Background & Key Change
In the One, Big, Beautiful Bill (OBBB), passed July 2025, Congress expanded the excise tax on excessive compensation and excess parachute payments in tax-exempt organizations. That includes altering who qualifies as a “covered employee.” Previously limited to the top five compensated; the new rule covers any employee whose pay exceeds $1 million in a tax year or who is subject to a parachute payment. (irs.gov)
Notice 2026-36, issued in early June, marks the IRS’s “intent to issue proposed regulations” that define how the new rules will work in practice. The notice also includes transition relief for organizations that may need it. (irs.gov)
Who’s Affected & What to Do Now
Tax‐Exempt Organizations (Nonprofits, Charities, Foundations)
- Identify any employee(s) exceeding $1 million in compensation (including salary, bonuses, benefits) in the tax year beginning after December 31, 2025. These individuals may now be treated as “covered employees” for excise purposes.
- Review any “parachute” or severance payment arrangements—they’re likely to be scrutinized and potentially taxed if exceeding defined limits.
- Ensure documentation is strong for any exceptions—Notice 2026-36 allows for limited-hours and nonexempt funds exceptions until further guidance is released. Use them if eligible. (irs.gov)
Individuals Employed by Nonprofits
- If you are compensated over $1 million, you’ll want to confirm whether your employer is an “applicable tax-exempt organization” (ATEO) under OBBB.
- Review benefit packages and any arrangements that might include steep severance, change of control or similar “parachute” triggers. Understand your tax exposure.
Compliance Checklist & Deadlines
| Task | Suggested Timeline |
|---|---|
| Audit all high-compensated employees (>$1 million) for 2026 | Immediately |
| Map out any severance or parachute clauses | Mid-2026 before fiscal-year closing |
| Track hours / fund classification to qualify for exceptions | As you go through 2026 reporting period |
| Monitor draft regulations | Proposed regs expected after Notice 2026-36; public comments open until August 4, 2026 (irs.gov) |
Risk Scenarios & How to Mitigate
- Risk: Paying someone over $1 million but failing to treat them as a covered employee—may lead to missed tax liabilities and penalties.
- Mitigate: Maintain accurate compensation records; implement policy reviews of severance/parachute payments.
- Risk: Losing transition relief if you don’t meet exceptions (limited hours / nonexempt funds).
- Mitigate: Document hours worked; document sources of compensation; avoid ambiguous classifications.
Practical Example
-
Example Nonprofit A: CEO earns $1.2 million in 2026. Under pre-OBBB law, only the top 5 highest paid would be covered—CEO already included. Under new law, in future years, there might be more covered employees if others cross $1 million even if not in top-5. Nonprofit must ensure that compensation committee evaluates every high earner—not just top ranks.
-
Example B: A nonprofit has a senior manager earning $800,000 plus a potential severance package of $400,000 if certain conditions met. Combine causes this to cross $1,000,000—parachute rules might apply, pushing them into “covered employee” classification for that year.
Strategic Advice
- Forecast compensation for all senior staff to see who might cross the threshold if bonus or benefits increase.
- Revise deferred compensation / severance arrangements to limit excess parachute exposure.
- Engage in comment process once proposed regulations are released—they may offer clarifications or exceptions favorable to certain situations.
Final Takeaway
OBBB has tightened the leash on high pay in nonprofits. Anyone earning $1 million+ per year, or with parachute arrangements, needs awareness now—well before final regulations arrive. Solid record-keeping, policy clarity, and proactive review are your best tools to stay compliant and avoid unexpected tax bills.