The IRS and Treasury announced intent on June 5, 2026, to issue proposed regulations expanding the 21% excise tax on excess compensation paid by nonprofit executives, a significant broadening of tax rules that will affect thousands of tax-exempt organizations nationwide.
In Notice 2026-36, the agencies signaled that the tax on nonprofit executive compensation—previously limited to an organization’s five highest-paid employees—will now apply to any employee earning more than $1 million in a single tax year, as well as to excess parachute payments. The change stems from the One Big Beautiful Bill, signed into law on July 4, 2025.
“The new law strengthens the accountability of tax-exempt organizations by expanding tax compliance requirements for certain organizations paying excessive compensation and excess parachute payments to their executives,” IRS Chief Executive Officer Frank J. Bisignano said in the announcement. “It broadens the scope of tax from a limited group of executives to potentially any highly compensated employee.”
From Five Highest-Paid to Any Employee Earning Over $1 Million
The expansion represents a fundamental shift in how the tax applies. Under the prior rule, which took effect in 2018 under Internal Revenue Code Section 4960, only the five highest-compensated employees at a nonprofit faced the excise tax if their pay exceeded $1 million. That limit is now gone.
Beginning in tax years after December 31, 2025, the tax can apply to any current or former employee—not just top executives—if their total compensation exceeds $1 million. This means a nonprofit with multiple employees earning above that threshold could owe 21% excise tax on the excess amount for each of them, a substantial increase in potential liability for larger organizations.
The notice clarifies that the definition of “covered employee” under the new rules includes any individual who is an employee of a tax-exempt organization in a tax year beginning after December 31, 2025, unless a covered employee exception applies. The IRS and Treasury anticipate forthcoming proposed regulations will include exceptions for employees who provide volunteer services and for certain limited-hours and nonexempt-fund arrangements, pending final guidance.
Why the Change Matters for Nonprofits
The expansion affects all applicable tax-exempt organizations (ATEOs)—a category that includes charities, foundations, educational institutions, and other 501(c)(3) entities. For organizations with significant executive payrolls, the change could create material tax obligations they did not face before.
The OBBB’s stated purpose is to ensure tax-exempt organizations do not use their unique tax status to circumvent congressional intent regarding executive compensation limits. Nonprofits have historically faced less regulatory scrutiny on compensation than for-profit corporations, and lawmakers sought to tighten that oversight.
Treasury and the IRS are requesting public comments on the proposed regulations through August 4, 2026. The agencies noted that the proposed rules are not expected to apply to tax years beginning before the issuance of final regulations, giving organizations some transition time once the rules are finalized.
Sources
- Internal Revenue Service — Official announcement (IR-2026-73) and Notice 2026-36 on the expansion of the excise tax on excess tax-exempt organization executive compensation under the One Big Beautiful Bill.
- EY — Analysis of the One Big Beautiful Bill’s removal of the five-employee limit and expansion to all employees earning over $1 million.
- Grant Thornton — Explanation of the expanded definition of covered employees for tax years beginning after December 31, 2025.
- Council on Foundations — Overview of the One Big Beautiful Bill’s impact on nonprofit executive compensation tax, effective July 4, 2025.
