IRS Notice 2026-36 clarifies changes to section 4960

Background

Section 4960 imposes an excise tax on most tax-exempt organizations and their related organizations to the extent that certain highly compensated employees (‘covered employees’) receive remuneration in excess of $1 million or severance payments in excess of certain thresholds. Liability for the excise tax is imposed on the employer(s) of the covered employees.

Expanded definition of covered employee

The One Big Beautiful Bill Act (‘OBBBA’) expanded the scope of section 4960 from applying to a limited group of highly compensated employees to potentially applying to any employee whose compensation exceeds the statutory thresholds.

Notice 2026‑36 provides the government’s current interpretation as to how this expanded definition of a covered employee will apply. Specifically, the Notice clarifies that:

• Individuals employed by an applicable tax-exempt organization (ATEO) in taxable years beginning after Dec. 31, 2016, and on or before Dec. 31, 2025, are treated as covered employees only if they were treated as covered employees under prior law.
• For tax years beginning after Dec. 31, 2025, any employee of an ATEO may be treated as a covered employee unless an exception applies.

The Notice also includes examples to illustrate how these changes apply in practice. In one example, an employee who was among an ATEO’s five highest compensated employees continues to be treated as a covered employee in all future years, consistent with the ‘once a covered employee, always a covered employee’ rule. By contrast, employees who were not covered employees under prior law–either because they were not in the top five or qualified for an exception as discussed below–are not treated as covered employees solely due to prior service. However, if such individuals are employed by the ATEO in a post-2025 tax year, they will generally be treated as covered employees going forward unless an exception applies.

Covered employee exceptions

Current regulations provide three volunteer exceptions to the definition of a covered employee: limited services, limited hours and nonexempt funds. These exceptions generally exclude certain employees of related non-ATEOs from being treated as a covered employee if they provide services as an employee to a related ATEO and meet certain conditions.

Notice 2026-36 confirms that the forthcoming regulations are expected to include covered employee exceptions for limited hours and nonexempt funds, but not a limited services exception, as it is no longer relevant under the expanded definition.

Until proposed regulations are issued, organizations may rely on the Notice and the following exceptions in the current regulations, explained below, to determine their covered employees for tax years beginning after Dec. 31, 2025.

• Limited hours exception–Neither the ATEO nor any related ATEO pays remuneration to the individual for services rendered to the ATEO. In addition, the individual spends no more than 10% of his/her total work hours for the ATEO and its related ATEOs. The current regulations also set forth a safe harbor when the total hours expended for the ATEO and all related ATEOs do not exceed 100 hours.
• Nonexempt funds exception–Over a two-year testing period, neither the ATEO, any related ATEO nor any taxable organization controlled by the ATEO pays remuneration to the individual for services rendered to the ATEO. In addition, no related organization that pays remuneration to the individual may provide services for a fee to the ATEO, any related ATEO or any taxable organization controlled by the ATEO. Finally, the individual spends less than 50% of his/her total work hours for the ATEO and its related ATEOs.

The IRS has requested comments on the scope and operation of the anticipated exceptions, with written submissions due by Aug. 4, 2026.

Applicability date

The Notice indicates that proposed regulations are expected to apply prospectively to taxable years beginning after final regulations are issued.