Treasury and IRS plan rules for expanded excise tax on tax-exempt executive pay

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IRS excise tax on executive pay

Highlights

Treasury and IRS issued Notice 2026-36 on June 5, planning to expand excise tax to any tax-exempt organization employee earning over $1 million or with excess parachute payments.
The revised covered-employee definition will include individuals working at applicable tax-exempt organizations from after Dec. 31, 2016, through Dec. 31, 2025, and after this period unless an exception applies.
Proposed regulations will maintain exceptions for volunteer service, limited hours, and nonexempt funds and will not apply to tax years before the final rules are issued.

Notice outlines broader employee coverage

As announced by the Internal Revenue Service, the Department of the Treasury and the IRS issued Notice 2026-36 on June 5 setting out their intent to propose regulations on excise tax tied to excessive compensation and excess parachute payments at applicable tax-exempt organizations.

The law expands the definition of a covered employee beyond the previous group of the five highest-compensated employees in a tax year. Under the revised framework, the tax may apply to any employee whose compensation exceeds $1 million in a tax year or who receives an excess parachute payment.

IRS Chief Executive Officer Frank J. Bisignano says the new law strengthens accountability for certain tax-exempt organizations by widening compliance requirements for executive compensation. He says the change extends the tax's reach from a limited executive group to potentially any highly compensated employee.

Interim exceptions and sector implications

Notice 2026-36 states that the amended covered-employee definition includes any individual who was an employee of an applicable tax-exempt organization in any tax year beginning after Dec. 31, 2016, and on or before Dec. 31, 2025, if that person was already a covered employee under prior law. It also includes any individual who is an employee of such an organization in any tax year beginning after Dec. 31, 2025, unless an exception applies.

The notice also provides exceptions for individuals who provide volunteer services and who might otherwise be affected by the changes. Until further guidance is issued, applicable tax-exempt organizations and related organizations may rely on the limited hours and nonexempt funds exceptions under the post-OBBB covered-employee definition.

Treasury and the IRS say the forthcoming proposed regulations are expected to include those limited-hours and nonexempt-funds exceptions. The agencies also say the proposed rules are not expected to apply to tax years beginning before final regulations are issued, a point that offers interim planning clarity for nonprofits and related entities.

Our earlier article on Morgan & Morgan’s potential private equity deal via a managed services organization (MSO) model explained how the structure could separate legal casework from business functions like marketing and back-office operations to accommodate outside investment. We noted that, if pursued, the transaction could become a high-profile test of regulatory and ethics constraints around non-lawyer involvement and fee-sharing in the U.S. legal market.

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