Amounts paid or accrued to any listed person that are not fixed amounts asdefined above are non-fixed payments► For example, amount paid to a person under a reimbursement arrangement where

discretion is exercised by any person as to the amount of expenses incurred orreimbursed is a non-fixed payment

Form 990, Schedule J: Part I, lines 8 and 9

► Line 8 – “yes” if amounts from organization reported on Form 990, Part VIIwere paid under contract subject to initial contract exception

► Describe such arrangements in Part III► Note: fixed payments made under an initial contract not subject to IRC

Section 4958 intermediate sanctions► Initial contract – binding written contract between organization and person

who was not a disqualified person (within meaning of Section 4958(f)(1))with respect to organization immediately prior to entering contract

► Line 9 – “yes” if payments described in line 8 were made under initialcontract reviewed and approved by organization following rebuttablepresumption procedure

► Rebuttable presumption of reasonableness includes:► Review and approval by independent persons► Comparability data► Contemporaneous substantiation of the deliberation and decision

Polling question 5

Payment of a discretionary bonus as determined by theboard of directors to an officer in recognition of a job welldone would be reported as a non-fixed payment onSchedule J, line 7.A. TrueB. False

Tax reform impact on tax-exempt organizationcompensation

Section 4960

► Prior law – tax-exempt organizations generally were not subject toexecutive compensation limitations but were limited by privateinurement rules and potential sanctions under Section 4958 ifcompensation was considered excessive relative to value provided toorganization

► Section 4960 provides that, effective for taxable years beginningafter December 31, 2017, an applicable tax-exempt organization issubject to a 21% excise tax on:► Remuneration over $1 million paid to a covered employee (other than an

excess parachute payment)► Excess parachute payments paid to a covered employee

► The intent of Section 4960 excise tax appears to be to treat tax-exempt organizations similarly to taxable businesses with respect tocompensation paid to executives above a specified threshold

Section 4960

(a) There is hereby imposed a tax equal to theproduct of the rate of tax under Section 11and the sum of:

(1) So much of the remuneration paid (otherthan any excess parachute payment) by anapplicable tax-exempt organization for thetaxable year with respect to employment ofany covered employee in excess of$1,000,000

(2) Any excess parachute payment paidby such an organization to any coveredemployee

Applicable tax-exemptorganization is onethat:► Is exempt from tax

under Section 501(a)► Is a farmers’ cooperative

described in Section521(b)(1)

► Has income excludedfrom tax under Section115Or

► Is a politicalorganization describedin Section 527

A covered employee isan employee who:► Was one of five HCEs

of the organization forthe tax yearOr

► Was a coveredemployee of theorganization (orpredecessor) for anypreceding tax yearbeginning afterDecember 31, 2016

Section 4960

(a) There is hereby imposed a tax equalto the product of the rate of tax underSection 11 and the sum of:

(1) So much of the remunerationpaid (other than any excessparachute payment) by anapplicable tax-exempt organizationfor the taxable year with respect toemployment of any coveredemployee in excess of $1,000,000.

Plus

(2) Any excess parachute paymentpaid by such an organization to anycovered employee.

Remuneration is wages withinmeaning of Section 3401(a),excluding designated Rothcontributions (wages reportedon Form W-2, Box 1)

► Excess parachutepayment iscompensation paid onaccount of separationfrom service if presentvalue of aggregateamount exceeds threetimes base amount,which is five-yearaverage

► Excise tax is imposed onfull amount above baseamount if present valueexceeds three timesbase amount

What are the basic provisions of the Section4960 excise tax?

► Applicable tax-exempt organization considerations:► Are state colleges and universities and similar entities included?

► Covered employee considerations:► Covered employee determination made beginning with taxable years after December 31,

2016► Once a covered employee, always a covered employee, even if no longer one of the five

highest-compensated employees► Applies to any employee, not just officers► Compensation paid to licensed medical professionals in performance of professional service is

not included in the definition of “remuneration”► No controlled group rule applies to determining who is a covered employee; the determination

may need to be made on an employer-by-employer basis► Employee’s compensation on the calendar-year (i.e., Form W-2 wages) basis is used to identify

who is a covered employee. For their first tax year beginning after December 31, 2017, fiscal-year taxpayers consider only the compensation paid within that first fiscal year. Subsequentyears, they will consider all compensation paid for the year ended within the fiscal year

► Excess parachute payment considerations► Does not apply to payments made to non-highly compensated employees within the meaning

of Section 414(q)► Only applies to involuntary separations

What are the basic provisions of the Section4960 excise tax?

► Compensation of a covered employee includes amounts paid with respect toemployment by a related person

► A related person includes any person that:► Controls, or is controlled by, the organization► Is controlled by one or more persons who also control the organization► Is a supporting or supported organization of the organization► For a voluntary employees’ beneficiary association (VEBA) described in Section

501(c)(9), an entity establishing, maintaining or making contributions to theVEBA

► Considerations for determining amount of compensation:► What constitutes control?► Interaction with joint ventures where the institution asserts sufficient control to

ensure charitable operations (and avoid unrelated business taxable income (UBTI)from pass-through income)

► Multiple supporting organizations, but with only a tangential connection to theorganization

► How is compensation allocated between tax-exempt and related taxable entity?

Deep dive into tax reform: executive compensation excise tax

Reporting the excise tax

► The 2018 Form 990 added a new question to Part V regarding theSection 4960 compensation excise tax

► Answering “yes” will require organization to complete the scheduleon Form 4720

Form 4720

► Compensation excise tax paid using Form 4720► Schedule N added to 2018 Form 4720

► No estimated tax payments required

Polling question 6

Any IRC Section 4960 excise tax is paid:A. On Form 990B. On Form 990TC. On Form 4720D. By the employee

Tips for reporting unusual or nonrecurringcompensation

Disclosure examples to help tell a more complete story

► Schedule J, Part II, column Bii (bonus and incentive) includes a $100,000 sign-on bonus forEric Anderson, making his compensation appear higher than normal► Included in bonuses reported in Part II, column Bii for Anderson is a one-time sign-on bonus as part

of his compensation package for accepting the position of Chief Medical Officer

► Schedule J, Part II, column Biii (other compensation) includes $25,000 of PTO cash-out forJohn Smith, making his compensation appear higher than normal► Included in other compensation reported in Part II, column Biii for Smith is $25,000 of PTO accrued

over XX years and paid out in one lump sum in the current year

► Schedule J, Part II, column Biii (other compensation) includes $40,000 of taxable movingexpenses for Sarah Jones, making her compensation appear higher than normal► Included in other compensation reported in Part II, column Biii for Jones is $40,000 of taxable

moving expenses as part of her compensation package for relocating to fill the CFO position

► Schedule J, Part II, column Biii (other compensation) includes $1,000,000 of supplementalexecutive retirement plan payment vesting for Gary Bartlett, making his compensationappear higher than normal► Included in other compensation reported in Part II, column Biii for Bartlett is $1,000,000 of

supplemental executive retirement plan payment vesting. The payment was earned over a period of20 years of service to the organization

Consider meeting with potential users/stakeholders

► Consider meeting proactively with potential users (media, union reps, etc.)► Explain the Form 990 and Schedule J required reporting► Explain your organization’s compensation process► Show your organization’s compensation as compared to similar organizations (taxable and

exempt)► Consider advance notice of disclosure to any person with compensation reported

You should now be able to…

► Recognize the importance of accurate compensation and benefits reporting for exemptorganizations

► Identify who is required to be reported on Form 990 and Schedule J► Identify components of compensation and benefits required to be reported► Recognize recent legislative changes related to compensation► Recognize strategies for explaining unusual or nonrecurring compensation components

Questions?

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