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In the context of an M&A transaction, the implications of
“280G” in a sale of a business should be considered as
early in the sale process as possible. Here we provide an overview
of some of the practical considerations and procedural steps
involved in addressing issues related to the punitive aspects of
280G.
Introduction
Sections 280G and 4999 of the U.S. Internal Revenue Code
(collectively, 280G) are punitive tax provisions that, on one hand,
impose a 20% excise tax on the so-called “excess parachute
payments” received by certain officers, shareholders and
highly compensated individuals of a corporation (the so-called
disqualified individuals) in connection with a change in control of
the corporation and, on the other hand, disallow tax deductions for
such payments by the payor.
Structuring considerations
There are opportunities to structure certain compensatory
arrangements that, if done sufficiently early, could mitigate the
impact of 280G. For example, an outstanding stock option may be
exercised in a calendar year prior to the closing of the proposed
sale, or an equity award that otherwise would have been granted
during the 12-month period before the closing may be granted before
such 12-month period, both of which will help reduce the likelihood
of creating a 280G issue for the affected individual. Another
“early prevention” effort might involve amending the
corporation’s governing documents to limit the shareholders who
would be entitled to vote on 280G matters.
Does 280G apply?
Once the structure of the transaction is determined, the
seller’s legal or tax advisors with 280G expertise should
consider whether 280G applies to the proposed transaction.
Generally, 280G only applies if there is an entity treated as a
“C” corporation (for U.S. federal income tax purposes)
undergoing a change in control, and 280G does not exclude a
non-U.S. corporation that is otherwise treated as a “C”
corporation for U.S. federal income tax purposes. As such, 280G is
commonly implicated in a transaction involving the U.S. operations
of a non-U.S. corporation. While less common, 280G may also be
relevant in a transaction that does not involve any U.S. subsidiary
or other U.S. operations to the extent that 280G’s excise tax
could apply to an individual who is a U.S. citizen or otherwise
subject to U.S. tax.
If 280G is implicated in a transaction, an outside accountant is
typically engaged to calculate the amount of potential excess
parachute payments with respect to each disqualified individual.
This process should occur as early as possible, and in any event
well in advance of the closing of the transaction. Gathering and
analyzing all relevant data in compliance with 280G’s technical
rules could be time-consuming. In addition, an early detection of
potential excess parachute payments will enable more collaborative
and effective discussions around how the 280G tax exposure may be
mitigated.
280G should be considered early and thoroughly in any M&A
transaction, whether or not it involves a U.S. corporation.
Mitigating tax exposure
For non-publicly traded corporations, the most common approach
to mitigate (if not, eliminate) the 280G issue is to rely on the
shareholder approval exception under 280G. Under this exception,
the adverse tax consequences of 280G can be avoided altogether by
obtaining the votes of the shareholders who collectively own more
than 75% of the voting power of all outstanding stock of the
corporation entitled to vote (generally applying the normal voting
rules of the corporation and disregarding shares owned or
constructively owned by certain disqualified individuals) and such
votes specifically approve the receipt and retention of the excess
parachute payments by the disqualified individuals.
In order to rely on this exception, a number of procedural
requirements must be satisfied. One such requirement is to obtain
from each applicable disqualified individual a legally binding and
irrevocable waiver of his or her right to the excess parachute
payments, with the right to such waived payments to be restored
only if the requisite shareholder approval is obtained.
Understandably, the affected individuals are often hesitant to sign
the waiver. Therefore, it is important to engage with the affected
individuals early and familiarize them with the implications and
purpose of the waiver.
Once the waivers are fully executed, adequate disclosure of all
material facts concerning the waived payments must be provided to
all shareholders who are entitled to vote on 280G matters,
regardless of whether a particular shareholder’s vote is needed
to pass the 75% voting threshold. This requirement to disclose
confidential or otherwise sensitive compensation information may be
problematic for certain corporations that have a large group of
employee shareholders. In this regard, we note that there is some
interpretive leeway under 280G and acceptable market practices
regarding whether certain shareholders may be excluded from
receiving such disclosure, what information must be included in the
disclosure document, and how the disclosure may be delivered.
However, the more liberal a particular approach is on an
interpretive issue, the greater the risk of the U.S. Internal
Revenue Service disagreeing with that approach and invalidating the
shareholder approval.
Conclusion
As a key takeaway of this article, we note that 280G should be
considered early and thoroughly in any M&A transaction, whether
or not it involves a U.S. corporation, so that any 280G issues may
be mitigated in a manner that is workable from business and
employee-relations perspectives.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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