IRS and Treasury to Expand Excise Tax on Nonprofit Compensation Over $1 Million to All Employees

The Internal Revenue Service and the Department of the Treasury issued a notice on June 5 announcing plans to issue proposed regulations that would expand an excise tax on compensation paid by tax-exempt organizations. The tax would apply to any employee receiving more than $1 million in a tax year beginning after December 31, 2025, removing the prior limit that restricted the levy to an organization’s five highest-compensated employees.

Section 4960 of the Internal Revenue Code already imposes the 21 percent excise tax on tax-exempt organizations that pay an employee more than $1 million or make an excess parachute payment.

An excess parachute payment is defined as any amount exceeding three times an employee’s average annual compensation over the most recent five years and is paid upon termination or in connection with a merger or acquisition. Under the new rule, the tax would also reach any former employee who ranked among the top five compensated employees and exceeded the $1 million threshold in any tax year from December 31, 2016, through December 31, 2025.

Taxation of parachute payments remains unchanged.

The notice provides exceptions for individuals who perform only volunteer services for tax-exempt organizations. IRS Chief Executive Officer Frank J. ” The Treasury and the IRS are accepting public comments on the notice until August 4.

The American Institute of CPAs, in a May 1 letter, urged the agencies to issue comprehensive guidance and transition relief, stating that without it “several immediate issues that could disrupt the operations of tax-exempt organizations” would remain unresolved.

Kelsey Mayo, chief of retirement policy and regulatory affairs at the American Retirement Association, said retirement plan professionals who work with tax-exempt employers must be aware of the notice. She added that nonprofits “may have to think more carefully” about how they deliver benefits to executives because payments made through qualified retirement plans can reduce the compensation counted toward the excise tax.