IRS Notice 2026-36, Notice of Intent to Issue Regulations Under Section 4960, June 5, 2026

The Internal Revenue Service (IRS) and the Department of the Treasury have recently signaled a significant shift in the regulatory landscape governing excise taxes on excess compensation for applicable tax-exempt organizations (ATEOs). Through Notice 2026-36, the Treasury Department and the IRS have announced their "intent to issue proposed regulations under section 4960 of the Internal Revenue Code (Code) pertaining to the tax on excess tax-exempt organization executive compensation." This notice is a direct response to the legislative changes introduced by the One, Big, Beautiful Bill Act (OBBBA), specifically Section 70416 of Public Law 119-21.

The Legislative Catalyst for Regulatory Revision

The primary impetus for this notice is the fundamental expansion of the "covered employee" definition. Under the previous framework established by the Tax Cuts and Jobs Act of 2017, the excise tax under section 4960 was effectively limited to a subset of highly compensated individuals. Specifically, the prior definition of a covered employee was restricted to "any employee (including any/or any former employee) of an ATEO if the employee (1) is one of the five highest-compensated employees of the ATEO for the taxable year, or (2) was a covered employee... for any preceding taxable year."

However, the OBBBA has fundamentally altered this scope. For "taxable years beginning after December 31, 2025," the definition now encompasses "any employee of an ATEO (or any predecessor of an ATEO) and any former employee of an ATEO (or its predecessor) who was such an employee during any taxable year beginning after December 31, 2016." As the Notice clarifies, "after the OBBBA, the definition of covered employee in section 4960 is no longer limited to an ATEO’s five highest-compensated employees."

The Substantive Rules for Post-OBBBA Covered Employees

In Section 4.01, the Notice references specific rules that the Treasury Department and the IRS intend to codify in forthcoming regulations. To understand what these rules entail, one must look to the interpretation provided in Section 3 of the Notice, which defines exactly who will be captured under the expanded definition for taxable years beginning after December 31, 2025.

According to the Notice, the amended definition of covered employee under section 4960(c)(2) will include only:

"Any individual who was an employee of an ATEO in any taxable year beginning after December 31, 2016, and on or before December 31, 2025, if the individual was a covered employee for the taxable year under prior law," and
"Any individual who is an employee of an ATEO in any taxable year beginning after December 31, 2025 (subject to any exceptions provided in future guidance, such as those described in section 4.01 of this notice)."

This effectively creates a two-tiered system for the transition period: individuals who already held "covered" status due to being among the five highest-compensated employees (or predecessors) will retain that permanent status, while every single employee of an ATEO—regardless of compensation level—will become a "covered employee" starting in taxable years beginning after December 31, 2025.

Anticipated Components of Forthcoming Proposed Regulations

The IRS has outlined specific intentions regarding the structure and content of the forthcoming proposed regulations. The Treasury Department and the IRS "intend to issue proposed regulations... revising the section 4960 regulations by removing references to an ATEO’s five highest-compensated employees and making conforming changes."

While the definition is broadening, the IRS does not intend to strip away all protections. It is anticipated that the forthcoming regulations will "provide covered employee exceptions for limited hours and nonexempt funds similar to those in section 53.4960-1(d)(2)(ii) and (iii)." However, practitioners should note that a key exception will be eliminated. The IRS does not intend to provide a "limited services exception to the amended definition of covered employee because the concern that motivated that exception—displacement of an employee who would otherwise have been one of the five highest-compensated employees of the ATEO—is no longer relevant."

Reliance on Notice Interpretations Pending Final Regulations

For tax professionals managing compliance for applicable tax-exempt organizations (ATEOs), a critical question arises: can taxpayers rely on these interpretations before the proposed regulations are formally released? The Notice provides an affirmative answer to this concern.

Section 5.01 of the Notice explicitly states that "Until the forthcoming proposed regulations are issued, ATEOs may rely on the rules described in section 4.01 of this notice that are anticipated to be included in the proposed regulations." This includes reliance on the Treasury's interpretation regarding the expanded definition and the continued application of the limited hours and nonexempt funds exceptions for the transition period.

As we await the formal issuance of the proposed regulations, tax professionals must prepare for a significant compliance shift where nearly all employees—and certain former employees—may fall under the regulatory umbrella of section 4960.

Prepared with assistance from LM Studio google/gemma-4-26b-a4b.