BONUS SECTION
Understand the “Golden Parachute” Rules As Early As Possible Tech M&A deals often trigger the so-called “golden parachute” rules under Sections 280G and 4999 of the Internal Revenue Code, and these draconian tax rules can hit tech startups especially hard when they apply. Golden Parachute Rules. The rules under Section 280G are extremely complex, but, in a nutshell: They apply when “disqualified individuals” – certain officers, shareholders, or highly-compensated employees – may become entitled to certain “parachute payments” that are contingent on a change in ownership or effective control of the company making the payment (if the company is a C corporation, whether public or private). When these rules apply, the individuals receiving those payments must pay a 20% excise tax on any “excess parachute payment” – and the corporation making those payments is banned from taking a tax deduction for that amount. In addition, buyers will absolutely care about potential 280G liability, and these issues can impact or even hold up the deal. The “excess parachute payment” amount, if any, depends on how much the parachute payments exceed the individuals “base amount,” which is essentially their average includible compensation over a 5-year base period. The reason these rules can be even harsher for “built to sell” tech startups is because founders and other key players often take low salaries (or even none at all) during that 5-year base period – and a low base amount makes it much easier for parachute payments to exceed the 280G threshold (3x the base amount) and increases the size of the excess parachute payment (and therefore the amount of the excise tax and deduction loss). The good news for private C corps is that the excise tax and deduction allowance that would otherwise apply can be completely avoided through by meeting the requirements of the “shareholder approval” exception. However, this involves a somewhat risky, and sometimes contentious, process.
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