By Ginika Igboke
The Internal Revenue Service (IRS) and the Department of the Treasury have announced plans to issue proposed regulations targeting how high compensation paid by tax-exempt organizations is taxed, particularly focusing on executive pay and termination-related payments.
In a June 5 statement, the IRS said the notice relates to “excess compensation” and “excess parachute payments.” Parachute payments are typically awarded to key employees upon termination or during mergers and acquisitions, and become “excess” when they exceed three times the employee’s average annual compensation over the past five years.
Under Section 4960 of the Internal Revenue Code, nonprofit and tax-exempt organizations are subject to an excise tax if they pay an employee more than $1 million in annual compensation or issue excess parachute payments.
Expanded Scope of the Excise Tax
The proposed changes would significantly broaden the scope of the tax on high earners within nonprofit organizations.
Previously, the tax applied only to the five highest-compensated employees at a tax-exempt organization whose pay exceeded $1 million. Under the updated rule, beginning after Dec. 31, 2025, the excise tax would apply to any employee whose annual compensation exceeds $1 million, regardless of ranking.
The rule would also apply retroactively to certain former employees who were among the top five highest-paid between Dec. 31, 2016, and Dec. 31, 2025, if their compensation exceeded the $1 million threshold.
There are no changes to how parachute payments are taxed, which will continue to be subject to existing rules.
The notice also includes limited exceptions for individuals providing volunteer services to tax-exempt organizations.
IRS Says Changes Improve Accountability
IRS Chief Executive Officer Frank J. Bisignano said the updated framework is intended to improve oversight of nonprofit compensation practices.
The regulation, he said, “strengthens the accountability of tax-exempt organizations” by expanding the reach of the tax from a small group of executives to a broader range of highly compensated employees.
The Treasury Department and IRS are accepting public comments on the proposal until Aug. 4.
Industry Raises Concerns Over Implementation
The announcement follows concerns raised by the American Institute of CPAs (AICPA), which urged regulators to provide clearer guidance and transition relief.
In a May 1 letter, the AICPA warned that without adequate transition measures, nonprofits could face unintended financial consequences.
“We respectfully urge Treasury and the IRS to prioritize the issuance of transition relief,” the group wrote, noting that delays in guidance could disrupt nonprofit operations.
The organization added that unclear implementation could create “significant and unintended financial exposure” for tax-exempt entities.
Impact on Retirement and Benefits Planning
Experts in retirement policy say the new rules may also influence how nonprofits structure executive compensation and benefits.
Kelsey Mayo, chief of retirement policy and regulatory affairs at the American Retirement Association (ARA), said retirement plan professionals working with nonprofit employers should closely review the proposed changes.
She noted that compensation tied to qualified retirement plans could play a role in reducing taxable income under the new framework.
“Because benefits provided through a qualified retirement plan can reduce the compensation that counts toward the excise tax, advisors… may have an opportunity to add value,” she said.
Mayo added that nonprofits may need to reconsider how executive benefits are designed in order to manage both talent retention and potential tax exposure.
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