What are “parachute payments” and 280G?
Takeaway: "Golden parachute" payments to executives during an M&A can trigger a massive 20% excise tax under IRC Section 280G; startups must conduct a formal 280G analysis and often require a special stockholder vote to avoid this punitive tax.
As you approach the sale of your company, you will encounter a highly complex and often surprising area of the U.S. tax code: Section 280G, which governs "golden parachute" payments. This law was designed to discourage companies from giving excessively large and lucrative severance or bonus packages to their executives as part of a change of control.
If the payments made to a key executive that are contingent on an acquisition exceed a certain limit, they can be classified as "excess parachute payments." The consequences are severe:
The company loses its tax deduction for the excess payment.
The executive is hit with a punishing 20% excise tax on the excess payment, in addition to their normal income tax.
Avoiding this tax trap is a critical, and often time-sensitive, part of any M&A process.
What is a Parachute Payment?
A parachute payment is any compensation to a "disqualified individual" (which includes officers, major shareholders, and highly compensated individuals) that is contingent on a change of control (i.e., the sale of the company). This is not just a cash severance payment. It includes a wide range of compensation:
Transaction Bonuses: Any cash bonus that is paid upon the closing of the deal.
Accelerated Vesting of Equity: This is the most common and dangerous trap. If the M&A deal triggers an acceleration of an executive's unvested stock options or restricted stock, the value of that accelerated vesting is considered a parachute payment.
The 280G Limit
The rules are triggered if the total value of an individual's parachute payments equals or exceeds three times their "base amount." The base amount is their average annual compensation from the company over the previous five years. For a founder who has been taking a low salary, this three-times-base-amount threshold can be surprisingly low.
The Solution: The 280G "Cleansing" Vote
Fortunately, for a private company, there is a powerful and standard solution to this problem: the 280G stockholder vote.
The company can "cleanse" the excess parachute payments and avoid the 20% excise tax if the payments are formally approved by a special vote of the stockholders. This vote has very specific requirements:
Full Disclosure: The company must first provide all stockholders with a full disclosure of the parachute payments.
The "Disinterested" Stockholder Vote: The payments must be approved by a vote of more than 75% of the company's voting stock. Critically, the individuals who are receiving the parachute payments (the executives) and anyone whose vote is influenced by them are disqualified from this vote.
This means you must get the approval of more than 75% of your disinterested stockholders (typically your venture investors and other employees) to waive the 280G tax penalties. This vote is a standard and critical part of the M&A closing process. It is essential to work with experienced legal and tax advisors to run the complex 280G calculations and to properly administer this cleansing vote.
Disclaimer: This post is for general informational purposes only and does not constitute legal, tax, or financial advice. Reading or relying on this content does not create an attorney–client relationship. Every startup’s situation is unique, and you should consult qualified legal or tax professionals before making decisions that may affect your business.