• Robert M. Fields

SECTION 280G: Pitfalls for the Unwary

Under Section 280G of the Code, corporations involved in change in control transactions are denied income tax deductions for certain “parachute payments” provided to specific classes of executives and owners. The persons receiving the parachute payments are subject to excise taxes under Section 4999 of the Code.

We are all aware that Code Sections 280G and 4999 apply to publicly-traded corporations. However, it is important to note that these rules also apply to privately-held corporations unless certain exceptions apply.

First, Code Sections 280G and 4999 do not apply to Subchapter S corporations or to other corporations that are eligible to elect Subchapter S treatment.


Second, the parachute payment rules do not apply to other privately-held corporations (and to certain other business entities), but only if the following shareholder approval rules are satisfied:

o The parachute payments must be subject to the approval of holders of more than 75 percent of the voting power of all classes of outstanding stock of the corporation who are entitled to vote, with the identity of such shareholders being determined “immediately before the change in control,” The “immediately before” rule can be met by reference to shareholders of record as of any day within the six-month period ending on the date of the change in control. The rules describing the shareholders who are “entitled” to vote are set forth below.


o Before the vote adequate disclosure is made to all persons entitled to vote of all material facts concerning all material payments which would be 280G parachute payments. These material facts include, but are not limited to, the event triggering the payment, the total dollar value of the payment that otherwise would be parachute payments if the shareholder vote rules were not satisfied, and a brief description of the payment (such as accelerated vesting of options, success bonuses, etc.). An omitted fact is considered “material” if there is a “substantial likelihood” that a reasonable shareholder would consider it important.


o The vote must determine the right of the executive/owner to receive the payment. Thus, the ability of the affected person to receive the payment must be subject to approval by the shareholders. Shareholder ratification of an otherwise legally enforceable payment is not sufficient. It should be noted that the shareholder approval rules will not be satisfied if the change in control is contingent upon shareholder approval of the payments.


o A separate vote can be held for each affected person, or for all affected persons as a group. However, the vote(s) must be separate from any votes cast by shareholders with regard to any other matters.


o In determining the shareholders entitled to vote, stock that would otherwise be entitled to vote is not counted as outstanding stock (and is not taken into account in determining whether the “more than the 75%” vote rule is satisfied) if the stock is directly or constructively owned by the executive/shareholder receiving the parachute payment (or is owned or constructively owned by any person who, under the constructive ownership rules, is deemed to own stock directly or constructively owned by any such executive/shareholder receiving the parachute payment).


o Lastly, certain additional rules apply if the corporation undergoing the change in control is a subsidiary of another entity.


It is important to note that the shareholder approval exception to the application of Code Sections 280G and 4999 do not apply if the corporation undergoing the change in control is a “substantial” asset of a publicly traded corporation.

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