The Internal Revenue Service (IRS) and the Department of the Treasury issued a notice on Friday, announcing their plan to issue proposed regulation concerning taxation on high compensation paid by tax-exempt organizations to employees.
The notice relates to excessive compensation and excess parachute payments, the IRS said in a June 5 statement. Parachute payments are made to key employees when they are terminated or when the business undergoes a merger or acquisition. An excess parachute payment is any such payment that exceeds three times an employee’s average annual compensation for the most recent five years.
Section 4960 of the Internal Revenue Code imposes an excise tax on any nonprofit or tax-exempt organization paying an employee more than $1 million in remuneration in a tax year or an excess parachute payment, according to the notice.
The new rule changes tax applicability regarding excessive compensation.
Prior to the One Big Beautiful Bill Act, taxes on such payments were applicable to a tax-exempt organization’s five highest-compensated employees for a tax year whose compensation exceeded $1 million.
But under the new rule, the excise tax is applicable to any employee whose compensation exceeds $1 million in a tax year beginning after Dec. 31, 2025. The requirement of being among the five-highest compensated employees has been eliminated.
The rule is also applicable to any former employee who was a top-five compensated employee exceeding $1 million for any tax year between Dec. 31, 2016, and Dec. 31, 2025.
There is no change to taxation on parachute payments. Such payments will continue attracting taxes as per existing rules.
The updates also provide certain exceptions regarding people offering volunteer services to tax-exempt organizations.
IRS Chief Executive Officer Frank J. Bisignano said the latest rule “strengthens the accountability of tax-exempt organizations.” The regulation “broadens the scope of tax from a limited group of executives to potentially any highly compensated employee.”
The Treasury and the IRS are inviting public comments on the notice until Aug. 4.
The notice comes after the American Institute of CPAs (AICPA) recently raised concerns about the implementation of the new regulations.
In a May 1 letter to IRS and Treasury officials, AICPA said there was a need for comprehensive guidance and transition relief given the changes made to the compensation rule.
“We respectfully urge Treasury and the IRS to prioritize the issuance of transition relief to address several immediate issues that could disrupt the operations of tax-exempt organizations,” the letter said.
“Absent timely transition relief, these issues may result in significant and unintended financial exposure for tax-exempt organizations and related entities subject to the section 4960 excise tax.”
Commenting on the latest IRS and Treasury notice, Kelsey Mayo, chief of retirement policy and regulatory affairs at the American Retirement Association (ARA), said that retirement plan professionals who work with tax-exempt employers must be aware of the notice, according to a June 5 statement from the National Association of Plan Advisors, a sister organization of the ARA.
With the changes in Section 4960, nonprofits may have to “think more carefully” regarding how they deliver benefits to their executives, Mayo said.
“Because benefits provided through a qualified retirement plan can reduce the compensation that counts toward the excise tax, advisors, TPAs, recordkeepers, and other plan professionals may have an opportunity to add value to their nonprofit clients by evaluating how their qualified plan design aligns with both their talent strategy and their excise tax exposure,” she said. TPA refers to third-party administrators who provide insurance services.