What the Notice Changes
Issued on June 5, 2026, IRS Notice 2026-36 outlines proposed regulations that significantly affect how tax-exempt organizations define “covered employees” under Section 4960 (Excise tax on excess compensation and parachute payments) of the Internal Revenue Code. (irs.gov)
Previously, only the top five highest compensated employees were potentially subject to the excise tax. Notice 2026-36 now extends applicability to any employee earning over $1,000,000 annually or receiving an excess parachute payment. (irs.gov)
Effective Period & Exceptions
- The new definition applies for tax years beginning after December 31, 2025, with certain exceptions.
- Organizations may rely on existing “limited hours” and “nonexempt funds” exceptions until further guidance is issued. These serve as relief while final rules are developed. (irs.gov)
Compliance Implications for Nonprofit Entities
What You Should Do Now:
- Identify potential covered employees: Pull compensation data for anyone earning over $1 million or receiving parachute payments.
- Review parachute payment arrangements for key staff; assess whether they could trigger excise tax liability.
- Document exceptions: If relying on limited hours or nonexempt funds exceptions, maintain robust records.
Risks to Be Aware Of:
- Applying previous definition incorrectly might lead to under-reporting and penalties.
- Final regulations could narrow exceptions or change the effective dates.
- Employees who weren’t in covered groups before may now become subject to taxation or withholding responsibilities.
Real-World Examples
- A nonprofit CEO earning $1.2 million in 2026 would now be a “covered employee,” whereas under the old rule, that status depended purely on whether they were among the top five.
- An employee receiving a substantial “golden parachute” in the event of severance may now generate liability for excess parachute payments under Section 4960.
Next Steps & Best Practices
- Monitor regulation progress: Note that the notice calls for public comment by August 4, 2026. (irs.gov)
- Plan ahead: Consider compensation packages with both tax-exempt requirements and Section 4960 consequences in mind.
- Consult counsel: Nonprofits should review their policies with experienced tax advisors as guidance evolves.
With enforcement likely to intensify in light of these broader definitions, tax-exempt organizations—and their executives—should evaluate their practices now and build stronger compliance mechanisms moving forward.