Pub. 7 2017-2018 Issue 1

10 O V E R A C E N T U R Y : B U I L D I N G B E T T E R B A N K S - H E L P I N G C O L O R A D A N S R E A L I Z E D R E A M S Tax Traps For The Unwary - Executive Compensation Issues In M&A Transactions (Part I: Section 280G) FEATURE ARTICLE CHARLES E. WERN JD, LLM AND D. LAIRD BLUE, JD, LLM, SHAREHOLDERS, JONES & KELLER, PC Transaction bonuses, severance payments and retention bonuses are subject to 280G, as well as various time and performance based incentive equity compensation that accelerates upon a CIC (including stock options, restricted stock, RSUs, SARs, and phantom stock). C hanges to the U.S. regulatory landscape and corporate tax law structure could spark increased M&A deal activity and strategic partnering in the banking industry. Variousprovisions of the Internal RevenueCode (“IRC”) can have a significant adverse impact on the recipients of compensation triggered upon a “Change in Control” (“CIC”) in an M&A transaction, as well as on the companies paying out suchcompensation. Asaresult, boards, com- pensation committees, and executives within the banking industry should consider reviewing all CIC-related agreements governing executive and director compensation arrangements and equity award plans for tax traps, including em- ployment agreements, severance or retention agreements, deferred compensation plans, and plansgoverningstockoptions, stockappreciation rights (“SARs”), restrictedstock, restrictedstock units (“RSUs”), and phantomstock. This article discusses the potential impact of IRC Section 280G parachute payments, while a subsequent article will discuss IRC Section 409A. 280G Parachute Payments The golden parachute payment rules under IRC Section 280G and Section 4999 (“280G”) can impose harsh penalties on "excess" para- chute payments made to "disqualified individ- uals" by corporations undergoing a CIC. Dis- qualified individuals are generally officers, 1% shareholders, and certain highly compensated employees or independent contractors. 280G works to both deny the corporation a tax de- duction on the "excess" parachute payment and to charge the recipient of such payments a 20% excise tax (in addition to regular taxes). "Excess" Parachute Payments So, what are "excess" parachute payments? Excess parachute payments are generally all payments contingent on a CIC (“parachute pay- ments”) that exceed, in present value dollars, 3 times thedisqualified individual's "baseamount" (i.e., their average W-2 compensation for the 5 calendar years preceding the CIC). If the total parachute payments don't exceed the 3x safe harbor amount, then 280G doesn't apply. If the total parachute payments do exceed the 3x safe harbor amount, then all payments over the 1x baseamount are "excess"parachutepayments subject to the 20%excise tax anddeduction loss. The corporation is also required towithhold the 20%excise taxowedby the recipient (inaddition to all other required tax withholdings). Accordingly, the 280G penalty is essentially a cliff over the 1x base amount so long as total parachute payments exceed the 3x safe harbor amount. Thisharsh rule canresult insignificant adverse tax consequences to both the recipient and the corporation. In addition, since through- out the financial crisis salaries, bonuses, and