August 21, 2018
Draft 2018 Form 4720 includes updates to reflect statutory changes to exempt organization excise taxes
The IRS has released a draft 2018 Form 4720 (Return of Certain Excise Taxes Under Chapters 41 and 42 of the Internal Revenue Code) and accompanying draft instructions. The draft form adds Schedules N and O for reporting related to the new Section 4960 compensation excise tax and the Section 4968 net investment income tax, respectively. The release of draft Form 4720 follows the IRS's release of draft 2018 Form 990 (Return of Organization Exempt from Income Tax), which referred to the two new Form 4720 schedules.
The draft 2018 Form 4720 instructions have also been updated to include a reference to the new Section 4943(g) exception to private foundation excess business holdings rules for philanthropic business holdings.
The Tax Cuts and Jobs Act of 2017 (TCJA) enacted numerous tax changes for tax-exempt organizations, individuals and businesses. For a detailed discussion of the TCJA provisions affecting tax-exempt organizations (including those highlighted below), see Tax Alert 2017-2142.
For tax years beginning after December 31, 2017, new Section 4960 requires most tax-exempt organizations to pay a 21% excise tax on remuneration (excluding remuneration paid to a licensed medical professional for medical or veterinary services) over $1 million paid to a "covered employee" within a tax year. The term "covered employee" includes any of the five highest paid employees for the organization's first tax year beginning after December 31, 2016, and for each subsequent tax year.
Section 4960 also requires most tax-exempt organizations to pay a 21% excise tax on any "excess parachute payment" paid by the organization to a covered employee. Generally, an excess parachute payment is a payment (or series of payments) contingent on an employee's separation from employment with a present value equal to or greater than three times the employee's average compensation over the prior five-year period (the base amount). The amount subject to the excise tax is the excess of the payment over the base amount.
Section 4968 imposes a 1.4% excise tax for each tax year on the net investment income of an "applicable educational institution." In general, the tax applies to private colleges or universities with at least 500 full-time tuition-paying students (more than half of whom are located in the US) and endowments of at least $500,000 per student. Net investment income for purposes of Section 4968 is determined using rules similar to the rules of Section 4940(c) that relate to the tax imposed on net investment income of private foundations.
In Notice 2018-55, the IRS announced that it plans to issue proposed regulations under which applicable educational institutions subject to the new Section 4968 investment income tax may, in certain circumstances, use a stepped-up basis for property sold for a gain. See Tax Alert 2018-1220.
Under Section 4943, a private foundation owning more than a 20% interest in a business enterprise is generally subject to an excise tax equal to 10% of the value of the excess business holding. A private foundation that does not divest itself of the excess business holding by the end of the applicable tax period becomes subject to a 200% excise tax on the excess business holding.
Both the House and Senate versions of the TCJA bill at one point included a provision that would exempt certain for-profit business holdings of private foundations from the excise tax if certain limiting conditions were met and the for-profit business contributed all of its net operating income after taxes to the private foundation. The enacted TCJA, however, included no such provision.
However, the Bipartisan Budget Act of 2018 (BBA 2018), enacted February 9, 2018, added this exception in Section 4943(g). Under the exception, the Section 4943 excise tax will not apply to private foundations with holdings in any business enterprise that meet certain requirements for the tax year, including: (1) an ownership requirement; (2) an "all profits to charity" distribution requirement; and (3) requirements regarding independent operation. For additional detail, see Tax Alert 2018-0356.
Draft 2018 Form 990
In July 2018, the IRS released a draft version of the 2018 Form 990 (Return of Organization Exempt from Income Tax) that adds two new questions regarding the Section 4960 compensation excise tax and the Section 4968 net investment income tax. An affirmative answer to either question, in turn, will require the organization to complete an additional schedule on Form 4720 (i.e., the new Schedule N or O). See Tax Alert 2018-1504.
Draft 2018 Form 4720 and Instructions
The draft 2018 Form 4720 adds the new schedules referenced in the draft 2018 Form 990: Schedule N, Tax on Excess Executive Compensation (Section 4960), and Schedule O, Excise Tax on Net Investment Income of Private Colleges and Universities (Section 4968). The instructions also include a reference to the new Section 4943(g).
Schedule N is the schedule used to report and pay any Section 4960 tax owed. The instructions state that organizations must complete Schedule N if they answered "Yes" to question 15 in Part V of Form 990, question 8 of Part VII-B of Form 990-PF, or if they are an "applicable tax exempt organization" (ATEO) or a related organization that is liable for the tax under Section 4960(a). The instructions include definitions of various relevant terms, including covered employee, remuneration and excess parachute payment.
To complete Schedule N, organizations must enter the name of each covered employee in column (b). For more than five covered employees, organizations must attach a statement with the additional information required. For each covered employee, organizations enter excess remuneration in column (c), excess parachute payments in column (d), and the total of both in column (e).
The instructions state that, for purposes of calculating the excise tax on excess executive compensation, "a governmental entity that is not exempt from tax under Section 501(a) as a Section 501(c)(3) organization and does not exclude income under Section 115(1) is not an ATEO for purposes of Section 4960." Organizations that exclude income under Section 115 are generally quasi-governmental organizations. This "Tip" lends credence to the position that purely governmental organizations such as states, political subdivisions, and integral parts of these organizations will not be subject to the excise tax on excess executive compensation.
Schedule O is used by applicable educational institutions to report and pay any Section 4968 tax owed. The instructions state that an organization must complete Schedule O if it is an applicable educational institution that answered "Yes" to Form 990, Part V, line 16, or that is otherwise subject to the Section 4968 tax on net investment income. The instructions include guidance on organizations subject to the tax, related organizations, net investment income and basis.
In completing Schedule O, organizations report gross investment income, capital gain net income and associated allocable administrative expenses of the filing organization on Line 1. Information from applicable related organizations is reported on Lines 2-5 (and attachments, if necessary). Total amounts are reported on Line 6, and the excise tax on such totals are calculated on Line 7.
The draft 2018 Form 4720 instructions also mention the new Section 4943(g) exception from the excise tax on excess business holdings that was enacted by BBA 2018. The instructions do not include further guidance on the exception, but they do instruct filers to see the Form 990-PF instructions for more detail.
The draft 2018 Form 4720 instructions also state that Form 990-W, Estimated Tax on Unrelated Business Taxable Income for Tax-Exempt Organizations, is not required for either new excise tax. This is particularly noteworthy for universities subject to the excise tax on net investment income. Unlike private foundations that must calculate and remit estimated excise taxes on net investment income, universities will not have to pay net investment income tax due until after the tax year has ended.
The 2018 draft Form 4720 and Instructions indicate that new Schedules N and O will require organizations to report information that goes beyond merely listing the amount of excise tax due from the organization. However, it remains unclear as to whether this information will be made available to the public. Although Internal Revenue Manual Section 18.104.22.168 specifically notes that Form 4720 will be subject to public disclosure by "foundations," there is no similar note regarding public charities. As of now, all instructions and guidance are silent as to the disclosure requirements for public charities.
Regarding the Section 4943 excess business holding exception created by the BBA in 2018, there is no additional information on the new rule. The form instructions simply note that there is an exception for certain operated enterprises whose voting stock is wholly owned by the private foundation, referencing the Form 990-PF instructions.
Form 4790 is generally due on the same due date as the organization's Form 990 series return, but should be extended (via Form 8868) and filed separately from the organization's Form 990 series return.
Tax-exempt organizations impacted by these Code sections should implement strategies and administrative steps to gather the information necessary to complete these new schedules when required.
Please contact your Ernst & Young LLP tax professional with any questions.