What’s Changing Under Section 4960
The One, Big, Beautiful Bill (OBBB) significantly expanded the scope of excise tax on excess compensation for tax-exempt organizations. Previously, only the five highest-paid employees of an applicable tax-exempt organization (ATEO) were potentially subject; now, any employee with compensation exceeding $1 million (or any excess parachute payment) might qualify as a covered employee. (irs.gov)
Proposed regulations (Notice 2026-36)
- Expand covered employee definition to include employees with compensation over $1 million in a taxable year or who receive excess parachute payments. (irs.gov)
- Retain exceptions such as limited-hours and nonexempt funds, though a limited-services exception is not expected under the new rules. (irs.gov)
- The changes are anticipated to be prospective, meaning they won’t apply to taxable years before the final regulations are issued. (irs.gov)
- IRS is requesting public comments by August 4, 2026. (irs.gov)
Why This Matters for Organizations
- Increased tax liability risk: More employees could now fall under the excise tax, leading to unexpected obligations.
- Expanded compliance burden: Need for pay structures review, compensation disclosure and defining who qualifies as “covered employee”.
- Recordkeeping importance: Must establish who is eligible, track exceptions, parachute payments, etc.
Examples
- Org A has 10 executives; three earn more than $1 million; under the new rule, all three could be covered employees—even if not in top five previously.
- Org B, small nonprofit with one high-earning program director ($1.2 million), must analyze whether that position should be treated as covered; apply exceptions carefully (limited hours or funds) if applicable.
Actionable Compliance Tips
- Identify all employees potentially earning $1 million+ or subject to parachute payments.
- Review existing exceptions: limited-hours status, nonexempt funds—do employees meet these?
- Update compensation disclosure, budgeting and contracts to anticipate potential excise taxes.
- Keep an eye out for final regulations and adjust practices accordingly.
- Participate in comment process: Prepare input if your organization has unusual compensation structures.
Tax-exempt entities ignoring this expansion could face penalties or unexpected taxes. Proactive compliance is key.