The Hidden Tax Liabilities Under the New OBBBA Rules

The One Big Beautiful Bill Act (OBBBA) created many significant changes to the tax code when it was signed into law last summer. The act’s deceptively simple modification to IRC 4960, which imposes an excise tax on certain excess compensation, impacts tax-exempt organizations. The OBBBA expands the pool of qualifying employees that might trigger this tax, and while the IRS has indicated intention to issue formal guidance, the AICPA has recently requested interim relief for navigating these changes in the near term.

IRC 4960 imposes an excise tax of 21% on remuneration exceeding $1,000,000, and certain “golden parachute payments” paid to “covered employees” of Applicable Tax Exempt Organizations (ATEO). First introduced by the Tax Cuts and Jobs Act of 2017 (TCJA), this provision seeks to bring parity with for-profit organizations who are unable to deduct compensation over $1,000,000 per employee each year. Crucially, the combined remuneration paid by the ATEO and its related organizations may trigger the thresholds, and related for-profit organizations can find themselves with a 4960 tax liability. Originally, only the top five highest compensated employees in a given year, or employees who had been such in the past, were considered covered employees. The OBBBA broadens the definition to nearly all employees. 

Importantly, status as a covered employee does not sunset. A covered employee of an ATEO who goes on to accept employment at a related organization, whether or not tax exempt, even years later, can trigger the excise tax for their new employer. The AICPA is requesting guidance and relief in the following scenarios in order to bring clarity and alleviate the burden of tracking all such employees:

• Fiscal year ATEOs: Previously the IRS issued explicit guidance on TCJA that fiscal year ATEOS were to base the tax on calendar year compensation, and remuneration paid during the fiscal year prior to the implementation date was excluded from tax. The AICPA would like to see equivalent guidance and relief for calculating the tax created by the expansion of the covered employee pool.
• Organizations relying on pre-OBBBA guidance for determining who is a covered employee: IRS regulations permitted excluding as covered employees in certain instances those working limited hours, providing limited services, or compensated with nonexempt funds. These exceptions provided meaningful relief, especially in larger organizations with complex related organization networks. The AICPA requests  that the IRS allow these exceptions to remain in place pending further guidance. 
• De minimis employment creates a covered employee relationship: Expanding the covered employee pool to everyone employed after 2016, regardless of compensation level, retroactively creates large groups of covered employees. This implements a 10 year lookback period, which the AICPA points out creates administratively burdensome employment history tracking obligations. A related non-ATEO might find themselves with an unexpected tax liability arising from an employee’s past relationship with an ATEO. The AICPA asks for interim relief allowing those employed by an ATEO only for a short time or on a very part-time basis to be excluded from the covered employee pool.
• Finally, the AICPA requests explicit relief where an employee of a related organization providing traditional volunteer services to an ATEO might create an unintentional covered employee relationship with an ATEO.

The tax on excess compensation continues to be top of mind for many exempt organizations, and the changes brought about in 2025 make awareness of this tax and planning around it even more critical. If you have questions as to how this tax modification impacts your organization, or would like to discuss planning around it, reach out to our team!