Learn · §4960 Excise Tax
§4960 Excise TaxThe Section 4960 Excise Tax: When Nonprofit Pay Crosses $1 Million
The 21% excise tax on nonprofit pay over $1 million and excess parachute payments — who's a covered employee, what counts as remuneration, and how boards manage the exposure.
Section 4960 of the Internal Revenue Code imposes an excise tax — at the corporate rate, currently 21% — on applicable tax-exempt organizations that pay any “covered employee” remuneration over $1 million in a year, or that pay an “excess parachute payment” on separation. Unlike §4958 intermediate sanctions, which fall on individuals, the §4960 tax is owed by the organization itself, and it applies even when the compensation is entirely reasonable.
That last point surprises boards: §4960 is not a penalty for excessive pay. It is a flat surcharge Congress added in 2017 to parallel the for-profit world's $1 million deduction limit. An organization can run a flawless §4958 process, document a bulletproof comparability file — and still owe the tax on every dollar of remuneration above $1 million.
Who is a “covered employee”?
The five highest-compensated employees of the organization for the taxable year, plus anyone who was a covered employee in any prior year beginning after December 31, 2016. Coverage is permanent — once covered, always covered — so the list only grows. Note the threshold for being a covered employee is being in the top five, not earning $1 million; an organization whose top earner makes $400,000 has covered employees, it just doesn't owe tax yet.
What counts as remuneration?
Wages for income-tax withholding purposes, plus amounts deferred under a §457(f) plan when they vest — which is the trap. A retention arrangement that vests a decade of deferred compensation in a single year can spike a covered employee's remuneration past $1 million in that year even though annual pay never approached it. Remuneration paid by related organizations is aggregated. Compensation paid to licensed medical professionals for the direct performance of medical or veterinary services is excluded from the $1 million test — the exclusion that keeps many hospital systems' physician pay out of scope (their administrative pay still counts).
What is an excess parachute payment?
Separation payments that equal or exceed three times a covered employee's “base amount” (roughly, five-year average compensation) trigger the tax on the amount above one times the base — a separate prong with no $1 million threshold. Severance arrangements for long-tenured executives at mid-sized organizations can trip this prong at total figures well below $1 million, which is why exit packages deserve §4960 modeling before they're signed, not after.
How should boards manage §4960 exposure?
Three practices cover most situations. Know your covered-employee roster — maintain the running list, because it is cumulative and includes departed employees. Model vesting events before adopting them — deferred compensation and retention plans should be designed with the vesting-year remuneration spike in view, sometimes by staging vesting across years. Model separations the same way — test any severance against the three-times-base-amount trigger before terms are offered. The tax is reported and paid on Form 4720; budgeting for a known liability is far better than discovering it at filing.
Frequently asked questions
Does §4960 apply to my organization?
It applies to applicable tax-exempt organizations — including 501(c)(3)s and 501(c)(4)s — that have covered employees. Every organization with employees has a top-five list; the tax is owed only when the remuneration or parachute triggers are met.
Is pay over $1 million unreasonable per se?
No. Reasonableness is a §4958 question answered by comparability data. §4960 is a tax on the organization that applies regardless of reasonableness — the two analyses run in parallel, and large organizations routinely handle both.
Who pays the tax — the executive or the organization?
The organization (allocated among related organizations that paid the remuneration). The executive owes nothing under §4960.
Can we avoid the tax by splitting pay across related entities?
No — remuneration from related organizations is aggregated precisely to prevent this, and the tax is apportioned among the payers.
Educational information, not legal or tax advice — §4960 calculations should be run with the organization's tax advisor. CauseComp's executive benchmarks show where pay falls in the market that context comes from; the §4960 modeling belongs in your annual comp planning alongside it.
Educational content from CauseComp, a service of RB Consulting Services, LLC. Provides data and documentation to support board deliberations — not legal advice.