Nonprofit Executive Compensation in 2026
Nonprofit executive compensation has entered a new era of scrutiny. The One Big Beautiful Bill Act (OBBBA), enacted in July 2025, fundamentally expanded the application of the excise tax on excess compensation paid by tax-exempt organizations. On June 5, 2026, the Treasury Department and IRS issued Notice 2026-36, announcing their intent to issue proposed regulations addressing these significant changes .
For nonprofit boards and executives across Virginia and Washington DC, understanding these new rules is essential. The expansion from a narrow “top five” framework to potentially any highly compensated employee represents a fundamental shift in how organizations must monitor and document compensation decisions . This guide examines the new requirements, the governance standards that protect organizations, and practical steps for compliance.
Understanding IRC Section 4960: The Foundation
The Original Framework
Section 4960 of the Internal Revenue Code, enacted as part of the Tax Cuts and Jobs Act in December 2017, imposes an excise tax equal to the corporate tax rate (currently 21%) on remuneration in excess of $1 million or any excess parachute payment paid to a “covered employee” of an applicable tax-exempt organization (ATEO) .
Under the original statute, the term “covered employee” was limited to an ATEO’s five highest-compensated employees for the current taxable year or any prior taxable year beginning after December 31, 2016 . Final regulations released in January 2021 provided important exceptions to covered employee status—including the “limited hours,” “nonexempt funds,” and “limited services” exceptions—designed to prevent inadvertent application of the excise tax to employees of related organizations who perform limited or temporary services for the ATEO .
The OBBBA Expansion
The OBBBA, signed into law on July 4, 2025, significantly expanded the definition of “covered employee.” For taxable years beginning after December 31, 2025, the term “covered employee” now means any employee or former employee of an ATEO, not just the five highest-compensated employees . This means that the excise tax can now apply to remuneration above $1 million paid to any employee of a tax-exempt organization—a significant broadening of the tax’s reach.
IRS Chief Executive Officer Frank J. Bisignano stated: “The new law strengthens the accountability of tax-exempt organizations by expanding tax compliance requirements for certain organizations paying excessive compensation and excess parachute payments to their executives. It broadens the scope of tax from a limited group of executives to potentially any highly compensated employee” .
Notice 2026-36: Key Guidance for Nonprofits
Effective Date Interpretation
Notice 2026-36 addresses several key issues relevant to ATEOs navigating this transition. The Treasury Department and the IRS interpret the OBBBA’s effective date provision to broaden the definition of covered employee only for taxable years beginning after December 31, 2025, while retaining the prior, narrower definition for earlier years .
Accordingly, the expanded definition includes only:
Any individual who was a covered employee under prior law for a pre-2026 taxable year, and
Any individual who is an employee of an ATEO in any taxable year beginning after December 31, 2025 (unless a covered employee exception applies) .
Without this guidance, there would have been uncertainty as to whether former employees who had been employed by an ATEO in any taxable year beginning after December 31, 2016 would automatically be considered covered employees for post-2025 taxable years, even if they had not been among the five highest-compensated employees in years when the earlier covered employee definition had been in effect .
Preservation of Limited Hours and Nonexempt Funds Exceptions
The Notice confirms that the forthcoming proposed regulations would provide exceptions from the definition of “covered employee” similar to the “limited hours” and “nonexempt funds” exceptions to the definition of “highest-compensated employee” in the existing regulations .
These exceptions were originally adopted to address situations where employees of non-ATEO-related organizations perform limited or temporary services for the related ATEO while receiving no compensation from the ATEO . The Notice acknowledges that with the elimination of the concept of highest-compensated employee from the statute, the exceptions need to be adjusted to remain applicable under the new framework .
Elimination of the Limited Services Exception
The Notice indicates that the proposed regulations will not retain the “limited services” exception because the concern that motivated it—displacement of an employee who would otherwise have been one of the five highest-compensated employees—is no longer relevant under the broadened definition of covered employee .
Prospective Application
The proposed regulations are anticipated to be prospective and would not apply to taxable years beginning before the issuance of final regulations . Treasury and the IRS request comments on all aspects of this notice by August 4, 2026 .
The Governance Framework: IRC Section 4958 and the Rebuttable Presumption
While Section 4960 addresses the excise tax on excess compensation, Section 4958 governs “excess benefit transactions” and provides the governance framework that protects both organizations and executives.
Understanding Excess Benefit Transactions
Section 4958 applies to public charities and social welfare organizations exempt under IRC Sections 501(c)(3) and 501(c)(4) . It does not apply to private foundations, which are governed by the self-dealing rules under IRC Section 4941.
A “disqualified person” for purposes of Section 4958 includes any person who was in a position to exercise substantial influence over the affairs of the organization at any time during the five-year period ending on the date of the transaction . This typically includes the CEO, CFO, COO, and other senior executives with meaningful authority over organizational finances or operations.
An “excess benefit transaction” is any transaction in which an economic benefit is provided by the organization to a disqualified person and the value of the benefit exceeds the value of the consideration received by the organization . For compensation, this means the total compensation paid—including salary, bonuses, deferred compensation, fringe benefits, and any other economic benefits—exceeds the fair market value of the services the executive provides.
The Excise Tax Consequences
The excise tax consequences for excess benefit transactions are significant :
The disqualified person pays a 25% excise tax on the excess benefit
If the excess benefit is not corrected within the taxable period, an additional 200% excise tax applies
Organization managers who knowingly participate in an excess benefit transaction may be subject to a separate $20,000 excise tax per transaction
The Rebuttable Presumption of Reasonableness
The practical defense for organizations and executives is the rebuttable presumption of reasonableness. An organization that follows specific procedures before paying compensation shifts the burden of proof to the IRS, which must then demonstrate that the compensation was not reasonable .
To establish the rebuttable presumption, an authorized body of the organization (such as a compensation committee of independent directors) must :
Ensure independence – The members of the decision-making body must not have a conflict of interest with respect to the interested director or the transaction
Obtain comparable data – The decision-making body must review compensation levels of similar positions at organizations of comparable size and scope within the same geographic region and sector
Document the process – The decision-making body must concurrently make its determination and record in detail how the decision was made, including the supporting data sources, in meeting minutes
When these steps are followed, it creates a rebuttable presumption that the compensation is reasonable, which shifts the burden of proof to the IRS if questions arise later .
Virginia and DC Considerations
Virginia Nonprofits
Virginia nonprofits face unique considerations regarding executive compensation. For organizations subject to Virginia’s sales and use tax exemption requirements, administrative costs—including salaries—must not exceed 40% of annual gross revenue . This creates an additional constraint on compensation levels for organizations seeking to maintain their exemption.
Virginia also has specific rules for state agency executives. The Virginia General Assembly sets salary ranges for directors of independent agencies and requires boards to report compensation criteria and supplement levels to legislative committees at least 60 days before effectuation .
Washington DC Nonprofits
For DC nonprofits, executive compensation must comply with both federal excise tax rules and DC tax exemption requirements. Organizations must maintain their DC tax-exempt status by filing Form FR-164 and renewing as required. DC franchise tax applies to unrelated business income.
The 2026 IRS Enforcement Landscape
New Form 990 Transparency Requirements
The IRS is updating the annual nonprofit tax return, Form 990, to bring more transparency to government contracts, grants, and fiscal sponsorship arrangements. According to IRS Chief Tax Compliance Officer Jarod Koopman, those changes should be ready by the next tax year .
“We want to make sure these entities aren’t utilizing what we consider a privilege and tax benefit to really commit some type of illicit finance or illicit activity,” Koopman said .
IRS Compliance Strategy
The IRS is focusing its enforcement strategy on abuse and illegal activity from tax-exempt organizations, leaning on automation and analytics. Critics of the initiative worry that the agency will be used to go after left-leaning groups or political enemies. Koopman said the goal is to prevent criminal activity—especially domestic and foreign terrorism—from funneling money through tax-exempt groups .
Congressional Oversight
Reps. Lloyd Doggett (D-TX) and Terri A. Sewell (D-AL) have renewed demands that IRS Chief Executive Officer Frank Bisignano answer sixteen outstanding questions about the Administration’s use of the IRS against tax-exempt organizations and their donors. The Members first wrote to Bisignano on April 14, 2026, and have received no response .
The renewed demand follows reports that Treasury Secretary Scott Bessent and his aides are preparing audits, revocations of tax-exempt status, and back-tax and penalty assessments against charitable organizations identified by their perceived opposition to the Administration rather than by any violation of the tax laws .
Practical Steps for Nonprofit Boards and Executives
1. Review Compensation Arrangements
Organizations should review all compensation arrangements for employees who may now qualify as “covered employees” under the expanded definition. This includes not only current employees but also former employees who received compensation in any taxable year beginning after December 31, 2016 .
2. Document the Rebuttable Presumption Process
Ensure that compensation decisions follow the three-step process for the rebuttable presumption of reasonableness:
Use an independent compensation committee
Obtain and review comparable data from organizations of similar size and scope
Document the decision-making process in contemporaneous meeting minutes
3. Analyze Deferred Compensation Arrangements
Section 457(b) plans permit elective deferrals of up to $23,500 in 2025 and provide tax-deferred growth until distribution. Section 457(f) plans allow deferrals beyond the 457(b) limit but require that deferred amounts be subject to a “substantial risk of forfeiture” . Organizations should review these arrangements in light of the expanded Section 4960 rules.
4. Monitor Regulatory Developments
The proposed regulations under Notice 2026-36 will provide additional guidance. Organizations should monitor developments and consider submitting comments during the public comment period, which closes on August 4, 2026 .
5. Consider Qualified Retirement Plan Design
Benefits provided through qualified retirement plans can reduce the compensation that counts toward the excise tax . Organizations should evaluate whether their retirement plan design effectively manages this exposure.
6. Conduct a Compliance Review
Given the increased scrutiny of nonprofit compensation, organizations should conduct a comprehensive compliance review of their compensation practices, including:
Reasonableness of compensation for all senior executives
Documentation supporting compensation decisions
Compliance with Section 4958 and Section 4960 requirements
Governance policies and procedures
How Nova Tax & Accounting Services Can Help
At Nova Tax & Accounting Services, we help nonprofit organizations navigate the complex and evolving landscape of executive compensation compliance. Our team provides:
Form 990 preparation and governance consulting
Internal controls assessment and compensation policy review
Nonprofit audit and assurance services to ensure accurate reporting
Consulting on deferred compensation and retirement plan design
Board training on fiduciary duties and compensation oversight
Our CPAs understand the unique challenges facing mission-driven organizations. We help you maintain tax-exempt status, satisfy IRS requirements, and demonstrate transparency to donors and regulators.
For more information, visit https://novataxservices.com/ or schedule a free consultation.
Additional Resources
For more detailed information on nonprofit executive compensation requirements, consult these official resources: