Section 280G Disqualified Individuals: Categories, Thresholds, and Exemptions

Under Section 280G, a disqualified individual is a person performing services for a corporation who falls into one of three categories during the 12 months before a change in ownership or control: a company officer, a shareholder who owns more than 1% of the stock, or one of the highest-paid employees at the company. If change-in-control payments to that person reach three times their average annual compensation, the individual owes a 20% excise tax on the excess and the corporation loses its deduction for the same amount.¹ The label matters because it applies to a narrower group than most executives assume, and the mechanics of who qualifies turn on precise regulatory definitions.

The Three Categories

Section 280G reaches officers, significant shareholders, and highly compensated employees. Each term has a technical meaning that differs from ordinary business usage.

Officers. Qualification depends on the authority the person actually exercises, not the title on the business card. A vice president with no real decision-making power may not count; someone without a formal officer title who functions as one can be swept in. The regulations cap the number of people treated as officers for 280G purposes at the lesser of 50 employees or the greater of three employees and 10% of the workforce. If a company has more officers than the cap allows, only the highest-paid ones within the cap are counted.²

Shareholders. Only individuals whose stock is worth more than 1% of the total fair market value of all outstanding shares qualify on this basis. Holding less than that does not make someone disqualified on shareholder grounds, though the same person can still be caught as an officer or highly compensated employee.²

Highly compensated individuals. This group is the highest-paid 1% of the company’s employees, or the top 250 by compensation if that is smaller. The calculation looks at all compensation includible in gross income during the determination period, bonuses and equity-based awards included.²

The 12-Month Determination Period

Status is measured across the 12 months ending on the date of the change in ownership or control. If you served as an officer, held more than 1% of the stock, or hit the compensation threshold at any point during that window, you are a disqualified individual for the transaction. Resigning or restructuring your role a few weeks before closing does not remove you from the list.²

The rules only bite when payments are tied to a qualifying change in ownership or effective control, or to the sale of a substantial portion of the corporation’s assets. Treasury regulations define each event by numerical thresholds (broadly, more than 50% stock ownership, 20% effective control, or 40% of gross asset value acquired within a 12-month period).²

What Counts as a Parachute Payment

A parachute payment is any compensation-related payment to a disqualified individual that is contingent on the change in control. The link can be direct, like severance that vests at closing, or indirect, like an existing bonus or equity award whose vesting accelerates because of the deal. If the payment would not have been made, or would not have been made at that time, without the ownership change, the regulations treat it as contingent.¹

Typical items: cash severance, closing bonuses, accelerated vesting of stock options and restricted stock units, and the value of continued benefits such as health coverage or personal use of corporate property. Non-cash items are counted at present value as of the date of the change.

There is also a one-year look-back presumption. Any agreement entered into or materially amended within one year before the ownership change is presumed contingent on it. The taxpayer can rebut the presumption only with clear and convincing evidence that the payment would have been made regardless, and the analysis weighs facts like whether a takeover attempt was already underway when the agreement was signed.²

The Base Amount

The base amount is the individual’s average annual compensation includible in gross income over the five most recent taxable years ending before the date of the ownership change. This is the measuring stick. If the person has been with the corporation for fewer than five years, the calculation uses only the portion of the window during which they actually performed services.²

Two details cause frequent errors. Compensation in a short year of service must be annualized to a 12-month equivalent, but one-time payments like sign-on bonuses are excluded from the annualization. A new hire who received a $100,000 signing bonus and started mid-year does not have that bonus scaled up to $200,000. And payments spread over time or paid in kind must be discounted to present value using 120% of the applicable federal rate, compounded semiannually.²

The Three-Times Threshold and the Cliff

Penalties activate only when the aggregate present value of all parachute payments to a disqualified individual equals or exceeds three times the base amount. Below that line, nothing happens. Once the line is crossed, the math surprises people.

The excess parachute payment is the total payment minus one times the base amount, not three times.¹ That creates a cliff. Take an executive with a base amount of $200,000:

Parachute payments of $599,999: below the $600,000 threshold. No penalty.
Parachute payments of $600,000: threshold crossed. Excess = $600,000 − $200,000 = $400,000. The 20% excise tax applies to the full $400,000, an $80,000 hit. The corporation also loses its deduction on $400,000.
Parachute payments of $700,000: excess = $500,000. Excise tax = $100,000.

One extra dollar above $599,999 produces an $80,000 tax bill. There is a range of payment amounts just above the three-times mark where the executive ends up worse off, after taxes, than if they had received less money. This is the “valley” that drives 280G planning.

Tax Consequences for Both Sides

Two separate penalties fall on two separate parties. The individual owes a 20% excise tax on the excess amount under Section 4999, stacked on top of regular federal and state income tax. Combined effective rates on the excess can approach 60% or more depending on the individual’s bracket.³

On the corporate side, Section 280G disallows the deduction for the entire excess parachute payment. For a corporation in the 21% federal bracket, losing the deduction on a $500,000 excess costs an additional $105,000 in tax.¹

The excise tax is treated as a regular income tax for filing purposes. It is due on the individual’s tax return for the year the excess payment is received, and companies generally report golden parachute amounts on the recipient’s Form W-2, with the excise tax withheld alongside federal income tax.

Payments That Do Not Count

Not every dollar paid around a deal falls into the parachute calculation. The regulations carve out reasonable compensation for services the individual actually performs after the ownership change. An executive who stays on and continues doing the same job at roughly the same pay can treat that post-closing salary as outside the parachute definition, even though it would not have continued but for the deal. The individual must show this with clear and convincing evidence, but the standard is concrete: payments only for periods of actual service, and compensation not significantly greater than pre-change levels.²

Non-competes get special treatment. Payments for a covenant not to compete can qualify as reasonable compensation, but only if the restriction is meaningful and realistically likely to be enforced. A boilerplate non-compete over a narrow geographic area or an industry the executive has no interest in reentering will not pass. When the non-compete fails, the payments are recharacterized as severance and swept into the parachute total.²

Severance itself is never treated as reasonable compensation under the regulations, and neither are damages for failing to make severance payments. Labeling a severance package as compensation for future services does not change the result.²

Exemptions From the 280G Regime

Small Business Corporations

Payments made by a corporation that qualifies as a small business corporation immediately before the ownership change are exempt from the parachute rules altogether. The definition borrows the S-corporation eligibility criteria under Section 1361(b): a domestic corporation with no more than 100 shareholders, one class of stock, and no entity shareholders (with narrow exceptions for certain trusts and estates).⁴ The corporation does not have to have actually elected S-corp status. It just has to meet the structural criteria, and the nonresident alien shareholder restriction is waived for this purpose.²

Qualified Retirement Plans

Distributions and accelerated vesting under qualified retirement plans are outside the parachute definition. This includes 401(a) plans, 403(a) annuity plans, simplified employee pensions, and SIMPLE retirement accounts. For executives with large qualified plan balances, this can meaningfully cut the total parachute number.¹

Tax-Exempt Organizations

Section 280G does not apply to organizations exempt under Section 501(a). Excessive executive compensation at nonprofits and charities is instead governed by Section 4960, which imposes its own excise tax on excess compensation and excess parachute-type payments. Section 4960 borrows several mechanical rules from 280G, but the two regimes are distinct, and the tax under 4960 falls on the organization itself rather than the individual.⁵

Private Company Shareholder Vote

Corporations that are not publicly traded have access to a route public companies do not. Under Section 280G(b)(5), if the company obtains proper shareholder approval of the parachute payments before they are made, those payments are removed from the parachute definition entirely. The excise tax disappears and the corporation keeps its deduction.¹

The mechanics are exacting. More than 75% of the voting power held by disinterested shareholders must approve. Disqualified individuals who are also shareholders cannot vote their shares. Before the vote, the company has to disclose every material fact to voting shareholders, including the triggering event, the total dollar amount at stake, and each component of the payments (accelerated vesting, cash bonuses, salary continuation, and so on). An omitted fact is material if there is a substantial likelihood a reasonable shareholder would consider it important.² If shareholders vote against the payments, the disqualified individual must forfeit the excess amounts to avoid the excise tax.

Cutbacks and Gross-Ups

Because the three-times line is a cliff, employment and severance agreements routinely include one of two contractual tools.

A better-of-net cutback, sometimes called a valley provision, reduces total payments to just below the three-times threshold if the executive would keep more after taxes by receiving less. The company runs both calculations, one with the full payment and the 20% excise tax and one with the cutback, and whichever number is larger in the executive’s pocket controls. This has become the market standard for new agreements because it costs the company nothing extra while protecting the executive from the cliff.

A gross-up provision does the opposite: the company agrees to pay enough extra to cover the executive’s excise tax, making them whole. Gross-ups are expensive because the additional payment is itself subject to income tax and excise tax, requiring a gross-up on the gross-up. Boards and institutional shareholder advisory firms have pushed hard against them over the past decade, and most new employment agreements no longer include them.

Structural planning can also shrink the parachute total itself. Allocating post-closing compensation to a genuine non-compete, extending equity vesting so acceleration is less dramatic, and structuring retention bonuses as reasonable compensation for post-closing services all reduce the numerator in the calculation. The earlier those conversations happen in a deal, the more flexibility the parties have.

1
Office of the Law Revision Counsel. 26 USC 280G – Golden Parachute Payments
2
eCFR. 26 CFR 1.280G-1 – Golden Parachute Payments
3
Office of the Law Revision Counsel. 26 USC 4999 – Golden Parachute Payments
4
Office of the Law Revision Counsel. 26 USC 1361 – S Corporation Defined
5
Office of the Law Revision Counsel. 26 USC 4960 – Tax on Excess Tax-Exempt Organization Executive Compensation