IRS to Issue Rule Implementing Changes to Exempt Organization Executive Compensation Excise Tax

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A notice from the Internal Revenue Service signals upcoming regulations that would expand the Section 4960 excise tax to cover a broader group of nonprofit employees earning over $1 million, reflecting recent statutory changes and inviting stakeholder input on implementation.

The Internal Revenue Service (IRS) on June 5, 2026, issued Notice 2026-36, Notice of Intent to Issue Regulations Under Section 4960 that would implement changes from HR 1 affecting certain tax-exempt organizations with employees who earn more than $1 million.

Section 4960 of the Internal Revenue Code generally imposes an excise tax on any applicable tax-exempt organization (ATEO) or related person or governmental entity that pays a covered employee remuneration in excess of $1 million in a taxable year or an excess parachute payment. Nonprofit organizations under Section 501(c) would be considered ATEOs since they are exempt from taxation under Section 501(a) of the Internal Revenue Code.

HR 1 changed the definition of "covered employee" under Section 4960 to expand the scope of employees who would be covered by the excise tax. Previously, "covered employee" was defined as "any employee (including any former employee) of an ATEO if the employee (1) is one of the five highest-compensated employees of the ATEO for the taxable year, or (2) was a covered employee of the ATEO (or any predecessor) for any preceding taxable year beginning after December 31, 2016." HR 1 revised the definition of "covered employee" to "any employee of an applicable tax-exempt organization (or any predecessor of such an organization) and any former employee of such an organization (or predecessor) who was such an employee during any taxable year beginning after December 31, 2016." The Notice clarified that IRS considers the new definition of "covered employee" to apply for taxable years beginning after December 31, 2025, and retains the prior definition of covered employee for taxable years beginning on or before December 31, 2025.

IRS intends to issue regulations to remove references to an ATEO's five highest-compensated employees and to provide its interpretation of the post-HR 1 definition of covered employee. IRS also anticipates that the proposed regulations would provide covered employee exceptions for limited hours and nonexempt funds similar to those currently in the regulations at 26 C.F.R 53.4960-1(d)(2)(ii) and (iii).

IRS has requested comments on the issues raised in the notice by August 4, 2026, particularly on: (1) any changes that are needed or appropriate to adapt the current limited hours and nonexempt funds exceptions to the new definition of "covered employee" under HR 1 and the appropriateness of applying these exceptions to officers of the ATEO; and (2) any other issues that should be addressed in the forthcoming proposed regulations.