Court: Executives Did Float on Golden Parachutes

October 31, 2003 ( - Because payments made to executives hinged on a change of company ownership, they are considered golden parachute distributions even though the contracts calling for them were executed after the ownership change occurred.

>That was the substance of a recent ruling by the US Tax Court on a dispute between the company and the Internal Revenue Service over the firm’s claiming of a tax deduction for the executives’ payments made under the firm’s contracts with them, according to a CCH report.

>CCH reported that the employer entered into agreements with its senior executives that included golden parachute provisions for lump-sum termination payments in the event the company changed hands. The firm was acquired the following year.

>The new owners, seeking to retain management expertise, hammered out contracts with most of the executives. The post-acquisition employment agreements replaced the pre-acquisition agreements, but included retention payments that more than compensated the executives for relinquishing their entitlement to lump-sum termination payments under the pre-acquisition agreements.

The company claimed a tax deduction for the compensation paid out under the employment agreements. The IRS disallowed most of the claimed deductions as excess parachute payments under Code Sec. 280G, and the matter came before the Tax Court.

>The firm claimed that the payments for which it sought a tax deduction were not golden parachute payments because they were made under employment agreements entered into after the company acquisition and not “contingent on a change of ownership,” as required by Code Sec. 280G(b)(2)(A)( i ). The court turned away this argument.

The purpose of Code Sec. 280G, stated the court, was to impose a tax penalty on corporations that paid excess parachute payments, defined as payments that were extraordinarily large in relation to the recipient’s historical compensation, and were contingent on a change in ownership. Citing 1989 Proposed Reg. ­1.280G-1 at Q&A-22 and Q&A-23, the court stated that a payment is treated as “contingent upon a change of ownership” if the payment would not have been made had a change in ownership not occurred.

The pre-acquisition agreements in this case, observed the court, gave the executives significant leverage in negotiations with the acquiring employer who needed to keep them. The existence of lump-sum termination provisions, contingent on a change of ownership, within the pre-acquisition agreements, were the cause of financially equivalent retention provisions in the post-acquisition agreements. The court found that the benefits to which the executives were entitled under the post-acquisition agreements were obtained in consideration of the rights they relinquished under the pre-acquisition agreements.