The IRS has released the draft of revised Form 4720 and its instructions, which colleges and universities will use to calculate and pay excise taxes on executive compensation and endowment investment income. The draft form includes instructions, but further implementation guidance on both areas is expected from the IRS.
Tax on $1 Million Executive Compensation
Draft 2018 Form 4720 has a new Schedule N for reporting and paying liabilities for the excise tax imposed on organizations that pay excessive compensation to covered employees. Section 4960 of the IRC, enacted in the Tax Cuts and Jobs Act (TCJA), imposes an excise tax equal to 21 percent of the sum of the compensation exceeding $1 million for the taxable year with respect to any covered employee and any excess parachute payment paid by the organization to any covered employee.
Form 4720 does not adequately address a key component of §4960: the pro-rata allocation of liability among related employers when remuneration from more than one employer is taken into account for purposes of determining the amount owed. For example, a university and its sports booster foundation might jointly pay a coach a salary of $1.5 million. Even if the university and foundation have agreed that the foundation will fully pay the 21 percent tax, both the school and the foundation are required to file the form and calculate and pay their proportionate share of tax on the $500,000 in excess remuneration.
Taking a joint and several liability approach, the form requires that each employer file Form 4720 and report proportionate tax on the covered employee’s total remuneration. In this entity-by-entity approach, there is no mechanism within Schedule N to indicate, for instance, that the foundation is paying all of the 21 percent tax so that the school is not liable for the payment and should be discharged from reporting obligations.
The instructions also do not recognize that related entities may have entered into an agreement to pay other than a pro-rata portion of their respective tax obligations under the statute. One purpose of such agreements is to relieve a party of the administrative burden of such reporting, and the IRS has perhaps unintentionally re-imposed this burden.
Until now, Form 4720 has been chiefly used to report excise taxes on private foundations. It may be unfamiliar to colleges and universities that now must use it to pay excise taxes on excessive executive compensation. (NACUBO explained this in comments filed with the IRS in April.)
Additionally, the lack of opportunity to describe how the related entities have allocated Section 4960 tax liabilities could be confusing to users of Form 4720. The specific instructions to Schedule N require taxpayers to attach a statement to Form 4720 indicating the name and EIN of related employers but do not require information on how tax liabilities have been allocated.
Excise Tax on Net Investment Income
Certain private colleges and universities will use Form 4720 to calculate the new 1.4 percent excise tax on their net investment income, enacted as part of the TCJA. The form must be filed for tax years beginning in 2018.
New Schedule O of Form 4720 provides line-by-line instructions on how to compute the endowment excise tax. The instructions reference and follow IRS Notice 2018-55, which provided preliminary guidance on definitions and the calculation of net investment income largely by reference to the private foundation net investment income tax rules.
The 2018 Form 990 provides the springboard for filing Form 4720. If an institution checks the “Yes” box to Part V, line 16, of the new draft 2018 Form 990 (that asks whether the organization is an educational institution subject to the excise tax on net investment income) it will be directed to complete Form 4720, Schedule O.
An institution is subject to the excise tax if it meets the following threshold tests:
(1) The institution has at least 500 tuition-paying students, based upon a daily average student count, during the preceding tax year;
(2) More than 50 percent of those students must have been located in the United States; and (3) At the end of the preceding tax year, the aggregate fair market value of the assets that are not used directly in carrying out the institution’s exempt purpose and are held by the institution and related organizations must be at least $500,000 per student.
The instructions to the draft 2018 Form 990 contain a worksheet (p. 19) with line-by-line instructions for organizations to use to determine whether they meet the threshold tests. To determine what assets are used directly in carrying out the college’s exempt purposes, the instructions to the Form 990 worksheet direct organizations to the private foundation rules regarding minimum distributions.
The draft Form 4720 instructions confirm that there is no requirement to make estimated tax payments for the college endowment excise tax, and thus Form 990-W does not apply to the new tax. While the form provides certain instructions, NACUBO anticipates that the IRS will issue further guidance related to compliance with the new tax.
Send Comments to the IRS
If implemented in its current form, draft Form 4720 could create administrative burdens for both taxpayers and the IRS. NACUBO encourages institutions to file comments on the form with the IRS. Comments may be submitted here.