IRS Announces Intent to Issue Regulations on Expanded Executive Compensation Excise Tax for Tax-Exempt Organizations

On June 5, 2026, the Internal Revenue Service released Notice 2026-36 announcing its intent to issue proposed regulations under Section 4960 of the Internal Revenue Code addressing the significant expansion under the One Big Beautiful Bill Act (OBBBA) of the excise tax on tax-exempt organization executive compensation. The Notice provides important interim guidance on the effective date of the expanded definition of “covered employee” and confirms that the IRS intends to preserve certain regulatory exceptions that protect tax-exempt organizations from inadvertent application of the tax.

Background: The 2017 Law and Existing Regulations

Section 4960, enacted as part of the Tax Cuts and Jobs Act in December 2017, imposes an excise tax equal to the corporate tax rate (currently 21%) on remuneration in excess of $1 million or any excess parachute payment paid to a “covered employee” of an applicable tax-exempt organization (ATEO). Under the original statute, the term “covered employee” was limited to an ATEO’s five highest-compensated employees for the current taxable year or any prior taxable year beginning after December 31, 2016. Final regulations released in January 2021 (explained in our prior Alert) provided important exceptions to covered employee status – including the “limited hours,” “nonexempt funds,” and “limited services” exceptions – designed to prevent the inadvertent application of the excise tax to employees of related organizations who perform limited or temporary services for the ATEO.

The 2025 Change: Expansion to All Employees

The OBBBA, signed into law on July 4, 2025, significantly expanded the definition of “covered employee.” For taxable years beginning after December 31, 2025, the term “covered employee” now means any employee or former employee of an ATEO, not just the five highest-compensated employees. This means that the excise tax can now apply to remuneration above $1 million paid to any employee of a tax-exempt organization, a significant broadening of the tax’s reach.

What the Notice Proposes

Notice 2026-36 addresses several key issues relevant to ATEOs navigating this transition:

Effective Date Interpretation. The Treasury Department and the IRS interpret the OBBBA’s effective date provision to broaden the definition of covered employee only for taxable years beginning after December 31, 2025, while retaining the prior, narrower definition for earlier years. Accordingly, the expanded definition includes only (1) any individual who was a covered employee under prior law for a pre-2026 taxable year, and (2) any individual who is an employee of an ATEO in any taxable year beginning after December 31, 2025, subject to any exceptions provided in future guidance. Without this guidance, there would have been uncertainty as to whether former employees who had been employed by an ATEO in any taxable year beginning after December 31, 2016 would automatically be considered covered employees for post-2025 taxable years, even if they had not been among the five highest-compensated employees in years when the earlier covered employee definition had been in effect.

Preservation of Limited Hours and Nonexempt Funds Exceptions. The Notice confirms that the forthcoming proposed regulations would provide exceptions from the definition of “covered employee” similar to the “limited hours” and “nonexempt funds” exceptions to the definition of “highest-compensated employee” in the existing regulations. These exceptions were originally adopted to address situations where employees of non-ATEO-related organizations perform limited or temporary services for the related ATEO while receiving no compensation from the ATEO. The Notice acknowledges that with the elimination of the concept of highest-compensated employee from the statute, the exceptions need to be adjusted to remain applicable under the new framework.

Elimination of the Limited Services Exception. The Notice indicates that the proposed regulations will not retain the “limited services” exception because the concern that motivated it (displacement of an employee who would otherwise have been one of the five highest-compensated employees) is no longer relevant under the broadened definition of covered employee.

Prospective Application. The proposed regulations are anticipated to be prospective and would not apply to taxable years beginning before the issuance of final regulations.

Relevance for Tax-Exempt Organizations

The expansion of Section 4960 to all employees represents a fundamental shift in the excise tax landscape for ATEOs and their related organizations. Organizations that previously needed to monitor compensation only for their five highest-paid employees must now consider the tax implications of compensation above $1 million paid to any employee. However, the Notice’s effective date interpretation is significant because it limits the retroactive reach of the OBBBA expansion. In addition, preserving the limited hours and nonexempt funds exceptions is welcome news for organizations with complex multi-entity structures, as it provides continued relief for employees of related organizations who perform limited services for the ATEO.

ATEOs may rely on the guidance in the Notice, including the effective date interpretation and the limited hours and nonexempt funds exceptions, until the proposed regulations are issued.

If you have any questions about the Notice, please contact Kendi Ozmon, Franziska Hertel, or Gil Ghatan.