When the 2017 tax reform bill passed, it included a provision that imposed an excise tax on compensation above $1 million for certain kinds of entities—including political action committees (PACs)—even if paid by the connected organization and not the PAC itself. Some companies feared that having senior executives provide services to the PAC could trigger this excise tax based on how the statute was worded. Fortunately, on June 5, 2020, the Internal Revenue Service issued proposed regulations providing guidance on this provision that will reduce the risk that the excise tax will apply.
Background on Proposed Regulations and Application to Company PACs
Section 4960 of the Internal Revenue Code, included as part of the 2017 Tax Cuts and Jobs Act, imposes an excise tax equal to the corporate income tax rate (currently 21%) on compensation above $1 million paid by a tax-exempt organization (including a PAC exempt from federal income tax under Section 527) to any of its five highest‑compensated employees (i.e., the “covered employees” whose compensation is potentially subject to the excise tax). A company‑sponsored PAC typically does not have its own employees. Instead, employees of the sponsoring company provide services to the PAC without receiving compensation from the PAC. Because Section 4960 applies to compensation paid by a PAC’s “related organization” (including the sponsoring company), some commentators expressed concern that the compensation of company executives that serve as officers of the company PAC would be subject to the excise tax and some companies reportedly dissolved their PACs due to concerns about the excise tax. The proposed regulations provide clarity and relief for companies and their connected PACs.
Relief Provided by the Proposed Regulations for Company PACs
The proposed regulations provide an important exception permitting a PAC to exclude certain employees when identifying the PAC’s covered employees.
Pursuant to the “nonexempt funds” exception, companies can be assured that no excise tax will apply if (a) the PAC does not pay the highly-compensated employees’ wages or reimburse the company (directly or indirectly) for the highly-compensated employees’ pay and (b) the highly‑compensated employee does not spend 50% or more of her or his time providing services to the PAC. Because PACs typically do not pay direct compensation to employees or reimburse the sponsoring company for the time company employees spend providing services to the PAC, the nonexempt funds exception will be useful to a large contingent of companies whose executives serve part-time in officer roles with the connected PAC.*
To illustrate the nonexempt funds exception, consider the following example:
Company and Connected PAC – Donated Services of Government Affairs Employees
The executive vice president of external affairs of a company receives compensation of more than $1 million from the company. The EVP also serves as the chair of the company-sponsored PAC. In her capacity as such, the EVP spends approximately 5% of her time on PAC matters and the remainder on other matters. The EVP is not compensated by the PAC and the PAC does not reimburse the company for the portion of the vice president’s time devoted to the PAC or pay a fee to the company for the services of other company employees. Pursuant to the nonexempt funds exception, the EVP does not constitute a “covered employee” of the PAC. Thus, the compensation the EVP receives from the company is not subject to excise tax under Section 4960. Other company employees that spend less than 50% of their time on PAC matters will similarly be disregarded for purposes of determining the PAC’s covered employees. To the extent certain company employees (such as a PAC administrator) spend 50% or more of their time on PAC matters, such employees would not be disregarded for purposes of determining the PAC’s covered employees. However, unless such employees receive more than $1 million of compensation from the company, their compensation will not trigger excise tax.
The conclusion is that the nonexempt funds exception in the proposed regulations should provide welcome relief to many companies whose highly-compensated employees serve as officers of a connected PAC. If you have questions about the proposed regulations, please reach out to Venable’s Political Law Practice.
* The proposed regulations also contain a “limited hours” exception whereby an individual will not be counted as a “covered employee” that potentially triggers the Section 4960 tax if the individual is not paid by the tax-exempt entity, and either provides no more than 10% of their hours of service to the tax-exempt entity or performs at most 100 hours of service per year for the tax-exempt entity.