Golden Parachutes For Kimberly-Clark Employees

According to a report published by the Wall Street Journal in October 2021, Golden Parachutes have become increasingly prevalent in recent years, especially in the tech industry. The report found that executives who left their positions in tech companies received an average of $33.6 million in compensation, with a significant portion of that amount coming from their Golden Parachute packages. This trend could have significant implications for Kimberly-Clark workers looking to retire, as it underscores the importance of negotiating fair and reasonable severance packages that include Golden Parachutes.

What Is A Golden Parachute?

Golden parachutes are separation agreements and other forms of compensation that shield crucial employees from the effects of a corporate takeover or change of control. The triggering event for golden parachute payments is a change in ownership or control of the company. They provide essential employees, whose employment is frequently terminated due to a takeover or change in control, with continued compensation for a specified period following their departure, a lump-sum payment, or another negotiated benefit.

Although golden parachute payments are deductible by corporations if they are reasonable, Section 280G of the Internal Revenue Code prohibits employers from deducting any 'excess parachute payment.' In addition, Section 4999 of the Internal Revenue Code imposes a 20% excise tax on any excess parachute payment.

Internal Revenue Code Definition--Section 280G

In accordance with IRC Section 280G, 'parachute payments' are defined as:

by virtue of the nature of compensation,
made to a 'disqualified individual,'
that are contingent upon a change in control in the ownership of a corporation, in the effective control of a corporation, or in the ownership of a substantial portion of a corporation's assets, and
which have a present value that is at least three times the individual's regular compensation. (The 'base amount' is the average annual compensation that was included in the employee's aggregate income for the five tax years preceding the date of the change in ownership.)

Example(s): Lee is an officer of the XYZ Corporation, with a basic salary of $100,000. Lee receives a payment of $400,000 contingent on a change in the ownership of XYZ Corporation on the date of the ownership change. It is a parachute payment because it is at least three times Lee's base salary. (3 x $100,000 = $300,000). If the payment was only $299,999, however, the Internal Revenue Service would not consider it a parachute payment (because it did not equal or exceed three times Lee's base salary).

Caution: The term 'parachute payment' also encompasses any recompense payment made to (or for the benefit of) a disqualified individual in violation of a generally enforced securities law or regulation. These payments are parachute payments regardless of whether the three-times-base-amount requirement is met and regardless of a change in corporate control or ownership.

In The Nature of Compensation

In general, all payments associated with an employment relationship or the performance of services are regarded as compensation. These include wages and salaries, bonuses, separation pay, perquisite benefits, property transfers, pension benefits, and other forms of deferred compensation.

Disqualified Individual

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

Tip: The 'disqualified individual determination period' is the twelve months preceding and ending on the date of a change in the corporation's ownership or control.

A highly compensated individual is a member of the group that consists of either the top 1% or the top 250 highest-paid employees of the company. A person is not deemed highly compensated, however, unless his or her compensation in the year of the change in control is at least the amount described in IRC Section 414(q) ($120k for both 2018 and 2017).

The officer status of an individual is determined based on all relevant facts and circumstances. However, no more than fifty (or, if fewer than fifty, the greater of three employees or ten percent of employees) are considered officers for this purpose.

Change in Ownership or Control

A payment is contingent on a change in ownership or control if it would not have been made if the ownership or control change had not occurred. If it is reasonably certain that a payment would have been made regardless of whether the change occurred, the payment is not contingent on a change in ownership or control. A payment is regarded as contingent on a change in ownership or control if the following conditions are met:

if the following conditions are met:
The payment is contingent on an event closely tied to a transfer of ownership or control.
A transformation in ownership or control does take place
The event is materially related to the change in ownership or control (i.e., it occurs within the period beginning one year prior to the date of change in ownership or control and ending one year after that date).

Examples of events that are closely associated with a change in ownership or control include:

initiation of a procurement offer
A substantial increase in the market price of the stock that occurs prior to a change in ownership or control and occurs within a brief time frame
the termination of the stock's listing on a major securities exchange
The acquisition of more than five percent of a corporation's stock by a group of individuals who do not control the corporation.

Tip: If an employee has a vested right to receive a payment in the future and the payment is accelerated due to a change in ownership or control, only the excess of the amount actually received over the present value of the future payment is considered contingent on the change. Even if a future payment is not accelerated, a portion of it may be treated as contingent upon a change in ownership or control if the right to the payment vests as a result of the change.

Caution: According to IRS regulations, a payment is presumed to be contingent on a change in ownership or control if it is made pursuant to an agreement entered into (or substantially modified) within one year of the change in ownership or control. This presumption can only be overcome by plain and convincing evidence that the payment was not contingent on a change in the corporation's ownership or control.

Exceptions

As the parachute provisions are primarily targeted at publicly traded companies, they do not apply to payments made by small business corporations and other entities. Specifically, the expression 'parachute payment' does not include any of the following:

A corporation eligible to elect S status, as defined in section 1361 of the Internal Revenue Code
A corporation whose stock was not easily tradable prior to the change in ownership, but only if more than 75 percent of the shareholders approve the payment.
A qualified plan, SEP, or SIMPLE IRA is an Individual Retirement Account.
A tax-exempt organization under sections 501(c), 501(d), and 529, if specific conditions are met.

If the individual demonstrates (through clear and convincing evidence) that certain payments are reasonable compensation for personal services to be performed on or after the date of the change in ownership or control, these payments are also excluded from the definition of parachute payment (and are not included in the three-times-base amount test).

Caution: severance pay and payments that are parachute payments due to agreements that violate securities laws or regulations are never considered reasonable compensation.

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What Are The Tax Consequences?

Recipient

When received, most parachute payments must be included in the recipient's taxable income. Moreover, Section 4999 of the Internal Revenue Code imposes a 20% excise tax on the recipient of any 'excess parachute payment.'

Employer

In general, parachute payments are deductible as reasonable compensation for services performed. Section 280G of the Internal Revenue Code disallows a deduction for any 'excess parachute payment' paid or incurred.

Excess Parachute Payments

An excess parachute payment is equal to the amount by which any parachute payment exceeds the individual's 'base amount.' The base amount is the average annual taxable compensation of the individual for the five years preceding the acquisition.

Example(s): John served as a director of the ABC Corporation, which was acquired by a different company. John's average salary over the past five years was $120,000. On the date of the acquisition, ABC Corporation paid John $500,000 per an agreement.

Consider that John's fixed salary is $120,000. The payment of $500,000 to John was an excess parachute payment because it exceeded the basic amount of $360,000 ($120,000 x 3). The corporation cannot deduct the excess payment of $380,000 ($500,000 - $120,000), so John must pay an excise tax of $76,000 (20% of $380,000).

Caution: Payments are not considered parachute payments unless the total amount received exceeds three times the employee's base pay. However, once this threshold is reached, the amount that constitutes an excess parachute payment is the portion of the employee's parachute payment that exceeds their base pay.

If an ineligible recipient receives multiple parachute payments, the base amount must be allocated among the payments in order to calculate the excess parachute payment amount. 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 yields the proportion of the base amount allocated to each parachute payment.

Example(s): Jane, whose base amount is $100,000, is entitled to two parachute distributions totaling $400,000 and $200,000, respectively. The $200,000 payment is made at the time of the transfer of ownership or control, while the $400,000 payment is due in the future. At the time of transfer of ownership or control, the present value of the $400,000 payment is $300,000. These payments are apportioned $40,000 (($200,000/$500,000) $100,000) and $60,000 (($300,000/$500,000) $100,000) of the base amount, respectively. The first excess parachute payment is therefore $160,000 ($200,000 minus $40,000) and the second is $340,000 ($400,000 minus $60,000).

Any portion of an excess parachute payment that the individual establishes (through clear and convincing evidence) is reasonable compensation for personal services actually rendered by the individual before the date of the change in ownership or control may be deducted from the excess parachute payment. Reasonable compensation is determined by the specifics of each case. The following considerations are relevant to the decision:

The nature of the provided services
The individual's prior pay for conducting comparable services
The compensation of analogous service providers in situations where compensation is not contingent on a change in ownership or control.

The following illustration is provided to our Kimberly-Clark clients to illustrate how an excess parachute payment is calculated when a disqualified individual establishes that a portion of the payment represents reasonable compensation.

Example(s): Assume that a disqualified individual receives a parachute payment of $600,000, and that $100,000 of the individual's base amount is allocated to the parachute payment. Also presume that $300,000 of the $600,000 parachute payment is determined to be reasonable compensation for personal services actually rendered by the disqualified individual prior to the date of the change in ownership or control. Prior to considering reasonable compensation, the quantity of the excess parachute payment is $500,000 ($600,000 - $100,000). The $300,000 of reasonable compensation is first allocated to the $100 base amount of the disqualified individual. The surplus ($200,000) is then subtracted from the surplus parachute payment. In this instance, the $500,000 surplus parachute payment is reduced by $200,000 of reasonable compensation, resulting in an adjusted excess parachute payment of $300,000.

Why Would an Employer Want to Use Golden Parachutes?

Employers, such as Kimberly-Clark, offer golden parachutes to essential employees for a variety of reasons, including:

To provide incentives for desirable employees to join an employer or potentially Kimberly-Clark (or to remain with an employer) despite the risk that a takeover or change in control could result in employees losing their employment.

Example(s): Bob Smith was employed as a senior executive by Toy Shop, Inc. Several international corporations expressed interest in acquiring Toy Shop, Inc. due to its exceptional profitability. Smith feared that he would be unemployed if the company accepted one of the foreign offers, so he requested the Toy Shop, Inc. officers to pay him a large bonus if the company was sold. This bonus would equal three times his annual compensation on average.

To reduce the incentive for key employees to oppose takeovers that are advantageous to the organization but may endanger their employment.

Conclusion

Retirement planning can be like gardening. Just as a gardener carefully selects and nurtures plants, retirees need to choose and cultivate their investments to grow and thrive. And just as a garden requires maintenance and adjustments over time, a retirement plan must be regularly tended to and adjusted to ensure a bountiful harvest in the future. By starting early and making smart choices, retirees can enjoy a fruitful retirement, much like a gardener reaps the rewards of a well-tended garden. Remember, just like plants need sunlight, water, and good soil to grow, a retirement plan requires careful attention, diversification, and regular contributions to flourish.