The 280g tax code is one of those IRS provisions that can quietly drain your company’s wallet if you’re not paying attention. Section 280G of the Internal Revenue Code addresses the tax treatment of executive severance payments and change-of-control bonuses—and it comes with some seriously expensive gotchas. Whether you’re a business owner, executive, or HR professional, understanding how 280G works is critical to avoiding unexpected tax bills that can derail your financial plans.
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What Is Section 280G?
Section 280G is a federal tax provision that penalizes what the IRS calls “excessive” severance and bonus payments made to executives in connection with corporate changes of control. Think of it as the tax code’s way of saying: we’re going to make this expensive if you’re too generous with golden parachutes.
Here’s the basic framework: if a company makes payments to executives that exceed three times their base amount (3x multiplier), the payments trigger both a 20% excise tax on the employee AND a corporate deduction limitation. This isn’t just a small penalty—it’s a significant financial consequence that affects both the company and the individual receiving the payment.
The provision applies to publicly traded companies, private companies, and even nonprofits in certain situations. If your organization is planning any kind of merger, acquisition, or leadership transition, 280G is directly relevant to your tax planning.
Golden Parachute Payments Explained
A “parachute payment” under 280G includes severance, bonuses, equity acceleration, and other compensation triggered by a change of control. The definition is broader than most people realize. It’s not just the big severance check—it includes:
- Cash severance packages
- Accelerated vesting of stock options or restricted stock
- Bonus payments triggered by the transaction
- Continuation of health insurance or other benefits
- Deferred compensation distributions
- Tax gross-ups (payments meant to cover the executive’s tax liability)
The IRS measures these payments against the executive’s “base amount,” which is typically their average taxable compensation over the five years before the change of control. If total payments exceed 3x this base amount, you’ve crossed into 280G territory.
What makes this tricky is that the calculation includes all forms of compensation. A company might think they’re offering a reasonable severance package, but once you add in stock acceleration, deferred comp distributions, and benefit continuation, the total can easily exceed the 3x threshold. This is where most companies get blindsided.
How to Calculate 280G Excise Tax
The math on 280G excise tax is straightforward in theory but complex in practice. Here’s the framework:
Step 1: Determine the Base Amount
Calculate the executive’s average taxable compensation over the five-year period immediately preceding the change of control. This includes W-2 wages, bonuses, and other taxable compensation.
Step 2: Calculate the 3x Threshold
Multiply the base amount by 3. This is your safe harbor. Payments up to this amount don’t trigger 280G.
Step 3: Identify Parachute Payments
Total all payments made to the executive in connection with the change of control, including severance, accelerated vesting, and benefits.
Step 4: Calculate Excess Parachute Amount
If parachute payments exceed the 3x threshold, the excess is subject to a 20% excise tax. The executive pays this tax directly on their individual return (Form 4999).
Example: An executive has a $200,000 base amount (average over five years). The 3x threshold is $600,000. The company offers $800,000 in severance and accelerated equity. The excess parachute amount is $200,000, triggering a $40,000 excise tax (20% × $200,000) paid by the executive.
But here’s where it gets worse: the company also loses its tax deduction for the excess amount. So the company gets hit twice—it can’t deduct the excess parachute payment, and the employee pays the 20% excise tax on top of regular income tax.
Shareholder Approval & Waivers
There’s a way to avoid 280G consequences, but it requires shareholder approval. Section 280G(b)(5) allows companies to obtain a shareholder vote that waives the 280G restrictions. This is called a “280G waiver” or “280G approval.”
Here’s how it works: before a change of control occurs, the company can disclose the potential 280G consequences to shareholders and ask them to vote on whether to allow the payments anyway. If shareholders approve by a majority vote, the 280G penalties don’t apply—the company can deduct the full amount, and the executive doesn’t pay the 20% excise tax.
This sounds simple, but there are strict procedural requirements:
- Disclosure must be made in writing to shareholders before the vote
- The disclosure must include specific information about the payments and their tax consequences
- Shareholders must have a reasonable opportunity to vote
- The vote must pass by a majority (more than 50% of voting power)
- The waiver must be obtained before the change of control is consummated
For private companies, this is often easier to manage. For public companies, this disclosure becomes part of proxy statements and can draw scrutiny from institutional investors and proxy advisors who increasingly oppose excessive executive pay.
Many companies fail to obtain proper 280G waivers because they underestimate the complexity of the disclosure requirements or because they’re negotiating the change of control deal and don’t want to tip off shareholders. This is a critical planning mistake.
Corporate Deduction Limits
Beyond the 20% excise tax on the employee, companies face a significant deduction limitation. Under 280G(e), a company cannot deduct the portion of parachute payments that exceed the 3x threshold.
This creates a double hit on the company:
- Lost Deduction: The excess amount is not deductible for federal income tax purposes
- State Tax Impact: Many states follow federal rules, so the company also loses state tax deductions on the excess amount
For a company in a 37% federal tax bracket (plus state taxes), losing the deduction on a $200,000 excess parachute amount costs roughly $74,000+ in additional taxes. This is real money that affects the bottom line.
The deduction limitation applies regardless of whether the employee actually pays the 20% excise tax. Even if the company obtains a 280G waiver and the employee doesn’t owe the excise tax, the company still loses the deduction unless the waiver is properly structured.
This is why corporate tax planning around change-of-control transactions must include 280G analysis from day one. Waiting until the deal is closing to address 280G issues is a recipe for expensive surprises.
Common 280G Mistakes to Avoid
Mistake #1: Forgetting About Accelerated Equity Vesting
Companies often focus on cash severance but overlook the tax impact of accelerating stock option or restricted stock vesting. The value of accelerated equity counts as a parachute payment and can easily push executives over the 3x threshold. Always include equity acceleration in your 280G calculations.
Mistake #2: Not Disclosing All Forms of Compensation
Executives sometimes receive deferred compensation, supplemental retirement benefits, or other long-term incentives that aren’t immediately visible. These all count toward the base amount and parachute payment calculations. Get a complete inventory of all compensation arrangements before doing the math.
Mistake #3: Assuming the 3x Safe Harbor Is Safe
Just because payments are under 3x doesn’t mean you’re in the clear. The IRS can challenge your calculation of the base amount or argue that certain payments should be included. Document your calculations and consider getting a professional valuation if there’s any ambiguity.
Mistake #4: Obtaining Shareholder Approval Too Late
Shareholder approval must happen before the change of control is consummated. If you’re already in the middle of a deal when you realize you need 280G approval, you may not have time to hold a shareholder vote. Plan ahead.
Mistake #5: Failing to Consider State Tax Consequences
While 280G is a federal provision, many states conform to it. Some states add their own penalties or apply different rules. For example, if executives are in high-tax states like California or New York, the combined federal and state tax hit can be devastating.
Mistake #6: Ignoring 280G in Retention Agreements
Some companies use retention bonuses to keep executives during a transition period. These bonuses can trigger 280G if they’re contingent on a change of control. Many companies pay these bonuses without realizing they’ve just created a 280G problem.
Practical Planning Strategies
Strategy #1: Negotiate Under the 3x Threshold
The simplest way to avoid 280G complications is to structure payments so they stay below the 3x threshold. This requires discipline during negotiations, but it eliminates the tax penalty entirely. Work with your CFO and tax advisor to model different severance scenarios against the 3x threshold.
Strategy #2: Obtain Shareholder Approval Early
If you anticipate a potential change of control (acquisition, merger, IPO), consider obtaining a preemptive 280G waiver. This gives you flexibility in negotiating executive compensation without worrying about 280G constraints. The waiver typically remains valid for a specified period (often 12-24 months).
Strategy #3: Use Tax Gross-Ups Strategically
Some companies offer to “gross up” the 280G excise tax—meaning they pay the executive an additional amount to cover the 20% excise tax. This is expensive (it requires paying 20% more on the excess amount) and increases the parachute payment amount, potentially pushing more payments into excess territory. Avoid this unless absolutely necessary for executive retention.
Strategy #4: Structure Equity Awards Carefully
Consider using equity awards that don’t automatically accelerate upon a change of control. Instead, make acceleration discretionary or tie it to continued employment. This gives you flexibility to control the timing and amount of equity acceleration, which can help manage 280G exposure.
Strategy #5: Separate Change-of-Control Payments from Severance
Some companies structure payments so that a portion is tied to change of control (and counts toward 280G) while another portion is severance for any termination (and may not count). This requires careful drafting, but it can help manage 280G exposure. Work with employment counsel on this approach.
Strategy #6: Document Your Base Amount Calculation
The IRS will scrutinize your base amount calculation. Keep detailed documentation of how you calculated average taxable compensation over the five-year period. If there are any unusual compensation items, document why they were included or excluded. This reduces the risk of an IRS challenge.
280G Compliance Checklist
Use this checklist to ensure you’re handling 280G correctly:
- ☐ Identify all executives who may receive parachute payments in a change-of-control transaction
- ☐ Calculate the base amount for each executive (average taxable compensation over five years)
- ☐ Identify all potential parachute payments (severance, equity acceleration, deferred comp, benefits)
- ☐ Calculate the 3x threshold for each executive
- ☐ Determine total parachute payments and compare to 3x threshold
- ☐ If payments exceed 3x, calculate the excess parachute amount
- ☐ Decide whether to obtain shareholder approval or restructure payments
- ☐ If obtaining shareholder approval, draft disclosure materials that comply with SEC/IRS requirements
- ☐ Document all calculations and assumptions
- ☐ Advise executives of their 20% excise tax liability (if applicable)
- ☐ Ensure executives report the excise tax on Form 4999
- ☐ File corporate tax returns claiming only deductible parachute payments
- ☐ Consider state tax implications and file any required state disclosures
- ☐ Review employment agreements and equity award agreements for 280G language
Frequently Asked Questions
What is the 280g tax code and why does it matter?
The 280g tax code (Section 280G of the Internal Revenue Code) regulates tax treatment of severance and bonus payments made to executives in connection with changes of control. It matters because it can trigger a 20% excise tax on the executive and eliminate the company’s tax deduction for excess payments. Understanding 280G is essential for any merger, acquisition, or leadership transition.
What is the 3x multiplier in 280g?
The 3x multiplier is the safe harbor threshold under 280G. It equals three times the executive’s average taxable compensation over the five years before the change of control. Parachute payments up to the 3x threshold don’t trigger 280G penalties. Payments exceeding 3x are subject to the 20% excise tax and deduction limitation.
Does 280g apply to private companies?
Yes. While 280G was originally designed to address excessive executive pay at public companies, it applies to all corporations—public, private, and nonprofit. Any organization that makes parachute payments in connection with a change of control must consider 280G.
Can we avoid 280g with a shareholder waiver?
Yes. Section 280G(b)(5) allows shareholders to vote to waive the 280G restrictions before a change of control occurs. If shareholders approve by majority vote, the 280G penalties don’t apply. However, the waiver must be obtained before the change of control is consummated, and it requires proper disclosure to shareholders.
What counts as a parachute payment under 280g?
Parachute payments include severance, bonuses, accelerated vesting of equity, deferred compensation distributions, continuation of benefits, and tax gross-ups—essentially any payment or benefit triggered by a change of control. The definition is broad, which is why companies often underestimate their 280G exposure.
Who pays the 280g excise tax?
The executive pays the 20% excise tax directly on their individual tax return (Form 4999). However, the company also bears a cost because it loses the tax deduction for the excess parachute amount. So both parties are hit by 280G consequences.
Can we include equity awards in 280g calculations?
Yes. Accelerated vesting of stock options, restricted stock, and other equity awards counts as parachute payments under 280G. The value of the acceleration is included in the parachute payment amount. This is why many companies are surprised by their 280G exposure—they forget to include equity acceleration in their calculations.
What is the base amount in 280g?
The base amount is the executive’s average taxable compensation over the five calendar years immediately preceding the change of control. It includes W-2 wages, bonuses, and other taxable compensation. The base amount is the foundation for calculating the 3x threshold and determining whether parachute payments are excessive.
How do we document 280g compliance?
Document your calculation of the base amount, identification of parachute payments, calculation of the 3x threshold, and determination of excess parachute amounts. Keep copies of employment agreements, equity award agreements, and any shareholder approvals. If you obtained a 280G waiver, keep the disclosure materials and voting records. This documentation protects you if the IRS ever challenges your 280G treatment.
Do state taxes apply to 280g?
Many states conform to federal 280G rules, so state tax consequences can mirror federal consequences. However, some states have different thresholds or rules. Additionally, executives in high-tax states face a combined federal and state tax hit on the 20% excise tax. Always consider state tax implications when analyzing 280G exposure.
What happens if we don’t comply with 280g?
If you fail to comply with 280G, the IRS can assess the 20% excise tax against the executive, disallow the company’s deduction for excess parachute payments, and assess penalties for underreporting. The company may also face penalties for failing to withhold and remit the excise tax. Non-compliance can result in significant additional tax liability years after the transaction closes.
Can we use 280g waivers for retention bonuses?
This is tricky. Retention bonuses paid during a change-of-control transaction may trigger 280G if they’re contingent on the transaction. However, if a retention bonus is paid simply for continued employment (not triggered by the change of control), it may not count as a parachute payment. The distinction depends on the facts and circumstances, so get professional guidance before paying retention bonuses in a transaction context.
Conclusion
The 280g tax code is a significant factor in any corporate transaction involving executive compensation. The combination of a 20% excise tax on the executive and a deduction limitation for the company makes 280G compliance expensive to ignore. The good news is that with proper planning—calculating your 3x threshold early, structuring payments carefully, and obtaining shareholder approval when appropriate—you can avoid costly 280G mistakes.
Start by getting a complete inventory of all executive compensation arrangements, including equity awards and deferred compensation. Calculate the base amount and 3x threshold for each executive who might receive parachute payments. Then work with your CFO, tax advisor, and employment counsel to structure payments in a way that minimizes 280G exposure while still attracting and retaining talent.
If you’re anticipating a change of control, don’t wait until the deal is closing to address 280G. The earlier you analyze this issue, the more options you have. Whether you decide to stay under the 3x threshold, obtain shareholder approval, or restructure equity acceleration, planning ahead will save you significant money and headaches down the road. Remember: 280G is one of those tax provisions where a little planning prevents a lot of pain.
