Acquisitions Involving Bonus Payments And Accelerated Vesting Of Options Or Option-Like Rights To Key Management Of The Target Company: Beware Of Section 280G And Section 4999

Congress enacted Section 280G in 1984. This provision addresses the income tax treatment of certain excess parachute payments incident to a change of control or takeover of a corporation. In enacting this provision, Congress was concerned that "golden parachutes" schemes, which were specifically adopted to detract or prevent a potential acquirer from engaging in a "friendly" or "hostile" takeover by imposing a high surcharge to target management in the event of a change of control or takeover, should be discouraged.

Section 280G therefore disallows a corporation a deduction for certain compensatory type payments made to a "disqualified individual" (whether or not incident to termination of the individual's employment) where the payment (1) is contingent on a change in the ownership or effective control of a corporation or in the ownership of a substantial portion of a corporation's assets, provided the present value of the payments exceeds three times a defined base amount, or (2) is paid pursuant to an agreement violating any generally enforced securities laws or regulations. Any payment made pursuant to an agreement or amendment entered into within one year before a change of ownership or control is presumed to be contingent on the change unless the contrary is established by clear and convincing evidence.

The term "disqualified individual" includes an officer, shareholder, or highly compensated individual (including a personal service corporation or similar entity), as well as any employee, independent contractor, or other person who performs personal services for the corporation and is specified in regulations. §280G(c). See Treas. Reg. §1.280G-1 (definitions of "highly-compensated individual" and "officer group"). A disqualified individual's "base amount" is defined by reference to the individual's average annual taxable compensation for a five-year base period preceding the change of control or ownership. The parachute payments that are compared with three times the base amount to determine the excess parachute payments are net of an allowance for amounts established as reasonable compensation for personal services that were rendered before the change (if not already compensated for) or that are to be rendered after the change as is pointed out again below. See §§280G(b)(3), 280G(b)(4). See Square D Co. v. Comm'r, 121 T.C. 168 (2003). The definition of "base amount" not only determines whether Section 280G will apply but also...