(a) Relationship between section 4955 excise taxes and substantive standards for exemption under section 501(c)(3). The excise taxes imposed by section 4955 do not affect the substantive standards for tax exemption under section 501(c)(3), under which an organization is described in section 501(c)(3) only if it does not participate or intervene in any political campaign on behalf of any candidate for public office.

(b) Imposition of initial taxes on organization managers—(1) In general. The excise tax under section 4955(a)(2) on the agreement of any organization manager to the making of a political expenditure by a section 501(c)(3) organization is imposed only in cases where—

(i) A tax is imposed by section 4955(a)(1);

(ii) The organization manager knows that the expenditure to which the manager agrees is a political expenditure; and

(iii) The agreement is willful and is not due to reasonable cause.

(2) Type of organization managers covered—(i) In general. The tax under section 4955(a)(2) is imposed only on those organization managers who are authorized to approve, or to exercise discretion in recommending approval of, the making of the expenditure by the organization and on those organization managers who are members of a group (such as the organization's board of directors or trustees) which is so authorized.

(ii) Officer. For purposes of section 4955(f)(2)(A), a person is an officer of an organization if—

(A) That person is specifically so designated under the certificate of incorporation, bylaws, or other constitutive documents of the foundation; or

(B) That person regularly exercises general authority to make administrative or policy decisions on behalf of the organization. Independent contractors, acting in a capacity as attorneys, accountants, and investment managers and advisors, are not officers. With respect to any expenditure, any person described in this paragraph (b)(2)(ii)(B) who has authority merely to recommend particular administrative or policy decisions, but not to implement them without approval of a superior, is not an officer.

(iii) Employee. For purposes of section 4955(f)(2)(B), an individual rendering services to an organization is an employee of the organization only if that individual is an employee within the meaning of section 3121(d)(2). With respect to any expenditure, an employee (other than an officer, director, or trustee of the organization) is described in section 4955(f)(2)(B) only if he or she has final authority or responsibility (either officially or effectively) with respect to such expenditure.

(3) Type of agreement required. An organization manager agrees to the making of a political expenditure if the manager manifests approval of the expenditure which is sufficient to constitute an exercise of the organization manager's authority to approve, or to exercise discretion in recommending approval of, the making of the expenditure by the organization. The manifestation of approval need not be the final or decisive approval on behalf of the organization.

(4) Knowing—(i) General rule. For purposes of section 4955, an organization manager is considered to have agreed to an expenditure knowing that it is a political expenditure only if—

(A) The manager has actual knowledge of sufficient facts so that, based solely upon these facts, the expenditure would be a political expenditure;

(B) The manager is aware that such an expenditure under these circumstances may violate the provisions of federal tax law governing political expenditures; and

(C) The manager negligently fails to make reasonable attempts to ascertain whether the expenditure is a political expenditure, or the manager is aware that it is a political expenditure.

(ii) Amplification of general rule. For purposes of section 4955, knowing does not mean having reason to know. However, evidence tending to show that an organization manager has reason to know of a particular fact or particular rule is relevant in determining whether the manager had actual knowledge of the fact or rule. Thus, for example, evidence tending to show that an organization manager has reason to know of sufficient facts so that, based solely upon those facts, an expenditure would be a political expenditure is relevant in determining whether the manager has actual knowledge of the facts.

(5) Willful. An organization manager's agreement to a political expenditure is willful if it is voluntary, conscious, and intentional. No motive to avoid the restrictions of the law or the incurrence of any tax is necessary to make an agreement willful. However, an organization manager's agreement to a political expenditure is not willful if the manager does not know that it is a political expenditure.

(6) Due to reasonable cause. An organization manager's actions are due to reasonable cause if the manager has exercised his or her responsibility on behalf of the organization with ordinary business care and prudence.

(7) Advice of counsel. An organization manager's agreement to an expenditure is ordinarily not considered knowing or willful and is ordinarily considered due to reasonable cause if the manager, after full disclosure of the factual situation to legal counsel (including house counsel), relies on the advice of counsel expressed in a reasoned written legal opinion that an expenditure is not a political expenditure under section 4955 (or that expenditures conforming to certain guidelines are not political expenditures). For this purpose, a written legal opinion is considered reasoned even if it reaches a conclusion which is subsequently determined to be incorrect, so long as the opinion addresses itself to the facts and applicable law. A written legal opinion is not considered reasoned if it does nothing more than recite the facts and express a conclusion. However, the absence of advice of counsel with respect to an expenditure does not, by itself, give rise to any inference that an organization manager agreed to the making of the expenditure knowingly, willfully, or without reasonable cause.

(8) Cross reference. For provisions relating to the burden of proof in cases involving the issue of whether an organization manager has knowingly agreed to the making of a political expenditure, see section 7454(b).

(c) Amplification of political expenditure definition—(1) General rule. Any expenditure that would cause an organization that makes the expenditure to be classified as an action organization by reason of § 1.501(c)(3)-1(c)(3)(iii) of this chapter is a political expenditure within the meaning of section 4955(d)(1).

(2) Other political expenditures—(i) For purposes of section 4955(d)(2), an organization is effectively controlled by a candidate or prospective candidate only if the individual has a continuing, substantial involvement in the day-to-day operations or management of the organization. An organization is not effectively controlled by a candidate or a prospective candidate merely because it is affiliated with the candidate, or merely because the candidate knows the directors, officers, or employees of the organization. The effectively controlled test is not met merely because the organization carries on its research, study, or other educational activities with respect to subject matter or issues in which the individual is interested or with which the individual is associated.

(ii) For purposes of section 4955(d)(2), a determination of whether the primary purpose of an organization is promoting the candidacy or prospective candidacy of an individual for public office is made on the basis of all the facts and circumstances. The factors to be considered include whether the surveys, studies, materials, etc. prepared by the organization are made available only to the candidate or are made available to the general public; and whether the organization pays for speeches and travel expenses for only one individual, or for speeches or travel expenses of several persons. The fact that a candidate or prospective candidate utilizes studies, papers, materials, etc., prepared by the organization (such as in a speech by the candidate) is not to be considered as a factor indicating that the organization has a purpose of promoting the candidacy or prospective candidacy of that individual where such studies, papers, materials, etc. are not made available only to that individual.

(iii) Expenditures for voter registration, voter turnout, or voter education constitute other expenses, treated as political expenditures by reason of section 4955(d)(2)(E), only if the expenditures violate the prohibition on political activity provided in section 501(c)(3).

(d) Abatement, refund, or no assessment of initial tax. No initial (first-tier) tax will be imposed under section 4955(a), or the initial tax will be abated or refunded, if the organization or an organization manager establishes to the satisfaction of the IRS that—

(1) The political expenditure was not willful and flagrant; and

(2) The political expenditure was corrected.

(e) Correction—(1) Recovery of expenditure. For purposes of section 4955(f)(3) and this section, correction of a political expenditure is accomplished by recovering part or all of the expenditure to the extent recovery is possible, and, where full recovery cannot be accomplished, by any additional corrective action which the Commissioner may prescribe. The organization making the political expenditure is not under any obligation to attempt to recover the expenditure by legal action if the action would in all probability not result in the satisfaction of execution on a judgment.

(2) Establishing safeguards. Correction of a political expenditure must also involve the establishment of sufficient safeguards to prevent future political expenditures by the organization. The determination of whether safeguards are sufficient to prevent future political expenditures by the organization is made by the District Director.

(f) Effective date. This section is effective December 5, 1995.

This section lists the major captions contained in §§ 53.4958-1 through 53.4958-8.

(a) In general. Section 4958 imposes excise taxes on each excess benefit transaction (as defined in section 4958(c) and § 53.4958-4) between an applicable tax-exempt organization (as defined in section 4958(e) and § 53.4958-2) and a disqualified person (as defined in section 4958(f)(1) and § 53.4958-3). A disqualified person who receives an excess benefit from an excess benefit transaction is liable for payment of a section 4958(a)(1) excise tax equal to 25 percent of the excess benefit. If an initial tax is imposed by section 4958(a)(1) on an excess benefit transaction and the transaction is not corrected (as defined in section 4958(f)(6) and § 53.4958-7) within the taxable period (as defined in section 4958(f)(5) and paragraph (c)(2)(ii) of this section), then any disqualified person who received an excess benefit from the excess benefit transaction on which the initial tax was imposed is liable for an additional tax of 200 percent of the excess benefit. An organization manager (as defined in section 4958(f)(2) and paragraph (d) of this section) who participates in an excess benefit transaction, knowing that it was such a transaction, is liable for payment of a section 4958(a)(2) excise tax equal to 10 percent of the excess benefit, unless the participation was not willful and was due to reasonable cause. If an organization manager also receives an excess benefit from an excess benefit transaction, the manager may be liable for both taxes imposed by section 4958(a).

(b) Excess benefit defined. An excess benefit is the amount by which the value of the economic benefit provided by an applicable tax-exempt organization directly or indirectly to or for the use of any disqualified person exceeds the value of the consideration (including the performance of services) received for providing such benefit.

(c) Taxes paid by disqualified person—(1) Initial tax. Section 4958(a)(1) imposes a tax equal to 25 percent of the excess benefit on each excess benefit transaction. The section 4958(a)(1) tax shall be paid by any disqualified person who received an excess benefit from that excess benefit transaction. With respect to any excess benefit transaction, if more than one disqualified person is liable for the tax imposed by section 4958(a)(1), all such persons are jointly and severally liable for that tax.

(2) Additional tax on disqualified person—(i) In general. Section 4958(b) imposes a tax equal to 200 percent of the excess benefit in any case in which section 4958(a)(1) imposes a 25-percent tax on an excess benefit transaction and the transaction is not corrected (as defined in section 4958(f)(6) and § 53.4958-7) within the taxable period (as defined in section 4958(f)(5) and paragraph (c)(2)(ii) of this section). If a disqualified person makes a payment of less than the full correction amount under the rules of § 53.4958-7, the 200-percent tax is imposed only on the unpaid portion of the correction amount (as described in § 53.4958-7(c)). The tax imposed by section 4958(b) is payable by any disqualified person who received an excess benefit from the excess benefit transaction on which the initial tax was imposed by section 4958(a)(1). With respect to any excess benefit transaction, if more than one disqualified person is liable for the tax imposed by section 4958(b), all such persons are jointly and severally liable for that tax.

(ii) Taxable period. Taxable period means, with respect to any excess benefit transaction, the period beginning with the date on which the transaction occurs and ending on the earlier of—

(A) The date of mailing a notice of deficiency under section 6212 with respect to the section 4958(a)(1) tax; or

(B) The date on which the tax imposed by section 4958(a)(1) is assessed.

(iii) Abatement if correction during the correction period. For rules relating to abatement of taxes on excess benefit transactions that are corrected within the correction period, as defined in section 4963(e), see sections 4961(a), 4962(a), and the regulations thereunder. The abatement rules of section 4961 specifically provide for a 90-day correction period after the date of mailing a notice of deficiency under section 6212 with respect to the section 4958(b) 200-percent tax. If the excess benefit is corrected during that correction period, the 200-percent tax imposed shall not be assessed, and if assessed the assessment shall be abated, and if collected shall be credited or refunded as an overpayment. For special rules relating to abatement of the 25-percent tax, see section 4962.

(d) Tax paid by organization managers—(1) In general. In any case in which section 4958(a)(1) imposes a tax, section 4958(a)(2) imposes a tax equal to 10 percent of the excess benefit on the participation of any organization manager who knowingly participated in the excess benefit transaction, unless such participation was not willful and was due to reasonable cause. Any organization manager who so participated in the excess benefit transaction must pay the tax.

(2) Organization manager defined—(i) In general. An organization manager is, with respect to any applicable tax-exempt organization, any officer, director, or trustee of such organization, or any individual having powers or responsibilities similar to those of officers, directors, or trustees of the organization, regardless of title. A person is an officer of an organization if that person—

(A) Is specifically so designated under the certificate of incorporation, by-laws, or other constitutive documents of the organization; or

(B) Regularly exercises general authority to make administrative or policy decisions on behalf of the organization. A contractor who acts solely in a capacity as an attorney, accountant, or investment manager or advisor, is not an officer. For purposes of this paragraph (d)(2)(i)(B), any person who has authority merely to recommend particular administrative or policy decisions, but not to implement them without approval of a superior, is not an officer.

(ii) Special rule for certain committee members. An individual who is not an officer, director, or trustee, yet serves on a committee of the governing body of an applicable tax-exempt organization (or as a designee of the governing body described in § 53.4958-6(c)(1)) that is attempting to invoke the rebuttable presumption of reasonableness described in § 53.4958-6 based on the committee's (or designee's) actions, is an organization manager for purposes of the tax imposed by section 4958(a)(2).

(3) Participation. For purposes of section 4958(a)(2) and this paragraph (d), participation includes silence or inaction on the part of an organization manager where the manager is under a duty to speak or act, as well as any affirmative action by such manager. An organization manager is not considered to have participated in an excess benefit transaction, however, where the manager has opposed the transaction in a manner consistent with the fulfillment of the manager's responsibilities to the applicable tax-exempt organization.

(4) Knowing—(i) In general. For purposes of section 4958(a)(2) and this paragraph (d), a manager participates in a transaction knowingly only if the person—

(A) Has actual knowledge of sufficient facts so that, based solely upon those facts, such transaction would be an excess benefit transaction;

(B) Is aware that such a transaction under these circumstances may violate the provisions of Federal tax law governing excess benefit transactions; and

(C) Negligently fails to make reasonable attempts to ascertain whether the transaction is an excess benefit transaction, or the manager is in fact aware that it is such a transaction.

(ii) Amplification of general rule. Knowing does not mean having reason to know. However, evidence tending to show that a manager has reason to know of a particular fact or particular rule is relevant in determining whether the manager had actual knowledge of such a fact or rule. Thus, for example, evidence tending to show that a manager has reason to know of sufficient facts so that, based solely upon such facts, a transaction would be an excess benefit transaction is relevant in determining whether the manager has actual knowledge of such facts.

(iii) Reliance on professional advice. An organization manager's participation in a transaction is ordinarily not considered knowing within the meaning of section 4958(a)(2), even though the transaction is subsequently held to be an excess benefit transaction, to the extent that, after full disclosure of the factual situation to an appropriate professional, the organization manager relies on a reasoned written opinion of that professional with respect to elements of the transaction within the professional's expertise. For purposes of section 4958(a)(2) and this paragraph (d), a written opinion is reasoned even though it reaches a conclusion that is subsequently determined to be incorrect so long as the opinion addresses itself to the facts and the applicable standards. However, a written opinion is not reasoned if it does nothing more than recite the facts and express a conclusion. The absence of a written opinion of an appropriate professional with respect to a transaction shall not, by itself, however, give rise to any inference that an organization manager participated in the transaction knowingly. For purposes of this paragraph, appropriate professionals on whose written opinion an organization manager may rely, are limited to—

(A) Legal counsel, including in-house counsel;

(B) Certified public accountants or accounting firms with expertise regarding the relevant tax law matters; and

(C) Independent valuation experts who—

(1) Hold themselves out to the public as appraisers or compensation consultants;

(2) Perform the relevant valuations on a regular basis;

(3) Are qualified to make valuations of the type of property or services involved; and

(4) Include in the written opinion a certification that the requirements of paragraphs (d)(4)(iii)(C)(1) through (3) of this section are met.

(iv) Satisfaction of rebuttable presumption of reasonableness. An organization manager's participation in a transaction is ordinarily not considered knowing within the meaning of section 4958(a)(2), even though the transaction is subsequently held to be an excess benefit transaction, if the appropriate authorized body has met the requirements of § 53.4958-6(a) with respect to the transaction.

(5) Willful. For purposes of section 4958(a)(2) and this paragraph (d), participation by an organization manager is willful if it is voluntary, conscious, and intentional. No motive to avoid the restrictions of the law or the incurrence of any tax is necessary to make the participation willful. However, participation by an organization manager is not willful if the manager does not know that the transaction in which the manager is participating is an excess benefit transaction.

(6) Due to reasonable cause. An organization manager's participation is due to reasonable cause if the manager has exercised responsibility on behalf of the organization with ordinary business care and prudence.

(7) Limits on liability for management. The maximum aggregate amount of tax collectible under section 4958(a)(2) and this paragraph (d) from organization managers with respect to any one excess benefit transaction is $10,000.

(8) Joint and several liability. In any case where more than one person is liable for a tax imposed by section 4958(a)(2), all such persons shall be jointly and severally liable for the taxes imposed under section 4958(a)(2) with respect to that excess benefit transaction.

(9) Burden of proof. For provisions relating to the burden of proof in cases involving the issue of whether an organization manager has knowingly participated in an excess benefit transaction, see section 7454(b) and § 301.7454-2 of this chapter. In these cases, the Commissioner bears the burden of proof.

(e) Date of occurrence—(1) In general. Except as otherwise provided, an excess benefit transaction occurs on the date on which the disqualified person receives the economic benefit for Federal income tax purposes. When a single contractual arrangement provides for a series of compensation or other payments to (or for the use of) a disqualified person over the course of the disqualified person's taxable year (or part of a taxable year), any excess benefit transaction with respect to these aggregate payments is deemed to occur on the last day of the taxable year (or if the payments continue for part of the year, the date of the last payment in the series).

(2) Special rules. In the case of benefits provided pursuant to a qualified pension, profit-sharing, or stock bonus plan, the transaction occurs on the date the benefit is vested. In the case of a transfer of property that is subject to a substantial risk of forfeiture or in the case of rights to future compensation or property (including benefits under a nonqualified deferred compensation plan), the transaction occurs on the date the property, or the rights to future compensation or property, is not subject to a substantial risk of forfeiture. However, where the disqualified person elects to include an amount in gross income in the taxable year of transfer pursuant to section 83(b), the general rule of paragraph (e)(1) of this section applies to the property with respect to which the section 83(b) election is made. Any excess benefit transaction with respect to benefits under a deferred compensation plan which vest during any taxable year of the disqualified person is deemed to occur on the last day of such taxable year. For the rules governing the timing of the reasonableness determination for deferred, contingent, and certain other noncash compensation, see § 53.4958-4(b)(2).

(3) Statute of limitations rules. See sections 6501(e)(3) and (l) and the regulations thereunder for statute of limitations rules as they apply to section 4958 excise taxes.

(f) Effective date for imposition of taxes—(1) In general. The section 4958 taxes imposed on excess benefit transactions or on participation in excess benefit transactions apply to transactions occurring on or after September 14, 1995.

(2) Existing binding contracts. The section 4958 taxes do not apply to any transaction occurring pursuant to a written contract that was binding on September 13, 1995, and at all times thereafter before the transaction occurs. A written binding contract that is terminable or subject to cancellation by the applicable tax-exempt organization without the disqualified person's consent (including as the result of a breach of contract by the disqualified person) and without substantial penalty to the organization, is no longer treated as a binding contract as of the earliest date that any such termination or cancellation, if made, would be effective. If a binding written contract is materially changed, it is treated as a new contract entered into as of the date the material change is effective. A material change includes an extension or renewal of the contract (other than an extension or renewal that results from the person contracting with the applicable tax-exempt organization unilaterally exercising an option expressly granted by the contract), or a more than incidental change to any payment under the contract.

(a) Organizations described in section 501(c)(3) or (4) and exempt from tax under section 501(a)—(1) In general. An applicable tax-exempt organization is any organization that, without regard to any excess benefit, would be described in section 501(c)(3) or (4) and exempt from tax under section 501(a). An applicable tax-exempt organization also includes any organization that was described in section 501(c)(3) or (4) and was exempt from tax under section 501(a) at any time during a five-year period ending on the date of an excess benefit transaction (the lookback period).

(2) Exceptions from definition of applicable tax-exempt organization—(i) Private foundation. A private foundation as defined in section 509(a) is not an applicable tax-exempt organization for section 4958 purposes.

(ii) Governmental unit or affiliate. A governmental unit or an affiliate of a governmental unit is not an applicable tax-exempt organization for section 4958 purposes if it is—

(A) Exempt from (or not subject to) taxation without regard to section 501(a); or

(B) Relieved from filing an annual return pursuant to the authority of § 1.6033-2(g)(6).

(3) Organizations described in section 501(c)(3). An organization is described in section 501(c)(3) for purposes of section 4958 only if the organization—

(i) Provides the notice described in section 508; or

(ii) Is described in section 501(c)(3) and specifically is excluded from the requirements of section 508 by that section.

(4) Organizations described in section 501(c)(4). An organization is described in section 501(c)(4) for purposes of section 4958 only if the organization—

(i) Has applied for and received recognition from the Internal Revenue Service as an organization described in section 501(c)(4); or

(ii) Has filed an application for recognition under section 501(c)(4) with the Internal Revenue Service, has filed an annual information return as a section 501(c)(4) organization under the Internal Revenue Code or regulations promulgated thereunder, or has otherwise held itself out as being described in section 501(c)(4) and exempt from tax under section 501(a).

(5) Effect of non-recognition or revocation of exempt status. An organization is not described in paragraph (a)(3) or (4) of this section during any period covered by a final determination or adjudication that the organization is not exempt from tax under section 501(a) as an organization described in section 501(c)(3) or (4), so long as that determination or adjudication is not based upon participation in inurement or one or more excess benefit transactions. However, the organization may be an applicable tax-exempt organization for that period as a result of the five-year lookback period described in paragraph (a)(1) of this section.

(6) Examples. The following examples illustrate the principles of this section, which defines an applicable tax-exempt organization for purposes of section 4958:

(b) Special rules—(1) Transition rule for lookback period. In the case of any excess benefit transaction occurring before September 14, 2000, the lookback period described in paragraph (a)(1) of this section begins on September 14, 1995, and ends on the date of the transaction.

(2) Certain foreign organizations. A foreign organization, recognized by the Internal Revenue Service or by treaty, that receives substantially all of its support (other than gross investment income) from sources outside of the United States is not an organization described in section 501(c)(3) or (4) for purposes of section 4958.

(a) In general—(1) Scope of definition. Section 4958(f)(1) defines disqualified person, with respect to any transaction, as any person who was in a position to exercise substantial influence over the affairs of an applicable tax-exempt organization at any time during the five-year period ending on the date of the transaction (the lookback period). Paragraph (b) of this section describes persons who are defined to be disqualified persons under the statute, including certain family members of an individual in a position to exercise substantial influence, and certain 35-percent controlled entities. Paragraph (c) of this section describes persons in a position to exercise substantial influence over the affairs of an applicable tax-exempt organization by virtue of their powers and responsibilities or certain interests they hold. Paragraph (d) of this section describes persons deemed not to be in a position to exercise substantial influence. Whether any person who is not described in paragraph (b), (c) or (d) of this section is a disqualified person with respect to a transaction for purposes of section 4958 is based on all relevant facts and circumstances, as described in paragraph (e) of this section. Paragraph (f) of this section describes special rules for affiliated organizations. Examples in paragraph (g) of this section illustrate these categories of persons.

(2) Transition rule for lookback period. In the case of any excess benefit transaction occurring before September 14, 2000, the lookback period described in paragraph (a)(1) of this section begins on September 14, 1995, and ends on the date of the transaction.

(b) Statutory categories of disqualified persons—(1) Family members. A person is a disqualified person with respect to any transaction with an applicable tax-exempt organization if the person is a member of the family of a person who is a disqualified person described in paragraph (a) of this section (other than as a result of this paragraph) with respect to any transaction with the same organization. For purposes of the following sentence, a legally adopted child of an individual is treated as a child of such individual by blood. A person's family is limited to—

(i) Spouse;

(ii) Brothers or sisters (by whole or half blood);

(iii) Spouses of brothers or sisters (by whole or half blood);

(iv) Ancestors;

(v) Children;

(vi) Grandchildren;

(vii) Great grandchildren; and

(viii) Spouses of children, grandchildren, and great grandchildren.

(2) Thirty-five percent controlled entities—(i) In general. A person is a disqualified person with respect to any transaction with an applicable tax-exempt organization if the person is a 35-percent controlled entity. A 35-percent controlled entity is—

(A) A corporation in which persons described in this section (except in paragraphs (b)(2) and (d) of this section) own more than 35 percent of the combined voting power;

(B) A partnership in which persons described in this section (except in paragraphs (b)(2) and (d) of this section) own more than 35 percent of the profits interest; or

(C) A trust or estate in which persons described in this section (except in paragraphs (b)(2) and (d) of this section) own more than 35 percent of the beneficial interest.

(ii) Combined voting power. For purposes of this paragraph (b)(2), combined voting power includes voting power represented by holdings of voting stock, direct or indirect, but does not include voting rights held only as a director, trustee, or other fiduciary.

(iii) Constructive ownership rules—(A) Stockholdings. For purposes of section 4958(f)(3) and this paragraph (b)(2), indirect stockholdings are taken into account as under section 267(c), except that in applying section 267(c)(4), the family of an individual shall include the members of the family specified in section 4958(f)(4) and paragraph (b)(1) of this section.

(B) Profits or beneficial interest. For purposes of section 4958(f)(3) and this paragraph (b)(2), the ownership of profits or beneficial interests shall be determined in accordance with the rules for constructive ownership of stock provided in section 267(c) (other than section 267(c)(3)), except that in applying section 267(c)(4), the family of an individual shall include the members of the family specified in section 4958(f)(4) and paragraph (b)(1) of this section.

(c) Persons having substantial influence. A person who holds any of the following powers, responsibilities, or interests is in a position to exercise substantial influence over the affairs of an applicable tax-exempt organization:

(1) Voting members of the governing body. This category includes any individual serving on the governing body of the organization who is entitled to vote on any matter over which the governing body has authority.

(2) Presidents, chief executive officers, or chief operating officers. This category includes any person who, regardless of title, has ultimate responsibility for implementing the decisions of the governing body or for supervising the management, administration, or operation of the organization. A person who serves as president, chief executive officer, or chief operating officer has this ultimate responsibility unless the person demonstrates otherwise. If this ultimate responsibility resides with two or more individuals (e.g., co-presidents), who may exercise such responsibility in concert or individually, then each individual is in a position to exercise substantial influence over the affairs of the organization.

(3) Treasurers and chief financial officers. This category includes any person who, regardless of title, has ultimate responsibility for managing the finances of the organization. A person who serves as treasurer or chief financial officer has this ultimate responsibility unless the person demonstrates otherwise. If this ultimate responsibility resides with two or more individuals who may exercise the responsibility in concert or individually, then each individual is in a position to exercise substantial influence over the affairs of the organization.

(4) Persons with a material financial interest in a provider-sponsored organization. For purposes of section 4958, if a hospital that participates in a provider-sponsored organization (as defined in section 1855(e) of the Social Security Act, 42 U.S.C. 1395w-25) is an applicable tax-exempt organization, then any person with a material financial interest (within the meaning of section 501(o)) in the provider-sponsored organization has substantial influence with respect to the hospital.

(d) Persons deemed not to have substantial influence. A person is deemed not to be in a position to exercise substantial influence over the affairs of an applicable tax-exempt organization if that person is described in one of the following categories:

(1) Tax-exempt organizations described in section 501(c)(3). This category includes any organization described in section 501(c)(3) and exempt from tax under section 501(a).

(2) Certain section 501(c)(4) organizations. Only with respect to an applicable tax-exempt organization described in section 501(c)(4) and § 53.4958-2(a)(4), this category includes any other organization so described.

(3) Employees receiving economic benefits of less than a specified amount in a taxable year. This category includes, for the taxable year in which benefits are provided, any full- or part-time employee of the applicable tax-exempt organization who—

(i) Receives economic benefits, directly or indirectly from the organization, of less than the amount referenced for a highly compensated employee in section 414(q)(1)(B)(i);

(ii) Is not described in paragraph (b) or (c) of this section with respect to the organization; and

(iii) Is not a substantial contributor to the organization within the meaning of section 507(d)(2)(A), taking into account only contributions received by the organization during its current taxable year and the four preceding taxable years.

(e) Facts and circumstances govern in all other cases—(1) In general. Whether a person who is not described in paragraph (b), (c) or (d) of this section is a disqualified person depends upon all relevant facts and circumstances.

(2) Facts and circumstances tending to show substantial influence. Facts and circumstances tending to show that a person has substantial influence over the affairs of an organization include, but are not limited to, the following—

(i) The person founded the organization;

(ii) The person is a substantial contributor to the organization (within the meaning of section 507(d)(2)(A)), taking into account only contributions received by the organization during its current taxable year and the four preceding taxable years;

(iii) The person's compensation is primarily based on revenues derived from activities of the organization, or of a particular department or function of the organization, that the person controls;

(iv) The person has or shares authority to control or determine a substantial portion of the organization's capital expenditures, operating budget, or compensation for employees;

(v) The person manages a discrete segment or activity of the organization that represents a substantial portion of the activities, assets, income, or expenses of the organization, as compared to the organization as a whole;

(vi) The person owns a controlling interest (measured by either vote or value) in a corporation, partnership, or trust that is a disqualified person; or

(vii) The person is a non-stock organization controlled, directly or indirectly, by one or more disqualified persons.

(3) Facts and circumstances tending to show no substantial influence. Facts and circumstances tending to show that a person does not have substantial influence over the affairs of an organization include, but are not limited to, the following—

(i) The person has taken a bona fide vow of poverty as an employee, agent, or on behalf, of a religious organization;

(ii) The person is a contractor (such as an attorney, accountant, or investment manager or advisor) whose sole relationship to the organization is providing professional advice (without having decision-making authority) with respect to transactions from which the contractor will not economically benefit either directly or indirectly (aside from customary fees received for the professional advice rendered);

(iii) The direct supervisor of the individual is not a disqualified person;

(iv) The person does not participate in any management decisions affecting the organization as a whole or a discrete segment or activity of the organization that represents a substantial portion of the activities, assets, income, or expenses of the organization, as compared to the organization as a whole; or

(v) Any preferential treatment a person receives based on the size of that person's contribution is also offered to all other donors making a comparable contribution as part of a solicitation intended to attract a substantial number of contributions.

(f) Affiliated organizations. In the case of multiple organizations affiliated by common control or governing documents, the determination of whether a person does or does not have substantial influence shall be made separately for each applicable tax-exempt organization. A person may be a disqualified person with respect to transactions with more than one applicable tax-exempt organization.

(g) Examples. The following examples illustrate the principles of this section. A finding that a person is a disqualified person in the following examples does not indicate that an excess benefit transaction has occurred. If a person is a disqualified person, the rules of section 4958(c) and § 53.4958-4 apply to determine whether an excess benefit transaction has occurred. The examples are as follows:

(a) Definition of excess benefit transaction—(1) In general. An excess benefit transaction means any transaction in which an economic benefit is provided by an applicable tax-exempt organization directly or indirectly to or for the use of any disqualified person, and the value of the economic benefit provided exceeds the value of the consideration (including the performance of services) received for providing the benefit. Subject to the limitations of paragraph (c) of this section (relating to the treatment of economic benefits as compensation for the performance of services), to determine whether an excess benefit transaction has occurred, all consideration and benefits (except disregarded benefits described in paragraph (a)(4) of this section) exchanged between a disqualified person and the applicable tax-exempt organization and all entities the organization controls (within the meaning of paragraph (a)(2)(ii)(B) of this section) are taken into account. For example, in determining the reasonableness of compensation that is paid (or vests, or is no longer subject to a substantial risk of forfeiture) in one year, services performed in prior years may be taken into account. The rules of this section apply to all transactions with disqualified persons, regardless of whether the amount of the benefit provided is determined, in whole or in part, by the revenues of one or more activities of the organization. For rules regarding valuation standards, see paragraph (b) of this section. For the requirement that an applicable tax-exempt organization clearly indicate its intent to treat a benefit as compensation for services when paid, see paragraph (c) of this section.

(2) Economic benefit provided indirectly—(i) In general. A transaction that would be an excess benefit transaction if the applicable tax-exempt organization engaged in it directly with a disqualified person is likewise an excess benefit transaction when it is accomplished indirectly. An applicable tax-exempt organization may provide an excess benefit indirectly to a disqualified person through a controlled entity or through an intermediary, as described in paragraphs (a)(2)(ii) and (iii) of this section, respectively.

(ii) Through a controlled entity—(A) In general. An applicable tax-exempt organization may provide an excess benefit indirectly through the use of one or more entities it controls. For purposes of section 4958, economic benefits provided by a controlled entity will be treated as provided by the applicable tax-exempt organization.

(B) Definition of control—(1) In general. For purposes of this paragraph, control by an applicable tax-exempt organization means—

(i) In the case of a stock corporation, ownership (by vote or value) of more than 50 percent of the stock in such corporation;

(ii) In the case of a partnership, ownership of more than 50 percent of the profits interests or capital interests in the partnership;

(iii) In the case of a nonstock organization (i.e., an entity in which no person holds a proprietary interest), that at least 50 percent of the directors or trustees of the organization are either representatives (including trustees, directors, agents, or employees) of, or directly or indirectly controlled by, an applicable tax-exempt organization; or

(iv) In the case of any other entity, ownership of more than 50 percent of the beneficial interest in the entity.

(2) Constructive ownership. Section 318 (relating to constructive ownership of stock) shall apply for purposes of determining ownership of stock in a corporation. Similar principles shall apply for purposes of determining ownership of interests in any other entity.

(iii) Through an intermediary. An applicable tax-exempt organization may provide an excess benefit indirectly through an intermediary. An intermediary is any person (including an individual or a taxable or tax-exempt entity) who participates in a transaction with one or more disqualified persons of an applicable tax-exempt organization. For purposes of section 4958, economic benefits provided by an intermediary will be treated as provided by the applicable tax-exempt organization when—

(A) An applicable tax-exempt organization provides an economic benefit to an intermediary; and

(B) In connection with the receipt of the benefit by the intermediary—

(1) There is evidence of an oral or written agreement or understanding that the intermediary will provide economic benefits to or for the use of a disqualified person; or

(2) The intermediary provides economic benefits to or for the use of a disqualified person without a significant business purpose or exempt purpose of its own.

(iv) Examples. The following examples illustrate when economic benefits are provided indirectly under the rules of this paragraph (a)(2):

(3) Exception for fixed payments made pursuant to an initial contract—(i) In general. Except as provided in paragraph (a)(3)(iv) of this section, section 4958 does not apply to any fixed payment made to a person pursuant to an initial contract.

(ii) Fixed payment—(A) In general. For purposes of paragraph (a)(3)(i) of this section, fixed payment means an amount of cash or other property specified in the contract, or determined by a fixed formula specified in the contract, which is to be paid or transferred in exchange for the provision of specified services or property. A fixed formula may incorporate an amount that depends upon future specified events or contingencies, provided that no person exercises discretion when calculating the amount of a payment or deciding whether to make a payment (such as a bonus). A specified event or contingency may include the amount of revenues generated by (or other objective measure of) one or more activities of the applicable tax-exempt organization. A fixed payment does not include any amount paid to a person under a reimbursement (or similar) arrangement where discretion is exercised by any person with respect to the amount of expenses incurred or reimbursed.

(B) Special rules. Amounts payable pursuant to a qualified pension, profit-sharing, or stock bonus plan under section 401(a), or pursuant to an employee benefit program that is subject to and satisfies coverage and nondiscrimination rules under the Internal Revenue Code (e.g., sections 127 and 137), other than nondiscrimination rules under section 9802, are treated as fixed payments for purposes of this section, regardless of the applicable tax-exempt organization's discretion with respect to the plan or program. The fact that a person contracting with an applicable tax-exempt organization is expressly granted the choice whether to accept or reject any economic benefit is disregarded in determining whether the benefit constitutes a fixed payment for purposes of this paragraph.

(iii) Initial contract. For purposes of paragraph (a)(3)(i) of this section, initial contract means a binding written contract between an applicable tax-exempt organization and a person who was not a disqualified person within the meaning of section 4958(f)(1) and § 53.4958-3 immediately prior to entering into the contract.

(iv) Substantial performance required. Paragraph (a)(3)(i) of this section does not apply to any fixed payment made pursuant to the initial contract during any taxable year of the person contracting with the applicable tax-exempt organization if the person fails to perform substantially the person's obligations under the initial contract during that year.

(v) Treatment as a new contract. A written binding contract that provides that the contract is terminable or subject to cancellation by the applicable tax-exempt organization (other than as a result of a lack of substantial performance by the disqualified person, as described in paragraph (a)(3)(iv) of this section) without the other party's consent and without substantial penalty to the organization is treated as a new contract as of the earliest date that any such termination or cancellation, if made, would be effective. Additionally, if the parties make a material change to a contract, it is treated as a new contract as of the date the material change is effective. A material change includes an extension or renewal of the contract (other than an extension or renewal that results from the person contracting with the applicable tax-exempt organization unilaterally exercising an option expressly granted by the contract), or a more than incidental change to any amount payable under the contract. The new contract is tested under paragraph (a)(3)(iii) of this section to determine whether it is an initial contract for purposes of this section.

(vi) Evaluation of non-fixed payments. Any payment that is not a fixed payment (within the meaning of paragraph (a)(3)(ii) of this section) is evaluated to determine whether it constitutes an excess benefit transaction under section 4958. In making this determination, all payments and consideration exchanged between the parties are taken into account, including any fixed payments made pursuant to an initial contract with respect to which section 4958 does not apply.

(vii) Examples. The following examples illustrate the rules governing fixed payments made pursuant to an initial contract. Unless otherwise stated, assume that the person contracting with the applicable tax-exempt organization has performed substantially the person's obligations under the contract with respect to the payment. The examples are as follows:

(4) Certain economic benefits disregarded for purposes of section 4958. The following economic benefits are disregarded for purposes of section 4958—

(i) Nontaxable fringe benefits. An economic benefit that is excluded from income under section 132, except any liability insurance premium, payment, or reimbursement that must be taken into account under paragraph (b)(1)(ii)(B)(2) of this section;

(ii) Expense reimbursement payments pursuant to accountable plans. Amounts paid under reimbursement arrangements that meet the requirements of § 1.62-2(c) of this chapter;

(iii) Certain economic benefits provided to a volunteer for the organization. An economic benefit provided to a volunteer for the organization if the benefit is provided to the general public in exchange for a membership fee or contribution of $75 or less per year;

(iv) Certain economic benefits provided to a member of, or donor to, the organization. An economic benefit provided to a member of an organization solely on account of the payment of a membership fee, or to a donor solely on account of a contribution for which a deduction is allowable under section 170 (charitable contribution), regardless of whether the donor is eligible to claim the deduction, if—

(A) Any non-disqualified person paying a membership fee or making a charitable contribution above a specified amount to the organization is given the option of receiving substantially the same economic benefit; and

(B) The disqualified person and a significant number of non-disqualified persons make a payment or charitable contribution of at least the specified amount;

(v) Economic benefits provided to a charitable beneficiary. An economic benefit provided to a person solely because the person is a member of a charitable class that the applicable tax-exempt organization intends to benefit as part of the accomplishment of the organization's exempt purpose; and

(vi) Certain economic benefits provided to a governmental unit. Any transfer of an economic benefit to or for the use of a governmental unit defined in section 170(c)(1), if the transfer is for exclusively public purposes.

(5) Exception for certain payments made pursuant to an exemption granted by the Department of Labor under ERISA. Section 4958 does not apply to any payment made pursuant to, and in accordance with, a final individual prohibited transaction exemption issued by the Department of Labor under section 408(a) of the Employee Retirement Income Security Act of 1974 (88 Stat. 854) (ERISA) with respect to a transaction involving a plan (as defined in section 3(3) of ERISA) that is an applicable tax exempt organization.

(b) Valuation standards—(1) In general. This section provides rules for determining the value of economic benefits for purposes of section 4958.

(i) Fair market value of property. The value of property, including the right to use property, for purposes of section 4958 is the fair market value (i.e., the price at which property or the right to use property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy, sell or transfer property or the right to use property, and both having reasonable knowledge of relevant facts).

(ii) Reasonable compensation—(A) In general. The value of services is the amount that would ordinarily be paid for like services by like enterprises (whether taxable or tax-exempt) under like circumstances (i.e., reasonable compensation). Section 162 standards apply in determining reasonableness of compensation, taking into account the aggregate benefits (other than any benefits specifically disregarded under paragraph (a)(4) of this section) provided to a person and the rate at which any deferred compensation accrues. The fact that a compensation arrangement is subject to a cap is a relevant factor in determining the reasonableness of compensation. The fact that a State or local legislative or agency body or court has authorized or approved a particular compensation package paid to a disqualified person is not determinative of the reasonableness of compensation for purposes of section 4958.

(B) Items included in determining the value of compensation for purposes of determining reasonableness under section 4958. Except for economic benefits that are disregarded for purposes of section 4958 under paragraph (a)(4) of this section, compensation for purposes of determining reasonableness under section 4958 includes all economic benefits provided by an applicable tax-exempt organization in exchange for the performance of services. These benefits include, but are not limited to—

(1) All forms of cash and noncash compensation, including salary, fees, bonuses, severance payments, and deferred and noncash compensation described in § 53.4958-1(e)(2);

(2) Unless excludable from income as a de minimis fringe benefit pursuant to section 132(a)(4), the payment of liability insurance premiums for, or the payment or reimbursement by the organization of—

(i) Any penalty, tax, or expense of correction owed under section 4958;

(ii) Any expense not reasonably incurred by the person in connection with a civil judicial or civil administrative proceeding arising out of the person's performance of services on behalf of the applicable tax-exempt organization; or

(iii) Any expense resulting from an act or failure to act with respect to which the person has acted willfully and without reasonable cause; and

(3) All other compensatory benefits, whether or not included in gross income for income tax purposes, including payments to welfare benefit plans, such as plans providing medical, dental, life insurance, severance pay, and disability benefits, and both taxable and nontaxable fringe benefits (other than fringe benefits described in section 132), including expense allowances or reimbursements (other than expense reimbursements pursuant to an accountable plan that meets the requirements of § 1.62-2(c)), and the economic benefit of a below-market loan (within the meaning of section 7872(e)(1)). (For this purpose, the economic benefit of a below-market loan is the amount deemed transferred to the disqualified person under section 7872(a) or (b), regardless of whether section 7872 otherwise applies to the loan).

(C) Inclusion in compensation for reasonableness determination does not govern income tax treatment. The determination of whether any item listed in paragraph (b)(1)(ii)(B) of this section is included in the disqualified person's gross income for income tax purposes is made on the basis of the provisions of chapter 1 of Subtitle A of the Internal Revenue Code, without regard to whether the item is taken into account for purposes of determining reasonableness of compensation under section 4958.

(2) Timing of reasonableness determination—(i) In general. The facts and circumstances to be taken into consideration in determining reasonableness of a fixed payment (within the meaning of paragraph (a)(3)(ii) of this section) are those existing on the date the parties enter into the contract pursuant to which the payment is made. However, in the event of substantial non-performance, reasonableness is determined based on all facts and circumstances, up to and including circumstances as of the date of payment. In the case of any payment that is not a fixed payment under a contract, reasonableness is determined based on all facts and circumstances, up to and including circumstances as of the date of payment. In no event shall circumstances existing at the date when the payment is questioned be considered in making a determination of the reasonableness of the payment. These general timing rules also apply to property subject to a substantial risk of forfeiture. Therefore, if the property subject to a substantial risk of forfeiture satisfies the definition of fixed payment (within the meaning of paragraph (a)(3)(ii) of this section), reasonableness is determined at the time the parties enter into the contract providing for the transfer of the property. If the property is not a fixed payment, then reasonableness is determined based on all facts and circumstances up to and including circumstances as of the date of payment.

(ii) Treatment as a new contract. For purposes of paragraph (b)(2)(i) of this section, a written binding contract that provides that the contract is terminable or subject to cancellation by the applicable tax-exempt organization without the other party's consent and without substantial penalty to the organization is treated as a new contract as of the earliest date that any such termination or cancellation, if made, would be effective. Additionally, if the parties make a material change to a contract (within the meaning of paragraph (a)(3)(v) of this section), it is treated as a new contract as of the date the material change is effective.

(iii) Examples. The following examples illustrate the timing of the reasonableness determination under the rules of this paragraph (b)(2):

(c) Establishing intent to treat economic benefit as consideration for the performance of services—(1) In general. An economic benefit is not treated as consideration for the performance of services unless the organization providing the benefit clearly indicates its intent to treat the benefit as compensation when the benefit is paid. Except as provided in paragraph (c)(2) of this section, an applicable tax-exempt organization (or entity controlled by an applicable tax-exempt organization, within the meaning of paragraph (a)(2)(ii)(B) of this section) is treated as clearly indicating its intent to provide an economic benefit as compensation for services only if the organization provides written substantiation that is contemporaneous with the transfer of the economic benefit at issue. If an organization fails to provide this contemporaneous substantiation, any services provided by the disqualified person will not be treated as provided in consideration for the economic benefit for purposes of determining the reasonableness of the transaction. In no event shall an economic benefit that a disqualified person obtains by theft or fraud be treated as consideration for the performance of services.

(2) Nontaxable benefits. For purposes of section 4958(c)(1)(A) and this section, an applicable tax-exempt organization is not required to indicate its intent to provide an economic benefit as compensation for services if the economic benefit is excluded from the disqualified person's gross income for income tax purposes on the basis of the provisions of chapter 1 of Subtitle A of the Internal Revenue Code. Examples of these benefits include, but are not limited to, employer-provided health benefits and contributions to a qualified pension, profit-sharing, or stock bonus plan under section 401(a), and benefits described in sections 127 and 137. However, except for economic benefits that are disregarded for purposes of section 4958 under paragraph (a)(4) of this section, all compensatory benefits (regardless of the Federal income tax treatment) provided by an organization in exchange for the performance of services are taken into account in determining the reasonableness of a person's compensation for purposes of section 4958.

(3) Contemporaneous substantiation—(i) Reporting of benefit—(A) In general. An applicable tax-exempt organization provides contemporaneous written substantiation of its intent to provide an economic benefit as compensation if—

(1) The organization reports the economic benefit as compensation on an original Federal tax information return with respect to the payment (e.g., Form W-2, “Wage and Tax Statement”, or Form 1099, “Miscellaneous Income”) or with respect to the organization (e.g., Form 990, “Return of Organization Exempt From Income Tax”), or on an amended Federal tax information return filed prior to the commencement of an Internal Revenue Service examination of the applicable tax-exempt organization or the disqualified person for the taxable year in which the transaction occurred (as determined under § 53.4958-1(e)); or

(2) The recipient disqualified person reports the benefit as income on the person's original Federal tax return (e.g., Form 1040, “U.S. Individual Income Tax Return”), or on the person's amended Federal tax return filed prior to the earlier of the following dates—

(i) Commencement of an Internal Revenue Service examination described in paragraph (c)(3)(i)(A)(1) of this section; or

(ii) The first documentation in writing by the Internal Revenue Service of a potential excess benefit transaction involving either the applicable tax-exempt organization or the disqualified person.

(B) Failure to report due to reasonable cause. If an applicable tax-exempt organization's failure to report an economic benefit as required under the Internal Revenue Code is due to reasonable cause (within the meaning of § 301.6724-1 of this chapter), then the organization will be treated as having clearly indicated its intent to provide an economic benefit as compensation for services. To show that its failure to report an economic benefit that should have been reported on an information return was due to reasonable cause, an applicable tax-exempt organization must establish that there were significant mitigating factors with respect to its failure to report (as described in § 301.6724-1(b) of this chapter), or the failure arose from events beyond the organization's control (as described in § 301.6724-1(c) of this chapter), and that the organization acted in a responsible manner both before and after the failure occurred (as described in § 301.6724-1(d) of this chapter).

(ii) Other written contemporaneous evidence. In addition, other written contemporaneous evidence may be used to demonstrate that the appropriate decision-making body or an officer authorized to approve compensation approved a transfer as compensation for services in accordance with established procedures, including but not limited to—

(A) An approved written employment contract executed on or before the date of the transfer;

(B) Documentation satisfying the requirements of § 53.4958-6(a)(3) indicating that an authorized body approved the transfer as compensation for services on or before the date of the transfer; or

(C) Written evidence that was in existence on or before the due date of the applicable Federal tax return described in paragraph (c)(3)(i)(A)(1) or (2) of this section (including extensions but not amendments), of a reasonable belief by the applicable tax-exempt organization that a benefit was a nontaxable benefit as defined in paragraph (c)(2) of this section.

(4) Examples. The following examples illustrate the requirement that an organization contemporaneously substantiate its intent to provide an economic benefit as compensation for services, as defined in paragraph (c) of this section:

(a) In general. Payments under a compensation arrangement are presumed to be reasonable, and a transfer of property, or the right to use property, is presumed to be at fair market value, if the following conditions are satisfied—

(1) The compensation arrangement or the terms of the property transfer are approved in advance by an authorized body of the applicable tax-exempt organization (or an entity controlled by the organization within the meaning of § 53.4958-4(a)(2)(ii)(B)) composed entirely of individuals who do not have a conflict of interest (within the meaning of paragraph (c)(1)(iii) of this section) with respect to the compensation arrangement or property transfer, as described in paragraph (c)(1) of this section;

(2) The authorized body obtained and relied upon appropriate data as to comparability prior to making its determination, as described in paragraph (c)(2) of this section; and

(3) The authorized body adequately documented the basis for its determination concurrently with making that determination, as described in paragraph (c)(3) of this section.

(b) Rebutting the presumption. If the three requirements of paragraph (a) of this section are satisfied, then the Internal Revenue Service may rebut the presumption that arises under paragraph (a) of this section only if it develops sufficient contrary evidence to rebut the probative value of the comparability data relied upon by the authorized body. With respect to any fixed payment (within the meaning of § 53.4958-4(a)(3)(ii)), rebuttal evidence is limited to evidence relating to facts and circumstances existing on the date the parties enter into the contract pursuant to which the payment is made (except in the event of substantial nonperformance). With respect to all other payments (including non-fixed payments subject to a cap, as described in paragraph (d)(2) of this section), rebuttal evidence may include facts and circumstances up to and including the date of payment. See § 53.4958-4(b)(2)(i).

(c) Requirements for invoking rebuttable presumption—(1) Approval by an authorized body—(i) In general. An authorized body means—

(A) The governing body (i.e., the board of directors, board of trustees, or equivalent controlling body) of the organization;

(B) A committee of the governing body, which may be composed of any individuals permitted under State law to serve on such a committee, to the extent that the committee is permitted by State law to act on behalf of the governing body; or

(C) To the extent permitted under State law, other parties authorized by the governing body of the organization to act on its behalf by following procedures specified by the governing body in approving compensation arrangements or property transfers.

(ii) Individuals not included on authorized body. For purposes of determining whether the requirements of paragraph (a) of this section have been met with respect to a specific compensation arrangement or property transfer, an individual is not included on the authorized body when it is reviewing a transaction if that individual meets with other members only to answer questions, and otherwise recuses himself or herself from the meeting and is not present during debate and voting on the compensation arrangement or property transfer.

(iii) Absence of conflict of interest. A member of the authorized body does not have a conflict of interest with respect to a compensation arrangement or property transfer only if the member—

(A) Is not a disqualified person participating in or economically benefitting from the compensation arrangement or property transfer, and is not a member of the family of any such disqualified person, as described in section 4958(f)(4) or § 53.4958-3(b)(1);

(B) Is not in an employment relationship subject to the direction or control of any disqualified person participating in or economically benefitting from the compensation arrangement or property transfer;

(C) Does not receive compensation or other payments subject to approval by any disqualified person participating in or economically benefitting from the compensation arrangement or property transfer;

(D) Has no material financial interest affected by the compensation arrangement or property transfer; and

(E) Does not approve a transaction providing economic benefits to any disqualified person participating in the compensation arrangement or property transfer, who in turn has approved or will approve a transaction providing economic benefits to the member.

(2) Appropriate data as to comparability—(i) In general. An authorized body has appropriate data as to comparability if, given the knowledge and expertise of its members, it has information sufficient to determine whether, under the standards set forth in § 53.4958-4(b), the compensation arrangement in its entirety is reasonable or the property transfer is at fair market value. In the case of compensation, relevant information includes, but is not limited to, compensation levels paid by similarly situated organizations, both taxable and tax-exempt, for functionally comparable positions; the availability of similar services in the geographic area of the applicable tax-exempt organization; current compensation surveys compiled by independent firms; and actual written offers from similar institutions competing for the services of the disqualified person. In the case of property, relevant information includes, but is not limited to, current independent appraisals of the value of all property to be transferred; and offers received as part of an open and competitive bidding process.

(ii) Special rule for compensation paid by small organizations. For organizations with annual gross receipts (including contributions) of less than $1 million reviewing compensation arrangements, the authorized body will be considered to have appropriate data as to comparability if it has data on compensation paid by three comparable organizations in the same or similar communities for similar services. No inference is intended with respect to whether circumstances falling outside this safe harbor will meet the requirement with respect to the collection of appropriate data.

(iii) Application of special rule for small organizations. For purposes of determining whether the special rule for small organizations described in paragraph (c)(2)(ii) of this section applies, an organization may calculate its annual gross receipts based on an average of its gross receipts during the three prior taxable years. If any applicable tax-exempt organization is controlled by or controls another entity (as defined in § 53.4958-4(a)(2)(ii)(B)), the annual gross receipts of such organizations must be aggregated to determine applicability of the special rule stated in paragraph (c)(2)(ii) of this section.

(iv) Examples. The following examples illustrate the rules for appropriate data as to comparability for purposes of invoking the rebuttable presumption of reasonableness described in this section. In all examples, compensation refers to the aggregate value of all benefits provided in exchange for services. The examples are as follows:

(3) Documentation—(i) For a decision to be documented adequately, the written or electronic records of the authorized body must note—

(A) The terms of the transaction that was approved and the date it was approved;

(B) The members of the authorized body who were present during debate on the transaction that was approved and those who voted on it;

(C) The comparability data obtained and relied upon by the authorized body and how the data was obtained; and

(D) Any actions taken with respect to consideration of the transaction by anyone who is otherwise a member of the authorized body but who had a conflict of interest with respect to the transaction.

(ii) If the authorized body determines that reasonable compensation for a specific arrangement or fair market value in a specific property transfer is higher or lower than the range of comparability data obtained, the authorized body must record the basis for its determination. For a decision to be documented concurrently, records must be prepared before the later of the next meeting of the authorized body or 60 days after the final action or actions of the authorized body are taken. Records must be reviewed and approved by the authorized body as reasonable, accurate and complete within a reasonable time period thereafter.

(d) No presumption with respect to non-fixed payments until amounts are determined—(1) In general. Except as provided in paragraph (d)(2) of this section, in the case of a payment that is not a fixed payment (within the meaning of § 53.4958-4(a)(3)(ii)), the rebuttable presumption of this section arises only after the exact amount of the payment is determined, or a fixed formula for calculating the payment is specified, and the three requirements for the presumption under paragraph (a) of this section subsequently are satisfied. See § 53.4958-4(b)(2)(i).

(2) Special rule for certain non-fixed payments subject to a cap. If the authorized body approves an employment contract with a disqualified person that includes a non-fixed payment (such as a discretionary bonus) subject to a specified cap, the authorized body may establish a rebuttable presumption with respect to the non-fixed payment at the time the employment contract is entered into if—

(i) Prior to approving the contract, the authorized body obtains appropriate comparability data indicating that a fixed payment of up to a certain amount to the particular disqualified person would represent reasonable compensation;

(ii) The maximum amount payable under the contract (taking into account both fixed and non-fixed payments) does not exceed the amount referred to in paragraph (d)(2)(i) of this section; and

(iii) The other requirements for the rebuttable presumption of reasonableness under paragraph (a) of this section are satisfied.

(e) No inference from absence of presumption. The fact that a transaction between an applicable tax-exempt organization and a disqualified person is not subject to the presumption described in this section neither creates any inference that the transaction is an excess benefit transaction, nor exempts or relieves any person from compliance with any Federal or state law imposing any obligation, duty, responsibility, or other standard of conduct with respect to the operation or administration of any applicable tax-exempt organization.

(f) Period of reliance on rebuttable presumption. Except as provided in paragraph (d) of this section with respect to non-fixed payments, the rebuttable presumption applies to all payments made or transactions completed in accordance with a contract, provided that the provisions of paragraph (a) of this section were met at the time the parties entered into the contract.

(a) In general. An excess benefit transaction is corrected by undoing the excess benefit to the extent possible, and taking any additional measures necessary to place the applicable tax-exempt organization involved in the excess benefit transaction in a financial position not worse than that in which it would be if the disqualified person were dealing under the highest fiduciary standards. Paragraph (b) of this section describes the acceptable forms of correction. Paragraph (c) of this section defines the correction amount. Paragraph (d) of this section describes correction where a contract has been partially performed. Paragraph (e) of this section describes correction where the applicable tax-exempt organization involved in the transaction has ceased to exist or is no longer tax-exempt. Paragraph (f) of this section provides examples illustrating correction.

(b) Form of correction—(1) Cash or cash equivalents. Except as provided in paragraphs (b)(3) and (4) of this section, a disqualified person corrects an excess benefit only by making a payment in cash or cash equivalents, excluding payment by a promissory note, to the applicable tax-exempt organization equal to the correction amount, as defined in paragraph (c) of this section.

(2) Anti-abuse rule. A disqualified person will not satisfy the requirements of paragraph (b)(1) of this section if the Commissioner determines that the disqualified person engaged in one or more transactions with the applicable tax-exempt organization to circumvent the requirements of this correction section, and as a result, the disqualified person effectively transferred property other than cash or cash equivalents.

(3) Special rule relating to nonqualified deferred compensation. If an excess benefit transaction results, in whole or in part, from the vesting (as described in § 53.4958-1(e)(2)) of benefits provided under a nonqualified deferred compensation plan, then, to the extent that such benefits have not yet been distributed to the disqualified person, the disqualified person may correct the portion of the excess benefit resulting from the undistributed deferred compensation by relinquishing any right to receive the excess portion of the undistributed deferred compensation (including any earnings thereon).

(4) Return of specific property—(i) In general. A disqualified person may, with the agreement of the applicable tax-exempt organization, make a payment by returning specific property previously transferred in the excess benefit transaction. In this case, the disqualified person is treated as making a payment equal to the lesser of—

(A) The fair market value of the property determined on the date the property is returned to the organization; or

(B) The fair market value of the property on the date the excess benefit transaction occurred.

(ii) Payment not equal to correction amount. If the payment described in paragraph (b)(4)(i) of this section is less than the correction amount (as described in paragraph (c) of this section), the disqualified person must make an additional cash payment to the organization equal to the difference. Conversely, if the payment described in paragraph (b)(4)(i) of this section exceeds the correction amount (as described in paragraph (c) of this section), the organization may make a cash payment to the disqualified person equal to the difference.

(iii) Disqualified person may not participate in decision. Any disqualified person who received an excess benefit from the excess benefit transaction may not participate in the applicable tax-exempt organization's decision whether to accept the return of specific property under paragraph (b)(4)(i) of this section.

(c) Correction amount. The correction amount with respect to an excess benefit transaction equals the sum of the excess benefit (as defined in § 53.4958-1(b)) and interest on the excess benefit. The amount of the interest charge for purposes of this section is determined by multiplying the excess benefit by an interest rate, compounded annually, for the period from the date the excess benefit transaction occurred (as defined in § 53.4958-1(e)) to the date of correction. The interest rate used for this purpose must be a rate that equals or exceeds the applicable Federal rate (AFR), compounded annually, for the month in which the transaction occurred. The period from the date the excess benefit transaction occurred to the date of correction is used to determine whether the appropriate AFR is the Federal short-term rate, the Federal mid-term rate, or the Federal long-term rate. See section 1274(d)(1)(A).

(d) Correction where contract has been partially performed. If the excess benefit transaction arises under a contract that has been partially performed, termination of the contractual relationship between the organization and the disqualified person is not required in order to correct. However, the parties may need to modify the terms of any ongoing contract to avoid future excess benefit transactions.

(e) Correction in the case of an applicable tax-exempt organization that has ceased to exist, or is no longer tax-exempt—(1) In general. A disqualified person must correct an excess benefit transaction in accordance with this paragraph where the applicable tax-exempt organization that engaged in the transaction no longer exists or is no longer described in section 501(c)(3) or (4) and exempt from tax under section 501(a).

(2) Section 501(c)(3) organizations. In the case of an excess benefit transaction with a section 501(c)(3) applicable tax-exempt organization, the disqualified person must pay the correction amount, as defined in paragraph (c) of this section, to another organization described in section 501(c)(3) and exempt from tax under section 501(a) in accordance with the dissolution clause contained in the constitutive documents of the applicable tax-exempt organization involved in the excess benefit transaction, provided that—

(i) The organization receiving the correction amount is described in section 170(b)(1)(A) (other than in section 170(b)(1)(A)(vii) and (viii)) and has been in existence and so described for a continuous period of at least 60 calendar months ending on the correction date;

(ii) The disqualified person is not also a disqualified person (as defined in § 53.4958-3) with respect to the organization receiving the correction amount; and

(iii) The organization receiving the correction amount does not allow the disqualified person (or persons described in § 53.4958-3(b) with respect to that person) to make or recommend any grants or distributions by the organization.

(3) Section 501(c)(4) organizations. In the case of an excess benefit transaction with a section 501(c)(4) applicable tax-exempt organization, the disqualified person must pay the correction amount, as defined in paragraph (c) of this section, to a successor section 501(c)(4) organization or, if no tax-exempt successor, to any organization described in section 501(c)(3) or (4) and exempt from tax under section 501(a), provided that the requirements of paragraphs (e)(2)(i) through (iii) of this section are satisfied (except that the requirement that the organization receiving the correction amount is described in section 170(b)(1)(A) (other than in section 170(b)(1)(A)(vii) and (viii)) shall not apply if the organization is described in section 501(c)(4)).

(f) Examples. The following examples illustrate the principles of this section describing the requirements of correction:

(a) Substantive requirements for exemption still apply. Section 4958 does not affect the substantive standards for tax exemption under section 501(c)(3) or (4), including the requirements that the organization be organized and operated exclusively for exempt purposes, and that no part of its net earnings inure to the benefit of any private shareholder or individual. Thus, regardless of whether a particular transaction is subject to excise taxes under section 4958, existing principles and rules may be implicated, such as the limitation on private benefit. For example, transactions that are not subject to section 4958 because of the initial contract exception described in § 53.4958-4(a)(3) may, under certain circumstances, jeopardize the organization's tax-exempt status.

(b) Interaction between section 4958 and section 7611 rules for church tax inquiries and examinations. The procedures of section 7611 will be used in initiating and conducting any inquiry or examination into whether an excess benefit transaction has occurred between a church and a disqualified person. For purposes of this rule, the reasonable belief required to initiate a church tax inquiry is satisfied if there is a reasonable belief that a section 4958 tax is due from a disqualified person with respect to a transaction involving a church. See § 301.7611-1 Q&A 19 of this chapter.

(c) Other substantiation requirements. These regulations, in § 53.4958-4(c)(3), set forth specific substantiation rules. Compliance with the specific substantiation rules of that section does not relieve applicable tax-exempt organizations of other rules and requirements of the Internal Revenue Code, regulations, Revenue Rulings, and other guidance issued by the Internal Revenue Service (including the substantiation rules of sections 162 and 274, or § 1.6001-1(a) and (c) of this chapter).

(a) Excise tax for failure to meet the section 501(r)(3) requirements—(1) In general. If a hospital organization (as defined in § 1.501(r)-1(b)(18)) fails to meet the requirements of section 501(r)(3) separately with respect to a hospital facility it operates in any taxable year, there is imposed on the hospital organization a tax equal to $50,000. If a hospital organization operates multiple hospital facilities and fails to meet the requirements of section 501(r)(3) with respect to more than one facility it operates, the $50,000 tax is imposed on the hospital organization separately for each hospital facility's failure. The tax is imposed for each taxable year that a hospital facility fails to meet the requirements of section 501(r)(3).

(2) Examples. The following examples illustrate this paragraph (a):

(b) Interaction with other provisions—(1) Correction. Unless a hospital organization's failure to meet the requirements of section 501(r)(3) involves an omission or error that is described in and corrected in accordance with § 1.501(r)-2(b) (and is thus not considered a failure), a failure to meet the requirements of section 501(r)(3) will result in a tax being imposed on the organization under this section, notwithstanding the organization's correction and disclosure of the failure in accordance with the guidance described in § 1.501(r)-2(c).

(2) Interaction with other taxes. The tax imposed by this section is in addition to any tax imposed by § 1.501(r)-2(d) or as a result of revocation of a hospital organization's section 501(c)(3) status.

(c) Effective/applicability date. Paragraph (a) of this section applies on and after December 29, 2014.

(a) Scope. This section provides definitions for purposes of section 4960, this section, and §§ 53.4960-2 through 53.4960-6. Section 53.4960-2 provides definitions and rules for determining the amount of remuneration paid for a taxable year. Section 53.4960-3 provides definitions and rules for determining whether a parachute payment is paid. Section 53.4960-4 provides definitions and rules for calculating the amount of excess remuneration paid for a taxable year, excess parachute payments paid in a taxable year, and liability for the excise tax. Section 53.4960-5 is reserved for rules on the coordination of sections 4960 and 162(m). Section 53.4960-6 provides rules regarding the applicability date for the regulations in §§ 53.4960-1 through 53.4960-5. The rules and definitions provided in this section through § 53.4960-6 apply solely for purposes of section 4960 unless specified otherwise.

(b) Applicable tax-exempt organization—(1) In general. Applicable tax-exempt organization or ATEO means any organization that is one of the following types of organizations:

(i) Section 501(a) organization. The organization is exempt from taxation under section 501(a) (except as provided in paragraph (b)(2) or (b)(3) of this section);

(ii) Section 521 farmers' cooperative. The organization is a farmers' cooperative organization described in section 521(b)(1);

(iii) Section 115(1) organization. The organization has income excluded from taxation under section 115(1); or

(iv) Section 527 political organization. The organization is a political organization described in section 527(e)(1).

(2) Certain foreign organizations. Any foreign organization described in section 4948(b) that either is exempt from tax under section 501(a) or is a taxable private foundation (section 4948(b) organization) is not an ATEO. A foreign organization is an organization not created or organized in the United States or in any possession thereof, or under the law of the United States, any State, the District of Columbia, or any possession of the United States. See section 4948(b) and § 53.4948-1. For purposes of this paragraph (b)(2) and the application of section 4960 to a taxable year, an organization's status as a section 4948(b) organization is determined at the end of its taxable year.

(c) Applicable year—(1) In general. Applicable year means the calendar year ending with or within the ATEO's taxable year. See § 53.4960-4 regarding how an ATEO's applicable year affects the liability of related organizations.

(2) Examples. The following examples illustrate the rules of paragraph (c)(1) of this section.

(i) Example 1 (Calendar year taxpayer)—(A) Facts. ATEO 1 uses the calendar year as its taxable year and became an ATEO before 2022.

(B) Conclusion. ATEO 1's applicable year for its 2022 taxable year is the period from January 1, 2022, through December 31, 2022 (that is, the 2022 calendar year).

(ii) Example 2 (Fiscal year taxpayer)—(A) Facts. ATEO 2 uses a taxable year that starts July 1 and ends June 30 and became an ATEO before 2022.

(B) Conclusion. ATEO 2's applicable year for the taxable year beginning July 1, 2022, and ending June 30, 2023, is the 2022 calendar year.

(3) Short applicable years—(i) In general. An ATEO may have an applicable year that does not span the entire calendar year for the initial taxable year that the organization is an ATEO or for the taxable year in which the taxpayer ceases to be an ATEO. The beginning and end dates of the applicable year in the case of an ATEO's change in status depend on when the change in status occurs.

(ii) Initial year of ATEO status. For the taxable year in which an ATEO first becomes an ATEO, applicable year means the period beginning on the date the ATEO first becomes an ATEO and ending on the last day of the calendar year ending with or within such taxable year (or, if earlier, the date of termination of ATEO status, as described in paragraph (c)(3)(ii)(A) of this section). If the taxable year in which an ATEO first becomes an ATEO ends before the end of the calendar year in which the ATEO first becomes an ATEO, then there is no applicable year for the ATEO's first taxable year; however, for the ATEO's next taxable year, applicable year means the period beginning on the date the ATEO first becomes an ATEO and ending on December 31 of the calendar year (or, if earlier, the date of termination of ATEO status, as described in paragraph (c)(3)(ii)(A) of this section).

(iii) Year of termination of ATEO status—(A) Termination on or before the close of the calendar year ending with or within the taxable year of termination. If an ATEO has a termination of ATEO status during the taxable year and the termination of ATEO status occurs on or before the close of the calendar year ending with or within such taxable year, then, for the taxable year of termination of ATEO status, applicable year means the period starting January 1 of the calendar year of the termination of ATEO status and ending on the date of the termination of ATEO status.

(B) Termination after the close of the calendar year ending in the taxable year of termination. If an ATEO has a termination of ATEO status during the taxable year and the termination of ATEO status occurs after the close of the calendar year ending within such taxable year, then, for the taxable year of the termination of ATEO status, applicable year means both the calendar year ending within such taxable year and the period beginning January 1 of the calendar year of the termination of ATEO status and ending on the date of the termination of ATEO status. Both such applicable years are treated as separate applicable years. See § 53.4960-4(b)(2)(ii) for rules regarding calculation of the tax in the event there are multiple applicable years associated with a taxable year.

(4) Examples. The following examples illustrate the rules of paragraph (c)(3) of this section. For purposes of these examples, assume any entity referred to as “ATEO” is an ATEO and any entity referred to as “CORP” is not an ATEO.

(i) Example 1 (Taxable year of formation ending after December 31)—(A) Facts. ATEO 1, ATEO 2, and CORP 1 are related organizations that all use a taxable year that starts July 1 and ends June 30. ATEO 1 is recognized as a section 501(c)(3) organization by the IRS on May 8, 2023, effective as of October 1, 2022. ATEO 2 became an ATEO in 2017.

(B) Conclusion (ATEO 1). ATEO 1's applicable year for the taxable year beginning October 1, 2022, and ending June 30, 2023, is the period beginning October 1, 2022, and ending December 31, 2022. For purposes of determining the amount of remuneration paid by ATEO 1 and all related organizations for ATEO 1's taxable year beginning October 1, 2022, and ending June 30, 2023, (including for purposes of determining ATEO 1's covered employees), only remuneration paid between October 1, 2022, and December 31, 2022, is taken into account. Thus, any remuneration paid by ATEO 1, ATEO 2, and CORP 1 before October 1, 2022, is disregarded for purposes of ATEO 1's applicable year associated with its initial taxable year.

(C) Conclusion (ATEO 2). ATEO 2's applicable year for its taxable year beginning July 1, 2022, and ending June 30, 2023, is the 2022 calendar year. Thus, any remuneration paid by ATEO 1, ATEO 2, and CORP 1 during the 2022 calendar year is taken into account for purposes of determining ATEO 2's covered employees and remuneration paid for ATEO 2's taxable year ending June 30, 2023.

(ii) Example 2 (Taxable year of formation ending before December 31)—(A) Facts. Assume the same facts as in paragraph (c)(4)(i)(A) of this section (Example 1), except that ATEO 1 is recognized as a section 501(c)(3) organization effective as of March 15, 2023.

(B) Conclusion. ATEO 1 has no applicable year for the taxable year starting March 15, 2023, and ending June 30, 2023, because no calendar year ends (or termination of ATEO status occurs) with or within the taxable year. ATEO 1's applicable year for the taxable year ending June 30, 2024, is the period beginning March 15, 2023, and ending December 31, 2023. For purposes of determining the amount of remuneration paid by ATEO 1 and all related organizations for ATEO 1's taxable year ending June 30, 2024 (including for purposes of determining ATEO 1's covered employees), only remuneration paid between March 15, 2023, and December 31, 2023, is taken into account. The conclusion for ATEO 2 is the same as in paragraph (c)(4)(i)(C) of this section (Example 1).

(iii) Example 3 (Termination before the close of the calendar year ending in the taxable year of termination)—(A) Facts. Assume the same facts as in paragraph (c)(4)(i)(A) of this section (Example 1). In addition, ATEO 1 has a termination of ATEO status on September 30, 2024.

(B) Conclusion. For ATEO 1's taxable year beginning July 1, 2024, and ending September 30, 2024, ATEO 1's applicable year is the period beginning January 1, 2024, and ending September 30, 2024.

(iv) Example 4 (Termination after the close of the calendar year ending in the taxable year of termination)—(A) Facts. Assume the same facts as in paragraph (c)(4)(i)(A) of this section (Example 1). In addition, ATEO 1 has a termination of ATEO status on March 31, 2025.

(B) Conclusion. For ATEO 1's taxable year beginning July 1, 2024, and ending March 31, 2025, ATEO 1 has two applicable years: the 2024 calendar year, and the period beginning on January 1, 2025, and ending on March 31, 2025.

(d) Covered employee—(1) In general. For each taxable year, covered employee means any individual who is one of the five highest-compensated employees of the ATEO for the taxable year or was a covered employee of the ATEO (or any predecessor) for any preceding taxable year beginning after December 31, 2016.

(2) Five highest-compensated employees—(i) In general. Except as otherwise provided in this paragraph (d)(2), an individual is one of an ATEO's five highest- compensated employees for the taxable year if the individual is among the five employees of the ATEO with the highest amount of remuneration paid during the applicable year, as determined under § 53.4960-2. However, remuneration for which the deduction is disallowed by reason of section 162(m) is taken into account for purposes of determining an ATEO's five highest-compensated employees. The five highest-compensated employees of an ATEO for the taxable year are identified on the basis of the total remuneration paid during the applicable year to the employee for services performed as an employee of the ATEO or any related organization. An ATEO may have fewer than five highest-compensated employees for a taxable year if it has fewer than five employees other than employees who are disregarded under paragraphs (d)(2)(ii) through (iv) of this section. For purposes of this paragraph (d)(2), a grant of a legally binding right (within the meaning of § 1.409A-1(b)) to vested remuneration is considered to be remuneration paid as of the date of grant, as described in § 53.4960-2(c)(2), and a person or governmental entity is considered to grant a legally binding right to nonvested remuneration if the person or governmental entity grants a legally binding right to remuneration that is not vested within the meaning of § 53.4960-2(c)(2). An employee is disregarded for purposes of determining an ATEO's five highest-compensated employees for a taxable year if, during the applicable year, neither the ATEO nor any related organization paid remuneration or granted a legally binding right to nonvested remuneration to the individual for services the individual performed as an employee of the ATEO or any related organization.

(ii) Limited hours exception—(A) In general. An individual is disregarded for purposes of determining an ATEO's five highest-compensated employees for a taxable year if all of the following requirements are met:

(1) Remuneration requirement. Neither the ATEO nor any related ATEO paid remuneration or granted a legally binding right to nonvested remuneration to the individual for services the individual performed as an employee of the ATEO during the applicable year; and

(2) Hours of service requirement. The individual performed services as an employee of the ATEO and all related ATEOs for no more than 10 percent of the total hours the individual worked as an employee of the ATEO and any related organizations during the applicable year. An ATEO may instead make this determination based on the total days the individual worked as an employee of the ATEO and all related ATEOs as a percentage of the total days worked as an employee of the ATEO and all related organizations, provided that for purposes of the calculation, any day that the individual worked at least one hour as an employee of the ATEO or a related ATEO is treated as a day worked as an employee of the ATEO and not for any other organization.

(B) Certain payments disregarded. For purposes of paragraph (d)(2)(ii)(A)(1) of this section, a payment of remuneration made to the individual by a related organization that is an employer of the individual and for which the related organization is neither entitled to reimbursement by the ATEO nor entitled to any other consideration from the ATEO is not considered remuneration paid by the ATEO under § 53.4960-2(b)(1), and a payment of remuneration made to the individual by a related organization is not treated as remuneration paid by the ATEO under § 53.4960-2(b)(2).

(C) Safe harbor. For purposes of paragraph (d)(2)(ii)(A)(2) of this section, an individual is treated as having performed services as an employee of the ATEO and all related ATEOs for no more than 10 percent of the total hours the individual worked as an employee of the ATEO and all related organizations during the applicable year if the employee performed no more than 100 hours of service as an employee of the ATEO and all related ATEOs during the applicable year.

(iii) Nonexempt funds exception—(A) In general. An individual is disregarded for purposes of determining an ATEO's five highest-compensated employees for a taxable year if all the following requirements are met:

(1) Remuneration requirement. Neither the ATEO, nor any related ATEO, nor any taxable related organization controlled by the ATEO, or by one or more related ATEOs, either alone or together with the ATEO, paid remuneration or granted a legally binding right to nonvested remuneration to the individual for services the individual performed as an employee of an ATEO during the applicable year and the preceding applicable year. For this purpose, whether a taxable related organization is controlled by the ATEO (or one or more related ATEOs) is determined without regard to paragraph (i)(2)(vii)(B)(2) of this section and without regard to section 318(a)(3) for purposes of applying paragraph (i)(2)(vii)(A) of this section, so that an interest in a corporation or nonstock entity is not attributed downward in determining control of the corporation or nonstock entity;

(2) Hours of service requirement. The individual performed services as an employee of the ATEO and any related ATEOs for not more than 50 percent of the total hours worked as an employee of the ATEO and any related organizations during the applicable year and the preceding applicable year. An ATEO may instead make this determination based on the total days the individual worked as an employee of the ATEO and all related ATEOs as a percentage of the total days worked as an employee of the ATEO and all related organizations, provided that for purposes of the calculation, any day that the individual worked at least one hour as an employee of the ATEO or a related ATEO is treated as a day worked as an employee of the ATEO and not for any other organization; and

(3) Related organizations requirement. No related organization that paid remuneration or granted a legally binding right to nonvested remuneration to the individual during the applicable year and the preceding applicable year provided services for a fee to the ATEO, to any related ATEO, or to any taxable related organization controlled by the ATEO or by one or more related ATEOs, either alone or together with the ATEO, during the applicable year and the preceding applicable year. For purposes of this paragraph (d)(2)(iii)(A)(3), whether a taxable related organization is controlled by the ATEO (or one or more related ATEOs) is determined without regard to paragraph (i)(2)(vii)(B)(2) of this section and without regard to section 318(a)(3) for purposes of applying paragraph (i)(2)(vii)(A) of this section, so that an interest in a corporation or nonstock entity is not attributed downward in determining control of the corporation or nonstock entity.

(B) Certain payments disregarded. For purposes of paragraph (d)(2)(iii)(A)(1) of this section, a payment of remuneration made to an individual by a related organization that is an employer of the individual and for which the related organization is neither entitled to reimbursement by the ATEO nor entitled to any other consideration from the ATEO is not considered remuneration paid by the ATEO under § 53.4960-2(b)(1) and a payment of remuneration made to the individual by a related organization is not treated as paid by the ATEO under § 53.4960-2(b)(2).

(iv) Limited services exception. An individual is disregarded for purposes of determining an ATEO's five highest-compensated employees for a taxable year even though the ATEO paid remuneration to the individual if, disregarding § 53.4960-2(b)(2), all of the following requirements are met:

(A) Remuneration requirement. The ATEO did not pay 10 percent or more of the individual's total remuneration for services performed as an employee of the ATEO and all related organizations during the applicable year; and

(B) Related ATEO requirement. The ATEO had at least one related ATEO during the applicable year and one of the following conditions applies:

(1) Ten percent remuneration condition. A related ATEO paid at least 10 percent of the remuneration paid by the ATEO and any related organizations during the applicable year; or

(2) Less remuneration condition. No related ATEO paid at least 10 percent of the total remuneration paid by the ATEO and any related organizations and the ATEO paid less remuneration to the individual than at least one related ATEO during the applicable year.

(3) Examples. The following examples illustrate the rules of this paragraph (d). For purposes of these examples, assume any entity referred to as “ATEO” is an ATEO, any entity referred to as “CORP” is not an ATEO and is not a publicly held company within the meaning of section 162(m)(2) unless otherwise stated, and each taxpayer uses the calendar year as its taxable year.

(i) Example 1 (Employee of two related ATEOs)—(A) Facts. ATEO 1 and ATEO 2 are related organizations and have no other related organizations. Both employ Employee A during calendar year 2022 and pay remuneration to Employee A for Employee A's services. During 2022, Employee A performed services for 1,000 hours as an employee of ATEO 1 and 1,000 hours as an employee of ATEO 2.

(B) Conclusion. Employee A may be a covered employee of both ATEO 1 and ATEO 2 as one of the five highest-compensated employees for taxable year 2022 under paragraph (d)(2)(i) of this section because the exceptions in paragraphs (d)(2)(ii) through (iv) of this section do not apply. Because they are related organizations, ATEO 1 and ATEO 2 must each include the remuneration paid to Employee A by the other during each of their applicable years in determining their respective five highest-compensated employees for taxable year 2022.

(ii) Example 2 (Employee of an ATEO and a related non-ATEO)—(A) Facts. Assume the same facts as in paragraph (d)(3)(i) of this section (Example 1), except that ATEO 1 is instead CORP 1.

(B) Conclusion (CORP 1). For taxable year 2022, CORP 1 is not an ATEO and therefore does not need to identify covered employees.

(C) Conclusion (ATEO 2). Employee A may be a covered employee of ATEO 2 as one of its five highest-compensated employees for taxable year 2022 under paragraph (d)(2)(i) of this section because no exception in paragraphs (d)(2)(ii) through (iv) of this section applies. ATEO 2 must include the remuneration paid to Employee A by CORP 1 during its applicable year in determining ATEO 2's five highest-compensated employees for taxable year 2022.

(iii) Example 3 (Amounts for which a deduction is disallowed under section 162(m) are taken into account for purposes of determining the five highest-compensated employees)—(A) Facts. CORP 2 is a publicly held corporation within the meaning of section 162(m)(2) and is a related organization of ATEO 3. ATEO 3 is a corporation that is part of CORP 2's affiliated group (as defined in section 1504, without regard to section 1504(b)) and has no other related organizations. Employee B is a covered employee (as defined in section 162(m)(3)) of CORP 2 and an employee of ATEO 3. In 2022, CORP 2 paid Employee B $8 million of remuneration for services provided as an employee of CORP 2 and ATEO 3 paid Employee B $500,000 of remuneration for services provided as an employee of ATEO 3. $7.5 million of the remuneration is compensation for which a deduction is disallowed pursuant to section 162(m)(1).

(B) Conclusion. The $7.5 million of remuneration for which a deduction is disallowed under section 162(m)(1) is taken into account for purposes of determining ATEO 3's five highest-compensated employees. Thus, ATEO 3 is treated as paying Employee B $8.5 million of remuneration for purposes of determining its five highest-compensated employees.

(iv) Example 4 (Employee disregarded due to receiving no remuneration)—(A) Facts. Employee C is an officer of ATEO 4 who performs more than minor services for ATEO 4. In 2022, neither ATEO 4 nor any related organization paid remuneration or granted a legally binding right to any nonvested remuneration to Employee C. ATEO 4 paid premiums for insurance for liability arising from Employee C's service with ATEO 4, which is properly treated as a working condition fringe benefit excluded from gross income under § 1.132-5.

(B) Conclusion. Even though Employee C is an employee of ATEO 4, Employee C is disregarded for purposes of determining ATEO 4's five highest-compensated employees for taxable year 2022 under paragraph (d)(2)(i) of this section because neither ATEO 4 nor any related organization paid Employee C any remuneration (nor did they grant a legally binding right to nonvested remuneration) in applicable year 2022. The working condition fringe benefit is not wages within the meaning of section 3401(a), as provided in section 3401(a)(19), and thus is not remuneration within the meaning of § 53.4960-2(a).

(v) Example 5 (Limited hours exception)—(A) Facts. ATEO 5 and CORP 3 are related organizations. ATEO 5 has no other related organizations. Employee D is an employee of CORP 3. As part of Employee D's duties at CORP 3, Employee D serves as an officer of ATEO 5. Only CORP 3 paid remuneration (or granted a legally binding right to nonvested remuneration) to Employee D and ATEO 5 did not reimburse CORP 3 for any portion of Employee D's remuneration in any manner. During 2022, Employee D provided services as an employee for 2,000 hours to CORP 3 and 200 hours to ATEO 5.

(B) Conclusion. Even though Employee D is an employee of ATEO 5 because Employee D provided more than minor services as an officer, Employee D is disregarded for purposes of determining ATEO 5's five highest-compensated employees for taxable year 2022. Employee D is disregarded under paragraph (d)(2)(ii) of this section because only CORP 3 paid Employee D any remuneration or granted a legally binding right to nonvested remuneration in applicable year 2022 and Employee D provided services as an employee of ATEO 5 for 200 hours, which is not more than ten percent of the 2,200 total hours (2,000 + 200 = 2,200) worked as an employee of ATEO 5 and all related organizations.

(vi) Example 6 (Limited hours exception)—(A) Facts. Assume the same facts as in paragraph (d)(3)(v) of this section (Example 5), except that ATEO 5 also provides a reasonable allowance for expenses incurred by Employee D in executing Employee D's duties as an officer of ATEO 5, which is properly excluded from gross income under an accountable plan described in § 1.62-2.

(B) Conclusion. The conclusion is the same as in paragraph (d)(3)(v)(B) of this section (Example 5). Specifically, even though Employee D is an employee of ATEO 5 because Employee D provided more than minor services for ATEO 5, Employee D is disregarded for purposes of determining ATEO 5's five highest-compensated employees for taxable year 2022 under paragraph (d)(2)(ii) of this section because the expense allowance under the accountable plan is excluded from wages within the meaning of section 3401(a), as provided in § 31.3401(a)-4, and thus is not remuneration within the meaning of § 53.4960-2(a).

(vii) Example 7 (No exception applies due to source of payment)—(A) Facts. Assume the same facts as in paragraph (d)(3)(v) of this section (Example 5), except that ATEO 5 has a contractual arrangement with CORP 3 to reimburse CORP 3 for the hours of service Employee D provides to ATEO 5 during applicable year 2022 by paying an amount equal to the total remuneration received by Employee D from both ATEO 5 and CORP 3, multiplied by a fraction equal to the hours of service Employee D provided ATEO 5 over Employee D's total hours of service to both ATEO 5 and CORP 3.

(B) Conclusion. Employee D may be one of ATEO 5's five highest-compensated employees for taxable year 2022 under paragraph (d)(2)(i) of this section because the exceptions in paragraphs (d)(2)(ii) through (iv) of this section do not apply. Pursuant to the contractual arrangement between CORP 3 and ATEO 5, ATEO 5 reimburses CORP 3 for a portion of Employee D's remuneration during applicable year 2022; thus, the exceptions under paragraphs (d)(2)(ii) and (iii) of this section do not apply. Further, while ATEO 5 paid Employee D less than 10 percent of the total remuneration from ATEO 5 and all related organizations (200 hours of service to ATEO 5/2,200 hours of service to ATEO 5 and all related organizations = 9 percent), it had no related ATEO; thus, the limited services exception under paragraph (d)(2)(iv) of this section does not apply.

(viii) Example 8 (Nonexempt funds exception for part-time services)—(A) Facts. ATEO 6 and CORP 4 are related organizations. ATEO 6 has no other related organizations and does not control CORP 4. During applicable year 2022, Employee E provided 2,000 hours of services as an employee of CORP 4 and 0 hours of services as an employee of ATEO 6; during applicable year 2023, Employee E provided 1,100 hours of services as an employee of CORP 4 and 900 hours of services as an employee of ATEO 6; during applicable year 2024, Employee E provided 1,100 hours of services as an employee of CORP 4 and 900 hours of services as an employee of ATEO 6. ATEO 6 neither paid any remuneration to Employee E nor paid a fee for services to CORP 4 during any applicable year. No exception under paragraphs (d)(2)(i), (ii), or (iv) applies to Employee E.

(B) Conclusion (2023). Employee E is disregarded for purposes of determining ATEO 6's five highest-compensated employees for taxable year 2023 under paragraph (d)(2)(iii) of this section because for applicable years 2022 and 2023, Employee E provided services as an employee of ATEO 6 for not more than 50 percent of the total hours Employee E provided services as an employee of ATEO 6 and CORP 4 (900 hours/4,000 hours), and ATEO 6 neither paid any remuneration to Employee E nor paid a fee for services to CORP 4 during applicable years 2022 and 2023.

(C) Conclusion (2024). Employee E is disregarded for purposes of determining ATEO 6's five highest-compensated employees for taxable year 2024 under paragraph (d)(2)(iii) of this section because for applicable years 2023 and 2024, Employee E provided services as an employee of ATEO 6 for not more than 50 percent of the total hours Employee E provided services as an employee of ATEO 6 and CORP 4 (1,800 hours/4,000 hours), and ATEO 6 neither paid any remuneration to Employee E nor paid a fee for services to CORP 4 during applicable years 2023 and 2024.

(ix) Example 9 (Nonexempt funds for full-time services in one applicable year)—(A) Facts. Assume the same facts as in paragraph (d)(3)(viii) of this section (Example 8), except that during applicable year 2022, Employee E provided services as an employee for 2,000 hours to CORP 4 and for 0 hours to ATEO 6; during applicable year 2023, Employee E provided services as an employee for 0 hours to CORP 4 and 2,000 hours to ATEO 6; and during applicable year 2024, Employee E resumes employment with CORP 4 so that Employee E provided services as an employee for 2,000 hours to CORP 4 and 0 hours to ATEO 6.

(B) Conclusion (2023). Employee E is disregarded for purposes of determining ATEO 6's five highest-compensated employees for taxable year 2023 under paragraph (d)(2)(iii) of this section because for applicable years 2022 and 2023, Employee E provided services as an employee of ATEO 6 for not more than 50 percent of the total hours Employee E provided services as an employee of ATEO 6 and CORP 4 (2,000 hours/4,000 hours), and ATEO 6 neither paid any remuneration to Employee E nor paid a fee for services to CORP 4 during applicable years 2022 and 2023.

(C) Conclusion (2024). Employee E is disregarded for purposes of determining ATEO 6's five highest-compensated employees for taxable year 2024 under paragraph (d)(2)(iii) of this section because for applicable years 2023 and 2024, Employee E provided services as an employee of ATEO 6 for not more than 50 percent of the total hours Employee E provided services as an employee of ATEO 6 and CORP 4 (2,000 hours/4,000 hours for ATEO 6 and CORP 4), and ATEO 6 neither paid any remuneration to Employee E nor paid a fee for services to CORP 4 during applicable years 2023 and 2024.

(x) Example 10 (Nonexempt funds exception for full-time services across two applicable years)—(A) Facts. Assume the same facts as in paragraph (d)(3)(viii)(A) of this section (Example 8), except that during applicable year 2022, Employee E provided services as an employee for 2,000 hours to CORP 4 and for 0 hours to ATEO 6; during applicable year 2023, Employee E provided services as an employee for 600 hours to CORP 4 and for 1,400 hours to ATEO 6; and during applicable year 2024, Employee E provided services as an employee for 1,400 hours to CORP 4 and for 600 hours to ATEO 6.

(B) Conclusion (2023). Employee E is disregarded for purposes of determining ATEO 6's five highest-compensated employees for taxable year 2023 under paragraph (d)(2)(iii) of this section because for applicable years 2022 and 2023, Employee E provided services as an employee of ATEO 6 for not more than 50 percent of the total hours Employee E provided services as an employee of ATEO 6 and CORP 4 (1,400 hours/4,000 hours), and ATEO 6 neither paid any remuneration to Employee E, nor paid a fee for services to CORP 4 during applicable years 2022 and 2023.

(C) Conclusion (2024). Employee E is disregarded for purposes of determining ATEO 6's five highest-compensated employees for taxable year 2024 under paragraph (d)(2)(iii) of this section because for applicable years 2023 and 2024, Employee E provided services as an employee of ATEO 6 for not more than 50 percent of the total hours Employee E provided services as an employee of ATEO 6 and CORP 4 (2,000 hours/4,000 hours), and ATEO 6 neither paid any remuneration to Employee E, nor paid a fee for services to CORP 4 during applicable years 2023 and 2024.

(xi) Example 11 (Failure under the nonexempt funds exception)—(A) Facts. Assume the same facts as in paragraph (d)(3)(viii)(A) of this section (Example 8), except that during applicable year 2022, Employee E provided services as an employee for 2,000 hours to CORP 4 and for 0 hours to ATEO 6; during applicable year 2023, Employee E provided services as an employee for 600 hours to CORP 4 and for 1,400 hours to ATEO 6; and during applicable year 2024, Employee E provided services as an employee for 1,300 hours to CORP 4 and for 700 hours to ATEO 6.

(B) Conclusion (2023). Employee E is disregarded for purposes of determining ATEO 6's five highest-compensated employees for taxable year 2023 under paragraph (d)(2)(iii) of this section because for applicable years 2022 and 2023, Employee E provided services as an employee of ATEO 6 for less than 50 percent of the total hours Employee E provided services as an employee of ATEO 6 and CORP 4 (1,400 hours/4,000 hours), and ATEO 6 neither paid any remuneration to Employee E, nor paid a fee for services to CORP 4 during applicable years 2022 and 2023.

(C) Conclusion (2024). Employee E may be a covered employee of ATEO 6 as one of its five highest-compensated employees for taxable year 2024 because the requirements under paragraph (d)(2)(iii) are not met and no other exception applies. For applicable years 2023 and 2024, Employee E provided services as an employee of ATEO 6 for more than 50 percent of the total hours Employee E provided services as an employee of ATEO 6 and CORP 4 (2,100 hours/4,000 hours).

(xii) Example 12 (Limited services exception)—(A) Facts. ATEO 7, ATEO 8, ATEO 9, and ATEO 10 are a group of related organizations, none of which have any other related organizations. During 2022, Employee F is an employee of ATEO 7, ATEO 8, ATEO 9, and ATEO 10. During applicable year 2022, ATEO 7 paid 5 percent of Employee F's remuneration, ATEO 8 paid 10 percent of Employee F's remuneration, ATEO 9 paid 25 percent of Employee F's remuneration, and ATEO 10 paid 60 percent of Employee F's remuneration. No exception under paragraph (d)(2)(i), (ii), or (iii) applies to Employee F for any of ATEO 7, ATEO 8, ATEO 9, or ATEO 10.

(B) Conclusion (ATEO 7). Employee F is disregarded for purposes of determining ATEO 7's five highest-compensated employees for taxable year 2022 under paragraph (d)(2)(iv) of this section because ATEO 7 paid less than 10 percent of Employee F's total remuneration from ATEO 7 and all related organizations during applicable year 2022, and another related ATEO paid at least 10 percent of that total remuneration.

(C) Conclusion (ATEO 8, ATEO 9, and ATEO 10). Employee F may be a covered employee of ATEO 8, ATEO 9, and ATEO 10 as one of their respective five highest-compensated employees for their taxable years 2022 because each of those ATEOs paid 10 percent or more of Employee F's remuneration during the 2022 applicable year. Thus, the limited services exception under paragraph (d)(2)(iv) of this section does not apply.

(xiii) Example 13 (Limited services exception if no ATEO paid at least 10 percent of remuneration)—(A) Facts. Assume the same facts as in paragraph (d)(3)(xii) of this section (Example 12), except that for applicable year 2022, ATEO 7 paid 6 percent of F's remuneration, ATEO 8, ATEO 9, and ATEO 10 each paid 5 percent of Employee F's remuneration, and Employee F also works as an employee of CORP 5, a related organization of ATEO 7, ATEO 8, ATEO 9, and ATEO 10 that paid 79 percent of Employee F's remuneration for applicable year 2022.

(B) Conclusion (ATEO 7). Employee F may be one of ATEO 7's five highest-compensated employees for taxable year 2022. Although ATEO 7 did not pay Employee F 10 percent or more of the total remuneration paid by ATEO 7 and all of its related organizations, no related ATEO paid more than 10 percent of Employee F's remuneration, and ATEO 7 did not pay less remuneration to Employee F than at least one related ATEO. Thus, the limited services exception under paragraph (d)(2)(iv) of this section does not apply, and Employee F may be one of ATEO 7's five highest-compensated employees because ATEO 7 paid Employee F more remuneration than any other related ATEO.

(C) Conclusion (ATEO 8, ATEO 9, and ATEO 10). Employee F is disregarded for purposes of determining the five highest-compensated employees of ATEO 8, ATEO 9, and ATEO 10 for taxable year 2022 under paragraph (d)(2)(iv) of this section because none paid 10 percent or more of Employee F's total remuneration, each had no related ATEO that paid at least 10 percent of Employee F's total remuneration, and each paid less remuneration than at least one related ATEO (ATEO 7).

(e) Employee—(1) In general. Employee means an employee as defined in section 3401(c) and § 31.3401(c)-1. Section 31.3401(c)-1 generally defines an employee as any individual performing services if the relationship between the individual and the person for whom the individual performs services is the legal relationship of employer and employee. As set forth in § 31.3401(c)-1, this includes common law employees, as well as officers and employees of government entities, whether or not elected. An employee generally also includes an officer of a corporation, but an officer of a corporation who as such does not perform any services or performs only minor services and who neither receives, nor is entitled to receive, any remuneration is not considered to be an employee of the corporation solely due to the individual's status as an officer of the corporation. Whether an individual is an employee depends on the facts and circumstances.

(2) Directors. A director of a corporation (or an individual holding a substantially similar position in a corporation or other entity) in the individual's capacity as such is not an employee of the corporation. See § 31.3401(c)-1(f).

(3) Trustees. The principles of paragraph (e)(2) of this section apply by analogy to a trustee of any arrangement classified as a trust for Federal tax purposes in § 301.7701-4(a).

(f) Employer—(1) In general. Employer means an employer within the meaning of section 3401(d), without regard to section 3401(d)(1) or (2), meaning generally the person or governmental entity for whom the services were performed as an employee. Whether a person or governmental entity is the employer depends on the facts and circumstances, but a person does not cease to be the employer through use of a payroll agent under section 3504, a common paymaster under section 3121(s), a person described in section 3401(d)(1) or (2), a certified professional employer organization under section 7705, or any similar arrangement.

(2) Disregarded entities. In the case of a disregarded entity described in § 301.7701-3, § 301.7701-2(c)(2)(iv) does not apply; thus, the sole owner of the disregarded entity is treated as the employer of any individual performing services as an employee of the disregarded entity.

(g) Medical services—(1) Medical and veterinary services—(i) In general. Medical services means services directly performed by a licensed medical professional (as defined in paragraph (g)(2) of this section) for the diagnosis, cure, mitigation, treatment, or prevention of disease in humans or animals; services provided for the purpose of affecting any structure or function of the human or animal body; and other services integral to providing such medical services. For purposes of section 4960, teaching and research services are not medical services except to the extent that they involve the services performed to directly diagnose, cure, mitigate, treat, or prevent disease or affect a structure or function of the body. Administrative services may be integral to directly providing medical services. For example, documenting the care and condition of a patient is integral to providing medical services, as is accompanying another licensed professional as a supervisor while that medical professional provides medical services. However, managing an organization's operations, including scheduling, staffing, appraising employee performance, and other similar functions that may relate to a particular medical professional or professionals who perform medical services, is not integral to providing medical services. See § 53.4960-2(a)(2)(ii) for rules regarding allocating remuneration paid to a medical professional who performs both medical services and other services.

(ii) Examples. The following examples illustrate the rules of this paragraph (g):

(A) Example 1 (Administrative tasks that are integral to providing medical services)—(1) Facts. Employee A is a doctor who is licensed to practice medicine in the state in which Employee A's place of employment is located. In the course of Employee A's practice, Employee A treats patients and performs some closely-related administrative tasks, such as examining and updating patient records.

(2) Conclusion. Employee A's administrative tasks are integral to providing medical services and thus are medical services.

(B) Example 2 (Administrative tasks that are not integral to providing medical services)—(1) Facts. Assume the same facts as in paragraph (g)(1)(ii)(A)(1) of this section (Example 1), except that Employee A also performs additional administrative tasks such as analyzing the budget, authorizing capital expenditures, and managing human resources for the organization by which Employee A is employed.

(2) Conclusion. Employee A's additional administrative tasks are not integral to providing medical services and thus are not medical services.

(C) Example 3 (Teaching duties that are and are not medical services)—(1) Facts. Employee B is a medical doctor who is licensed to practice medicine in the state in which her place of employment, a university hospital, is located. Employee B's duties include overseeing and teaching a group of resident physicians who have restricted licenses to practice medicine. Those duties include supervising and instructing the resident physicians while they treat patients and instruction in a classroom setting.

(2) Conclusion. Employee B's supervision and instruction of resident physicians during the course of patient treatment are necessary for the treatment, and thus are medical services. Employee B's classroom instruction is not necessary for patient treatment, and thus is not medical services.

(D) Example 4 (Research services that are and are not medical services)—(1) Facts. Employee C is a licensed medical doctor who is employed to work on a research trial. Employee C provides an experimental treatment to patients afflicted by a disease and performs certain closely-related administrative tasks that ordinarily are performed by a medical professional in a course of patient treatment. As part of the research trial, Employee C also compiles and analyzes patient results and prepares reports and articles that would not ordinarily be prepared by a medical professional in the course of patient treatment.

(2) Conclusion. Employee C's services that are ordinarily performed by a medical professional in a course of treatment, including closely-related administrative tasks, are medical services. Because the compilation and analysis of patient results and the formulation of reports and articles are neither services ordinarily performed by a medical professional in a course of treatment nor necessary for such treatment, these services are not medical services.

(2) Definition of licensed medical professional. Licensed medical professional means an individual who is licensed under applicable state or local law to perform medical services, including as a doctor, nurse, nurse practitioner, dentist, veterinarian, or other licensed medical professional.

(h) Predecessor—(1) Asset acquisitions. If an ATEO (acquiror) acquires at least 80 percent of the operating assets or total assets (determined by fair market value on the date of acquisition) of another ATEO (target), then the target is a predecessor of the acquiror. For an acquisition of assets that occurs over time, only assets acquired within a 12-month period are taken into account to determine whether at least 80 percent of the target's operating assets or total assets were acquired. However, this 12-month period is extended to include any continuous period that ends or begins on any day during which the acquiror has an arrangement to acquire directly or indirectly, assets of the target. Additions to the assets of target made as part of a plan or arrangement to avoid the application of this subsection to acquiror's purchase of target's assets are disregarded in applying this paragraph. This paragraph (h)(1) applies for purposes of determining whether an employee is a covered employee under paragraph (d)(1) of this section only with respect to a covered employee of the target who commences the performance of services for the acquiror (or a related organization with respect to the acquiror) within the period beginning 12 months before and ending 12 months after the date of the transaction as defined in paragraph (h)(7) of this section.

(2) Corporate reorganizations. A predecessor of an ATEO includes another separate ATEO the stock or assets of which are acquired in a corporate reorganization as defined in section 368(a)(1)(A), (C), (D), (E), (F), or (G) (including by reason of section 368(a)(2)).

(3) Predecessor change of form or of place of organization. An ATEO that restructured by changing its organizational form or place of organization (or both) is a predecessor of the restructured ATEO.

(4) ATEO that becomes a non-ATEO—(i) General rule. An organization is a predecessor of an ATEO if it ceases to be an ATEO and then again becomes an ATEO effective on or before the predecessor end date. The predecessor end date is the date that is 36 months following the date that the organization's Federal information return under section 6033 (or, for an ATEO described in paragraph (b)(1)(ii) or (iii) of this section, its Federal income tax return under section 6011(a)) is due (or would be due if the organization were required to file), excluding any extension, for the last taxable year for which the organization previously was an ATEO. If the organization becomes an ATEO again effective after the predecessor end date, then the former ATEO is treated as a separate organization that is not a predecessor of the current ATEO.

(ii) Intervening changes or entities. If an ATEO that ceases to be an ATEO (former ATEO) would be treated as a predecessor to an organization that becomes an ATEO before the predecessor end date (successor ATEO), and if the former ATEO would be treated as a predecessor to each intervening entity (if such intervening entities had been ATEOs) under the rules of this paragraph (h), then the former ATEO is a predecessor of the successor ATEO. For example, if ATEO 1 loses its tax-exempt status and then merges into Corporation X, Corporation X then merges into Corporation Y, and Corporation Y becomes an ATEO before the predecessor end date, then ATEO 1 is a predecessor of Corporation Y.

(5) Predecessor of a predecessor. A reference to a predecessor includes any predecessor or predecessors of such predecessor, as determined under these rules.

(6) Elections under sections 336(e) and 338. For purposes of this paragraph (h), when an ATEO organized as a corporation makes an election to treat as an asset purchase either the sale, exchange, or distribution of stock pursuant to regulations under section 336(e) or the purchase of stock pursuant to regulations under section 338, the corporation that issued the stock is treated as the same corporation both before and after such transaction.

(7) Date of transaction. For purposes of this paragraph (h), the date that a transaction is treated as having occurred is the date on which all events necessary to complete the transaction described in the relevant provision have occurred.

(i) Related organization—(1) In general. Related organization means any person or governmental entity, domestic or foreign, that meets any of the following tests:

(i) Controls or controlled by test. The person or governmental entity controls, or is controlled by, the ATEO;

(ii) Controlled by same persons test. The person or governmental entity is controlled by one or more persons that control the ATEO;

(iii) Supported organization test. The person or governmental entity is a supported organization (as defined in section 509(f)(3)) with respect to the ATEO;

(iv) Supporting organization test. The person or governmental entity is a supporting organization described in section 509(a)(3) with respect to the ATEO; or

(v) VEBA test. With regard to an ATEO that is a voluntary employees' beneficiary association (VEBA) described in section 501(c)(9), the person or governmental entity establishes, maintains, or makes contributions to such VEBA.

(2) Control—(i) In general. Control may be direct or indirect. For rules concerning application of the principles of section 318 in applying this paragraph (i)(2), see paragraph (i)(2)(vii) of this section.

(ii) Stock corporation. A person or governmental entity controls a stock corporation if it owns (by vote or value) more than 50 percent of the stock in the stock corporation.

(iii) Partnership. A person or governmental entity controls a partnership if it owns more than 50 percent of the profits interests or capital interests in the partnership, determined in accordance with the rules and principles of § 1.706-1(b)(4)(ii) for a partner's interest in the profits of a partnership and § 1.706-1(b)(4)(iii) for a partner's interest in the capital of a partnership.

(iv) Trust. A person or governmental entity controls a trust if it owns more than 50 percent of the beneficial interests in the trust, determined by actuarial value.

(v) Nonstock organization—(A) In general. A person or governmental entity controls a nonstock organization if more than 50 percent of the trustees or directors of the nonstock organization are either representatives of, or directly or indirectly controlled by, the person or governmental entity. A nonstock organization is a nonprofit organization or other organization without owners and includes a governmental entity.

(B) Control of a trustee or director of a nonstock organization. A person or governmental entity controls a trustee or director of the nonstock organization if the person or governmental entity has the power (either at will or at regular intervals) to remove such trustee or director and designate a new one.

(C) Representatives. Trustees, directors, officers, employees, or agents of a person or governmental entity are deemed representatives of the person or governmental entity. However, an employee of a person or governmental entity (other than a trustee, director, or officer, or an employee who possesses at least the authority commonly exercised by an officer) who is a director or trustee of a nonstock organization (or acting in that capacity) will not be treated as a representative of the person or governmental entity if the employee does not act as a representative of the person or governmental entity and that fact is reported in the form and manner prescribed by the Commissioner in forms and instructions.

(vi) Brother-sister related organizations. Under paragraph (i)(1)(ii) of this section, an organization is a related organization with respect to an ATEO if one or more persons control both the ATEO and the other organization. In the case of control by multiple persons, the control tests described in this paragraph (i)(2) of this section apply to the persons as a group. For example, if 1,000 individuals who are members of both ATEO 1 and ATEO 2 elect a majority of the board members of each organization, then ATEO 1 and ATEO 2 are related to each other because the same group of 1,000 persons controls both ATEO 1 and ATEO 2.

(vii) Section 318 principles—(A) In general. Section 318 (relating to constructive ownership of stock) applies in determining ownership of stock in a corporation. The principles of section 318 also apply for purposes of determining ownership of interests in a partnership or in a trust with beneficial interests. For example, applying the principles of section 318(a)(1)(A), an individual is considered to own the partnership interest or trust interest owned, directly or indirectly, by or for the family members specified in such section.

(B) Nonstock organizations—(1) Attribution of ownership interest from a nonstock organization to a controlling person. If a person or governmental entity controls a nonstock organization, the person or governmental entity is treated as owning a percentage of the stock (or partnership interest or beneficial interest in a trust) owned by the nonstock organization in accordance with the percentage of trustees or directors of the nonstock organization that are representatives of, or directly or indirectly controlled by, the person or governmental entity.

(2) Attribution of ownership interest from a controlling person to a nonstock organization. If a person or governmental entity controls a nonstock organization, the nonstock organization is treated as owning a percentage of the stock (or partnership interest or beneficial interest in a trust) owned by the person or governmental entity in accordance with the percentage of trustees or directors of the nonstock organization that are representatives of, or directly or indirectly controlled by, the person or governmental entity.

(3) Indirect control of a nonstock organization through another nonstock organization. If a person or governmental entity controls one nonstock organization that controls a second nonstock organization, the person or governmental entity is treated as controlling the second nonstock organization if the product of the percentage of trustees or directors of the first nonstock organization that are representatives of, or directly or indirectly controlled by, the person or governmental entity, multiplied by the percentage of trustees or directors of the second nonstock organization that are representatives of, or directly or indirectly controlled by, the person or governmental entity or first nonstock organization, exceeds 50 percent. Similar principles apply to successive tiers of nonstock organizations.

(4) Attribution of control of nonstock organization to family member. An individual's control of a nonstock organization or of a trustee or director of a nonstock organization is attributed to the members of the individual's family (as set forth in section 318(a)(1) and the regulations thereunder), subject to the limitation of section 318(a)(5)(B) and the regulations thereunder.

(3) Examples. The following examples illustrate the principles of this paragraph (i). For purposes of these examples, assume any entity referred to as “ATEO” is an ATEO and any entity referred to as “CORP” is not an ATEO.

(i) Example 1 (Related through a chain of control)—(A) Facts. ATEO 1, ATEO 2, and ATEO 3 are nonstock organizations. ATEO 3 owns 80 percent of the stock (by value) of corporation CORP 1. Eighty percent of ATEO 2's directors are representatives of ATEO 1. In addition, 80 percent of ATEO 3's directors are representatives of ATEO 1.

(B) Conclusion. ATEO 1 is a related organization with respect to ATEO 2 (and vice versa) because more than 50 percent of ATEO 2's directors are representatives of ATEO 1; thus, ATEO 1 controls ATEO 2. Based on the same analysis, ATEO 1 is also a related organization with respect to ATEO 3 (and vice versa). CORP 1 is a related organization with respect to ATEO 3 because, as the owner of more than 50 percent of CORP 1's stock, ATEO 3 controls CORP 1. Applying the principles of section 318, ATEO 1 is deemed to own 64 percent of the stock of CORP 1 (80 percent of ATEO 3's stock in CORP 1). Thus, CORP 1 is a related organization with respect to ATEO 1 because ATEO 1 controls CORP 1. ATEO 2 is a related organization with respect to ATEO 3, ATEO 3 is a related organization with respect to ATEO 2, and CORP 1 is a related organization with respect to ATEO 2 because ATEO 2, ATEO 3, and CORP 1 are all controlled by the same person (ATEO 1).

(ii) Example 2 (Not related through a chain of control)—(A) Facts. ATEO 4, ATEO 5, and ATEO 6 are nonstock organizations. Sixty percent of ATEO 5's directors are representatives of ATEO 4. In addition, 60 percent of ATEO 6's directors are representatives of ATEO 5, but none are representatives of ATEO 4.

(B) Conclusion. ATEO 4 is a related organization with respect to ATEO 5 (and vice versa) because more than 50 percent of ATEO 5's directors are representatives of ATEO 4; thus, ATEO 4 controls ATEO 5. Based on the same analysis, ATEO 6 is a related organization with respect to ATEO 5 (and vice versa). Applying the principles of section 318, ATEO 4 is deemed to control 36 percent of ATEO 6's directors (60 percent of ATEO 5's 60 percent control over ATEO 6). Because less than 50 percent of ATEO 6's directors are representatives of ATEO 4, and absent any facts suggesting that ATEO 4 directly or indirectly controls ATEO 6, ATEO 4 and ATEO 6 are not related organizations with respect to each other.

(a) Remuneration—(1) In general. For purposes of section 4960, remuneration means any amount that is wages as defined in section 3401(a), excluding any designated Roth contribution (as defined in section 402A(c)) and including any amount required to be included in gross income under section 457(f). Remuneration includes amounts includible in gross income as compensation for services as an employee pursuant to a below-market loan described in section 7872(c)(1)(B)(i) (compensation-related loans) but does not include amounts excepted by section 7872(c)(3) ($10,000 de minimis exception). For example, see § 1.7872-15(e)(1)(i). Director's fees paid by a corporation to a director of the corporation are not remuneration, provided that if the director is also an employee of the corporation, the director's fees are excluded from remuneration only to the extent that they do not exceed fees paid to a director who is not an employee of the corporation or any related organization or, if there is no such director, they do not exceed reasonable director's fees. Remuneration does not include any amount that vested or was paid by a taxpayer before the start of the taxpayer's first taxable year that began on or after January 1, 2018.

(2) Exclusion of remuneration for medical services—(i) In general. Remuneration does not include the portion of any remuneration paid to a licensed medical professional that is for the performance of medical services by such professional.

(ii) Allocation of remuneration for medical services and non-medical services. If, during an applicable year, an employer pays a covered employee remuneration for providing both medical services and non-medical services, the employer must make a reasonable, good faith allocation between the remuneration for medical services and the remuneration for non-medical services. For example, if a medical doctor receives current remuneration (or vests in remuneration under a deferred compensation plan) for providing medical services and administrative or management services, the employer must make a reasonable, good faith allocation between the remuneration for the medical services and the remuneration for the administrative or management services. For this purpose, if an employment agreement or similar written arrangement sets forth the remuneration to be paid for particular services, that allocation of remuneration applies unless the facts and circumstances demonstrate that the amount allocated to medical services is unreasonable for those services or that the allocation was established for purposes of avoiding application of the excise tax under section 4960. If some or all of the remuneration is not reasonably allocated in an employment agreement or similar arrangement, an employer may use any reasonable allocation method. For example, an employer may use a representative sample of records, such as patient, insurance, and Medicare/Medicaid billing records or internal time reporting mechanisms to determine the time spent providing medical services, and then allocate remuneration to medical services in the proportion such time bears to the total hours the employee worked for the employer (and any related employer) for purposes of making a reasonable allocation of remuneration. Similarly, if some or all of the remuneration is not reasonably allocated in an employment agreement or other similar arrangement, an employer may use salaries or other remuneration paid by the employer or similarly situated employers for duties comparable to those the employee performs (for example, hospital administrator and physician) for purposes of making a reasonable allocation between remuneration for providing medical services and for providing non-medical services.

(iii) Examples. The following examples illustrate the rules of this paragraph (a)(2). For purposes of these examples, assume any entity referred to as “ATEO” is an ATEO.

(A) Example 1 (Allocation based on employment agreement)—(1) Facts. Employee A is a covered employee of ATEO 1. Employee A is a licensed medical professional who provides patient care services for ATEO 1 and also provides management and administrative services to ATEO 1 as the manager of a medical practice group within ATEO 1. The employment agreement between ATEO 1 and Employee A specifies that of Employee A's salary, 30 percent is allocable to Employee A's services as manager of the medical practice group and 70 percent is allocable to Employee A's services as a medical professional providing patient care services. The facts regarding Employee A's employment indicate the employment agreement provides a reasonable allocation and that the allocation was not established for purposes of avoiding application of the excise tax.

(2) Conclusion. Consistent with Employee A's employment agreement, ATEO 1 must allocate 30 percent of Employee A's salary to the provision of non-medical services and 70 percent of Employee A's salary to the provision of medical services. Accordingly, only the 30 percent portion of Employee A's salary allocated to the other, non-medical services is remuneration for purposes of paragraph (a) of this section.

(B) Example 2 (Allocation based on billing records)—(1) Facts. Assume the same facts as in paragraph (a)(2)(iii)(A) of this section (Example 1), except that the employment agreement does not allocate Employee A's salary between medical and non-medical services performed by Employee A. Based on a representative sample of insurance and Medicare billing records, as well as time reports that Employee A submits to ATEO 1, ATEO 1 determines that Employee A spends 50 percent of her work hours providing patient care and 50 percent of her work hours performing administrative and management services. ATEO 1 allocates 50 percent of Employee A's remuneration to medical services.

(2) Conclusion. ATEO 1's allocation of Employee A's salary is a reasonable, good faith allocation. Accordingly, only the 50 percent portion of Employee A's remuneration allocated to the non-medical services is remuneration for purposes of paragraph (a) of this section.

(b) Source of payment. For purposes of this section, the determination of the source of a payment of remuneration may involve the application of one or both of two separate rules described in this paragraph (b). Paragraph (b)(1) of this section addresses payments by a third party for services performed as an employee of a separate employer entity, while paragraph (b)(2) of this section addresses the application of section 4960(c)(4)(A) to treat certain remuneration paid by a related organization (after application of paragraph (b)(1) of this section, if applicable) as paid by the ATEO.

(1) Remuneration paid by a third party for employment by an employer. Remuneration paid (or a grant of a legally binding right to nonvested remuneration) by a third-party payor (whether a related organization, payroll agent, agent designated under section 3504, certified professional employer organization under section 7705, or other entity) during an applicable year for services performed as an employee of an employer is remuneration paid (or payable) by the employer, except as otherwise provided in § 53.4960-1(d)(2)(ii) and (iii).

(2) Remuneration paid by a related organization for employment by the related organization. Pursuant to section 4960(c)(4)(A), remuneration paid (or a grant of a legally binding right to nonvested remuneration) by a related organization to an ATEO's employee during an applicable year for services performed as an employee of the related organization is treated as remuneration paid (or payable) by the ATEO, except as otherwise provided in § 53.4960-1(d)(2)(ii) and (iii).

(c) Applicable year in which remuneration is treated as paid—(1) In general. Remuneration that is a regular wage within the meaning of § 31.3402(g)-1(a)(1)(ii) is treated as paid on the date it is actually or constructively paid and all other remuneration is treated as paid on the first date on which the remuneration is vested.

(2) Vested remuneration. Remuneration is vested if it is not subject to a substantial risk of forfeiture within the meaning of section 457(f)(3)(B) (regardless of whether the arrangement under which the remuneration is to be paid is deferred compensation described in section 457(f) or 409A). In general, an amount is subject to a substantial risk of forfeiture if entitlement to the amount is conditioned on the future performance of substantial services or upon the occurrence of a condition that is related to a purpose of the remuneration if the possibility of forfeiture is substantial. Except as provided in paragraph (c)(1) of this section, remuneration that is never subject to a substantial risk of forfeiture is considered paid on the first date the service provider has a legally binding right to the payment. For purposes of this section, a plan means a plan within the meaning of § 1.409A-1(c), an account balance plan means an account balance plan within the meaning of § 1.409A-1(c)(2)(i)(A), and a nonaccount balance plan means a nonaccount balance plan within the meaning of § 1.409A-1(c)(2)(i)(C). Net earnings on previously paid remuneration (described in paragraph (d)(2) of this section) that are not subject to a substantial risk of forfeiture are vested (and, thus, treated as paid) at the earlier of the date actually or constructively paid to the employee or the close of the applicable year in which they accrue. For example, the present value of a principal amount accrued to an employee's account under an account balance plan (under which the earnings and losses attributed to the account are based solely on a predetermined actual investment as determined under § 31.3121(v)(2)-1(d)(2)(i)(B) or a reasonable market interest rate) is treated as paid on the date vested, but the present value of any net earnings subsequently accrued on that amount (the increase in value due to the predetermined actual investment or a reasonable market interest rate) is treated as paid at the close of the applicable year in which they accrue. Similarly, while the present value of an amount accrued under a nonaccount balance (including earnings that accrued while the amount was nonvested) is treated as paid on the date it is first vested, the present value of the net earnings on that amount (the increase in the present value) is treated as paid at the close of the applicable year in which they accrue.

(3) Change in related status during the year. If a taxpayer becomes or ceases to be a related organization with respect to an ATEO during an applicable year, then only the remuneration paid by the taxpayer to an employee with respect to services performed as an employee of the related organization during the portion of the applicable year during which the employer is a related organization is treated as paid by the ATEO. If an amount is treated as paid due to vesting in the year the taxpayer becomes or ceases to be a related organization with respect to the ATEO, then the amount is treated as paid by the ATEO only if the amount becomes vested during the portion of the applicable year that the taxpayer is a related organization with respect to the ATEO.

(d) Amount of remuneration treated as paid—(1) In general. For each applicable year, the amount of remuneration treated as paid by the employer to a covered employee is the sum of regular wages within the meaning of § 31.3402(g)-1(a)(1)(ii) actually or constructively paid during the applicable year and the present value (as determined under paragraph (e) of this section) of all other remuneration that vested during the applicable year. The amount of remuneration that vests during an applicable year is determined on an employer-by-employer basis with respect to each covered employee.

(2) Earnings and losses on previously paid remuneration—(i) In general. The amount of net earnings or losses on previously paid remuneration paid by an employer is determined on an employee-by-employee basis, such that amounts accrued with regard to one employee do not affect amounts accrued with regard to a different employee. Similarly, losses accrued on previously paid remuneration from one employer do not offset earnings accrued on previously paid remuneration from another employer. The amount of net earnings or losses on previously paid remuneration paid by the employer is determined on a net aggregate basis for all plans maintained by the employer in which the employee participates for each applicable year. For example, losses under an account balance plan may offset earnings under a nonaccount balance plan for the same applicable year maintained by the same employer for the same employee.

(ii) Previously paid remuneration—(A) New covered employee. For an individual who was not a covered employee for any prior applicable year, previously paid remuneration means, for the applicable year for which the individual becomes a covered employee, the present value of vested remuneration that was not actually or constructively paid or otherwise includible in the employee's gross income before the start of the applicable year plus any remuneration that vested during the applicable year but that is not actually or constructively paid or otherwise includible in the employee's gross income before the close of the applicable year.

(B) Existing covered employee. For an individual who was a covered employee for any prior applicable year, previously paid remuneration means, for each applicable year, the amount of remuneration that the employer treated as paid in the applicable year or for a prior applicable year but that is not actually or constructively paid or otherwise includible in the employee's gross income before the close of the applicable year. Actual or constructive payment or another event causing an amount of previously paid remuneration to be includible in the employee's gross income thus reduces the amount of previously paid remuneration.

(iii) Earnings. Earnings means any increase in the vested present value of previously paid remuneration as of the close of the applicable year, regardless of whether the plan denominates the increase as earnings. For example, an increase in the vested account balance of a nonqualified deferred compensation plan based solely on the investment return of a predetermined actual investment (and disregarding any additional contributions) constitutes earnings. Similarly, an increase in the vested present value of a benefit under a nonqualified nonaccount balance plan due solely to the passage of time (and disregarding any additional benefit accruals) constitutes earnings. However, an increase in an account balance of a nonqualified deferred compensation plan due to a salary reduction contribution or an employer contribution does not constitute earnings (and therefore may not be offset with losses). Likewise, an increase in the benefit under a nonaccount balance plan due to an additional year of service or an increase in compensation that is reflected in a benefit formula does not constitute earnings.

(iv) Losses. Losses means any decrease in the vested present value of previously paid remuneration as of the close of the applicable year, regardless of whether the plan denominates that decrease as losses.

(v) Net earnings. Net earnings means, for each applicable year, the amount (if any) by which the earnings accrued for the applicable year on previously paid remuneration exceeds the sum of the losses accrued on previously paid remuneration for the applicable year and any net losses carried forward from a previous taxable year.

(vi) Net losses. Net losses means, for each applicable year, the amount (if any) by which the sum of the losses accrued on previously paid remuneration for the applicable year and any net losses carried forward from a previous taxable year exceed the earnings accrued for the applicable year on previously paid remuneration. Losses may only be used to offset earnings and thus do not reduce the remuneration treated as paid for an applicable year except to the extent of the earnings accrued for that applicable year. However, with regard to a covered employee, an employer may carry net losses forward to the next applicable year and offset vested earnings for purposes of determining net earnings or losses for that subsequent applicable year. For example, if a covered employee who participates in a nonaccount balance plan and an account balance plan vests in an amount of earnings under the nonaccount balance plan and has losses under the account balance plan that exceed the vested earnings treated as remuneration under the nonaccount balance plan, those excess losses are carried forward to the next applicable year and offset vested earnings for purposes of determining net earnings or losses for that applicable year. If, for the next applicable year, there are not sufficient earnings to offset the entire amount of losses carried forward from the previous year (and any additional losses), the offset process repeats for each subsequent applicable year until there are sufficient earnings for the applicable year to offset any remaining losses carried forward.

(3) Remuneration paid for a taxable year before the employee becomes a covered employee—(i) In general. In accordance with the payment timing rules of paragraph (c) of this section, any remuneration that is vested but is not actually or constructively paid or otherwise includible in an employee's gross income as of the close of the applicable year for the taxable year immediately preceding the taxable year in which the employee first becomes a covered employee of an ATEO is treated as previously paid remuneration for the taxable year in which the employee first becomes a covered employee. Net losses on this previously paid remuneration from any preceding applicable year do not carry forward to subsequent applicable years. However, net earnings and losses that vest on such previously paid remuneration in subsequent applicable years are treated as remuneration paid for a taxable year for which the employee is a covered employee.

(ii) Examples. The following examples illustrate the rules of this paragraph (d)(3). For purposes of these examples, assume any organization described as “ATEO” is an ATEO.

(A) Example 1 (Earnings on pre-covered employee remuneration)—(1) Facts. ATEO 1 uses a taxable year beginning July 1 and ending June 30. Employee A becomes a covered employee of ATEO 1 for the taxable year beginning July 1, 2023, and ending June 30, 2024. During the 2022 applicable year, Employee A vests in $1 million of nonqualified deferred compensation. As of December 31, 2022, the present value of the amount deferred under the plan is $1.1 million. During the 2023 applicable year, ATEO 1 pays Employee A $1 million in regular wages. The present value as of December 31, 2023, of Employee A's nonqualified deferred compensation is $1.3 million.

(2) Conclusion (Taxable year beginning July 1, 2022, and ending June 30, 2023). ATEO 1 pays Employee A $1.1 million of remuneration in the 2022 applicable year. This is comprised of $1 million of vested nonqualified deferred compensation, and $100,000 of earnings, all of which is treated as paid for the taxable year beginning July 1, 2022, and ending June 30, 2023.

(3) Conclusion (Taxable year beginning July 1, 2023, and ending June 30, 2024). ATEO 1 pays Employee A $1.2 million of remuneration in the 2023 applicable year. This is comprised of $1 million regular wages and $200,000 of earnings ($1.3 million present value as of December 31, 2023, minus $1.1 million previously paid remuneration as of December 31, 2022).

(B) Example 2 (Losses on pre-covered employee remuneration)—(1) Facts. Assume the same facts as in paragraph (d)(3)(ii)(A) of this section (Example 1), except that the present value of the nonqualified deferred compensation as of December 31, 2022, is $900,000.

(2) Conclusion (Taxable year beginning July 1, 2022, and ending June 30, 2023). ATEO 1 pays Employee A $1 million of remuneration in the 2022 applicable year. This is comprised of $1 million of vested nonqualified deferred compensation. The present value of all vested deferred compensation as of December 31 of the 2022 applicable year ($900,000) is treated as previously paid remuneration for the next applicable year (as Employee A is a covered employee for the next taxable year). The $100,000 of losses accrued while Employee A was not a covered employee do not carry forward to the next applicable year.

(3) Conclusion (Taxable year beginning July 1, 2023, and ending June 30, 2024). ATEO 1 pays Employee A $1.4 million of remuneration in the 2023 applicable year. This is comprised of $1 million cash and $400,000 of earnings ($1.3 million present value as of December 31, 2023, minus $900,000 previously paid remuneration).

(e) Calculation of present value—(1) In general. The employer must determine present value using reasonable actuarial assumptions regarding the amount, time, and probability that a payment will be made. For this purpose, a discount for the probability that an employee will die before commencement of benefit payments is permitted, but only to the extent that benefits will be forfeited upon death. The present value may not be discounted for the probability that payments will not be made (or will be reduced) because of the unfunded status of the plan; the risk associated with any deemed or actual investment of amounts deferred under the plan; the risk that the employer, the trustee, or another party will be unwilling or unable to pay; the possibility of future plan amendments; the possibility of a future change in the law; or similar risks or contingencies. The present value of the right to future payments as of the vesting date includes any earnings that have accrued as of the vesting date that are not previously paid remuneration.

(2) Treatment of future payment amount as present value for certain amounts. For purposes of determining the present value of remuneration that is scheduled to be actually or constructively paid within 90 days of vesting, the employer may treat the future amount that is to be paid as the present value at vesting.

(f) Examples. The following examples illustrate the rules of this section. For purposes of these examples, assume any entity referred to as “ATEO” is an ATEO, any entity referred to as “CORP” is not an ATEO, and all taxpayers use the calendar year as their taxable year.

(1) Example 1 (Account balance plan)—(i) Facts. Employee A is a covered employee of ATEO 1. Employee A participates in a nonqualified deferred compensation plan (the NQDC plan) in which the account balance is adjusted based on the investment returns on predetermined actual investments. On January 1, 2022, ATEO 1 credits $100,000 to Employee A's account under the plan, subject to the requirement that Employee A remain employed through June 30, 2024. On June 30, 2024, the vested account balance is $110,000. Due to earnings or losses on the account balance, the closing account balance on each of the following dates is: $115,000 on December 31, 2024, $120,000 on December 31, 2025, $100,000 on December 31, 2026, and $110,000 on December 31, 2027. During 2028, Employee A defers an additional $10,000 under the plan, all of which is vested at the time of deferral. On December 31, 2028, the closing account balance is $125,000. In 2029, ATEO 1 pays $10,000 to Employee A under the plan. On December 31, 2029, the closing account balance is $135,000 due to earnings on the account balance.

(ii) Conclusion (2022 and 2023 applicable years—nonvested amounts). For 2022 and 2023, ATEO 1 is not treated as paying Employee A any remuneration attributable to Employee A's participation in the NQDC plan because the amount deferred under the plan remains subject to a substantial risk of forfeiture within the meaning of section 457(f)(3)(B).

(iii) Conclusion (2024 applicable year—amounts in year of vesting). For 2024, ATEO 1 is treated as paying Employee A $115,000 of remuneration attributable to Employee A's participation in the NQDC plan, including $110,000 of remuneration on June 30, 2024, when the amount becomes vested, and an additional $5,000 of remuneration on December 31, 2024, which is earnings on the previously paid remuneration ($110,000).

(iv) Conclusion (2025 applicable year—earnings). For 2025, ATEO 1 is treated as paying Employee A $5,000 of remuneration attributable to Employee A's participation in the NQDC plan, which is the additional earnings on the previously paid remuneration ($115,000) as of December 31, 2025.

(v) Conclusion (2026 applicable year—losses). For 2026, ATEO 1 is not treated as paying Employee A any remuneration attributable to Employee A's participation in the NQDC plan because the present value of the previously paid remuneration ($120,000) decreased to $100,000 as of December 31, 2026. The $20,000 loss for 2026 does not reduce any amount previously treated as remuneration but is available for carryover to subsequent taxable years to offset earnings.

(vi) Conclusion (2027 applicable year—recovery of losses). For 2027, ATEO 1 is not treated as paying Employee A any remuneration attributable to Employee A's participation in the NQDC plan because the present value of the previously paid remuneration ($120,000) was $110,000 as of December 31, 2027. Due to increases on the account balance, ATEO 1 recovers $10,000 of the $20,000 of losses carried over from 2026. The net losses as of December 31, 2027, are $10,000, and none of the $10,000 in earnings during 2027 is treated as remuneration paid in 2027.

(vii) Conclusion (2028 applicable year—no recovery of losses against additional deferrals of compensation). For 2028, ATEO 1 is treated as paying Employee A $10,000 of remuneration attributable to Employee A's participation in the NQDC plan. The additional $10,000 deferral is vested and thus is treated as remuneration paid on the date credited to Employee A's account. This credit increases the amount of previously paid remuneration from $120,000 to $130,000. Additionally, due to earnings, ATEO 1 recovers $5,000 of the $10,000 loss carried over from 2027, none of which was remuneration paid for 2026, so that as of December 31, 2028, the net loss available for carryover to 2029 is $5,000.

(viii) Conclusion (2029 applicable year—distributions, recovery of remainder of losses through earnings and additional earnings). For 2029, ATEO 1 is treated as paying Employee A $15,000 of remuneration attributable to Employee A's participation in the NQDC plan. The $10,000 payment reduces the amount of previously paid remuneration (from $130,000 to $120,000) and the account balance (from $125,000 to $115,000). The present value of the vested account balance increases by $20,000 (from $115,000 to $135,000) as of December 31, 2029. Therefore, due to earnings, ATEO 1 recovers the remaining $5,000 loss carried over from 2028 (the difference between the $120,000 previously paid remuneration before earnings and the $115,000 account balance before earnings) and is treated as paying Employee A an additional $15,000 of remuneration as earnings (the difference between the $135,000 account balance after earnings and the $120,000 previously paid remuneration after loss recovery).

(2) Example 2 (Nonaccount balance plan with earnings)—(i) Facts. ATEO 2 and CORP 2 are related organizations. Employee B is a covered employee of ATEO 2 and is also employed by CORP 2. On January 1, 2022, CORP 2 and Employee B enter into an agreement under which CORP 2 will pay Employee B $100,000 on December 31, 2025, if B remains employed by CORP 2 through January 1, 2024. Employee B remains employed by CORP 2 through January 1, 2024. On January 1, 2024, the present value based on reasonable actuarial assumptions of the $100,000 to be paid on December 31, 2025, is $75,000. On December 31, 2024, the present value of the $100,000 future payment increases to $85,000 due solely to the passage of time. On December 31, 2025, CORP 2 pays Employee B $100,000.

(ii) Conclusion (2022 and 2023 applicable years—nonvested amounts). For 2022 and 2023, CORP 2 is not treated as paying Employee B any remuneration attributable to the agreement because the amount deferred under the agreement remains subject to a substantial risk of forfeiture within the meaning of section 457(f)(3)(B).

(iii) Conclusion (2024 applicable year—amounts in year of vesting). For 2024, CORP 2 is treated as paying Employee B $75,000 of remuneration attributable to the agreement on January 1, 2024, which is the present value on that date of the $100,000 payable on December 31, 2025. In addition, CORP 2 is treated as paying Employee B $10,000 of remuneration attributable to the agreement on December 31, 2024, which is earnings based on the increase in the present value of the previously paid remuneration (from $75,000 to $85,000) as of December 31, 2024.

(iv) Conclusion (2025 applicable year—earnings and distribution of previously paid remuneration). For 2025, CORP 2 is treated as paying Employee B $15,000 in remuneration attributable to the agreement on December 31, 2025, which is earnings based on the increase in the present value of the previously paid remuneration (from $85,000 to $100,000) as of December 31, 2025. In addition, the $100,000 payment is treated as reducing the amount of previously paid remuneration ($100,000) to zero.

(3) Example 3 (Treatment of amount payable as present value at vesting)—(i) Facts. Employee C is a covered employee of ATEO 3. Under an agreement between ATEO 3 and Employee C, ATEO 3 agrees to pay Employee C $100,000 two months after the date Employee C meets a specified performance goal that is a substantial risk of forfeiture within the meaning of section 457(f)(3)(B). Employee C meets the performance goal on November 30, 2022, and ATEO 3 pays Employee C $100,000 on January 31, 2023. In accordance with § 53.4960-2(e)(2), because the payment is to be made within 90 days of vesting, ATEO 3 elects to treat the full payment amount as the amount of remuneration paid at vesting.

(ii) Conclusion (2022 applicable year—election to treat amount payable within 90 days as paid at vesting). For taxable year 2022, ATEO 3 is treated as paying Employee C $100,000 of remuneration attributable to the agreement. Employee C vests in the $100,000 payment in 2022 upon meeting the performance goal. Under the general rule, ATEO 3 would be treated as paying for the taxable year 2022 the present value as of November 30, 2022, of $100,000 payable on January 31, 2023 (two months after the date of vesting), with adjustments to the present value as of the end of the year. However, because ATEO 3 elected to treat the full $100,000 amount payable within 90 days of vesting as the remuneration paid, the $100,000 payable to Employee C in 2023 is treated as remuneration paid in 2022 (and no additional amount related to the $100,000 paid on January 31, 2023, is treated as remuneration paid in 2023).

(4) Example 4 (Aggregation of remuneration from related organizations)—(i) Facts. Employee D is a covered employee of ATEO 4 and also an employee of CORP 4 and CORP 5. ATEO 4, CORP 4, and CORP 5 are related organizations. ATEO 4, CORP 4, and CORP 5 each pay Employee D $200,000 of salary during 2022 and 2023. On January 1, 2022, ATEO 4 promises to pay Employee D $120,000 on December 31, 2023, under a nonaccount balance plan, the right to which is vested and the present value of which is $100,000 on January 1, 2022. On January 1, 2022, CORP 4 and CORP 5 each contribute $100,000 on Employee D's behalf to account balance plans of CORP 4 and CORP 5, respectively, under which all amounts deferred are vested. On December 31, 2022, the present value of the amounts deferred under the ATEO 4 plan is $110,000, the present value of the amounts deferred under the CORP 4 plan is $120,000, and the present value of the amounts deferred under the CORP 5 plan maintained is $90,000. On December 31, 2023, the present value of the amounts deferred under the ATEO 4 plan is $120,000, the present value of the amounts deferred under the CORP 4 plan is $130,000, and the present value of the amounts deferred under the CORP 5 plan is $110,000.

(ii) Conclusion (2022 applicable year). For 2022, before aggregation of remuneration paid by related organizations, ATEO 4 is treated as paying Employee D $310,000 of remuneration ($200,000 salary + $100,000 upon vesting of deferred amounts + $10,000 net earnings on vested deferred amounts). CORP 4 is treated as paying Employee D $320,000 of remuneration ($200,000 salary + $100,000 upon vesting of deferred amounts + $20,000 net earnings on vested deferred amounts). CORP 5 is treated as paying Employee D $300,000 of remuneration ($200,000 salary + $100,000 upon vesting of deferred amounts) and has $10,000 of net losses on vested deferred amounts, which are carried forward to 2023. Thus, ATEO 4 is treated as paying $930,000 of remuneration to Employee D for the applicable year.

(iii) Conclusion (2023 applicable year). For 2023, before aggregation of remuneration paid by related organizations, ATEO 4 is treated as paying Employee D $210,000 of remuneration ($200,000 salary + $10,000 earnings on previously paid remuneration). CORP 4 is treated as paying Employee D $210,000 of remuneration ($200,000 salary + $10,000 net earnings on previously paid remuneration). CORP 5 is treated as paying Employee D $210,000 of remuneration ($200,000 salary + $10,000 net earnings on previously paid remuneration after taking into account the loss carryforward). Thus, ATEO 4 is treated as paying $630,000 of remuneration to Employee D for the applicable year.

(5) Example 5 (Treatment of regular wages for a pay period spanning applicable years)—(i) Facts. ATEO 5 pays its employees' salaries in accordance with a two-week payroll period that begins Sunday of the first week and ends Saturday of the second week. Payment occurs the Friday following the end of the payroll period. The last payroll period of 2023 ends on December 31, 2023. For the last payroll period, Employee E earns $8,000 of salary. In addition, ATEO 5 awards Employee E a $10,000 bonus that vests on December 31, 2023. ATEO 5 pays Employee E $18,000 on Friday, January 5, 2024, reflecting Employee E's salary for the last payroll period of 2023 and the bonus, the right to which vested on December 31, 2023.

(ii) Conclusion (Regular wages). The $8,000 of salary is regular wages within the meaning of § 31.3402(g)-1(a)(1)(ii) because it is an amount paid at a periodic rate for the current payroll period. Thus, $8,000 is treated as remuneration paid on January 5, 2024 (when it is actually or constructively paid), and, therefore, is treated as remuneration paid in ATEO 5's 2024 applicable year.

(iii) Conclusion (Amounts other than regular wages). The $10,000 bonus is not regular wages within the meaning of § 31.3402(g)-1(a)(1)(ii) because it is not an amount paid at a periodic rate for the current payroll period. Thus, $10,000 is treated as remuneration paid on December 31, 2023 (when it is vested) and, therefore, is treated as remuneration paid in ATEO 5's 2023 applicable year.

(a) Parachute payment—(1) In general. Except as otherwise provided in paragraph (a)(2) of this section (relating to payments excluded from the definition of a parachute payment), parachute payment means any payment in the nature of compensation made by an ATEO (or a predecessor of the ATEO) or a related organization to (or for the benefit of) a covered employee if the payment is contingent on the employee's separation from employment with the employer, and the aggregate present value of the payments in the nature of compensation to (or for the benefit of) the individual that are contingent on the separation equals or exceeds an amount equal to 3-times the base amount.

(2) Exclusions. The following payments are not parachute payments:

(i) Certain qualified plans. A payment that is a contribution to or a distribution from a plan described in section 401(a) that includes a trust exempt from tax under section 501(a), an annuity plan described in section 403(a), a simplified employee pension (as defined in section 408(k)), or a simple retirement account described in section 408(p);

(ii) Certain annuity contracts. A payment made under or to an annuity contract described in section 403(b) or a plan described in section 457(b);

(iii) Compensation for medical services. A payment made to a licensed medical professional for the performance of medical services performed by such professional; and

(iv) Payments to non-HCEs. A payment made to an individual who is not a highly compensated employee (HCE) as defined in paragraph (a)(3) of this section.

(3) Determination of HCEs for purposes of the exclusion from parachute payments. For purposes of this section, highly compensated employee or HCE means, with regard to an ATEO that maintains a qualified retirement plan or other employee benefit plan described in § 1.414(q)-1T, Q/A-1, any person who is a highly compensated employee within the meaning of section 414(q) and, with regard to an ATEO that does not maintain such a plan, any person who would be a highly compensated employee within the meaning of section 414(q) if the ATEO did maintain such a plan. For purposes of determining the group of highly compensated employees for a determination year, consistent with § 1.414(q)-1T, Q/A-14(a)(1), the determination year calculation is made on the basis of the applicable plan year under § 1.414(q)-1T, Q/A-14(a)(2) of the plan or other entity for which a determination is made, and the look-back year calculation is made on the basis of the 12-month period immediately preceding that year. For an ATEO that does not maintain a plan described in § 1.414(q)-1T, Q/A-1, the rules are applied by analogy, substituting the calendar year for the plan year. Thus, for example, in 2022, an ATEO that does not maintain such a plan must use its employees' 2021 annual compensation (as defined in § 1.414(q)-1T, Q/A-13, including any of the safe harbor definitions if applied consistently to all employees) to determine which employees are HCEs for 2022, if any, for purposes of section 4960. If an employee is an HCE at the time of separation from employment, then for purposes of section 4960 any parachute payment that is contingent on the separation from employment (as defined in paragraph (d) of this section) is treated as paid to an HCE so that the exception from the term parachute payment under paragraph (a)(2)(iv) of this section does not apply, even if the payment occurs during one or more later taxable years (that is, taxable years after the taxable year during which the employee separated from employment).

(b) Payment in the nature of compensation—(1) In general. Any payment—in whatever form—is a payment in the nature of compensation if the payment arises out of an employment relationship, including holding oneself out as available to perform services and refraining from performing services. Thus, for example, a payment made under a covenant not to compete or a similar arrangement is a payment in the nature of compensation. A payment in the nature of compensation includes (but is not limited to) wages and salary, bonuses, severance pay, fringe benefits, life insurance, pension benefits, and other deferred compensation (including any amount characterized by the parties as interest or earnings thereon). A payment in the nature of compensation also includes cash when paid, the value of the right to receive cash, the value of accelerated vesting, or a transfer of property. The vesting of an option, stock appreciation right, or similar form of compensation as a result of a covered employee's separation from employment is a payment in the nature of compensation. However, a payment in the nature of compensation does not include attorney's fees or court costs paid or incurred in connection with the payment of any parachute payment or a reasonable rate of interest accrued on any amount during the period the parties contest whether a parachute payment will be made.

(2) Consideration paid by covered employee. Any payment in the nature of compensation is reduced by the amount of any money or the fair market value of any property (owned by the covered employee without restriction) that is (or will be) transferred by the covered employee in exchange for the payment.

(c) When payment is considered to be made—(1) In general. A payment in the nature of compensation is considered made in the taxable year in which it is includible in the covered employee's gross income or, in the case of fringe benefits and other benefits that are excludable from income, in the taxable year the benefits are received. In the case of taxable non-cash fringe benefits provided in a calendar year, payment is considered made on the date or dates the employer chooses, but no later than December 31 of the calendar year in which the benefits are provided, except that when the fringe benefit is the transfer of personal property (either tangible or intangible) of a kind normally held for investment or the transfer of real property, payment is considered made on the actual date of transfer. If the fringe benefit is neither a transfer of personal property nor a transfer of real property, the employer may, in its discretion, treat the value of the benefit actually provided during the last two months of the calendar year as paid during the subsequent calendar year. However, an employer that treats the value of a benefit paid during the last two months of a calendar year as paid during the subsequent calendar year under this rule must treat the value of that fringe benefit as paid during the subsequent calendar year with respect to all employees who receive it.

(2) Transfers of section 83 property. A transfer of property in connection with the performance of services that is subject to section 83 is considered a payment made in the taxable year in which the property is transferred or would be includible in the gross income of the covered employee under section 83, disregarding any election made by the employee under section 83(b) or (i). Thus, in general, such a payment is considered made at the later of the date the property is transferred (as defined in § 1.83-3(a)) to the covered employee or the date the property becomes substantially vested (as defined in § 1.83-3(b) and (j)). The amount of the payment is the compensation as determined under section 83, disregarding any amount includible in income pursuant to an election made by an employee under section 83(b).

(3) Stock options. An option (including an option to which section 421 applies) is treated as property that is transferred when the option becomes vested (regardless of whether the option has a readily ascertainable fair market value as defined in § 1.83-7(b)). For purposes of determining the timing and amount of any payment related to the option, the principles of § 1.280G-1, Q/A-13 and any method prescribed by the Commissioner in published guidance of general applicability under § 601.601(d)(2) apply.

(d) Payment contingent on an employee's separation from employment—(1) In general. A payment is contingent on an employee's separation from employment if the facts and circumstances indicate that the employer would not make the payment in the absence of the employee's involuntary separation from employment. A payment generally would be made in the absence of the employee's involuntary separation from employment if it is substantially certain at the time of the involuntary separation from employment that the payment would be made whether or not the involuntary separation occurred. A payment the right to which is not subject to a substantial risk of forfeiture within the meaning of section 457(f)(3)(B) at the time of an involuntary separation from employment generally is a payment that would have been made in the absence of an involuntary separation from employment (and is therefore not contingent on a separation from employment), except that the increased value of an accelerated payment of a vested amount described in paragraph (f)(3) of this section resulting from an involuntary separation from employment is not treated as a payment that would have been made in the absence of an involuntary separation from employment. A payment the right to which is no longer subject to a substantial risk of forfeiture within the meaning of section 457(f)(3)(B) as a result of an involuntary separation from employment, including a payment the vesting of which is accelerated due to the separation from employment as described in paragraph (f)(3) of this section, is not treated as a payment that would have been made in the absence of an involuntary separation from employment (and thus is contingent on a separation from employment). A payment does not fail to be contingent on a separation from employment merely because the payment is conditioned upon the execution of a release of claims, noncompetition or nondisclosure provisions, or other similar requirements. See paragraph (d)(3) of this section for the treatment of a payment made pursuant to a covenant not to compete. If, after an involuntary separation from employment, the former employee continues to provide certain services as a nonemployee, payments for services rendered as a nonemployee are not payments that are contingent on a separation from employment to the extent those payments are reasonable and are not made on account of the involuntary separation from employment. Whether services are performed as an employee or nonemployee depends upon all the facts and circumstances. See § 53.4960-1(e). For rules on determining whether payments are reasonable compensation for services, the rules of § 1.280G-1, Q/A-40 through Q/A-42 (excluding Q/A-40(b) and Q/A-42(b)), and Q/A-44 are applied by analogy (substituting involuntary separation from employment for change in ownership or control).

(2) Employment agreements—(i) In general. If a covered employee involuntarily separates from employment before the end of a contract term and is paid damages for breach of contract pursuant to an employment agreement, the payment of damages is treated as a payment that is contingent on a separation from employment. An employment agreement is an agreement between an employee and employer that describes, among other things, the amount of compensation or remuneration payable to the employee for services performed during the term of the agreement.

(ii) Example. The following example illustrates the rules of this paragraph (d)(2). For purposes of this example, assume any entity referred to as “ATEO” is an ATEO.

(A) Example—(1) Facts. Employee A, a covered employee, has a 3-year employment agreement with ATEO 1. Under the agreement, Employee A will receive a salary of $200,000 for the first year and, for each succeeding year, an annual salary that is $100,000 more than the previous year. The agreement provides that, in the event of A's involuntary separation from employment without cause, Employee A will receive the remaining salary due under the agreement. At the beginning of the second year of the agreement, ATEO 1 involuntarily terminates Employee A's employment without cause and pays Employee A $700,000 representing the remaining salary due under the employment agreement ($300,000 for the second year of the agreement plus $400,000 for the third year of the agreement).

(2) Conclusion. The $700,000 payment is treated as a payment that is contingent on a separation from employment.

(3) Noncompetition agreements. A payment under an agreement requiring a covered employee to refrain from performing services (for example, a covenant not to compete) is a payment that is contingent on a separation from employment if the payment would not have been made in the absence of an involuntary separation from employment. For example, a payment contingent on compliance in whole or in part with a covenant not to compete negotiated as part of a severance arrangement arising from an involuntary separation from employment is contingent on a separation from employment. Similarly, one or more payments contingent on compliance in whole or in part with a covenant not to compete not negotiated as part of a severance arrangement arising from an involuntary separation from employment but that provides for a payment specific to an involuntary separation from employment (and not voluntary separation from employment) is contingent on a separation from employment. Payments made under an agreement requiring a covered employee to refrain from performing services that are contingent on separation from employment are not treated as paid in exchange for the performance of services and are not excluded from parachute payments.

(4) Payment of amounts previously included in income or excess remuneration. Actual or constructive payment of an amount that was previously included in gross income of the employee is not a payment contingent on a separation from employment. For example, payment of an amount included in income under section 457(f)(1)(A) due to the lapsing of a substantial risk of forfeiture on a date before the separation from employment generally is not a payment that is contingent on a separation from employment, even if the amount is paid in cash or otherwise to the employee because of the separation from employment. In addition, actual or constructive receipt of an amount treated as excess remuneration under § 53.4960-4(b)(1) is not a payment that is contingent on a separation from employment (and thus is not a parachute payment), even if the amount is paid to the employee because of the separation from employment.

(5) Window programs. A payment under a window program is contingent on a separation from employment. A window program is a program established by an employer in connection with an impending separation from employment to provide separation pay if the program is made available by the employer for a limited period of time (no longer than 12 months) to employees who separate from employment during that period or to employees who separate from service during that period under specified circumstances. A payment made under a window program is treated as a payment that is contingent on an employee's separation from employment notwithstanding that the employee may not have had an involuntary separation from employment.

(6) Anti-abuse provision. Notwithstanding paragraphs (d)(1) through (5) of this section, if the facts and circumstances demonstrate that either the vesting or the payment of an amount (whether before or after an employee's involuntary separation from employment) would not have occurred but for the involuntary nature of the separation from employment, the payment of the amount is contingent on a separation from employment. For example, an employer's exercise of discretion to accelerate vesting of an amount shortly before an involuntary separation from employment may indicate that the acceleration of vesting was due to the involuntary nature of the separation from employment and was therefore contingent on the employee's separation from employment. Similarly, payment of an amount in excess of an amount otherwise payable (for example, increased salary), shortly before or after an involuntary separation from employment, may indicate that the amount was paid because the separation was involuntary and was therefore contingent on the employee's separation from employment. If an ATEO becomes a predecessor as a result of a reorganization or other transaction described in § 53.4960-1(h), any payment to an employee by a successor organization that is contingent on the employee's separation from employment with the predecessor ATEO is treated as paid by the predecessor ATEO.

(e) Involuntary separation from employment—(1) In general. Involuntary separation from employment means a separation from employment due to the independent exercise of the employer's unilateral authority to terminate the employee's services, other than due to the employee's implicit or explicit request, if the employee was willing and able to continue performing services as an employee. An involuntary separation from employment may include an employer's failure to renew a contract at the time the contract expires, provided that the employee was willing and able to execute a new contract providing terms and conditions substantially similar to those in the expiring contract and to continue providing services. The determination of whether a separation from employment is involuntary is based on all the facts and circumstances.

(2) Separation from employment for good reason—(i) In general. Notwithstanding paragraph (e)(1) of this section, an employee's voluntary separation from employment is treated as an involuntary separation from employment if the separation occurs under certain bona fide conditions (referred to herein as a separation from employment for good reason).

(ii) Material negative change required. A separation from employment for good reason is treated as an involuntary separation from employment if the relevant facts and circumstances demonstrate that it was the result of unilateral employer action that caused a material negative change to the employee's relationship with the employer. Factors that may provide evidence of such a material negative change include a material reduction in the duties to be performed, a material negative change in the conditions under which the duties are to be performed, or a material reduction in the compensation to be received for performing such services.

(iii) Deemed material negative change. An involuntary separation from employment due to a material negative change is deemed to occur if the separation from employment occurs within 2 years following the initial existence of one or more of the following conditions arising without the consent of the employee:

(A) Material diminution of compensation. A material diminution in the employee's base compensation;

(B) Material diminution of responsibility. A material diminution in the employee's authority, duties, or responsibilities;

(C) Material diminution of authority of supervisor. A material diminution in the authority, duties, or responsibilities of the supervisor to whom the employee is required to report, including a requirement that an employee report to a corporate officer or employee instead of reporting directly to the board of directors (or similar governing body) of an organization;

(D) Material diminution of budget. A material diminution in the budget over which the employee retains authority;

(E) Material change of location. A material change in the geographic location at which the employee must perform services; or

(F) Other material breach. Any other action or inaction that constitutes a material breach by the employer of the agreement under which the employee provides services.

(3) Separation from employment. Except as otherwise provided in this paragraph, separation from employment has the same meaning as separation from service as defined in § 1.409A-1(h). Pursuant to § 1.409A-1(h), an employee generally separates from employment with the employer if the employee dies, retires, or otherwise has a termination of employment with the employer or experiences a sufficient reduction in the level of services provided to the employer. For purposes of applying the rules regarding reductions in the level of services set forth in the definition of termination of employment in § 1.409A-1(h)(1)(ii), the rules are modified for purposes of this paragraph such that an employer may not set the level of the anticipated reduction in future services that will give rise to a separation from employment, meaning that the default percentages set forth in § 1.409A-1(h)(1)(ii) apply in all circumstances. Thus, an anticipated reduction of the level of service of less than 50 percent is not treated as a separation from employment, an anticipated reduction of more than 80 percent is treated as a separation from employment, and the treatment of an anticipated reduction between those two levels is determined based on the facts and circumstances. The measurement of the anticipated reduction of the level of service is based on the average level of service for the prior 36 months (or shorter period for an employee employed for less than 36 months). In addition, an employee's separation from employment is determined without regard to § 1.409A-1(h)(2) and (5) (application to independent contractors), since, for purposes of this section, only an employee may have a separation from employment, and a change from bona fide employee status to bona fide independent contractor status is also a separation from employment. See § 53.4960-2(a)(1) regarding the treatment of an employee who also serves as a director of a corporation (or in a substantially similar position). The definition of separation from employment also incorporates the rules under § 1.409A-1(h)(1)(i) (addressing leaves of absence, including military leaves of absence), § 1.409A-1(h)(4) (addressing asset purchase transactions), and § 1.409A-1(h)(6) (addressing employees participating in collectively bargained plans covering multiple employers). The definition further incorporates the rules of § 1.409A-1(h)(3), under which an employee separates from employment only if the employee has a separation from employment with the employer and all employers that would be considered a single employer under section 414(b) and (c), except that the “at least 80 percent” rule under section 414(b) and (c) is used, rather than replacing it with “at least 50 percent.” However, for purposes of determining whether there has been a separation from employment, a purported ongoing employment relationship between a covered employee and an ATEO or a related organization is disregarded if the facts and circumstances demonstrate that the purported employment relationship is not bona fide, or the primary purpose of the establishment or continuation of the relationship is avoidance of the application of section 4960.

(f) Accelerated payment or accelerated vesting resulting from an involuntary separation from employment—(1) In general. If a payment or the lapse of a substantial risk of forfeiture is accelerated as a result of an involuntary separation from employment, generally only the value due to the acceleration of payment or vesting is treated as contingent on a separation from employment, as described in paragraphs (f)(3) and (4) of this section, except as otherwise provided in this paragraph (f). For purposes of this paragraph (f), the terms vested and substantial risk of forfeiture have the same meaning as provided in § 53.4960-2(c)(2).

(2) Nonvested payments subject to a non-service vesting condition. If (without regard to a separation from employment) vesting of a payment would depend on an event other than the performance of services, such as the attainment of a performance goal, and that vesting event does not occur prior to the employee's separation from employment and the payment vests due to the employee's involuntary separation from employment, the full amount of the payment is treated as contingent on the separation from employment.

(3) Vested payments. If an involuntary separation from employment accelerates actual or constructive payment of an amount that previously vested without regard to the separation, the portion of the payment, if any, that is contingent on the separation from employment is the amount by which the present value of the accelerated payment exceeds the present value of the payment absent the acceleration. The payment of an amount otherwise due upon a separation from employment (whether voluntary or involuntary) is not treated as an acceleration of the payment unless the payment timing was accelerated due to the involuntary nature of the separation from employment. If the value of the payment absent the acceleration is not reasonably ascertainable, and the acceleration of the payment does not significantly increase the present value of the payment absent the acceleration, the present value of the payment absent the acceleration is the amount of the accelerated payment (so the amount contingent on the separation from employment is zero). If the present value of the payment absent the acceleration is not reasonably ascertainable but the acceleration significantly increases the present value of the payment, the future value of the payment contingent on the separation from employment is treated as equal to the amount of the accelerated payment. For purposes of this paragraph (f)(3), the acceleration of a payment by 90 days or less is not treated as significantly increasing the present value of the payment. For rules on determining present value, see paragraph (f)(6) and paragraphs (h), (i) and (j) of this section.

(4) Nonvested payments subject to a service vesting condition—(i) In general. If an involuntary separation from employment accelerates vesting of a payment, the portion of the payment that is contingent on separation from employment is the amount described in paragraph (f)(3) of this section (if any) plus the value of the lapse of the obligation to continue to perform services described in paragraph (f)(4)(ii) of this section (but the amount cannot exceed the amount of the accelerated payment, or, if the payment is not accelerated, the present value of the payment), to the extent that all of the following conditions are satisfied with respect to the payment:

(A) Vesting trigger. The payment vests as a result of an involuntary separation from employment;

(B) Vesting condition. Disregarding the involuntary separation from employment, the vesting of the payment was contingent only on the continued performance of services for the employer for a specified period of time; and

(C) Services condition. The payment is attributable, at least in part, to the performance of services before the date the payment is made or becomes certain to be made.

(ii) Value of the lapse of the obligation to continue to perform services. The value of the lapse of the obligation to continue to perform services is one percent of the amount of the accelerated payment multiplied by the number of full months between the date that the employee's right to receive the payment is vested and the date that, absent the acceleration, the payment would have been vested. This paragraph (f)(4)(ii) applies to the accelerated vesting of a payment in the nature of compensation even if the time when the payment is made is not accelerated. In that case, the value of the lapse of the obligation to continue to perform services is one percent of the present value of the future payment multiplied by the number of full months between the date that the individual's right to receive the payment is vested and the date that, absent the acceleration, the payment would have been vested.

(iii) Accelerated vesting of equity compensation. For purposes of this paragraph (f)(4), the acceleration of the vesting of a stock option or stock appreciation right (or similar arrangement) or the lapse of a restriction on restricted stock or a restricted stock unit (or a similar arrangement) is considered to significantly increase the value of the payment.

(5) Application to benefits under a nonqualified deferred compensation plan. In the case of a payment of benefits under a nonqualified deferred compensation plan, paragraph (f)(3) of this section applies to the extent benefits under the plan are vested without regard to the involuntary separation from employment, but the payment of benefits is accelerated due to the involuntary separation from employment. Paragraph (f)(4) of this section applies to the extent benefits under the plan are subject to the conditions described in paragraph (f)(4)(i) of this section. For any other payment of benefits under a nonqualified deferred compensation plan (such as a contribution made due to the employee's involuntary separation from employment), the full amount of the payment is contingent on the employee's separation from employment.

(6) Present value. For purposes of this paragraph (f), the present value of a payment is determined based on the payment date absent the acceleration and the date on which the accelerated payment is scheduled to be made. The amount that is treated as contingent on the separation from employment is the amount by which the present value of the accelerated payment exceeds the present value of the payment absent the acceleration.

(7) Examples. See § 1.280G Q/A-24(f) for examples that may be applied by analogy to illustrate the rules of this paragraph (f).

(g) Three-times-base-amount test for parachute payments—(1) In general. To determine whether payments in the nature of compensation made to a covered employee that are contingent on the covered employee separating from employment with the ATEO are parachute payments, the aggregate present value of the payments must be compared to the individual's base amount. To do this, the aggregate present value of all payments in the nature of compensation that are made or to be made to (or for the benefit of) the same covered employee by an ATEO (or any predecessor of the ATEO) or related organization and that are contingent on the separation from employment must be determined. If this aggregate present value equals or exceeds the amount equal to 3-times the individual's base amount, the payments are parachute payments. If this aggregate present value is less than the amount equal to 3-times the individual's base amount, the payments are not parachute payments. See paragraphs (f)(6), (h), (i), and (j) of this section for rules on determining present value.

(2) Examples. The following examples illustrate the rules of this paragraph (g). For purposes of these examples, assume any entity referred to as “ATEO” is an ATEO.

(i) Example 1 (Parachute payment)—(A) Facts. Employee A is a covered employee and an HCE of ATEO 1. Employee A's base amount is $200,000. Payments in the nature of compensation that are contingent on a separation from employment with ATEO 1 totaling $800,000 are made to Employee A on the date of Employee A's separation from employment.

(B) Conclusion. The payments are parachute payments because they have an aggregate present value at the time of the separation from employment of $800,000, which is at least equal to 3-times Employee A's base amount of $200,000 (3 × $200,000 = $600,000).

(ii) Example 2 (No parachute payment)—(A) Facts. Assume the same facts as in paragraph (g)(2)(i) of this section (Example 1), except that the payments contingent on Employee A's separation from employment total $580,000.

(B) Conclusion. Because the aggregate present value of the payments ($580,000) is not at least equal to 3-times Employee A's base amount ($600,000), the payments are not parachute payments.

(h) Calculating present value—(1) In general. Except as otherwise provided in this paragraph (h), for purposes of determining if a payment contingent on a separation from employment exceeds 3-times the base amount, the present value of a payment is determined as of the date of the separation from employment or, if the payment is made prior to that date, the date on which the payment is made.

(2) Deferred payments. For purposes of determining whether a payment is a parachute payment, if a payment in the nature of compensation is the right to receive payments in a year (or years) subsequent to the year of the separation from employment, the value of the payment is the present value of the payment (or payments) calculated on the basis of reasonable actuarial assumptions and using the applicable discount rate for the present value calculation that is determined in accordance with paragraph (i) of this section.

(3) Health care. If the payment in the nature of compensation is an obligation to provide health care (including an obligation to purchase or provide health insurance), then, for purposes of this paragraph (h) and for applying the 3-times-base-amount test under paragraph (g) of this section, the present value of the obligation is calculated in accordance with generally accepted accounting principles. For purposes of paragraph (g) of this section and this paragraph (h), the obligation to provide health care is permitted to be measured by projecting the cost of premiums for health care insurance, even if no health care insurance is actually purchased. If the obligation to provide health care is made in coordination with a health care plan that the employer makes available to a group, then the premiums used for purposes of this paragraph (h)(3) may be the allocable portion of group premiums.

(i) Discount rate. Present value generally is determined by using a discount rate equal to 120 percent of the applicable Federal rate (determined under section 1274(d) and the regulations in part 1 under section 1274(d)), compounded semiannually. The applicable Federal rate to be used is the Federal rate that is in effect on the date as of which the present value is determined, using the period until the payment is expected to be made as the term of the debt instrument under section 1274(d). See paragraph (h) of this section for rules with respect to the date as of which the present value is determined. However, for any payment, the employer and the covered employee may elect to use the applicable Federal rate that is in effect on the date on which the parties entered into the contract that provides for the payment if that election is set forth in writing in the contract.

(j) Present value of a payment to be made in the future that is contingent on an uncertain future event or condition—(1) Treatment based on the estimated probability of payment. In certain cases, it may be necessary to apply the 3-times-base-amount test to a payment that is contingent on separation from employment at a time when the aggregate present value of all the payments is uncertain because the time, amount, or right to receive one or more of the payments is also contingent on the occurrence of an uncertain future event or condition. In that case, the employer must reasonably estimate whether it will make the payment. If the employer reasonably estimates there is a 50-percent or greater probability that it will make the payment, the full amount of the payment is considered for purposes of the 3-times-base-amount test and the allocation of the base amount. If the employer reasonably estimates there is a less than 50-percent probability that the payment will be made, the payment is not considered for either purpose.

(2) Correction of incorrect estimates. If an ATEO later determines that an estimate it made under paragraph (j)(1) of this section was incorrect, it must reapply the 3-times-base-amount test to reflect the actual time and amount of the payment. In reapplying the 3-times-base-amount test (and, if necessary, reallocating the base amount), the ATEO must determine the aggregate present value of payments paid or to be paid as of the date described in paragraph (h) of this section using the discount rate described in paragraph (i) of this section. This redetermination may affect the amount of any excess parachute payment for a prior taxable year. However, if, based on the application of the 3-times-base-amount test without regard to the payment described in this paragraph (j), an ATEO has determined it will pay an employee an excess parachute payment or payments, then the 3-times-base-amount test does not have to be reapplied when a payment described in this paragraph (j) is made (or becomes certain to be made) if no base amount is allocated to that payment under § 53.4960-4(d)(5).

(3) Initial option value estimate. To the extent provided in published guidance of general applicability under § 601.601(d)(2), an initial estimate of the value of an option subject to paragraph (c) of this section is permitted to be made, with the valuation subsequently redetermined and the 3-times-base-amount test reapplied. Until guidance is published under section 4960, published guidance of general applicability described in § 601.601(d)(2) that is issued under section 280G applies by analogy.

(4) Examples. See § 1.280G-1, Q/A-33(d) for examples that may be applied by analogy to illustrate the rules of this paragraph (j).

(k) Base amount—(1) In general. A covered employee's base amount is the average annual compensation for services performed as an employee of the ATEO (including compensation for services performed for a predecessor of the ATEO), and/or, if applicable, a related organization, with respect to which there has been a separation from employment, if the compensation was includible in the gross income of the individual for taxable years in the base period (including amounts that were excluded under section 911) or that would have been includible in the individual's gross income if the individual had been a United States citizen or resident. See paragraph (l) of this section for the definition of base period and for examples of base amount computations.

(2) Short or incomplete taxable years. If the base period of a covered employee includes a short taxable year or less than all of a taxable year of the employee, compensation for the short or incomplete taxable year must be annualized before determining the average annual compensation for the base period. In annualizing compensation, the frequency with which payments are expected to be made over an annual period must be taken into account. Thus, any amount of compensation for a short or incomplete taxable year that represents a payment that will not be made more often than once per year is not annualized.

(3) Excludable fringe benefits. Because the base amount includes only compensation that is includible in gross income, the base amount does not include certain items that may constitute parachute payments. For example, payments in the form of excludable fringe benefits or excludable health care benefits are not included in the base amount but may be treated as parachute payments.

(4) Section 83(b) income. The base amount includes the amount of compensation included in income under section 83(b) during the base period.

(l) Base period—(1) In general. The base period of a covered employee is the covered employee's 5 most-recent taxable years ending before the date on which the separation from employment occurs. However, if the covered employee was not an employee of the ATEO for this entire 5-year period, the individual's base period is the portion of the 5-year period during which the covered employee performed services for the ATEO, a predecessor, or a related organization.

(2) Determination of base amount if employee separates from employment in the year hired. If a covered employee commences services as an employee and experiences a separation from employment in the same taxable year, the covered employee's base amount is the annualized compensation for services performed for the ATEO (or a predecessor or related organization) that was not contingent on the separation from employment and either was includible in the employee's gross income for that portion of the employee's taxable year prior to the employee's separation from employment (including amounts that were excluded under section 911) or would have been includible in the employee's gross income if the employee had been a United States citizen or resident.

(3) Examples. The following examples illustrate the rules of paragraph (k) of this section and this paragraph (l). For purposes of these examples, assume any entity referred to as “ATEO” is an ATEO, any entity referred to as “CORP” is not an ATEO, and all employees are HCEs of their respective employers.

(i) Example 1 (Calculation with salary deferrals)—(A) Facts. Employee A, a covered employee of ATEO 1, receives an annual salary of $500,000 per year during the 5-year base period. Employee A defers $100,000 of salary each year under a nonqualified deferred compensation plan (none of which is includible in Employee A's income until paid in cash to Employee A).

(B) Conclusion. Employee A's base amount is $400,000 (($400,000 × 5)/5).

(ii) Example 2 (Calculation for less-than-5-year base period)—(A) Facts. Employee B, a covered employee of ATEO 1, was employed by ATEO 1 for 2 years and 4 months preceding the year in which Employee B separates from employment. Employee B's compensation includible in gross income was $100,000 for the 4-month period, $420,000 for the first full year, and $450,000 for the second full year.

(B) Conclusion. Employee B's base amount is $390,000 (((3 × $100,000) + $420,000 + $450,000)/3). Any compensation Employee B receives in the year of separation from employment is not included in the base amount calculation.

(iii) Example 3 (Calculation for less-than-5-year base period with signing bonus)—(A) Facts. Assume the same facts as in paragraph (l)(3)(ii)(A) of this section (Example 2), except that Employee B also received a $60,000 signing bonus when Employee B's employment with ATEO 1 commenced at the beginning of the 4-month period.

(B) Conclusion. Employee B's base amount is $410,000 ((($60,000 + (3 × $100,000)) + $420,000 + $450,000)/3). Pursuant to paragraph (k)(2) of this section, because the bonus is a payment that will not be paid more often than once per year, the bonus is not taken into account in annualizing Employee B's compensation for the 4-month period.

(iv) Example 4 (Effect of non-employee compensation)—(A) Facts. Employee C, a covered employee of ATEO 1, was not an employee of ATEO 1 for the full 5-year base period. In 2024 and 2025, Employee C is only a director of ATEO 1 and receives $30,000 per year for services as a director. On January 1, 2026, Employee C becomes an officer and covered employee of ATEO 1. Employee C's includible compensation for services as an officer of ATEO 1 is $250,000 for each of 2026 and 2027, and $300,000 for 2028. In 2028, Employee C separates from employment with ATEO 1.

(B) Conclusion. Employee C's base amount is $250,000 ((2 × $250,000)/2). The $30,000 of director's fees paid to Employee C in each of 2024 and 2025 is not included in Employee C's base amount calculation because it was not for services performed as an employee of ATEO 1.

(a) Liability, reporting, and payment of excise taxes—(1) Liability. For each taxable year, with respect to each covered employee, the taxpayer is liable for tax at the rate imposed under section 11 on the sum of the excess remuneration allocated to the taxpayer under paragraph (c) of this section and, if the taxpayer is an ATEO, any excess parachute payment paid by the taxpayer or a predecessor during the taxable year.

(2) Reporting and payment. The excise tax imposed by section 4960 is reported as provided in §§ 53.6011-1(b) and 53.6071-1(i) and paid in the form and manner prescribed by the Commissioner.

(3) Arrangements between an ATEO and a related organization. Calculation of, and liability for, the excise tax imposed by section 4960 is separate from, and unaffected by, any arrangement that an ATEO and any related organization may have for bearing the cost of any liability for the excise tax imposed by section 4960.

(4) Certain foreign related organizations. A related organization that is a foreign organization described in section 4948(b) that either is exempt from tax under section 501(a) or is a taxable private foundation (section 4948(b) related organization) is not liable for the excise tax imposed by section 4960. A foreign organization is an organization not created or organized in the United States or in any possession thereof, or under the law of the United States, any State, the District of Columbia, or any possession of the United States. See section 4948(b) and § 53.4948-1. For purposes of this paragraph (a)(4) and the application of section 4960 to a taxable year, an organization's status as a section 4948(b) related organization is determined at the end of its taxable year. However, remuneration that the section 4948(b) related organization pays to a covered employee of an ATEO must be taken into account by the ATEO and other related organizations for purposes of section 4960 generally, including for purposes of determining the five highest-compensated employees and the total remuneration paid to a covered employee. For example, if an ATEO and its related organization that is a section 4948(b) related organization each paid $600,000 remuneration to a covered employee during the applicable year, then the related organization would not be liable for the tax that would otherwise be allocable to it, and the ATEO would be liable for tax on $100,000 (50 percent of the $200,000 excess remuneration paid to the employee).

(5) [Reserved]

(b) Amounts subject to tax—(1) Excess remuneration—(i) In general. Excess remuneration means the amount of remuneration paid by an ATEO to any covered employee during an applicable year in excess of $1 million, as determined under § 53.4960-2.

(ii) Exclusion for excess parachute payments. Excess remuneration does not include any amount that is an excess parachute payment as defined in paragraph (b)(2) of this section.

(2) Excess parachute payment. Excess parachute payment means an amount equal to the excess (if any) of the amount of any parachute payment paid by an ATEO, a predecessor of the ATEO, or a related organization, or on behalf of any such person, during the taxable year over the portion of the base amount allocated to such payment.

(c) Calculation of liability for tax on excess remuneration—(1) In general. For each taxable year, an employer is liable for the tax on excess remuneration paid in the applicable year ending with or within the employer's taxable year. If, for the taxable year, remuneration paid during an applicable year by an ATEO or one or more related organizations to a covered employee is taken into account in determining the tax imposed on excess remuneration for that taxable year, then each employer is liable for the tax in an amount that bears the same ratio to the total tax determined under section 4960(a) as the amount of remuneration paid by the employer to the covered employee (including remuneration paid by the employer as described in § 53.4960-2(b)(1), but disregarding remuneration treated as paid by the employer under § 53.4960-2(b)(2)), bears to the total amount of remuneration paid by the ATEO under § 53.4960-2 (including remuneration treated as paid by the ATEO under § 53.4960-2(b)(2)).

(2) Calculation if liability is allocated from more than one ATEO with regard to an individual. If liability for the tax on excess remuneration is allocated to an employer from more than one ATEO in a taxable year with regard to an individual that is a covered employee of each ATEO, then the employer is liable for the tax only in the capacity in which it is liable for the greatest amount of the tax with respect to that individual for the taxable year. For example, assume ATEO 1 is a related organization to both ATEO 2 and ATEO 3 and pays excess remuneration to Employee D, and Employee D is a covered employee of ATEO 1, ATEO 2, and ATEO 3. In this case, ATEO 1's liability for the tax on excess remuneration to Employee D is the highest of its liability as an ATEO, as a related organization to ATEO 2, or as a related organization to ATEO 3.

(3) Calculation if liability is allocated from an ATEO with a short applicable year. If liability for the tax on excess remuneration paid to an individual is allocated to an employer from an ATEO with a short applicable year under § 53.4960-1(c)(3), then the liability with respect to the excess remuneration paid to that individual is allocated in accordance with the principles of this paragraph (c) adjusted as necessary to avoid, to the extent possible, duplication of application of the excise tax. The Commissioner may provide additional guidance of general applicability, published in the Internal Revenue Bulletin (see § 601.601(d)(2) of this chapter), on the application of this paragraph (c)(3) to particular circumstances, including circumstances involving an ATEO with a short applicable year that has one or more related organizations and the ATEO's short applicable year and the preceding applicable year both end with or within the related organization's taxable year, such that the ATEO and related organizations are liable for the tax for multiple applicable years ending with or within the employer's taxable year.

(4) Examples. The following examples illustrate the rules of this paragraph (c). For purposes of these examples, assume that the rate of excise tax under section 4960 is 21 percent, that any entity that is referred to as “ATEO” is an ATEO, that any entity referred to as “CORP” is not an ATEO and is not a publicly held corporation within the meaning of section 162(m)(2) or a covered health insurance provider within the meaning of section 162(m)(6)(C), that no related organization is a section 4948(b) related organization, all taxpayers use the calendar year as their taxable year unless otherwise stated, and that no parachute payments are made in any of the years at issue.

(i) Example 1 (Remuneration from multiple employers)—(A) Facts. ATEO 1 and CORP 1 are related organizations. Employee A is a covered employee of ATEO 1 and an employee of CORP 1. In the 2022 applicable year, ATEO 1 pays Employee A $1.2 million of remuneration, and CORP 1 pays A $800,000 of remuneration. Remuneration paid by each employer is for services performed by Employee A solely as an employee of that employer.

(B) Conclusion. For the 2022 taxable year, ATEO 1 is treated as paying Employee A $2 million of remuneration, $1 million of which is excess remuneration. The total excise tax is $210,000 (21 percent × $1 million). ATEO 1 paid 3/5 of Employee A's total remuneration ($1.2 million/$2 million); thus, ATEO 1 is liable for 3/5 of the excise tax, which is $126,000. CORP 1 paid 2/5 of Employee A's total remuneration ($800,000/$2 million); thus, CORP 1 is liable for 2/5 of the excise tax, which is $84,000.

(ii) Example 2 (Application when taxpayers have different taxable years)—(A) Facts. Assume the same facts as in paragraph (c)(4)(i) of this section (Example 1), except that CORP 2 uses a taxable year beginning July 1 and ending June 30.

(B) Conclusion. The conclusion is the same as the conclusion in paragraph (c)(4)(i) of this section (Example 1), except that ATEO 1 is liable for the tax for its taxable year starting January 1, 2022, and ending December 31, 2022, and CORP 1 is liable for the tax for its taxable year beginning July 1, 2022, and ending June 30, 2023 (the taxable year with or within which ATEO 1's 2022 applicable year ends).

(iii) Example 3 (Multiple liabilities for same applicable year due to multiple ATEOs)—(A) Facts. The following facts are all with respect to the 2023 applicable year: ATEO 5 owns 60 percent of the stock of CORP 2. Sixty percent of ATEO 4's directors are representatives of ATEO 3. In addition, 60 percent of ATEO 5's directors are representatives of ATEO 4, but none are representatives of ATEO 3. Employee B is a covered employee of ATEO 3, ATEO 4, and ATEO 5 and is an employee of CORP 2. ATEO 3, ATEO 4, ATEO 5, and CORP 2 each pay Employee B $1.2 million of remuneration in the applicable year. ATEO 4's related organizations are ATEO 3 and ATEO 5. ATEO 3's only related organization is ATEO 4. ATEO 5's related organizations are ATEO 4 and CORP 2.

(B) Calculation (ATEO 3). Under ATEO 3's calculation as an ATEO for the 2023 applicable year, ATEO 3 is treated as paying Employee B a total of $2.4 million in remuneration ($1.2 million from ATEO 3 + $1.2 million from ATEO 4). The total excise tax is $294,000 (21 percent × $1.4 million). ATEO 3 and ATEO 4 each paid 1/2 of Employee B's total remuneration ($1.2 million/$2.4 million); thus, under ATEO 3's calculation, ATEO 3 and ATEO 4 each would be liable for 1/2 of the excise tax, which is $147,000.

(C) Calculation (ATEO 4). Under ATEO 4's calculation as an ATEO for the 2023 applicable year, ATEO 4 is treated as paying Employee B a total of $3.6 million in remuneration for the 2022 applicable year ($1.2 million from ATEO 3 + $1.2 million from ATEO 4 + $1.2 million from ATEO 5). The total excise tax is $546,000 (21 percent × $2.6 million). ATEO 3, ATEO 4, and ATEO 5 each paid 1/3 of the total remuneration to Employee B ($1.2 million/$3.6 million); thus, under ATEO 4's calculation, ATEO 3, ATEO 4, and ATEO 5 each would be liable for 1/3 of the excise tax, which is $182,000.

(D) Calculation (ATEO 5). Under ATEO 5's calculation as an ATEO for the 2023 applicable year, ATEO 5 is treated as paying Employee B a total of $3.6 million in remuneration ($1.2 million from ATEO 4 + $1.2 million from ATEO 5 + $1.2 million from CORP 2). The total excise tax is $546,000 (21 percent × $2.6 million). ATEO 4, ATEO 5, and CORP 2 each paid 1/3 of the total remuneration to Employee B ($1.2 million/$3.6 million); thus, under ATEO 5's calculation, ATEO 4, ATEO 5, and CORP 2 each would be liable for 1/3 of the excise tax, which is $182,000.

(E) Conclusion (Liability of ATEO 3). For the 2023 applicable year, ATEO 3 is liable for $182,000 of excise tax as a related organization under ATEO 4's calculation, which is greater than the $147,000 of excise tax under ATEO 3's own calculation. Thus, ATEO 3's excise tax liability with respect to Employee B is $182,000 for its 2023 taxable year.

(F) Conclusion (Liability of ATEO 4). For the 2023 applicable year, ATEO 4 is liable as a related organization for $147,000 of excise tax according to ATEO 3's calculation, for $182,000 according to ATEO 4's own calculation, and for $182,000 according to ATEO 5's calculation. Thus, ATEO 4's excise tax liability with respect to Employee B is $182,000 for its 2023 taxable year.

(G) Conclusion (Liability of ATEO 5). For the 2023 applicable year, ATEO 5 is liable as a related organization for $182,000 of excise tax under ATEO 4's calculation, and is liable for $182,000 of excise tax under ATEO 5's own calculation. Thus, ATEO 5's excise tax liability with respect to Employee B is $182,000 for its 2023 taxable year.

(H) Conclusion (Liability of CORP 2). For the 2023 applicable year, CORP 2 is liable as a related organization for $182,000 of excise tax according to ATEO 5's calculation only. Thus, CORP 2's excise tax liability with respect to Employee B is $182,000 for its 2023 taxable year.

(d) Calculation of liability for excess parachute payments—(1) In general. Except as provided in paragraph (d)(3) of this section, only excess parachute payments made by or on behalf of an ATEO are subject to tax under this section. However, parachute payments made by related organizations that are not made by or on behalf of an ATEO are taken into account for purposes of determining the total amount of excess parachute payments.

(2) Computation of excess parachute payments—(i) Calculation. The amount of an excess parachute payment is the excess of the amount of any parachute payment made by an ATEO, a predecessor of the ATEO, or a related organization, or on behalf of any such person, over the portion of the covered employee's base amount that is allocated to the payment. The portion of the base amount allocated to any parachute payment is the amount that bears the same ratio to the base amount as the present value of the parachute payment bears to the aggregate present value of all parachute payments made or to be made to (or for the benefit of) the same covered employee. Thus, the portion of the base amount allocated to any parachute payment is determined by multiplying the base amount by a fraction, the numerator of which is the present value of the parachute payment and the denominator of which is the aggregate present value of all parachute payments.

(ii) Examples. The following examples illustrate the rules of this paragraph (d)(2). For purposes of these examples, assume any entity referred to as “ATEO” is an ATEO and all employees are HCEs of their respective employers.

(A) Example 1 (Compensation from related organizations)—(1) Facts. ATEO 1 and ATEO 2 are related organizations. Employee A is a covered employee of ATEO 1 and an employee of ATEO 2 who has an involuntary separation from employment with ATEO 1 and ATEO 2. Employee A's base amount is $200,000 with respect to ATEO 1 and $400,000 with respect to ATEO 2. A receives $1 million from ATEO 1 contingent upon Employee A's involuntary separation from employment from ATEO 1 and $1 million from ATEO 2 contingent upon Employee A's involuntary separation from employment from ATEO 2.

(2) Conclusion. Employee A has a base amount of $600,000 ($200,000 + $400,000). The two $1 million payments are parachute payments because their aggregate present value is at least 3-times Employee A's base amount (3 × $600,000 = $1.8 million). The portion of the base amount allocated to each parachute payment is $300,000 (($1 million/$2 million) × $600,000). Thus, the amount of each excess parachute payment is $700,000 ($1 million−$300,000).

(B) Example 2 (Multiple parachute payments)—(1) Facts. Employee B is a covered employee of ATEO 3 with a base amount of $200,000 who is entitled to receive two parachute payments: One of $200,000 and the other of $900,000. The $200,000 payment is made upon separation from employment, and the $900,000 payment is to be made on a date in a future taxable year. The present value of the $900,000 payment is $800,000 as of the date of the separation from employment.

(2) Conclusion. The portion of the base amount allocated to the first payment is $40,000 (($200,000 present value of the parachute payment/$1 million present value of all parachute payments) × $200,000 total base amount) and the portion of the base amount allocated to the second payment is $160,000 (($800,000 present value of the parachute payment/$1 million present value of all parachute payments) × $200,000 total base amount). Thus, the amount of the first excess parachute payment is $160,000 ($200,000−$40,000) and that the amount of the second excess parachute payment is $740,000 ($900,000−$160,000).

(3) Reallocation when the payment is disproportionate to base amount. In accordance with section 4960(d), the Commissioner may treat a parachute payment as paid by an ATEO if the facts and circumstances indicate that the ATEO and other payors of parachute payments structured the payments in a manner primarily to avoid liability under section 4960. For example, if an ATEO would otherwise be treated as paying a portion of an excess parachute payment in an amount that is materially lower in proportion to the total excess parachute payment than the proportion that the amount of average annual compensation paid by the ATEO (or any predecessor) during the base period bears to the total average annual compensation paid by the ATEO (or any predecessor) and any related organization (or organizations), and the lower amount is offset by payments from a non-ATEO or an unrelated ATEO, this may indicate that that the parachute payments were structured in a manner primarily to avoid liability under section 4960.

(4) Election to prepay tax. An ATEO may prepay the excise tax under paragraph (a)(1) of this section on any excess parachute payment for the taxable year of the separation from employment or any later taxable year before the taxable year in which the parachute payment is actually or constructively paid. However, an employer may not prepay the excise tax on a payment to be made in cash if the present value of the payment is not reasonably ascertainable under § 31.3121(v)(2)-1(e)(4) or on a payment related to health coverage. Any prepayment must be based on the present value of the excise tax that would be due for the taxable year in which the employer will pay the excess parachute payment, and be calculated using the discount rate equal to 120 percent of the applicable Federal rate (determined under section 1274(d) and the regulations in part 1 under section 1274) and the tax rate in effect under section 11 for the year in which the excise tax is paid. For purposes of projecting the future value of a payment that provides for interest to be credited at a variable interest rate, the employer may make a reasonable assumption regarding the variable rate. An employer is not required to adjust the excise tax paid merely because the actual future interest rates are not the same as the rate used for purposes of projecting the future value of the payment.

(5) Liability after a redetermination of total parachute payments. If an ATEO determines that an estimate made under § 53.4960-3(j)(1) was incorrect, it must reapply the 3-times-base-amount test to reflect the actual time and amount of the payment. In reapplying the 3-times-base-amount test (and, if necessary, reallocating the base amount), the ATEO must determine the correct base amount allocable to any parachute payment paid in the taxable year. See § 1.280G-1, Q/A-33(d) for examples that may be applied by analogy to illustrate the rules of this paragraph (d)(5).

(6) Examples. The following examples illustrate the rules of this paragraph (d). For purposes of these examples, assume any entity referred to as “ATEO” is an ATEO, any entity referred to as “CORP” is not an ATEO, and all employees are HCEs of their respective employers.

(i) Example 1 (Excess parachute payment paid by a non-ATEO)—(A) Facts. ATEO 1 and CORP 1 are related organizations that are treated as the same employer for purposes of § 53.4960-3(e)(3) (defining separation from employment) and are both calendar year taxpayers. For 2022 through 2026, ATEO 1 and CORP 1 each pay Employee A $250,000 of compensation per year for services performed as an employee of each organization ($500,000 total per year). In 2027, ATEO 1 and CORP 1 each pay Employee A $1 million payment ($2 million total) that is contingent on Employee A's separation from employment with both ATEO 1 and CORP 1, all of which is remuneration, and no other compensation. Employee A is a covered employee of ATEO 1 in 2027.

(B) Conclusion. Employee A's base amount in 2027 is $500,000 (Employee A's average annual compensation from both ATEO 1 and CORP 1 for the previous 5 years). ATEO 1 makes a parachute payment of $2 million in 2027, the amount paid by both ATEO 1 and CORP 1 that is contingent on Employee A's separation from employment with ATEO 1 and all organizations that are treated as the same employer under § 53.4960-3(e)(3). Employee A's $2 million payment exceeds 3-times the base amount ($1.5 million). ATEO 1 makes a $1.5 million excess parachute payment (the amount by which $2 million exceeds the $500,000 base amount). However, ATEO 1 is liable for tax only on the excess parachute payment paid by ATEO 1 ($1 million parachute payment−$250,000 base amount = $750,000) that is subject to tax under § 53.4960-4(a). CORP 1 is not liable for tax under § 53.4960-4(a) in 2027.

(ii) Example 2 (Election to prepay tax on excess parachute payments and effect on excess remuneration)—(A) Facts. Employee B is a covered employee of ATEO 2 with a base amount of $200,000 who is entitled to receive two parachute payments from ATEO 2, one of $200,000 and the other of $900,000. The $200,000 payment is made upon separation from employment, and the $900,000 payment is to be made on a date in a future taxable year. The present value of the $900,000 payment is $800,000 as of the date of the separation from employment. ATEO 2 elects to prepay the excise tax on the $900,000 future parachute payment (of which $740,000 is an excess parachute payment). The tax rate under section 11 is 21 percent for the taxable year the excise tax is paid and, using a discount rate determined under § 53.4960-3(i), the present value of the $155,400 ($740,000 × 21 percent) excise tax on the $740,000 future excess parachute payment is $140,000.

(B) Conclusion. The excess parachute payment is thus $800,000 ($200,000 plus $800,000 present value of the $900,000 future payment, less $200,000 base amount), with $40,000 of the base amount allocable to the $200,000 payment and $160,000 of the base amount allocable to the $900,000 payment. To prepay the excise tax on the $740,000 future excess parachute payment, the employer must satisfy its $140,000 obligation under section 4960 with respect to the future payment, in addition to the $33,600 excise tax ($160,000 × 21 percent) on the $160,000 excess parachute payment made upon separation from employment. For purposes of determining the amount of excess remuneration (if any) under section 4960(a)(1), the amount of remuneration paid by the employer to the covered employee for the taxable year of the separation from employment is reduced by the $900,000 of total excess parachute payments ($160,000 + $740,000).

(a) General applicability date. Sections 53.4960-0 through 53.4960-4 apply to taxable years beginning after December 31, 2021. Taxpayers may choose to apply §§ 53.4960-0 through 53.4960-4 to taxable years beginning after December 31, 2017, and on or before December 31, 2021, provided the taxpayer applies §§ 53.4960-0 through 53.4960-4 in their entirety and in a consistent manner.

(b) [Reserved]

If any taxable event is corrected during the correction period for the event, then any second tier tax imposed with respect to the event shall not be assessed. If the tax has been assessed, it shall be abated. If the tax has been collected, it shall be credited or refunded as an overpayment. For purposes of this section, the tax imposed includes interest, additions to the tax and additional amounts. For definitions of the terms second tier tax, taxable event, correct, and correction period, see § 53.4963-1.

(a) Introduction. Under section 4961 (b) and (c), the period of limitations on collection may be suspended and assessment or collection of first or second tier tax may be prohibited during the pendency of administrative and judicial proceedings conducted to determine a taxpayer's liability for second tier tax. This section provides rules relating to the suspension of the limitations period and the prohibitions on assessment and collection. In addition, this section describes the administrative and judicial proceedings to which these rules apply.

(b) Initial proceeding—(1) Defined. For purposes of subpart K, an initial proceeding means a proceeding described in subparagraph (2) or (3).

(2) Tax Court proceeding before assessment. A proceeding is described in this subparagraph (2) if it is a proceeding with respect to the taxpayer's liability for second tier tax and is commenced in accordance with section 6213 (a).

(3) Refund proceeding commenced before correction period ends. A proceeding is described in this subparagraph (3) if it is a proceeding commenced under section 7422, in accordance with the provisions of § 53.4963-1(e) (4) and (5) (relating to prerequisites to extension of the correction period during certain refund proceedings), and with respect to the taxpayer's liability for second tier tax.

(c) Supplemental proceeding—(1) Jurisdiction. If a determination in an initial proceeding that a taxpayer is liable for a second tier tax has become final, the court in which the initial proceeding was commenced shall have jurisdiction to conduct any necessary supplemental proceeding to determine whether the taxable event was corrected during the correction period.

(2) Time for beginning proceeding. The time for beginning a supplemental proceeding begins on the day after a determination in an initial proceeding becomes final and ends on the 90th day after the last day of the correction period.

(d) Restriction on assessment during Tax Court proceeding. If a supplemental proceeding described in section 4961 (b) and § 53.4961-2(c) is commenced in the Tax Court, the provisions of the second and third sentences of section 6213(a) and the first and third sentences of § 301.6213-1(a)(2) apply with respect to a deficiency in second tier tax until the decision of the Tax Court in the supplemental proceeding is final.

(e) Suspension of period of collection for second tier tax—(1) Scope. Except as provided in subparagraph (6), this paragraph (e) applies to the second tier tax assessed with respect to a taxable event if a claim described in subparagraph (2) is filed.

(2) Claim for refund. A claim for refund is described in this subparagraph (2) if, no later than 90 days after the day on which the second tier tax is assessed with respect to a taxable event, the taxpayer—

(i) Pays the full amount of first tier tax for the taxable period, and

(ii) Files a claim for refund of the amount paid.

(3) Collection prohibited. No levy or proceeding in court for the collection of the second tier tax shall be made, begun, or prosecuted until the end of the collection prohibition period described in subparagraph (5). Notwithstanding section 7421(a), the collection by levy or proceeding may be enjoined during the collection prohibition period by a proceeding in the proper court.

(4) Suspension of running of period of limitations on collection. With respect to a second tier tax to which this paragraph (e) applies, the running of the period of limitations provided in section 6502 (relating to collection of tax by levy or by a proceeding in court) shall be suspended for the collection prohibition period described in subparagraph (5).

(5) Collection prohibition period. The collection prohibition period begins on the day the second tier tax is assessed and ends on the latest of:

(i) The day a decision in a refund proceeding commenced before the 91st day after denial of the claim described in subparagraph (2) of this paragraph (including any supplemental proceeding under § 53.4961-2(c)) becomes final;

(ii) The 90th day after the claim referred to in subparagraph (2) is denied; or

(iii) The 90th day after the second tier tax is assessed.

(6) Jeopardy collection. If the Secretary makes a finding that the collection of the second tier tax is in jeopardy, nothing in this paragraph (e) shall prevent the immediate collection of such tax.

(f) Finality—(1) Tax Court proceeding. For purposes of this subpart K, section 7481 applies in determining when a decision in a Tax Court proceeding becomes final.

(2) Refund proceeding. For purposes of this subpart K, § 301.7422-1 applies in determining when a decision in a refund proceeding becomes final.

(a) First tier tax. For purposes of this subpart K, the term first tier tax means any tax imposed by subsection (a) of section 4941, 4942, 4943, 4944, 4945, 4951, 4952, 4955, 4958, 4966, 4967, 4971, or 4975. A first tier tax may also be referred to as an “initial tax” in parts 53 and 54.

(b) Second tier tax. For purposes of this subpart K, the term second tier tax means any tax imposed by subsection (b) of section 4941, 4942, 4943, 4944, 4945, 4951, 4952, 4955, 4958, 4971, or 4975. A second tier tax may also be referred to as an “additional tax” in parts 53 and 54.

(c) Taxable event. For purposes of this subpart K, the term taxable event means any act, or failure to act, giving rise to liability for tax under section 4941, 4942, 4943, 4944, 4945, 4951, 4952, 4955, 4958, 4966, 4967, 4971, or 4975.

(d) Correct—(1) In general. Except as provided in subparagraph (2), the term correct has the same meaning for purposes of this subpart K as in the section which imposes the second tier tax or the regulations thereunder.

(2) Special rules. The term correct means—

(i) For a second tier tax imposed by section 4942(b), reducing the amount of the undistributed income to zero,

(ii) For a second tier tax imposed by section 4943(b), reducing the amount of the excess business holdings to zero, and

(iii) For a second tier tax imposed by section 4944(b), removing the investment from jeopardy.

(e) Correction period—(1) In general. The correction period with respect to any taxable event shall begin with the date on which the taxable event occurs and shall end 90 days after the date of mailing of a notice of deficiency under section 6212 with respect to the second tier tax imposed with respect to the taxable event.

(2) Extensions of correction period. The correction period referred to in subparagraph (1) of this paragraph shall be extended by any period in which a deficiency cannot be assessed under section 6213(a). In addition, the correction period referred to in subparagraph (1) of this paragraph (e) shall be extended in accordance with subparagraph (3), (4), and (5) of this paragraph except that subparagraph (4), or (5) shall not operate to extend a correction period with respect to which a taxpayer has filed a petition with the United States Tax Court for redetermination of a deficiency within the time prescribed by section 6213(a).

(3) Extensions by Commissioner. The correction period referred to in subparagraph (1) of this paragraph may be extended by any period which the Commissioner determines is reasonable and necessary to bring about correction (including, for taxes imposed by section 4975, equitable relief sought by the Secretary of Labor) of the taxable event. The Commissioner ordinarily will not extend the correction period unless the following factors are present.

(i) The taxpayer on whom the second tier tax is imposed, the Secretary of Labor (for taxes imposed by section 4975), or an appropriate State officer (as defined in section 6104(c)(2)) is actively seeking in good faith to correct the taxable event;

(ii) Adequate corrective action cannot reasonably be expected to result during the unextended correction period;

(iii) For taxes imposed by section 4975, the Secretary of Labor requests the extension because subdivision (ii) applies; and

(iv) For taxes imposed by chapter 42 (other than taxes imposed by section 4940), the taxable event appears to have been an isolated occurrence so that it appears unlikely that similar taxable events will occur in the future.

(4) Extension for payment of first tier tax. If, within the unexpected correction period, the taxpayer pays the full amount of the first tier tax imposed with respect to the taxable event the Commissioner shall extend the correction period to the later of—

(i) Ninety days after the payment of the first tier tax, or

(ii) The last day of the correction period determined without regard to this paragraph.

(5) Extensions for filing claim for refund or refund suit. If prior to the expiration of the correction period (including extensions) a claim for refund is filed with respect to payment of the full amount of the first tier tax imposed with respect to the taxable event, the Commissioner shall extend the correction period during the pendency of the claim plus an additional 90 days. If within that time a suit or proceeding referred to in section 7422(g) with respect to the claim is filed, the Commissioner shall extend the correction period until the determination in the suit for refund (determined without regard to a supplemental proceeding under section 4861(b)) is final, determined under § 301.7422-2(a).

(6) End of correction period if waiver accepted. If the notice of deficiency referred to in paragraph (1) is not mailed because there is a waiver of the restrictions on assessment and collection of the deficiency or because the deficiency is paid, the correction period will end with the end of the collection prohibition period described in § 53.4961-2(e)(5).

(7) Date on which taxable event occurs. For purposes of subparagraph (1), the taxable event shall be treated as occurring—

(i) Under section 4942, on the first day of the taxable year for which there is undistributed income,

(ii) Under section 4943, on the first day on which there are excess business holdings,

(iii) Under section 4971, on the last day of the plan year in which there is an accumulated funding deficiency, and

(iv) In all other cases, the date on which the event occurred.

(f) Effective date. The provisions of this subpart K are effective with respect to second tier taxes assessed after December 24, 1980. The preceding sentence shall not be construed to permit the assessment of a tax in a case to which, on December 24, 1980, the doctrine of res judicata applied.

(a) Entity-level excise tax. Section 4965 imposes two excise taxes with respect to certain tax shelter transactions to which tax-exempt entities are parties. Section 4965(a)(1) imposes an entity-level excise tax on certain tax-exempt entities that are parties to “prohibited tax shelter transactions,” as defined in section 4965(e). See § 53.4965-2 for the discussion of covered tax-exempt entities. See § 53.4965-3 for the definition of prohibited tax shelter transactions. See § 53.4965-4 for the definition of tax-exempt party to a prohibited tax shelter transaction. The entity-level excise tax under section 4965(a)(1) is imposed on a specified percentage of the entity's net income or proceeds that are attributable to the transaction for the relevant tax year (or a period within that tax year). The rate of tax depends on whether the entity knew or had reason to know that the transaction was a prohibited tax shelter transaction at the time the entity became a party to the transaction. See § 53.4965-7(a) for the discussion of the entity-level excise tax under section 4965(a)(1). See § 53.4965-6 for the discussion of “knowing or having reason to know.” See § 53.4965-8 for the definition of net income and proceeds and the standard for allocating net income and proceeds that are attributable to a prohibited tax shelter transaction to various periods.

(b) Manager-level excise tax. Section 4965(a)(2) imposes a manager-level excise tax on “entity managers,” as defined in section 4965(d), of tax-exempt entities who approve the entity as a party (or otherwise cause the entity to be a party) to a prohibited tax shelter transaction and know or have reason to know, at the time the tax-exempt entity enters into the transaction, that the transaction is a prohibited tax shelter transaction. See § 53.4965-5 for the definition of entity manager and the meaning of “approving or otherwise causing,” and § 53.4965-6 for the discussion of “knowing or having reason to know.” See § 53.4965-7(b) for the discussion of the manager-level excise tax under section 4965(a)(2).

(c) Effective/applicability dates. See § 53.4965-9 for the discussion of the relevant effective and applicability dates.

(a) In general. Under section 4965(c), the term “tax-exempt entity” refers to entities that are described in sections 501(c), 501(d), or 170(c) (other than the United States), Indian tribal governments (within the meaning of section 7701(a)(40)), and tax-qualified pension plans, individual retirement arrangements and similar tax-favored savings arrangements that are described in sections 4979(e)(1), (2) or (3), 529, 457(b), or 4973(a). The tax-exempt entities referred to in section 4965(c) are divided into two broad categories, non-plan entities and plan entities.

(b) Non-plan entities. Non-plan entities are—

(1) Entities described in section 501(c);

(2) Religious or apostolic associations or corporations described in section 501(d);

(3) Entities described in section 170(c), including states, possessions of the United States, the District of Columbia, political subdivisions of states and political subdivisions of possessions of the United States (but not including the United States); and

(4) Indian tribal governments within the meaning of section 7701(a)(40).

(c) Plan entities. Plan entities are—

(1) Entities described in section 4979(e)(1) (qualified plans under section 401(a), including qualified cash or deferred arrangements under section 401(k) (including a section 401(k) plan that allows designated Roth contributions));

(2) Entities described in section 4979(e)(2) (annuity plans described in section 403(a));

(3) Entities described in section 4979(e)(3) (annuity contracts described in section 403(b), including a section 403(b) arrangement that allows Roth contributions);

(4) Qualified tuition programs described in section 529;

(5) Eligible deferred compensation plans under section 457(b) that are maintained by a governmental employer as defined in section 457(e)(1)(A);

(6) Arrangements described in section 4973(a) which include—

(i) Individual retirement plans defined in section 408(a) and (b), including—

(A) Simplified employee pensions (SEPs) under section 408(k);

(B) Simple individual retirement accounts (SIMPLEs) under section 408(p);

(C) Deemed individual retirement accounts or annuities (IRAs) qualified under a qualified plan (deemed IRAs) under section 408(q); and

(D) Roth IRAs under section 408A.

(ii) Arrangements described in section 220(d) (Archer Medical Savings Accounts (MSAs));

(iii) Arrangements described in section 403(b)(7) (custodial accounts treated as annuity contracts);

(iv) Arrangements described in section 530 (Coverdell education savings accounts); and

(v) Arrangements described in section 223(d) (health savings accounts (HSAs)).

(d) Effective/applicability dates. See § 53.4965-9 for the discussion of the relevant effective and applicability dates.

(a) In general. Under section 4965(e), the term prohibited tax shelter transaction means—

(1) Listed transactions within the meaning of section 6707A(c)(2), including subsequently listed transactions described in paragraph (b) of this section; and

(2) Prohibited reportable transactions, which consist of the following reportable transactions within the meaning of section 6707A(c)(1)—

(i) Confidential transactions, as described in § 1.6011-4(b)(3) of this chapter; or

(ii) Transactions with contractual protection, as described in § 1.6011-4(b)(4) of this chapter.

(b) Subsequently listed transactions. A subsequently listed transaction for purposes of section 4965 is a transaction that is identified by the Secretary as a listed transaction after the tax-exempt entity has entered into the transaction and that was not a prohibited reportable transaction (within the meaning of section 4965(e)(1)(C) and paragraph (a)(2) of this section) at the time the entity entered into the transaction.

(c) Cross-reference. The determination of whether a transaction is a listed transaction or a prohibited reportable transaction for section 4965 purposes shall be made under the law applicable to section 6707A(c)(1) and (c)(2).

(d) Effective/applicability dates. See § 53.4965-9 for the discussion of the relevant effective and applicability dates.

(a) In general. For purposes of sections 4965 and 6033(a)(2), a tax-exempt entity is a party to a prohibited tax shelter transaction if the entity—

(1) Facilitates a prohibited tax shelter transaction by reason of its tax-exempt, tax indifferent or tax-favored status; or

(2) Is identified in published guidance, by type, class or role, as a party to a prohibited tax shelter transaction.

(b) Published guidance may identify which tax-exempt entities, by type, class or role, will not be treated as a party to a prohibited tax shelter transaction.

(c) Example. The following example illustrates the principle of paragraph (a)(1) of this section:

(d) Effective/applicability dates. See § 53.4965-9 for the discussion of the relevant effective and applicability dates.

(a) Entity manager of a non-plan entity—(1) In general. Under section 4965(d)(1), an entity manager of a non-plan entity is—

(i) A person with the authority or responsibility similar to that exercised by an officer, director, or trustee of an organization (that is, the non-plan entity); and

(ii) With respect to any act, the person who has final authority or responsibility (either individually or as a member of a collective body) with respect to such act.

(2) Definition of officer. For purposes of paragraph (a)(1)(i) of this section, a person is considered to be an officer of the non-plan entity (or to have similar authority or responsibility) if the person—

(i) Is specifically designated as such under the certificate of incorporation, by-laws, or other constitutive documents of the non-plan entity; or

(ii) Regularly exercises general authority to make administrative or policy decisions on behalf of the non-plan entity.

(3) Exception for acts requiring approval by a superior. With respect to any act, any person is not described in paragraph (a)(2)(ii) of this section if the person has authority merely to recommend particular administrative or policy decisions, but not to implement them without approval of a superior.

(4) Delegation of authority. A person is an entity manager of a non-plan entity within the meaning of paragraph (a)(1)(ii) of this section if, with respect to any prohibited tax shelter transaction, such person has been delegated final authority or responsibility with respect to such transaction (including by transaction type or dollar amount) by a person described in paragraph (a)(1)(i) of this section or the governing board of the entity. For example, an investment manager is an entity manager with respect to a prohibited tax shelter transaction if the non-plan entity's governing body delegated to the investment manager the final authority to make certain investment decisions and, in the exercise of that authority, the manager committed the entity to the transaction. To be considered an entity manager of a non-plan entity within the meaning of paragraph (a)(1)(ii) of this section, a person need not be an employee of the entity. A person is not described in paragraph (a)(1)(ii) of this section if the person is merely implementing a decision made by a superior.

(b) Entity manager of a plan entity—(1) In general. Under section 4965(d)(2), an entity manager of a plan entity is the person who approves or otherwise causes the entity to be a party to the prohibited tax shelter transaction.

(2) Special rule for plan participants and beneficiaries who have investment elections—(i) Fully self-directed plans or arrangements. In the case of a fully self-directed qualified plan, IRA, or other savings arrangement (including a case where a plan participant or beneficiary is given a list of prohibited investments, such as collectibles), if the plan participant or beneficiary selected a certain investment and, therefore, approved the plan entity to become a party to a prohibited tax shelter transaction, the plan participant or the beneficiary is an entity manager.

(ii) Plans or arrangements with limited investment options. In the case of a qualified plan, IRA, or other savings arrangement where a plan participant or beneficiary is offered a limited number of investment options from which to choose, the person responsible for determining the pre-selected investment options is an entity manager and the plan participant or the beneficiary generally is not an entity manager.

(c) Meaning of “approves or otherwise causes”—(1) In general. A person is treated as approving or otherwise causing a tax-exempt entity to become a party to a prohibited tax shelter transaction if the person has the authority to commit the entity to the transaction, either individually or as a member of a collective body, and the person exercises that authority.

(2) Collective bodies. If a person shares the authority described in paragraph (c)(1) of this section as a member of a collective body (for example, board of trustees or committee), the person will be considered to have exercised such authority if the person voted in favor of the entity becoming a party to the transaction. However, a member of the collective body will not be treated as having exercised the authority described in paragraph (c)(1) of this section if he or she voted against a resolution that constituted approval or an act that caused the tax-exempt entity to be a party to a prohibited tax shelter transaction, abstained from voting for such approval, or otherwise failed to vote in favor of such approval.

(3) Exceptions—(i) Successor in interest. If a tax-exempt entity that is a party to a prohibited tax shelter transaction is dissolved, liquidated, or merged into a successor entity, an entity manager of the successor entity will not, solely by reason of the reorganization, be treated as approving or otherwise causing the successor entity to become a party to a prohibited tax shelter transaction, provided that the reorganization of the tax-exempt entity does not result in a material change to the terms of the transaction. For purposes of this paragraph (c)(3)(i), a material change includes an extension or renewal of the agreement (other than an extension or renewal that results from another party to the transaction unilaterally exercising an option granted by the agreement) or a more than incidental change to any payment under the agreement. A change for the sole purpose of substituting the successor entity for the original tax-exempt party is not a material change.

(ii) Exercise or nonexercise of options. Nonexercise of an option pursuant to a transaction involving the tax-exempt entity generally will not constitute an act of approving or causing the entity to be a party to the transaction. If, pursuant to a transaction involving the tax-exempt entity, the entity manager exercises an option (such as a repurchase option), the entity manager will not be subject to the entity manager-level tax if the exercise of the option does not result in the tax-exempt entity becoming a party to a second transaction that is a prohibited tax shelter transaction.

(4) Example. The following example illustrates the principles of paragraph (c)(3)(ii) of this section:

(5) Coordination with the reason-to-know standard. The determination that an entity manager approved or caused a tax-exempt entity to be a party to a prohibited tax shelter transaction, by itself, does not establish liability for the section 4965(a)(2) tax. For rules on determining whether an entity manager knew or had reason to know that the transaction was a prohibited tax shelter transaction, see § 53.4965-6(b).

(d) Effective/applicability dates. See § 53.4965-9 for the discussion of the relevant effective and applicability dates.

(a) Attribution to the entity. An entity will be treated as knowing or having reason to know for section 4965 purposes if one or more of its entity managers knew or had reason to know that the transaction was a prohibited tax shelter transaction at the time the entity manager(s) approved the entity as (or otherwise caused the entity to be) a party to the transaction. The entity shall be attributed the knowledge or reason to know of any entity manager described in § 53.4965-5(a)(1)(i) even if that entity manager does not approve the entity as (or otherwise cause the entity to be) a party to the transaction.

(b) Determining whether an entity manager knew or had reason to know—(1) In general. Whether an entity manager knew or had reason to know that a transaction is a prohibited tax shelter transaction is based on all facts and circumstances. In order for an entity manager to know or have reason to know that a transaction is a prohibited tax shelter transaction, the entity manager must have knowledge of sufficient facts that would lead a reasonable person to conclude that the transaction is a prohibited tax shelter transaction. An entity manager will be considered to have “reason to know” if a reasonable person in the entity manager's circumstances would conclude that the transaction was a prohibited tax shelter transaction based on all the facts reasonably available to the manager at the time of approving the entity as (or otherwise causing the entity to be) a party to the transaction. Factors that will be considered in determining whether a reasonable person in the entity manager's circumstances would conclude that the transaction was a prohibited tax shelter transaction include, but are not limited to—

(i) The presence of tax shelter indicia (see paragraph (b)(2) of this section);

(ii) Whether the entity manager received a disclosure statement prior to the consummation of the transaction indicating that the transaction may be a prohibited tax shelter transaction (see paragraph (b)(3) of this section); and

(iii) Whether the entity manager made appropriate inquiries into the transaction (see paragraph (b)(4) of this section).

(2) Tax-shelter indicia. The presence of indicia that a transaction is a tax shelter will be treated as an indication that the entity manager knew or had reason to know that the transaction was a prohibited tax shelter transaction. Tax shelter indicia include but are not limited to—

(i) The transaction is extraordinary for the entity considering prior investment activity;

(ii) The transaction promises an economic return for the organization that is exceptional considering the amount invested by, the participation of, or the absence of risk to the organization; or

(iii) The transaction is of significant size relative to the receipts of the entity.

(3) Effect of disclosure statements. Receipt by an entity manager of a statement, including a statement described in section 6011(g), in advance of a transaction that the transaction may be a prohibited tax shelter transaction (or a statement that a partnership, hedge fund or other investment conduit may engage in a prohibited tax shelter transaction in the future) is a factor relevant in the determination of whether the entity manager knew or had reason to know that the transaction is a prohibited transaction. However, an entity manager will not be treated as knowing or having reason to know that the transaction was a prohibited tax shelter transaction solely because the entity manager receives such a disclosure.

(4) Appropriate inquiries. What inquiries are appropriate will be determined from the facts and circumstances of each case. For example, if one or more tax shelter indicia are present or if an entity manager receives a disclosure statement described in paragraph (b)(3) of this section, an entity manager has a responsibility to inquire further whether the transaction is a prohibited tax shelter transaction.

(c) Reliance on professional advice—(1) In general. An entity manager is not required to obtain the advice of a professional tax advisor to establish that the entity manager made appropriate inquiries. Moreover, not seeking professional advice, by itself, shall not give rise to an inference that the entity manager had reason to know that a transaction is a prohibited tax shelter transaction.

(2) Reliance on written opinion of professional tax advisor. An entity manager may establish that he or she did not have a reason to know that a transaction was a prohibited tax shelter transaction at the time the tax-exempt entity entered into the transaction if the entity manager reasonably, and in good faith, relied on the written opinion of a professional tax advisor. Reliance on the written opinion of a professional tax advisor establishes that the entity manager did not have reason to know if, taking into account all the facts and circumstances, the reliance was reasonable and the entity manager acted in good faith. For example, the entity manager's education, sophistication, and business experience will be relevant in determining whether the reliance was reasonable and made in good faith. In no event will an entity manager be considered to have reasonably relied in good faith on an opinion unless the requirements of this paragraph (c)(2) are satisfied. The fact that these requirements are satisfied, however, will not necessarily establish that the entity manager reasonably relied on the opinion in good faith. For example, reliance may not be reasonable or in good faith if the entity manager knew, or reasonably should have known, that the advisor lacked knowledge in the relevant aspects of Federal tax law.

(i) All facts and circumstances considered. The advice must be based upon all pertinent facts and circumstances and the law as it relates to those facts and circumstances. The requirements of this paragraph (c)(2) are not satisfied if the entity manager fails to disclose a fact that it knows, or reasonably should know, is relevant to determining whether the transaction is a prohibited tax shelter transaction.

(ii) No unreasonable assumptions. The advice must not be based on unreasonable factual or legal assumptions (including assumptions as to future events) and must not unreasonably rely on the representations, statements, findings, or agreements of the entity manager or any other person (including another party to the transaction or a material advisor within the meaning of sections 6111 and 6112).

(iii) “More likely than not” opinion. The written opinion of the professional tax advisor must apply the appropriate law to the facts and, based on this analysis, must conclude that the transaction was not a prohibited tax shelter transaction at a “more likely than not” level of certainty at the time the entity manager approved the entity (or otherwise caused the entity) to be a party to the transaction.

(3) Special rule. An entity manager's reliance on a written opinion of a professional tax advisor will not be considered reasonable if the advisor is, or is related to a person who is, a material advisor with respect to the transaction within the meaning of sections 6111 and 6112.

(d) Subsequently listed transactions. An entity manager will not be treated as knowing or having reason to know that a transaction (other than a prohibited reportable transaction as defined in section 4965(e)(1)(C) and § 53.4965-3(a)(2)) is a prohibited tax shelter transaction if the entity enters into the transaction before the date on which the transaction is identified by the Secretary as a listed transaction.

(e) Effective/applicability dates. See § 53.4965-9 for the discussion of the relevant effective and applicability dates.

(a) Entity-level taxes—(1) In general. Entity-level excise taxes apply to non-plan entities (as defined in § 53.4965-2(b)) that are parties to prohibited tax shelter transactions.

(i) Prohibited tax shelter transactions other than subsequently listed transactions—(A) Amount of tax if the entity did not know and did not have reason to know. If the tax-exempt entity did not know and did not have reason to know that the transaction was a prohibited tax shelter transaction at the time the entity entered into the transaction, the tax is the highest rate of tax under section 11 multiplied by the greater of—

(1) The entity's net income with respect to the prohibited tax shelter transaction (after taking into account any tax imposed by Subtitle D, other than by this section, with respect to such transaction) for the taxable year; or

(2) 75 percent of the proceeds received by the entity for the taxable year that are attributable to such transaction.

(B) Amount of tax if the entity knew or had reason to know. If the tax-exempt entity knew or had reason to know that the transaction was a prohibited tax shelter transaction at the time the entity entered into the transaction, the tax is the greater of—

(1) 100 percent of the entity's net income with respect to the transaction (after taking into account any tax imposed by Subtitle D, other than by this section, with respect to such transaction) for the taxable year; or

(2) 75 percent of the proceeds received by the entity for the taxable year that are attributable to such transaction.

(ii) Subsequently listed transactions—(A) In general. In the case of a subsequently listed transaction (as defined in section 4965(e)(2) and § 53.4965-3(b)), the tax-exempt entity's income and proceeds attributable to the transaction are allocated between the period before the transaction became listed and the period beginning on the date the transaction became listed. See § 53.4965-8 for the standard for allocating net income or proceeds to various periods. The tax for each taxable year is the highest rate of tax under section 11 multiplied by the greater of—

(1) The entity's net income with respect to the subsequently listed transaction (after taking into account any tax imposed by Subtitle D, other than by this section, with respect to such transaction) for the taxable year that is allocable to the period beginning on the later of the date such transaction is identified by the Secretary as a listed transaction or the first day of the taxable year; or

(2) 75 percent of the proceeds received by the entity for the taxable year that are attributable to such transaction and allocable to the period beginning on the later of the date such transaction is identified by the Secretary as a listed transaction or the first day of the taxable year.

(B) No increase in tax. The 100 percent tax under section 4965(b)(1)(B) and § 53.4965-7(a)(1)(i)(B) does not apply to any subsequently listed transaction (as defined in section 4965(e)(2) and § 53.4965-3(b)) entered into by a tax-exempt entity before the date on which the transaction is identified by the Secretary as a listed transaction.

(2) Taxable year. The excise tax imposed under section 4965(a)(1) applies for the taxable year in which the entity becomes a party to the prohibited tax shelter transaction and any subsequent taxable year for which the entity has net income or proceeds attributable to the transaction. A taxable year for tax-exempt entities is the calendar year or fiscal year, as applicable, depending on the basis on which the tax-exempt entity keeps its books for Federal income tax purposes. If a tax-exempt entity has not established a taxable year for Federal income tax purposes, the entity's taxable year for the purpose of determining the amount and timing of net income and proceeds attributable to a prohibited tax shelter transaction will be deemed to be the annual period the entity uses in keeping its books and records.

(b) Manager-level taxes—(1) Amount of tax. If any entity manager approved or otherwise caused the tax-exempt entity to become a party to a prohibited tax shelter transaction and knew or had reason to know that the transaction was a prohibited tax shelter transaction, such entity manager is liable for the $20,000 tax. See § 53.4965-5(d) for the meaning of approved or otherwise caused. See § 53.4965-6 for the meaning of knew or had reason to know.

(2) Timing of the entity manager tax. If a tax-exempt entity enters into a prohibited tax shelter transaction during a taxable year of an entity manager, then the entity manager that approved or otherwise caused the tax-exempt entity to become a party to the transaction is liable for the entity manager tax for that taxable year if the entity manager knew or had reason to know that the transaction was a prohibited tax shelter transaction.

(3) Example. The application of paragraph (b)(2) of this section is illustrated by the following example:

(4) Separate liability. If more than one entity manager approved or caused a tax-exempt entity to become a party to a prohibited tax shelter transaction while knowing (or having reason to know) that the transaction was a prohibited tax shelter transaction, then each such entity manager is separately (that is, not jointly and severally) liable for the entity manager-level tax with respect to the transaction.

(c) Effective/applicability dates. See § 53.4965-9 for the discussion of the relevant effective and applicability dates.

(a) In general. For purposes of section 4965(a), the amount and the timing of the net income and proceeds attributable to the prohibited tax shelter transaction will be computed in a manner consistent with the substance of the transaction. In determining the substance of listed transactions, the IRS will look to, among other items, the listing guidance and any subsequent guidance published in the Internal Revenue Bulletin relating to the transaction.

(b) Definition of net income and proceeds—(1) Net income. A tax-exempt entity's net income attributable to a prohibited tax shelter transaction is its gross income derived from the transaction reduced by those deductions that are attributable to the transaction and that would be allowed by chapter 1 of the Internal Revenue Code if the tax-exempt entity were treated as a taxable entity for this purpose, and further reduced by taxes imposed by Subtitle D, other than by this section, with respect to the transaction.

(2) Proceeds—(i) Tax-exempt entities that facilitate the transaction by reason of their tax-exempt, tax indifferent or tax-favored status. Solely for purposes of section 4965, in the case of a tax-exempt entity that is a party to the transaction by reason of § 53.4965-4(a)(1) of this chapter, the term proceeds means the gross amount of the tax-exempt entity's consideration for facilitating the transaction, not reduced for any costs or expenses attributable to the transaction. Published guidance with respect to a particular prohibited tax shelter transaction may designate additional amounts as proceeds from the transaction for section 4965 purposes.

(ii) Treatment of gifts and contributions. To the extent not otherwise included in the definition of proceeds in paragraph (b)(2)(i) of this section, any amount that is a gift or a contribution to a tax-exempt entity and is attributable to a prohibited tax shelter transaction will be treated as proceeds for section 4965 purposes, unreduced by any associated expenses.

(c) Allocation of net income and proceeds—(1) In general. For purposes of section 4965(a), the net income and proceeds attributable to a prohibited tax shelter transaction must be allocated in a manner consistent with the tax-exempt entity's established method of accounting for Federal income tax purposes. If the tax-exempt entity has not established a method of accounting for Federal income tax purposes, solely for purposes of section 4965(a) the tax-exempt entity must use the cash receipts and disbursements method of accounting (cash method) provided for in section 446 of the Internal Revenue Code to determine the amount and timing of net income and proceeds attributable to a prohibited tax shelter transaction.

(2) Special rule. If a tax-exempt entity has established a method of accounting other than the cash method, the tax-exempt entity may nevertheless use the cash method of accounting to determine the amount of the net income and proceeds—

(i) Attributable to a prohibited tax shelter transaction entered into prior to the effective date of section 4965(a) tax and allocable to pre- and post-effective date periods; or

(ii) Attributable to a subsequently listed transaction and allocable to pre- and post-listing periods.

(d) Transition year rules. In the case of the taxable year that includes August 16, 2006 (the transition year), the IRS will treat the period beginning on the first day of the transition year and ending on August 15, 2006, and the period beginning on August 16, 2006, and ending on the last day of the transition year as short taxable years. This treatment is solely for purposes of allocating net income or proceeds under section 4965. The tax-exempt entity continues to file tax returns for the full taxable year, does not file tax returns with respect to these deemed short taxable years and does not otherwise take the short taxable years into account for Federal tax purposes. Accordingly, the net income or proceeds that are properly allocated to the transition year in accordance with this section will be treated as allocable to the period—

(1) Ending on or before August 15, 2006 (and accordingly not subject to tax under section 4965(a)) to the extent such net income or proceeds would have been properly taken into account in accordance with this section by the tax-exempt entity in the deemed short year ending on August 15, 2006; and

(2) Beginning after August 15, 2006 (and accordingly subject to tax under section 4965(a)) to the extent such income or proceeds would have been properly taken into account in accordance with this section by the tax-exempt entity in the short year beginning August 16, 2006.

(e) Allocation to pre- and post-listing periods. If a transaction other than a prohibited reportable transaction (as defined in section 4965(e)(1)(C) and § 53.4965-3(a)(2)) to which the tax-exempt entity is a party is subsequently identified in published guidance as a listed transaction during a taxable year of the entity (the listing year) in which it has net income or proceeds attributable to the transaction, the net income or proceeds are allocated between the pre- and post-listing periods. The IRS will treat the period beginning on the first day of the listing year and ending on the day immediately preceding the date of the listing, and the period beginning on the date of the listing and ending on the last day of the listing year as short taxable years. This treatment is solely for purposes of allocating net income or proceeds under section 4965. The tax-exempt entity continues to file tax returns for the full taxable year, does not file tax returns with respect to these deemed short taxable years and does not otherwise take the short taxable years into account for Federal tax purposes. Accordingly, the net income or proceeds that are properly allocated to the listing year in accordance with this section will be treated as allocable to the period—

(1) Ending before the date of the listing (and accordingly not subject to tax under section 4965(a)) to the extent such net income or proceeds would have been properly taken into account in accordance with this section by the tax-exempt entity in the deemed short year ending on the day immediately preceding the date of the listing; and

(2) Beginning on the date of the listing (and accordingly subject to tax under section 4965(a)) to the extent such income or proceeds would have been properly taken into account in accordance with this section by the tax-exempt entity in the short year beginning on the date of the listing.

(f) Examples. The following examples illustrate the allocation rules of this section:

(g) Effective/applicability dates. See § 53.4965-9 for the discussion of the relevant effective and applicability dates.

(a) In general. The taxes under section 4965(a) and § 53.4965-7 are effective for taxable years ending after May 17, 2006, with respect to transactions entered into before, on or after that date, except that no tax under section 4965(a) applies with respect to income or proceeds that are properly allocable to any period ending on or before August 15, 2006.

(b) Applicability of the regulations. As of July 6, 2010, except as provided in paragraph (c) of this section, §§ 53.4965-1 through 53.4965-8 of this chapter will apply to taxable years ending after July 6, 2007. A tax-exempt entity may rely on the provisions of §§ 53.4965-1 through 53.4965-8 for taxable years ending on or before July 6, 2007.

(c) Effective/applicability date with respect to certain knowing transactions—(1) Entity-level tax. The 100 percent tax under section 4965(b)(1)(B) and § 53.4965-7(a)(1)(i)(B) does not apply to prohibited tax shelter transactions entered into by a tax-exempt entity on or before May 17, 2006.

(2) Manager-level tax. The IRS will not assert that an entity manager who approved or caused a tax-exempt entity to become a party to a prohibited tax shelter transaction is liable for the entity manager tax under section 4965(b)(2) and § 53.4965-7(b)(1) with respect to the transaction if the tax-exempt entity entered into such transaction prior to May 17, 2006.

(a) Excise tax on the investment income of certain private colleges and universities. For taxable years beginning after December 31, 2017, section 4968 of the Internal Revenue Code (Code) imposes a tax equal to 1.4 percent of the net investment income (as defined in section 4968(c) and § 53.4968-2) of an applicable educational institution (as defined in section 4968(b)(1) and paragraph (b)(1) of this section).

(b) Definitions. The definitions in this paragraph (b) apply for purposes of section 4968 and §§ 53.4968-1 through 53.4968-4.

(1) Applicable educational institution. The term applicable educational institution means any eligible educational institution (as defined in section 25A(f)(2) of the Code and § 1.25A-2(b) of this chapter)—

(i) That had at least 500 tuition-paying students during the preceding taxable year;

(ii) More than 50 percent of whose tuition-paying students are located in the United States;

(iii) That is not described in the first sentence of section 511(a)(2)(B) of the Code (relating to state colleges and universities); and

(iv) The aggregate fair market value of the assets of which at the end of such preceding taxable year (other than those assets that are used directly in carrying out the institution's exempt purpose) is at least $500,000 per student.

(2) Student. The term student means a person who is enrolled and attending a course for academic credit from the institution and who is being charged tuition at a rate that is commensurate with the tuition rate charged to students enrolled for a degree. The number of students of an educational institution (including for purposes of determining the number of students at a particular location) is based on the daily average number of full-time students (with part-time students taken into account on a full-time student equivalent basis). The standards for determining part-time students, full-time students, full-time equivalents, and daily average are determined by each educational institution. However, the standards may not be lower than the minimum applicable standards established by the Department of Education under the Higher Education Act of 1965 (20 U.S.C. 1088), as amended.

(3) Tuition-paying—(i) In general. The term tuition-paying means the payment of any tuition or fees required for the enrollment or attendance of a student for a course of instruction at an educational institution. Tuition and fees do not include payment for supplies or equipment required during a specific course once a student is enrolled in and attending the course, or payment for room and board or other personal living expenses.

(ii) Treatment of a comprehensive or bundled fee. If a student is required to pay a fee (such as a comprehensive fee or a bundled fee) to an educational institution that combines charges for tuition with charges for personal expenses such as room and board, the student is a tuition-paying student.

(iii) Scholarships, grants, and work study programs. Whether a student is tuition-paying is determined after taking into account any scholarships and grants provided directly by the educational institution or by the Federal government or any state or local government, and after application of any work study programs operated directly by the institution. Scholarships and grants provided by non-governmental third parties, even if administered by the institution, are considered payments of tuition on behalf of the student. Accordingly, a student will be considered a tuition-paying student if payment of tuition or a fee is required for the enrollment or attendance of the student for courses of instruction after the application of any scholarships offered directly by the institution, any work study program operated directly by the institution, and any grants and scholarships provided by the Federal government or any state or local government.

(4) Located in the United States. A student is located in the United States if the student resided in the United States for at least a portion of the time the student attended the educational institution during the institution's preceding taxable year. Whether a student resided in the United States in any given year can be determined using any reasonable method, as long as that method is consistently applied.

(5) Assets used directly in carrying out an institution's exempt purpose—(i) In general. Except as provided in paragraph (b)(5)(iv) of this section, an asset is used directly in carrying out an educational institution's exempt purpose only if the asset is actually used directly by the institution in carrying out its exempt purpose. Whether an asset is used directly by the institution to carry out its exempt purpose is determined based on all the facts and circumstances. If property is used for an exempt purpose and for other purposes, and the exempt use represents 95 percent or more of the total use, the property is considered to be used exclusively for an exempt purpose. If the exempt use of such property represents less than 95 percent of the total use, the institution must make a reasonable allocation between such exempt and nonexempt uses.

(ii) Illustrations. Examples of assets that are used directly in carrying out an institution's exempt purpose include, but are not limited to, the following—

(A) Administrative assets, such as office equipment and supplies used by the institution directly in the administration of its exempt activities;

(B) Real estate or the portion of any building used by the institution directly in its exempt activities;

(C) Physical property such as paintings or other works of art owned by the institution that are on public display (or held for public display), fixtures and equipment in classrooms, research facilities and related equipment that under the facts and circumstances serve a useful purpose in the conduct of the institution's exempt activities;

(D) The reasonable cash balance, determined using any reasonable method, necessary to cover current operating and administrative expenses and other normal and current disbursements directly connected with the educational institution's exempt activities. For this purpose, a reasonable method would include calculating an amount equal to three months of operating expenses allocable to program services, calculated by dividing annual functional expenses allocable to program services by four. A larger amount may be a reasonable cash balance for this purpose if, under the facts and circumstances, a larger amount is established to be necessary to cover administrative expenses and other normal disbursements directly connected with the institution's exempt activity.

(E) Any property the educational institution leases to other persons at no cost (or at a nominal rent) to the lessee in furtherance of the institution's exempt purposes; and

(F) Patents, copyrights, and other intellectual property and intangible property to the extent that income from those assets is excluded from net investment income by § 53.4968-2(b)(2)(iii).

(iii) Assets not used directly. The following assets are examples of assets not used directly in carrying out an institution's exempt purpose—

(A) Assets that are held for the production of income or for investment (for example, stocks, bonds, interest-bearing notes, endowment funds, or leased real estate not described in paragraph (b)(5)(ii)(E) of this section), even if the income from such assets is used to carry out such exempt purpose; and

(B) Property (such as offices and equipment) used for the purpose of managing the institution's endowment funds.

(iv) Assets of related organizations. An asset of a related organization that is treated as an asset of an educational institution by section 4968(d) and § 53.4968-3(c) and that is used directly in carrying out an educational institution's exempt purpose, or that is used directly in carrying out the exempt purpose of a related organization that is described in section 501(c)(3), is considered used directly by the educational institution in carrying out its exempt purpose.

(v) Valuation of assets not used directly in carrying out an institution's exempt purpose—(A) In general. The values of assets not used directly in carrying out an educational institution's exempt purpose are determined under the rules of section 4942(e) and § 53.4942(a)-2(c)(4), as modified by paragraph (b)(5)(v)(B) of this section.

(B) Modifications. In applying the rules of § 53.4942(a)-2(c)(4), an educational institution must—

(1) Substitute “educational institution” for “private foundation” or “foundation” every place they appear; and

(2) Make such adjustments as are reasonable and necessary to obtain the fair market value of any and all assets as of the last day of the preceding taxable year, rather than as of any other times permitted or required by § 53.4942(a)-2(c)(4).

(a) Net investment income—(1) In general. For taxable years beginning after December 31, 2017, section 4968(a) of the Internal Revenue Code (Code) imposes a 1.4 percent excise tax on the net investment income (as defined in section 4968(c) and this section) of an applicable educational institution and on certain amounts of net investment income of certain related organizations, as described in section 4968(d) and § 53.4968-3. For purposes of this section, net investment income is determined under rules similar to the rules of section 4940(c) of the Code. Thus, net investment income generally is the amount by which the sum of the gross investment income (as defined in paragraph (b) of this section) and the capital gain net income (as defined in paragraph (d) of this section) exceeds the deductions allowed by paragraph (c) of this section. Except to the extent inconsistent with the provisions of this section, net investment income is determined under the principles of subtitle A of the Code.

(2) Tax-exempt income. For purposes of this section, net investment income is determined by applying section 103 of the Code (relating to State and local bonds) and section 265 of the Code (relating to expenses and interest relating to tax-exempt income).

(b) Gross investment income—(1) In general. For purposes of this section and except as provided in paragraph (b)(2) of this section, the term gross investment income means the gross amounts of income from interest, dividends, rents, payments with respect to securities loans (as defined in section 512(a)(5) of the Code), and royalties, but not including any such income to the extent included in computing the tax imposed by section 511 of the Code. Such term also includes income from sources similar to those in the preceding sentence. In general, gross investment income includes the items of investment income described in § 1.512(b)-1(a) of this chapter.

(2) Exceptions. The following items of income are excluded from the definition of gross investment income:

(i) Interest income from a student loan that was made by the applicable educational institution or a related organization to a student of the applicable educational institution in connection with the student's attendance at the institution;

(ii) Rental income from the provision of housing by the applicable educational institution or a related organization to students of the applicable educational institution and from housing for faculty and staff if the housing is provided contingent on their roles as faculty or staff of the applicable educational institution; and

(iii) Royalty income that is derived from patents, copyrights, and other intellectual property and intangible property to the extent those assets resulted from the work of student(s) or faculty member(s) in their capacities as such with the applicable educational institution. However, neither royalty income from trademarks on the institution's logo or name nor royalty income from intellectual property donated or sold to the institution is excluded from gross investment income under this rule.

(c) Deductions—(1) In general. For purposes of computing net investment income—

(i) There is allowed as a deduction from gross investment income all the ordinary and necessary expenses paid or incurred for the production or collection of gross investment income or for the management, conservation, or maintenance of property held for the production of such income, determined with the modifications set forth in paragraph (c)(2) of this section. Taxes paid or incurred under section 4968 are not paid or incurred for the production or collection of gross investment income. Allowable expenses include that portion of an applicable educational institution's operating expenses that is paid or incurred for the production or collection of gross investment income. An applicable educational institution's operating expenses include compensation of officers, other salaries and wages of employees, outside professional fees, interest, and rent and taxes on property used in the applicable educational institution's operations. Where an applicable educational institution's officers or employees engage in activities on behalf of the institution for both activities that generate net investment income and for activities that do not generate net investment income, compensation and salaries paid to such officers or employees must be allocated between the activities that generate net investment income and for activities that do not generate net investment income.

(ii) Where only a portion of property produces, or is held for the production of, income subject to the section 4968 excise tax, and the remainder of the property is used for other purposes, the deductions allowed by this paragraph must be apportioned between the taxable and other uses.

(iii) No amount is allowable as a deduction under this section to the extent it is paid or incurred for purposes other than those described in paragraph (c)(1)(i) of this section. Thus, for example, the charitable deductions prescribed under sections 170 and 642(c) of the Code; the net operating loss deduction prescribed under section 172; and the special deductions prescribed under part VIII of subchapter B of chapter 1 of the Code are not allowable.

(2) Deduction modifications. The following modifications must be made in determining deductions otherwise allowable under this paragraph (c):

(i) The depreciation deduction is allowed, but only on the basis of the straight-line method provided in section 168(b)(3) and without regard to section 168(b)(1) and (2).

(ii) The depletion deduction is allowed, but such deduction is determined without regard to sections 613 and 613A of the Code, relating to percentage depletion.

(iii) The basis to be used for purposes of the deduction allowed for depreciation or depletion is the basis determined under the rules of part II of subchapter O of chapter 1 of the Code (part II of subchapter O), subject to the modifications found in paragraphs (c)(2)(i) and (ii) of this section (relating to depreciation and depletion), and without regard to § 53.4968-2(d)(2) (relating to the basis for determining gain for property held on December 31, 2017, and continuously thereafter to the date of disposition), or section 362(c) of the Code (relating to certain special basis rules regarding contributions of capital to corporations). Thus, an applicable educational institution must reduce the cost or other substituted or transferred basis by an amount equal to the straight-line depreciation or cost depletion, without regard to whether the applicable educational institution deducted such depreciation or depletion during the period prior to its first taxable year beginning after December 31, 2017. However, where an applicable educational institution has previously taken depreciation or depletion deductions in excess of the amount which would have been taken had the straight-line or cost method been employed, such excess depreciation or depletion also is taken into account to reduce basis. If the facts necessary to determine the basis of property in the hands of the donor or the last preceding owner by whom it was not acquired by gift are unknown to the applicable educational institution, then the original basis to the applicable educational institution of such property is determined under the rules of § 1.1015-1(a)(3) of this chapter.

(iv) The deduction for expenses paid or incurred in any taxable year for the production of gross investment income earned as an incident to a charitable function can be no greater than the income earned from such function which is includible as gross investment income for such year. For example, where rental income incidentally is realized in a year from historic buildings held open to the public, deductions for amounts paid or incurred in that year for the production of such income is limited to the amount of rental income includible as gross investment income for the year.

(d) Capital gains and losses—(1) In general. In determining capital gain net income for purposes of the tax imposed by section 4968—

(i) Interaction with section 511. No gain or loss from the sale or other disposition of property is taken into account to the extent that such gain or loss is taken into account for purposes of computing the tax imposed by section 511.

(ii) Sales or other dispositions of exempt use property. To the extent that property is used by the educational institution for its exempt purposes, capital gain from the sale or exchange of the portion of that property that is used by the educational institution for its exempt purposes is disregarded;

(iii) Sales of donated property—(A) In general. Any appreciation in the value of donated property that occurred prior to the date of its donation to the institution is disregarded.

(B) Date of donation. The date of donation is determined under the timing rules of § 1.170A-1(b) of this chapter.

(C) Value on the date of donation. The value of the donated property on the date of donation is determined under the valuation rules of § 1.170A-1(c) of this chapter; and

(iv) Capital losses. Net losses from sales or other dispositions of property by one related organization (or by the applicable educational institution) reduce (but not below zero) net gains from such sales or other dispositions by other related organizations (or by the applicable educational institution). Should overall net losses from sales or other dispositions of property exceed gains from sales or other dispositions of such property during the same taxable year, such excess may not be deducted from gross investment income in any taxable year, nor may such excess be used to reduce gains in prior taxable years. However, capital loss carryovers are allowed and may be deducted from capital gains in a future year.

(2) Basis—(i) For purposes of calculating gain from the sale or other disposition of property other than a partnership interest. Subject to the modifications of paragraphs (c)(2)(i) and (ii) of this section (referring to the modifications relating to deductions against gross investment income) and without regard to section 362(c), the basis for purposes of determining gain from the sale or other disposition of property (other than a partnership interest) for purposes of determining capital gain net income for purposes of the tax imposed by section 4968 is the greater of—

(A) Fair market value on December 31, 2017, plus or minus all adjustments after December 31, 2017, and before the date of disposition under the rules of part II of subchapter O, provided that the property was held by the applicable educational institution on December 31, 2017, and continuously thereafter to the date of disposition, or

(B) Basis as determined under the rules of part II of subchapter O.

(ii) For purposes of determining a distributive share of gain from the sale or other disposition of a partnership asset. For purposes of determining an applicable educational institution's share of gain upon the sale or other disposition of a partnership asset, the applicable educational institution's basis in each such partnership asset generally is determined under the rules of subchapter K of chapter 1 of the Code (subchapter K). However, see paragraph (d)(3) of this section.

(iii) For purposes of determining gain on the sale or other disposition of a partnership interest. For purposes of determining an applicable educational institution's gain upon the sale or other disposition of all or a portion of a partnership interest, the applicable educational institution's basis in such partnership interest is generally determined under the rules of subchapter K, subject to the special rules in paragraph (d)(3) of this section.

(iv) For purposes of calculating loss. Subject to the modifications of paragraphs (c)(2)(i) and (ii) of this section (referring to the modifications relating to deductions against gross investment income) and without regard to section 362(c), basis as determined in paragraph (d)(2)(i)(B) of this section applies for purposes of determining loss. For purposes of determining loss from the sale or other disposition of a partnership interest, basis is determined under the rules of subchapter K.

(3) Special rules regarding partnership interests and partnership assets—(i) Reduction of distributive share of capital gain net income from a partnership. For purposes of computing net investment income, an applicable educational institution reduces the amount of its distributive share of capital gain net income from a partnership by the least of—

(A) The applicable educational institution's share of applicable capital gain (as defined in paragraph (d)(3)(iii)(A) of this section) from such partnership;

(B) One-third of the applicable educational institution's unadjusted step-up (as defined in paragraph (d)(3)(iii)(B) of this section) for such partnership; or

(C) The applicable educational institution's adjusted step-up (as defined in paragraph (d)(3)(iii)(C) of this section) for such partnership.

(ii) Reduction of capital gain net income from a sale or other disposition of all or a portion of a partnership interest. For purposes of computing net investment income, an applicable educational institution reduces the amount of its capital gain net income upon the sale or other disposition of all or a portion of a partnership interest by an amount that bears the same relation to the applicable educational institution's adjusted step-up (as defined in paragraph (d)(3)(iii)(C) of this section) for such partnership as the fair market value of the transferred portion of the interest bears to the fair market value of the applicable educational institution's entire interest in such partnership before the sale or other disposition.

(iii) Definitions. For purposes of this section—

(A) Applicable capital gain. For an applicable educational institution's first taxable year beginning after December 31, 2017, the term applicable capital gain means an applicable educational institution's share of both short-term and long-term capital gains and losses subject to section 4968 from a partnership. For subsequent taxable years, applicable capital gain does not include an applicable educational institution's share of short-term capital gains and losses subject to section 4968 from a partnership. For purposes of this paragraph, applicable capital gain is not less than zero.

(B) Unadjusted step-up. An applicable educational institution computes an unadjusted step-up for each partnership interest it held on December 31, 2017. The unadjusted step-up for a partnership interest equals the excess, if any, of the fair market value of such partnership interest on December 31, 2017, over the adjusted basis of such partnership interest on December 31, 2017.

(C) Adjusted step-up. An applicable educational institution computes an adjusted step-up for each partnership interest it held on December 31, 2017. The adjusted step-up for a partnership interest equals the unadjusted step-up for such partnership, reduced by the amount of any capital gain net income reduction pursuant to paragraphs (d)(3)(i) and (ii) of this section for such partnership.

(4) Examples. The following examples illustrate paragraph (d)(3) of this section. Unless stated otherwise in the examples, partners have no tax items other than those listed in the example. With respect to partnerships, all allocations are in accordance with section 704(b) and the regulations under section 704(b) in part 1 of this chapter (Income Tax Regulations).

(i) Example 1—(A) Facts. University (U), an applicable educational institution, is a partner in partnership PRS. On December 31, 2017, U's PRS interest had a fair market value of $130 and tax basis of $100. In 2018, U's share of capital gain net income from PRS is $5, which is comprised of $20 of gain from the sale of capital asset X and ($15) of loss from the sale of capital asset Y. Further, such $5 of capital gain net income is applicable capital gain (as defined in paragraph (d)(3)(iii)(A) of this section).

(B) Analysis. U has an unadjusted step-up (as defined in paragraph (d)(3)(iii)(B) of this section) for PRS of $30 ($130 fair market value − $100 tax basis on December 31, 2017). Pursuant to paragraph (d)(3)(i) of this section, for purposes of computing its net investment income, U reduces the amount of its capital gain net income from PRS by $5, which is the least of: U's share of applicable capital gain from PRS ($5); or one-third of U's unadjusted step-up for PRS ($10); or U's adjusted step-up for PRS ($30). Thus, U reduces its $5 of capital gain net income allocated from PRS by $5, resulting in U having $0 of capital gain net income in 2018 for purposes of section 4968. As a result, U's adjusted step-up for PRS for subsequent taxable years is reduced to $25 ($30 − $5) pursuant to paragraph (d)(4)(iii)(C) of this section. Pursuant to section 705, the $5 of gain allocated to U increases U's tax basis in its PRS interest to $105.

(ii) Example 2—(A) Facts. The facts are the same as in paragraph (d)(4)(i)(A) of this section (Example 1). In 2019, U sells its entire interest in PRS for $130, which, immediately prior to the sale, had a tax basis of $105. As a result, U has $25 of capital gain from the sale of its PRS interest.

(B) Analysis. Pursuant to paragraph (d)(3)(iii) of this section, for purposes of computing its net investment income, U reduces its capital gain net income resulting from the sale of its entire PRS interest by $25, which is the amount that bears the same relation to U's adjusted step-up for PRS ($25) as the fair market value of the transferred portion of PRS ($130) bears to the fair market value of the U's entire interest in PRS before the sale or other disposition ($130). Thus, U reduces its $25 of capital gain net income from the sale of its PRS interest by $25, resulting in U having $0 of capital gain net income in 2019 for purposes of section 4968.

(iii) Example 3—(A) Facts. The facts are the same as in paragraph (d)(4)(i)(A) of this section (Example 1). In 2019, U's share of capital gain net income from PRS is $15, which is comprised of $15 of gain from the sale of capital asset Z. Further, such $15 of capital gain net income is applicable capital gain (as defined in paragraph (d)(3)(iii)(A) of this section).

(B) Analysis. Pursuant to paragraph (d)(3)(i) of this section, for purposes of computing its net investment income, U reduces the amount of its capital gain net income from PRS by $10, which is the least of: U's share of applicable capital gain from PRS ($15); or one-third of U's unadjusted step-up for PRS ($10); or U's adjusted step-up for PRS ($25, computed as $30 of unadjusted step-up, less $5 of capital gain net income reduced in 2018 pursuant to paragraph (d)(3)(i) of this section). Thus, U reduces its $15 of capital gain net income allocated from PRS by $10, resulting in U having $5 of capital gain net income in 2019 for purposes of section 4968. As a result, U's adjusted step-up for PRS is reduced for subsequent taxable years to $15 ($25 − $10) pursuant to paragraph (d)(3)(iii)(C) of this section. Pursuant to section 705, the $15 of gain allocated to U increases U's tax basis in its PRS interest to $120.

(a) Definition of related organization—(1) In general. For purposes of section 4968(d) of the Internal Revenue Code (Code) and §§ 53.4968-1 through 53.4968-4, except as provided in paragraph (a)(2) of this section, the term related organization means, with respect to an educational institution, any organization that—

(i) Controls such institution;

(ii) Is controlled by such institution;

(iii) Is controlled by one or more persons that also control such institution;

(iv) Is a supported organization (as defined in section 509(f)(3) of the Code) with respect to such institution during the taxable year; or

(v) Is a supporting organization (as described in section 509(a)(3)) with respect to such institution during the taxable year.

(2) Organizations not considered related organizations. For purposes of section 4968(d) and §§ 53.4968-1 through 53.4968-4, the term related organization does not include any organization that is—

(i) A taxable corporation;

(ii) A taxable trust, including a non-grantor charitable lead trust (except to the extent the trust is controlled by the educational institution as described in paragraph (b)(2)(ii) of this section);

(iii) A grantor charitable lead trust;

(iv) A charitable remainder trust;

(v) A partnership, S corporation (as defined in section 1361(a)(1) of the Code), or other pass-through entity that is generally not subject to Federal income tax, the income of which is taxable to its partners or other interest holders; or

(vi) A decedent's estate.

(3) Employee benefit plans or arrangements. A trust or similar funding vehicle of an employee benefit plan or arrangement, such as a section 501(a) trust funding a section 401(a) qualified retirement plan, or an annuity contract funding a section 403(b) plan, or a section 419(e) welfare benefit fund (including a voluntary employees' beneficiary association under section 501(c)(9)) funding a welfare benefit plan, will not be treated as a related organization and its assets will not be treated as the assets of the educational institution or of a related organization. A trust or other funding vehicle of an unfunded employee benefit plan of an educational institution or a related organization, such as a grantor trust described in section 671 et seq., used in connection with a section 457(b) plan or an arrangement subject to section 457(f), will be treated as a related organization for purposes of section 4968(d) and its assets will be treated as the assets of the educational institution or of a related organization, but the assets are not considered “used directly in carrying out the institution's exempt purpose” for purposes of section 4968(b)(1)(D). For purposes of determining whether the employee benefit plan of an educational institution is funded or unfunded, the educational institution and all of its related organizations are treated as a single sponsor and payor of the benefits.

(b) Control—(1) Controls such institution. For purposes of section 4968(d) and §§ 53.4968-1 through 53.4968-4, an organization controls an educational institution if—

(i) The organization owns (by vote or value) more than 50 percent of the voting and non-voting stock or membership interest of the educational institution; or

(ii) The organization (or one or more of its managers, directors, officers, trustees, or employees, acting only in those capacities) can—

(A) Appoint or elect (which must include the power to remove and replace) more than 50 percent of the members of the educational institution's governing body (such as directors, officers, or trustees), or otherwise has the ongoing power to appoint or elect more than 50 percent of such members with reasonable frequency;

(B) Require the educational institution to make an expenditure (or prevent the educational institution from making an expenditure); or

(C) Require the educational institution to perform any act that significantly affects its operations (or prevent it from performing such an act).

(2) Is controlled by such institution. For purposes of section 4968(d) and §§ 53.4968-1 through 53.4968-4, an organization is controlled by an educational institution:

(i) Tax-exempt corporation. In the case of a corporation recognized as exempt from income tax under section 501(a), if the educational institution owns (by vote or value) more than 50 percent of the voting and nonvoting stock or membership interest of the corporation.

(ii) Trust—(A) In general. In the case of a trust—

(1) If the educational institution is substantially the sole permissible trust beneficiary or appointee of both income and principal, whether or not the timing of the distribution is subject to the trustee's discretion;

(2) If the trust is a pooled income fund described in sections 642(c)(3) and 642(c)(5);

(3) If, but only to the extent that, the assets of the trust were contributed to the trust by the educational institution (or by a person controlled by the educational institution); or

(4) If, but only to the extent that, the educational institution (or person controlled by the educational institution) has the right to demand (or can otherwise cause) a distribution of principal from the trust to the educational institution (or a person controlled by the educational institution).

(B) Person controlled by the educational organization. For purposes of this paragraph (b)(2)(ii), a person is controlled by an educational institution if the educational institution has the power to remove and replace such person or otherwise controls the person under one of the tests described in § 53.4968-3(b)(2)(i), (ii), or (iii), with similar principles applying for purposes of determining control of any other form of entity.

(iii) Nonstock organization. In the case of a nonstock organization, if the educational institution (or one or more of its managers, directors, officers, trustees, or employees, acting only in those capacities) can—

(A) Appoint or elect (which must include the power to remove and replace) more than 50 percent of the members of the organization's governing body (such as directors, officers, or trustees), or otherwise has an ongoing power to appoint or elect more than 50 percent of such members with reasonable frequency);

(B) Require the organization to make an expenditure (or prevent the organization from making an expenditure); or

(C) Require the organization to perform any act that significantly affects its operations (or prevent it from performing such an act).

(3) Is controlled by one or more persons that also control such institution. For purposes of section 4968(d) and this section, an organization (other than one described in paragraph (a)(2) of this section) is controlled by one or more persons that also control the educational institution if more than 50 percent of the members of the governing body of the other organization are directly or indirectly controlled by persons that comprise more than 50 percent of the members of the governing body of the educational institution.

(4) Constructive ownership. The principles of section 318(a)(2) (relating to ownership attribution from partnerships, estates, trusts, and corporations) apply for purposes of determining ownership of stock in a corporation, and similar principles apply for purposes of determining ownership of an interest in any other entity.

(5) Method of control. Control includes control by aggregating votes or positions of authority (including by veto power), but applies regardless of the method by which the control is exercised or exercisable.

(c) Organization described in section 509(a)(3) during the taxable year with respect to the educational institution. A section 509(a)(3) organization is a supporting organization with respect to an educational institution only if the supporting organization meets the organizational, operational, and relationship tests of section 509(a)(3)(B) and § 1.509(a)-4 of this chapter with respect to the educational institution.

(d) Assets and net investment income of related organizations—(1) In general. A related organization's assets and net investment income are taken into account both in determining whether an institution is an applicable educational institution and in computing the net investment income of an applicable educational institution. For purposes of determining the aggregate fair market value of the assets and net investment income of an educational institution, the assets and net investment income of all related organizations are treated as the assets and net investment income, respectively, of the institution, unless an exception provided in paragraph (d)(2) of this section or the exception provided in § 53.4968-1(b)(5)(iv) (relating to assets used directly in carrying out an exempt purpose) applies. In cases in which an organization is a related organization with respect to an educational institution under more than one definition of this § 53.4968-3, then the rule that attributes the largest amount of assets and net investment income of the related organization to the educational institution must be applied.

(2) Exceptions. For purposes of section 4968 and this paragraph (d)(2)—

(i) No amount is taken into account with respect to more than one educational institution. In determining the aggregate fair market value of the assets and net investment income of an educational institution, assets and net investment income of a related organization are not taken into account with respect to more than one educational institution. Thus, in any case in which an organization is a related organization with respect to more than one educational institution, the assets and net investment income of the related organization must be allocated between or among the educational institutions as to which the organization is a related organization, subject to paragraph (d)(2)(ii) of this section. The educational institution must make such allocation in a reasonable manner, taking into account all facts and circumstances, that is consistent across all related organizations.

(ii) Assets and net investment income that are not intended or available for the use or benefit of the educational institution—(A) In general. Unless a related organization is controlled by the educational institution or is a supporting organization described in section 509(a)(3) with respect to such institution for the taxable year, assets and net investment income of a related organization that are not intended or available for the use or benefit of the educational institution are not taken into account by that educational institution.

(B) Determining whether assets and net investment income of a related organization are intended or available for the use or benefit of an educational institution. If a related organization controls the educational institution, is controlled by one or more persons that also control such institution (but is not described in section 509(a)(3) with respect to the educational institution for the taxable year), or is a supported organization (as defined in section 509(f)(3)) during the taxable year with respect to the educational institution, then the related organization's assets and net investment income are taken into account as assets and net investment income of the educational institution only to the extent the assets and net investment income are intended or available for the use or benefit of that educational institution. Assets and net investment income of a related organization are intended or available for the use or benefit of an educational institution if such assets and net investment income are specifically earmarked or restricted for the benefit of, or otherwise are fairly attributable to, the educational institution. For example, assets are fairly attributable to the educational institution if they have been affirmatively designated or appropriated for the educational institution or made available for the educational institution to draw upon at will. Conversely, assets and net investment income of a related organization are not intended or available for the use or benefit of an educational institution if such assets and net investment income are specifically earmarked or restricted for another entity or for unrelated purposes or otherwise are not fairly attributable to the educational institution. The assets and net investment income of a related organization must be allocated between those intended or available for the use or benefit of an educational institution and those not intended or not available for the use or benefit of that same educational institution. The educational institution must make such allocation in a reasonable manner, taking into account all facts and circumstances, that is consistent across all related organizations.

(C) Related organizations that are controlled by the educational institution or that are supporting organizations (as described in section 509(a)(3)) with respect to the educational institution during the taxable year—(1) In general. If a related organization is controlled, as defined in paragraph (b)(2) of this section, by an educational institution, or is a supporting organization with respect to the educational institution during the taxable year, as defined in paragraph (c) of this section, the assets and net investment income of the related organization are taken into account as assets and net investment income of the educational institution regardless of whether those assets and net investment income are earmarked or restricted for the benefit of, or otherwise are fairly attributable to, the educational institution and even if they are specifically earmarked or restricted for another entity or for unrelated purposes or otherwise are not fairly attributable to the educational institution, subject to paragraph (d)(2)(ii)(C)(2) of this section. However, see §§ 53.4968-1(b)(2)(ii)(A)(3) and (4) regarding trusts that are controlled related organizations only to the extent assets of the trust were contributed to the trust by the educational institution (or by a person controlled by the educational institution), or only to the extent the educational institution (or person controlled by the educational institution) has the right to demand (or can otherwise cause) a distribution of principal from the trust to the educational institution (or a person controlled by the educational institution). See also § 53.4968-1(b)(5)(iv) for rules relating to when assets of a related organization are deemed to be used directly in carrying out the institution's exempt purpose.

(2) Special rule for Type III supporting organizations with respect to an educational institution as of December 31, 2017. An educational institution with a related organization that was a Type III supporting organization with respect to the educational institution on December 31, 2017, takes into account only the assets and net investment income of such Type III supporting organization that are intended or available for the use or benefit of, or otherwise are fairly attributable to, the educational institution, as described in paragraph (d)(2)(ii)(B) of this section. An educational institution may determine whether the assets and net investment income of such a Type III supporting organization are intended or available for the use or benefit of, or otherwise are fairly attributable to, the educational institution using any reasonable method. A method that attributes to an educational institution assets and net investment income of a supporting organization that specifically are earmarked for the educational institution, are restricted for the benefit of the educational institution, or otherwise are fairly attributable to the educational institution (such as those that have been affirmatively designated or appropriated for the educational institution or made available for the educational institution to draw upon at will) will be deemed to be reasonable.

(3) Determining assets of related organizations. To determine which assets of a related organization are included by an educational institution under section 4968(b)(1)(D) for a particular year, an educational institution determines which organizations are related organizations, as defined in section 4968(d)(2) and § 53.4968-3, as of the end of the educational institution's preceding taxable year, and values the relevant assets on that date.

(4) Determining net investment income of related organizations. To determine the amount of net investment income of a related organization that is included by the applicable educational institution in calculating the tax imposed by section 4968(a) for a particular taxable year, an applicable educational institution determines which organizations are related organizations, as defined in section 4968(d)(2) and § 53.4968-3, as of the end of that taxable year of the applicable educational institution and includes the net investment income from each related organization's taxable year that ends with or within that same taxable year of the applicable educational institution. If an organization became a related organization after the beginning of the applicable educational institution's taxable year, then the applicable educational institution includes the organization's net investment income for the portion of the year that the organization was a related organization, using any reasonable method.

The rules of §§ 53.4968-1 through 53.4968-3 apply to taxable years of an educational institution beginning after October 15, 2020.