The expansion of Internal Revenue Code Section 4960 under the One Big Beautiful Bill Act is prompting many nonprofit organizations to take a fresh look at executive compensation and the financial risks tied to it.
When Section 4960 was first enacted, many organizations viewed it as a fairly limited excise tax that would apply only to a small number of highly paid executives. The IRS guidance and final regulations issued under Section 4960 have made clear that the rules can affect a much broader range of compensation arrangements and organizational structures than many nonprofits originally expected. Beginning with tax years after December 31, 2025, the excise tax may apply more broadly to employees earning more than $1 million, rather than being limited primarily to a smaller group of top executives.
As a result, nonprofit finance teams and advisors are no longer focused solely on identifying employees whose salaries exceed $1 million. Deferred compensation, severance arrangements, and payments made through related entities can all create unexpected excise tax exposure, even where annual base compensation appears well below the threshold.
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For many organizations, Section 4960 is evolving from a narrow compliance issue into a broader budgeting and financial planning concern.
Understanding Where Exposure Can Arise
One of the biggest challenges under Section 4960 is determining what compensation actually counts toward the excise tax threshold.
In addition to salary and bonuses, the rules may pull in vested deferred compensation, retention incentives, and certain taxable fringe benefits. That means an employee who normally falls below the threshold could still trigger excise tax liability because of a large vesting event or separation related payout in a particular year.
Deferred compensation arrangements have become an especially important area of focus. Supplemental executive retirement plans, long term incentive arrangements, and retention programs can create significant spikes in taxable remuneration once benefits vest.
The aggregation rules add another layer of complexity. Compensation paid by related organizations, taxable subsidiaries, or affiliated entities may need to be combined when calculating whether the threshold has been exceeded. For larger nonprofit systems operating across multiple entities, gathering and coordinating that information can be far more difficult than many initially anticipated.
In addition, once an individual becomes a covered employee under Section 4960, the individual generally remains a covered employee permanently, which can extend excise tax exposure well beyond the year in which the employee first exceeds the threshold.
Budgeting for Excise Tax Liability
Unlike income taxes that fall on the employee, the Section 4960 excise tax is paid directly by the employer organization. Nonprofits that operate with tight margins, donor restrictions, or grant based funding may find that even relatively modest excise tax liability creates meaningful budget pressure.
The problem is not simply the amount of tax itself, but the unpredictability of when liability may arise. A single executive departure, a vesting event, or large deferred compensation payout can dramatically increase remuneration in a single year.
That unpredictability has pushed many organizations to look more closely at compensation modeling. Annual salary figures alone often do not tell the full story, particularly when deferred compensation arrangements, retention incentives, or separation payments exist.
Many finance departments are now incorporating a Section 4960 analysis into annual budgeting and forecasting discussions rather than treating it as a year end reporting exercise.
Reassessing Compensation Structures
The expanded rules are also causing some nonprofits to reconsider whether existing compensation arrangements remain financially efficient.
Deferred compensation has become a particular area of concern because vesting events can create major spikes in taxable remuneration. In some cases, organizations are exploring whether compensation can be spread more evenly across multiple years to reduce unexpected spikes.
Separation arrangements deserve similar attention. Section 4960 applies not only to compensation above the $1 million threshold, but also to certain excess parachute payments tied to an employee’s separation from service. As a result, employment agreements with accelerated vesting provisions or large severance payments are drawing increased attention.
Many nonprofits are taking a harder look at compensation paid through affiliated entities. Once those payments are aggregated, compensation that initially appeared below the threshold can trigger excise tax exposure once the payments are aggregated together.
For most nonprofits, the goal is not necessarily to eliminate excise tax exposure altogether. The bigger challenge is understanding when liability may hit and how compensation decisions may affect long term financial planning.
Administrative and Governance Considerations
The impact of Section 4960 extends beyond the excise tax itself. In many organizations, payroll, finance, human resources, and legal departments now have to work together much earlier in the compensation planning process. Tracking deferred compensation schedules, historical employment arrangements, and compensation paid across multiple entities can also create administrative challenges that many nonprofits did not anticipate.
Those issues are pushing many nonprofits to involve outside compensation consultants, benefits counsel and tax advisors earlier in the process, particularly when negotiating executive employment agreement or evaluating separation agreements.
Looking Ahead
As nonprofits continue adapting to the expanded Section 4960 rules, executive compensation planning is becoming more closely tied to broader financial risk management.
Organizations that begin modeling potential exposure early, review compensation structures carefully, and improve coordination across departments will likely be in a stronger position to manage both compliance obligations and long-term financial impact.
The broader lesson is that executive compensation can no longer be viewed in isolation. For many nonprofits, Section 4960 has become an ongoing operational and financial planning issue that will continue influencing compensation strategy well beyond the next filing cycle.
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Andrew Dorado is Senior Counsel at Liebert Cassidy Whitmore, where he advises nonprofits, particularly in high-cost markets like Los Angeles and the Bay Area, on how to navigate growing compensation pressures while managing increased tax exposure.
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