What Changed About Section 4960 and Covered Employees
The One, Big, Beautiful Bill (OBBBA) of July 2025 revised section 4960 of the Internal Revenue Code: previously the excise tax on excess compensation applied only to the top five highest-paid employees of a tax-exempt organization. Now, the law potentially covers any employee whose compensation exceeds $1 million or who receives an excess parachute payment. (irs.gov)
Notice 2026-36: What Organizations Need to Know Now
Published June 5, 2026, Notice 2026-36 announces proposed regulations are coming. Key features:
- Clarifies amendments to the covered employee definition.
- Provides for exceptions, especially the “limited hours” and “nonexempt funds” exceptions—allowing some flexibility until final guidance.
- Regulations not expected to apply prior to their effective date; tax years beginning after the final regulations are issued.
- Solicits public comments by August 4, 2026. (irs.gov)
Risk Points & Strategic Planning
Who might now be covered:
- Any executive earning over $1 million.
- Executives receiving parachute payments (e.g., large severance or change-in-control payments).
Exemptions to watch for:
- Limited hours exception: if compensation doesn’t exceed threshold or doesn’t reach required number of hours under the law.
- Nonexempt funds exception: parts of pay funded by sources not exempt under the Code might be exempted. These are still under debate in proposed rules.
What Nonprofits Should Do Now
- Review compensation structures, including severance plans and fringe benefits, to identify potential exposures.
- Monitor which employees might now cross $1 million threshold.
- Plan for benefit redesigns or timing changes to compensation to avoid unnecessary tax exposure.
- Ensure clear documentation and consistent hours tracking if relying on limited hours exceptions.
- Consider delaying certain payouts until after final regulations are issued if that offers compliance relief.
- Submit feedback by August 4, 2026, particularly about how exceptions should be defined.
Example Scenarios
- Senior VP earning $1.2 million including bonuses: now likely a covered employee, may need to assess compensation under section 4960.
- Executive leaving nonprofit with parachute payment clause: that exit package may trigger excess parachute tax unless adjusted or structured properly.
Key Takeaways
- The shift from “top five” to “$1 million threshold” is significant—more employees could now be subject.
- Exceptions will matter greatly—track hours and sources of funds.
- Timing matters: pay or structure decisions made before final regulation effective dates could provide relief.
- Nonprofits should act proactively to minimize exposure and avoid surprises.