United States: IRS Updates Golden Parachute Audit Guide

This is our first of many alerts during 2017 as the new administration signals the rollback of many regulations (e.g., fiduciary rules and pay ratio). We will keep you posted.

In January 2017, the Internal Revenue Service ("IRS") released an updated Golden Parachute Payments Audit Technique Guide ("ATG") that covers the examination of golden parachutes under Internal Revenue Code ("IRC") Sections 280G and 4999.

Background

Golden parachutes are arrangements that provide executives with significant financial compensation in the event of a change in ownership or control of the employer corporation. If a golden parachute is too rich, the executive may incur a 20% excise tax on "excess parachute payments" and the corporation may lose the corresponding tax deduction. 

The golden parachute examination can occur during the audit of either the corporation's or the executive's return. ATGs are primarily referenced by IRS examiners; however, for corporations and executives with golden parachutes, the ATG contains helpful insight into the IRS's examination focus and techniques. 

The 2017 Audit Technique Guide

The 2017 ATG is the first update released since the release of the IRS's initial 2005 ATG, and conforms the 2005 version to current tax code provisions and Securities and Exchange Commission filing requirements. The ATG includes: (1) an overview of the rules and the consequences of potential adjustments in the audit; (2) the documentation an IRS agent should review as background regarding a corporation's golden parachute payments; and (3) the nine steps involved in a parachute examination, including an examination flow chart.

The 2017 ATG expands and updates the list of documents for IRS examiners to review in connection with a golden parachute examination. The additional documents include:

  • Information Statements (Schedules 14A and 14C). The schedules disclose information regarding golden parachute payments in connection with the solicitation for shareholders' approval. Additionally, any parachute payments actually made upon a change in control must be reported.
  • Registration Statements (Forms S-4 and F-4). The Forms are used to provide information to investors when registering securities, and provide information related to mergers, acquisitions, or when securities are exchanged between companies.

The ATG also outlines the technical interplay between IRC Sections 162(m) and 280G. Under IRC Section 162(m), the $1 million limitation must be reduced by any amount of excess parachute payment paid.

For example, if the chief executive officer of a publicly held corporation receives a parachute payment in the amount of $2,000,000 from her company in the year it was being acquired, of which $200,000 was an excess parachute payment, the corporation would be (i) denied a deduction under IRC Section 280G for the $200,000 excess parachute payment and (ii) limited to a deduction under IRC Section 162(m) of $800,000 ($1,000,000-$200,000). The ATG notes, however, that the provision for reducing the $1 million limitation for the excess parachute payment may not apply if the executive of the target corporation is not a covered employee during the year of an acquisition. The rationale is that the target corporation will no longer exist and the executive's pay will not be reported in the proxy statement.

With respect to private corporations, which are often eligible for an exemption from IRC Section 280G, the revised examination flow chart suggests that the IRS may increase scrutiny of exemption eligibility.

Because the 2017 ATG was issued right before the current administration took office, it is unclear whether this revised ATG signals that the IRS will have an increased focus on IRC Section 280G issues in general. 

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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