What is a Golden Parachute?
A golden parachute is a large sum of money given to top executives if their company is taken over by another company and the executives are fired as a result of the merger or takeover. Golden parachutes are contracts with key executives that can be used as an anti-takeover measure, also known as poison pills, taken by a company to discourage an unwanted takeover attempt. Stock options, cash bonuses, and generous severance pay are all possible benefits.
Golden parachutes are so named because they are designed to provide a soft landing for certain levels of employees who lose their jobs. The golden parachute regulations were extended to tax-exempt organisations as part of the 2017 Tax Cuts and Jobs Act (TCJA). The rule is the same, but the excise tax is 21%.
How do Golden Parachutes work?
Golden parachute clauses can be used to specify the lucrative benefits that an employee will receive if they are fired. The term is frequently used to describe the dismissal of top executives as a result of a takeover or merger. Severance pay in the form of cash, a special bonus, stock options, or the vesting of previously-awarded compensation are all examples of golden parachutes. The employment contract specifies the circumstances in which the silver parachute clause becomes effective.
Other examples of opulent parachute benefits, in addition to monetary awards, include:
- Continued participation in company pension plans
- Vesting of all retirement benefits
- Paid health and dental insurance
- Legal fees reimbursement
Instances of these and other exclusive benefits have sparked outrage among shareholders and the general public. As a result, many companies have reviewed their executive compensation policies and devised new ways to link executive performance to corporate success in the post-financial crisis era. In many cases, their goal was to see if such deals were in the best interests of the company and its shareholders.
What is the Golden Parachute rule?
To ascertain whether the parachute payment is subject to significant taxes under the golden parachute rule, several steps must be taken.
- Is there a change in the business's ownership or control?
The payment would not have been made if there had been no change in ownership or control, according to IRS policy.
- Is the payment going to an ineligible person?
A disqualified individual is someone who was an employee or independent contractor as well as a shareholder, officer, or highly compensated individual at any time during the 12-month period preceding a change in ownership or control of the corporation.
- Is the base pay within the safe harbour (maximum) range?
To stay within the maximum, base pay cannot be more than three times the person's average annual pay over the previous five tax years. The IRS also considers the amount of compensation that is directly related to the change in control, as well as the portion of compensation that is for services rendered (not included in the base calculation).
- Is this person well compensated?
This is someone who owned more than 5% of the company during the current or previous year, or who received compensation in excess of a certain amount ($130,000 for 2020 and 2021).