Building Your Business Operations & Success What Is a Golden Parachute? How Golden Parachute Payments Work By Jean Murray Jean Murray Facebook Twitter Jean Murray, MBA, Ph.D., is an experienced business writer and teacher who has been writing for The Balance on U.S. business law and taxes since 2008. She has taught accounting, business law, and business finance at business and professional schools for over 35 years, has authored several books on saving money and simplifying your business, and was the owner of startup-focused company Emence Enterprises, LLC. learn about our editorial policies Published on January 26, 2021 In This Article View All In This Article What Is a Golden Parachute? Golden Parachute Payments and Taxes Small Business Exemption Securities Law Requirements Taxes on Golden Parachute Payments Seek Attorney Advice Photo: Robert Daly / Getty Images As its name implies, a golden parachute payment is meant to provide a safe financial landing for a corporate executive if they are forced to leave a company after a merger, acquisition, or takeover. These payments come with tax and securities law implications for both the company and the executive. Small business corporations, however, may qualify for an exemption from the tax requirements. What Is a Golden Parachute? A golden parachute is a substantial incentive in a corporate executive’s compensation package that is paid if the executive leaves because they are forced out due to a merger or sale of the company. Golden parachute payments may include cash, severance pay, stock options, or a combination. The 2017 Tax Cuts and Jobs Act (TCJA) extended the golden parachute regulations to tax-exempt organizations. The rule is similar, but the excise tax is 21%. An IRS presentation on excess tax-exempt organization executive compensation gives greater detail. Note Both employees and non-employees (including independent contractors) can receive golden parachutes. Golden Parachute Payments and Taxes The IRS designates golden parachute agreements as nonqualified deferred compensation (NQDC) plans between an executive and employer. Deferred compensation is compensation in an employee’s contract that is required to be paid in the future as a result of a specific event including death, disability, or termination of employment. In order for this type of deferred compensation plan to be qualified by the IRS, it must meet some specific requirements to ensure that the plan is operated in accordance with plan documents. Golden Parachute Rule For tax purposes, there are several steps to determine whether the parachute payment is subject to additional taxes under the golden parachute rule. Has there been a change in ownership or control of the business? A general IRS rule is that the payment would not have been made if no change in ownership or control had occurred. Is the payment being given to a disqualified individual? A disqualified individual is someone who was an employee or independent contractor and was a shareholder, officer, or highly compensated individual at any time during the 12-month period prior to a change in ownership or control of the corporation. Is the base compensation within the safe harbor (maximum) amount? To be within the maximum, base compensation can’t be more than three times the person’s average annual compensation for the most recent five tax years. The IRS also looks at the amount of compensation directly related to the change in control and what part of compensation is for services rendered (not included in the base calculation). Is this person a highly compensated individual? This is someone who owned more than 5% interest in the business during the present or previous year, or received compensation during the preceding year of more than a specific amount ($130,000 for 2020 and 2021). Tax Effects of Excess Payments If the IRS decides that all of the payments are “excess” (the amount over the safe harbor amount), there are two consequences: The business can’t deduct the excess compensation on its business income tax return.The recipient must pay a 20% excise tax in addition to regular income taxes and FICA taxes (for Social Security and Medicare benefits) for this payment amount. Small Business Corporation Exemption Small business corporations aren’t subject to the golden parachute payment rules. If the corporation qualifies, the payments are not subject to additional excise tax and may be fully deductible to the company. To qualify as a small business corporation for this purpose, the corporation must meet several qualifications, including: Only individuals as shareholders (with a few exceptions)No more than 100 individuals as shareholdersOnly one class of stock Note This exception comes with some other complicated qualifications, so check with your tax professional if you think your small business might qualify. Securities Law Requirements for Golden Parachutes As part of the 2010 Dodd-Frank Act, the Securities and Exchange Commission (SEC) increased its disclosure requirements for executive compensation in general and golden parachutes specifically to give more information to shareholders. The SEC gives more details on the requirements of the law on shareholder approval of golden parachute compensation. Paying Taxes on Golden Parachute Payments Several payroll tax reporting processes are affected by golden parachute payments. Withholding From Payments to Employees Golden parachute payments for employees are subject to withholding and FICA taxes (for Social Security and Medicare). In addition, excise taxes should also be withheld, and included on the employee’s Form W-2. Reporting Payments Businesses must report employment taxes, including golden parachute payments, on Form 941, which is the employer’s quarterly report. Employers must also report on any amounts withheld on excise taxes for these payments. Reporting on Annual Tax Report Employers must report golden parachute payments on the W-2 form of the employee who received the payment. Payments to non-employees, including independent contractors, are normally reported on Form 1099-NEC, but golden parachute payments for these individuals must be reported on Form 1099-MISC instead. Seek Attorney Advice Golden parachute rules affect taxes and securities laws, and the regulations are complicated. Before you consider giving an executive a golden parachute plan, talk to a tax professional and securities attorney. Key Takeaways Companies give golden parachute plans to executives as an incentive. The executive receives the golden parachute payments when they leave the company because of a sale or takeover. IRS rules require the executive to pay excise taxes on excess payments. Securities law requires corporations to disclose these golden parachute plans to shareholders. Was this page helpful? Thanks for your feedback! Tell us why! Other Submit Sources The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy. IRS. "Final Regulations Tax on Tax-Exempt Organization Executive Compensation." Pages 2, 76. Accessed Jan. 26, 2021. IRS. "Instructions for Forms 1099-MISC and 1099-NEC." Page 11. Accessed Jan. 26, 2021. IRS. "Golden Parachute Payments Guide Audit Techniques Guide." Page 6. Accessed Jan. 26, 2021. IRS. "Definitions: Highly Compensated Employee." Accessed Jan. 26, 2021. IRS. "RR-05-39 Section 280G –Golden Parachute Payments." Page 3. Accessed Jan. 26, 2021. Cornell Legal Information Institute. "26 U.S. Code Section 280G – Golden Parachute Payments. Section (b)(5) Exemption for Small Business Corporations, etc." Accessed Jan. 25, 2021. Securities & Exchange Commission. "Final Rule Shareholder Approval of Executive Compensation and Golden Parachute Compensation. Accessed Jan. 25, 2021.