The multitude of mergers and acquisitions in recent years (especially in the banking industry) has raised various issues that practitioners need to consider even before the prospect of an acquisition arises. These issues range from the proper structuring of a transaction to provide tax-free treatment to the shareholders and the corporations, to the use of tax attributes carried forward from a target following the acquisition.
One issue common to many acquisitions is the application of the golden parachute rules of Sec. 280G. Golden parachute payments are severance payments to be made to a corporation's top employees and directors on a change in control. The reasons for these are varied, but the tax implications are comparatively straightforward. Sec. 4999 imposes a 20% nondeductible excise tax on the recipient of an "excess parachute payment." In addition, the corporation making the payments cannot deduct any amount considered an excess parachute payment. These results can be costly, both to the recipient of the payments and the corporation. In some cases, the recipient will receive substantially fewer benefits than if the change in control had not occurred.
One of the more difficult and time-consuming tasks involving golden parachute payments is the determination and computation of excess parachute payments. Although some other issues must first be resolved, these computations are critical. Additionally, this is the area in which the recipient and the corporation have the best opportunity to minimize the effects of the golden parachute rules through careful tax planning.
Sec. 280G contains some basic definitions related to excess parachute payments, but Prop. Regs. Sec. 1.280G-1 includes numerous questions and answers providing far more explanations (and examples).
The golden parachute rules apply to "payments in the nature of compensation" to a "disqualified individual," if such payments are contingent (1) on a change in ownership or effective control of a corporation or (2) in the ownership of a substantial portion of a corporation's assets. Payments are in the nature of compensation "if they arise out of an employment relationship or are associated with the performance of services" (Prop. Regs. Sec. 1.280G-1, Q&A-11). These payments generally include wages, bonuses, severance pay, fringe benefits, pension benefits and other deferred compensation.
Certain payments are exempt from the golden parachute rules, even if they would otherwise be considered in the nature of compensation. These include payments from qualified plans (e.g., Sec. 401(a) plans), certain payments of reasonable compensation, payments made by a small business corporation (i.e., a corporation meeting the requirements of Sec. 1361(b), without regard to Sec. 1361(b)(1)(C)) and certain payments made by a corporation, no stock of which is readily tradable on an established securities market (Kegs. Sec. 1.280G-1, Q&A-5).
A disqualified individual is any employee or independent contractor of a corporation who, during the 12-month period immediately preceding the date of the change in control of the corporation, was...