Golden Parachutes: Section 280G and the Private Company Vote
When change-in-control payments to executives lose their deduction and trigger a 20 percent tax on the recipient, the three-times test, and the shareholder vote that exempts most private companies.
Reviewed by the Fairlight Accounting cross-border tax team — U.S. & Canadian Tax Desks
Section 280G targets payments to executives and large shareholders that are triggered by a sale of the company. If such payments equal or exceed three times the person's average compensation over the prior five years, the amount above one times that average is an excess parachute payment: nondeductible to the company, and the recipient owes a 20 percent excise tax.
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How does the test work?
| Step | Rule |
|---|---|
| Disqualified individual | Employees or independent contractors who, during the 12 months ending on the change, are officers, shareholders owning more than 1 percent of the stock's value, or highly compensated individuals (the highest-paid 1 percent of employees or, if fewer, the highest-paid 250, and paid at least the Section 414(q) amount — $160,000 for 2025 and 2026) |
| Parachute payment | Compensation contingent on a change in ownership or effective control, or in ownership of a substantial portion of the assets — accelerated vesting, transaction bonuses, severance triggered by the deal, retention payments |
| Base amount | Average annual compensation from the company includible in income over the most recent five taxable years ending before the change (or the shorter period worked) |
| Threshold | Total parachute payments (at present value) of three times the base amount or more |
| Excess parachute payment | Everything above one times the base amount, once the threshold is crossed |
| Consequences | No deduction for the company; 20 percent excise tax on the individual (withheld by the company), plus ordinary income tax |
The cliff is severe: payments of 2.99 times base are fully deductible and free of the excise tax; payments of 3.0 times base make two-thirds of the total an excess payment.
Who is exempt?
- S corporations and other companies that, immediately before the change, would qualify as small business corporations (ignoring the nonresident alien shareholder bar), whether or not an S election is in effect.
- Private companies whose shareholders approve the payments in a cleansing vote: more than 75 percent of the voting power, excluding shares held by the disqualified individuals receiving the payments, after adequate disclosure of all material facts — and the payments must be conditioned on that approval.
- Payments from qualified retirement plans, simplified employee pensions, and SIMPLE retirement accounts.
- Reasonable compensation for services performed after the change (such as a consulting agreement) is excluded from parachute payments, and reasonable compensation for services before it reduces the excess parachute payment — in both cases only if shown by clear and convincing evidence.
How does the vote work in practice?
The company identifies the disqualified individuals and calculates each one's parachute payments and base amount; those over the threshold waive the excess subject to shareholder approval; the company discloses the payments to all shareholders; and the non-recipient shareholders vote. Buyers typically require this process in the purchase agreement.
What does the recipient face without planning?
Income tax on the payment at ordinary rates, the 20 percent excise tax, and often a gross-up fight with the company. For founders selling a company with accelerated equity vesting, the calculation can turn a large payout into a materially smaller one.
Frequently asked questions
Does the rule apply to payments to the founder who sells?
Payments for stock are not compensation; payments for services, non-competes, or accelerated options can be.
Is a non-compete payment a parachute payment?
It is included unless shown otherwise: a non-compete is treated as an agreement for services — so reasonable pay under it is excluded — only if clear and convincing evidence shows it substantially constrains the individual and is reasonably likely to be enforced; otherwise the payments are treated as severance.
Can an LLC taxed as a partnership have a 280G issue?
The statute applies to corporations; partnerships are generally outside it, but an LLC that elects to be taxed as a corporation, or a publicly traded partnership taxed as one, is covered.
Does the excise tax apply to the company?
The company loses the deduction; the 20 percent tax is on the individual, though companies sometimes agree to gross it up.
Official sources
The statute provides: “No deduction shall be allowed under this chapter for any excess parachute payment.” — Legal Information Institute, Cornell Law School, 26 U.S. Code § 280G - Golden parachute payments, https://www.law.cornell.edu/uscode/text/26/280G
The Treasury regulation provides: “The shareholder approval requirements referred to in paragraph (a)(2)(ii) of Q/A-6 of this section are met with respect to any payment if— (1) Such payment is approved by more than 75 percent of the voting power of all outstanding stock of the corporation entitled to vote (as described in this A-7) immediately before the change in ownership or control…” — Legal Information Institute, Cornell Law School, 26 CFR § 1.280G-1 - Golden parachute payments., https://www.law.cornell.edu/cfr/text/26/1.280G-1
Next step
Fairlight Accounting handles U.S. domestic, cross-border (U.S.–Canada), and international tax returns, plus bookkeeping, payroll, and CFO advisory. Our U.S. Tax Desk runs the parachute calculations and the cleansing-vote process before a sale closes. See pricing or book a free fit call.
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