Tax-Exempt Orgs and Executive Pay: New Regulations in the Pipeline for Section 4960

What’s Coming Under Section 4960

In the IRS bulletin IRB 2026-26 (June 22, 2026), the agency signaled proposed regulations under section 4960 concerning excess executive compensation for tax-exempt organizations.(irs.gov) These will address changes introduced by section 70416 of the One, Big, Beautiful Bill Act, specifically how the definition of “covered employee” is expanded and what exceptions may apply (e.g., limited hours, non-exempt funds).(irs.gov)

Key Implications for Tax-Exempt Organizations

• Organizations will need clearer policies to determine who qualifies as a “covered employee” under the new law.
• Anticipate new exceptions similar to limited-hours or nonexempt funds—understanding the thresholds will be critical.
• Penalties: Section 4960 levies a 21% excise tax on remuneration above $1 million or on parachute payments for covered employees.(irs.gov)

Action Items for Affected Entities

1. Audit current compensation practices to identify which employees might newly qualify under expanded definition.
2. Track hours and funding sources where services to the tax-exempt organization are limited or funded externally—these may qualify for exceptions.
3. Review boards or compensation committees must document role definitions and compensation sources carefully.
4. Prepare for compliance systems that can capture required data—hours, funding, employment classification.

Example Scenario

Imagine a private university where adjunct professors are paid via external grant funds but sometimes also perform paid work directly for the institution. Under the upcoming regulations:

• If these professors qualify as “covered employees” due to expanded definitions, their grant-derived pay might or might not count, depending on whether exceptions apply.
• If services are limited and funded via non-exempt funds, the proposed regulations may allow an exception.

Timing and Next Steps

• Regulations are proposed, not yet final. A comment period will follow.
• The effective dates will hinge on publication in the Federal Register and may include transitional relief.

Key Takeaways

• Tax-exempt entities should proactively prepare—review compensation structures, and record keeping around funding and hours.
• The $1 million cap and excise tax can impose significant costs if misclassification occurs.
• When final regulations arrive, they will reshape how tax­-exempt organizations manage and justify executive compensation.