Type: Law Bulletins
Date: 01/12/2021

IRS Issues Final Regulations Regarding Application of Code Section 4960

Taft has been closely following the guidance issued by the Internal Revenue Service (IRS) regarding Code Section 4960. Code Section 4960, a provision added to the Internal Revenue Code as part of the Tax Cuts and Jobs Act of 2017, imposes a 21% excise tax on annual compensation of more than $1 million to certain employees of applicable tax-exempt organizations (ATEOs), including nonprofit corporations, private foundations, and company foundations. Prior bulletins from Taft can be found here and here.

The IRS issued final regulations on Jan. 11, 2021. The final regulations largely follow the proposed regulations issued last summer, which clarify earlier concerns raised in connection with Notice 2019-9, which was issued in early 2019. The full text of the final regulations can be found here. We highlight a few clarifications and modifications made by the IRS between the proposed and final regulations, as well as confirmations where the proposed regulations match the final regulations, below. We have followed the same format as our bulletin concerning the proposed regulations, as it addresses the topics of concern to most organizations. 

What do the Final Regulations Say?

Who is and is not an ATEO

Generally, the final regulations follow the proposed regulations for purposes of determining which organizations are ATEOs. However, the IRS specifically reserved the right to issue future guidance concerning whether or not federal instrumentalities described in Code Section 501(c)(1)(A)(i) – entities created pursuant to Acts of Congress which are instrumentalities of the United States prior to July 18, 1984 – are subject to Code Section 4960. The final regulations clarify that until future guidance is issued, such federal instrumentalities may assume Code Section 4960 is not applicable to them.

Applicable Year

The “applicable year” will generally be coterminous with the calendar year, which is the same as provided for in the proposed regulations.


The final regulations match the proposed regulations concerning who is and is not an “employee.” As described in our bulletin about the proposed regulations, the IRS defined “employee” to be consistent with the definition of “employee” for purposes of federal income tax withholding, which includes common-law employees, officers or elected or appointed officials of governments, or agencies or instrumentalities thereof, and certain corporation officers. Board members are not employees by virtue of a board member’s role as a director. 

Covered Employees

In general, a “covered employee” is any individual who is one of the five highest compensated employees of an ATEO in a given taxable year or was a “covered employee” in an earlier taxable year that began after Dec. 31, 2016. In other words, once determined to be a “covered employee” a person will continue to be a “covered employee” for the duration of their time with the ATEO or any successor organization. To determine whether or not someone is a “covered employee” all remuneration paid to the individual by the ATEO and any related organization is aggregated. The final regulations generally match the proposed regulations concerning who is and is not a “covered employee,” including providing an exemption from the “covered employee” analysis for remuneration paid for medical services to licensed medical professionals — including veterinarians.

Limited Hours Exception

The final regulations adopt the proposed regulatory provisions concerning the “limited hours exception” from being a covered employee. While board members are not considered employees of an ATEO, officers are presumed to be employees for purposes of applying Code Section 4960. The final regulations adopt the same safe harbor that was provided for in the proposed regulations – an employee who is not paid by an ATEO and performs fewer than 100 hours of services as an employee of an ATEO, is treated as having worked less than 10% of the employee’s total hours for the ATEO, thereby qualifying for safe harbor treatment as not being a covered employee. We anticipate that many persons serving as officers of company or family foundations who devote minimal time to such roles but receive compensation greater than $1 million from a related for-profit entity, will fall within the “limited hours exception.”

Non-Exempt Funds Exception

Under the “non-exempt funds exception,” an employee who performs more significant services for an ATEO but is paid by the related for-profit entity, may not be subject to the Code Section 4960 excise tax when certain conditions are met. To meet the exception, the employee must be compensated solely by the related for-profit entity using assets of the entity that are not tax exempt, and the services provided by the employee must have been primarily for the benefit of the related for-profit entity rather than of the ATEO. However, the final regulations differ from the proposed regulations in determining if the employee has met the hours threshold. To meet the hours threshold, the employee’s time devoted to the related for-profit entity must exceed 50% of the total hours worked for the ATEO and all related organizations — including the for-profit entity. In a change from the proposed regulations, the final regulations make the determination concerning the 50% threshold over a period of two years rather than one to provide more flexibility for ATEOs that may utilize the services of an employee of a related for-profit entity. 


For purposes of the final regulations, like the proposed regulations, “remuneration” means wages within the meaning of Code Section 3401(a), which roughly equates to W-2 Box 1 wages with some modifications. Remuneration also includes amounts paid by a related organization, including an ATEO. A number of comments to the IRS requested that taxable fringe benefits be excluded from the definition of remuneration. The IRS declined to issue such guidance. Instead, the IRS clarified that remuneration includes any amount includible in gross income as compensation under Code Section 7872. 

As explained above and consistent with the proposed regulations, in the final regulations remuneration does not include amounts paid to licensed medical professionals for medical services, which includes administrative tasks like medical recordkeeping. Amounts paid to medical professionals for teaching and research, however, may be considered remuneration, unless it meets within the regulatory exception. The IRS clarified that ATEOs may use a good faith, reasonable allocation between the remuneration for providing medical services and that which is for nonmedical services. The ATEO may use the same principles in making allocations for purposes of any deferred compensation arrangements.

Grandfathered Rule

A number of commenters to the IRS requested that there be some grandfathered period provided in the final regulations — of varying lengths for different provisions within Code Section 4960. The IRS declined to allow for any grandfathered period citing a lack of legislative history to support such a rule. Accordingly, Code Section 4960 is applicable to all ATEOs for all tax years beginning after Dec. 31, 2016.

What Happens Next?

These regulations are final and are binding guidance on both the IRS and taxpayers. This means that all taxpayers to whom Code Section 4960 applies must comply with these regulations, and complying with such regulations is protective to the taxpayer in that the IRS has agreed that the regulations clarify the application of Code Section 4960. We have not addressed all the changes, nor the many nuances, in the final regulations. As with the application of any code section, the analysis of any organization’s specific treatment is fact-specific. Please contact your tax advisor to determine if Code Section 4960 applies to you or your organization, or if you have any questions concerning the application of Code Section 4960 to you or your organization. 

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