Understanding Parachute Payments Under Section 280G
Startup Law ResourcesEmployment Law, Human ResourcesLearn about golden parachute payments under IRC Section 280G, which regulates compensation for executives in corporate changes to protect shareholder interests. 5 min read updated on February 04, 2025
Key Takeaways:
- Section 280G of the Internal Revenue Code restricts excessive “golden parachute” payments, applying excise tax on payments to certain executives during corporate control changes.
- Payments qualify as parachutes if they are contingent on change-in-control events, like acquiring a 50% stake in a corporation or board turnover within a year.
- Common parachute payment types include severance, bonuses, stock options, and continued benefits, with specific exclusions and exceptions.
- Payments must be under three times the average salary of the past five years; excess payments incur a 20% excise tax and lose corporate deductibility.
- S corporations, partnerships, and some shareholder-approved payments may be exempt from 280G limitations.
A “golden parachute” is a payment or benefit made by a corporation to certain executives, managers or others (called “disqualified individuals” by the IRS) when there is a “change in control” of that corporation. Internal Revenue Code Section 280G, also known as the “golden parachute payment rule,” is the federal tax provision that covers these payments.
280G: What does it do?
Section 280G both limits the amount of golden parachute payments and imposes a special excise tax on them. The rule applies only if the value of the payment is more than, or equal to, three times the average annual amount of taxable compensation that the disqualified individual received over the five years immediately preceding the change in control. If the payment is less than three times the compensation amount, even slightly, Section 280G does not apply.
How Section 280G is Calculated
o determine if Section 280G applies, the IRS calculates the "base amount," which represents the disqualified individual’s average annual taxable income over the previous five years. Payments exceeding three times the base amount are subject to excise tax and may not be deducted by the corporation. However, payments slightly below the threshold escape the Section 280G excise tax, providing incentive for corporations to carefully structure such agreements.
Why Is 280G Important?
Section 280G was created to protect the interests of shareholders by stopping corporations from making unreasonably large payments to disqualified individuals when control of a corporation changes hands.
Section 280G applies only to corporations, both public and private. It does not apply to S-Corps, Partnerships or LLCs that are taxed as partnerships.
Implications for Corporate Governance
Section 280G promotes responsible governance by discouraging disproportionate payments that can diminish corporate value upon ownership changes. This regulation reassures shareholders that executive compensation aligns with shareholder interests, fostering transparency. Importantly, compliance with 280G can bolster corporate reputation and accountability.
What is a “disqualified individual”?
“Disqualified individuals” include corporate officers, shareholders and other “highly-compensated individuals”. A “highly-compensated individual” is a person who has an annual salary of at least $115,000 and is either one of the highest paid one percent of the corporation’s employees or, if less, one of the top 250 highest paid employees of the corporation. It is important to note that while foreign individuals are are subject to Sec. 4999 excise tax, they are still subject to 280G.
What does “change in control” of a corporation mean?
Generally speaking, a “change in control” of a corporation occurs:
- With the acquisition of 50 percent or more of the corporation’s total fair market value or of the total voting power of the corporation’s stock, or;
- When an individual or group acquires 20 percent or more of the voting power within a 12-month period, and this degree of voting power effectively gives the individual or group control corporate operations, or;
- When the majority of the board of directors changes during a 12-month period.
Examples of Parachute Payments
Examples of parachute payments include, among others:
- Severance pay.
- Cash bonuses.
- Any continued benefits.
- Accelerated vesting of any compensation, equity option or otherwise.
- Retention payments.
- Continuation of welfare or fringe benefits.
- Success fees or transaction bonuses.
- Stock options, restricted stock, phantom stock, or stock appreciation award
- Equity or option grants made up to 12 months before the change of control
- Increases in compensation as a result of the change of control
- Changes made to employment agreements up to 12 months before the change of control
Exclusions from Parachute Payments
Certain payments do not count as parachute payments, including reasonable post-termination payments or payments under non-compete agreements. These exclusions allow corporations to compensate executives without triggering 280G taxes if payments are part of standard compensation and not contingent on control changes. Additionally, 403(a) annuities, individual retirement accounts, and pensions are excluded from 280G, ensuring standard retirement benefits remain unaffected.
280G Exceptions
There are a number of exceptions to Section 280G, most notably for:
- Payments made in connection to certain severance packages, 403(a) annuities, individual pensions, retirement plans and accounts.
- Payments approved by at least 75 percent of the corporation’s disinterested shareholders. This is only possible if the stock of the corporation is not tradeable on a securities market and all people entitled to vote must receive adequate disclosure of all the important facts regarding the payments that make up the parachute payment.
- Sale of a wholly-owned subsidiary will not result in a change of control for the parent corporation unless a substantial portion of the parent corporation’s assets change.
- S Corporations are not subject to 280G
Tax Consequences of 280G
Under Section 280g, a 20 percent excise tax is charged to the individual on the golden parachute payment amount, in addition to any income tax. Also, the corporation making the parachute payment cannot claim a deduction on that payment.
Impact of Shareholder Approval on Tax Consequences
Shareholder approval can shield certain payments from 280G’s excise tax if at least 75% of disinterested shareholders approve the payment in a private corporation. Adequate disclosure of payment details must be provided. When shareholder-approved, the corporation retains its tax deduction, incentivizing transparency and communication between shareholders and executives.
Next Steps
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FAQ Section:
-
What is Section 280G?
Section 280G limits and taxes certain executive payments during corporate control changes, aiming to protect shareholder interests. -
Who qualifies as a “disqualified individual”?
Executives, highly-compensated employees, and key shareholders may qualify as disqualified individuals if they hold significant compensation or influence. -
What is considered a “parachute payment”?
Parachute payments include severance, bonuses, accelerated vesting, and benefits contingent on change-in-control events. -
Are any corporations exempt from 280G?
Yes, S corporations, partnerships, and private companies with shareholder-approved payments may be exempt from Section 280G. -
How does shareholder approval impact 280G payments?
In private corporations, disinterested shareholder approval of parachute payments may prevent excise tax and preserve the corporation's tax deduction.