Regulatory Changes to Section 4960: IRS Expands Definition of Covered Employees for Tax-Exempt Organizations
IRS Notice 2026-36
Notice 2026-36 announces the Internal Revenue Service (IRS) and the Department of the Treasury’s intent to issue proposed regulations under IRC Section 4960, which imposes an excise tax on excess remuneration and excess parachute payments paid by applicable tax-exempt organizations (ATEOs). The guidance addresses changes enacted by The One Big Beautiful Bill Act (OBBBA), which significantly expands the definition of a covered employee, and indicates the anticipated preservation of the limited hours and nonexempt funds exceptions under Section 4960.
Expanded Definition of Covered Employees Under Section 4960
Before enactment of the OBBBA, a covered employee generally included an ATEO’s five highest-compensated employees for the year and any individual previously identified as a covered employee for tax years beginning after December 31, 2016.
For tax years beginning after December 31, 2025, the OBBBA broadens the definition to include virtually all employees of an ATEO, as well as former employees who were employed during a taxable year beginning after December 31, 2016.
Under Notice 2026-36, covered employees will include:
- Individuals who were covered employees under the pre-OBBBA rules for any tax year beginning after December 31, 2016, and before January 1, 2026; and
- Any individual employed by an ATEO during a tax year beginning after December 31, 2025, subject to future regulatory exceptions.
As a result, covered employees generally will consist of:
- Individuals previously identified as covered employees under prior law; and
- All employees of an ATEO for taxable years beginning after December 31, 2025.
Anticipated Regulatory Exceptions
Although the definition of a covered employee is expanding, the Notice indicates that the covered employee exceptions for limited hours and nonexempt funds will continue. However, the Notice also indicates that the limited services exception will be eliminated. The limited services exception was originally adopted to prevent an employee to whom the ATEO paid minimal remuneration from displacing an employee who would otherwise have been one of the five highest compensated employees, thereby making them a covered employee of the ATEO. With the expanded definition of covered employees, the limited services exception no longer serves a purpose.
Reliance and Applicability of IRS Notice 2026-36
ATEOs and tax professionals may rely on the positions described in the Notice until proposed regulations are issued, including reliance on Treasury’s interpretation of the expanded definition of covered employees and the continued application of the limited hours and nonexempt funds exceptions.
The Notice states that the proposed regulations are expected to apply prospectively to tax years beginning after final regulations are issued. This approach should provide ATEOs with advance notice and time to prepare for any changes in compliance and reporting requirements.
The IRS has invited public comments on the provisions outlined in the Notice, particularly regarding the scope and operation of the anticipated exceptions. Organizations affected by section 4960 may wish to consider whether the expanded covered employee definition or the proposed exceptions raise practical concerns. Written comments are due August 4, 2026.
Next Steps
We will continue to monitor developments on these regulations and circulate information as it becomes available. For questions, contact your nonprofit tax provider or reach out to GRF’s Nonprofit Tax team.
