Summer 2025

Section 280G of the Internal Revenue Code, often referred to as the “golden parachute” provision, is an important regulation that affects compensation for executives and independent contractors during certain corporate transactions, such as a merger or acquisition. The purpose of Section 280G is to curb what could be viewed as excessive payouts to upper management at the expense of shareholders when a company undergoes a change in control. These payouts could otherwise negatively impact a company’s financial health or even discourage potential acquirers. While still preventing undue enrichment, there are ways to soften the implications of Section 280G through proper planning and coordination between a corporation and its shareholders.

The Mechanics of Section 280G

For Section 280G to apply, there must be what is called a “parachute payment.” A parachute payment is generally defined as a compensatory payment made to a “disqualified individual,” is contingent upon a change in ownership or “effective control,” and the aggregated present value of such payment exceeds three times the individual’s “base amount.” The base amount is the average taxable compensation (e.g., Box 1 of Forms W-2 or 1099-NEC) for such individual over the previous five years. Compensation that is subject to the rules of Section 280G includes not only normal salaries and wages, but also other types of compensation such as cash bonuses, severance pay, fringe benefits, deferred compensation, and accelerated vesting of stock awards.

A disqualified individual¹ is typically an employee, independent contractor, or other person who performs services for a corporation and who is an officer,² shareholder, or highly compensated individual.³ For purposes of Section 280G, a change of control occurs when one person (or more than one person acting as a group) acquires greater than 50% of the total vote or value of the stock of a corporation, or more than one-third of the total gross value of a corporation’s assets are acquired within a given 12-month period, among other scenarios.⁴

If a compensatory payment is subject to the provisions of Section 280G, the corporation is permanently denied a tax deduction for the portion of the parachute payment that exceeds the base amount.⁵ Furthermore, under Section 4999, individuals receiving parachute payments face a 20% excise tax on the portion exceeding the base amount. This is in addition to the normal income and employment taxes. The dual penalty system is designed to discourage exorbitant payouts that could undermine corporate stability.

For example, assume the following facts relate to a disqualified individual:

• Base amount of $100,000 (five-year average of includible compensation)
• Base limitation threshold of $300,000 (or three times the base)
• Aggregate parachute payments of $500,000

Based on the above, and assuming no mitigating measures or exemptions (discussed below), the company would be denied a corporate tax deduction of $400,000 (the portion of the $500,000 total parachute payments over the base amount of $100,000). It is important to note that the amount of the disallowed deduction is calculated using the parachute payments over the base amount (1x compensation), not the base limitation threshold (3x compensation). Furthermore, the disqualified individual would be subject to an excise tax of $80,000 ($400,000 excess parachute payment x 20% excise tax), which must be withheld by the employer, in addition to the normal federal, state, and local income taxes on the $500,000 compensation payment.

Mitigating Measures

There are several strategies companies employ to mitigate Section 280G. Probably the most obvious approach is to carefully structure compensation packages so that they fall below the thresholds by reducing bonuses, severance pay, and other forms of compensation to avoid triggering the excess parachute payment rules.

Another tactic to mitigate Section 280G is only available to privately held corporations. A shareholder vote could effectively “cleanse” the parachute payments if approved by more than 75% outstanding voting stock immediately before the change in control. To avoid a conflict of interest, however, stockholders who are receiving a parachute payment are not eligible to vote and are excluded from the pool when determining the number of votes needed to obtain 75% approval. For the vote to be valid, it requires full disclosure of the compensatory payments (including the event triggering the payment, the dollar amount, the timing of the payment, and any specific conditions or terms) and must be performed prior to the change in control transaction. In addition, prior to the vote the disqualified individuals must sign an irrevocable waiver forfeiting any parachute payments that would otherwise be forthcoming (or agree to return the parachute payment if already received) if the shareholders do not approve the payments. There must be a separate vote (apart from the vote for the change in control transaction itself), but there can be one vote on all payments to disqualified individuals.

There is also an ability to reduce the impact of Section 280G by demonstrating, with clear and convincing evidence, that proposed payments are “reasonable compensation” for services previously provided or to be provided in the future. While the final regulations provide general guidelines for what is “reasonable compensation,” it is very much facts and circumstance based. The burden is on the taxpayer to provide sufficient evidence as to reasonableness.

In Closing

The effect of Section 280G – on both a corporation and the individuals performing services on behalf of the corporation – can be quite costly to both parties. Without proper planning and coordination, Section 280G can make potential merger and acquisition (M&A) deals more costly, alter executive compensation agreements, create payroll tax compliance burdens, and impact deal structuring, among other issues.

It is imperative that taxpayers conduct thorough due diligence in M&A transactions to identify any potential Section 280G issues by reviewing executive contracts, compensation plans, and other relevant documents to ensure compliance and avoid unexpected tax liabilities. By understanding these implications, companies can navigate the regulatory landscape more effectively and achieve more successful transactions. 

¹ In the case of an affiliated group of corporations, the determination of a disqualified individual looks to all members of such affiliated group within the meaning of Section 1504.

² Depending on the size of the corporation, the number of officers whose compensation could be subject to Section 280G may be no less than three and no more than 50 officers.

³ A “highly compensated individual” in 2024 is deemed to be someone whose annual compensation is above $155,000. The figure is adjusted under Section 414(q)(1)(B)(i) and indexed annually under an IRS announcement published in the fall for pension plan limitations. A highly compensated individual also would be among a group consisting of the lesser of the highest paid 1% of the corporation or highest 250 employees of the corporation.

⁴ There is a presumption that a change of control could also be triggered upon the acquisition of only 20% of the voting power of a corporation’s stock within a given 12-month period or if there is a majority change of a corporation’s board of directors within any 12-month period without approval of the existing board. That presumption, however, may be rebutted by establishing that the change did not effectively transfer the power to control the management and policies of the corporation.

⁵ For publicly traded corporations who are subject to limitations under Section 162(m), any disallowed deductions under Section 280G also reduce the $1 million annual threshold dollar for dollar, but not below zero, for purposes of calculating the Section 162(m) limitation.

Section 280G of the Internal Revenue Code, often referred to as the “golden parachute” provision, is an important regulation that affects compensation for executives and independent contractors during certain corporate transactions, such as a merger or acquisition. The purpose of Section 280G is to curb what could be viewed as excessive payouts to upper management at the expense of shareholders when a company undergoes a change in control. These payouts could otherwise negatively impact a company’s financial health or even discourage potential acquirers. While still preventing undue enrichment, there are ways to soften the implications of Section 280G through proper planning and coordination between a corporation and its shareholders.

The Mechanics of Section 280G

For Section 280G to apply, there must be what is called a “parachute payment.” A parachute payment is generally defined as a compensatory payment made to a “disqualified individual,” is contingent upon a change in ownership or “effective control,” and the aggregated present value of such payment exceeds three times the individual’s “base amount.” The base amount is the average taxable compensation (e.g., Box 1 of Forms W-2 or 1099-NEC) for such individual over the previous five years. Compensation that is subject to the rules of Section 280G includes not only normal salaries and wages, but also other types of compensation such as cash bonuses, severance pay, fringe benefits, deferred compensation, and accelerated vesting of stock awards.

A disqualified individual¹ is typically an employee, independent contractor, or other person who performs services for a corporation and who is an officer,² shareholder, or highly compensated individual.³ For purposes of Section 280G, a change of control occurs when one person (or more than one person acting as a group) acquires greater than 50% of the total vote or value of the stock of a corporation, or more than one-third of the total gross value of a corporation’s assets are acquired within a given 12-month period, among other scenarios.⁴

If a compensatory payment is subject to the provisions of Section 280G, the corporation is permanently denied a tax deduction for the portion of the parachute payment that exceeds the base amount.⁵ Furthermore, under Section 4999, individuals receiving parachute payments face a 20% excise tax on the portion exceeding the base amount. This is in addition to the normal income and employment taxes. The dual penalty system is designed to discourage exorbitant payouts that could undermine corporate stability.

For example, assume the following facts relate to a disqualified individual:

• Base amount of $100,000 (five-year average of includible compensation)
• Base limitation threshold of $300,000 (or three times the base)
• Aggregate parachute payments of $500,000

Based on the above, and assuming no mitigating measures or exemptions (discussed below), the company would be denied a corporate tax deduction of $400,000 (the portion of the $500,000 total parachute payments over the base amount of $100,000). It is important to note that the amount of the disallowed deduction is calculated using the parachute payments over the base amount (1x compensation), not the base limitation threshold (3x compensation). Furthermore, the disqualified individual would be subject to an excise tax of $80,000 ($400,000 excess parachute payment x 20% excise tax), which must be withheld by the employer, in addition to the normal federal, state, and local income taxes on the $500,000 compensation payment.

Mitigating Measures

There are several strategies companies employ to mitigate Section 280G. Probably the most obvious approach is to carefully structure compensation packages so that they fall below the thresholds by reducing bonuses, severance pay, and other forms of compensation to avoid triggering the excess parachute payment rules.

Another tactic to mitigate Section 280G is only available to privately held corporations. A shareholder vote could effectively “cleanse” the parachute payments if approved by more than 75% outstanding voting stock immediately before the change in control. To avoid a conflict of interest, however, stockholders who are receiving a parachute payment are not eligible to vote and are excluded from the pool when determining the number of votes needed to obtain 75% approval. For the vote to be valid, it requires full disclosure of the compensatory payments (including the event triggering the payment, the dollar amount, the timing of the payment, and any specific conditions or terms) and must be performed prior to the change in control transaction. In addition, prior to the vote the disqualified individuals must sign an irrevocable waiver forfeiting any parachute payments that would otherwise be forthcoming (or agree to return the parachute payment if already received) if the shareholders do not approve the payments. There must be a separate vote (apart from the vote for the change in control transaction itself), but there can be one vote on all payments to disqualified individuals.

There is also an ability to reduce the impact of Section 280G by demonstrating, with clear and convincing evidence, that proposed payments are “reasonable compensation” for services previously provided or to be provided in the future. While the final regulations provide general guidelines for what is “reasonable compensation,” it is very much facts and circumstance based. The burden is on the taxpayer to provide sufficient evidence as to reasonableness.

In Closing

The effect of Section 280G – on both a corporation and the individuals performing services on behalf of the corporation – can be quite costly to both parties. Without proper planning and coordination, Section 280G can make potential merger and acquisition (M&A) deals more costly, alter executive compensation agreements, create payroll tax compliance burdens, and impact deal structuring, among other issues.

It is imperative that taxpayers conduct thorough due diligence in M&A transactions to identify any potential Section 280G issues by reviewing executive contracts, compensation plans, and other relevant documents to ensure compliance and avoid unexpected tax liabilities. By understanding these implications, companies can navigate the regulatory landscape more effectively and achieve more successful transactions. 

¹ In the case of an affiliated group of corporations, the determination of a disqualified individual looks to all members of such affiliated group within the meaning of Section 1504.

² Depending on the size of the corporation, the number of officers whose compensation could be subject to Section 280G may be no less than three and no more than 50 officers.

³ A “highly compensated individual” in 2024 is deemed to be someone whose annual compensation is above $155,000. The figure is adjusted under Section 414(q)(1)(B)(i) and indexed annually under an IRS announcement published in the fall for pension plan limitations. A highly compensated individual also would be among a group consisting of the lesser of the highest paid 1% of the corporation or highest 250 employees of the corporation.

⁴ There is a presumption that a change of control could also be triggered upon the acquisition of only 20% of the voting power of a corporation’s stock within a given 12-month period or if there is a majority change of a corporation’s board of directors within any 12-month period without approval of the existing board. That presumption, however, may be rebutted by establishing that the change did not effectively transfer the power to control the management and policies of the corporation.

⁵ For publicly traded corporations who are subject to limitations under Section 162(m), any disallowed deductions under Section 280G also reduce the $1 million annual threshold dollar for dollar, but not below zero, for purposes of calculating the Section 162(m) limitation.