An M&A transaction can trigger Internal Revenue Code (IRC) Section 280G regulations. Learn more about Section 280G golden parachutes—and the relevant tax considerations—below.
The term golden parachute refers to financial compensation or contracts with key executives and are connected to a transaction or takeover attempt.
While Section 280G is titled Golden Parachute Payments, this isn’t a defined or technical term in the IRC or Treasury regulations. The terms defined in Section 280G are:
Section 280G was initially implemented to prevent abuses in management compensation practices and protect shareholders from management depriving shareholders of transaction gains.
When a company is looking to undergo a transaction that could constitute a change in control, Section 280G is an important consideration. If the company has parachute payments that rise to the level of excess parachute payments, the company won’t get a tax deduction for those excess payments. Additionally, the individual receiving the payments will be subject to a 20% excise tax on the payments received, in addition to other applicable federal and state income taxes.
A parachute payment, as defined in Section 280G, is a compensatory payment made to certain disqualified individuals if both of the following are true:
The term disqualified individual under Section 280G generally includes an employee, independent contractor, or other person providing services for a corporation that falls into one or more of the following groups.
Some common examples of golden parachute payments include the following.
Treasury regulations are tax regulations issued by the IRS. Treasury Regulation Section 1.280G-1 is the only regulation under Section 280G currently. This regulation is formatted as 48 questions with answers and examples of how to apply Section 280G.
In general, there are five types of payments exempt from parachute payment taxes in the 280G regulations.
The 20% excise tax will apply to the parachute payments. The most common way private companies mitigate it is following the process in the Section 280G regulations to obtain shareholder approval of these payments. This generally includes all of the following:
There are also times when obtaining the 75% approval from shareholders may not be possible or practical. For example, when there are several individual shareholders and management doesn’t feel confident enough individuals will approve the payments.
In this case, the individual may benefit from giving up a portion of the payments or having a clawback provision in payment agreements, so they won’t have excess parachute payments.
For example, if a disqualified individual had a base amount of $100, three times the base amount would be $300. If that individual was entitled to $320 of payments, $220 would be subject to the 20% excise tax, which would be $44.
Alternatively, if the individual could give up their rights to $21 of that payment such that the payments received were $299, the excise tax wouldn’t apply, and the individual would end up with more net cash.
Section 280G is a common issue affecting corporations in M&A transactions. The seller, and buyer in cases where retention of key employees is important, will want to ensure the compensatory plans in place for key employees benefit those employees in a way that isn’t subject to an overly heavy tax burden.
Those payments lose value to employees when they’re subject to around 70% tax, assuming the 20% excise tax on top of the 37% federal tax and, for this example, assuming a state tax rate of 13%.
The corporation will have an interest in making sure it’s allowed a tax deduction for any of the payments made.
Parachute payments include those paid to a disqualified individual if such payment is contingent on any of the following conditions.
When a person or group of persons acquires stock that exceeds 50% of fair market value or total voting power of the stock.
This can happen when either:
When there’s a change in ownership of the corporation’s assets that equals or exceeds a third of the fair market value of all corporation assets during a 12-month period.
For private companies, there‘s an option to undergo a shareholder approval process for payments and exempt those payments from Section 280G. This requires each of the following:
A buyer usually cares about Section 280G during due diligence for the following reasons:
For guidance exploring Section 280G golden parachute guidelines and requirements, reach out to your Moss Adams professional.
You can find additional resources at our M&A Tax Services webpage.