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Section 4960 Executive Compensation Tax Changes for Tax-Exempt Organizations: What to Know
New notice from the Treasury/IRS signals upcoming changes to how high compensation for executives at tax-exempt nonprofits will be taxed—especially around the definition of "covered employee."
By NomadicTax Research Team • 5-8 min read • August 31, 2026
## Background: Section 4960 Under OBBBA
The One, Big, Beautiful Bill Act (OBBBA), enacted July 4, 2025, significantly changed the rules for **excess compensation excise tax** under IRC §4960. These changes introduced a broader definition of **covered employee**, modifying which employees of an applicable tax-exempt organization (ATEO) are subject to the excise tax. ([irs.gov](https://www.irs.gov/retirement-plans/employee-plans-news?utm_source=openai))
## What the IRS is Proposing Now
### Notice from IRB 2026-26
- The IRS and Treasury have published **Notice 2026-26**, which announces that proposed regulations for section 4960 will **clarify the effective date** of the amended definition of covered employee and suggest **exceptions** similar to existing “limited hours” and “non-exempt funds” exceptions. ([irs.gov](https://www.irs.gov/irb/2026-26_irb?utm_source=openai))
- Public comments are being solicited on the proposed definitions and exceptions. ([irs.gov](https://www.irs.gov/irb/2026-26_irb?utm_source=openai))
## Impacts & Key Considerations for Nonprofits
- **Effective Date**: The proposed effective date will determine when already paying organizations must begin calculating excise tax under the new scope.
- **Covered Employee Definition**: The updated definition under OBBBA may sweep in more employees—beyond the prior top five highest-paid employees. This could increase tax exposure.
- **Exceptions**: The proposed limited hours and non-exempt funds exceptions may provide relief for employees who do not receive high compensation or whose compensation is primarily from public or governmental funds.
## Action Steps for Nonprofits
- Perform an **internal audit** of current executive compensation to identify who fits under the new broader “covered employee” definition—look beyond traditional officers and top five employees.
- Track **hours worked and funding sources** to see whether individuals might qualify for the proposed non-exempt funds or limited hours exceptions.
- Prepare comment submissions to IRS’s proposed regulations if you have unique cases—comments are part of rule-making and may shape final definitions.
## Example Case
A tax-exempt hospital pays its board chair $800,000 annually, who previously wasn’t classified as one of the top five highest paid employees. Under new rules, that role might now be subject to §4960 excise tax if the definition expands accordingly. Likewise, someone earning less but whose compensation comes from non-exempt funds might still be affected.
## Summary
Notice 2026-26 signals major regulatory shifts under §4960, clarifying how nonprofits, charities, and universities will need to treat high compensation. Monitor updates, assess current employee pay, and stay ready to align policies with evolving definitions to avoid unexpected tax liabilities.