Authors: David W. Sands, CVA, Will Kaufmann, JD, MBA, and Fred M. Lara, CFA, ASA, CVA

2018 was the first tax year during which the new excise tax must be paid on compensation over $1,000,000 for any covered employees of 501(c)(3) organizations.  A covered employee is “any active or former employee who is one of the 5 highest compensated employees of the organization for the current tax year, or was a covered employee in any prior year beginning in 2017 (so that the “covered employee” status persists into subsequent years, meaning that a tax-exempt employer may eventually accumulate more than 5 covered employees).”[1]  This excise tax is paid by the organization and is in addition to potential excise taxes levied on individuals (i.e., covered employees) for “excess benefits” received.  The excise tax is assessed on total compensation of a covered employee, including base compensation, benefits, deferred compensation, and bonuses. 

By way of example, a covered employee (“Executive A”) receives a base compensation of $750,000 per year, plus (i) healthcare insurance premium reimbursement at 75% of the actual cost, (ii) retirement contributions at a rate of 10% per year, (iii) performance bonuses dependent on preset criterion and in varying amounts, and (iv) access to and use of company fleet vehicles for personal and professional use.  Therefore, Executive A’s compensation is summarized as follows:

  • Base Compensation: $750,000 per year
  • Health Insurance Benefits: $25,000 per year
  • Transportation Benefits: $25,000 per year
  • Retirement Contributions: $75,000 per year
  • Net Bonus: $375,000 per year

Assuming total compensation is $1,250,000 (based on the sum of the above), the 21% excise tax would be applicable to $250,000 (i.e., the amount of compensation in excess of $1,000,000, for an excise tax of $52,500; calculated as $250,000 x 21%).

Organizations contending with this new tax are considering its impact as applicable to recruitment and compensation plans for key executives.  Organizations already paying covered employees above the $1,000,000 threshold, may first look to engage in some restructuring or alternative compensation methods.  However, such workarounds do not always achieve their desired goal.  For example, shifting part of the compensation into a non-employment-based consulting arrangement, or making payments through pass-through entities, would not avoid the excise tax. 

A viable alternative structure rapidly gaining traction is the split dollar loan arrangement.  Modern Healthcare provides a simple summary, noting that split dollar loan arrangements involve employers making substantial loans to executives that go toward their life insurance premiums.  Loans are not considered wages and are thus not subject to the excise tax.  Split dollar loan arrangements then allow those executives to, upon retirement, borrow accumulated, non-taxable cash from those life insurance companies every year.  The cash borrowing has to be done within prescribed limits so that the employer and the executives’ beneficiaries are paid the full benefits under the life insurance policy upon the executive’s death.[2]  The interest associated with the loan is accrued and must be paid back vis-à-vis the death benefit, which should be assigned to the organization.[3]

While some organizations desire to avoid the excise tax altogether, others view it simply as the cost of doing business.  What is yet to be seen is how the new tax will affect compensation and recruiting trends for nonprofit organizations. 

Consider the following:

  • Can the excise tax be leveraged as a negotiating tool in hiring?
  • Will this encourage leadership changes to reduce payroll and tax liabilities?
  • Who will ultimately bear the burden of the excise tax?
  • What is going to be the trend in executive compensation after the first few years of the new rule?
  • Are executive and other leadership hiring decisions going to be affected? If so, how?
  • How will inflation affect the $1,000,000 threshold that was set in 2017?

Regardless of the impact the excise has on the organization, the issue of “excess benefit” remains.  Determination that compensation provided excess benefit would result in intermediate sanctions for the individual executive (see our general overview of executive compensation for additional details).  If you would like to determine the potential impact the excise tax would have on your organization, revise a compensation plan, or explore alternative compensation approaches, please contact HealthCare Appraisers so we can discuss tailored solutions for your needs.

[1] “2018 Tax Reform Series: New Excise Tax on “Excess” Executive Compensation Paid by Tax-Exempt Employers,” Alec Nealon and Melissa Ostrower, Benefits Law Advisor, January 8, 2018;
[2] Modern Healthcare, “Not-for-profit health systems working to get around tax on high exec pay,” Tara Bannow, June 23, 2018,
[3] JD Supra, “Understanding And Planning For The Excise Tax On Executive Compensation Paid By Tax-Exempt Employers,” Ofer Lion and Douglas Mancino, August 13, 2018, available at