Even in the current economic and business disruptions caused by COVID-19, we are still seeing key executive hiring go forward.  Executive employment agreements contain many tax terms, and while some are largely boilerplate (proper and helpful nevertheless), some tax provisions can have a major impact on how the executive is compensated under the agreement.  One such tax provision that often goes “under the radar” relates to the “golden parachute” tax under Code Section 280G.

In basic terms, Code Section 280G is intended to prevent key service providers (generally highly compensated, officers, and significant shareholders) from getting excessive benefits at the expense of shareholders in a change of control.  Excess benefits are determined by comparing payments that are contingent on the change of control against the executive’s average compensation.  Transaction-contingent compensation typically includes equity acceleration, severance, signing bonuses, and transaction bonuses, although other payments can be included.  If the contingent payments exceed a calculated threshold, a 20% excise tax and a loss of corporate deduction apply.  There is a shareholder approval process that can cure golden parachute taxes that is available to private companies only.

For executive agreements, there are typically three choices for how 280G parachute payments will be considered: “haircut,” “best-of,” and the rarely but sometimes seen “gross-up” provisions.  While the names are somewhat explanatory, the haircut involves forfeiting payments sufficient to fall below the specified threshold where 280G penalties apply. The best-of requires the executive to choose either forfeiting payments so that the penalties don’t apply or receiving the full payments, whichever results in the greatest benefit to the executive.  The gross-up involves additional payments to the executive to make the executive whole for 280G taxes that may have applied.