Treasury and the IRS issued Notice 2026-36 on June 5, 2026, announcing intent to issue proposed regulations under Section 4960 of the Internal Revenue Code. Section 4960 imposes an excise tax on excessive compensation and excess parachute payments made by applicable tax exempt organizations (ATEOs) to their covered employees. The One, Big, Beautiful Bill (OBBB) rewrote the definition of “covered employee,” and the notice tells the tax exempt community how the government intends to interpret that rewrite before formal regulations land.
Counsel advising ATEOs (hospitals, universities, foundations, large 501(c)(3) and 501(c)(4) organizations, and their related entities) should read this notice as a change in the shape of exposure, not a change in the rate.
What the statute did before OBBB
Under prior law, the 21 percent excise tax applied to “excessive” compensation (generally, remuneration over $1 million) and excess parachute payments made to a covered employee. Covered employee was defined narrowly. It captured the five highest compensated employees for the tax year, plus any individual who had previously been a covered employee in any tax year beginning after December 31, 2016. Once tagged, always tagged. But the initial gate was only five people per organization per year.
What OBBB changed
OBBB expanded the covered employee definition. The tax may now apply to any employee of an ATEO with compensation exceeding $1 million in a tax year, or any employee who receives an excess parachute payment. The top five limitation is gone. In the words of IRS CEO Frank J. Bisignano, the statute “broadens the scope of tax from a limited group of executives to potentially any highly compensated employee.”
What Notice 2026-36 does
The notice clarifies how the amended definition of covered employee will operate under the forthcoming proposed regulations. Two categories are included:
First, any individual who was an employee of an ATEO in any tax year beginning after December 31, 2016, and on or before December 31, 2025, if the individual was a covered employee for that tax year under prior law. In other words, the pre OBBB “once covered, always covered” tail is preserved for anyone who was tagged under the old five person rule.
Second, any individual who is an employee of an ATEO in any tax year beginning after December 31, 2025, unless a covered employee exception applies. This is where the expansion lives.
The notice also flags two exceptions that Treasury and the IRS intend to include in the proposed regulations: a limited hours exception and a nonexempt funds exception. Until further guidance issues, ATEOs and their related organizations may rely on both exceptions in applying the post OBBB covered employee definition. These exceptions matter in fact patterns involving affiliated for profit entities, medical or academic staff whose compensation is paid from nonexempt sources, and volunteers whose services blur the employee line.
The proposed regulations are not expected to apply to tax years beginning before final regulations are issued. That timing matters for planning.
Why this matters for tax pros
For counsel and tax advisors on the ATEO side, the compliance surface just got wider. A few points to work through with clients now.
First, reset the inventory. Prior year Section 4960 planning almost always started with identifying the top five. That gate no longer controls. The right first move on every ATEO client is a full compensation review to identify every employee whose total remuneration (including deferred compensation, certain fringe benefits, and amounts treated as paid for Section 4960 purposes) may exceed $1 million in tax years beginning after December 31, 2025. Physician compensation at hospital systems, coach and athletic director compensation at universities, and executive teams at larger 501(c)(3) and 501(c)(4) organizations should all be re examined against the new definition.
Second, model the parachute risk. Excess parachute payments trigger covered employee status independent of the $1 million threshold. Any severance arrangement, change in control provision, or accelerated vesting event at an ATEO now needs a Section 4960 review before it is signed. Counsel drafting or negotiating executive employment agreements for ATEOs should be building parachute analysis into the deal structure, not addressing it after the fact.
Third, use the exceptions carefully. The limited hours and nonexempt funds exceptions are the working tools for managing exposure in shared service and affiliated entity structures. Notice 2026-36 permits reliance on both exceptions until further guidance issues, but the burden to document eligibility sits with the organization. Contemporaneous records of hours worked, source of funds, and allocation methodology should be built into the compensation file for every position where an exception is being claimed.
Fourth, watch the comment window. Treasury and the IRS have requested comments on all aspects of the notice, with a submission deadline of August 4, 2026. If your organization has a fact pattern the exceptions do not cleanly address (particularly around affiliated for profit subsidiaries, joint ventures, or dual employer arrangements), this is the window to raise it. Comment instructions are in the notice.
Finally, plan for the effective date. The proposed regulations will not apply to tax years beginning before final regulations issue, which gives ATEOs time to restructure compensation arrangements before the enforcement clock starts. That runway should be used, not wasted.
THE TTR TAKE
Section 4960 used to be a top five problem. Under OBBB, it is a “anyone over a million” problem, and every ATEO advisor should be reworking their client’s compensation review process before the final regulations land. The August 4 comment window is a real opportunity to shape how the exceptions get written.
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Direct link to the official Internal Revenue Service announcement.