What is a 280G Parachute payment?

Planning for a potential acquisition or sale is crucial, regardless of the current probability of a change in control occurring.

Payments contingent specifically upon a change in control are often known as 280G parachute payments or golden parachute payments.

When structuring deferred compensation plans for your financial institution, practicing due diligence will help set up your bank for success.

We will explain Sections 280G and 4999 to help ensure your compensation plans are structured soundly.

What risks arise as a result of Sections 280G and 4999?

If a payment breaches the threshold set by IRC Sections 4999 and 280G, it is deemed to be an “excess parachute payment,” and 280G tax penalties will be levied against the individuals and corporation.

When a change of control occurs, there are many associated costs for the bank, particularly those that relate to compensating employees, shareholders, and officers.

These “parachute payments” may include unvested payments from long term compensation plans, severance pay, and other benefits received during a severance period (such as healthcare benefits).

Compensation payments fall under IRC Section 280G if they wouldn’t have been made if not for a change of control or if they’ve been accelerated due to the change of control.

If what constitutes an excessive parachute payment is made to a “disqualified individual,” the bank is penalized with non-deductibility of anything over one times the base amount (the average taxable compensation that the individual received over the five most recent tax years).

Disqualified individuals can include officers, shareholders, and highly compensated individuals.

More specifically, highly compensated individuals under Section 280G are either in the highest paid 1% of the organization’s members or are in the group of the 250 most highly compensated members of the organization.

While Section 280G can create problems for the bank, Section 4999 of the code creates problems for the recipient by imposing a 20 percent excise tax on the recipient of any excess parachute payment.

How can banks avoid the penalties on excessive 280G parachute payments?

Although the matter may seem alarming, it is possible to take control, plan ahead, and avoid a costly disaster for the bank and your highly compensated individuals.

Be attentive to 280G tax consequences when structuring compensation plans, whether you’re currently expecting a change in control or not.

Agreements need to be in place for 12 months prior to the change of control to be considered valid. Specific strategies to address 280G issues include:

• Limiting language in agreements: Limit language to relay that you will not pay out more than 2.99x base amount. Make sure you’re careful that this language is present in all agreements, as even one missed agreement can cause complications.
• Non*Competes: It’s possible to use a non-compete agreement in lieu of an “employment agreement” payment. This represents a “Payment for Service” not includible under parachute payments. Because there’s an upside and downside to the transaction, you should discuss this strategy with a qualified institutional advisor to decide if it’s the right course of action.
• Vesting: If bank is positioning for a sale, vest executives annually to help minimize the acceleration of benefits that occur upon the change of control.

Some banks turn to gross-up payments in order to cover the tax burdens Section 499 places on disqualified individuals, but this isn’t the best course of action.

280G gross-ups are highly scrutinized, and detractors consider them to be excessive compensation.

More than that, they can be extremely expensive for an institution if limiting gross-up language is not incorporated into the agreement.

Be proactive and work with compensation experts who understand 280G parachute payments

Compensation agreements can be complicated, and there’s a lot at stake: An excess payment as low as one dollar could cost you tens or hundreds of thousands of dollars in 280G penalties.

Know that adding equity or other NQDC plans can dramatically affect the calculation of what constitutes an excessive payment.

Your bank should only enter into compensation agreements when you have a full understanding of all implications. Be proactive relative to your agreements, and have them reviewed by institutional experts.

This will position your bank for success and make a possible change in control significantly less costly for the organization and its highly compensated individuals.

Illustration: 280G Noncompliance vs. 280G Compliance

To understand the associated tax consequences and penalties with 280G noncompliance, here’s an illustration that compares what happens when you plan ahead and are compliant:

 

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The experts at Compensation Advisors possess over 50 years of compensation experience at the community bank level.

We leverage that experience to design and implement relevant, innovative solutions that relate to current regulatory environments.

Our primary goal is helping our clients attract and retain key executives and top performers. Compensation Advisors is a member of Meyer-Chatfield Group.