Interim Guidance on Section 4960 Excise Tax Allocations: Considerations for Tax-Exempt Healthcare Organizations

Section 4960 holds Section 501(c)(3) organizations to requirements of publically held corporations’ relative to covered employee compensation under IRC Section 162(m)⁶ and parachute payments under IRC Section 280(G),⁷ thus evening the playing field between tax exempt and publicly held corporations. 

However, compensation attributable to medical services of certain qualified medical professionals is exempt from the definitions of remuneration and compensation. For purposes of determining a who is a covered employee under Section 4960, remuneration paid to a licensed medical professional, including a doctor or nurse, which is directly related to the performance of medical services is not taken into account. Remuneration paid to such a professional in any other capacity is taken into account.⁸

Thus, while remuneration relative to medical practice would not apply to the $1 million excise tax, remuneration for administrative and other non-medical services would. Physicians who serve multiple roles, including administrative, research and teaching activities could be affected, as would their hospital employers for purposes of IRC Section 4960’s excise tax.

Internal Revenue Service Request for Comments Following Enactment of the TCJA

 The Department of Treasury (The Treasury) and Internal Revenue Service (IRS) included Section 4960 as a priority on the February 7, 2018 second quarter update to the 2017-2018 Priority Guidance Plan.⁹ This updated Priority Guidance Plan reflected 29 additional projects, including those that had become near term priorities as a result of the TCJA, e.g., guidance on certain issues relating to the excise tax on excess remuneration paid by an ATEO under Section 4960.¹⁰

Issuing periodic updates to the annual  Priority Guidance Plan allows the IRS flexibility to consider comments received from taxpayers and tax practitioners relating to guidance priorities and to respond to developments arising during the plan year.¹¹ Therefore, the IRS invited the public to provide comments and suggestions as it develops guidance throughout the plan year, including comments relative to Section 4960. 

On April 27, 2018, The Treasury and IRS released Notice 2018-43 inviting public comment on recommendations for items that should be included on the 2018-2019 Priority Guidance Plan.¹² In it, The Treasury and IRS reiterated its expectation to continue to concentrate on guidance implementing the TCJA during the current plan year (2017-2018) and during the 2018-2019 plan year. The Treasury and IRS did not expect to be able to complete a number of guidance projects on the 2017-2018 Priority Guidance Plan, but would carry them over to the 2018-2019 Priority Guidance Plan.¹³

Since enactment of the TCJA, The Treasury and IRS received a number of letters specifically asking for guidance related to implementation of the provisions of the TCJA. Those suggestions informed the projects then in development and were also considered in formulating the 2018-2019 Priority Guidance  Plan.¹⁴  Following the comment period, The Treasury and IRS released the 2018-2019 Priority Guidance Plan on November 8, 2018. Included within Part 1: Implementation of the TCJA is item 39, guidance on the excise tax on excess remuneration under new Section 4960, as added by Section 13701 of the TCJA.¹⁵

Interim Guidance Under Section 4960, Notice 2019-09

On January 1, 2019, the IRS issued Notice 2019-09 (Notice) providing interim guidance regarding Section 4960. The interim guidance is intended to assist taxpayers in applying Section 4960 until The Treasury and the IRS issue Proposed Regulations as part of the 2018-2019 Priority Guidance Plan. The Treasury and IRS will incorporate guidance provided in the Notice in the forthcoming Proposed Regulations.¹⁶ Until further guidance is issued, taxpayers may base their position upon a good faith, reasonable interpretation of the statute. The positions represented within the Notice constitute a good faith, reasonable interpretation of the statute.¹⁷

Specifically, commenters, representing nonprofit healthcare organizations, had requested guidance as to the meaning of “licensed medical professional,” which is not defined in the statute.¹⁸ Commenters also requested guidance on the definition of medical services for purposes of Section 4940. In addition, commenters requested guidance on whether activities related to medical services, such as administrative, teaching and research services are medical services.¹⁹

Tax Treatment of Remuneration for Medical Services Under Section 4960

For the purposes of Section 4960, remuneration paid to a licensed medical professional for the direct performance of medical services (including nursing services) by the professional is not remuneration for purposes of calculating the excess remuneration subject to excise tax. Remuneration for medical services is also disregarded for purposes of determining whether an individual is a covered employee and for purposes of determining whether a payment is a parachute payment.²⁰

Definition of Medical Professional

As noted above, the TCJA did not provide a definition for a “licensed medical professional.” The interim guidance explains that a licensed medical professional is an individual who is licensed under state or local law to perform medical services (including nursing services).²¹

Definition of Medical [Care] Services

As the TCJA did not define medical services, the Notice²² relies upon established tax sources, i.e. applicable IRC sections and Treasury Regulations to provide such guidance. A licensed medical professional directly performs medical services to the extent those services constitute “medical care” as defined under Section 213(d)(1)(A)²³ and Treasury Regulation 1.213(e)(1)(i).²⁴ Services for the diagnosis, cure, mitigation, treatment or preventing of disease, including services for the purpose of affecting any structure or function of the body constitute medical care services. In contrast, teaching or research services are not medical services to the extent the services performed do not relate directly to the diagnosis, cure, mitigation, treatment of prevention of disease or affect a structure of function of the body.

Documenting patient care and condition is also part of the direct performance of medical services, as is accompanying another licensed professional as a supervisor while that medical professional performs medical services.²⁵ However, managing an organization’s operations, including scheduling, staffing, appraisal and similar functions that may relate to a particular medical professional or professionals who perform medical services is not the performance of medical services and thus subject to the excise tax.²⁶

Allocation of Remuneration Between Medical Services and Other Services

The IRS provides in the interim guidance that if during a calendar year an employer pays a covered employee remuneration for both medical and other services, such as administrative or management services, the employer must make a reasonable, good faith allocation between remuneration for those medical services and the other services.

If an employment agreement or similar written arrangement sets forth the remuneration to be paid for particular services, that allocation must be applied unless the facts and circumstances demonstrate that the amount allocated for medical services is unreasonable for those services or that the allocation was established for purposes of avoiding excise tax application under Section 4960.²⁷

If some or all of the remuneration is not reasonably allocated in the employment or other agreement, an employer may use a representative sample of records, such as patient, insurance and Medicare/Medicaid billing records or internal time reporting mechanisms to determine the time spent providing medical services. The employer then allocates remuneration to medical services in proportion to the total hours the covered employee worked for the employer.

Further, if some or all of the remuneration is not reasonably allocated in an employment or other agreement, an employer may use salaries or other remuneration for duties comparable to those the employee performs, as a medical doctor or hospital administrator, for purposes of making a reasonable allocation between remuneration for medical and nonmedical services.²⁸

Allocation Examples

The Notice, Q/A-15(e) presents three examples of the most common scenarios with licensed medical professionals serving multiple roles in ATEO hospitals and/or organizations. 

Example 1 illustrates the most common scenario where a medical doctor provides both patient care services to an ATEO hospital and management and administrative services to the hospital as head of a medical practice group within the hospital. Based on a representative sample of insurance and Medicare billing records, as well as time reports that the medical doctor submits to the hospital, the hospital determines half of the medical doctor’s time is spent on medical services (to his or her patients) and half performing administrative and management services as head of the practice group. Thus, only that portion of the medical doctor’s remuneration allocated to the other, non-medical services is remuneration subject to excise tax imposition.²⁹

Example 2 describes the scenario involving a medical research organization that is also an ATEO. Here, the medical doctor is a covered employee of the medical research organization and works on a research trial. The medical doctor provides experimental treatment to patients and tracks the patients’ individual conditions in a manner that ordinarily occurs in a medical practice. Thus, to the extent the medical doctor is treating a patient’s disease within the meaning of Section 213(d)(1)(A), said services will be considered medical services for purposes of Section 4960 and associated remuneration will not be subject to excise tax imposition.

However, as part of research trial, the medical doctor also compiles patients’ records and prepares reports for both individual patient and overall trial results. Such reports are not those ordinarily generated in a medical practice. When the medical doctor performs research services not ordinarily performed in a medical practice, said services will not be considered medical services for purposes of Section 4960 and associated remuneration will be subject to excise tax imposition.³⁰

Example 3 describes the scenario where a medical doctor is employed by a university hospital that is an ATEO. The medical doctor’s duties include overseeing and teaching a group of resident physicians who have a restricted license to practice medicine. To the extent that the medical doctor, in conjunction with the resident physicians, performs services directly related to the diagnosis, cure, mitigation, treatment or prevention of a patient’s disease or affecting a structure or function of the patient’s body, those services constitute medical  services for purposes of Section 213(d)(1)(A) and will not be subject to excise tax imposition.

The medical doctor’s duties also include instructing the resident physicians in the classroom setting. Because classroom instruction does not involve actual patient treatment, those activities are not medical care under Section 213(d)(1)(A) and remuneration allocated to those services will be subject to excise tax imposition under Section 4960.³¹

Request for Comment

While Notice 2019-09 provides initial advice to ATEOs, The Treasury and IRS intend to propose Treasury Regulations with respect to Section 4960. The IRS request comments on the several topics addressed in Notice 2019-09. Specific to allocation determinations, the Treasury Department and IRS requests comments on how remuneration paid to medical service providers should be reasonably allocated between medical and other services, including how reasonable allocations can be made, taking into account comparable salaries, time spent performing medical services and other services and any applicable agreements.³²

All materials submitted will be available for public inspection and copying. Public comments should be submitted no later than April 2, 2019. Comments should include a reference to Notice 2019-09. All recommendations for guidance submitted by the public in response to the Notice will be available for public inspection and copying in their entirety.

Until further guidance is issued in the proposed regulations, taxpayers may rely on the rules in the Notice for the purposes of Section 4960 effective from December 22, 2017 (date of enactment). Further guidance will be prospective and will not apply to taxable years beginning before the issuance of such guidance.³³

1.  IRC Section 4960 generally provides that an applicable tax-exempt organization that pays remuneration in excess of $1 million or any excess parachute payment to a covered employee is subject to an excise tax on the amount of the excess remuneration and excess parachute payments at a rate equal to the rate of tax imposed on corporations under Section 11 (currently 21 percent). See IRS Notice, 2019-09, page 5, https://www.irs.gov/pub/irs-drop/n-19-09.pdf.
2.  The term remuneration means wages (as defined in section 3401(a)), except that such term shall not include any designated Roth contribution (as defined in section 402A(c)) and shall include amounts required to be included in gross income under Section 457(f). See IRC Section 4960(c)(3)(A), http://uscode.house.gov/view.xhtml?path=/prelim@title26/subtitleD/chapter42&edition=prelim.
3.  As provided in Section 4960(c)(1), an ATEO is any organization which for its taxable year is exempt from taxation under Section 501(c)(3). See http://uscode.house.gov/view.xhtml?path=/prelim@title26/subtitleD/chapter42&edition=prelim.
4.  A covered employee is an employee of an ATOE if the employee is one of the five highest compensated employees of the organization for the taxable year. See Section 4960(c)(2), http://uscode.house.gov/view.xhtml?path=/prelim@title26/subtitleD/chapter42&edition=prelim.
5.  The term 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)(A). The term parachute payment means any payment in the nature of compensation to (or for the benefit of) a covered employee if such payment is contingent on such employee’s separation from employment with the employer and the aggregate present value of the payments of compensation (or for the benefit of) such individual which are contingent on such separation equals or exceeds an amount equal to three times the base amount. See Section 4960(c)(5)(B), http://uscode.house.gov/view.xhtml?path=/prelim@title26/subtitleD/chapter42&edition=prelim.
6.  In the case of any publicly held corporation, no deduction (from corporate income of ordinary and necessary expenses per IRC Section 162(a)) shall be allowed for applicable employee remuneration with respect to any covered employee to the extent that the amount of such remuneration for the taxable year with respect to such employee exceeds $1 million in accordance with IRC Section 162(m). See http://uscode.house.gov/view.xhtml?path=/prelim@title26/subtitleA/chapter1/subchapterB&edition=prelim.
7.  No deduction (from corporate income) is allowed for any excess parachute payment, i.e. any payment equal to the excess of any parachute payment over the portion of the base amount allocated to such payment. See Section 280G(a) and (b)(1), http://uscode.house.gov/view.xhtml?path=/prelim@title26/subtitleA/chapter1/subchapterB&edition=prelim. While the excess parachute payment rules are modeled after Section 280G, there are subtle differences between Section 280(G) and Section 4960. Although Section 280(G) and Section 4860 both use the term “parachute payment,” they define it differently. Whereas the section 4960 definition refers to payments contingent on an employee’s separation from employment, the section 280(G) definition refers to payments contingent on a change in the ownership or effective control of a corporation. There are also other differences between sections 280(G) and Section 4960, e.g., Section 280(G) does not include exceptions for payments to licensed medical professionals or non-highly compensated employees. See IRS Notice-2019-09, page 25, https://www.irs.gov/pub/irs-drop/n-19-09.pdf.
8. The conference agreement exempts compensation paid to employees who are not highly compensated employees (within the meaning of Section 414(q)) from the definition of parachute payments and also exempts compensation attributable to medical services of certain qualified medical professionals from the definitions of remuneration and parachute payment. For purposes of determining whether someone is a covered employee, remuneration paid to a licensed medical professional which is directly related to the performance of medical services by such professional is not taken into account, whereas remuneration paid to such a professional in any capacity is taken into account. A medical professional for this purpose includes a doctor or nurse. Tax Cuts and Jobs Act of 2017, Joint Explanatory Statement of the Committee Conference, supra, page 349, available at https://www.finance.senate.gov/imo/media/doc/CRPT-115hrpt466.pdf.
9.  The 2017-2018 Priority Guidance Plan sets forth guidance priorities for the Treasury and the IRS based on public input and taking into account the deregulatory policies and reforms described in Section 1 of Executive Order 13879 and Executive Order 13777. The 2017-2018 Priority Guidance Plan contains projects that the IRS hopes to complete during the 12-month period from July 1, 2017 through June 30, 2018 (the plan year). Most of the projects do not involve the issuance of new regulations. Rather, these projects provide helpful guidance to taxpayers on a variety of tax issues important to individuals and businesses in the form of: (1) revocations of final, temporary or proposed regulations; (2) notices, revenue rulings and revenue procedures; (3) simplifying and burden reducing amendments to existing regulations; (4) proposed regulations; or (5) final regulations adopting proposed regulations. See https://www.irs.gov/pub/irs-utl/2017-2018_pgp_initial.pdf. The Treasury Department’s Office of Tax Policy and the IRS issue a Priority Guidance Plan each year, and update it periodically throughout the year.
10. Id. at page 4.
11. The public guidance process can be fully successful only if the IRS has the benefit of the insight and experience of taxpayers and practitioners who must apply the internal revenue laws, Id. at page 2.
12. The 2018-2019 Priority Guidance Plan  identifies guidance projects that the Treasury and IRS intend to work on as priorities during the period from July 1, 2018 through June 30, 2019, IRS Notice 2018-43, Public Comment Invited on Recommendations for 2018-2019 Priority Guidance Plan, https://www.irs.gov/pub/irs-drop/n-18-43.pdf.
13. Id. at page 2.
14. Taxpayers were encouraged to submit recommendations by June 15, 2018 for possible inclusion on the original 2018-2019 Priority Guidance Plan. Id. at page 3.
15.  Department of Treasury Joint Statement by the Assistant Secretary for Tax Policy, U.S. Department of Treasury, Commission, Internal Revenue Service and Acting Chief Counsel and Deputy Chief Counsel (Technical), Internal Revenue Service, 2018-2019 Priority Guidance Plan, page 7, available at https://www.irs.gov/pub/irs-utl/2018-2019_pgp_initial.pdf.
16.  A regulation is issued by the IRS and Treasury Department to provide guidance for new legislation or to address issues that arise with respect to existing IRC sections. Regulations interpret and give directions on complying with the law. Regulations are published in the Federal Register. Generally, regulations are first published in proposed form in the Notice of Proposed Rulemaking (NPRM). After public input is fully considered through written comments and even after a public hearing, a final regulation or a temporary regulation as a Treasury Decision (TD), is again published  in the Federal Register. IRS Understanding IRS Guidance - A Brief Primer, https://www.irs.gov/newsroom/understanding-irs-guidance-a-brief-primer.
17.  Notice 2019-09, supra, page 4.
18.  Id. at page 22.
19.  Id. at 23.
20.  Id. at 59.
21.  Id. at 59.
22.  A notice is a public pronouncement that may contain guidance that involves substantive interpretations of the IRC or other provisions of the law. For example, notices can be used to relate what the regulations will say in situations where the regulations may not be published in the immediate future. IRS, Understanding IRS Guidance - A Brief Primer, supra, at page 2.
23.  Per Section 213(d)(1)(A), the term “medical care” means amounts paid for the diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of acting any structure or function of the body. See http://uscode.house.gov/view.xhtml?path=/prelim@title26/subtitleA/chapter1/subchapterB&edition=prelim.
24.  Treas. Reg. 1.213(e)(1)(i), states that the term medical care includes the diagnosis, cure, mitigation, treatment or prevention of disease. Expenses paid for “medical care” shall include those paid for the purpose of affecting any structure of function of the body or for transportation primarily for and essential to medical care. See https://www.govinfo.gov/content/pkg/CFR-2014-title26-vol3/pdf/CFR-2014-title26-vol3-sec1-213-1.pdf.
25.  Including supervision of residents as they perform medical services.
26.  Notice 2019-09, supra, page 60.
27.  Id.
28.  Id. at 61.
29.  Id.
30.  Id. at 62.
31.  Id.
32.  Id. at 90 and 91.
33.  Id.