Tax Insight

Forthcoming Section 4960 regulations will address expanded covered employee definition

Insight
5 minute read
June 09, 2026

What happened?

The IRS and Treasury on June 5 issued Notice 2026-36, announcing their intent to issue proposed regulations under Section 4960 addressing the effective date of the One Big Beautiful Bill Act (OBBBA) amendment and proposing exceptions to the “covered employee” definition. The notice also solicits public comments on these matters.

Under prior law, “covered employee” was limited to an applicable tax-exempt organization’s (ATEO) five highest-compensated employees. OBBBA expanded this definition to generally include any current employee or former employees, effective for tax years beginning after December 31, 2025. The exceptions are anticipated to be similar to the limited hours and nonexempt funds exceptions in the existing Section 4960 regulations.

The notice provides favorable transition relief: for tax years beginning on or before December 31, 2025, prior law continues to apply in determining whether an individual became a covered employee. As a result, a former employee who was not a covered person under the prior law generally will not become one solely because of the expanded definition.

Why is it relevant?

The expanded definition could significantly increase the number of individuals that ATEOs must track for Section 4960 purposes. While the tax generally applies only when covered employee remuneration exceeds $1 million or when an excess parachute payment is made, the shift from a “top five” framework to a potentially all-employee framework could require changes to compensation tracking, related-organization data gathering, and Form 4720 compliance processes.

Until proposed regulations are issued, ATEOs can rely on the anticipated rules described in the notice, including the effective-date interpretation and the anticipated limited hours and nonexempt funds exceptions.

Actions to consider

Tax-exempt organizations may want to:

review historical covered employee determinations for tax years beginning after December 31,2016 and on or before December 31, 2025;
identify employees who may become covered employees for tax years beginning after December 31, 2025;
reassess arrangements involving employees of related taxable or non-ATEO organizations who perform services for an ATEO;
evaluate whether limited hours or nonexempt funds exceptions may apply and whether positions are sufficiently supported;
update Section 4960 compliance processes, including compensation aggregation across related organizations;
model potential excise tax exposure under the expanded definition; and
submit comments by August 4, 2026, particularly on how the limited hours and nonexempt funds exceptions should be adapted and whether they should apply to officers.