Executive Compensation - Change in Control Agreements/Code Section 280G
A change in control agreement (also referred to as a “golden parachute” plan) is an arrangement that pays benefits to an executive of a corporation as a result of a corporate transaction which results in the change in control of the target corporation. These benefits may be provided by employment agreements, stand-alone change in control agreements, or change in control plans that cover a group of executives. Whatever the vehicle, a change in control agreement potentially is subject to the restrictions and excise taxes set forth in Sections 280G and 4999 Internal Revenue Code (“Code”).
A change in control includes a change in greater than fifty percent (50%) of the corporation’s stock ownership, a change in the “effective control” of the corporation, or a significant change in the ownership of the corporation’s assets.
Code Sections 280G and 4999 were added to the Code in 1984 by the Deficit Reduction Act of 1984 (“1984 DEFRA”) in response to the large number of corporate mergers and acquisitions in the early 1980’s and the perception that executives in these transactions received lucrative “golden parachute” payments to the detriment of shareholders. Code Section 280G applies to corporations, whether public or private, that have undergone a change in control, and treats affiliated groups as a single corporation. Small business corporations (as defined in Code Section 1361(b)) are exempt from Code Sections 280G and 4999.
Code Section 4999 imposes a twenty percent (20%) excise tax upon certain “disqualified individuals” who receive excess parachute payments (as defined under Code Section 280G), in addition to income taxes and other taxes that apply to such payments. The corporation is penalized by not being able to claim a deduction for such payments, and is required to withhold the excise tax from the payment to the disqualified individual to the extent that it constitutes “wages” under Code Section 3401. A “disqualified individual” includes officers, certain shareholders and the highest paid employees or independent contractors of the corporation.
Code Section 280G defines an “excess parachute payment” as any payment in excess of three times the disqualified individual’s base amount. The disqualified individual’s “base amount” is the individual’s average taxable compensation from the corporation over the five years preceding the change in control. If an individual receives an excess parachute payment (more than three times the base amount), then the excise tax applies to the entire parachute payment (i.e., change in control compensation in excess of one times the base amount).
Eligibility for change in control benefits can be subject to a “single trigger” or a “double trigger.” Single trigger change in control benefits are paid solely as the result of the change in control. Double trigger change in control benefits are paid as the result of the occurrence of a change in control plus the executive’s involuntary termination of employment within a certain period of time.