Your 457(f) Plan and the Impact of the new 21% Nonprofit Excise Tax
Published by CUNA Councils

Your 457(f) Plan and the Impact of the new 21% Nonprofit Excise Tax
Published by CUNA Councils

By now, anyone who has been paying attention knows that the 2017 Tax Act holds significant ramifications for nonprofit organizations, including credit unions. In particular, the provision of the bill that imposes a 21 percent excise tax on the part of executive salaries that exceeds $1 million has credit unions scrambling for ways to mitigate this new potential tax burden.Wildly unpopular (for obvious reasons) with tax-exempt organizations, the excise tax provision is designed to correlate nonprofit executive compensation to the corporate world, where compensation that exceeds $1 million is not tax-deductible. The notion that nonprofit and for-profit compensation should be equally taxed is debatable. But for now, Congress has decided it’s the law.Granted, most credit union executives don’t receive annual compensation in excess of $1 million. But keep in mind that “total taxable compensation” includes cash and the cash value of all remuneration, including benefits (except contributions to qualified plans), from all related organizations. The excise tax also applies to distributions from 457(f) plans that push an executive’s current compensation above the $1million threshold.

If your credit union uses a 457(f) plan to enhance an executive’s post retirement income, odds are good you’ve got a problem. In the year the executive retires, the assets in the 457(f) plan immediately transfer from the credit union’s balance sheet to the executive’s. The IRS considers that transfer to be current compensation for the year, making your credit union liable for the 21 percent excise tax for amounts in excess of the $1 million threshold.

In the past, Congress would often “grandfather” existing plans to exempt them from newly passed tax laws. As yet, they have not done so with this provision of the 2017 Tax Act. Furthermore, having an excise tax expense of several hundred thousand dollars on your Form 990 doesn’t look good to credit union members who may already consider executive compensation to be excessive.

All of which makes it in your best interests – to your credit union and your executives – to address the excise tax issue in a timely manner.

Choosing the Right Approach

Depending on your particular situation, there are several options available that can provide the credit union and the executive with the most appropriate and efficient structure. These include traditional and modified 457(f) and loan regime split dollar programs, as well as several other types of arrangements that are gaining in popularity because of the new excise tax.

Each type of plan has its own strengths and weaknesses, all of which should be carefully considered before proceeding with a specific course of action. The key to achieving the best solution is to weigh the advantages and disadvantages of each plan type against the unique needs of your credit union and the executive.

One of the first steps in determining the right type of plan for your situation is to classify the income level of the plan participants into one of two categories:

  • Executives with more than $1 million in current compensation, who expect to receive a distribution from a 457(f) plan in the future
  • Executives with less than $1 million in current compensation, who expect to receive a distribution from a 457(f) plan in the future that will push total compensation above $1 million in the year they retire

Once executives are classified and the potential tax is quantified, the credit union should then focus on three additional factors – plan expense, administrative burden and liquidity/flexibility – all of which can vary significantly according to the type of plan implemented. When evaluating these factors, keep in mind that the long-term goal is to minimize the time and expense to the credit union while maximizing the benefit to the executive.

Scott B. Hinkle is a partner and credit union practice leader for Grant, Hinkle & Jacobs, a consulting firm that specializes in executive compensation, business succession, fixed-asset alternatives, and special programs for credit unions.