Background: What’s changing for tax-exempt organizations
Under the One, Big, Beautiful Bill (OBBB), the IRS has broadened the scope of the excise tax on excessive compensation and “excess parachute payments” for tax-exempt organizations (ATEOs). Notice 2026-36 announced proposed regulations to expand the definition of covered employee beyond simply the top five highest paid—now any employee with compensation over USD 1 million per year may be affected. Volunteering roles and certain exceptions for non-exempt funds or limited hours may still apply. (irs.gov)
Case: CharityPlus—a nonprofit in the U.S.
Scenario: CharityPlus, a mid-sized nonprofit, with 8 employees. Two executives make USD 1.2 million/year, and one mid-ranking senior manager makes USD 950,000. Under prior rules, only the top five highest-paid employees are “covered employees.” Under the new proposal, both executives are covered, and possibly the senior manager if including parachute or termination payments pushes total compensation above USD 1 million.
Potential implications
- CharityPlus might owe excise tax on excess compensation (amounts above “reasonable” compensation thresholds) for both executives.
- If there are parachute payments (severance or termination pay linked to change in control or similar events), they could attract additional tax as “excess parachute payments”.
- Must ensure careful documentation of board and compensation committees and limit generous severance arrangements.
How nonprofits can prepare
- Conduct compensation benchmarking: Ensure salaries are justified based on size, mission, comparable nonprofits.
- Audit severance agreements and parachute pay clauses: Limit excess payments and ensure good governance.
- Review volunteer policies: Ensure that exceptions for volunteer work are properly documented so exempt from these rules when applicable.
- Monitor proposed regulations: IRS has requested comments; nonprofits should consider filing or coordinating comments to shape final rules. (irs.gov)
- Incorporate in budgeting: Estimate potential excise tax exposure, including compensation above thresholds, to forecast financial impact.
Key takeaways
- The expansion means more employees may be classified as covered and thus subject to excise tax rules.
- Governance and documentation are critical—boards should review compensation policies now.
- Nonprofits previously safe under “top five” may now find multiple employees subject to excise tax in a single year—so risk management matters.
- Proposed rules are not yet final—stakeholder comments due date was August 4, 2026—but affected entities should begin preparing now. (irs.gov)