Golden Parachutes

A “golden parachute” agreement is one in which an employer states that it will pay a key executive or group of executives an amount over and above normal compensation in the event of a change in ownership or control of the corporation or a substantial portion of the corporation’s assets. Such an agreement is usually intended to serve two purposes: (1) deterring outside parties who may in the future seek a hostile takeover of the employer, and (2) providing additional severance compensation for executives whose employment would potentially be terminated following such a hostile takeover. Accordingly, in most cases golden parachute payments are designed to be triggered upon the executive’s loss of employment within a designated period of time following the acquisition of the employer.

What’s the interaction of golden parachutes with federal ERISA law? In most cases, golden parachute arrangements are designed to fit the definition of a “top-hat” plan under section 201(2) of the Employment Retirement Income Security Act of 1974, as amended (“ERISA”), as they are unfunded and maintained primarily for the purpose of providing deferred compensation for a select group of management or highly compensated employees. As a result, such arrangements are exempted from the substantive rules of Title I of ERISA, including rules regarding minimum participation, vesting, distribution, minimum funding, fiduciary standards and the requirement that plan assets be held in trust. Therefore, the responsibility for ensuring that the executive’s rights are protected under the agreement falls upon the executive, as the safety net ordinarily established by ERISA provides no security.

Are their tax consequences associated with receiving a golden parachute? In addition, golden parachute arrangements can raise important tax implications that must be considered before they are entered into. Pursuant to the Internal Revenue Code, to the extent the amount of a golden parachute payment is deemed to be excessive, there are adverse tax consequences faced by both the payer and the recipient of the excess payment. According to Section 280G of the Code, an employer is not entitled to a deduction for the excess parachute payment and the executive-recipient is subject to an excise tax of 20% of the amount of the excess payment. In general, to constitute an excess parachute payment, the total present value of the payment must equal or exceed three times the individual’s average annual compensation over the most recent five taxable years prior to the change in ownership or control. However, it should be noted that an excess parachute payment generally does not include any portion of the payment that is established by clear and convincing evidence to be reasonable compensation for personal services actually rendered or in exchange for a covenant not to compete.

Receive advice from experienced counsel. Therefore, when negotiating and entering golden parachute arrangements it is imperative that executives have knowledge of the relevant Internal Revenue Code provisions in order to minimize the potential for taking a significant tax loss.

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