Section 280G: Everything You Need to Know About Golden Parachute Payments

Section 280G of the Internal Revenue Code and its implications on golden parachute payments constitutes one such issue. The provisions laid out in Section 280G, while complex, hold vital implications for executives, HR professionals, and business owners alike.

Given the profound financial and regulatory implications, understanding these tax rules becomes imperative. Here are some of the most commonly asked questions about Section 280G.

What Is Section 280G?

Section 280G of the Internal Revenue Code concerns so-called "golden parachute payments". These payments are compensations paid to certain employees (often executives) when a company undergoes a significant transaction, like a merger or acquisition.

According to this section, if these payments exceed a certain limit, they can trigger substantial tax consequences. The company cannot deduct the excess amount, and the recipient faces a 20% excise tax on top of their regular income tax.

Why Is 280G Important?

The relevance of Section 280G arises from its tax implications and potential impact on business transactions. It affects the manner in which companies structure their executive compensation packages, particularly in a change-in-control scenario.

High tax burdens can discourage potential acquirers, affecting deal flow. For executives, the additional excise tax could significantly reduce the net payout.

Understanding and planning for 280G can be crucial to all parties involved in a transaction.

What Triggers the Application of Section 280G?

Section 280G comes into play when a corporation experiences a "change in control". This could occur through a merger or acquisition, a stock purchase agreement, or a management-led buyout, among other situations.

The key trigger for 280G is the existence of parachute payments - compensation to "disqualified individuals" that exceed a safe harbor limit set by the IRS.

Who Is a Disqualified Individual Under Section 280G?

In the context of Section 280G, a "disqualified individual" is any employee, independent contractor, or other individual who is a shareholder, officer, or highly-compensated individual of the corporation. This typically includes top management and key executives who stand to receive significant compensation in a change-of-control event.

What Are the Types of Parachute Payments?

Parachute payments under Section 280G encompass a wide range of compensations. These include severance pay, bonuses, stock options, and other equity compensations.

It's essential to note that not all payments qualify as parachute payments. The IRS considers a payment as a parachute payment only if it is contingent on a change in control and exceeds three times the individual's base amount (average of the past five years' taxable compensation).

How Are Golden Parachute Payments Calculated?

Calculating golden parachute payments involves several steps.

First, determine the total compensation contingent on a change in control to the disqualified individual. Then, compute the individual's "base amount," which is the average annualized compensation over the past five years.

If the total compensation is more than three times the base amount, it is subject to 280G rules. The excess over one times the base amount is considered an excess parachute payment, and it faces the 20% excise tax and loss of corporate deduction.

Can Section 280G be Avoided or Mitigated?

Section 280G can indeed be mitigated or potentially avoided altogether with careful planning and strategic decisions.

These strategies can range from limiting compensation to restructuring agreements, redesigning compensation packages, or seeking shareholder approval under the so-called "shareholder exemption."

Consulting with knowledgeable transaction advisors can help identify and implement the most appropriate strategies for each unique situation.

What Strategies Can Companies Employ to Minimize the Impact of Section 280G?

Several strategies can help mitigate the impact of Section 280G.

These include negotiating compensation packages that fall below the 280G thresholds, incorporating "cutback" provisions in employment agreements to limit payments to the safe harbor amount, or pursuing a shareholder approval process mentioned above.

HoganTaylor can help identify and implement effective strategies in line with the business's specific circumstances as part of our transaction advisory services.

How Does Section 280G Affect Mergers, Acquisitions, and Change of Control Transactions?

Section 280G can significantly influence M&A transactions, primarily by impacting the financial calculus for both acquirer and executive recipients.

From the acquirer's perspective, the non-deductibility of excess parachute payments increases the acquisition cost.

For executives, the 20% excise tax cuts into the change-of-control compensation.

In either case, understanding 280G implications can help structure the deal in a way that minimizes the tax impact while maintaining deal attractiveness.

What Are the Penalties for Non-Compliance with Section 280G?

Non-compliance with Section 280G can result in substantial penalties.

The corporation loses its tax deduction for any excess parachute payments, increasing its tax liability. Disqualified individuals receiving the payments must pay a 20% excise tax in addition to their regular income tax. These penalties underscore the importance of proper planning and compliance with Section 280G rules.

Let HoganTaylor Help You Navigate Section 280G

A comprehensive understanding of Section 280G and its implications on golden parachute payments is crucial for executives, HR professionals, and business owners. Knowledge of these rules can guide strategic decisions, impact the structuring of compensation packages, and influence the overall approach to significant transactions like mergers and acquisitions. This understanding also aids in avoiding or minimizing tax liabilities and penalties that can significantly impact financial outcomes.

Moreover, with the profound implications and intricate complexity of these tax rules, consulting with experts in the field, such as HoganTaylor, becomes highly advantageous. With a wealth of experience and a deep understanding of the tax landscape, our experts are well-equipped to provide strategic advice and practical solutions tailored to the unique circumstances of each
business.

Our transaction advisory services offer a comprehensive suite of solutions aimed at guiding businesses through the complexities of significant transactions, including understanding and navigating the implications of Section 280G. In a world where regulatory understanding can be the key to strategic advantages and the avoidance of unforeseen liabilities, partnering with HoganTaylor offers the guidance, clarity, and peace of mind that businesses need.

INFORMATIONAL PURPOSE ONLY. This content is for informational purposes only. This content does not constitute professional advice and should not be relied upon by you or any third party, including to operate or promote your business, secure financing or capital in any form, obtain any regulatory or governmental approvals, or otherwise be used in connection with procuring services or other benefits from any entity. Before making any decision or taking any action, you should consult with professional advisors.