Section 70416 of the One Big Beautiful Bill Act (OB3) significantly broadens the reach of the §4960 excise tax on excess compensation paid by applicable tax-exempt organizations (ATEOs) and their related organizations. The change applies to taxable years beginning after December 31, 2025. On June 5, 2026, the U.S. Department of the Treasury and the IRS issued Notice 2026-36 (IR-2026-73), announcing their intent to issue proposed regulations implementing the change, providing an interim reliance framework, and soliciting public comments by August 4, 2026.
The change is especially important for tax-exempt hospitals, health systems, universities, and other large exempt organizations, where compensation above $1 million may extend beyond a small group of senior executives and where complex affiliated structures result in additional compliance challenges.
What Changed
Section 4960 imposes a 21% excise tax on an ATEO and its related organizations for remuneration paid to a “covered employee” in excess of $1 million in a taxable year or for any excess parachute payment. The tax falls on the employer, not the employee. Before the OB3, the covered employee group was generally limited to an ATEO’s five highest-compensated employees for any taxable year beginning after December 31, 2016, with covered employee status permanent once attained.
The OB3 removed the five-highest limitation. For taxable years beginning after December 31, 2025, the covered employee analysis is no longer limited to the ATEO’s five highest-compensated employees; any employee whose remuneration or parachute payment brings the employee within §4960 may become a covered employee. The $1 million threshold and parachute payment rules are unchanged—only the population of employees whose compensation can trigger the tax has expanded.
Notice 2026-36 clarifies the effective date of the expanded definition, which the forthcoming proposed regulations are anticipated to adopt. Under the notice, the amended definition of covered employee includes only:
- Any individual who was an employee of an ATEO in any taxable year beginning after December 31, 2016, and on or before December 31, 2025, if the individual was a covered employee for that year under prior law; and
- Any individual who is an employee of an ATEO in any taxable year beginning after December 31, 2025 (subject to any exceptions provided in future guidance, such as the limited hours and nonexempt funds exceptions described in the notice).
Importantly, the notice’s interpretation avoids a full retroactive sweep of an organization’s historical workforce. An individual employed before 2026 who was never one of the ATEO’s five highest-compensated employees under prior law does not become a covered employee solely by reason of that pre-2026 employment. For anyone other than a legacy covered employee under prior law, status must be newly attained in a taxable year beginning after December 31, 2025, and whether attained under prior law or the expanded definition, covered employee status, once obtained, is permanent.
Exceptions—& One That Is Going Away
The existing §4960 regulations provide “limited hours” and “nonexempt funds” exceptions designed primarily for employees of related taxable organizations who perform limited or temporary services for an ATEO without receiving compensation from it, e.g., a for-profit executive who serves as an uncompensated officer or director of a related foundation. Notice 2026-36 permits ATEOs and their related organizations to rely on these two exceptions, adapted to the post-OB3 definition of covered employee, until further guidance is issued, and Treasury and the IRS have indicated the forthcoming proposed regulations are expected to retain them.
In contrast, the forthcoming proposed regulations are not expected to retain the “limited services” exception, which existed only to prevent minimally compensated employees from displacing others in the five-highest-compensated group (displacement is a concern the OB3 renders moot). Organizations that have factored that exception into their analysis should revisit it. Treasury and the IRS have also specifically requested comments on whether the limited hours and nonexempt funds exceptions should apply to officers of an ATEO, an important issue for organizations with shared or uncompensated executives.
Why This Matters for Tax-Exempt Hospitals & Other Exempt Organizations
The removal of the five-highest compensated limitation dramatically increases the potential scope of §4960. Under prior law, an ATEO generally could add no more than five new covered employees per year. Going forward, the covered employee population can expand significantly in large organizations, reaching highly compensated physicians, coaches, investment professionals, researchers, and other key employees whose total remuneration exceeds the statutory threshold.
For tax-exempt hospitals and health systems, the impact is especially pronounced in the handling of physician compensation. The medical services exclusion under §4960(c)(3)(B) continues to apply. Section 4960(c)(3)(B) excludes from remuneration the portion of any remuneration paid to a licensed medical professional (including a veterinarian) that is for the performance of medical or veterinary services by such professional. A physician compensated solely for clinical care is therefore excluded, regardless of pay level. However, compensation for administrative, executive, teaching, and research duties counts, so for physician-executives, chief medical officers, department chairs, and medical directors, the allocation between clinical and nonclinical services now determines whether the $1 million threshold is crossed. Under prior law, that allocation mattered for only a handful of individuals; now it matters for every highly compensated physician with mixed duties. Hospitals should revisit whether their employment agreements, time records, compensation committee materials, and allocation methodologies adequately support the clinical/nonclinical split.
Related-organization complexity. Remuneration is aggregated across an ATEO and its related organizations (including parents, affiliates, supporting organizations, and taxable subsidiaries), with any excise tax liability apportioned among the paying entities. For health systems, this often involves captive professional corporations, management companies, joint operating agreements, and for-profit subsidiaries. Similar dynamics arise at private universities (athletics and endowment operations), large foundations (in-house investment teams), and church-affiliated systems.
Organizational Clients—Nonprofits, Hospitals, Educational Institutions, and Similar Entities ATEOs and their related entities should begin preparing for the expanded rules now. Key steps include:
- Identifying employees who may newly attain covered employe status in taxable years beginning after December 31, 2025;
- Reviewing medical-services allocation methodologies, time records, employment agreements, severance arrangements, and deferred compensation plans;
- Assessing related-organization compensation and the availability of the limited hours and nonexempt funds exceptions; and
- Updating compliance processes for tracking covered employees and Form 4720 reporting.
State & Government Entities—Including Dual-Status Entities. Governmental entities are not automatically exempt from §4960. Section 4960(c)(1)(C) includes organizations whose income is excluded from taxation under §115(1), so public hospitals, state universities, and other governmental units or instrumentalities that rely on §115(1) may be ATEOs. Dual-status entities with §501(c)(3) determination letters may also be ATEOs.
By contrast, under the existing final regulations, a governmental entity that does not rely on §115(1) and does not have a §501(c)(3) determination letter generally is not an ATEO, even if its income is not otherwise subject to federal income tax. Governmental and dual-status entities should confirm the basis for their tax treatment, evaluate their ATEO status, and consider whether they may have related-organization exposure.
Individuals. Although the §4960 excise tax is imposed on the employer rather than the employee, the expansion will still affect many highly compensated individuals. Executives, physicians with significant administrative or leadership roles, coaches, investment professionals, and other key employees should understand how the broader covered employee definition may influence compensation design, severance negotiations, deferred compensation arrangements, and allocation of clinical vs. nonclinical duties.
Where Things Stand
Treasury and the IRS indicated that the forthcoming proposed regulations are anticipated to (1) codify the effective-date rules described in Notice 2026-23, (2) retain the limited hours and nonexempt funds exceptions in adapted form, (3) eliminate the limited services exception, and (4) potentially address other matters, including issues reserved in the existing §4960 regulations. The proposed regulations are expected to be prospective only, not applying to taxable years beginning before the issuance of final regulations; in the interim, organizations may rely on the rules described in the notice. The notice indicates written comments should be submitted by August 4, 2026.
The statutory expansion is in effect now, but the regulatory framework is still taking shape. This creates a meaningful window for organizations to assess exposure, adjust arrangements, and submit comments.
Forvis Mazars can assist with compliance assessments, modeling potential tax liabilities, evaluating compensation and related-organization structures, and identifying issues for further evaluation as guidance developments occur. If you have questions about the expanded §4960 rules, including compliance implications for your organization or compensation-planning considerations, please reach out to a professional at Forvis Mazars.
The analysis and conclusions presented are general in nature and should not be treated as legal, tax, accounting, or other professional advice regarding any specific organization, individual, transaction, or factual situation. The reader should perform their own analysis and form their own conclusions regarding any specific situation. Further, the author(s)’conclusions may be revised without notice with or without changes in industry information and legal authorities.