In Notice 2026-36, released on June 5, 2026, Treasury and the IRS announced that forthcoming proposed regulations under IRC Section 4960 would align the existing regulations with the One Big Beautiful Bill Act's (OBBBA) changes expanding the definition of "covered employee" to all applicable tax-exempt organization (ATEO) employees.

Background

IRC Section 4960 generally imposes an excise tax on any ATEO, related person or governmental entity that pays a "covered employee" over $1 million in a tax year or an excess parachute payment.

Under prior law, covered employees were limited to:

• The five highest-compensated employees for a tax year (with exceptions for limited hours, nonexempt funds and limited services)

or

• Any individual previously identified as a covered employee for tax years beginning after December 31, 2016

The OBBBA amended IRC Section 4960(c)(2) for tax years beginning after December 31, 2025, to include as a covered employee any current or former employee of an ATEO or its predecessor during any tax year beginning after December 31, 2016 (see Tax Alert 2025-1423).

Notice 2026-36

The Notice states that Treasury and the IRS intend to propose regulations that are consistent with the OBBBA changes. Thus, the definition of covered employee would no longer be limited to the five highest-compensated employees and instead would include all employees of an ATEO (and certain former employees). The Notice includes an illustrative example of several employees of an ATEO and whether each of those employees would or would not be a covered employee under the proposed regulations.

The proposed regulations would retain the limited-hours exception (for employees who work less than a specified amount for an ATEO) and the nonexempt-funds exception (for employees who are not paid with funds from an ATEO). The proposed regulations would eliminate the limited-services exception as the concerns prompting this exception no longer apply.

The proposed regulations would also clarify that the new definition of covered employee applies only to ATEO tax years starting after December 31, 2025, while the previous definition remains for tax years before then, and would be used to determine if someone was a covered employee in those earlier years.

When published, the final regulations will apply prospectively, but ATEOs may choose to immediately rely on the Notice.

Request for comments

Treasury and the IRS request comments by August 4, 2026, on:

• How to adapt the limited-hours and nonexempt-funds exceptions to the new definition of covered employee
• Whether the exceptions should apply to officers of the ATEO
• Which additional issues should be addressed in the proposed regulations, if any

Implications

By far, the most important part of the Notice is the reassurance that the limited-hours exception and the nonexempt-funds exception remain available notwithstanding the OBBBA amendments. Some practitioners were concerned that the OBBBA may have eliminated technical underpinnings of these exceptions, so this reassurance is particularly welcome news for the many tax-exempt organizations and related organizations relying on them. In contrast, the elimination of the limited-services exception would be far less impactful. Unlike the other two exceptions, this exception rarely applies.

Another reassuring part of the Notice is the promise that the final regulations, when published, would apply prospectively.

Finally, the Notice makes clear that the OBBBA amendments did not retroactively change prior-year covered-employee status. In other words, if an employee of an ATEO was not a covered employee in a tax year ending on or before December 31, 2025, the OBBBA change to IRC Section 4960(c)(2) does not cause that employee to be a "covered employee" for that tax year. Accordingly, the OBBBA amendments should not require any taxpayer to amend prior-year tax returns.