The One Big Beautiful Bill Act and Its Impact on IRC Section 4960: What Tax-Exempt Organizations Need to Know

The One Big Beautiful Bill Act (OBBBA) was signed into law on July 4, 2025, introducing extensive changes to the U.S. tax code. Among the changes that are consequential for tax-exempt organizations include the expansion of IRC Section 4960, which governs the 21% excise tax imposed on compensation exceeding $1M or “excess parachute payments”¹ for certain individuals. These changes will take effect after December 31, 2025.

1. Broader Definition of “Covered Employee”

IRC § 4960 currently defines a “Covered Employee” as any employee (or former employee) of an applicable tax-exempt organization that is one of the five highest compensated employees. OBBBA expands the definition to include any current or former employee during any taxable year after December 31, 2016 and removes the requirement of being one of the five highest paid.

2. Expanded Provisions are Effective 2026

Further IRS guidance is expected, but for many tax-exempt organizations, this revision will broaden the list of individuals potentially subject to the 21% excise tax on total compensation exceeding $1M or receipt of “excess parachute payments.”  

3. Governmental Entities Remain Exempt

Governmental employers (e.g., public universities) remain exempt from IRC § 4960. Earlier drafts proposed extending the excise tax to cover governmental entities, but this was removed from the final bill.

Next Steps for Boards and Executives

In the lead-up to updated IRC § 4960 rules taking effect, non-governmental tax exempt organizations would be well served to assess the potential implications.

• Audit Employee Compensation Structures. Identify all current and former employees with total compensation exceeding $1M under the expanded “Covered Employee” definition.
• Review Deferred Compensation and Separation Arrangements. Assess the accrued value for “Covered Employees” under any outstanding deferred compensation arrangements and severance policies to understand potential incremental excise tax exposure and determine if any programmatic changes should be considered to mitigate potential future liability.
• Review and Update Applicable Governance Policies. Revisions to IRC § 4960 may prompt compensation committee discussions on whether its oversight should be expanded to cover all individuals with total annual compensation exceeding the $1M excise tax threshold, as well as organization-wide severance policies. Any revisions could potentially be documented in the compensation committee’s charter and/or compensation policies. The decision factors will vary by organization, including: number of positions affected; operational influence of these positions; cost implications; and current scope of committee oversight.

Final Thoughts

The OBBBA represents a significant shift in the tax landscape for tax-exempt organizations. With the expansion of IRC § 4960, tax-exempt boards should proactively review their compensation programs, policies, and procedures to prepare for full compliance and continue to diligently monitor the evolving regulatory environment.

¹ The term “parachute payment” refers to any compensation contingent on an employee’s involuntary separation where the aggregate value equals or exceeds three times the “base amount,” which is generally defined as the average annual compensation paid to a Covered Employee in the five most recent taxable years prior to the employee's separation. “Excess parachute payments” are the amounts that exceed one times the base amount.

Elaine Yim
Principal

Elaine Yim specializes in tax-exempt executive compensation evaluations ("Intermediate Sanctions" reviews) and provides support on all compensation matters including executive and board compensation program evaluation, annual and long-term incentive structures, and performance measurement guidelines. She participates in an array of client engagements in multiple industries including healthcare, universities, foundations, research institutes, life sciences and technology, among others.