What Is IRC Section 280G and How Does It Impact Golden Parachute Payments?

IRC Section 280G plays a critical role in regulating golden parachute payments—compensation packages granted to executives during corporate takeovers or mergers. These payments often attract scrutiny due to their financial impact and tax consequences for companies and executives alike. Understanding the section’s effect on golden parachute arrangements is essential for organizations managing executive compensation.

Covered Transactions

IRC Section 280G applies to corporate events triggering golden parachute rules, such as mergers, acquisitions, or significant changes in corporate control. These events involve a shift in ownership or voting power, activating compensation agreements designed to protect executives financially. A change in control occurs when an individual or group acquires more than 50% of the fair market value or voting power of a corporation’s stock.

These transactions determine whether golden parachute payments are subject to the 20% excise tax imposed by IRC Section 280G. Excess parachute payments are those exceeding three times the executive’s base amount, which is the average annual compensation over the five years preceding the change in control. Companies must carefully review executive compensation agreements to ensure compliance, often requiring collaboration among legal, financial, and tax professionals.

Payment Thresholds

The payment threshold under IRC Section 280G is three times the executive’s base amount, calculated as the average annual compensation over the prior five years. For example, if the base amount is $500,000, any parachute payment exceeding $1.5 million is subject to the excise tax.

Accurate data compilation is essential to determine the base amount, as payments can include cash bonuses, stock options, and severance packages. Stock options, for instance, are typically valued at their fair market value at the time of the change in control. Missteps in calculating the base or total parachute payments can lead to significant tax liabilities.

Calculating Excise Tax

To calculate the excise tax under IRC Section 280G, companies must identify total parachute payments, which include bonuses, accelerated stock options, and other benefits tied to the corporate change. The excess amount is determined by subtracting the threshold—three times the base amount—from the total parachute payments. This excess is taxed at 20%.

For instance, if an executive receives $2 million in parachute payments and the threshold is $1.5 million, the excess amount of $500,000 results in a $100,000 excise tax liability. This tax, which is non-deductible, can have significant financial and reputational implications for companies.

Shareholder Approval Requirements

Shareholder approval can reduce or eliminate the excise tax under IRC Section 280G. If parachute payments exceed the threshold, corporations may seek approval from disinterested shareholders—those without a financial stake in the payments. Approval requires more than 75% of votes cast.

This process necessitates detailed disclosures to shareholders, including the nature and amount of proposed payments. Companies often prepare comprehensive proxy statements to provide transparency and justify the compensation.

Exceptions for Certain Payments

Certain payments are excluded from being classified as excess parachute payments under IRC Section 280G. Payments deemed “reasonable compensation” for services rendered before or after the change in control may not be subject to the excise tax. Determining reasonableness involves analyzing the executive’s role, responsibilities, and compensation benchmarks within the industry.

Payments under qualified retirement plans, such as 401(k)s or pensions, are also excluded, as they are not contingent on the change in control. Additionally, small de minimis payments that do not materially impact the transaction may be exempt. These exceptions allow companies to structure compensation packages in compliance with regulatory requirements while minimizing tax exposure.