What is Section 4960?
Section 4960 imposes an excise tax on “applicable tax-exempt organizations” (ATEOs) for compensation paid to covered employees above $1 million or for excess parachute payments. Under prior law, only the top five highest-compensated employees were “covered.”(irs.gov)
Expansion under the One, Big, Beautiful Bill (OBBBA)
With enactment of Public Law 119-21 (signed July 4, 2025), the definition of “covered employee” under Sec. 4960 was broadened for taxable years beginning after December 31, 2025. Now, it includes:
- Any employee who was employed by the ATEO in any taxable year after December 31, 2016 and on or before December 31, 2025, if that individual was already a covered employee under prior law
- Any employee in any taxable year beginning after December 31, 2025 (regardless of rank) unless an exception is carved out in forthcoming guidance.(irs.gov)
Implications for entities
- Entities may see many more employees subject to a $1 million compensation cap tax than before.
- Exempt organizations must assess compensation arrangements across a broader span of employees—for instance, someone who earned above the threshold in isolated years between 2017-2025 could now be permanently covered.
- Budgeting for the excise tax must incorporate costs for potentially more covered employees.
What’s coming & how to prepare
The IRS and Treasury issued Notice 2026-36, signaling they intend to issue proposed regulations under Sec. 4960. These proposals will include exceptions (e.g., limited hours, nonexempt funds) and clarify the effective date of the expanded definition, although taxable years beginning after Dec 31, 2025 are already in scope.(irs.gov)
To prepare:
- Identify if any employee who worked any time since 2017 might qualify under “covered employee” by compensation history.
- Review and document all compensation arrangements exceeding $1 million or parachute provision provisions.
- Assess whether contracts or deferred compensation may trigger the tax in unexpected employees.
- Monitor for upcoming proposed regulations to see options for exclusions or carve-outs.
Example scenario
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Organization X, a nonprofit, had 10 employees. Only top 5 earned over $1 million in 2024—but a 10th‐rank employee earned just under threshold. That person is not a covered employee under prior law, so no tax—for that year. But under OBBBA’s new law, for taxable years post-2025, that same employee is likely treated as a covered employee, although tax on them depends on compensation exceeding limit.
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Organization Y employs someone who left in 2018 but earned over $1 million that year. Under new expanded definition, if they met “covered employee” under older rules then, they remain covered for future payable or parachute payments.
Strategic tip: Audit your compensation records from 2017-2025. If someone was “covered” previously, they may stay covered forever. Consider adjusting compensation strategy (bonuses, deferred pay) for newer hires if possible.