In 2017, congress passed a comprehensive tax bill that made several changes to how charitable organizations are taxed. Included in this bill was a new provision that levies a 21 percent excise tax on compensation in excess of $1 million paid to nonprofit employees and officers. At first blush, you may not think it applies to you. But it could if you draw a salary from a family business.
Historically, publicly traded companies are taxed on salaries paid to certain highly compensated executives. During tax reform, congress decided to tax highly compensated executives at foundations and charities the same as those public companies, but while doing so, also swept in compensation from “related organizations”, like a private family business.
Treasury then took it a step further in Notice 2019-9 and defined “related organizations” broadly to include family businesses. So, even if a family foundation has a volunteer officer with no or limited salary who also draws a salary from a family business, their compensation above $1 million could be taxed at 21 percent, with the tax allocated between the foundation and the business.
Here’s an example:
Lisa Loo is the CEO of her family’s foundation and earns a salary of $20,000. She is also the founder of the private company that funds that family’s foundation and earns $1.1 million. The family foundation and private company now both have to a pay a portion of a 21 percent tax on Lisa’s combined amount over $1 million – a 21 percent tax on $120,000.
And even if Lisa takes no compensation as CEO, $100,000 of her income will now be subject to the 21 percent tax because she volunteers at the private foundation.
This new tax not only has financial implications for both foundations and private businesses, but it also could force qualified executives to rethink lending their expertise to foundations if they’re already a business leader, therefore curbing meaningful engagement in civil society. It punishes successful business leaders for being generous.
ACR submitted comments to Treasury to address our concerns and urged the department to consider exempting both volunteers of foundations and those who spend a minimal time at, or receive minimal compensation from, the foundation. We’re working with Treasury and policymakers to address our concerns, and we’re cautiously optimistic that forthcoming guidance will include some of the exemptions necessary to preserve philanthropic engagement.