As M&A activity continues to accelerate, understanding the tax implications of executive payouts has become increasingly important for boards, compensation committees, and deal teams. One of the most technical and consequential areas is IRC Section 280G, which governs how “golden parachute” payments are treated during a corporate change in control.
Section 280G limits a company’s ability to deduct certain compensation payments made to top executives when those payments are triggered by a merger or acquisition. If parachute payments exceed a specific threshold, they can result in both a loss of corporate tax deduction and a 20% excise tax for the executive receiving the payout.
Key Concepts in 280G Calculations
Parachute Payments – Payments or benefits triggered by a change in control, such as severance, accelerated vesting of equity, bonuses, or other contingent compensation.
Base Amount – The executive’s average annual taxable compensation over the five years preceding the change in control. This serves as the baseline for testing excess parachute payments.
Excess Parachute Payment – If the total parachute payments equal or exceed three times the base amount, the excess over one times the base amount becomes non-deductible for the company and subject to a 20% excise tax under Section 4999.
Example
An executive’s base amount is $500,000. If they receive $1.6 million in parachute payments as part of a merger:
- 3 × base amount = $1.5 million
- Total parachute payments = $1.6 million
- Excess = $1.6 million – $500,000 = $1.1 million
The company cannot deduct $1.1 million, and the executive pays a 20% excise tax on that amount.
Mitigating 280G Consequences
Companies often take proactive steps to minimize 280G exposure, including:
- Shareholder approval for private companies to exempt payments
- Cutback provisions that reduce payouts to stay below the 3× threshold
- Valuation studies to allocate value appropriately between contingent and non-contingent compensation elements
Final Takeaway
Navigating 280G rules requires a blend of technical tax expertise, executive compensation insight, and defensible valuation modeling. It’s critical that your company is able to:
- Determine base amounts and parachute payment values
- Model payout alternatives, such as cutbacks or gross-ups
- Prepare documentation for shareholder approvals and audit support
280G compliance is not just a technical exercise; it’s a critical component of sound deal planning. By engaging experts early, companies can ensure alignment between executive incentives, shareholder interests, and tax efficiency.
To discuss how Infinite Equity can model, document, and defend your 280G calculations, contact us here.
