What's Happening?
The Internal Revenue Service (IRS) and the Treasury Department have announced plans to issue proposed regulations that will limit the ability of tax-exempt organizations to pay high compensation and parachute payments to their top executives. This move
is part of the One Big Beautiful Bill Act (OBBBA), which expanded the application of excise tax on excess compensation by broadening the definition of a 'covered employee' of an 'applicable tax-exempt organization' (ATEO). Previously, the tax applied to the five highest-compensated employees for the tax year. Under the new rules, it can apply to any employee with compensation exceeding $1 million in a tax year or an excess parachute payment. Notice 2026-36 clarifies that the amended definition of covered employee includes individuals who were employees of an ATEO in any tax year beginning after December 31, 2016, and on or before December 31, 2025, if they were covered employees under prior law, and any individual who is an employee of an ATEO in any tax year beginning after December 31, 2025, unless a covered employee exception applies.
Why It's Important?
The proposed regulations are significant as they aim to enhance accountability and tax compliance among tax-exempt organizations by expanding the scope of the excise tax to potentially include any highly compensated employee, not just a limited group of executives. This could lead to a more equitable distribution of resources within these organizations and ensure that funds are used in alignment with their tax-exempt purposes. The changes could also impact the financial planning and compensation strategies of nonprofits, potentially leading to a reevaluation of executive pay structures. Organizations may need to adjust their compensation policies to avoid the excise tax, which could reach as high as 21% of remuneration over $1 million. This development is particularly relevant for stakeholders in the nonprofit sector, including board members, donors, and regulatory bodies, as it underscores the importance of transparency and fiscal responsibility.
What's Next?
The Treasury and the IRS are seeking public comments on all aspects of the notice, with a deadline for submissions set for August 4, 2026. They are particularly interested in feedback on the issues raised by the latest notice, including the proposed exceptions for limited hours and nonexempt funds. The proposed regulations are not expected to apply to tax years beginning before the issuance of final regulations. The American Institute of CPAs has already submitted a letter requesting guidance on the excise tax and transition relief. As the process unfolds, tax-exempt organizations will need to stay informed about the developments and prepare for potential changes in their compensation practices.
