Section 280G: Golden Parachute Rules, Triggers, and Cutbacks

Section 280G governs golden parachute payments: when a corporation undergoes a change in ownership or control and pays a top executive compensation worth three times or more of that executive’s recent average pay, the executive owes a 20% excise tax on the excess and the corporation loses its federal tax deduction on the same amount. The rule catches people off guard because the excess is measured from one times the base amount, not from the three-times trigger, so crossing the line by a dollar can create hundreds of thousands in penalties.

What Counts as a Change in Control

The rule only engages when the corporation experiences one of three events defined in the Treasury regulations. Any one is enough.¹

A person or group acquires more than 50% of the total fair market value or total voting power of the corporation’s stock.
A person or group acquires 35% or more of the corporation’s total voting power over a 12-month period, or a majority of the board is replaced during a 12-month period without approval by the existing board.
A person or group acquires one-third or more of the total fair market value of the corporation’s assets over a 12-month window.

The asset threshold is one-third. Higher figures sometimes appear in casual summaries; they are wrong.

Who the Rule Applies To

Section 280G targets only “disqualified individuals,” not the general workforce. You qualify if, during the 12-month period ending on the date of the change in control, you were:

An officer of the corporation at any point during that period;
A shareholder owning stock with a fair market value exceeding 1% of all outstanding shares; or²
A highly compensated individual, meaning within the highest-paid 1% of the workforce or the top 250 employees, whichever group is smaller.²

Independent contractors who meet the compensation or shareholder thresholds can also qualify. The 12-month lookback stops companies from reclassifying executives right before closing to escape the rule.

The Base Amount and the Three-Times Trigger

The base amount is the yardstick. It equals the individual’s average annual compensation includible in gross income over the five most recent taxable years ending before the change in control. If the executive worked at the company for less than five years, the average uses only the actual period of employment, with shorter periods annualized.¹

Salary, bonuses, commissions, and the taxable portion of equity awards all feed the base amount. “Includible in gross income” is broader than any single box on a W-2, so getting the figure right takes care. Every dollar of error is magnified three times when the number is tested against the trigger.

Multiply the base amount by three. If the aggregate present value of all parachute payments to the disqualified individual equals or exceeds that number, the rule applies to the entire package. “Aggregate” is doing serious work in that sentence. You do not evaluate each payment on its own. Cash bonuses, accelerated vesting of stock options, severance, continued health coverage, and any other compensation tied to the change are pooled and tested together. Agreements signed within the year before the change are presumed contingent on that change unless the company can prove otherwise by clear and convincing evidence.²

Present value of future payments uses a discount rate of 120% of the applicable federal rate, compounded semiannually, measured as of the date of the change in control.¹ Stock options and deferred payments require real valuation work.

How the Penalty Is Calculated

The three-times figure is only the trigger. Once total parachute payments cross it, the penalty applies to everything above one times the base amount. The “excess parachute payment” equals the total parachute payment minus the base amount.²

Take an executive with a $200,000 base amount. The three-times trigger sits at $600,000. If total parachute payments come in at $650,000, the excess is not the $50,000 above the trigger. It is $450,000, the amount above one times the base. That gap surprises people every time.

The penalty falls on both sides:

The executive owes a 20% excise tax under Section 4999 on the entire excess parachute payment, on top of regular income taxes.³
The corporation loses its federal tax deduction on that same excess amount under Section 280G.⁴

In the example above, the executive owes $90,000 in excise tax ($450,000 × 20%) plus ordinary income tax on the full $650,000, and the company loses its deduction on $450,000 of compensation it actually paid out.

Reducing the Excess: Reasonable Compensation

The statute lets you shrink or eliminate the excess parachute payment by showing that part of the compensation is reasonable pay for actual services. Both pieces of this carve-out require clear and convincing evidence.²

Amounts that represent reasonable compensation for services the executive will perform after the change in control are excluded from the parachute calculation entirely. They never enter the three-times test.
Amounts that represent reasonable compensation for work already completed before the change reduce the excess parachute payment, though they are first offset against the base amount.

Non-compete agreements are the most common way to claim the future-services exclusion. If the executive agrees to real restrictions on competing after closing, the value of that agreement can count as reasonable compensation for refraining from services. The regulations require the corporation to show the non-compete “substantially constrains” the executive’s ability to work for competitors and that there is a “reasonable likelihood” the company would actually enforce it.¹ A boilerplate clause the company has never enforced will not do. Valuing the agreement typically requires an independent appraiser, and the IRS looks closely at these numbers on audit.

Cutbacks and Gross-Ups

Executive compensation agreements usually address the risk directly with one of two mechanisms.

A cutback provision automatically reduces total payments to just below three times the base amount. The executive receives less, but no excise tax applies and the corporation keeps its full deduction. A “better-of” or “best net” version compares the executive’s after-tax result under full payment (with the excise tax) against a cut-back payment (without it), and delivers whichever leaves more money in hand.

A gross-up provision does the opposite. The corporation pays the executive an additional amount to cover the 20% excise tax, plus the income tax on the gross-up itself, plus the additional excise tax the gross-up triggers. The math compounds, and the corporation loses its deduction on all of it. Proxy advisory firms and institutional investors have soured on gross-ups, so they appear less often than they used to, but they have not disappeared.

The Private Company Shareholder Vote

Private corporations get an escape route the public markets do not. If no stock is readily tradeable on an established securities market, the company can exempt parachute payments from Section 280G entirely by getting shareholder approval.⁴

The conditions are strict. More than 75% of the voting power held by shareholders immediately before the change must vote in favor. Before the vote, the company must disclose all material facts about every payment that would qualify as a parachute payment, including dollar amounts and tax consequences.² Only disinterested shareholders count. Anyone who is themselves a disqualified individual is excluded from the vote. The disqualified individual must agree, before the vote, to forfeit any payment above the safe harbor if shareholders reject it.

A successful vote wipes out both the excise tax and the lost deduction. The process, often called a “280G cleansing vote,” is standard in private company acquisitions. If it is skipped or the disclosure is botched, the problem cannot be fixed after closing.

Entities and Payments That Are Exempt

Not every company falls under Section 280G. Small business corporations, meaning entities that would qualify as S corporations under Section 1361(b) immediately before the change in control, are fully exempt whether or not they actually elected S corporation status.⁴ Payments from certain tax-exempt organizations described in Section 501(c) are also excluded.¹ Payments from qualified retirement plans are carved out too, so accelerated 401(k) vesting or pension distributions triggered by a change in control do not count toward the three-times threshold.

Interaction with the $1 Million Cap Under Section 162(m)

Executives caught by Section 280G often also fall under Section 162(m), which caps a public corporation’s deductible compensation for “covered employees” at $1 million per year. When both apply, the limits compound. The $1 million cap is reduced by any excess parachute payments already non-deductible under Section 280G.⁵ The corporation can end up losing its deduction on the excess parachute payment and on remaining compensation above the $1 million line. Modeling one without the other understates the real cost.

Reporting and Withholding

For employees, golden parachute payments are included in wages on Form W-2, and the 20% excise tax appears separately in Box 12 under Code K. The employee reports that excise tax on Form 1040.⁶ When the parachute payment qualifies as wages, the employer must withhold the excise tax, increasing normal withholding under Section 3402 by the 20% amount.³ For independent contractors, payments go on Form 1099-MISC with excess parachute payments broken out separately, and no withholding applies.

1
eCFR. 26 CFR 1.280G-1 – Golden Parachute Payments
2
Office of the Law Revision Counsel. 26 USC 280G – Golden Parachute Payments
3
Office of the Law Revision Counsel. 26 USC 4999 – Golden Parachute Payments
4
Office of the Law Revision Counsel. 26 U.S. Code 280G – Golden Parachute Payments
5
U.S. Department of the Treasury. Notice 2008-94
6
Internal Revenue Service. Golden Parachute Payments Guide