Golden parachute calculations: 10 misunderstood aspects of secs. 280G and 4999.

• Author: Van Leuven, Mary

When a company experiences a change in control, the golden parachute rules are intended to discourage excessive compensation for "disqualified individuals" (certain officers, highly compensated individuals, and 1% shareholders) by imposing adverse tax consequences on both the company and the disqualified individuals. The adverse tax consequences are triggered if the present value of change-in-control payments to a disqualified individual equals or exceeds a "safe harbor" equal to three times the individual's "base amount" (Sec. 280G; Regs. Sec. 1.280G-1).

The base amount is the individual's average taxable compensation from the company over the five most recent tax years preceding the change in control (Secs. 280G(d)(1) and (2)). If the golden parachute rules are triggered, the company loses tax deductions for the amount considered an "excess parachute payment" under Sec. 280G, and the disqualified individual incurs a 20% excise tax on the excess parachute payment under Sec.4999.

Below are some misunderstood aspects of the golden parachute calculations.

1. Calculation of Penalties on Excess Parachute Payments: Three--Not One--Times the Base Amount

   If the present value of change-in-control payments to a disqualified individual is outside the safe harbor, that is, the present value equals or exceeds three times the base amount, then the excess parachute payments are calculated on amounts paid in excess of the disqualified individual's base amount, rather than the amount in excess of the safe harbor (Sec. 280G(b)(2)(A) (ii); Regs. Sec. 1.280G-1, Q&A-38(a)). In other words, parachute payments can go up to 2.99 times the base amount without penalty, but if the payments equal or exceed three times the base amount, penalties apply to everything over the base amount.

2. Identification of Disqualified Individuals Includes Foreign Individuals

   There are several common misunderstandings with respect to the identification of disqualified individuals subject to the parachute calculations. Among these are the failure to include foreign individuals in the calculations--a foreign disqualified individual may not be subject to the Sec. 4999 excise tax, but the company remains subject to the Sec. 280G deduction limitation (Regs. Sec. 1.280G-1, Q&A-1(b) and Q&A-15). Similarly, U.S. persons are subject to Sec. 4999, even if the company making the payments does not have a deduction limited under Sec. 280G (e.g., the buyer is making the payment, but the selling...