Section 280G does not apply to an LLC taxed as a partnership, a single-member LLC treated as a disregarded entity, or an LLC that has elected S-corporation status. The golden parachute rules reach “corporations,” and those LLCs are not corporations for federal tax purposes. The answer flips when an LLC has filed to be taxed as a C-corporation or sits inside an affiliated corporate group, because at that point the LLC is a corporation for federal tax purposes and the full weight of Section 280G, along with the 20% excise tax under Section 4999, can apply.
Why Most LLCs Sit Outside the Rules
Section 280G penalizes compensation that becomes payable because of a change in ownership or control of a “corporation.”1Office of the Law Revision Counsel. 26 USC 280G – Golden Parachute Payments The hook is corporate status, and the check-the-box regulations decide what counts.
A domestic LLC with two or more members defaults to partnership classification. A single-member LLC defaults to disregarded-entity status, meaning its activity is treated as the owner’s own.2eCFR. 26 CFR 301.7701-3 – Classification of Certain Business Entities Neither is a corporation. There is no corporate-level deduction for Section 280G to deny, because income passes through to the members or the sole owner. The deduction-denial penalty has nothing to attach to.
That is the structural reason, and it holds even for very large LLCs with elaborate management compensation. Big transaction bonuses, accelerated profits-interest vesting, and generous severance can all be paid out of a partnership-taxed LLC without any 280G calculation, because the entity itself is not within the statute’s reach.
The S-Corporation Carve-Out
An LLC that has elected S-corporation treatment is also exempt, but for a different reason. Section 280G(b)(5) excludes payments made with respect to any corporation that qualifies as a “small business corporation” under Section 1361(b) immediately before the ownership change.1Office of the Law Revision Counsel. 26 USC 280G – Golden Parachute Payments
To qualify, the entity cannot have more than 100 shareholders, cannot have a non-individual shareholder (with limited exceptions for certain trusts and tax-exempt organizations), cannot include a nonresident alien shareholder, and cannot have more than one class of stock.3Office of the Law Revision Counsel. 26 USC 1361 – S Corporation Defined The exemption looks at whether the entity would qualify, not whether an S election is actually in effect.
When an LLC Does Get Pulled In
Four situations bring an LLC inside Section 280G. Any one of them is enough.
A C-Corporation Election
An LLC can file Form 8832 to elect classification as an association taxable as a corporation.2eCFR. 26 CFR 301.7701-3 – Classification of Certain Business Entities Once that election takes effect, the LLC is treated as a C-corporation for all federal tax purposes. Every payment contingent on a future change in ownership is now potentially a parachute payment, subject to both the deduction denial and the 20% excise tax.
Membership in an Affiliated Corporate Group
Even an LLC taxed as a partnership can be swept in if it is part of an affiliated group with a corporate parent. The Treasury Regulations treat all members of the same affiliated group as a single corporation for Section 280G purposes.4eCFR. 26 CFR 1.280G-1 – Golden Parachute Payments When the C-corporation parent undergoes a change in control, payments flowing through a subsidiary LLC can be aggregated with the parent’s and treated as though the corporation itself made them.
An Asset Sale to a Corporate Buyer
A change in ownership of a “substantial portion of the assets” of a corporation also triggers Section 280G. The threshold is assets with a gross fair market value equal to or greater than one-third of the corporation’s total gross asset value immediately before the transaction.1Office of the Law Revision Counsel. 26 USC 280G – Golden Parachute Payments When a C-corporation sells assets held through an LLC subsidiary, or when a corporate buyer acquires assets that happen to be held in an LLC inside a corporate group, the test can be met even though the operating LLC itself is not a corporation.
A Pre-Deal Conversion
Converting an LLC from partnership taxation to C-corporation status shortly before closing a sale invites scrutiny under predecessor and successor entity rules. The IRS looks at whether the conversion was designed to sidestep Section 280G. An LLC that spent years as a partnership but converts to a C-corporation just before a sale should expect the transaction-related payments to be examined as though the entity had been a corporation throughout.
What 280G Costs When It Applies
When the rules do apply, the consequences are stacked. If a disqualified individual receives compensation contingent on the ownership change, and the total present value of those payments reaches at least three times the individual’s “base amount” (generally annualized includible compensation for the five tax years ending before the change), the entire amount above one times the base amount becomes an “excess parachute payment.”1Office of the Law Revision Counsel. 26 USC 280G – Golden Parachute Payments
Two penalties follow. The company loses its deduction for the excess amount. The individual owes a 20% excise tax on the same excess, on top of ordinary income taxes.5Office of the Law Revision Counsel. 26 USC 4999 – Golden Parachute Payments Cash severance, transaction bonuses, and the acceleration of equity awards all count. Anything that would not have been paid but for the ownership change enters the calculation.
Escape Routes for an LLC Taxed as a C-Corporation
An LLC that falls under Section 280G because of its C-corporation election is not automatically stuck with the penalties. Two statutory exemptions do most of the work for private companies.
The Small Business Corporation Exemption
The same carve-out that protects S-corporation-electing LLCs is also available to C-corporations that would qualify as small business corporations under Section 1361(b) immediately before the change in ownership. No shareholder vote is needed and no additional procedure is required; the entity simply has to meet the criteria (no more than 100 shareholders, only individual shareholders with limited trust and tax-exempt exceptions, no nonresident alien shareholders, and only one class of stock).3Office of the Law Revision Counsel. 26 USC 1361 – S Corporation Defined Many C-corporation-electing LLCs with a tight investor base will clear this bar.
The Private Company Shareholder Approval Exemption
If the small business corporation test is not met, Section 280G(b)(5)(A)(ii) provides a second path for any company whose stock was not readily tradable on an established securities market immediately before the ownership change.6GovInfo. 26 USC 280G – Golden Parachute Payments An LLC taxed as a C-corporation will almost never have publicly traded stock, so this is the primary planning tool.
The procedure has to be run correctly or it fails. The payment must be approved by holders of more than 75% of the voting power of all outstanding stock immediately before the change in control, and shares owned by the disqualified individual receiving the payment are excluded from that count. Before the vote, the company has to provide adequate disclosure to every shareholder entitled to vote, including the triggering event, the total amount at stake, and a description of each payment that would otherwise be a parachute payment.4eCFR. 26 CFR 1.280G-1 – Golden Parachute Payments
The disqualified individual must waive the right to receive any payment that would trigger the penalties before the vote happens. If shareholders say no, the waiver holds and the compensation is forfeited. The shareholder vote on the parachute payments has to be separate from any vote on the deal itself.
The Reasonable Compensation Reduction
Even when Section 280G applies and no exemption is available, Section 280G(b)(4) can shrink the amount exposed to penalties. Compensation for services the individual will perform after the ownership change can be excluded from the parachute calculation entirely, so it does not count toward the three-times threshold. Compensation for services the individual actually performed before the change can reduce the excess parachute payment after the threshold is crossed. In both cases, the taxpayer must show reasonableness by “clear and convincing evidence.”1Office of the Law Revision Counsel. 26 USC 280G – Golden Parachute Payments
The IRS weighs the nature of the services, the individual’s historical pay for similar work, and what comparable people earn in situations not tied to an ownership change.4eCFR. 26 CFR 1.280G-1 – Golden Parachute Payments Non-compete agreements are a common vehicle: the fair market value of a non-compete can be subtracted from the parachute amount, but the valuation has to reflect how enforceable the agreement actually is under the relevant state’s law, including any limits on duration or geographic scope.