Section 280G: Overview, definition, and example
What is Section 280G?
Section 280G of the Internal Revenue Code (IRC) is a U.S. tax provision that limits the deductibility of certain executive compensation payments, known as golden parachute payments, made in connection with a change in control of a company. If these payments exceed a specific threshold (typically three times the executive’s base salary), the excess amount is subject to an additional 20% excise tax, and the company loses the ability to deduct the excess compensation as a business expense.
For example, if a corporation is acquired, and its CEO receives a severance package that qualifies as an excess parachute payment under Section 280G, both the company and the executive may face significant tax consequences.
Why is Section 280G important?
Section 280G is important because it prevents executives from receiving excessive compensation at the expense of shareholders and tax authorities during mergers, acquisitions, or other corporate transactions. It also affects how companies structure executive severance and retention packages in change-of-control situations.
For businesses, understanding Section 280G helps avoid unexpected tax liabilities, ensures compliance with tax regulations, and allows for strategic planning of executive compensation to minimize penalties. Many companies include shareholder approval provisions or structure compensation to avoid triggering the excise tax.
Understanding Section 280G through an example
Imagine a publicly traded company is being acquired, and its CFO is entitled to a severance package worth $6 million. If the CFO’s base salary is $1 million per year, the 280G threshold (three times the base salary) would be $3 million. Since the severance exceeds this threshold, the excess $3 million would be subject to the 20% excise tax, and the company would lose its ability to deduct this amount from its taxable income.
In another scenario, a private company preparing for acquisition wants to avoid 280G penalties. The company seeks shareholder approval for executive severance packages before finalizing the deal. If at least 75% of shareholders approve the compensation, the company can avoid the 280G excise tax, making the transaction more tax-efficient.
An example of a Section 280G clause
Here’s how a Section 280G clause might appear in an executive compensation agreement:
“In the event that any payments or benefits provided to the Executive in connection with a change of control would result in excess parachute payments under Section 280G of the Internal Revenue Code, such payments shall be reduced to the maximum amount that avoids excise tax liability, unless the Executive elects to receive the full amount and assumes any applicable excise tax.”
Conclusion
Section 280G limits excessive executive compensation payments in corporate transactions by imposing tax penalties on golden parachute payments that exceed a defined threshold. Companies must carefully structure executive compensation to comply with Section 280G, often using shareholder approval or payment adjustments to minimize tax consequences.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.