IRS Issues Relief for Exempt Organization Executive Compensation Excise Tax

The Internal Revenue Service (IRS) released Notice 2026-36 on June 5, 2026, announcing it intends to issue proposed regulations under Section 4960 of the Internal Revenue Code (IRC) addressing the expansion under the One Big Beautiful Bill Act (OBBBA) of the excise tax on tax-exempt organization executive compensation (for prior coverage, see the tax alert dated July 23, 2025 (New Tax Law Will Have Significant Impact on Tax-Exempt Organizations) and for an overview of the excise tax, see the article published on August 29, 2022). In particular, the notice provides interim relief and clarity regarding the excise tax on annual executive compensation over $1 million and excess parachute payments for applicable tax-exempt organizations (ATEOs). Most importantly, it protects ATEOs from unexpected tax liabilities by confirming that the existing exceptions for “limited hours” “limited services,” and “non-exempt funds” will continue to apply, which essentially prevents volunteers from inadvertently being classified as "covered employees" who subject the ATEO to the excise tax.

Section 4960, enacted in 2017 as part of the Tax Cuts and Jobs Act, imposes an excise tax equal to the corporate tax rate on remuneration in excess of $1 million or any excess parachute payment made to a “covered employee” of an ATEO. A covered employee was originally the five highest compensated employees of an ATEO, subject to certain exceptions in the 2021 final regulations. However, the definition of a covered employee was expanded in OBBBA to include any employee or former employee of an ATEO, not just the highest compensated. 

Key Implications of Notice 2026-36

IRS Notice 2026-36 clarifies who is a "covered employee" following legislative changes under the 2025 One Big Beautiful Bill Act (OBBBA). The notice provides the following information for ATEOs:

• Covered Employee Definition: Forthcoming proposed regulations will narrow the classification to individuals who were employees of an ATEO from 2017 through 2025 and were treated as covered employees under prior law, and any employee of an ATEO in tax years beginning after December 31, 2025.
• Retroactive Protection: The IRS intends for proposed regulations to apply prospectively. As a result, tax years beginning before the issuance of final regulations will generally not be penalized under the updated framework.

Volunteer Exception (Limited Hours, Limited Services and Nonexempt Funds)

A major focus of Notice 2026-36 is the protection of individuals who donate their time to nonprofit organizations. Until final regulations are issued, ATEOs and related organizations may continue to rely on the following exemptions:

• Limited Hours/Limited Services: Individuals who provide volunteer services and whose compensated hours (if any) fall below forthcoming regulatory thresholds will generally not be treated as covered employees.
• Nonexempt Funds: Similarly, individuals whose compensation is paid entirely from nonexempt funds (e.g., funds not derived from the ATEO or certain related organizations) may also qualify for exclusion.

The impact of these proposed changes means that board members, advisors, and hands-on volunteers who are not substantive paid employees of the tax-exempt entity will not trigger the 21% excise tax under IRC Section 4960 on their compensation packages or benefits. The ATEO — not the individual — is responsible for the tax, which is reported on Form 4720.

Action Steps for Tax-Exempt Organizations

While the IRS and Treasury intend to formalize these parameters in future proposed regulations, ATEOs should use this transition period opportunity to review and strengthen their compensation and governance practices:

• Review compensation classifications, including stipends, reimbursements, and board payments.
• Document eligibility for individuals who may fall under the limited hours/limited services or non-exempt funds exceptions.