Interim Guidance on EO Excess Comp Excise Tax

Notice 2026-36 provides interim guidance that ATEOs can use when applying the Section 4960 excise tax after the OBBBA expanded the definition of a covered employee for taxable years beginning after Dec. 31, 2025.

Until proposed regulations are issued, ATEOs can rely on the rules outlined in the notice, including the definition of covered employee for taxable years beginning after Dec. 31, 2025, while continuing to apply the prior definition for taxable years beginning before Jan. 1, 2026. Regulations implementing the OBBBA changes will not apply to taxable years beginning before the date that final regulations are issued.

Background

Section 4960 generally imposes an excise tax on remuneration in excess of $1 million paid to a covered employee of an ATEO and on excess parachute payments. Before the OBBBA amendment, a covered employee generally meant one of the ATEO’s five highest-compensated employees for the taxable year or an individual who had previously been a covered employee for any taxable year beginning after Dec. 31, 2016. Once an individual became a covered employee, that status was permanent. The final Section 4960 regulations issued in 2021 included three exceptions to the covered employee rules relevant to identifying the five highest-compensated employees: a limited hours exception, a nonexempt funds exception, and a limited services exception.

The OBBBA changed the Section 4960 covered-employee framework for taxable years beginning after Dec. 31, 2025. As described in Notice 2026-36, the amended statute no longer is limited to an ATEO’s five highest-compensated employees. Instead, the provision applies to any employee or former employee of an ATEO who was a covered employee during any taxable year beginning after Dec. 31, 2016.

Crowe observation

The OBBBA language created uncertainty about whether all individuals with post-2016 employment history might be treated as covered employees beginning in 2026, even if they had never been covered employees under prior law. The notice goes a long way to resolve that uncertainty.

Key provisions of Notice 2026-36

The notice indicates that the proposed regulations are expected to provide that:

• The broader covered-employee definition applies only for taxable years of an ATEO beginning after Dec. 31, 2025.
• Pre-2026 years continue to be tested under prior law, including when determining whether a former employee had already become a covered employee before 2026.
• An individual with pre-2026 service is included only if that person was a covered employee under prior law.
• Any individual who is an employee of an ATEO in a taxable year beginning after Dec. 31, 2025, is a covered employee unless an exception applies.
• Exceptions similar to the current limited hours and nonexempt funds exceptions are expected to be retained.
• The limited services exception is not expected to be retained because it addressed a concern tied to the former top-five methodology.

Crowe observation

The notice provides that ATEOs can rely on the notice now while monitoring the proposed regulations for any changes.

The notice provides examples to illustrate these rules. Under those examples:

• An employee who was a covered employee in 2025 remains covered in 2026.
• A current employee who qualifies for the limited-hours exception is not treated as a covered employee in 2026.
• A former employee whose only ATEO service occurred before 2026, and who never became a covered employee under prior law, is not covered in 2026 solely because of that earlier service.
• If a former employee who was not a covered employee under the prior rules returns to the ATEO in a post-2025 taxable year and no exception applies, the employee becomes a covered employee for that year and all future years.

Looking ahead

The notice resolves a significant transition question by confirming that the OBBBA amendment does not automatically sweep in every individual who worked for an ATEO after 2016. At the same time, the Section 4960 analysis required is substantially expanded for post-2025 years because current employees generally become covered employees without regard to whether they are among the five highest compensated employees.

Now that interim guidance has been issued, ATEOs should identify current employees whose remuneration or parachute payments might trigger the tax under the broader post-2025 rule and separate former employees who were covered employees under prior law from individuals whose pre-2026 service never resulted in covered-employee status. ATEOs also should consult their tax advisers to evaluate whether shared service personnel might qualify for a limited hours or nonexempt funds exception and review deferred compensation, severance, and parachute arrangements for potential Section 4960 exposure.