Federal tax on nonprofit pay above $1 million now reaches every employee, not only the five highest paid
Since the 2026 tax year, the 21 percent excise tax under Section 4960 applies to any employee of a tax-exempt organization paid more than $1 million. An IRS notice in June said how the IRS reads the change and which exceptions organizations may rely on.
Washington. A federal excise tax on nonprofit pay above $1 million now applies to every employee of a tax-exempt organization, not only to its five highest paid. The change, made by section 70416 of Public Law 119-21, the tax and spending law signed July 4, 2025, covers tax years beginning after Dec. 31, 2025. For organizations on the calendar year, it has applied since Jan. 1.
Section 4960 of the Internal Revenue Code, added in 2017, taxes the employer at the corporate income tax rate, now 21 percent, on pay to a covered employee above $1 million in a year and on certain excess parachute payments made when a covered employee leaves. It reaches organizations exempt under Section 501(a), farmers' cooperatives, political organizations and some governmental entities.
Who counts now
Until 2026 a covered employee was one of the organization's five highest paid in a year, and stayed covered for good. The new text makes any employee covered. In Notice 2026-36, published in the Internal Revenue Bulletin of June 22, the Treasury Department and the IRS said they read the change as applying only from 2026 on: a former employee is covered for having worked there before 2026 only if that person was among the five highest paid under the old rule.
The notice said proposed regulations would keep two exceptions from the current rules, for people who work limited hours for the organization and for people paid from funds of a related taxable organization. Organizations may rely on both until the proposal appears. A third exception, for employees paid very little, would be dropped. Comments were due Aug. 4.
What counts as pay
Pay under the law means wages, plus deferred pay counted in the year it vests, and includes pay from related organizations such as a taxable subsidiary. Pay to a licensed doctor or veterinarian for medical services is left out. The tax is reported on Form 4720.
Writing in the Journal of Accountancy on Nov. 1, Andrew Dorado, senior counsel at the law firm Liebert Cassidy Whitmore in Los Angeles, said health systems, universities, research institutions and large social service organizations face the most exposure because they pay people through several related entities. He wrote that boards are reviewing retirement plans, retention agreements and bonus timing, and advised organizations to identify anyone whose total pay could pass $1 million, including in past years back to 2017.
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501c3.help wrote this story from the sources listed with it, not from material an organization sent. Our editors approved it on Nov. 3, 2026. Stories in The Nonprofit Herald are free, and nothing is asked in return. Editorial rules.
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