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.
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.
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
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.
