June 10, 2026 – On June 5, 2026, the Internal Revenue Service (“IRS”) issued Notice 2026-36 (the “Notice”), announcing its intent to issue new proposed regulations under section 4960 of the Internal Revenue Code (“IRC”) which will address recent statutory changes to the excise tax on excess compensation paid by tax-exempt organizations. The Notice provides initial guidance and transitional relief until the forthcoming regulations are issued and finalized.
Background
Section 4960 imposes an excise tax on compensation exceeding $1 million and on certain excess parachute payments made to “covered employees” of applicable tax-exempt organizations (“ATEOs”). Before the changes enacted by Public Law 119-21, 139 Stat. 72 (July 4, 2025), also known as the One Big Beautiful Bill Act (“OBBBA”), covered employees under section 4960 generally were limited to an ATEO’s five highest-compensated employees for a tax year.
Statutory Changes
In the OBBBA, Congress expanded the definition of “covered employee” (for tax years beginning after December 31, 2025) to include: (1) any current employee of an ATEO or its predecessor; and (2) any former employee of the ATEO (or its predecessor) who was employed during any taxable year beginning after December 31, 2016. This change removes the top five limit, resulting in a broader application of excise tax to current and former employees. However, Congress in the OBBBA notably directed the IRS to issue regulations and guidance implementing this change.
Notice 2026-36
As directed by Congress in the OBBBA, the IRS has provided limited guidance in Notice 2026-36 for ATEOs to rely on until the issuance of the proposed regulations implementing the OBBBA changes. Key aspects of this guidance include:
Categories of Covered Employees. The Notice describes two categories of covered employees:
- Former employees who worked for the ATEO between January 1, 2017, and December 31, 2025, and who qualified as covered employees under the prior definition; and
- Current employees of an ATEO for tax years beginning after December 31, 2025, unless an exception in future guidance applies.
Possible Exceptions. The proposed regulations are expected to include exceptions similar to the limited-hours exception (for individuals who perform volunteer services and whose compensated hours fall below a specified threshold) and the nonexempt-funds exception (for individuals whose compensation is paid from the nonexempt funds of unrelated organizations).
Prospective Application. The IRS intends for the proposed regulations to apply prospectively to tax years beginning after final regulations are issued.
Implications for Tax-Exempt Organizations
In light of the Notice, ATEOs should begin evaluating how the expanded definition of covered employee may affect their compensation programs, compliance obligations, and talent-retention strategies. Overall, the broader scope of section 4960 is likely to increase both administrative burden and excise tax exposure for organizations with comprehensive compensation arrangements, including universities, certain healthcare systems, and large nonprofit entities. Such organizations should consider the following questions when balancing executive compensation packages with recruitment and retention goals:
- Who may now qualify as “covered employees”;
- What compensation is includable for section 4960 purposes;
- Whether compensation is being aggregated across related entities, including taxable affiliates; and
- How are incentive, retention, deferred compensation, and/or severance arrangements structured, and when are they payable, with an eye towards section 4960 excise tax.
For more information on the Notice, please contact Dwayne Littauer, Malerie Bulot, or Emily Tastet of the Kullman Firm to assist you.