Section 280G (Golden Parachute)

What Is Section 280G?

Section 280G of the Internal Revenue Code addresses so-called golden parachute payments — compensation paid to certain officers, shareholders, and highly compensated individuals that is contingent on a change of control of the company. If the total present value of these payments equals or exceeds three times the individual's base amount (generally their average annual W-2 compensation over the five calendar years preceding the change of control), the excess over one times the base amount is subject to a 20% excise tax under Section 4999. Additionally, the company loses its tax deduction for the excess parachute payments.

Section 280G was designed to discourage excessive severance and equity acceleration payouts in connection with corporate acquisitions. For startup employees with significant equity positions, it can create an unexpected and substantial tax hit when the company is acquired.

How the Golden Parachute Rules Work

The Base Amount

Your base amount is your average annualized includible compensation over the five tax years preceding the year of the change of control. For example, if your W-2 income over the last five years averaged $250,000, your base amount is $250,000.

The Three-Times Threshold

The golden parachute rules are triggered when the total present value of your change-of-control payments (called parachute payments) equals or exceeds three times your base amount. Using the example above, the threshold is $750,000 (3 x $250,000). If your parachute payments total $749,999, no excise tax applies. If they total $750,000 or more, the excess over $250,000 (one times the base amount) is subject to the 20% excise tax.

What Counts as a Parachute Payment

Parachute payments include any compensation contingent on the change of control:

• Accelerated vesting of stock options: The value of option vesting that would not have occurred but for the CIC
• Accelerated vesting of RSUs and restricted stock: The fair market value of shares that vest due to the CIC
• Severance payments: Cash severance triggered by the CIC
• Bonus payments: Transaction bonuses or retention bonuses tied to the CIC
• Continued benefits: Health insurance continuation, outplacement services, etc.
• Non-compete payments: Payments for agreeing to a non-compete in connection with the CIC

The Excise Tax

The excise tax is 20% of the excess parachute payment (total parachute payments minus one times the base amount). This tax is in addition to regular income tax — it is not a substitute. It is paid by the individual, not the company.

Example: Base amount = $250,000. Total parachute payments = $900,000.

• Threshold: 3 x $250,000 = $750,000 (exceeded, so rules apply)
• Excess parachute payment: $900,000 - $250,000 = $650,000
• Excise tax: $650,000 x 20% = $130,000
• Plus regular income tax on the full $900,000

Disqualified Individuals

Section 280G applies only to disqualified individuals, which include:

• Officers of the company
• Shareholders owning more than 1% of the company
• Highly compensated individuals (top 250 employees by compensation, approximately)

Rank-and-file employees without officer status and with less than 1% ownership are generally not subject to 280G.

Practical Implications for Startup Employees

The Cliff Effect

The 280G rules create a harsh cliff: going from $749,999 to $750,000 in parachute payments (using the $250,000 base amount example) triggers the excise tax on $500,000 of excess payments. This cliff effect means that even a small increase in parachute payments can trigger a massive tax liability. Companies and their advisors often structure CIC provisions to stay below the three-times threshold.

Cutback Provisions vs. Gross-Ups

Many equity plans include a 280G cutback provision: if your parachute payments would exceed the three-times threshold, they are automatically reduced (cut back) to just below the threshold to avoid triggering the excise tax. Some executives negotiate a gross-up, where the company pays the excise tax on their behalf — but this is increasingly rare and costly for the company.

Private Company Exemption

Section 280G does not apply to corporations where no stock is readily tradeable on an established securities market — if the company obtains shareholder approval of the parachute payments. This means private companies can potentially exempt themselves from 280G by holding a shareholder vote. The vote requires approval by more than 75% of the voting power of all outstanding stock, and the shareholders must receive adequate disclosure. Many private company acquisition agreements include a 280G shareholder vote as a closing condition.

How It Relates to Exercising Stock Options

Section 280G directly affects the value of your stock options in an acquisition. If your option acceleration is treated as a parachute payment and you are a disqualified individual, the excise tax can consume 20% of the excess value — on top of regular income tax. This makes pre-acquisition exercise planning important: if you exercise options before the change of control is triggered, the exercise is not contingent on the CIC and may not be counted as a parachute payment. Consult with a tax advisor well before a potential acquisition to model your 280G exposure and explore strategies to mitigate it.