Compliance
How Nonprofits Should Prepare for the Expanded Excise Tax on Executive Pay Under the One, Big, Beautiful Bill
With new rules effective for tax years after Dec. 31, 2025, any employee earning over $1 million at a tax-exempt organization may become subject to the excise tax—not just the top five, broadening both risk and exposure.
By NomadicTax Research Team • 5-8 min read • July 2, 2026
## What’s Changing Under Section 4960
The **One, Big, Beautiful Bill Act (OBBBA)** amended IRS Code Section 4960 to broaden which individuals at **Applicable Tax-Exempt Organizations (ATEOs)** are considered *covered employees*. Previously, only the top five highest-paid employees in ATEOs were in scope. Now, any employee (or former employee if they were ever covered in a post-2016 year) who earns more than **$1 million** in a tax year or receives an excess parachute payment is a covered employee. ([irs.gov](https://www.irs.gov/newsroom/treasury-irs-announce-intent-to-issue-proposed-regulations-for-excise-tax-on-excess-tax-exempt-organization-executive-compensation-under-the-one-big-beautiful-bill?utm_source=openai))
## Transitional Relief and Exceptions
Notice 2026-36 offers some **relief during the transition**:
- The new definition applies **only to taxable years beginning after December 31, 2025**. Prior years are under the old rules. ([irs.gov](https://www.irs.gov/pub/irs-irbs/irb26-26.pdf?utm_source=openai))
- Exceptions are expected in the forthcoming regulations for employees with **limited hours** or whose pay comes from **nonexempt funds**. These mirror existing exceptions for “highest paid employees” status. ([irs.gov](https://www.irs.gov/pub/irs-irbs/irb26-26.pdf?utm_source=openai))
- There is *no limited services exception* anticipated under the amended definition. ([irs.gov](https://www.irs.gov/pub/irs-irbs/irb26-26.pdf?utm_source=openai))
## Practical Steps for Nonprofits
To stay compliant and limit surprise tax exposure, organizations should:
- **Identify individuals** who will be covered employees under the new definition. Check both current and former employees (post-2016) who earned > \$1 million or would do so under the new test.
- **Audit historical compensation practices**, including parachute payments or any large severance payments that could trigger the tax.
- **Assess sources of compensation**, distinguishing between exempt and nonexempt funds (such as endowments vs. donor-restricted or nonpublic sources) to apply the nonexempt funds exception. Verify hours worked to apply limited hours exception if relevant.
- **Track and document compensation and hours** meticulously. Maintain records so that any argument for exception is supported by verifiable data.
- **Monitor forthcoming regulations**, scheduled to be released post-Notice 2026-36. Since IRS solicited comments due Aug. 4, 2026, final rules may clarify definitions, timelines and compliance obligations. ([irs.gov](https://www.irs.gov/newsroom/treasury-irs-announce-intent-to-issue-proposed-regulations-for-excise-tax-on-excess-tax-exempt-organization-executive-compensation-under-the-one-big-beautiful-bill?utm_source=openai))
## Example Scenario
**Case**: Jane Doe, who works part-time (20 hours/week) for a university foundation (an ATEO), earns \$1.2 million per year, funded partially via nonexempt funds. Under the expanded definition, she would be a **covered employee** unless she qualifies for the **limited hours exception** (yes, possibly given part-time status) or **nonexempt funds exception** (yes, some income from parts nonexempt). If she qualifies on either exception, the excise tax on excess compensation may not apply; if not, the excise tax of 21% (for nonprofits) on her excess over \$1 million could be triggered. Proper documentation from payroll and fund source tracking enables reliance on exceptions.
## Action Plan Before Fiscal Year End
- Perform an internal review of all employees near or exceeding \$1 million in compensation.
- Identify which employees may qualify for limited hours or nonexempt fund exceptions.
- Evaluate your fiscal year, begin mapping what changes in payroll policies or staff time tracking you need to implement.
- Draft commentary or feedback if the proposed regulations' current structure imposes undue burdens before they become final.
- Update governance materials and communicate with leadership about financial risk under expanded excise tax.
**Bottom line**: The expansion of Section 4960 under OBBBA dramatically increases the number of individuals in tax-exempt entities who may be subject to excise tax on excess compensation. Nonprofits must act promptly to evaluate coverage, document exceptions, and prepare for compliance under final regulations.