Golden Parachute Section 280g

Payment Threshold

Calculations for the potential tax liability begin by determining whether the total value of the benefits exceeds three times the base amount of the recipient. The base amount is defined as the average annual compensation that the individual received over the five years preceding the change in control. If the aggregate payments reach or exceed this limit, the entire amount over the base amount is considered an excess parachute payment.

Under the rules of golden parachute section 280g, these excess payments are not deductible by the company for corporate tax purposes. Furthermore, the individual receiving the payment is subject to a non deductible twenty percent excise tax on the excess portion. This dual penalty is designed to discourage boards of directors from awarding massive payouts that could harm the financial health of the company or its shareholders.

Management teams must carefully track all forms of compensation, including health benefits and fringe benefits, to ensure an accurate calculation of the total package.

Disqualified Person

Restrictions on parachute payments apply only to a specific group of people who hold significant influence or ownership in the corporation. A disqualified person under golden parachute section 280g typically includes officers, highly compensated individuals and significant shareholders. The definition ensures that the rules target those who are in a position to negotiate their own exit packages at the expense of the other owners.

For the purpose of this regulation, a highly compensated individual is someone who is among the top one percent of the company employees or the top two hundred and fifty employees. Significant shareholders are those who own more than one percent of the stock by value. During the due diligence phase of a transaction, the buyer will identify every individual who fits this description to calculate the potential tax exposure.

If the management team is not clearly defined, the tax authorities may use a functional test to determine who was actually running the company.

Cleansing Vote

Private companies have a unique opportunity to avoid the penalties associated with these payments through a specific shareholder approval process. To use the exception provided by golden parachute section 280g, the corporation must obtain a vote from shareholders who own more than seventy five percent of the voting power. This vote must be preceded by a full disclosure of all the payments that would otherwise be subject to the excise tax.

The executives must agree to waive their right to the payments if the shareholders do not approve them, which puts the decision entirely in the hands of the owners. This cleansing vote ensures that the people who are actually paying for the transaction agree that the executive compensation is reasonable and fair. If the vote is successful, the payments become tax deductible for the firm and the executives avoid the excise tax.

Most venture capital backed startups perform this vote as a matter of routine before a sale to clean up the balance sheet. Proper execution of this procedure is a requirement for a smooth closing in the private market.