Golden Parachutes 3M

Golden parachutes are controversial but are one component of compensation that can affect an employee's financial future - especially within 3M companies, says Patrick Ray of The Retirement Group, a division of Wealth Enhancement Group. Employees need to understand these agreements to ensure they are fairly compensated in the event of a corporate takeover, 'he said.

With Golden Parachutes becoming increasingly prevalent -- particularly in tech -- 3M employees should be negotiating such packages early on, says Michael Corgiat, a representative of The Retirement Group, a division of Wealth Enhancement Group. 'This foresight can provide considerable security and peace of mind during corporate transitions.'

In this article, we will discuss:

1. The Golden Parachutes Are Rising: How such severance packages have become commonplace in tech and what they mean for executives.

2. Regulatory Framework & Tax Impacts: How to limit golden parachutes and understand the financial implications - Part 2 of 3 under the Internal Revenue Code.

3. Companies & Employees Strategic Importance: Why do companies offer such packages and how do they help both sides during changes in corporate control?

A report from The Wall Street Journal in October 2021 stated that Golden Parachutes have become more common in recent years, particularly in the tech industry. That report found executives who quit tech companies received, on average, USD 33.6 million in compensation - much of that from Golden Parachute packages. That trend could be troubling to future 3M workers looking to retire - and it points out how important it is to negotiate fair severance packages that include Golden Parachutes.

What Is A Golden Parachute Exactly?

Golden parachutes are separation agreements and other compensation designed to protect employees from the shock of a corporate takeover or change of control. Change of control of the company is the trigger for golden parachute payments. They pay essential employees, often laid off due to a takeover or change of control, continued compensation for a specified period after they leave, a lump-sum payment, or another negotiated benefit.

Although golden parachute payments are deductible by corporations if reasonable, Section 280G of the Internal Revenue Code bars employers from deducting any 'excess parachute payment.' Additional parachute payment amounts to a 20% excise tax under Internal Revenue Code Section 4999.

Internal Revenue Code Definition--Section 280G.

By IRC Section 280G, parachute payments are defined as:

By virtue of the nature of compensation, this is so. made to a 'disqualified person' which depend on a change in control of a corporation, in the effective control of a corporation or in the ownership of a substantial part of a corporation's assets and which have a present value at least three times the individual's regular compensation. (The 'base amount' is the employee's average annual compensation for the five tax years before the change in ownership.

Caution:

The term parachute payment also includes any compensation payment made to or on behalf of a disqualified person in violation of a generally enforced securities law or regulation. These payments are parachute payments whether or not the three-times-base-amount requirement is met and regardless of a change in corporate control or ownership.

The Nature of Compensation.

All payments relating to an employment relationship or the performance of services are in general considered compensation. They include wages and salaries, bonus, separation pay, perquisite benefits, property transfers, pension benefits and other deferred compensation.

Disqualified Individual

An employee or independent contractor that at any time during the 'disqualified individual determination period' is a shareholder owning more than 1% of the corporation, an officer or other highly compensated individual is a disqualified individual for purposes of the parachute payment provisions.

Tip:

This is the twelve months preceding and ending on the date of a change in the corporation's ownership or control.

A highly compensated person is a member of the group that includes the top 1% or the top 250 highest paid employees of the company. A person is not considered highly compensated unless his or her compensation in the year of the change in control equals or exceeds the amount described in IRC Section 414(q) (USD 120k for 2018 and 2017).

An individual's officer status is determined by all the facts and circumstances. But no more than fifty (or, if fewer than fifty, the greater of three employees or ten percent of employees) are officers for this purpose.

Change of Ownership/Control.

If the ownership or control change had not taken place, then the payment is contingent upon that change in ownership or control. Unless reasonably certain that a payment would have been made regardless of whether the change occurred, the payment is not contingent upon a change in ownership or control. The following are conditions under which a payment is deemed contingent upon an ownership change or control change:

IF ONE OF the following EVENTS HAPPENS:

The payment depends on something closely connected to a transfer of ownership or control. It does happen that ownership or control changes. The event is materially related to the change in ownership or control (that is, it takes place one year before the date of the change in ownership or control and one year after that date).

Start of procurement offer a substantial increase in The market price of the stock that occurs before A change in ownership or control occurs and that occurs within A short time frame The stock's listing on A major securities exchange the purchase of more than five percent of the stock of A corporation by A group of people who do not control The corporation.

Tip:

In the case of an employee having a vested right to receive a payment in the future and the payment is accelerated because of a change in ownership or control, only the excess of the amount actually received over the present value of the future payment is contingent on the change. Moreover, even if a future payment is not accelerated, some of it may be treated as contingent upon a change in ownership or control if the right to the payment vests as the result of that change.

Caution:

The IRS rules provide that any payment is presumed contingent on a change in ownership or control only if it is made under an agreement entered into (or substantially modified) within a year of the change in ownership or control. This presumption can be overcome only by plain and convincing evidence that the payment was not contingent on the corporation's ownership or control changing hands.

Exceptions

The parachute provisions are intended for publicly traded companies only and do not apply to payments made by small business corporations and other entities. For example, parachute payment means nothing if it includes the following:

S corporations:

A corporation electing S status under section 1361 of the Internal Revenue Code. A corporation whose stock was not easily tradable before the change of ownership, but only if more than 75 percent of the shareholders approve the payment. An Individual Retirement Account is a qualified plan, SEP or SIMPLE IRA. A tax-exempt organization under section 501(c), 501(d) and 529, subject to certain conditions.

If the individual can show by clear and convincing evidence that some payments are reasonable compensation for personal services rendered on or after the date of the change in ownership or control, such payments are also excluded from the parachute payment definition (and from the three-times-base amount test).

Caution:

Severance pay and parachute payments arising from agreements that violate securities laws or regulations are never reasonable compensation.

Tax Consequences - What Are They?

Recipient

When received, most parachute payments are taxable as income for the recipient. Furthermore, the recipient of any 'excess parachute payment' is subject to a 20% excise tax under Section 4999 of the Internal Revenue Code.

Employer

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In general, parachute payments are deductible as reasonable compensation for services rendered. The excess parachute payment is not deductible under Internal Revenue Code section 280G.

Excess Parachute Payments

Any parachute payment over the individual's 'base amount' constitutes an excess parachute payment. This is the average annual taxable compensation of the individual for the five years prior to the acquisition.

Example(s):

John was a director of the ABC Corporation, which another company bought. The average salary for John over the past five years was USD 120,000. By acquisition date, ABC Corporation paid John USD 500,000 per an agreement.

Consider John's USD 120,000 fixed salary. It was an excess parachute payment of USD 500,000 to John for going over the basic USD 360,000 (USD 120,000 x 3). The excess payment of USD 380,000 cannot be deducted by the corporation (USD 500,000 - USD 120,000), so John pays an excise tax of USD 76,000 (20% of USD 380,000).

Caution:

The payments are parachute payments only if they exceed three times the base pay of the employee. But once that threshold is reached, the amount that is considered an excess parachute payment is that portion of the employee's parachute payment that is greater than their base pay.

When an ineligible recipient has several parachute payments, the base amount must be divided among the payments to determine the excess parachute payment amount. By multiplying the base amount by a fraction whose numerator is the present value of the parachute payment and whose denominator is the total present value of all parachute payments, the proportion of the base amount allocated to each parachute payment is given.

Anything which the person establishes (through clear and convincing evidence) to be reasonable compensation for personal services actually rendered by the person before the date of the change in ownership or control may be subtracted from the excess parachute payment. Reasonable compensation varies with each case. Considerations that affect the decision:

The nature of the services. The person's prior pay for performing comparable services. In situations where compensation is not contingent upon a change in ownership or control, compensation of analogous service providers is not contingent upon a change in ownership or control.

Below is an illustration that we provide to our 3M clients of how an excess parachute payment is calculated when a disqualified person determines that some portion of the payment represents fair compensation.

Why Use Golden Parachutes?

Employers like 3M give golden parachutes to essential employees for reasons including:

For example - incentives for desirable employees to join an employer or possibly 3M (or to stay with an employer) even though a takeover or change in control could mean employees lose their jobs.

Reduce incentive for key employees to oppose takeovers that benefit the organization but may put their jobs at risk.

Retirement planning resembles gardening. Like a gardener selects plants to grow and care for, so too must retirees choose and care for their investments. But just as a garden needs attention and adjustments over time, so too must a retirement plan be attended to and adjusted periodically to ensure a healthy harvest later on. Start early and make smart choices so retirees can enjoy a fruitful retirement a la a gardener does when he tends his garden. Remember, like plants need sunlight, water, and good soil, a retirement plan needs attention, diversification, and regular contributions to grow.

Sources:

1. Landi, Heather. 'Golden Parachute Payouts Worth $20M for Cerner's Feinberg, Former CEO with Proposed Sale to Oracle.'  Fierce Healthcare , 26 Jan. 2022,  www.fiercehealthcare.com . Accessed 22 Feb. 2025.

2. Hayes, Adam. 'Golden Parachute: Definition, Examples, Controversy.'  Investopedia , 11 Mar. 2021,  www.investopedia.com . Accessed 22 Feb. 2025.

3. 'Golden Parachutes | Definition, Components, Rules, Pros, Cons.'  Finance Strategists ,  www.financestrategists.com . Accessed 22 Feb. 2025.

4. 'Say on Golden Parachutes: What to Know Before the Vote?'  Compensation Advisory Partners ,  www.capartners.com . Accessed 22 Feb. 2025.

5. 'Adam Neumann’s WeWork Golden Parachute Even Bigger Than Previously Reported.'  The Real Deal , 27 May 2021,  www.therealdeal.com . Accessed 22 Feb. 2025.