Section 280G: The “Golden Parachute” Tax Rules Every Executive Should Understand

What growth-stage company leaders should know before an M&A transaction

When a company is acquired, executives and key employees often receive payouts through transaction bonuses, retention bonuses, accelerated or new equity awards, and/or severance benefits.

What many don’t realize until the deal negotiations are well-underway is that section 280G of the U.S. tax code can subject a portion of these payments to a significant U.S. excise tax and strip the company or acquirer of corresponding U.S. tax deductions if the value of those payments exceed certain limits.

We sat down with Brandon Gantus, a Partner and co-leader of the Employee Benefits & Compensation practice at Wilson Sonsini, to break down how the 280G rules work, who they apply to, and what companies can do now to minimize 280G surprises at the time of a deal.

What is 280G?

Section 280G of the U.S. tax code applies to certain deal-related compensation made to a limited group of individuals in connection with a change in control of a company.

At a high level, 280G compares:

  1. An individual’s average historical compensation from the company,  generally over the prior five calendar years, to
  2. The value of deal-related compensation that the individual receives in connection with the transaction.

If the deal-related compensation exceeds 300% of the average compensation, a covered individual may owe a 20% excise tax under U.S. tax code section 4999, and the company or acquirer may lose a corresponding tax deduction under 280G.

How the 280G Calculation Works

The basic 280G framework starts with an individual’s average annual compensation, generally over the previous five calendar years (or whatever period of service the individual has provided to the company, if less than five calendar years).  This is known as the “base amount.”

That “base amount” is then multiplied by three. If the value of the individual’s deal-related compensation equals or exceeds 3x the individual’s base amount, the individual may be subject to 280G taxes.

For example, if an executive has average annual compensation of $100,000, three times that amount would be $300,000. If that executive receives a $1 million transaction bonus, the payment exceeds the 280G threshold.

Importantly, the excise tax is not calculated only on the amount above 3x the base amount. In the example above, the excise tax actually applies to everything above 1x the individual’s base amount. So if the base amount is $100,000 and the parachute payment is $1 million, the 20% excise tax would apply to $899,999 and result in an approximately $180,000 excise tax.

That makes 280G personal for covered individuals, but it is also important for the company and acquirer because the amount that is subject to the excise tax is also not permitted as a tax deduction for the company or acquirer.

Who Is Impacted by 280G?

280G does not apply to every employee. It only applies to a specific group of individuals known as disqualified individuals. There are three main categories below. If an individual falls into any of these categories, the individual is a disqualified individual.

1. Officers

The 280G rules define this as officers of the company over the last 12 months before the change in control, which generally include anyone with a C-suite title. EVP and SVP roles may be included as well.

The rules require a minimum of the lesser of three individuals or 10% of the employee population (rounded up, not to exceed 50), but they must have officer-type functions like the ability to bind the company, for example. It’s a somewhat flexible definition determined based on the facts and circumstances of a particular company. 

2. 1% Shareholders Who Provide Services

Any company shareholder who owns more than 1% of the company’s stock (considering all classes) and provides services to the company at any time over the last 12 months before the change in control is included. This calculation factors in both vested equity and options vesting at the transaction. 

The ownership also covers directly held equity and certain equity that is constructively held (e.g. by family members or trusts). In practice, this might capture individuals other than officers, including consultants with significant equity ownership or founders who no longer have an operating role but still sit on the board or advise the company.

3. Highly Compensated Employees

The top 1% of the employee population by annualized compensation over the last 12 months before the change in control, subject to certain limits. There’s often overlap with the officer or 1% shareholder groups, but this category can also sweep in high-earning salespeople or other employees who do not hold officer titles, such as employees who had a particularly strong commission year.

When Does 280G Matter?

280G is triggered in any of the following transactions:

  • Change in ownership: a person or group acquires more than 50% of the total fair market value or total voting power of the corporation’s stock.
  • Change in effective control: a person or group acquires stock representing 20% or more of the total voting power, or a majority of the board of directors is replaced during a 12-month period by directors not endorsed by the incumbent board.
  • Change in ownership of a substantial portion of assets: a person or group acquires, in a 12-month period, assets with a total gross fair market value equal to or exceeding one-third of the total gross fair market value of all corporate assets (not net assets).

Most commonly, that means a company sale, but the rules also apply in situations that may not feel like a traditional change in control.

For example, 280G can apply in an asset sale if the company sells assets (including a sale of a subsidiary) that represent at least one-third of the gross fair market value of the company assets. This can surprise companies because their equity plans or contracts may define a change in control differently, often using a higher threshold for an asset sale.

It can also arise in more nuanced situations, such as certain dual-class recapitalizations, the signing of option-to-buy agreements that are seen in the biotech industry, or other transactions that shift effective control of the company.

In short, 280G is not limited to the obvious “we sold the whole company” scenario. Any company considering a transformative transaction should assess whether the 280G rules apply. Some entities that are not subject to 280G rules, including entities that are or could be taxed as partnership or “S” corporation under U.S. tax law or subsidiaries or affiliates of larger organizations that do not meet the thresholds under the asset sale rules above.

What Counts as 280G Parachute Payment?

A payment made to a disqualified individual is treated as a 280G parachute payment if it is (a) in the nature of compensation and (b) contingent upon a change in control. The contingency requirement is applied broadly. A payment is presumed contingent on the change in control if it would not have been made absent the transaction, even if the formal legal obligation predates it. 

Common examples include:

  • Transaction bonuses
  • Retention bonuses
  • Severance payments
  • Equity award acceleration or recent equity award grants
  • Performance-based award payouts triggered or accelerated by the deal
  • Certain post-closing compensation arrangements 

Even payments or benefits agreed before the closing, but made after closing can count. For example, if an executive has double-trigger severance in place prior to a change in control that is triggered after both a change in control and a qualifying termination, the severance payable after the change in control may still be treated as a 280G parachute payment even if the termination occurs several months after the closing.

Private vs. Public Companies: A Critical Difference

One of the most important structural differences under the 280G rules is a  shareholder vote exception, which is available to privately-held companies, but not public companies.

Private Companies: The Shareholder Vote Exception

Private companies undergoing a 280G change in control can eliminate the adverse 280G tax consequences by completing the following steps:

  • Securing a waiver from the disqualified individuals who are expected to receive parachute payments in excess of their thresholds; and
  • Disclosing to shareholders entitled to vote the material terms and value of the parachute payments and seeking shareholder approval of the parachute payments in excess of their thresholds for which a waiver has been signed.

The 280G shareholder vote must determine the rights of the disqualified individuals to receive or retain the waived payments.

Successful vote: If more than 75% of the disinterested shareholders (shareholders who do not have parachute payments submitted for shareholder approval) approve these payments, the disqualified individuals keep their full amounts of payments without any adverse tax consequences under 280G.

Unsuccessful vote: If more than 75% of disinterested shareholders do not approve these payments, the waivers mean that the disqualified individuals forfeit their parachute payments in excess of their thresholds.

This shareholder approval process is common in change in control transactions involving private companies, but it can be sensitive. The biggest challenge is often not the math. It is the communication. The shareholder vote process requires disclosure of what executives and other senior leaders could receive in the deal. 

If the company has a broad employee shareholder base, that disclosure can reach a large group of current or former employees at an emotionally charged moment, which is even more problematic in a transaction where shareholders are not receiving large payments but insider employees do get them.

For that reason, companies seeking a 280G shareholder vote need to think carefully about messaging, timing, and process around the 280G shareholder vote and related disclosures.

Public Companies: No Shareholder Vote Exception

Public companies do not have access to the same shareholder vote exception, and instead must look to other 280G mitigation strategies.

Other 280G Mitigation Strategies

Strategies companies use to reduce or offset 280G exposure include:

  • Assigning value to enforceable non-competition agreement – but this only works if the noncompetition agreement is legally enforceable, meaning it is ineffective for individuals in some jurisdictions
  • Demonstrating that certain compensation is reasonable compensation for past or future services – historical compensation practices and market-based compensation data can help with this fact-based analysis 
  • Having the company pay the 280G taxes (and the taxes due on those payments) “280G gross-ups” in certain transactions – although these may be subject to scrutiny from investors and other third parties (including acquirors in the change in control)
  • Increasing the base amount by accelerating payments or vesting into an earlier calendar year if a change in control is expected to close in a subsequent calendar year.

Each of these strategies involves specific considerations often unique to the specific transaction or payment or benefit being provided, and all strategies are not available in all situations.

What Growth-Stage Companies Can Do to Prepare for 280G Before a Transaction

Growth-stage companies that are anticipating a change in control can reduce surprises by thinking about and planning for 280G before the transaction is well underway.

1. Understand how RSUs may affect future transactions

RSUs can be a valuable compensation tool, particularly for late-stage private companies and certain public companies.  Many private company RSU programs, particularly in the technology space, are designed with a double trigger vesting structure – requiring satisfaction of both time-based and liquidity-event vesting triggers. 

While the double trigger vesting structure is helpful to avoid triggering an RSU income tax event until a liquidity event in the U.S., it can have a meaningful 280G impact.  The full value of any RSUs vesting on change in control, including those that satisfy their time-based vesting conditions prior to the change in control, generally is treated as a parachute payment.   Contrast this with stock options that have vested prior to the change in control generally are not treated as a parachute payment (and if they are accelerated in connection with the change in control are valued at values much less than full value). 

That does not mean companies should avoid RSUs. It does mean they should understand how those awards may be treated for 280G purposes in a future transaction.

On the other hand, RSUs issued in public companies can, in fact, be helpful for reducing 280G exposure if the public company gets sold because the income from RSU vesting in prior calendar years ultimately can increase the disqualified individual’s “base amount.”

2. Be thoughtful about early exercise programs

Many growth-stage private companies implement early exercise programs to help employees begin their capital gains holding period and potentially receive more favorable U.S. tax treatment when they sell their shares.

But early exercise also means more employees become shareholders.

If the company later is sold in a change in control and  uses the private company shareholder vote exception for addressing 280G liabilities, those employee shareholders will receive 280G disclosures about parachute payments.  If the employee instead held unexercised options at the time of the change in control, the employee would not receive the 280G disclosures. 

That does not necessarily mean early exercise is the wrong choice. It simply means companies should understand the potential downstream implications.

3. Plan ahead when hiring executives before a potential deal

If a company is hiring a senior executive in anticipation of a transaction, 280G should be part of the compensation planning conversation, particularly for public companies where the shareholder vote exception is not available.

Companies may be able to structure compensation in ways that reduce future exposure, such as adjusting the mix or payment timing of sign-on bonuses, equity award types (e.g., RSUs, options, and/or performance-based awards) , or vesting schedules.

4. Review equity and compensation programs before a transaction

Companies should understand which payments could be considered deal-related, including severance, bonuses, equity award grants or acceleration, and retention arrangements.

The earlier the company has this information, the easier it is to evaluate potential exposure and start planning for mitigation strategies.

5. Talk to advisors early

280G is highly technical, fact-specific, and time-sensitive. Companies should work with legal and tax advisors before a transaction is imminent, especially if they are planning executive hires, changes to their compensation programs, or taking active steps to prepare for a sale process.

Quick FAQs About 280G

No. 280G can apply to CEOs, CFOs, other C-suite leaders and some other senior level employees (e.g., some EVPs or SVPs).  It also applies to certain highly compensated employees and more-than-1% shareholders who are or have recently provided services to the company (e.g., directors, consultants, and certain founders).

No. While it most commonly comes up in company acquisitions, 280G can also apply to certain asset sales, ownership changes, restructuring events, or other transactions that meet the change in control definition under 280G.

Yes. Severance generally is treated as a parachute payment if it is contingent on a change in control. Double-trigger severance can also count, even if the termination and payment occur after closing.

They can. Retention bonuses entered into or that become payable as a result of the transaction or transaction bonuses paid or awarded in connection with a deal are generally treated as deal-related compensation.

They can. For options granted more than 12 months before the change in control that accelerate vesting or could accelerate vesting in connection with the change in control, the parachute payment value is generally limited to the present value of the accelerated vesting (calculated under the 280G rules), not the full economic spread. That can result in a lower value for 280G purposes. Vested options from these grants are not 280G payments.

Options granted within 12 months of a change in control can be more complicated, as they are presumed to be granted in connection with the change in control which can cause the full value to be treated as the parachute payment value unless the presumption is rebutted with clear and convincing facts. For example, if an executive received a normal annual grant within the 12 months of a change in control, the company may be able to show that the award was part of a standard compensation program rather than a transaction-related payment, in which case the valuation rules in the prior paragraph apply.

Yes, and in the case of private companies, double-trigger RSUs can create meaningful 280G exposure.  When the transaction satisfies the liquidity trigger, the RSUs that have satisfied their time-based condition vest and the full current value is treated as a parachute payment.  This can result in materially higher parachute payment values than the acceleration-discount methodology applied to time-based options. In a public company change in control, RSUs that only vest on a time-based vesting schedule are subject to the same valuation rules as described above for options.

Yes, performance-based awards that are awarded or vest on a change in control generally are treated as parachute payments and their 280G value is their full value, subject to certain limited exceptions.

Sometimes. If a non-competition agreement is enforceable in the relevant jurisdiction, the company may be able to assign value to that agreement and use it to offset certain 280G payments.

This strategy is more common in public company deals, in part because private companies often rely on the shareholder vote exception instead. However, the usefulness of a non-competition agreement depends heavily on the jurisdiction where the individual resides. In California, for example, enforceability of non-competes under current law is limited to shareholders owning a meaningful stake in a company that is sold in a sale of business transactions, and so often is not available in most public company deals.

In many cases, private companies can use the shareholder vote exception. If the required process is followed and more than 75% of disinterested shareholders approve the parachute payments, the disqualified individuals can keep their parachute payments and adverse tax consequences can be avoided.

No. Public companies do not have access to the same private company shareholder approval exception, so they need to use other mitigation strategies. These may include valuing enforceable non-competes, showing that certain past or future compensation is reasonable, using tax gross-ups in certain cases, or accelerating payment or vesting of certain parachute payments in certain cases. These mitigation strategies are available for private companies as well, but are not used as much because of the availability of the shareholder vote exception.