If your nonprofit, association, or tax-exempt health system pays anyone more than $1 million — or approves a large severance package — a 21% excise tax that used to apply to just five people now potentially applies to everyone on payroll. And if your organization is part of a group with taxable affiliates or related entities, the compensation those affiliates pay counts too.
That is the effect of the One Big Beautiful Bill Act (OBBBA), enacted July 4, 2025, on Section 4960 of the Internal Revenue Code. The IRS previewed how it will implement the expansion in Notice 2026-36, released June 5, 2026. For calendar-year exempt organizations, the new rules take effect January 1, 2026 — meaning your 2026 compensation decisions are already in scope.
Here is what changed, who is affected, and how to track exposure before the proposed regulations are finalized.
What Section 4960 Has Done Since 2018
Section 4960 was enacted by the Tax Cuts and Jobs Act of 2017 and first applied to tax years beginning in 2018. It does not limit what a tax-exempt organization can pay. It imposes an excise tax on the organization itself equal to the corporate tax rate (currently 21%) when it pays certain amounts to certain people.
Two buckets trigger the tax:
- Remuneration over $1 million: Compensation paid to a covered employee in excess of $1 million in a taxable year, as determined on the employer's tax year. Remuneration includes wages, bonuses, and other amounts treated as wages for withholding, plus amounts vested under Section 457(f) plans.
- Excess parachute payments: Payments contingent on separation from employment that equal or exceed three times the covered employee's base amount (average compensation over the prior five years). The excess over one times the base amount is taxed, not just the amount over three times — a common misunderstanding.
The tax is reported on Form 4720 and paid by the applicable tax-exempt organization (ATEO), not by the employee. Related organizations that pay remuneration to the same person can also be liable for their allocable share.
The Old Narrow Definition of Covered Employee
From 2018 through 2025, a covered employee was the five highest-compensated employees of the ATEO for the tax year, plus anyone who was ever a covered employee for any tax year beginning after December 31, 2016. Once you were in the five, you stayed in the group forever — even after you left, retired, or moved to a lower-paying role. That "once covered, always covered" rule was already expansive, but it still capped the annual headcount at five plus former members.
Many small and midsize nonprofits reasonably assumed they were outside Section 4960 entirely because no one earned near $1 million, or because only the executive director and one or two others crossed the threshold. That assumption is no longer safe.
What OBBBA Changed: From Five People to Everyone
OBBBA amended Section 4960 to expand the definition of covered employee for taxable years beginning after December 31, 2025. For calendar-year ATEOs, that is the 2026 calendar year.
Under the amended rule, a covered employee is:
- Any employee (or former employee) of the ATEO who was employed at any time during the tax year, and
- Any former employee who was an employee at any time during any taxable year beginning after December 31, 2016
In plain terms: if you worked for the organization in 2026, you are a covered employee for 2026. If you worked for it in any year from 2017 forward, you remain a covered employee for every later year, even if you left years ago and now earn well below $1 million elsewhere in the group. The five-person cap is gone. The headcount is now the entire workforce, current and historic.
The change does not alter the $1 million threshold, the 21% rate, or the definition of remuneration itself — a point Notice 2026-36 emphasizes. It also does not change the exclusions that were in the 2021 final regulations, including the exclusion for remuneration paid for medical or veterinary services (critical for nonprofit hospitals and university medical centers) and the treatment of volunteer services. What it does is make those rules apply to far more people, so organizations that previously ran a single five-person test must now evaluate every highly compensated individual.
The IRS estimates the number of covered employees per organization will grow dramatically. For a large university, health system, or national nonprofit with coaches, physicians, researchers, or investment staff who earn above $1 million, the annual covered group could jump from five to dozens or even hundreds.
Why This Hits Larger Nonprofits Hardest
Consider a university with a head basketball coach earning $3.2 million, a medical school department chair earning $1.4 million, an endowment chief investment officer earning $2.8 million, and a health system CEO earning $4 million who splits time between the university and a related taxable faculty practice. Under the old rule, only the top five by compensation in a given year were covered — if the coach, CIO, and CEO were in the five, the department chair might have escaped the definition (unless previously covered). Under the new rule, all four are covered employees for 2026 by virtue of being employees, and the $2.2 million, $0.4 million, $1.8 million, and $3 million excess amounts respectively are each subject to 21% excise tax at the employer level. The aggregation rules can push the exposure even higher if related entities pay additional amounts.
Small nonprofits with no one near $1 million still have no tax due — the expansion does not create liability where no one exceeds the threshold — but they still need a process to confirm that annually, because a one-time bonus, severance, or deferred-compensation vesting event can push someone over $1 million unexpectedly.
Who Is an ATEO (and Why Related Organizations Matter)
Section 4960 applies to applicable tax-exempt organizations, a term broader than "501(c)(3) charity":
- Organizations exempt under Section 501(a), including 501(c)(3) public charities and private foundations, 501(c)(4) social welfare organizations, 501(c)(5) labor organizations, and 501(c)(6) business leagues and chambers
- Farmers' cooperative organizations under Section 521(b)(1)
- Organizations with income excluded under Section 115(1) (instrumentalities of government)
- Political organizations under Section 527(e)(1)
Related organizations are equally important. Remuneration paid by a related entity to a covered employee of the ATEO is treated as paid by the ATEO for purposes of the $1 million test, and each related payer is liable for its allocable share of the excise tax.
A related organization generally includes:
- An organization that controls or is controlled by the ATEO, or is under common control with the ATEO (using a 50%+ control test)
- A supported organization or supporting organization under Section 509(f)(3) with respect to the ATEO
- A voluntary employees' beneficiary association (VEBA) associated with the ATEO
For example, a 501(c)(3) hospital that is part of a system with a taxable management company, a for-profit physician group, and a 501(c)(3) foundation must aggregate compensation across the entire controlled group to test the $1 million threshold. If the CEO receives $800,000 from the hospital and $600,000 from the management company, the combined $1.4 million creates a $400,000 excess, and the hospital and management company each owe excise tax on their allocable portion.
What Notice 2026-36 Previews
Notice 2026-36 does not itself change the law — it announces the IRS's intent to issue proposed regulations and provides interim guidance that taxpayers may rely on until those regulations are proposed and finalized. Two items are flagged as central to the forthcoming package:
1. Expanded Covered Employee Mechanics
The proposed regulations are expected to address how the expanded definition interacts with the "once covered, always covered" principle. Under the current statute, anyone who was a covered employee for a prior year beginning after 2016 remains a covered employee forever. With the expanded definition, that permanence now applies to every employee who ever worked for the ATEO after 2016. The IRS is expected to clarify how to identify and track the historic pool, including employees who left long before 2026 and whose compensation records may be archived.
For organizations with turnover, that means your covered-employee roster for 2026 is not just your current payroll — it includes everyone who was on payroll at any point from 2017 through 2025, as well as anyone new in 2026. Some organizations will need to reconstruct that list.
2. Transition Relief and Allocation Details
The notice states that transition relief will be available for ATEOs and their related organizations, and that the proposed regulations will address how to allocate the excise tax among multiple payers. While the details await the proposal, the relief is expected to address the practical difficulty of applying the expanded definition to compensation arrangements entered into before OBBBA was enacted.
Until the proposed regulations are issued, Notice 2026-36 says taxpayers may rely on the guidance in the notice. That interim reliance language is important — it gives you a documented basis for your 2026 filings if you follow the notice's approach.
What Did Not Change
Notice 2026-36 and the practitioner analyses around it emphasize continuity in several areas:
- The $1 million threshold is not indexed for inflation. It remains $1 million per covered employee per year, not per employer — aggregation across related organizations still applies.
- The medical and veterinary services exclusion remains. Remuneration paid for the direct performance of medical or veterinary services — as distinct from administrative or executive services — is excluded from both remuneration and parachute calculations. For a clinician-executive who both sees patients and serves as department chair, the allocation between clinical and administrative compensation matters and should be documented.
- Volunteer and hours-based exceptions in the 2021 regulations continue to inform the analysis, but they now apply to a larger pool. An individual whose services are limited or who receives only expense reimbursements will still be analyzed under those exceptions — you simply have more individuals to analyze.
- Parachute rules still use the three-times-base-amount test. A severance package negotiated today can trigger parachute exposure for 2026 if the separation occurs after January 1, even though the contract was signed before the expansion.
A Compliance Checklist for 2026
Treat 2026 as a rebuild year. The old five-person spreadsheet will not suffice.
Rebuild your covered-employee roster. Pull payroll records for every employee from 2017 through 2026. Anyone who was on payroll in any of those years is a covered employee for 2026 if still employed in 2026, and former employees from that window remain covered regardless of current employment. For large organizations, this is a data project — involve HRIS and payroll, not just tax.
Identify your ATEO group and related entities. Map every entity under common control, every supporting or supported organization, and every VEBA or management company that pays compensation to people who also work for the ATEO. Diagram the control relationships and calculate the aggregation. If you restructured after OBBBA, document whether related-organization status changed.
Quantify exposure by individual, not just by title. For each covered employee who may exceed $1 million — including highly compensated coaches, physicians, researchers, investment staff, and executives with deferred compensation vesting — compute:
- Total remuneration for the organization's tax year, aggregated across the ATEO and all related payers
- Excess over $1 million
- Potential excess parachute amount using the base-amount calculation
- Allocable excise tax at 21% by payer
A common miss is qualified deferred compensation under Section 457(f): an amount that vests in 2026 counts as remuneration in 2026 even if not yet paid. A $600,000 salary plus a $500,000 457(f) vesting event puts the individual over $1 million for that year.
Review contracts and separation agreements. If a covered employee's contract provides for severance equal to two or three times base pay, the parachute computation could be triggered by a termination in 2026. Consider whether amendments, payment timing, or restructuring can reduce parachute exposure — with counsel, not unilaterally.
Separate medical services compensation cleanly. For clinician-executives, maintain time allocations, job descriptions, and payroll codes that distinguish clinical compensation from executive compensation. The exclusion turns on documented facts, not intent.
Document your methodology. Because the proposed regulations are not yet issued, your reliance on Notice 2026-36 and the 2021 final regulations should be memorialized. Keep a workpaper that states the definition of covered employee you applied, the roster you used, and the sources you relied on. That file is your exam support if the final regulations later refine the mechanics.
Bookkeeping and Financial Reporting Implications
The excise tax is an entity-level obligation, not a withholding item. Budget for it as a separate line — it is not deductible and should not be netted against compensation expense. For Form 990 filers, excess remuneration and parachute amounts affect the compensation disclosures and may draw governance questions from the board.
For bookkeeping, the most durable improvement is to integrate payroll, deferred compensation, and related-entity compensation into a single covered-employee ledger. Many nonprofits keep ATEO payroll in one system, taxable subsidiary payroll in another, and deferred compensation records in a spreadsheet. The aggregation rule requires a consolidated view. A simple control is to add a flag in your payroll or HR system for anyone who meets the post-2016 employment test and to run a quarterly aggregation report across all related payers.
If your organization uses a fiscal year that does not align with the calendar year, confirm which tax year is the relevant period for Section 4960 — the tax applies to taxable years beginning after December 31, 2025, so a June 30 year-end will have a split-year application that requires prorating remuneration.
Plan Now, File Confidently Later
The expansion of Section 4960 does not change the math for most small nonprofits whose highest-paid person earns well below $1 million. It fundamentally changes the compliance burden for large exempt organizations, health systems, universities, and any ATEO with highly compensated staff or complex related-entity structures. The population of covered employees is now everyone who ever worked for you after 2016, and the tax applies at 21% to every dollar over $1 million and to excess parachute amounts, allocated across every payer in the group.
Notice 2026-36 is the bridge until proposed regulations arrive. It confirms the expanded definition, promises transition relief, and lets you rely on its approach in the interim. Use that window to rebuild rosters, map related organizations, and model 2026 exposure — so when the regulations are proposed, you are refining a process you already have, not starting one from scratch.
Simplify Your Financial Management
Managing nonprofit compensation across multiple entities and tracking the Section 4960 excise tax requires clear, auditable financial records. Beancount.io provides plain-text accounting that keeps every payroll, deferred compensation vesting, and inter-entity transfer transparent and version-controlled — so your ATEO group can quantify exposure accurately and support every filing. Get started for free and keep your nonprofit finances organized.