The American Institute of Certified Public Accountants (AICPA) is calling on the IRS to issue immediate transition relief and guidance on recent changes to the excise tax on excess tax-exempt organization executive compensation.
In a May 1 letter, the AICPA warns that without swift action, legislative changes that retroactively expand the definition of a “covered employee” under IRC § 4960 could create “significant and unintended financial exposure for tax-exempt organizations and related entities.”
Background and OBBB Expansion
First enacted as part of the Tax Cuts and Jobs Act of 2017 (TCJA), IRC § 4960 imposes a 21% excise tax on remuneration over $1 million paid by an applicable tax-exempt organization (ATEO) to any of its covered employees. When first enacted, the law defined a “covered employee” as one of the organization’s five highest-compensated employees for the current tax year or any preceding tax year beginning after December 31, 2016.
Section 70416 of the One Big Beautiful Bill Act (OBBB) expanded the definition of a “covered employee” to include all employees of an ATEO. This change applies retroactively, encompassing any individual employed during any taxable year beginning after December 31, 2016, and is effective for the first tax year beginning after December 31, 2025.
Relief for Fiscal-Year Organizations
The AICPA is requesting that the IRS provide immediate guidance for ATEOs that operate on a fiscal year. For an ATEO with a June 30 year-end, the expanded definition of “covered employee” will apply for its fiscal year beginning July 1, 2026. The tax calculation for that year is based on remuneration paid during the “applicable year,” which is defined as the calendar year ending with or within the ATEO’s fiscal year.
The letter notes that this creates the same issue that arose after the TCJA first enacted IRC § 4960. In response to that, the IRS issued Notice 2019-09, which provided transition relief confirming that remuneration paid during the portion of an applicable year that fell before the statute’s effective date was not subject to the tax. The AICPA is urging the IRS to apply a similar approach now to prevent the tax from being applied retroactively to individuals who were not considered covered employees before the OBBB’s changes took effect.
Preservation of Existing ‘Covered Employee’ Exceptions
The AICPA is also asking for transition relief to preserve a series of regulatory exceptions to the definition of “covered employee” that were established in final regulations (T.D. 9938). The letter expresses concern that the OBBB’s broad statutory change could be interpreted as invalidating these regulatory exceptions. “Although we anticipate that future final regulations will permanently extend the existing regulatory exceptions for determining covered employees,” the AICPA wrote, “the absence of current guidance creates immediate and potentially irreversible harm.”
Without these exceptions, many highly compensated employees of for-profit companies who provide limited or unpaid services to a related ATEO, such as a corporate foundation, could become subject to the excise tax based on their for-profit compensation. The letter states that taxpayers may soon begin “dismantling personnel structures, winding down operations, and in some cases shutting down their organizations entirely” without clarification.
Proposed ‘De Minimis’ Exception for Prior Employment
The retroactive application of the expanded “covered employee” definition presents a substantial administrative burden for ATEOs. The AICPA letter illustrates this with an example of an individual who worked as a paid summer intern in 2018 and later, in 2036, is employed by a related organization. The AICPA argues this result is “harsh in that the impact of the individual’s limited service to the ATEO is disproportionate to the potential impact to that entity, and that the individual could not have known during a brief summer internship that such service could trigger these consequences.”
To address this, the AICPA recommends transition relief that creates a de minimis exception. This would exclude from the covered employee definition individuals who served as non-highly compensated employees for short durations from 2017 through the enactment of the OBBB.
Clarity on Unpaid Volunteers
Finally, the AICPA is asking for clarification on the status of traditional unpaid volunteers. The expanded definition has raised concerns that employees of a related for-profit who participate in a corporate volunteer event, such as sorting food at an ATEO’s food bank, could fall under the new definition. This interpretation, the letter warns, “could create an overwhelming burden on ATEOs.”
To prevent this outcome, the AICPA recommends that the IRS clarify that such individuals are not treated as covered employees. “Providing services as an unpaid volunteer in furtherance of the ATEO’s mission,” the letter states, “would not seem to be the type of relationship intended to lead to categorization as a covered employee at the related entity.”
For more on the § 4960 excise tax, see Checkpoint’s Federal Tax Coordinator 2d ¶ D-4046.
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