Many companies find themselves, at some point, needing to part ways with a valued team member as part of a merger with or acquisition by another company. In these kinds of situations, the company being acquired often wants to reward the old employee for their services or offer them a softer landing while they seek new employment. In these situations, companies should take care not to run afoul of tax rules governing these payments. These tax rules come from Internal Revenue Code 280G (note the capital G), covering “golden parachute payments.”
What qualifies as a Golden Parachute?
Typically, when people hear the phrase “Golden Parachute,” they think about C-Suite executives of large corporations getting large payouts when they separate from their companies. That fact pattern is only one example, though. Any compensation, including non-cash benefits like continued health care coverage or pensions, can be considered a Golden Parachute payment if:
- The total value of the compensation equals three times the individual’s annualized base compensation or more,
- The compensation is paid to an employee, independent contractor, service provider, officer of the company, shareholder, or other “highly-compensated individual”, and
- The payment is contingent on a change of control of the corporation or the sale of a substantial portion of the corporation’s assets (defined as more than one-third of outstanding assets).
If a company’s payment meets all of the above criteria, it’s a Golden Parachute payment under 280G. There are two additional exceptions: any payments from S Corporations or 501(c) entities are specifically excluded from 280G analysis, and payments that come from “qualified plans” under Section 401 are similarly excluded.
What are the consequences of 280G applying?
Every year, companies deduct salaries and wages paid to employees, independent contractors, and other service providers from the company’s taxable income. 280G modified that general rule, disallowing companies from deducting the “excess” of the Golden Parachute payment that exceeds the recipient’s annualized base compensation. Additionally, the IRS assesses an excise tax equal to 20% of that excess. However, companies worried about 280G impacts have some tools to avoid this tax hit. Two of the most common are:
Limit “excess” compensation
The 280G default rule presumes that the relationship between the company and the service provider ends when the payment is made. However, many individuals provide transition or consulting services shortly after these kinds of deals. Accordingly, 280G(4) provides that “reasonable compensation” paid for these types of services, whether they are provided before or after the change of control, reduces excess payments.
Get out of 280G entirely
Private corporations, including LLCs, can eliminate the application of 280G through a shareholder approval process. The process requires 75% of outstanding voting power to authorize the payment (with adjustments made where voters may be voting on payments for themselves), as well as a disclosure to all shareholders that adequately describes the payment and its structure.
Notably, the disclosure and question posited to voters must bifurcate the authorization of the Golden Parachute payments from any other decision; questions like “do you approve of the acquisition and parachute payments to CEO A” run afoul of the requirements.
280G contains some technical complexities, but proper planning can often allow companies to reward key players that built the value an acquiring company wants to capture. It’s important to be careful!
