Meaning
Tax regulations impose a large penalty on excess parachute payments made to primary individuals during a change in corporate control. This section 280g tax drag reduces the net amount a founder receives when their total exit compensation exceeds a specific threshold. It discourages companies from granting overly generous severance packages to executives at the expense of shareholders.
Excess Payment
The calculation begins by finding the average annual compensation of the individual over the previous five years. If the total payments triggered by the acquisition exceed three times this base amount, the penalty applies. The section 280g tax drag then creates a non deductible expense for the company.
Excise Penalty
The individual recipient faces a twenty percent excise tax on the portion of the payment deemed excessive. This comes in addition to standard income taxes, measurably lowering the take home pay from a successful exit. Calculating the exact limit is a standard part of deal preparation for any American startup.
Deal Structure
Founders often agree to cap their payments at the limit to avoid the additional tax. Another option involves a shareholder vote to approve the payments, which can waive the penalty for private companies under certain conditions. Managing this burden is essential for maximizing the value delivered to the leadership team.
