An Overview of §280G
In corporate mergers and acquisitions, only a handful of corporate representatives control the outcome of negotiations. Such representatives of selling corporations can unfairly choose deals that provide handsome payments to the representatives while leaving less for shareholders. To prevent this, Internal Revenue Code (“IRC”) §280G prevents both selling and acquiring corporations involved in a corporate acquisition from deducting such payments if they are excessive. Further, IRC § 4999 imposes a 20% excise tax on those who receive these payments.
More specifically, §280G and §4999 apply to (1) payments in the nature of compensation made to (2) “disqualified individuals” that are (3) contingent or presumed contingent on (4) a “change in ownership or control” which are (5) “excess parachute payments.” These five elements contain considerable nuance:
- Payments in nature of compensation. This broadly-construed term includes accelerated vesting of equity awards, severance payments, bonuses, early vesting and/or payout of nonqualified deferred compensation, continued payment of health, welfare and other fringe benefits, and any enhancement to benefits provided to the individuals.
- Disqualified individuals. For §280G, the term “disqualified individual” means any individual who is an employee or independent contractor who performs personal services for the corporation, and who is an officer, greater-than-1-percent shareholder, or among the highest paid 1 percent of the corporation (a “highly-compensated individual”).
- Contingent or presumed contingent. In general, a payment is contingent on a change in ownership or control if two elements are met. First, the disqualified individual must either acquire a right to receive payment or have an existing right to payment accelerated. Second, this change in rights occurs (i) as a result of the change in control, (ii) as a result of events closely associated with the change, or (iii) (absent rebuttal of a presumption) pursuant to an agreement entered into or amended within one year before the change. For presumed contingencies under (iii), the presumption can be rebutted only by showing, by clear and convincing evidence, that such payment was unrelated to the change in control event. Payments entered into post-change are generally not considered contingent.
- Change in ownership or control. A change in ownership or control occurs when there is a change in the “ownership” or “effective control” of the corporation, or there is a change in the ownership of a “substantial portion of the assets” of the corporation. These terms are defined differently than any comparable terms in the tax law.
- Excess parachute payments. If the present value of the aforementioned payments to the disqualified individual at the date of change in control equals or exceeds three times such individual’s average annual taxable compensation for the five taxable years preceding the year of change in control (the “base amount”), then the value of the payments less the individual’s base amount (“excess parachute payment”) is nondeductible and subject to §4999 excise tax.
In addition to its five core concepts, §280G provides that it will not generally apply to certain payments, including the following:
- Payments made with respect to a sale of wholly-owned subsidiary that will not result in a change in control of the parent corporation.
- Payments made pursuant to qualified employee benefit plans.
- Payments made with respect to a corporation which (immediately before the change in ownership or control) would qualify as an S corporation (except that nonresident aliens can be shareholders).
- Payments made with respect to a private company, where 75% of the disinterested shareholders approve the payments, following an adequate disclosure and waiver of payees’ rights to receive the payments if shareholders do not approve the payments.
- Payments that constitute reasonable compensation to the recipient. Reasonable compensation includes any payment that is established by clear and convincing evidence to represent reasonable compensation for services to be rendered on, after, or before the change in control.
With adequate planning, the impact of §280G can often be minimized. Nonetheless, buyers and sellers of corporations proceed at their peril when they do not pay appropriate attention to §280G.
 The regulations define a change in target’s ownership as occurring on the date that any person (or persons acting as a group) acquires ownership of stock that, together with stock already owned by the person or group, possesses more than 50 percent of target’s total value or voting power.
 A change in target’s effective control is presumed to occur on the date that either: (a) any person (or persons acting as a group) acquires during a 12-month period stock that possesses 20 percent or more of target’s voting power or (b) a majority of the members of target’s board of directors is replaced during a 12-month period by persons not endorsed by a majority of the previous board. The presumption can be overcome by showing that event has not transferred the power to control target’s management and policies.
 A change in ownership of a substantial portion of target’s assets occurs on the date a person (or persons acting as a group) acquires, within a 12-month period, assets having a gross fair value without regard to liabilities equal to one third or more of target’s gross assets (certain transfers are disregarded for this purposeDisclaimer: This blog and website are public sources of general information concerning our firm and its lawyers, as well as the information presented. They are intended, but not promised or guaranteed, to be correct, complete, and up-to-date as of the date posted. This blog and website are not intended to be, and are not, sources of legal opinion or advice. The materials, information, and communications on this blog and website do not apply to any particular person, entity, or situation, and do not apply to you or to your specific situation. You will need to consult with an attorney and/or other appropriate professional about your specific situation. Thank you.