By Ray Birch
BIRMINGHAM, Ala.—The IRS has now issued interim guidance on how tax-exempt organizations will comply with the new excise tax that was part of the Tax Cuts and Jobs Act—and Dennis Dollar says federal CUs have dodged a bullet with the new 92-page document.
However, the former NCUA chairman also sees some bad news in the guidance, including no clause grandfathering existing compensation plans or deferred benefits already in place, and he fears the new rule could slow FCU growth by having a chilling effect on hiring and retaining quality executive talent.
As CUToday.info has reported, the new law imposes a 21% excise tax on executive compensation, including salary and benefits, that exceeds $1 million annually. The tax would be paid by the credit union.
A Win For FCUs
Dollar said the interim guidance is a win for FCUs in that they have dodged IRS form 990. The interim guidance requires federal credit unions to report executive compensation on IRS form 4720. State-chartered CUs have been required to complete 990 forms, and that has not changed. State charters must also now complete form 4720.
“Before this guidance was issued, and it was long in coming, many of us hoped the IRS would not require the 990 form, because of its widespread reporting requirements and how the public accessibility of 990 data can cause potential public relations concerns,” said Dollar about the law that was enacted more than a year ago, even though the IRS didn’t provide any guidance until this month, giving credit unions little time to make plans for filing their 2018 tax year documents
Unlike form 990, which requires an organization to report the names and compensation (salary and benefits) for its top five executives, form 4720 only asks for the names and compensation for those who make more than $1 million annually. It also requires only reporting the amount above $1 million that’s made by an executive in the tax year.
In noting “PR concerns” that credit unions should be prepared to deal with, Dollar cited news stories in recent years—some of which have been highlighted by the banking industry—that report CU CEO compensation, with the banking industry then raising questions over why the individual would make that amount of money at a not-for-profit cooperative.
What It Takes
“It takes investment in talent to get quality talent,” Dollar said. “But the banks like to keep credit unions at a competitive disadvantage, so they try to make an issue out of credit union executive compensation.”
Dollar, currently principal at Dollar Associates, shared his comments during a recent webinar on the new guidance led by his firm and TriscendNP, which provides executive benefit, compensation and succession planning services for credit unions and other nonprofit institutions. The webinar was attended by nearly 300 credit unions.
“The one line applicable to credit unions on a ten-page 4720 form is not nearly as extensive as the 990 form, which can with its schedules, instructions and preparation guidance, end up being 60 to 70 pages” said Dollar, noting that dodging the 990 eliminates considerable additional regulatory burden for FCUs. “The 4720 is also not publicly available data in the same way as is the 990. You can get 990 data from a Google web search, but you can’t get 4720 data as easily.”
Filing a FOIA
But that does not prevent someone from asking for a 4720 form via a Freedom of Information Act request, noted Dollar.
“So, if someone wants to, they can go through some additional steps and get your credit union’s 4720 information. But again, they will only see the names of the executives with compensation over $1 million annually and—even in that case—the amount above $1 million,” he said.
Dollar contends that extra step of having to get a 4720 form via a Freedom of Information Act request will likely limit inquiries to those who “may have been tipped about something potentially newsworthy is in the document.”
However, Dollar stressed any FCU that files a 4720 and lists an executive making more than $1 million in salary and benefits annually should be prepared for that information to someday become public.
“It is best to have a plan as to how you will address it if it gets in the media rather than scrambling after the fact to come up with a communication plan,” he said. “And if you ever have to address this, I think the best way is head on: ‘This is what we paid our executive. This is why the executive deserves it based upon the
Dennis Dollar
marketplace for top talent. This is why we need this person to help our organization grow.’”
Reluctant Raises?
But it’s a potential slowing of growth as a result of the excise tax and its reporting that troubles Dollar, who fears some federal CUs may be reluctant to pay higher compensation and provide fuller benefit plans to executives in hopes of avoiding the $1-million mark, its reporting and excise tax implications. That, he emphasized, will only hurt credit unions as they compete with the high-paying bank salaries for talent to lead the movement forward. Dollar noted all of this is coming about at the same time a significant number of CU CEOs are approaching the age when they will likely retire.
“The key to credit union growth over the next 15 to 20 years is the ability to keep and grow the executive talent necessary to expand the industry’s market footprint” said Dollar. “We are in a very competitive market for executive talent that will become even more competitive. The biggest concern I have about this new reporting regime and excise tax is the tendency some credit unions already have to be quite conservative in executive benefits might result in them becoming even more conservative on executive competitiveness to their competitive disadvantage.”
Split-Dollar Plans
Dale Edwards, principal and cofounder of TriscendNP, pointed out even though there had been some concern initially, the ability to keep executives off of the excess compensation and potential excise tax list through the split-dollar structure for deferred executive benefits programs versus the standard 457f-type SERP plans is protected under the guidance.
The structure of split-dollar plans are non-compensatory because they are loans repaid by life insurance owned by the CU. That leaves in play a structural option to avoid the excise tax and improve the reporting numbers, said Edwards.
“Split-dollar is an increasingly popular option for credit unions and other non-profits since the excise tax came about,” explained Edwards. “It’s a terrific alternative, but must be stress tested by the credit union first.”
How It Works
Dale Edwards
Edwards said that collateral assignment split-dollar life insurance arrangements can work best toward providing a leader with an incentive to stay, and also avoid the excise tax. The arrangements are called split-dollar because the death benefits, cash surrender values, and premium payments are split between an employer and employee.
In this case the credit union is loaning substantial funds to the executives to buy life insurance policies. The arrangement generally provides that the employer will be repaid its cumulative premiums upon the death of the employee from the proceeds of the policy and any remaining proceeds will be paid to the employee’s named beneficiary.
Collateral assignment split-dollar life insurance is used by many credit unions as a more affordable means of funding an executive’s supplemental retirement benefits, sources have stated.
Several versions of split-dollar programs exist, and a loan regime split-dollar arrangement, Edwards said, may be the best option to address the excise tax issue.
No Recognition of Tax Exemption
Dollar made the point that there is no recognition of the longstanding FCU tax exemption on this new 21% excise tax in the language of the IRS guidance.
“They did not use the hoped for broad authority to extend the CU corporate tax exemption over to the excise tax,” he said. “Credit unions are unequivocally covered by the excise tax even though they remain exempt from corporate income taxation. They must report executive compensation over $1 million and must pay 21% on amounts over $1 million with no grandfather clause for existing compensation plans or deferred benefits already in place.”
Edwards said FCUs should not expect any IRS leniency going forward, but at the same time should also not expect the road to get rougher, such as having federal credit unions someday complete the 990 form. The IRS still must issue final guidance, but that may not happen for a number of months, Edwards said, noting FCUs will file their 2018 tax form under the interim guidance.
No Threat Seen
Some experts, over the past year, have been concerned the excise tax indicates the CU corporate tax exemption could someday come under serious challenge in Washington. But Dollar does not see that.
“I don’t see this as some harbinger of losing the credit union tax exemption, because of the distinct difference in the tax law between corporate income taxation and the excise tax,” said Dollar. “These are two completely different things and the IRS affirmed that in this interim guidance by actually quoting the tax section that says credit unions retain their corporate income tax exemption. However, they said this does not exempt credit unions from being subject to the excise tax.
“The retention of the corporate income tax exemption at the same time they were imposing the excise tax on executive compensation over $1 million is a recognition on the part of the IRS—and, most importantly on the part of Congress when they passed the latest tax bill—that we could have chosen to tax you on the corporate income tax but we did not. We respect the CU tax exemption. But the excise tax is something different, and credit unions are covered by that.”
Congress is Watching
Nevertheless, Dollar said the excise tax is, while not a shot across the bow on taxation, an indication that Congress and IRS are watching not-for-profit entities more closely than in the past.
“Obviously, there is a feeling in Congress that compensation above a certain level at not-for-profit entities should be disclosed and perhaps even taxed,” Dollar said. “That is a trend at IRS and Congress worth watching.”