Top State Colleges, Universities Could Dodge Excise Tax on Coaching Salaries

Morgan Lewis

Morgan Lewis

The Internal Revenue Service has stated in recently promulgated interim guidance that a 21% excise tax will not apply to salaries of more than $1 million paid to coaches of sports teams at state colleges and universities that abandon 501(c)(3) status but remain exempt from federal income tax as state instrumentalities.

In recently promulgated interim guidance, the Internal Revenue Service (IRS) stated that the 21% excise tax imposed by newly enacted Internal Revenue Code Section 4960 on nonprofit organizations that pay compensation in excess of $1 million will not apply to the top earners at certain state colleges and universities—specifically, those state colleges and universities that revoke or do not have determination letters from the IRS recognizing their tax-exempt status as organizations described in Section 501(c)(3). These institutions may remain tax exempt under the doctrine of implied governmental immunity despite no longer being tax exempt under Section 501(a). Until Congress acts to address this “gap,” those state colleges and universities are exempt from paying the excise tax on such salaries.


Historically, publicly held corporations have been unable to deduct amounts greater than $1 million of compensation in each taxable year for any “covered employee.”[1] Covered employees, as defined by Section 162(m), include the principal executive officers or principal financial officers of such publicly held corporations.[2]

The 2017 Tax Cuts and Jobs Act (TCJA) expanded the scope of the provision denying deductions for compensation to many more employers, and in the interest of “parity” of treatment, it added the new tax on nonprofit employers. In deliberations preceding the TCJA’s enactment, the House of Representatives’ Ways and Means Committee observed that “[t]he Committee believes that tax-exempt organizations enjoy a tax subsidy from the Federal government because contributions to such organizations are generally deductible and such organizations are generally not subject to tax (except on unrelated business income).”[3] The Committee further stated that the “excessive compensation” paid to senior executives of those organizations diverts resources from the specific purposes of the organizations, and that addressing the disparity in tax treatment of excessive executive compensation between for-profit and tax-exempt employers would further the “larger tax reform effort.”[4]

To address its concerns, Congress enacted Section 4960, which imposes a 21% excise tax both on “remuneration paid by an applicable tax-exempt organization for the taxable year with respect to employment of any covered employee in excess of $1,000,000” and on excess parachute payments paid by such organizations.[5] The statute, however, contains an error: The tax is only to be applied to “applicable tax-exempt organizations,” which are defined under Section 4960(c) as any entity that

  1. is exempt from taxation under Section 501(a) (including organizations described in Section 501(c)(3));
  2. is a farmers’ cooperative organization described in Section 521(b)(1);
  3. has income excluded from taxation under Section 115(1); or
  4. is a political organization described in Section 527(e)(1).[6]

State colleges and universities may be exempt from federal income tax under the doctrine of implied statutory immunity, under Section 501(c)(3), or both; however, they generally are not exempt from tax by virtue of Section 115. The reference to Section 115 is a mistake, and it leaves open the possibility for state colleges and universities to avoid the new tax, but only if they are not organizations described in Section 501(c)(3) and exempt from tax under Section 501(a). As a result, some schools with dual classifications as both Section 501(c)(3) organizations and state instrumentalities are considering abandoning their 501(c)(3) status so that they will not be subject to the new excise tax.

Notice 2019-09

In recently promulgated interim IRS guidance, the IRS announced that public universities that received determination letters recognizing their tax-exempt status under Section 501(c)(3) would be subject to the Section 4960 excise tax.[7] The IRS noted, however, that the income of a state, political subdivision of a state, or integral part of a state or political subdivision of a state, including certain public colleges and universities, is generally not taxable in the absence of specific statutory authority for the taxation of that income.[8] Thus, in the same interim guidance, the IRS announced that public universities that do not have 501(c)(3) determination letters are not subject to the excise tax.[9] Had Congress intended to impose the excise tax on state colleges and universities, the IRS reasoned, it would have provided a specific statutory authorization for that tax, as it did in Section 511(a)(2)(B).[10]

Under this guidance, then, a state college or university may employ a football or basketball coach who earns more than $1 million per year without having to pay the 21% excise tax, provided that the university does not currently have a determination letter recognizing it as an organization described in Section 501(c)(3) and exempt under Section 501(a).[11]

Future Implementation

In light of both the statutory language itself and the interim IRS guidance, Congress would need to take affirmative steps to close this excise tax “loophole.” One such step would be to amend the statute, including by repealing it or, more likely, issuing technical corrections to add state colleges and universities to the definition of “applicable tax-exempt organizations” under Section 4960.

Indeed, the Joint Committee on Taxation’s “Bluebook,” released in December 2018, contemplated the need for such technical corrections.[12] While the Bluebook stated that “[a]pplicable tax-exempt organizations are intended to include State colleges and universities,” the Bluebook acknowledged in a footnote that “[a] technical correction may be necessary to reflect this intent.”[13]


In its current form, Section 4960 fails to assess an excise tax on a category of taxpayers that may well have fallen among its primary targets at the time of enactment: state colleges and universities that employ the nation’s most highly paid football and basketball coaches. Until and unless Congress takes action to affirmatively address this omission, the college and university employers of the Dabo Swinneys and John Caliparis of the world will continue to “exercise” their rights to avoid paying the 21% excise tax on their coaches’ $1 million–plus salaries.

[1] See IRC § 162(m)(1).

[2] See IRC § 162(m)(2).

[3] See H.R. Rep. 115-409, 333 (Nov. 13, 2017).

[4] Id.

[5] IRC § 4960(a).

[6] See IRC § 4960(c).

[7] See Notice 2019-09, “Interim Guidance Under Section 4960,” at 39.

[8] See id.

[9] See id. at 40.

[10] See id. at 39-40.

[11] Until further guidance is issued, taxpayers may base their positions on a good-faith, reasonable interpretation of Section 4960 to comply with its requirements. The interim guidance itself states that the “positions reflected in this notice constitute a good faith, reasonable interpretation of the statute.” See id. at 4.

[12] See General Explanation of Public Law 115-97, prepared by the staff of the Joint Committee on Taxation (Dec. 2018).

[13] See id. at 264.


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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