280G Regulations: Golden Parachutes, Penalties, and Exemptions

Golden parachute payments are compensation packages that pay out to a company’s key people when the company changes hands, and under Section 280G of the Internal Revenue Code they carry a dual tax penalty once they get large enough. The company loses its deduction on the oversized portion, and the executive owes a separate 20 percent excise tax on that same amount under Section 4999.¹² The penalties only apply to specific people, only after a specific type of transaction, and only above a precise dollar threshold tied to the recipient’s own pay history. Several exemptions can wipe them out entirely.

Who the Rules Reach

Section 280G only applies to payments made to a “disqualified individual.” You fall into that category if, during the determination period, you work for the corporation as an employee or independent contractor and you meet one of three tests: you own stock worth more than one percent of the total fair market value of outstanding shares, you are a corporate officer, or you are a highly compensated individual.³ Directors count only if they independently satisfy one of those three tests.

The officer test runs on facts and circumstances rather than a bright line. Anyone holding the title is presumed to be an officer unless the evidence shows the title carries no real authority. The highly compensated test looks at where the person ranks among the corporation’s top earners. A rank-and-file employee with a tiny equity stake does not get swept in; a well-paid executive with no equity usually does.⁴

What Counts as a Change in Control

The penalties only engage when the corporation goes through one of three triggering events. Any one is enough.¹

A change in ownership, meaning a person or group acquires more than 50 percent of the total fair market value or voting power of the stock. Once someone is already over 50 percent, further purchases by that same person or group do not count as a new trigger.⁵
A change in effective control, which captures situations where no one crosses the 50 percent line but control shifts anyway. The classic example is a majority of the board being replaced within a 12-month period without the incumbent board’s endorsement.⁶
A change in ownership of a substantial portion of assets, meaning a transfer of one-third or more of the corporation’s gross asset value. The stock itself can stay put.⁷

The payment also has to be contingent on the event. If the executive would have received the money regardless of whether the deal closed, it is not a parachute payment. In practice that contingency question is where most disputes live.

Which Payments Qualify

The statute defines a parachute payment broadly as any payment “in the nature of compensation” to a disqualified individual that is contingent on the change in control.¹ Cash severance is the clearest case, but the net is wide: transaction bonuses, accelerated vesting of stock options and restricted stock units, employer-paid continued health insurance premiums, and non-compete payments all count. If the money would not flow without the deal, it is almost certainly caught.

Equity acceleration is often the biggest number in the calculation. The IRS will not let you value an accelerated stock option by just looking at the current spread between strike and market price. A full option-pricing method has to account for the fact that acceleration itself increases the award’s value, and only the portion attributable to the acceleration gets treated as contingent on the change in control.⁸ Equity-heavy packages are what push most executives over the threshold.

The One-Year Presumption

Any payment under an agreement signed within one year before the change in control is presumed contingent on the deal. The same presumption applies if an existing agreement was significantly amended in that window.⁹ Rebutting it requires clear and convincing evidence that the arrangement was unrelated to the transaction, which is a high bar.¹⁰ Boards negotiating employment deals in the lead-up to a transaction should assume the resulting payments will be treated as parachute payments.

Reasonable Compensation Carve-Outs

Two offsets can shrink the number. Amounts shown to be reasonable compensation for services to be performed after the change in control are excluded from the parachute payment definition entirely, which reduces the total before the threshold test even runs. Amounts shown to be reasonable compensation for services already rendered reduce the excess parachute payment after the threshold is tripped, which shrinks the penalized number but does not prevent penalties from applying.¹¹ Both require clear and convincing evidence, with the regulations weighing the nature of the services, the individual’s pay history, and what comparable executives earn outside a change-in-control setting.¹² A properly valued non-compete is the most commonly used offset.

The Base Amount and the Three-Times Cliff

Each disqualified individual has a personal benchmark called the base amount. It equals the average annualized includible compensation for the five taxable years ending before the change in control.¹³ Includible compensation covers everything that was or should have been included in gross income: salary, bonuses, the taxable value of exercised options, and similar items. For someone employed less than five full years, the base is annualized over the actual period of employment, with one-time items like signing bonuses excluded from annualization to avoid distortion.¹⁴

The trigger is a sharp cliff. If the aggregate present value of all parachute payments to the individual equals or exceeds three times the base amount, the penalty regime kicks in on the full package.¹⁵ At $2,999,999 against a $1,000,000 base, nothing happens. At $3,000,000, the structure engages. There is no phase-in.

The penalized amount is not just the dollars above the three-times line. The “excess parachute payment” is total parachute payments minus one times the base amount. With a $1,000,000 base and $3,100,000 in payments, the penalized amount is $2,100,000, not the $100,000 that crossed the threshold.¹⁶ That gap between the trigger and the base of the calculation is what makes the cliff so punishing.

The Two Penalties

Once the threshold is tripped, both penalties apply at once. The corporation loses its deduction on the entire excess parachute payment. At a 21 percent corporate rate, a $2,100,000 excess costs the company an extra $441,000 in federal tax.¹⁷ The recipient separately owes a 20 percent excise tax on that same $2,100,000, on top of regular income tax and employment taxes, which comes to another $420,000.²

Why Gross-Ups Backfire

Some older agreements require the company to “gross up” the executive by covering the excise tax so the intended after-tax benefit comes through intact. The gross-up payment is itself compensation contingent on the change in control, so it is treated as excess parachute payment too. The company cannot deduct it, the gross-up is itself hit with the 20 percent excise tax, and that can trigger another layer of gross-up. The total cost often exceeds the original excess parachute payment. Most deal advisors now steer clients toward cutback provisions instead.

How to Avoid the Penalties

The Small Business Corporation Exemption

If, immediately before the change in control, the corporation qualifies as a small business corporation under Section 1361(b), no payment to a disqualified individual is treated as a parachute payment. The analysis ends there.¹⁸ That generally means 100 or fewer shareholders, all individuals or qualifying trusts, and only one class of stock. The corporation does not actually need to have an S election in place; it only needs to meet the Section 1361(b) eligibility requirements at the time of the deal.¹⁹ Plenty of private C corporations with a handful of individual owners qualify without realizing it.

Private Company Shareholder Approval

Corporations that are too large for the small business exemption but have no stock traded on an established securities market can wipe out the penalties through a shareholder vote. Two conditions must both be met.²⁰

More than 75 percent of the voting power of outstanding stock entitled to vote must approve the payments, measured on shares outstanding immediately before the change in control.
Every shareholder entitled to vote must receive adequate disclosure before the vote, including the triggering event, the total dollar amounts, and a breakdown by disqualified individual. An omitted fact counts as material if a reasonable shareholder would find it important.

The vote has to happen before the change in control becomes effective, and the procedural requirements are strict enough that most deal teams run shareholder approval as a formal workstream alongside the rest of the transaction. If any member of the corporation’s affiliated group has publicly traded stock, the exemption is off the table.²¹ Public companies cannot use this route at all.

Cutback and Best-Net Provisions

When no exemption applies, many compensation agreements include a cutback clause that automatically trims total payments to one dollar below three times the base amount whenever doing so leaves the executive better off after tax. The most common form is a “best-net” provision: compare the executive’s take-home with payments made in full and the excise tax paid, against take-home with payments cut back below the threshold, and give whichever is larger. The cutback often wins the math, because the excise tax applies to everything above one times the base amount, not just the amount above the three-times line. Public companies rely on cutback provisions because they have no shareholder approval route. Private companies often include them as a backstop in case a vote fails or the timeline will not accommodate one.

A Separate Rule for Tax-Exempt Employers

Section 280G does not generally apply to tax-exempt organizations.²² A parallel regime under Section 4960 imposes an excise tax at the corporate rate on excess parachute payments to covered employees of tax-exempt entities, borrowing the same three-times-base-amount threshold and excess parachute payment definition.²³ The important difference is the trigger: under Section 4960, the payment has to be contingent on the employee’s separation from employment, not on a change in corporate control. A hospital or university CEO leaving with a large severance can land in the Section 4960 framework without any acquisition occurring.

1
Office of the Law Revision Counsel. 26 U.S. Code 280G – Golden Parachute Payments
2
Office of the Law Revision Counsel. 26 USC 4999 – Golden Parachute Payments
3
eCFR. 26 CFR 1.280G-1 – Golden Parachute Payments – Section: Q/A-15 Through Q/A-17
4
eCFR. 26 CFR 1.280G-1 – Golden Parachute Payments – Section: Q/A-18 and Q/A-19
5
eCFR. 26 CFR 1.280G-1 – Golden Parachute Payments – Section: Q/A-27
6
eCFR. 26 CFR 1.280G-1 – Golden Parachute Payments – Section: Q/A-28
7
eCFR. 26 CFR 1.280G-1 – Golden Parachute Payments – Section: Q/A-6, Example 3
8
Internal Revenue Service. Revenue Procedure 2003-68
9
eCFR. 26 CFR 1.280G-1 – Golden Parachute Payments – Section: Q/A-25
10
Office of the Law Revision Counsel. 26 U.S. Code 280G – Golden Parachute Payments – Section: (b)(2)(C)
11
Office of the Law Revision Counsel. 26 U.S. Code 280G – Golden Parachute Payments – Section: (b)(4)(B)
12
eCFR. 26 CFR 1.280G-1 – Golden Parachute Payments – Section: Q/A-40
13
Office of the Law Revision Counsel. 26 U.S. Code 280G – Golden Parachute Payments – Section: (b)(3)
14
eCFR. 26 CFR 1.280G-1 – Golden Parachute Payments – Section: Q/A-34 and Q/A-36
15
Office of the Law Revision Counsel. 26 U.S. Code 280G – Golden Parachute Payments – Section: (b)(2)(A)(ii)
16
GovInfo. 26 USC 280G – Golden Parachute Payments – Section: (b)(1)
17
Office of the Law Revision Counsel. 26 U.S. Code 280G – Golden Parachute Payments – Section: (a)
18
Office of the Law Revision Counsel. 26 U.S. Code 280G – Golden Parachute Payments – Section: (b)(5)(A)(i)
19
eCFR. 26 CFR 1.280G-1 – Golden Parachute Payments – Section: Q/A-6(a)(1)
20
eCFR. 26 CFR 1.280G-1 – Golden Parachute Payments – Section: Q/A-7
21
eCFR. 26 CFR 1.280G-1 – Golden Parachute Payments – Section: Q/A-6(c)
22
eCFR. 26 CFR 1.280G-1 – Golden Parachute Payments – Section: Q/A-5(a)(4)
23
Office of the Law Revision Counsel. 26 U.S. Code 4960 – Tax on Excess Tax-Exempt Organization Executive Compensation