Quick Overview

  • The American Institute of CPAs (AICPA) is urging federal regulators to issue guidance on changes made by last year's One Big Beautiful Bill Act (OBBBA) to Section 4960 of the Internal Revenue Code. The amendment expands the definition of employees subject to a 21% excise tax at tax-exempt organizations, requiring any employee earning over $1 million to pay the tax.
  • Since OBBBA took effect, all employees of applicable tax-exempt organizations are subject to the excise tax, rather than only the top five highest-paid employees. In a letter submitted to the IRS this month, the accounting industry grouprequested transitional relief for these organizations, and asked for clear exceptions for certain specific employees, such as interns or volunteers.
  • "Without this guidance, nonprofit organizations and related entities may face unexpected excise taxes, additional compliance burdens, and financial risks under current law," said Scott Klein, AICPA Senior Manager of Tax Policy & Advocacy, in a statement in a recent AICPA press release.

In-Depth Insights

The Tax Cuts and Jobs Act of 2017imposed a 21% excise tax on tax-exempt organizations that pay remuneration of $1 million or more to any of their top five highest-paid employees. The tax has been effective since the 2018 tax year and also applies to individuals who were covered employees in any preceding tax year.

The original provision has drawn some criticism. Elaine Waterhouse Wilson of West Virginia University College of Law argued in a 2024 article in the Loyola University Chicago Law Journal that the tax unfairly targets nonprofit organizations. Wilson also noted that the provision, as a similar effort to use tax law to constrainfor-profit executive compensation, is flawed, as it instead leads companies to manipulate compensation structures to avoid the tax without actually reducing pay.

"Section 4960 was never truly aimed at regulating excessive compensation, but rather reinforced a harmful narrative about nonprofit wages while raising revenue from an already disfavored sector," Wilson wrote, while also acknowledging that some charity executives are overpaid.

Even if executive compensation itself does not exceed $1 million, certain tax-exempt organizations may still face trouble due to theexcess compensation tax, according to a report by public accounting firm DeanDorton. For example, if a nonprofit pays its president an $800,000 annual salary and contributes $50,000 annually to a deferred compensation plan for ten years, it could face a $63,000 tax bill in the year of vesting, DeanDorton wrote.

The revised Section 4960's definition of covered employees takes effect at the start of the 2026 tax year and retroactively applies to individuals who worked at the organization since the 2017 tax year.

The AICPA, as an organization representing the CPA profession, stated that the amendment creates financial risks and compliance burdens for certain nonprofits and urged the IRS and Treasury to issue new guidance to clarify relevant procedures.

The organization requested transitional relief to prevent the excise tax from applying retroactively to compensation paid before the enactment of the OBBBA amendment.

It also asked the IRS to provide transitional relief through regulatory exceptions to exempt organizations from the law's definition of covered employees. The AICPA warned that without such changes, some organizations may be "forced to make significant adjustments, such as restructuring their workforce, scaling back operations, or even shutting down entirely."

The industry group stated that the definition of covered employees in the amendment requires further clarification.

The AICPA noted that part-time employees or short-term workers, such as interns, could be permanently classified as covered employees if traced back to 2017, potentially subjecting organizations to new indefinite tracking obligations or future excise taxes.

"Without a de minimis exception, these individuals and [applicable tax-exempt organizations] and related entities could face consequences entirely disproportionate to the nature and duration of their services," the AICPA stated.

Finally, the organization called for transitional relief for volunteers who provide services to tax-exempt organizations. The industry group stated that tracking every volunteer who has served an organization since 2017 would impose a "heavy burden" on organizations.