Largest CUs to Face New Tax Day

May 15, 2019 will become a new Tax Day for some of the nation’s largest federal and state credit unions. On that date, these credit unions, including some of the national industry organizations, leagues and associations, will be required to pay a 21% excise tax on executive pay that exceeds $1 million in total salary, bonuses, incentives and deferred compensation.

While it may be tempting for senior management and boards to say they want to avoid paying the 21% excise tax because they are concerned about economic costs and the possibility of bad publicity when their compensation information becomes public, that strategy could end up hurting their credit unions.

“If you just simply look at that one dimension, you may find yourself in an outcome that is really not advantageous to the credit union or the talent the credit union is trying to attract and retain,” said Dale Edwards, principal and cofounder of Triscend in Flower Mound, Texas, a provider of talent management and capital optimization solutions for non-profit organizations.

Edwards was one of the featured speakers in a webinar about the excise tax hosted by former NCUA Chair Dennis Dollar earlier this year. Dollar is now the principal partner of the Birmingham, Ala.-based Dollar Associates, a credit union consultancy firm.

To mitigate the effects of the 21% excise tax, credit unions have limited options. Moreover, credit unions will be required to submit a document to the IRS to report the amount of excise tax paid. Because this document will be available for public inspection, credit unions may want to prepare to respond to the inevitable criticisms from the banking industry.

Last December, the IRS issued a long-awaited 92-page interim guidance document to assist tax-exempt organizations to comply with the excise tax, which was part of the controversial Tax Cuts and Jobs Act passed by Congress and signed into law by President Donald Trump in December 2017.

Among credit unions and other non-profit organizations, there had been hopes that the IRS interim guidance document would contain a grandfather provision stating the excise tax would not be assessed on deferred compensation plans that were agreed to before the new tax became effective on Jan. 1, 2018. But no such grandfather provision was in the IRS interim guidance document released at the end of last year, which means more large credit unions could be required to pay the new tax.

Presumably, not many large credit unions pay their executives a W2 base salary, plus incentives/bonuses and other compensation of more than $1 million. However, in addition to the W2 compensation, the 21% tax is also assessed against most deferred compensation plans. That means more credit unions will be paying the tax because their executives’ W2 compensation coupled with their deferred compensation payouts will more than likely exceed the $1 million threshold subject to the excise tax.

A 2018 CU Times review of CEO compensation at the 55 largest state-chartered credit unions in the nation showed that more than half of them – about 30 – could be paying the 21% excise tax on May 15. The review was based on IRS 990 documents filed by state-chartered credit unions that manage assets ranging from $2.3 billion to $37 billion. Presumably, the approximate same number of federal credit unions that manage more than $1 billion in assets will be paying the excise tax as well.

For example, after 10 years of service, let’s assume an executive for a large credit union is earning about $600,000 in W2 compensation. When the executive’s deferred compensation plan reaches $800,000 and becomes vested after 10 years of service, the executive’s total compensation in that 10th year would amount to $1.4 million. That means the credit union would be required to pay the 21% excise tax on the $400,000, which would total $84,000.

One alternative to avoid paying the 21% tax is to make deferred compensation payments to the executive every two or three years, which would keep the total compensation under the $1 million threshold.

Alexandria Staron, vice president at Triscend, said her firm is getting many inquiries about restructuring 457(f) deferred compensation plans, which most credit unions provide to recruit retain executive talent.

“Even though this may be a positive for the organization to avoid the excise tax, there are other implications [because] interim payments [of every two or three years] may have a less retentive value for retaining executives over the long term,” Staron said. “And also, the more frequently these payouts occur, at least [based on] what we’ve seen in the industry, it may be more likely that executives kind of treat these payouts as part of their normal compensation package rather than specifically for retirement planning.”

But Jay Petty, an EVP for Sheeter Consulting based in Carlsbad, Calif., sees it differently.

“I know some will say that having a big lump sum of money hanging out at the end of [a 10-year payout period] is a stronger retention plan,” Petty said. “But even if they do break up the payouts, and pay them over time, it still is increasing the executive’s compensation plan, and that doesn’t hurt from a retention perspective in my view.”

But if any credit union considers restructuring their 457(f) deferred compensation plan, it is important to obtain advice from a qualified professional who is experienced in this area to prevent any future complications, Petty warned.

“We have found that a lot of credit unions put these 457(f) plans in place years ago and the 21% excise tax has been an impetus for credit unions to finally say, OK, let’s look at our options, and I think that’s healthy for any credit union,” he said.

Another option that has become increasingly popular after the passage of the excise tax is the loan regime split dollar plan. Under this arrangement, the executive purchases a life insurance policy with a loan from the credit union, which pays for the life insurance premiums. This type of plan can also be set up to supplement an executive’s retirement income. When the executive dies, the life insurance policy repays the credit union’s premiums plus interest.

This loan regime split-dollar plan is not subject to the 21% excise tax because the IRS considers the plan as non-compensatory to the executive.

“Think of it as no different than if you borrowed money to buy a house from your credit union, and you paid it back plus interest – that’s not a compensatory event,” Edwards explained. “But if you really study closely the underlying economics of the [loan regime split-dollar] transaction, you’re going to find that the rate of return of the asset that you put the money in – in this case life insurance policies – becomes everything. It is absolutely fundamentally critical to make sure that you understand the underlying assumptions, stress test those assumptions and look for structural alternatives to these plans that make them more resilient to less than anticipated rates of return.”

Edwards warned, however, that the loan regime split-dollar plan is not necessarily the best option for every credit union.

Another aspect of the excise tax is the IRS reporting requirement. State-chartered credit unions will continue to be required to report on IRS Form 990 the executive’s name, his or her compensation, bonuses and deferred compensation numbers. But federal credit unions will be required to only report on IRS form 4720, under Schedule N, the executive’s name and only the amount exceeding $1 million that will be subject to the 21% excise tax.

Through a written request via the Freedom of Information Act, however, anyone, including the credit union’s competitors, the media, bankers and members, would have the right to access IRS form 4720.

Dollar said credit unions should assume that the information on IRS form 4720 will be revealed by competitors, bankers or the media.

“I think it’s worth having some discussions internally among your public relations people, and among your executive team members on how are you going to deal with that when that [information] becomes common knowledge,” he said.

Dollar said believes the best way to address a media inquiry is to always be straight up as to why an executive is paid compensation that may otherwise raise a few eyebrows among some.

He recommended a credit union say, “We feel like it’s an investment worth our making in the membership and the long-term impact the credit union is going to make in the community, and we want the best people possible working for us.”

If nothing else, Dollar said, the credit union creates a free advertisement for potential employees and executives that your credit union is not shying away from the fact that it pays well, because that’s what it takes to compete in today’s marketplace.