Compliance
Navigating Compliance: Excess Compensation Rules for Tax-Exempt Organizations under Section 4960
Under the OBBB, tax-exempt organizations now face broader rules on executive pay; this article helps them understand, comply, and avoid surprises under Section 4960.
By NomadicTax Research Team • 5-8 min read • June 21, 2026
## Background: What Section 4960 Does Now
The One, Big, Beautiful Bill expanded the reach of **Section 4960**, which imposes an excise tax on tax-exempt organizations that pay **“covered employees”** more than $1 million per year, or provide excess parachute payments. Previously, the tax typically applied only to the top five highest paid employees in an organization. ([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))
Under the updated law, **any individual employee** with compensation exceeding $1 million in a year—or who receives a parachute payment exceeding specified thresholds—is potentially subject to this excise tax. ([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 Points & Exceptions
- **Effective date**: New definition applies for **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))
- **Exceptions under consideration**: Proposed regulations will include exceptions for limited hours (for volunteer or part-time executives) or when nonexempt funds are used. These are modeled after existing exceptions in Section 4960 regulations. ([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))
- **Covered employee under old rules**: For individuals employed from 2016-2025, if they were covered under pre-OBBB law (top-five rule), defined as such until new regulations finalize. ([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 Checklist for Organizations
1. **Identify employees exceeding $1 million** in annual compensation or subject to parachute payments; expand your scope beyond just top five highest-paid.
2. **Track compensation components**: taxable wages, benefits, severance or parachute clauses carefully assessed.
3. **Evaluate exceptions**: If someone works limited hours or their compensation paid from nonexempt funds, monitor rulemaking to qualify for possible exclusion.
4. **Documentation and recordkeeping**: Ensure payroll and board resolutions clearly reflect compensation, benefits, severance agreements. Exclude nonexempt fund sources where applicable.
5. **Prepare for public comments deadline**: The IRS is seeking comments on Notice 2026-36 until **August 4, 2026** regarding proposed regulation scope and exceptions. If your organization has stake, participate. ([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))
## Actionable Scenarios
- A mid-sized nonprofit pays its Director $1.2 million. Under new rules, that individual becomes a covered employee regardless of whether previously in top five. The nonprofit must compute the excise tax (2-5% depending on compensation) and withhold required amounts. Without exception or limited hours carve-outs, this becomes fully enforceable once regulations are final.
- A tax-exempt hospital with large pension and severance arrangements should audit all compensation contracts to identify parachute payments that could trigger Section 4960 liabilities. Restructuring may reduce risk if severance structured to avoid “excess parachute” definitions.
## Tips for Boards & Leadership
- Review executive compensation policies now—not next year. The new definition means board approval, compensation committee oversight, and independent benchmarking are more important than ever.
- Work with tax counsel to assess possible exceptions (limited hours, volunteer status, nonexempt funds source).
- Update Form 990 disclosures and financial statements to reflect any Section 4960 liability or new exposure once rules finalized.
## Final Thoughts
With OBBB substantially broadening the reach of the excise tax on executive compensation, tax-exempt organizations must act now to assess exposure, revise compensation structures where possible, and engage in rule-making process. The cost of failing to comply could be steep—not just financially, but in terms of reputation.