October 2026 - Executive Compensation
Section 280G of the Internal Revenue Code is an important part of corporate dealmaking. It impacts people retention, taxes, and deal closing speed. And yet, too often it is put on the back burner. Below is an overview of 280G in private company deals and some early action items buyers and their counsel should take in their next transaction.
Overview:
280G generally applies to a corporate transaction when a corporation undergoes a change in ownership or control and pays a “disqualified individual” compensation that is contingent on the change in ownership or control. If the present value of payments made to disqualified individual equals or exceeds three times the individual’s “base amount,” every dollar above one time the base amount is an “excess parachute payment.” The consequences of excess parachute payments are (i) the corporation loses its deduction for the amounts in excess and (ii) the disqualified individual owes a 20 percent excise tax on the excess, on top of ordinary income tax.
For purposes of 280G, the following must be analyzed: whether (1) a change in ownership or control as defined under applicable regulations exist such that 280G applies (2) whether the payments in question are paid to a “disqualified individual” (3) if payments are made to disqualified individuals, do any excess parachute payments exist, (4) if excess parachute payments exists, what mitigation measures are available to avoid the adverse consequences of 280G , and (5) what documents should be drafted or revised and covenant’s made in the purchase agreement.
1. Does 280G Apply?
280G applies when a qualifying change in ownership or control occurs, as defined under applicable regulations. 280G applies to entities taxed as corporations and LLC’s who elect corporate tax treatment. It even applies to asset deals in certain situations.
The base amount is generally the individual’s average annual taxable compensation from the company (typically, what is reported on Form W-2, over the five calendar years before the year of the change). 280G however does not apply to corporations who make valid S corporation elections and to corporations who immediately before the change in control would be eligible to elect S corporation status.
2. Are Payments Being Made to Disqualified Individuals?
Disqualified individuals are officers, shareholders who own more than 1 percent of the company’s stock by value, and highly compensated individuals, roughly the top 1 percent of earners who also earn above the IRS highly compensated employee threshold. Directors and independent contractors can qualify. A conservative approach is often used when deciding who is a disqualified individual for 280G purposes.
3. Are the Payments Excess Parachute Payments?
For payments to disqualified individuals to count as excess parachute payments, they must be above the base amount and made contingent upon a change in control. Payments made for services rendered not contingent upon a change in control do not count. Typical examples of excess parachute payments include severance, retention bonuses, other transaction bonuses, and accelerated equity vesting. Payments made within a year of the change in control are presumed to be contingent on the change in control.
4. Potential Mitigation Measures
If 280G applies and excess parachute payments exists, or are too close for comfort, then certain mitigation measures may be taken. The most common private company mitigation measure is the shareholder cleanse vote.
If no stock of the company is readily tradeable on an established securities market, payments approved by more than 75 percent of the voting power of all outstanding stock entitled to vote, after adequate disclosure to every shareholder entitled to vote, are not parachute payments. If all specific shareholder voting requirements are met, the vote eliminates both the excise tax and the lost deduction. Note that this vote must occur before closing.
If the shareholder cleanse vote is not available, consider engaging counsel to negotiate the offer letters, retention agreements, and bonus agreements to reduce the payment amount such that payments are no longer above the 280G threshold.
Finally, moving the closing date to the following year could impact the disqualified individuals base amount numbers and may bring disqualified individuals under (or above) the threshold amount. Preliminary analysis can be run to help determine the closing date best suited for 280G purposes.
5. Transaction Documents
If a shareholder cleanse vote is used, a standard 280G covenant should be included in the purchase agreement. Additionally, certain disclosures are typically made against the purchase agreement such as offer letters, retention agreements, equity acceleration, and severance payments. Keep an eye on the 280G analysis and update the transaction documents as needed.
Early Action Items:
Contact Momentum Advisors as your outside employee benefits and executive compensation counsel.
Ask Seller whether the target is a corporation and whether it qualifies as a small business corporation.
If an asset deal, ask Seller whether the sale will be one-third or more of the company’s assets by value is a change in ownership of a substantial portion of its assets.
Request a list of officers, 1 percent shareholders, and top earners, with five years of W-2 compensation. Note that directors and independent contractors may count as key employees that count as a disqualified individual.
Decide which key employees you want to retain and negotiate offer letter terms early.
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