Entity Setup
How Nonprofits Should Prepare: The New Regulations on Excess Compensation Under Section 4960
Section 4960 changes redefine 'covered employees' for nonprofits and tax-exempt organizations—understand what expanded liability means and what steps you should take ahead of proposed regulation deadlines.
By NomadicTax Research Team • 7 min read • August 10, 2026
## Background: Section 4960 and the OBBB Expansion
The One Big Beautiful Bill amended **Section 4960** to broaden the definition of *covered employee* for applicable tax-exempt organizations (ATEOs). Previously, this excise tax only targeted the top five highest-paid employees; now, **any employee** earning over **$1 million** or receiving an excess parachute payment may be covered. ([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))
Notice 2026-36 (issued June 5, 2026) officially signals the Treasury and IRS’ intent to issue **proposed regulations** to clarify these expanded obligations. This includes defining exceptions (limited hours, nonexempt funds) that may shield certain employees temporarily. ([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))
## Scope & Effective Timing
- The expansion to “covered employee” applies to tax years **beginning after December 31, 2025**. ([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))
- Proposed regulations will address the effective dates as well as transition relief for organizations during adjustment period. ([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))
## Key Considerations for Nonprofits & ATEOs
### Identifying Who is Covered
- Employees who earned **above $1 million** this tax year, regardless of rank.
- Those receiving **excess parachute payments** triggered under Section 4960 even if they don’t hit the top-5 threshold.
- If an individual was already a “covered employee” under old rules, that status becomes permanent under new rules. ([irs.gov](https://www.irs.gov/pub/irs-irbs/irb26-26.pdf?utm_source=openai))
### Exceptions & Relief Paths
- Organizations can use exceptions for employees with limited hours or funded by non-exempt sources.
- These exceptions persist only until final regulations are published. Maintain documentation for hours worked and funding sources. ([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))
### Compliance Steps Now
- Audit compensation records: track employees approaching or exceeding $1 million in pay or set to recieve parachute payments.
- Document hours and funding sources carefully—not just for payroll but for all remuneration components.
- Estimate potential excise tax exposure for planning and budgeting purposes.
- Monitor publication of proposed rules/regulations; comments were due by **August 4, 2026**. ([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 Situation
Consider “Charity X” employing 10 individuals, two of whom earn $1.2 million in 2026. Under the new law, both are “covered employees” regardless of rank. If one of them is to receive an excess parachute payment (say, upon termination), the exec compensation excise tax under Section 4960 may apply. Using limited hours or non-exempt funding exceptions may help, but only if properly documented and until guidance solidifies.
## What Nonprofits Should Do Today
- Review all compensation structures and agreements now.
- Consider policy changes: thresholds for raises, severance plans, parachute payments.
- Collaborate with payroll, grants accounting to report source funds correctly.
- Stay engaged: Submit feedback on proposed rules; prepare for compliance once finalized.
For nonprofits, these changes signal a new era of accountability. The broadened liability means what was once reserved for the upper echelons now includes well-compensated staff beyond just the top few. By preparing now, organizations can avoid compliance missteps and unexpected excise taxes.