Golden Parachute Payments

DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 1 [REG-209114-90] RIN 1545-AH49 Golden Parachute Payments AGENCY:

Internal Revenue Service (IRS), Treasury.

ACTION:

Notice of proposed rulemaking and notice of public hearing.

SUMMARY:

This document contains proposed regulations relating to golden parachute payments to provide guidance to taxpayers who must comply with section 280G. Proposed regulations under section 280G were previously published in the Federal Register on May 5, 1989 (the 1989 proposed regulations). These proposed regulations are proposed to apply to any payments that are contingent on a change in ownership or control occurring on or after January 1, 2004. Taxpayers may rely on these proposed regulations until the effective date of the final regulations. Alternatively, taxpayers may rely on the 1989 regulations for any payment contingent on a change in ownership or control that occurs prior to January 1, 2004.

DATES:

Written or electronic comments must be received by June 5, 2002. Requests to speak and outlines of topics to be discussed at the public hearing scheduled for June 26, 2002, must be received by June 5, 2002.

ADDRESSES:

Send submissions to CC:ITA:RU (REG-209114-90), room 5226, Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be hand delivered Monday through Friday between the hours of 8 a.m. and 5 p.m. to: CC:ITA:RU (REG-209114-90), Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue, NW, Washington, DC or sent electronically, via the IRS Internet site www.irs.gov/regs. The public hearing will be held in the IRS Auditorium, Internal Revenue Building, 1111 Constitution Avenue, NW, Washington, DC.

FOR FURTHER INFORMATION CONTACT:

Concerning the regulations, Erinn Madden at (202) 622-6030 (not a toll-free number). To be placed on the attendance list for the hearing, please contact LaNita M. Vandyke at (202) 622-7180

y, via the IRS Internet site www.irs.gov/regs. The public hearing will be held in the IRS Auditorium, Internal Revenue Building, 1111 Constitution Avenue, NW, Washington, DC.

FOR FURTHER INFORMATION CONTACT:

Concerning the regulations, Erinn Madden at (202) 622-6030 (not a toll-free number). To be placed on the attendance list for the hearing, please contact LaNita M. Vandyke at (202) 622-7180.

SUPPLEMENTARY INFORMATION:

Background

This document contains proposed amendments to 26 CFR part 1 under section 280G of the Internal Revenue Code (Code). Sections 280G and 4999 of the Code were added to the Code by sec. 67 of the Deficit Reduction Act, Public Law 98-369 (98 Stat. 585). Section 280G was amended by sec. 1804(j) of the Tax Reform Act of 1986, Public Law 99-514 (100 Stat. 2807), sec. 1018(d) of the Technical and Miscellaneous Revenue Act of 1988, Public Law 100-647 (102 Stat. 3581) and sec. 1421 of the Small Business Job Protection Act of 1996, Public Law 104-188 (110 Stat. 1755).

Section 280G denies a deduction to a corporation for any excess parachute payment. Section 4999 imposes a 20-percent excise tax on the recipient of any excess parachute payment. Related provisions include section 275(a)(6), which denies the recipient a deduction for the section 4999 excise tax, and section 3121(v)(2)(A), which relates to Federal Insurance Contributions Act. Proposed regulations (PS-217-84) under section 280G were previously published in the Federal Register at 54 FR 19390 on May 5, 1989 (the 1989 proposed regulations).

Explanation of Provisions

Overview

Section 280G denies a deduction to a corporation for any excess parachute payment. Section 4999 imposes a 20-percent excise tax on the recipient of any excess parachute payment. The disallowance of the deduction under section 280G is not contingent on the imposition of the excise tax under section 4999, and the imposition of the excise tax under section 4999 is not contingent on the disallowance of the deduction under section 280G

a corporation for any excess parachute payment. Section 4999 imposes a 20-percent excise tax on the recipient of any excess parachute payment. The disallowance of the deduction under section 280G is not contingent on the imposition of the excise tax under section 4999, and the imposition of the excise tax under section 4999 is not contingent on the disallowance of the deduction under section 280G. For example, an individual may be subject to the 20-percent excise tax under section 4999 even though the payor is a foreign corporation not subject to United States income tax.

Section 280G(b)(2)(A) defines a parachute payment as any payment that meets all of the following four conditions: (a) The payment is in the nature of compensation; (b) the payment is to, or for the benefit of, a disqualified individual; (c) the payment is contingent on a change in the ownership of a corporation, the effective control of a corporation, or the ownership of a substantial portion of the assets of a corporation (a change in ownership or control); and (d) the payment has (together with other payments described in (a), (b), and (c) of this paragraph with respect to the same individual) an aggregate present value of at least 3 times the individual's base amount. Section 280G(b)(2)(B) provides that the term parachute payment also includes any payment in the nature of compensation to, or for the benefit of, a disqualified individual if the payment is pursuant to an agreement that violates any generally enforced securities laws or regulations (securities violation parachute payment).

Section 280G(b)(1) defines the term excess parachute payment as an amount equal to the excess of any parachute payment over the portion of the disqualified individual's base amount that is allocated to such payment

of, a disqualified individual if the payment is pursuant to an agreement that violates any generally enforced securities laws or regulations (securities violation parachute payment).

Section 280G(b)(1) defines the term excess parachute payment as an amount equal to the excess of any parachute payment over the portion of the disqualified individual's base amount that is allocated to such payment. For this purpose, the portion of the base amount allocated to a parachute payment is the amount that bears the same ratio to the base amount as the present value of the parachute payment bears to the aggregate present value of all such payments to the same disqualified individual.

Generally, excess parachute payments may be reduced by certain amounts of reasonable compensation. Section 280G(b)(4)(B) provides that, except in the case of securities violation parachute payments, the amount of an excess parachute payment is reduced by any portion of the payment that the taxpayer establishes by clear and convincing evidence is reasonable compensation for personal services actually rendered by the disqualified individual before the date of change in ownership or control. Such reasonable compensation is first offset against the portion of the base amount allocated to the payment.

The 1989 proposed regulations provided guidance regarding the application of section 280G to corporations and individuals. Although many aspects of the 1989 proposed regulations were well-received, the IRS has received numerous comments requesting modification and clarification of the 1989 proposed regulations. In response, these proposed regulations clarify and revise, as described below, the 1989 proposed regulations. Many aspects of the 1989 proposed regulations are preserved, and these proposed regulations retain the same organizational structure as the 1989 proposed regulations. Major modifications to the 1989 proposed regulations are described below

d clarification of the 1989 proposed regulations. In response, these proposed regulations clarify and revise, as described below, the 1989 proposed regulations. Many aspects of the 1989 proposed regulations are preserved, and these proposed regulations retain the same organizational structure as the 1989 proposed regulations. Major modifications to the 1989 proposed regulations are described below.

Disqualified Individuals

A payment constitutes a parachute payment only if the payment is made to (or for the benefit of) a disqualified individual. Section 280G(c) defines the term disqualified individual to include any individual who (a) is an employee or independent contractor who performs personal services for a corporation, and (b) is an officer, shareholder, or highly-compensated individual.

The determination of whether an individual is a disqualified individual under these proposed regulations is substantially the same as under the 1989 proposed regulations, with three significant changes. First, Q/A-17 of the 1989 regulations provides a de minimis rule for purposes of identifying which shareholders of a corporation are disqualified individuals. Under the 1989 proposed regulations, an individual is a shareholder for purposes of section 280G if the individual, at any time during the disqualified individual determination period, owns stock of a corporation with a fair market value exceeding the lesser of $1 million or 1 percent of the total fair market value of the outstanding shares of all classes of the corporation's stock. Since the issuance of the 1989 proposed regulations, it has become apparent that this rule may include individuals who do not possess significant influence over the corporation. Therefore, under Q/A-17 of these proposed regulations, the $1 million test is eliminated

lesser of $1 million or 1 percent of the total fair market value of the outstanding shares of all classes of the corporation's stock. Since the issuance of the 1989 proposed regulations, it has become apparent that this rule may include individuals who do not possess significant influence over the corporation. Therefore, under Q/A-17 of these proposed regulations, the $1 million test is eliminated. Under these proposed regulations, an individual is a shareholder only if, during the disqualified individual determination period, the individual owns stock of a corporation with a fair market value that exceeds 1 percent of the total fair market value of the outstanding shares of all classes of the corporation's stock. The constructive ownership rules of section 318(a) continue to apply for purposes of determining the amount of stock owned by the individual. Under these rules, for example, to determine the amount of stock owned by an individual, the stock underlying vested stock options is considered constructively owned by that individual.

Second, these proposed regulations modify the annualized compensation method for determining who is a highly-compensated individual under Q/A-19. Under the 1989 proposed regulations, no individual whose annualized compensation during the disqualified individual determination period is less than $75,000 is treated as a highly-compensated individual, even if the individual otherwise satisfies the definition of a highly-compensated individual. Q/A-19 is modified to provide that an individual must have annualized compensation equal to at least the amount described in section 414(q)(1)(B)(i). This amount for 2002 is $90,000 and is adjusted periodically for cost-of-living increases. This modification both updates the amount provided in the 1989 proposed regulations and provides a mechanism to update this amount periodically without further amendment of these regulations.

Finally, these proposed regulations change the disqualified individual determination period under Q/A-20

(1)(B)(i). This amount for 2002 is $90,000 and is adjusted periodically for cost-of-living increases. This modification both updates the amount provided in the 1989 proposed regulations and provides a mechanism to update this amount periodically without further amendment of these regulations.

Finally, these proposed regulations change the disqualified individual determination period under Q/A-20. Under the 1989 proposed regulations, the disqualified individual determination period is the portion of the year of the corporation ending on the date of the change in ownership or control and the immediately preceding twelve months (with an option to use the calendar year or the corporation's fiscal year). Q/A-20 of these proposed regulations is modified to change this period to the twelve months prior to and ending on the date of the change in ownership or control of the corporation. Under this rule, the disqualified individual determination period is the same length for any change in ownership or control and is not affected by the date of the change in ownership or control.

Payment in the Nature of Compensation

A payment may be a parachute payment only if it is a payment in the nature of compensation. All payments, in whatever form, are payments in the nature of compensation if the payments arise out of the employment relationship or are associated with the performance of services. In Q/A-11, these proposed regulations clarify that payments in the nature of compensation include cash, the right to receive cash, or a transfer of property.

Q/A-13 of the 1989 proposed regulations provides that the transfer of a nonstatutory option is treated as a payment in the nature of compensation (even if the option does not have a readily ascertainable fair market value within the meaning of § 1.83-7(b)). The 1989 proposed regulations reserve the issue of the treatment of statutory options (i.e., options to which section 421 applies)

property.

Q/A-13 of the 1989 proposed regulations provides that the transfer of a nonstatutory option is treated as a payment in the nature of compensation (even if the option does not have a readily ascertainable fair market value within the meaning of § 1.83-7(b)). The 1989 proposed regulations reserve the issue of the treatment of statutory options (i.e., options to which section 421 applies). These proposed regulations revise Q/A-13 to address the treatment of statutory stock options to provide that nonstatutory stock options and statutory stock options are treated the same. Because both the transfer of a statutory option and the transfer of a nonstatutory stock option are payments in the nature of compensation, there is no basis for distinguishing between these two types of options for purposes of section 280G.

In addition, these proposed regulations revise Q/A-13 with respect to the valuation of both statutory and nonstatutory stock options. Under the 1989 proposed regulations, the value of an option with an ascertainable fair market value is determined under all the facts and circumstances, including the difference between the option's exercise price and the value of the property at the time of vesting, the probability of an increase or decrease in the value of such property, and the length of the option exercise period.

Since the issuance of the 1989 proposed regulations, commentators have indicated that Q/A-13 does not provide sufficient guidance about the determination of the value of a stock option. In particular, commentators question whether the intrinsic value of the option (the difference between the exercise price and the value of the property, or spread) determined at the time of the change in ownership or control, or a value determined under a valuation model such as Black-Scholes, should be used for purposes of section 280G

dance about the determination of the value of a stock option. In particular, commentators question whether the intrinsic value of the option (the difference between the exercise price and the value of the property, or spread) determined at the time of the change in ownership or control, or a value determined under a valuation model such as Black-Scholes, should be used for purposes of section 280G. Using the factors listed in the 1989 proposed regulations results in a value different from the value obtained from using only the difference between the exercise price and the value of the property. Commentators have also noted that valuation methods other than spread are often complicated and difficult to apply in some circumstances, particularly when the stock underlying the option is not publicly traded.

These proposed regulations continue to provide for the use of the factors described in the 1989 proposed regulations. To provide further guidance on acceptable and administrable methods for valuing stock options, these proposed regulations delegate authority to the Commissioner to provide methods for valuation of stock options

Contingent on Change

To be a parachute payment, a payment in the nature of compensation to a disqualified individual must be contingent on a change in ownership or control. Q/A-22 of the 1989 proposed regulations provides guidance on when a payment is contingent on a change in ownership or control. Generally, a payment is treated as contingent on a change in ownership or control if the payment would not in fact have been made had no change in ownership or control occurred. A payment generally is treated as one which would not in fact have been made in the absence of a change in ownership or control unless it is substantially certain, at the time of the change, that the payment would have been made whether or not the change in ownership or control occurred

rship or control if the payment would not in fact have been made had no change in ownership or control occurred. A payment generally is treated as one which would not in fact have been made in the absence of a change in ownership or control unless it is substantially certain, at the time of the change, that the payment would have been made whether or not the change in ownership or control occurred.

These proposed regulations clarify in Q/A-22 that a payment is contingent on a change in ownership or control if the payment would not have been made absent the change in ownership or control, even if the payment is also contingent on a second event, such as termination of employment within a period following the change in ownership or control. In addition, as under the 1989 proposed regulations, a payment generally is treated as contingent on a change in ownership or control if (a) the payment is contingent on an event that is closely associated with such a change, (b) a change in ownership or control actually occurs, and (c) the event is materially related to the change in ownership or control. The fact that a payment that is contingent on an event closely associated with a change in ownership or control is also conditioned on the occurrence of a second event does not affect the determination that the payment is contingent on a change in ownership or control as the result of the occurrence of the first event.

Under Q/A-24 of the 1989 proposed regulations, the entire amount of a payment is generally treated as contingent on a change in ownership or control. These proposed regulations clarify that the general rule of Q/A-24(a) (and not the special rules in either Q/A-24(b) or (c), discussed below) applies to the payment of amounts due under an employment agreement on a termination of employment or change in ownership or control that, without regard to the change, would have been paid for the performance of services after the termination of employment or change in ownership or control, as applicable

ral rule of Q/A-24(a) (and not the special rules in either Q/A-24(b) or (c), discussed below) applies to the payment of amounts due under an employment agreement on a termination of employment or change in ownership or control that, without regard to the change, would have been paid for the performance of services after the termination of employment or change in ownership or control, as applicable. Also, the general rules of Q/A-24(a) apply to the accelerated payment of an amount that is otherwise payable only on the attainment of a performance goal or contingent on an event or condition other than the continued performance of services for a specified period of time. In situations governed by Q/A-24(a), the determination of whether a portion of the payment is reasonable compensation for services rendered before, on, or after the change in ownership or control is determined under Q/As-38 through 44. With respect to amounts due under an employment agreement, however, in most situations, a reduction for reasonable compensation for services rendered before the change in ownership or control is inappropriate, given the general expectation that an individual is not under-compensated for services rendered before a change in ownership or control. See Conf. Rep. No. 98-861, at 852 (1984).

Q/A-24(b) and (c) provide an objective method for determining the portion of a payment that is treated as contingent on a change in ownership or control for certain types of payments. These rules are not appropriate in situations such as the acceleration of salary payments under an employment agreement, when the periodic nature of the payments for services means that there is no issue in determining the amount of the payment that is accelerated, or in situations where a payment is conditioned on achievement of a performance goal or other event

rol for certain types of payments. These rules are not appropriate in situations such as the acceleration of salary payments under an employment agreement, when the periodic nature of the payments for services means that there is no issue in determining the amount of the payment that is accelerated, or in situations where a payment is conditioned on achievement of a performance goal or other event.

As under the 1989 proposed regulations, these proposed regulations provide that a payment is treated as contingent on a change in ownership or control if the change accelerates the time at which the payment is made or accelerates the vesting of a payment. ­Q/A-24(b) and (c) provide rules for determining the portion of such payment that is treated as contingent on the change in ownership or control. These proposed regulations clarify when Q/A-24(b) and (c) apply to a contingent payment.

These proposed regulations clarify that Q/A-24(b) applies if a payment is vested, without regard to the change in ownership or control, and is treated as contingent on a change in ownership or control because the change accelerates the time the payment is made. For example, if an individual has a vested right to a payment at normal retirement age under a nonqualified deferred compensation plan, but instead that payment is made immediately following a change in ownership or control, Q/A-24(b) applies to determine the portion, if any, of the payment that is treated as contingent on the change in ownership or control.

These regulations clarify that Q/A-24(c) applies to a payment that becomes vested as a result of a change in ownership or control to the extent that (i) without regard to the change, the payment was contingent only on the performance of services for the corporation for a specified period of time and (ii) the payment is attributable, at least in part, to the performance of services before the date the payment is made or becomes certain to be made

to a payment that becomes vested as a result of a change in ownership or control to the extent that (i) without regard to the change, the payment was contingent only on the performance of services for the corporation for a specified period of time and (ii) the payment is attributable, at least in part, to the performance of services before the date the payment is made or becomes certain to be made. For example, if an individual will receive a bonus if employed at the end of a 3-year period, but the bonus is paid immediately on the date of the change of control, Q/A-24(c) applies to determine the portion of the payment that is treated as contingent on the change in ownership or control.

Q/A-24(b) provides that, when a payment is accelerated, the portion of the payment that is contingent on the change is the amount by which the accelerated payment exceeds the present value of the payment absent acceleration. Q/A-24(b) further provides that if the amount of a payment without acceleration is not reasonably ascertainable, and the acceleration does not significantly increase the value of the payment, then the present value of the payment absent the acceleration is equal to the amount of the accelerated payment. As a result, the value of the accelerated payment is equal to the value of the payment absent acceleration and no portion of the payment is treated as contingent on a change in control. If the value of a payment absent acceleration is not reasonably ascertainable and the acceleration significantly increases the value of the payment, the future value of the payment is equal to the amount

Q/A-24(c) provides that the portion of the payment treated as contingent on the change when both vesting and payment are accelerated is the lesser of (1) the payment or (2) the amount determined under Q/A-24(b) plus an additional amount to reflect the lapse of the obligation to perform additional services

increases the value of the payment, the future value of the payment is equal to the amount

Q/A-24(c) provides that the portion of the payment treated as contingent on the change when both vesting and payment are accelerated is the lesser of (1) the payment or (2) the amount determined under Q/A-24(b) plus an additional amount to reflect the lapse of the obligation to perform additional services. Q/A-24(c) provides that for purposes of determining the amount under paragraph (b), the acceleration of the vesting of a stock option or the lapse of a restriction on restricted stock is considered to increase significantly the value of the payment.

Because Q/A-24(b) and (c) operate to provide an objective basis for determining the portion of a payment that is earned as of the date of a change in ownership or control, and therefore, not contingent on a change in ownership or control, these proposed regulations clarify that the rules in Q/As-38 through 44 (which provide rules related to reasonable compensation for services rendered), are inapplicable if the special rules in Q/A-24(b) or (c) apply to a payment.

Change in Ownership or Control

These proposed regulations follow the same approach as the 1989 proposed regulations for determining when a change in ownership or control occurs. However, these proposed regulations clarify that, for purposes of determining whether two or more persons acting as a group are considered to own more than 50 percent of the total fair market value or total voting power of the stock of a corporation on the date of a merger, acquisition, or similar transaction involving that corporation, a person who owns stock in both corporations involved in the transaction is treated as acting as a group with respect to the other shareholders in a corporation only to the extent of such person's ownership of stock in that corporation prior to the transaction, and not with respect to his or her ownership in the other corporation

ger, acquisition, or similar transaction involving that corporation, a person who owns stock in both corporations involved in the transaction is treated as acting as a group with respect to the other shareholders in a corporation only to the extent of such person's ownership of stock in that corporation prior to the transaction, and not with respect to his or her ownership in the other corporation. For example, assume individual A owns stock in both corporations X and Y when corporation X acquires stock in Y in exchange for X stock. In determining whether corporation Y has undergone a change in ownership or control, individual A is considered to be acting as a group with other shareholders in corporation Y only to the extent of A's holdings in corporation Y prior to the transaction, and not with respect to A's ownership in X. In determining whether Corporation X has undergone a change in ownership or control, individual A is considered to be acting as a group with other shareholders in Corporation X only to the extent of individual A's holdings in Corporation X prior to the transaction, and not with respect to individual A's ownership interest in Corporation Y. This rule applies without regard to the type of shareholder involved (i.e., whether the shareholder is an individual or an institutional shareholder, such as a corporation, mutual fund, or trust).

Comments are requested with respect to whether the change in ownership or control rules in these proposed regulations should be further revised. Comments are also requested with respect to whether additional guidance is necessary regarding the application of the change in ownership or control provisions, and these proposed regulations in general, in the context of specific business situations such as bankruptcy.

Shareholder Approval Requirements

Section 280G specifically exempts from the definition of the term parachute payment several types of payments that would otherwise constitute parachute payments

ce is necessary regarding the application of the change in ownership or control provisions, and these proposed regulations in general, in the context of specific business situations such as bankruptcy.

Shareholder Approval Requirements

Section 280G specifically exempts from the definition of the term parachute payment several types of payments that would otherwise constitute parachute payments. Deductions for payments exempt from the definition of parachute payment are not disallowed by section 280G, and such exempt payments are not subject to the 20-percent excise tax of section 4999. In addition, such exempt payments are not taken into account in applying the 3-times-base-amount test of section 280G(b)(2)(A)(ii).

The most significant revisions made by these proposed regulations with respect to exempt payments are clarifications to the shareholder approval requirements which must be met for payments with respect to a corporation in which no stock is readily tradeable on an established securities market or otherwise immediately before the change in ownership or control.

Section 280G(b)(5)(B) provides that the shareholder approval requirements are met if two conditions are satisfied. First, the payment is approved by a vote of the persons who owned, immediately before the change in ownership or control, more than 75% of the voting power of all outstanding stock of the corporation. Second, there is adequate disclosure to shareholders of all material facts concerning all payments which (but for this rule) would be parachute payments with respect to a disqualified individual. Since the issuance of the 1989 proposed regulations, commentators have indicated that the 1989 proposed regulations do not fully explain how the shareholder approval requirements operate or accurately reflect business practices connected with a change in ownership or control.

The proposed regulations clarify the process of obtaining shareholder approval within the structure provided by section 280G(b)(5)(B)

suance of the 1989 proposed regulations, commentators have indicated that the 1989 proposed regulations do not fully explain how the shareholder approval requirements operate or accurately reflect business practices connected with a change in ownership or control.

The proposed regulations clarify the process of obtaining shareholder approval within the structure provided by section 280G(b)(5)(B). Under this section, a shareholder approval vote is valid only if (1) it is a vote of more than 75% of the shareholders entitled to vote based on ownership in the corporation immediately before the change in ownership or control, and (2) disclosure is made with respect to all payments that would otherwise be parachute payments for an individual.

The first step in obtaining shareholder approval is to identify the shareholders entitled to vote. Q/A-7 is revised to clarify that stock held by a disqualified individual (or by certain entity shareholders) is not entitled to vote with respect to a payment to be made to any disqualified individual and that this stock is disregarded in determining whether the more than 75% approval requirement has been met. Once the stock entitled to vote is determined, more than 75% of the voting power of such stock must approve the payment. Q/A-7 also includes a rule of administrative convenience providing that a vote to approve the payment does not fail to be a vote of the shareholders who own stock immediately before the change in ownership or control if eligibility to vote is based on the shareholders of record at the time of any vote taken in connection with a transaction or event giving rise to the change in ownership or control within the three-month period ending on the date of the change in ownership or control. This rule only applies if the disclosure requirements are also met.

These proposed regulations further clarify that not all parachute payments must be subject to a shareholder vote to satisfy the shareholder approval requirements with respect to a payment

vent giving rise to the change in ownership or control within the three-month period ending on the date of the change in ownership or control. This rule only applies if the disclosure requirements are also met.

These proposed regulations further clarify that not all parachute payments must be subject to a shareholder vote to satisfy the shareholder approval requirements with respect to a payment. It is permissible for only a portion of the payments that would otherwise be made to a disqualified individual to be subject to vote. For example, assume that a disqualified individual with a base amount of $150,000 would receive payments that (but for the exemption for a corporation with no readily tradeable stock) would be parachute payments including (i) a bonus payment of $200,000, (ii) vesting in stock options with a fair market value of $500,000, $200,000 of which is contingent on the change in ownership or control, and (iii) severance payments of $100,000. In this

These proposed regulations also clarify that the shareholder approval requirements are met by a single vote on all payments submitted to the vote, including payments to more than one disqualified individual (assuming the disclosure requirements, described below, are also met).

The shareholder approval requirements also require adequate disclosure of all material facts concerning the amount of all parachute payments. For this purpose, the proposed regulations clarify that the amount of all parachute payments to be made to each disqualified individual, and not just the amount of the payments subject to vote, is a material fact. These proposed regulations also clarify that shareholders should be provided with basic information about the type of payments involved (e.g., vesting of stock options or severance payments). This disclosure of information must be made to all shareholders entitled to vote, not just to shareholders with 75% of the voting power entitled to vote

nt of the payments subject to vote, is a material fact. These proposed regulations also clarify that shareholders should be provided with basic information about the type of payments involved (e.g., vesting of stock options or severance payments). This disclosure of information must be made to all shareholders entitled to vote, not just to shareholders with 75% of the voting power entitled to vote.

Reasonable Compensation

The determination of whether amounts are reasonable compensation is relevant for two purposes. First, an excess parachute payment is reduced by any portion of the payment that constitutes reasonable compensation for services actually rendered before a change in ownership or control. Second, amounts that are reasonable compensation for services to be rendered after a change in ownership or control are exempt from the definition of parachute payment. In both situations, reasonable compensation for services must be demonstrated by clear and convincing evidence.

These proposed regulations clarify two issues with respect to reasonable compensation for services performed after a change in ownership or control. The proposed regulations clarify that clear and convincing evidence that a payment is reasonable compensation for services rendered after a change in ownership or control exists if the individual's annual compensation after the change in ownership or control (apart from normal increases) is not significantly greater then the individual's annual compensation before the change in ownership or control, provided that the individual's duties and responsibilities are substantially the same after the change in ownership or control as they were before the change in ownership or control

individual's annual compensation after the change in ownership or control (apart from normal increases) is not significantly greater then the individual's annual compensation before the change in ownership or control, provided that the individual's duties and responsibilities are substantially the same after the change in ownership or control as they were before the change in ownership or control. If the individual's duties and responsibilities have changed, then the clear and convincing evidence must demonstrate that the individual's annual compensation after the change in ownership or control is not significantly greater than the compensation customarily paid by the employer, or by comparable employers, to persons performing comparable services.

Payments to an individual under an agreement that requires the individual to refrain from providing services (such as under a covenant not to compete) may also constitute reasonable compensation for services to be rendered on or after the date of the change in ownership or control. Under Q/A-42 of these proposed regulations, an agreement is treated as an agreement to refrain from services (rather than an agreement for severance pay) if it is demonstrated with clear and convincing evidence that the agreement substantially constrains the individual's ability to perform services and there is a reasonable likelihood that the agreement will be enforced against the individual. If, under the facts and circumstances, the agreement does not satisfy these criteria, the payments under the agreement are instead treated as severance payments under Q/A-44. If the agreement does satisfy these criteria, then the agreement is treated as an agreement for the performance of services, and the payment are exempt from the definition of parachute payment to the extent the payments are show to be reasonable compensation under Q/A-42(a)(2)

does not satisfy these criteria, the payments under the agreement are instead treated as severance payments under Q/A-44. If the agreement does satisfy these criteria, then the agreement is treated as an agreement for the performance of services, and the payment are exempt from the definition of parachute payment to the extent the payments are show to be reasonable compensation under Q/A-42(a)(2).

Application to Tax-Exempt Organizations

Commentators have asked whether a payment with respect to a tax-exempt entity is exempt from the definition of the term parachute payment . These proposed regulations clarify that a payment with respect to a tax-exempt entity that would otherwise constitute a parachute payment is exempt from the definition of the term parachute payment if the following two conditions are satisfied.

First, the payment must be made by a corporation undergoing a change in ownership or control that is a tax-exempt organization , as defined in these proposed regulations. A tax-exempt organization is defined as any organization described in section 501(c) that is subject to an express statutory prohibition against inurement of net earnings to the benefit of any private shareholder or individual, an organization described in subsections 501(c)(1) or 501(c)(21), any religious or apostolic organization described in section 501(d), or any qualified tuition program described in section 529.

Second, the organization must meet the definition of tax-exempt organization , as defined in these regulations, both immediately before and immediately after the change in ownership or control. If this second condition is not met, a payment made by a tax-exempt organization is not exempt from the definition of parachute payment

501(d), or any qualified tuition program described in section 529.

Second, the organization must meet the definition of tax-exempt organization , as defined in these regulations, both immediately before and immediately after the change in ownership or control. If this second condition is not met, a payment made by a tax-exempt organization is not exempt from the definition of parachute payment .

As noted above, the term tax-exempt organizations includes organizations that are described in section 501(c) that already are subject to express statutory rules that prohibit the inurement of the net earnings of such organizations to the benefit of “any private shareholder or individual.” Organizations described in the following subsections of 501(c) are tax-exempt organizations under application of this rule: 501(c)(3) (including any organization described in subsections 501(e), (f), or (k)), 501(c)(4), 501(c)(6), 501(c)(9), 501(c)(11), 501(c)(13) (but only with respect to those organizations subject to the express anti-inurement provision), 501(c)(19), and 501(c)(26). In light of the existing restrictions on these organizations, the Service and the Treasury Department believe the additional protections of section 280G are unnecessary. In addition, the term tax-exempt organization in the proposed regulations includes federal instrumentalities organized under Act of Congress (described in section 501(c)(1)), black lung trusts (described in section 501(c)(21)), certain religious and apostolic organizations (described in section 501(d)) and qualified tuition programs (described in section 529). The Service and the Treasury Department recognize that it may be appropriate to exempt payments made by other types of tax-exempt organizations. Comments are requested on whether any additional categories of organizations should be included in the definition of tax-exempt organization for purposes of section 280G

scribed in section 501(d)) and qualified tuition programs (described in section 529). The Service and the Treasury Department recognize that it may be appropriate to exempt payments made by other types of tax-exempt organizations. Comments are requested on whether any additional categories of organizations should be included in the definition of tax-exempt organization for purposes of section 280G.

Definition of Corporation

Under the 1989 proposed regulations, corporation is defined by reference to section 7701(a)(3) of the Code. These proposed regulations clarify that the term corporation, for purposes of section 280G and the regulations thereunder, includes any entity described in § 301.7701-2(b) such as, for example, a real estate investment trust under section 856(a), a corporation that has mutual or cooperative (rather than stock) ownership, such as a mutual insurance company, a mutual savings bank, or a cooperative bank (as defined in section 7701(a)(32)), and a foreign corporation (as defined in section 7701(a)(5)).

Accordingly, the term corporation also includes any entity described in § 301.7701-3(c)(1)(v)(A). That regulation provides, in general, that an entity that claims to be, or is determined to be, an entity that is exempt from taxation under section 501(a) is treated as an association for purposes of the Code. Because the definition of corporation includes an association, any entity described in § 301.7701-3(c)(1)(v)(A) is a corporation for purposes of sections 7701 and 280G.

Determination of Excess Parachute Payments

Once all parachute payments are identified, the determination of what portion, if any, of each parachute payment is an excess parachute payment is made. This determination is based on the aggregate present value of all parachute payments. These proposed regulations modify the method described in Q/A-33 of the 1989 proposed regulations for determining the present value of a payment contingent on an uncertain future event or condition

tified, the determination of what portion, if any, of each parachute payment is an excess parachute payment is made. This determination is based on the aggregate present value of all parachute payments. These proposed regulations modify the method described in Q/A-33 of the 1989 proposed regulations for determining the present value of a payment contingent on an uncertain future event or condition. Under Q/A-33 of these proposed regulations, if there is at least a 50-percent probability that the payment will be made, the entire present value of a contingent payment should be included for purposes of determining if there are excess parachute payments. If there is less than a 50-percent probability, then the present value of the contingent payment is not included. Once it is certain whether or not the payment will be made, the 3-times-base amount test in Q/A-30 is reapplied if the initial determination as to whether to include the payment was incorrect. If the inclusion or exclusion of the payment for purposes of Q/A-30 at the time of the change in ownership or control was correct, there is no need to reapply the 3-times-base-amount test. In addition, if it is reasonably estimated that there is a less than 50-percent probability that the payment will be made and the payment is not included in the 3-times-base-amount test, but the payment is later made, the 3-times-base-amount test is not reapplied if the test without regard to the contingent payment resulted in a determination that the individual received (or would receive) excess parachute payments and no base amount is allocated to the contingent payment.

Finally, Q/A-31 provides guidance on determining the present value of an obligation to provide health care over a period of years. Under these proposed regulations, the determination of the present value of this obligation should be calculated in accordance with generally accepted accounting principles

receive) excess parachute payments and no base amount is allocated to the contingent payment.

Finally, Q/A-31 provides guidance on determining the present value of an obligation to provide health care over a period of years. Under these proposed regulations, the determination of the present value of this obligation should be calculated in accordance with generally accepted accounting principles. For purposes of Q/A-31, it is permissible for the obligation to provide health care to be measured by projecting the cost of premiums for purchased health care insurance, even if no health care insurance is actually purchased. If the obligation to provide health care is made in coordination with a health care plan that the corporation makes available to a group, then the premiums used for this purpose may be group premiums. This method only applies for purposes of determining present value. Premiums for health care insurance can be used for purposes of determining a corporation's loss of deduction or the excise tax obligation for a disqualified individual only to the extent such premiums are actually paid for health care insurance used to satisfy the corporation's obligation to provide health care.

Timing of the Payment of Tax under Section 4999

In general, the excise tax under section 4999 is due at the time that the payment is considered made under Q/A-11 through 13. Q/A-11(b) of these proposed regulations clarifies that, except as provided in Q/A-12 or 13, a payment is considered made in the taxable year that it is includible in the disqualified individual's gross income, or for benefits excludible from income, in the year the benefit is received

the excise tax under section 4999 is due at the time that the payment is considered made under Q/A-11 through 13. Q/A-11(b) of these proposed regulations clarifies that, except as provided in Q/A-12 or 13, a payment is considered made in the taxable year that it is includible in the disqualified individual's gross income, or for benefits excludible from income, in the year the benefit is received. Q/A-11(c) of these proposed regulations permits a disqualified individual, for purposes of section 4999, to treat certain payments as made in the year of the change in ownership or control (or the first year for which a payment contingent on a change in ownership or control is certain to be made), even though the payment is not yet includible in income (or otherwise received). This treatment is not available, however, for a payment if the present value is not reasonably ascertainable within the meaning of section 3121(v) and § 1.3121(v)-1(e)(4) or for a payment related to health benefits or coverage. These proposed regulations indicate in Q/A-11(c) that the Commissioner may provide through published guidance that Q/A-11(c) is or is not available with respect to other types of payments.

According to Q/A-11(c) of these proposed regulations, the payment of the excise tax under section 4999 must be made based on the amount calculated for purposes of determining excess parachute payments. Therefore, to the extent that the determination of whether there is an excess parachute payment is based on an incorrect valuation of the payment, the excise tax payment under this provision is also incorrect.

Proposed Effective Date

These regulations are proposed to apply to any payments that are contingent on a change in ownership or control occurring on or after January 1, 2004. Taxpayers may rely on these proposed regulations until the effective date of the final regulations

payment is based on an incorrect valuation of the payment, the excise tax payment under this provision is also incorrect.

Proposed Effective Date

These regulations are proposed to apply to any payments that are contingent on a change in ownership or control occurring on or after January 1, 2004. Taxpayers may rely on these proposed regulations until the effective date of the final regulations. Alternatively, taxpayers may rely on the 1989 proposed regulations for any payment contingent on a change in ownership or control that occurs prior to January 1, 2004.

Special Analyses

It has been determined that this notice of proposed rulemaking is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations, and, because the regulations do not impose a collection of information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f), this notice of proposed rulemaking will be submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

Comments and Public Hearing

Before these proposed regulations are adopted as final regulations, consideration will be given to any written or electronic comments (a signed original and eight (8) copies) that are submitted timely to the IRS. All comments will be available for public inspection and copying.

A public hearing has been scheduled for June 26, 2002, beginning at 10 a.m. in the IRS Auditorium of the Internal Revenue Building, 1111 Constitution Avenue, NW, Washington, DC. All FOR FURTHER INFORMATION CONTACT section of this preamble.

The rules of 26 CFR 601.601(a)(3) apply to the hearing

at are submitted timely to the IRS. All comments will be available for public inspection and copying.

A public hearing has been scheduled for June 26, 2002, beginning at 10 a.m. in the IRS Auditorium of the Internal Revenue Building, 1111 Constitution Avenue, NW, Washington, DC. All FOR FURTHER INFORMATION CONTACT section of this preamble.

The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who wish to present oral comments at the hearing must submit written comments and an outline of the topics to be discussed and the time to be devoted to each topic (signed original and eight (8) copies) by June 5, 2002. A period of 10 minutes will be allotted to each person for making comments. An agenda showing the schedule of speakers will be prepared after the deadline for receiving outlines has passed. Copies of the agenda will be available free of charge at the hearing.

Drafting Information

The principal author of these proposed regulations is Erinn Madden, Office of the Division Counsel/Associate Chief Counsel (Tax Exempt and Government Entities). However, other personnel from the IRS and Treasury Department participated in their development.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

The proposed amendments to 26 CFR part 1 are as follows:

PART I—INCOME TAX; TAXABLE YEARS BEGINNING AFTER DECEMBER 31, 1986

1. The authority citation for part 1 is amended by adding the following entry in numerical order to read in part as follows:

Authority:

26 U.S.C. 7805 * * *

Section 1.280G-1 also issued under 26 U.S.C. 280G (b) and (e). * * *

2. Section § 1.280G-1 is added to read as follows:

§ 1.280G-1 Golden parachute payments. The following questions and answers relate to the treatment of golden parachute payments under section 280G of the Internal Revenue Code of 1986, as added by section 67 of the Tax Reform Act of 1984 (Pub. L. 98-369; 98 Stat

. 7805 * * *

Section 1.280G-1 also issued under 26 U.S.C. 280G (b) and (e). * * *

2. Section § 1.280G-1 is added to read as follows:

§ 1.280G-1 Golden parachute payments. The following questions and answers relate to the treatment of golden parachute payments under section 280G of the Internal Revenue Code of 1986, as added by section 67 of the Tax Reform Act of 1984 (Pub. L. 98-369; 98 Stat. 585) and amended by section 1804(j) of the Tax Reform Act of 1986 (Pub. L. 99-514; 100 Stat. 2807), section 1018(d) (6)-(8) of the Technical and Miscellaneous Revenue Act of 1988 (Pub. L. 100-647; 102 Stat. 3581), and section 1421 of the Small Business Job Protection Act of 1996 (Pub. L. 104-188, 110 Stat. 1755). The following is a table of contents for this section:

Overview: Effect of section 280G Q/A-1 Meaning of “parachute payment” Q/A-2 Meaning of “excess parachute payment” Q/A-3 Effective date of section 280G Q/A-4 Exempt Payments: Exempt payments generally Q/A-5 Exempt payments with respect to certain corporations Q/A-6 Shareholder approval requirements Q/A-7 Exempt payments under a qualified plan Q/A-8 Exempt payments of reasonable compensation Q/A-9 Payor of Parachute Payments Q/A-10 Payments in the Nature of Compensation: The nature of compensation Q/A-11 Property transfers Q/A-12 Stock options Q/A-13 Reduction of amount of payment by consideration paid Q/A-14 Disqualified Individuals: Meaning of “disqualified individual” Q/A-15 Personal service corporation treated as individual Q/A-16 Meaning of “shareholder” Q/A-17 Meaning of “officer” Q/A-18 Meaning of “highly-compensated individual” Q/A-19 Meaning of “disqualified individual determination period” Q/A-20 Meaning of “compensation” Q/A-21 Contingent on Change in Ownership or Control: General rules for determining payments contingent on change Q/A-22 Payments under agreement entered into after change Q/A-23 Amount of payment contingent on change Q/A-24 Presumption that payment is contingent on change Q/A-25, 26 Change in ownership or control Q/A-27, 28, 29

ied individual determination period” Q/A-20 Meaning of “compensation” Q/A-21 Contingent on Change in Ownership or Control: General rules for determining payments contingent on change Q/A-22 Payments under agreement entered into after change Q/A-23 Amount of payment contingent on change Q/A-24 Presumption that payment is contingent on change Q/A-25, 26 Change in ownership or control Q/A-27, 28, 29 Three-Times-Base-Amount Test for Parachute Payments: Three-times-base-amount test Q/A-30 Determination of present value Q/A-31, 32, 33 Meaning of “base amount” Q/A-34 Meaning of “base period” Q/A-35 Special rule for determining base amount Q/A-36 Securities Violation Parachute Payments Q/A-37 Computation and Reduction of Excess Parachute Payments: Computation of excess parachute payments Q/A-38 Reduction by reasonable compensation Q/A-39 Determination of Reasonable Compensation: General criteria for determining reasonable compensation Q/A-40 Types of payments generally considered reasonable compensation Q/A-41, 42, 43 Treatment of severance payments Q/A-44 Miscellaneous rules: Definition of corporation Q/A-45 Treatment of affiliated group as one corporation Q/A-46 Effective date: General effective date of section 280G Q/A-47 Effective date of regulations Q/A-48 Overview

Q-1: What is the effect of Internal Revenue Code section 280G?

A-1: (a) Section 280G disallows a deduction for any excess parachute payment paid or accrued. For rules relating to the imposition of a nondeductible 20-percent excise tax on the recipient of any excess parachute payment, see Internal Revenue Code sections 4999, 275(a)(6), and 3121(v)(2)(A).

ive date of regulations Q/A-48 Overview

Q-1: What is the effect of Internal Revenue Code section 280G?

A-1: (a) Section 280G disallows a deduction for any excess parachute payment paid or accrued. For rules relating to the imposition of a nondeductible 20-percent excise tax on the recipient of any excess parachute payment, see Internal Revenue Code sections 4999, 275(a)(6), and 3121(v)(2)(A).

(b) The disallowance of a deduction under section 280G is not contingent on the imposition of the excise tax under section 4999. The imposition of the excise tax under section 4999 is not contingent on the disallowance of a deduction under section 280G. Thus, for example, because the imposition of the excise tax under section 4999 is not contingent on the disallowance of a deduction under section 280G, a payee may be subject to the 20-percent excise tax under section 4999 even though the disallowance of the deduction for the excess parachute payment may not directly affect the federal taxable income of the payor.

Q-2: What is a parachute payment for purposes of section 280G?

A-2: (a) The term parachute payment means any payment (other than an exempt payment described in Q/A-5) that—

(1) Is in the nature of compensation;

(2) Is made or is to be made to (or for the benefit of) a disqualified individual;

(3) Is contingent on a change—

(i) In the ownership of a corporation;

(ii) In the effective control of a corporation; or

(iii) In the ownership of a substantial portion of the assets of a corporation; and

(4) Has (together with other payments described in paragraphs (a)(1), (2), and (3) of this A-2 with respect to the same disqualified individual) an aggregate present value of at least 3 times the individual's base amount.

) In the ownership of a corporation;

(ii) In the effective control of a corporation; or

(iii) In the ownership of a substantial portion of the assets of a corporation; and

(4) Has (together with other payments described in paragraphs (a)(1), (2), and (3) of this A-2 with respect to the same disqualified individual) an aggregate present value of at least 3 times the individual's base amount.

(b) Hereinafter, a change referred to in paragraph (a)(3) of this A-2 is referred to as a change in ownership or control. For a discussion of the application of paragraph (a)(1), see Q/A-11 through Q/A-14; paragraph (a)(2), Q/A-15 through Q/A-21; paragraph (a)(3), Q/A-22 through Q/A-29; and paragraph (a)(4), Q/A-30 through Q/A-36.

(c) The term parachute payment also includes any payment in the nature of compensation to (or for the benefit of) a disqualified individual that is pursuant to an agreement that violates a generally enforced securities law or regulation. This type of parachute payment is referred to in this section as a securities violation parachute payment. See Q/A-37 for the definition and treatment of securities violation parachute payments.

Q-3: What is an excess parachute payment for purposes of section 280G?

A-3: The term excess parachute payment means an amount equal to the excess of any parachute payment over the portion of the base amount allocated to such payment. Subject to certain exceptions and limitations, an excess parachute payment is reduced by any portion of the payment which the taxpayer establishes by clear and convincing evidence is reasonable compensation for personal services actually rendered by the disqualified individual before the date of the change in ownership or control. For a discussion of the nonreduction of a securities violation parachute payment by reasonable compensation, see Q/A-37. For a discussion of the computation of excess parachute payments and their reduction by reasonable compensation, see Q/A-38 through Q/A-44

e compensation for personal services actually rendered by the disqualified individual before the date of the change in ownership or control. For a discussion of the nonreduction of a securities violation parachute payment by reasonable compensation, see Q/A-37. For a discussion of the computation of excess parachute payments and their reduction by reasonable compensation, see Q/A-38 through Q/A-44.

Q-4: What is the effective date of section 280G and this section?

A-4: In general, section 280G applies to payments under agreements entered into or renewed after June 14, 1984. Section 280G also applies to certain payments under agreements entered into on or before June 14, 1984, and amended or supplemented in significant relevant respect after that date. This section applies to any payment contingent on a change in ownership or control which occurs on or after January 1, 2004. For a discussion of the application of the effective date, see Q/A-47 and Q/A-48.

Exempt Payments

Q-5: Are some types of payments exempt from the definition of the term parachute payment?

A-5: (a) Yes, the following five types of payments are exempt from the definition of parachute payment —

(1) Payments with respect to a small business corporation (described in Q/A-6 of this section);

(2) Certain payments with respect to a corporation no stock in which is readily tradeable on an established securities market (or otherwise) (described in Q/A-6 of this section);

(3) Payments to or from a qualified plan (described in Q/A-8 of this section);

m the definition of parachute payment —

(1) Payments with respect to a small business corporation (described in Q/A-6 of this section);

(2) Certain payments with respect to a corporation no stock in which is readily tradeable on an established securities market (or otherwise) (described in Q/A-6 of this section);

(3) Payments to or from a qualified plan (described in Q/A-8 of this section);

(4) Certain payments made by a corporation undergoing a change in ownership or control that is described in any of the following sections of the Internal Revenue Code: section 501(c) (but only if such organization is subject to an express statutory prohibition against inurement of net earnings to the benefit of any private shareholder or individual, or if the organization is described in section 501(c)(1) or section 501(c)(21)), section 501(d), or section 529, collectively referred to as tax-exempt organizations (described in Q/A-6 of this section); and

(5) Certain payments of reasonable compensation for services to be rendered on or after the change in ownership or control (described in Q/A-9 of this section).

(b) Deductions for payments exempt from the definition of parachute payment are not disallowed by section 280G, and such exempt payments are not subject to the 20-percent excise tax of section 4999. In addition, such exempt payments are not taken into account in applying the 3-times-base-amount test of Q/A-30 of this section.

Q-6: Which payments with respect to a corporation referred to in paragraph (a)(1), (a)(2), or (a)(4) of Q/A-5 of this section are exempt from the definition of parachute payment?

A-6: (a) The term parachute payment does not include—

(1) Any payment to a disqualified individual with respect to a corporation which (immediately before the change in ownership or control) was a small business corporation (as defined in section 1361(b) but without regard to section 1361(b)(1)(C) thereof),

r (a)(4) of Q/A-5 of this section are exempt from the definition of parachute payment?

A-6: (a) The term parachute payment does not include—

(1) Any payment to a disqualified individual with respect to a corporation which (immediately before the change in ownership or control) was a small business corporation (as defined in section 1361(b) but without regard to section 1361(b)(1)(C) thereof),

(2) Any payment to a disqualified individual with respect to a corporation (other than a small business corporation described in paragraph (a)(1) of this A-6) if—

(i) Immediately before the change in ownership or control, no stock in such

(ii) The shareholder approval requirements described in Q/A-7 of this section are met with respect to such payment; or

(3) Any payment to a disqualified individual made by a corporation which is a tax-exempt organization (as defined in paragraph (a)(4) of Q/A-5 of this section), but only if the corporation meets the definition of a tax-exempt organization both immediately before and immediately after the change in ownership or control.

(b) For purposes of paragraph (a)(1) of this A-6, the members of an affiliated group are not treated as one corporation.

(c) The requirements of paragraph (a)(2)(i) of this A-6 are not met if a substantial portion of the assets of a corporation undergoing a change in ownership or control consists (directly or indirectly) of stock in another entity (or any ownership interest in such entity) and stock of such entity (or any ownership interest in such entity) is readily tradeable on an established securities market or otherwise. For this purpose, such stock constitutes a substantial portion of the assets of an entity if the total fair market value of the stock is equal to or exceeds one third of the total gross fair market value of all of the assets of the entity

terest in such entity) and stock of such entity (or any ownership interest in such entity) is readily tradeable on an established securities market or otherwise. For this purpose, such stock constitutes a substantial portion of the assets of an entity if the total fair market value of the stock is equal to or exceeds one third of the total gross fair market value of all of the assets of the entity. If a corporation is a member of an affiliated group (which group is treated as one corporation under A-46 of this section), the requirements of paragraph (a)(2)(i) of this A-6 are not met if any stock in any member of such group is readily tradeable on an established securities market or otherwise.

(d) For purposes of paragraph (a)(2)(i) of this A-6, the term stock does not include stock described in section 1504(a)(4) if the payment does not adversely affect the redemption and liquidation rights of any shareholder owning such stock.

(e) For purposes of paragraph (a)(2)(i) of this A-6, stock is treated as readily tradeable if it is regularly quoted by brokers or dealers making a market in such stock.

(f) For purposes of paragraph (a)(2)(i) of this A-6, the term established securities market means an established securities market as defined in § 1.897-1(m).

(g) The following examples illustrate the application of this exemption:

Example 1.

A small business corporation (within the meaning of paragraph (a)(1) of this A-6) operates two businesses. The corporation sells the assets of one of its businesses, and these assets represent a substantial portion of the assets of the corporation. Because of the sale, the corporation terminates its employment relationship with persons employed in the business the assets of which are sold. Several of these employees are highly-compensated individuals to whom the owners of the corporation make severance payments in excess of 3 times each employee's base amount

and these assets represent a substantial portion of the assets of the corporation. Because of the sale, the corporation terminates its employment relationship with persons employed in the business the assets of which are sold. Several of these employees are highly-compensated individuals to whom the owners of the corporation make severance payments in excess of 3 times each employee's base amount. Since the corporation is a small business corporation immediately before the change in ownership or control, the payments are not parachute payments.

Example 2.

Assume the same facts as in Example 1, except that the corporation is not a small business corporation within the meaning of paragraph (a)(1) of this A-6. If no stock in the corporation is readily tradeable on an established securities market (or otherwise) immediately before the change in ownership or control and the shareholder approval requirements described in Q/A-7 of this section are met, the payments are not parachute payments.

Example 3.

Stock of Corporation S is wholly owned by Corporation P, stock in which is readily tradeable on an established securities market. The Corporation S stock equals or exceeds one third of the total gross fair market value of Corporation P, and thus, represents a substantial portion of the assets of Corporation P. Corporation S makes severance payments to several of its highly-compensated individuals that are parachute payments under section 280G and Q/A-2 of this section. Because stock in Corporation P is readily tradeable on an established securities market, the payments are not exempt from the definition of parachute payments under this A-6.

Example 4.

A is a corporation described in section 501(c)(3), and accordingly, its net earnings are prohibited from inuring to the benefit of any private shareholder or individual. A transfers substantially all of its assets to another corporation resulting in a change in ownership or control

curities market, the payments are not exempt from the definition of parachute payments under this A-6.

Example 4.

A is a corporation described in section 501(c)(3), and accordingly, its net earnings are prohibited from inuring to the benefit of any private shareholder or individual. A transfers substantially all of its assets to another corporation resulting in a change in ownership or control. Contingent on the change in ownership or control, A makes a payment that, but for the potential application of the excemption described in A-5(a)(4), would constitute a parachute payment. However, one or more aspects of the transaction that constitutes the change in ownership or control causes A to fail to be described in section 501(c)(3). Accordingly, A fails to meet the definition of a tax-exempt organization both immediately before and immediately after the change in ownership or control, as required by this A-6. As a result, the payment made by A that was contingent on the change in ownership or control is not exempt from the definition of parachute payment under this A-6.

Example 5.

B is a corporation described in section 501(c)(15). B does not meet the definition of a tax-exempt organization because section 501(c)(15) does not expressly prohibit inurement of B's net earnings to the benefit of any private shareholder or individual. Accordingly, if B has a change in ownership or control and makes a payment pays or accrues a payment that would otherwise meet the definition of a parachute payment, such payment is not exempt from the definition of the term parachute payment for purposes of this A-6.

Q-7: How are the shareholder approval requirements referred to in paragraph (a)(2)(ii) of Q/A-6 of this section met?

A-7: (a) General rule. The shareholder approval requirements referred to in paragraph (a)(2)(ii) of Q/A-6 of this section are met with respect to any payment if—

hute payment, such payment is not exempt from the definition of the term parachute payment for purposes of this A-6.

Q-7: How are the shareholder approval requirements referred to in paragraph (a)(2)(ii) of Q/A-6 of this section met?

A-7: (a) General rule. The shareholder approval requirements referred to in paragraph (a)(2)(ii) of Q/A-6 of this section are met with respect to any payment if—

(1) Such payment was approved by more than 75 percent of the voting power of all outstanding stock of the corporation entitled to vote (as described in this A-7) immediately before the change in ownership or control; and

(2) There was adequate disclosure to all persons entitled to vote (as described in this A-7) of all material facts concerning all material payments which (but for Q/A-6 of this section) would be parachute payments with respect to a disqualified individual.

(b) Voting requirements —(1) General rule. The vote described in paragraph (a)(1) of this A-7 must determine the right of the disqualified individual to receive the payment, or, in the case of a payment made before the vote, the right of the disqualified individual to retain the payment. For purposes of this A-7, the vote can be no less than the full amount of the payment(s) to be made. The total payment(s) submitted for shareholder approval must be separately approved by the shareholders. Shareholder approval can be a single vote on all payments submitted to vote, including payments to more than one disqualified individual. The requirements of this paragraph (b)(1) are not satisfied if approval of the change in ownership or control is contingent on the approval of any payment that would be a parachute payment but for Q/A-6 of this section to a disqualified individual.

hareholders. Shareholder approval can be a single vote on all payments submitted to vote, including payments to more than one disqualified individual. The requirements of this paragraph (b)(1) are not satisfied if approval of the change in ownership or control is contingent on the approval of any payment that would be a parachute payment but for Q/A-6 of this section to a disqualified individual.

(2) Special rule for vote within 3 months before change. A vote to approve the payment does not fail to be a vote of the outstanding stock of the corporation entitled to vote immediately before the change in ownership or control merely because the determination of the shareholders entitled to vote on the payment is based on the shareholders of record at the time of any shareholder vote taken in connection with a transaction or event giving rise to such change in ownership or control and within the three-month period ending on date of the change in ownership or control, provided the disclosure requirements described in paragraph (c) of this A-7 are met.

(3) Entity shareholder. Approval of a payment by any shareholder that is not an individual (an entity shareholder) generally must be made by the person

(4) Attribution of stock ownership. In determining the persons who comprise the “more than 75 percent” group referred to in paragraph (a)(1) or (b)(3) of this A-7, stock is not counted as outstanding stock if the stock is actually owned or constructively owned under section 318(a) by or for a disqualified individual who receives (or is to receive) payments that would be parachute payments if the shareholder approval requirements described in paragraph (a) of this A-7 were not met. Likewise, stock is not counted as outstanding stock if the owner is considered under section 318(a) to own any part of the stock owned directly or indirectly by or for a disqualified individual described in the preceding sentence

al who receives (or is to receive) payments that would be parachute payments if the shareholder approval requirements described in paragraph (a) of this A-7 were not met. Likewise, stock is not counted as outstanding stock if the owner is considered under section 318(a) to own any part of the stock owned directly or indirectly by or for a disqualified individual described in the preceding sentence. In addition, if a partner authorized by a partnership to approve a payment is a disqualified individual with respect to the corporation undergoing a change in ownership or control, none of the stock held by the partnership is considered outstanding stock. However, if all persons who hold voting power in the corporation are disqualified individuals or related persons described in either of the two preceding sentences, then stock owned by such persons is counted as outstanding stock.

(5) Disqualified individuals. To satisfy the approval requirements of paragraph (a) of this A-7, the vote of a disqualified individual who receives (or is to receive) a payment that would be a parachute payment if the shareholder approval requirements described in paragraph (a) of this A-7 were not met is not considered in determining whether the more than 75 percent vote has been obtained for purposes of any vote under paragraph (a) of this A-7. However, if all persons who hold voting power in the corporation are disqualified individuals or related persons, then votes by such persons are considered in determining whether the more than 75% vote has been obtained.

ph (a) of this A-7 were not met is not considered in determining whether the more than 75 percent vote has been obtained for purposes of any vote under paragraph (a) of this A-7. However, if all persons who hold voting power in the corporation are disqualified individuals or related persons, then votes by such persons are considered in determining whether the more than 75% vote has been obtained.

(c) Adequate disclosure. To be adequate disclosure for purposes of paragraph (a)(2) of this A-7, disclosure must be full and truthful disclosure of the material facts and such additional information as is necessary to make the disclosure not materially misleading at the time the disclosure was made. Disclosure of such information must be made to every shareholder of the corporation entitled to vote under this A-7. For each disqualified individual, material facts that must be disclosed include the total amount of the payments that would be parachute payments if the shareholder approval requirements described in paragraph (a) of this A-7 were not met and a brief description of each payment (e.g., accelerated vesting of options, bonus, or salary). An omitted fact is considered a material fact if there is a substantial likelihood that a reasonable shareholder would consider it important.

(d) Corporation without shareholders. If a corporation does not have shareholders, the exemption described in Q/A-6(a)(2) of this section and the shareholder approval requirements described in this A-7 do not apply. For purposes of this paragraph (d), a shareholder does not include a member in an association, joint stock company, or insurance company.

le shareholder would consider it important.

(d) Corporation without shareholders. If a corporation does not have shareholders, the exemption described in Q/A-6(a)(2) of this section and the shareholder approval requirements described in this A-7 do not apply. For purposes of this paragraph (d), a shareholder does not include a member in an association, joint stock company, or insurance company.

(e) Examples. The following examples illustrate the application of this A-7:

Example 1.

Corporation S has two shareholders—Corporation P, which owns 76 percent of the stock of Corporation S, and A, a disqualified individual. No stock of Corporation P or S is readily tradeable on an established securities market (or otherwise). Stock of Corporation S equals or exceeds one third of the assets of Corporation P, and thus, represents a substantial portion of the assets of Corporation P. All of the stock of Corporation S is sold to Corporation M. Contingent on the change in ownership of Corporation S, severance payments are made to the officers of Corporation S in excess of 3 times each officer's base amount. If the payments are approved by a separate vote of the persons who hold, immediately before the sale, more than 75 percent of the voting power of the outstanding stock of Corporation P and the disclosure rules of paragraph (a)(2) of this A-7 are complied with, the shareholder approval requirements of this A-7 are met, and the payments are exempt from the definition of parachute payment pursuant to A-6 of this section.

Example 2.

Corporation M is wholly owned by Partnership P. No interest in either M or P is readily tradeable on an established securities market (or otherwise). Stock of Corporation M equals or exceeds one third of the assets of Partnership P, and thus, represents a substantial portion of the assets of Partnership P. Corporation M undergoes a change in ownership or control. Partnership P has one general partner and 200 limited partners

d by Partnership P. No interest in either M or P is readily tradeable on an established securities market (or otherwise). Stock of Corporation M equals or exceeds one third of the assets of Partnership P, and thus, represents a substantial portion of the assets of Partnership P. Corporation M undergoes a change in ownership or control. Partnership P has one general partner and 200 limited partners. None of the limited partners are entitled to vote on issues involving the management of the partnership investments. If the payments that would be parachute payments if the shareholder approval requirements of this A-7 are not met are approved by the general partner and the disclosure rules of paragraph (a)(2) of this A-7 are complied with, the shareholder approval requirements of this A-7 are met, and the payments are exempt from the definition of parachute payment pursuant to A-6 of this section.

Example 3.

Corporation A has several shareholders including X and Y, who are disqualified individuals with respect to Corporation A. No stock of Corporation A is readily tradeable on an established securities market (or otherwise). Corporation A undergoes a change in ownership or control. Contingent on the change, severance payments are payable to X and Y that are in excess of 3 times each individual's base amount. To determine whether the approval requirements of paragraph (a)(1) of this A-7 are satisfied regarding the payments to X and Y, the stock of X and Y is not considered outstanding, and X and Y are not eligible to vote.

Example 4.

Assume the same facts as in Example 3 except that after adequate disclosure (within the meaning of paragraph (a)(2) of this A-7) to all shareholders entitled to vote, 60 percent of the shareholders who are entitled to vote approve the payments to X and Y. Because more than 75 percent of the shareholders did not approve the payments to X and Y, the shareholder approval requirements of paragraph (a)(1) of this A-7 are not satisfied, and the payments are not made to X and Y

(within the meaning of paragraph (a)(2) of this A-7) to all shareholders entitled to vote, 60 percent of the shareholders who are entitled to vote approve the payments to X and Y. Because more than 75 percent of the shareholders did not approve the payments to X and Y, the shareholder approval requirements of paragraph (a)(1) of this A-7 are not satisfied, and the payments are not made to X and Y.

Example 5.

Assume the same facts as in Example 3 except that disclosure of all the material facts regarding the payments to X and Y is made to two of Corporation A's shareholders, who collectively own 80 percent of Corporation A's stock entitled to vote and approve the payment. Assume further that no disclosure of the material facts regarding the payments to X and Y is made to other Corporation A shareholders who are entitled to vote within the meaning of this A-7. Because disclosure regarding the payments to X and Y is not made to all of Corporation A's shareholders who were entitled to vote, the disclosure requirements of paragraph (a)(2) of this A-7 are not met, and the payments are not exempt from the definition of parachute payment pursuant to Q/A-6.

Example 6.

Corporation C has three shareholders—Partnership, which owns 20 percent of the stock of Corporation C; A, an individual who owns 60 percent of the stock of Corporation C; and B, an individual who owns 20 percent of Corporation C. Stock of Corporation C does not represent a substantial portion of the assets of Partnership. No interest in either Partnership or Corporation C is readily tradeable on an established securities market (or otherwise). P, a one-third partner in Partnership, is a disqualified individual with respect to Corporation C. Corporation C undergoes a change in ownership or control. Contingent on the change, a severance payment is payable to P in excess of 3 times P's base amount

sets of Partnership. No interest in either Partnership or Corporation C is readily tradeable on an established securities market (or otherwise). P, a one-third partner in Partnership, is a disqualified individual with respect to Corporation C. Corporation C undergoes a change in ownership or control. Contingent on the change, a severance payment is payable to P in excess of 3 times P's base amount. To determine the persons who comprise the “more than 75 percent group” referred to in paragraph (a)(1) of this A-7 who must approve the payment to P, one third of the stock held by Partnership is not considered outstanding stock. If, however, P is the person authorized by Partnership to approve the payment, none of the shares of Partnership are considered outstanding stock.

Example 7.

X, an employee of Corporation E, is a disqualified individual with respect to Corporation E. No stock in Corporation E is readily tradeable on an established securities market (or otherwise). X, Y, and Z are all employees and disqualified individuals with respect to Corporation E. Each individual has a base amount of $100,000. Corporation E undergoes a change in ownership or control. Contingent on the change, a severance payment of $400,000 is payable to X; $600,000 is payable to Y; and $1,000,000 is payable to Z. Corporation E provides a ballot to each Corporation E shareholder entitled to vote under paragraph(a)(1) of this A-7 listing the payments of $400,000 to X; $600,000 to Y; and $1,000,000 to Z. Next to each name and corresponding amount on the ballot, Corporation E requests approval (with a “yes” and “no” box) of each total payment to be made to each individual and states that if the payment is not approved the payment will not be made. Adequate disclosure, within the meaning of this A-7 is made to each shareholder entitled to vote under this A-7. More than 75 percent of the Corporation E shareholders who are entitled to vote under paragraph (a)(1) of this A-7, approve each payment to each individual

x) of each total payment to be made to each individual and states that if the payment is not approved the payment will not be made. Adequate disclosure, within the meaning of this A-7 is made to each shareholder entitled to vote under this A-7. More than 75 percent of the Corporation E shareholders who are entitled to vote under paragraph (a)(1) of this A-7, approve each payment to each individual. The shareholder approval requirements of this A-7 are met, and the payments are exempt from the definition of parachute payment pursuant to A-6 of this section.

Example 8.

Assume the same facts as in Example 7 except that the ballot does not request approval of each total payment to each individual separately. Instead, the ballot states that $2,000,000 in payments will be made to X, Y, and Z and requests approval of all of the $2,000,000 payments. Assuming the nature of the payments to X, Y, and Z are separately described to the shareholders entitled to vote under this A-7, the shareholder approval requirements of paragraph (a)(1) of this A-7 are met, and the payments are exempt from the definition of parachute payment pursuant to A-6 of this section.

Example 9.

B, an employee of Corporation X, is a disqualified individual with respect to Corporation X. Stock of Corporation X is not readily tradeable on an established securities market (or otherwise). Corporation X undergoes a change in ownership or control. B's base amount is $205,000. Under B's employment agreement with Corporation X, in the event of a change in ownership or control, B's stock options will vest and B will receive a severance and bonus payment. Contingent on the change, B's stock options immediately vest with a fair market value of $500,000, $200,000 of which is contingent on the change, and B will receive a $200,000 bonus payment and a $400,000 severance payment. Corporation X distributes a ballot to every shareholder of Corporation X who immediately before the change is entitled to vote

and B will receive a severance and bonus payment. Contingent on the change, B's stock options immediately vest with a fair market value of $500,000, $200,000 of which is contingent on the change, and B will receive a $200,000 bonus payment and a $400,000 severance payment. Corporation X distributes a ballot to every shareholder of Corporation X who immediately before the change is entitled to vote. The ballot lists the following payments to be made to B: the contingent payment of $200,000 attributable to options, a $200,000 bonus payment, and a $400,000 severance payment. The ballot requests shareholder approval of the $200,000 bonus payment to B and states that whether or not the $200,000 bonus payment is approved, B will receive $200,000 attributable to options and a $400,000 severance payment. More than 75 percent of the shareholders entitled to vote approve the $200,000 bonus payment to B. The shareholder approval requirements of this A-7 are met, and the $200,000 payment is exempt from the definition of parachute payment pursuant to A-6 of this section.

Q-8: Which payments under a qualified plan are exempt from the definition of parachute payment?

A-8: The term parachute payment does not include any payment to or from—

(a) A plan described in section 401(a) which includes a trust exempt from tax under section 501(a);

(b) An annuity plan described in section 403(a);

(c) A simplified employee pension (as defined in section 408(k)); or

n.

Q-8: Which payments under a qualified plan are exempt from the definition of parachute payment?

A-8: The term parachute payment does not include any payment to or from—

(a) A plan described in section 401(a) which includes a trust exempt from tax under section 501(a);

(b) An annuity plan described in section 403(a);

(c) A simplified employee pension (as defined in section 408(k)); or

(d) A simple retirement account (as defined in section 408(p)).

Q-9: Which payments of reasonable compensation are exempt from the definition of parachute payment?

A-9: Except in the case of securities violation parachute payments, the term parachute payment does not include any payment (or portion thereof) which the taxpayer establishes by clear and convincing evidence is reasonable compensation for personal services to be rendered by the disqualified individual on or after the date of the change in ownership or control. See Q/A-37 of this section for the definition and treatment of securities violation parachute payments. See Q/A-38 through Q/A-44 of this section for rules on determining amounts of reasonable compensation.

Payor of Parachute Payments

Q-10: Who may be the payor of parachute payments?

A-10: Parachute payments within the meaning of Q/A-2 of this section may be paid, directly or indirectly, by—

(a) The corporation referred to in paragraph (a)(3) of Q/A-2 of this section,

(b) A person acquiring ownership or effective control of that corporation or ownership of a substantial portion of that corporation's assets, or

Payments

Q-10: Who may be the payor of parachute payments?

A-10: Parachute payments within the meaning of Q/A-2 of this section may be paid, directly or indirectly, by—

(a) The corporation referred to in paragraph (a)(3) of Q/A-2 of this section,

(b) A person acquiring ownership or effective control of that corporation or ownership of a substantial portion of that corporation's assets, or

(c) Any person whose relationship to such corporation or other person is such as to require attribution of stock ownership between the parties under section 318(a).

Payments in the Nature of Compensation

Q-11: What types of payments are in the nature of compensation?

A-11: (a) General rule. For purposes of this section, all payments—in whatever form—are payments in the nature of compensation if they arise out of an employment relationship or are associated with the performance of services. For this purpose, the performance of services includes holding oneself out as available to perform services and refraining from performing services (such as under a covenant not to compete or similar arrangement). Payments in the nature of compensation include (but are not limited to) wages and salary, bonuses, severance pay, fringe benefits, and pension benefits and other deferred compensation (including any amount characterized by the parties as interest thereon). A payment in the nature of compensation also includes cash when paid, the value of the right to receive cash, or a transfer of property. However, payments in the nature of compensation do not include attorney's fees or court costs paid or incurred in connection with the payment of any amount described in paragraphs (a)(1), (2), and (3) of Q/A-2 of this section or a reasonable rate of interest accrued on any amount during the period the parties contest whether a payment will be made.

ight to receive cash, or a transfer of property. However, payments in the nature of compensation do not include attorney's fees or court costs paid or incurred in connection with the payment of any amount described in paragraphs (a)(1), (2), and (3) of Q/A-2 of this section or a reasonable rate of interest accrued on any amount during the period the parties contest whether a payment will be made.

(b) When payment is considered to be made. Except as otherwise provided in A-11 through Q/A-13 of this section, a payment in the nature of compensation is considered made (and is subject to the excise tax under section 4999) in the taxable year in which it is includible in the disqualified individual's gross income or, in the case of fringe benefits and other benefits excludible from income, in the taxable year the benefits are received.

(c) Pre-payment rule. Notwithstanding the general rule described in paragraph (b) of this A-11, for purposes of section 4999, a disqualified individual is

(d) Transfers of property. Transfers of property are treated as payments for purposes of this A-11. See Q/A-12 of this section for rules on determining when such payments are considered made and the amount of such payments. See Q/A-13 of this section for special rules on transfers of statutory and nonstatutory stock options.

Q-12: If a property transfer to a disqualified individual is a payment in the nature of compensation, when is the payment considered made (or to be made), and how is the amount of the payment determined?

A-12: (a) Except as provided in this A-12 and Q/A-13 of this section, a transfer of property is considered a payment made (or to be made) in the taxable year in which the property transferred is includible in the gross income of the disqualified individual under section 83 and the regulations thereunder

the payment considered made (or to be made), and how is the amount of the payment determined?

A-12: (a) Except as provided in this A-12 and Q/A-13 of this section, a transfer of property is considered a payment made (or to be made) in the taxable year in which the property transferred is includible in the gross income of the disqualified individual under section 83 and the regulations thereunder. Thus, in general, such a payment is considered made (or to be made) when the property is transferred (as defined in § 1.83-3(a)) to the disqualified individual and becomes substantially vested (as defined in § 1.83-3(b) and (j)) in such individual. In such case, the amount of the payment is determined under section 83 and the regulations thereunder. Thus, in general, the amount of the payment is equal to the excess of the fair market value of the transferred property (determined without regard to any lapse restriction, as defined in § 1.83-3(i)) at the time that the property becomes substantially vested, over the amount (if any) paid for the property.

(b) An election made by a disqualified individual under section 83(b) with respect to transferred property will not apply for purposes of this A-12. Thus, even if such an election is made with respect to a property transfer that is a payment in the nature of compensation, the payment is generally considered made (or to be made) when the property is transferred to and becomes substantially vested in such individual.

(c) See Q/A-13 of this section for rules on applying this A-12 to transfers of stock options.

apply for purposes of this A-12. Thus, even if such an election is made with respect to a property transfer that is a payment in the nature of compensation, the payment is generally considered made (or to be made) when the property is transferred to and becomes substantially vested in such individual.

(c) See Q/A-13 of this section for rules on applying this A-12 to transfers of stock options.

(d) The following example illustrates the principles of this A-12:

Example.

On January 1, 2006, Corporation M gives to A, a disqualified individual, a bonus of 100 shares of Corporation M stock in connection with the performance of services to Corporation M. Under the terms of the bonus arrangement A is obligated to return the Corporation M stock to Corporation M unless the earnings of Corporation M double by January 1, 2009, or there is a change in ownership or control of Corporation M before that date. A's rights in the stock are treated as substantially nonvested (within the meaning of § 1.83-3(b)) during that period because A's rights in the stock are subject to a substantial risk of forfeiture (within the meaning of § 1.83-3(c)) and are nontransferable (within the meaning of § 1.83-3(d)). On January 1, 2008, a change in ownership or control of Corporation M occurs. On that day, the fair market value of the Corporation M stock is $250 per share. Because A's rights in the Corporation M stock become substantially vested (within the meaning of § 1.83-3(b)) on that day, the payment is considered made on that day, and the amount of the payment for purposes of this section is equal to $25,000 (100 × $250). See Q/A-38 through 41 for rules relating to the reduction of the excess parachute payment by the portion of the payment which is established to be reasonable compensation for personal services actually rendered before the date of a change in ownership or control

the payment is considered made on that day, and the amount of the payment for purposes of this section is equal to $25,000 (100 × $250). See Q/A-38 through 41 for rules relating to the reduction of the excess parachute payment by the portion of the payment which is established to be reasonable compensation for personal services actually rendered before the date of a change in ownership or control.

Q-13: How are transfers of statutory and nonstatutory stock options treated?

A-13: (a) For purposes of this section, an option (including an option to which section 421 applies) is treated as property that is transferred not later than the time at which the option becomes substantially vested (whether or not the option has a readily ascertainable fair market value as defined in § 1.83-7(b)). Thus, for purposes of this section, the vesting of such an option is treated as a payment in the nature of compensation. The value of an option with an ascertainable fair market value at the time the option vests is determined under all the facts and circumstances in the particular case. Factors relevant to such a determination include, but are not limited to: the difference between the option's exercise price and the value of the property subject to the option at the time of vesting; the probability of the value of such property increasing or decreasing; and the length of the period during which the option can be exercised. Valuation may be determined by any method prescribed by the Commissioner in published guidance for purposes of this A-13. See Q/A-33 of this section for the treatment of options the granting or vesting of which is contingent on a change in ownership or control and that do not have an ascertainable fair market value at the time of granting or vesting.

riod during which the option can be exercised. Valuation may be determined by any method prescribed by the Commissioner in published guidance for purposes of this A-13. See Q/A-33 of this section for the treatment of options the granting or vesting of which is contingent on a change in ownership or control and that do not have an ascertainable fair market value at the time of granting or vesting.

(b) Any money or other property transferred to the disqualified individual on the exercise, or as consideration on the sale or other disposition, of an option described in paragraph (a) of this A-13 after the time such option vests is not treated as a payment in the nature of compensation to the disqualified individual under Q/A-11 of this section. Nonetheless, the amount of the otherwise allowable deduction under section 162 or 212 with respect to such transfer is reduced by the amount of the payment described in paragraph (a) of this A-13 treated as an excess parachute payment.

Q-14: Are payments in the nature of compensation reduced by consideration paid by the disqualified individual?

A-14: Yes, to the extent not otherwise taken into account under Q/A-12 and Q/A-13 of this section, the amount of any payment in the nature of compensation is reduced by the amount of any money or the fair market value of any property (owned by the disqualified individual without restriction) that is (or will be) transferred by the disqualified individual in exchange for the payment. For purposes of the preceding sentence, the fair market value of property is determined as of the date the property is transferred by the disqualified individual

nsation is reduced by the amount of any money or the fair market value of any property (owned by the disqualified individual without restriction) that is (or will be) transferred by the disqualified individual in exchange for the payment. For purposes of the preceding sentence, the fair market value of property is determined as of the date the property is transferred by the disqualified individual.

Disqualified Individuals

Q-15: Who is a disqualified individual?

A-15: (a) For purposes of this section, an individual is a disqualified individual with respect to a corporation if, at any time during the disqualified individual determination period (as defined in Q/A-20 of this section), the individual is an employee or independent contractor of the corporation and is, with respect to the corporation—

(1) A shareholder (but see Q/A-17 of this section);

(2) An officer (see Q/A-18 of this section); or

(3) A highly-compensated individual (see Q/A-19 of this section).

(b) A director is a disqualified individual with respect to a corporation if, at any time during the disqualified (as defined in Q/A-20 of this section), the director is an employee or independent contractor and is, with respect to the corporation, either a shareholder (see Q/A-17 of this section) or a highly-compensated individual (see Q/A-19 of this section).

Q-16: Is a personal service corporation treated as an individual?

A-16: (a) Yes. For purposes of this section, a personal service corporation (as defined in section 269A(b)(1)), or a noncorporate entity that would be a personal service corporation if it were a corporation, is treated as an individual.

see Q/A-17 of this section) or a highly-compensated individual (see Q/A-19 of this section).

Q-16: Is a personal service corporation treated as an individual?

A-16: (a) Yes. For purposes of this section, a personal service corporation (as defined in section 269A(b)(1)), or a noncorporate entity that would be a personal service corporation if it were a corporation, is treated as an individual.

(b) The following example illustrates the principles of this A-16:

Example.

Corporation N, a personal service corporation (as defined in section 269A(b)(1)), has a single individual as its sole shareholder and employee. Corporation N performs personal services for Corporation M. The compensation paid to Corporation N by Corporation M puts Corporation N within the group of the highly-compensated individuals of Corporation M as determined under A-19 of this section. Thus, Corporation N is treated as a highly-compensated individual with respect to Corporation M.

Q-17: Are all shareholders of a corporation considered shareholders for purposes of paragraph (a)(1) of Q/A-15 of this section?

A-17: (a) No, only an individual who owns stock of a corporation with a fair market value that exceeds 1 percent of the fair market value of the outstanding shares of all classes of the corporation's stock is treated as a disqualified individual with respect to the corporation by reason of stock ownership. An individual who owns a lesser amount of stock may, however, be a disqualified individual with respect to the corporation if such individual is an officer or highly-compensated individual with respect to the corporation. For purposes of determining the amount of stock owned by an individual, the constructive ownership rules of section 318(a) apply.

o the corporation by reason of stock ownership. An individual who owns a lesser amount of stock may, however, be a disqualified individual with respect to the corporation if such individual is an officer or highly-compensated individual with respect to the corporation. For purposes of determining the amount of stock owned by an individual, the constructive ownership rules of section 318(a) apply.

(b) The following examples illustrates the principles of this A-17:

Example 1.

E, an employee of Corporation A, received options under Corporation A's Stock Option Plan. E's stock options vest three years after the date of grant. E is not an officer or highly compensated individual during the disqualified individual determination period and does not own any other Corporation A stock. Two years after the options are granted to E, all of Corporation A's stock is acquired by Corporation B. Under Corporation A's Stock Option Plan, E's options are converted to Corporation B options and the vesting schedule remains the same. To determine whether E is a disqualified individual based on E's stock ownership, the stock underlying the unvested options held by E on the date of the change in ownership or control is not considered constructively owned by E under section 318(a). Because E does not own, or constructively own, Corporation A stock with a fair market value exceeding 1 percent of the total fair market value of all of the outstanding shares of all classes of Corporation A and E is not an officer or highly-compensated individual during the disqualified individual determination period, E is not a disqualified individual within the meaning of A-15 of this section with respect to Corporation A.

Example 2.

Assume the same facts as in Example 1 except that Corporation A's Stock Option Plan provides that all unvested options will vest immediately on a change in ownership or control

tively own, Corporation A stock with a fair market value exceeding 1 percent of the total fair market value of all of the outstanding shares of all classes of Corporation A stock and E is not an officer or highly compensated individual during the disqualified individual determination period, E is not a disqualified individual within the meaning of A-15 of this section with respect to Corporation A.

Q-18: Who is an officer?

A-18: (a) For purposes of this section, whether an individual is an officer with respect to a corporation is determined on the basis of all the facts and circumstances in the particular case (such as the source of the individual's authority, the term for which the individual is elected or appointed, and the nature and extent of the individual's duties). Generally, the term officer means an administrative executive who is in regular and continued service. The term officer implies continuity of service and excludes those employed for a special and single transaction. An individual who merely has the title of officer but not the authority of an officer is not considered an officer for purposes of this section. Similarly, an individual who does not have the title of officer but has the authority of an officer is considered an officer for purposes of this section.

(b) An individual who is an officer with respect to any member of an affiliated group that is treated as one corporation pursuant to Q/A-46 of this section is treated as an officer of such one corporation.

fficer for purposes of this section. Similarly, an individual who does not have the title of officer but has the authority of an officer is considered an officer for purposes of this section.

(b) An individual who is an officer with respect to any member of an affiliated group that is treated as one corporation pursuant to Q/A-46 of this section is treated as an officer of such one corporation.

(c) No more than 50 employees (or, if less, the greater of 3 employees, or 10 percent of the employees (rounded up to the nearest integer)) of the corporation (in the case of an affiliated group treated as one corporation, each member of the affiliated group) are treated as disqualified individuals with respect to a corporation by reason of being an officer of the corporation. For purposes of the preceding sentence, the number of employees of the corporation is the greatest number of employees the corporation has during the disqualified individual determination period (as defined in Q/A-20 of this section). If the number of officers of the corporation exceeds the number of employees who may be treated as officers under the first sentence of this paragraph (c), then the employees who are treated as officers for purposes of this section are the highest paid 50 employees (or, if less, the greater of 3 employees, or 10 percent of the employees (rounded up to the nearest integer)) of the corporation when ranked on the basis of compensation (as determined under Q/A-21 of this section) paid during the disqualified individual determination period

paragraph (c), then the employees who are treated as officers for purposes of this section are the highest paid 50 employees (or, if less, the greater of 3 employees, or 10 percent of the employees (rounded up to the nearest integer)) of the corporation when ranked on the basis of compensation (as determined under Q/A-21 of this section) paid during the disqualified individual determination period.

Q-19: Who is a highly-compensated individual?

A-19: (a) For purposes of this section, a highly-compensated individual with respect to a corporation is any individual who is, or would be if the individual were an employee, a member of the group consisting of the lesser of the highest paid 1 percent of the employees of the corporation (rounded up to the nearest integer), or the highest paid 250 employees of the corporation, when ranked on the basis of compensation (as determined under Q/A-21 of this section) paid during the disqualified individual determination period (as defined in Q/A-20 of this section). For purposes of the preceding sentence, the number of employees of the corporation is the greatest number of employees the corporation has during the disqualified individual determination period (as defined in Q/A-20 of this section). However, no individual whose annualized

(b) An individual who is not an employee of the corporation is not treated as a highly-compensated individual with respect to the corporation on account of compensation received for performing services (such as brokerage, legal, or investment banking services) in connection with a change in ownership or control of the corporation, if the services are performed in the ordinary course of the individual's trade or business and the individual performs similar services for a significant number of clients unrelated to the corporation.

ration on account of compensation received for performing services (such as brokerage, legal, or investment banking services) in connection with a change in ownership or control of the corporation, if the services are performed in the ordinary course of the individual's trade or business and the individual performs similar services for a significant number of clients unrelated to the corporation.

(c) In determining the total number of employees of a corporation for purposes of this A-19, employees are not counted if they normally work less than 17 1/2 hours per week (as defined in section 414(q)(5)(B) and the regulations thereunder) or if they normally work during not more than 6 months during any year (as defined in section 414(q)(5)(C) and the regulations thereunder). However, an employee who is not counted for purposes of the preceding sentence may still be a highly-compensated individual.

Q-20: What is the disqualified individual determination period?

A-20: The disqualified individual determination period is the twelve-month period prior to and ending on the date of the change in ownership or control of the corporation.

Q-21: How is compensation defined for purposes of determining who is a disqualified individual?

A-21: (a) For purposes of determining who is a disqualified individual, the term compensation is the compensation which was earned by the individual for services performed for the corporation with respect to which the change in ownership or control occurs (changed corporation), for a predecessor entity, or for a related entity. Such compensation is determined without regard to sections 125, 132(f)(4), 402(e)(3), and 402(h)(1)(B). Thus, for example, compensation includes elective or salary reduction contributions to a cafeteria plan, cash or deferred arrangement or tax-sheltered annuity and amounts credited under a nonqualified deferred compensation plan.

d corporation), for a predecessor entity, or for a related entity. Such compensation is determined without regard to sections 125, 132(f)(4), 402(e)(3), and 402(h)(1)(B). Thus, for example, compensation includes elective or salary reduction contributions to a cafeteria plan, cash or deferred arrangement or tax-sheltered annuity and amounts credited under a nonqualified deferred compensation plan.

(b) For purposes of this A-21, a predecessor entity is any entity which, as a result of a merger, consolidation, purchase or acquisition of property or stock, corporate separation, or other similar business transaction transfers some or all of its employees to the changed corporation or to a related entity or to a predecessor entity of the changed corporation. The term related entity include—

(1) All members of a controlled group of corporations (as defined in section 414(b)) that includes the changed corporation or a predecessor entity;

(2) All trades or business (whether or not incorporated) that are under common control (as defined in section 414(c)) if such group includes the changed corporation or a predecessor entity;

(3) All members of an affiliated service group (as defined in section 414(m)) that includes the changed corporation or a predecessor entity; and

(4) Any other entities required to be aggregated with the changed corporation or a predecessor entity pursuant to section 414(o) and the regulations thereunder (except leasing organizations as defined in section 414(n)).

tion or a predecessor entity;

(3) All members of an affiliated service group (as defined in section 414(m)) that includes the changed corporation or a predecessor entity; and

(4) Any other entities required to be aggregated with the changed corporation or a predecessor entity pursuant to section 414(o) and the regulations thereunder (except leasing organizations as defined in section 414(n)).

(c) For purposes of Q/A-18 and Q/A-19 of this section, compensation that was contingent on the change in ownership or control and that was payable in the year of the change is not treated as compensation.

Contingent on Change in Ownership or Control

Q-22: When is a payment contingent on a change in ownership or control?

A-22: (a) In general, a payment is treated as contingent on a change in ownership or control if the payment would not, in fact, have been made had no change in ownership or control occurred, even if the payment is also conditioned on the occurrence of another event. A payment generally is treated as one which would not, in fact, have been made in the absence of a change in ownership or control unless it is substantially certain, at the time of the change, that the payment would have been made whether or not the change occurred. (But see Q/A-23 of this section regarding payments under agreements entered into after a change in ownership or control.) A payment that becomes vested as a result of a change in ownership or control is not treated as a payment which was substantially certain to have been made whether or not the change occurred. For purposes of this A-22, vested means the payment is substantially vested within the meaning of § 1.83-3(b) and (j) or the right to the payment is not otherwise subject to a substantial risk of forfeiture.

(b)(1) For purposes of paragraph (a), a payment is treated as contingent on a change in ownership or control if—

substantially certain to have been made whether or not the change occurred. For purposes of this A-22, vested means the payment is substantially vested within the meaning of § 1.83-3(b) and (j) or the right to the payment is not otherwise subject to a substantial risk of forfeiture.

(b)(1) For purposes of paragraph (a), a payment is treated as contingent on a change in ownership or control if—

(i) The payment is contingent on an event that is closely associated with a change in ownership or control;

(ii) A change in ownership or control actually occurs; and

(iii) The event is materially related to the change in ownership or control.

(2) For purposes of paragraph (b)(1)(i) of this A-22, a payment is treated as contingent on an event that is closely associated with a change in ownership or control unless it is substantially certain, at the time of the event, that the payment would have been made whether or not the event occurred. An event is considered closely associated with a change in ownership or control if the event is of a type often preliminary or subsequent to, or otherwise closely associated with, a change in ownership or control. For example, the following events are considered closely associated with a change in the ownership or control of a corporation: The onset of a tender offer with respect to the corporation; a substantial increase in the market price of the corporation's stock that occurs within a short period (but only if such increase occurs prior to a change in ownership or control); the cessation of the listing of the corporation's stock on an established securities market; the acquisition of more than 5 percent of the corporation's stock by a person (or more than one person acting as a group) not in control of the corporation; the voluntary or involuntary termination of the disqualified individual's employment; a significant reduction in the disqualified individual's job responsibilities; and a change in ownership or control as defined in the disqualified individual's employment agr

f more than 5 percent of the corporation's stock by a person (or more than one person acting as a group) not in control of the corporation; the voluntary or involuntary termination of the disqualified individual's employment; a significant reduction in the disqualified individual's job responsibilities; and a change in ownership or control as defined in the disqualified individual's employment agreement (or elsewhere) that does not meet the definition of a change in ownership or control described in Q/A-27, 28, or 29 of this section. Whether other events are treated as closely associated with a change in ownership or control is based on all the facts and circumstances of the particular case.

(3) For purposes of determining whether an event (as described in paragraph (b)(2) of this A-22) is materially related to a change in ownership or control, the event is presumed to be materially related to a change in ownership or control if such event occurs within the period beginning one year before and ending one year after the date of change in ownership or control. If such event occurs outside of the period beginning one year before and ending one year after the date of change in ownership or control, the event is presumed not materially related to the change in ownership or control. A payment does

(c) A payment that would in fact have been made had no change in ownership or control occurred is treated as contingent on a change in ownership or control if the change in ownership or control (or the occurrence of an event that is closely associated and materially related to a change in ownership or control within the meaning of paragraph (b)(1) of this A-22), accelerates the time at which the payment is made. Thus, for example, if a change in ownership or control accelerates the time of payment of deferred compensation that is vested without regard to the change in ownership or control, the payment may be treated as contingent on the change

and materially related to a change in ownership or control within the meaning of paragraph (b)(1) of this A-22), accelerates the time at which the payment is made. Thus, for example, if a change in ownership or control accelerates the time of payment of deferred compensation that is vested without regard to the change in ownership or control, the payment may be treated as contingent on the change. See Q/A-24 of this section regarding the portion of a payment that is so treated. See also Q/A-8 of this section regarding the exemption for certain payments under qualified plans and Q/A-40 of this section regarding the treatment of a payment as reasonable compensation.

(d) A payment is treated as contingent on a change in ownership or control even if the employment or independent contractor relationship of the disqualified individual is not terminated (voluntarily or involuntarily) as a result of the change.

(e) The following examples illustrate the principles of this A-22:

Example 1.

A corporation grants a stock appreciation right to a disqualified individual, A, more than one year before a change in ownership or control. After the stock appreciation right vests and becomes exercisable, a change in ownership or control of the corporation occurs, and A exercises the right. Assuming neither the granting nor the vesting of the stock appreciation right is contingent on a change in ownership or control, the payment made on exercise is not contingent on the change in ownership or control.

Example 2.

A contract between a corporation and B, a disqualified individual, provides that a payment will be made to B if the corporation undergoes a change in ownership or control and B's employment with the corporation is terminated at any time over the succeeding 5 years. Eighteen months later, a change in the ownership of the corporation occurs. Two years after the change in ownership, B's employment is terminated and the payment is made to B

a disqualified individual, provides that a payment will be made to B if the corporation undergoes a change in ownership or control and B's employment with the corporation is terminated at any time over the succeeding 5 years. Eighteen months later, a change in the ownership of the corporation occurs. Two years after the change in ownership, B's employment is terminated and the payment is made to B. Because it was not substantially certain that the corporation would have made the payment to B on B's termination of employment if there had not been a change in ownership, the payment is treated as contingent on the change in ownership under paragraph (a) of this A-22. This is true even though B's termination of employment is presumed not to be, and in fact may not be, materially related to the change in ownership or control.

Example 3.

A contract between a corporation and C, a disqualified individual, provides that a payment will be made to C if C's employment is terminated at any time over the succeeding 3 years (without regard to whether or not there is a change in ownership or control). Eighteen months after the contract is entered into, a change in the ownership of the corporation occurs. Six months after the change in ownership, C's employment is terminated and the payment is made to C. Termination of employment is considered an event closely associated with a change in ownership or control. Because the termination occurred within one year after the date of the change in ownership, the termination of C's employment is presumed to be materially related to the change in ownership under paragraph (b)(3) of this A-22. If this presumption is not successfully rebutted, the payment will be treated as contingent on the change in ownership under paragraph (b) of this A-22.

Example 4.

A contract between a corporation and a disqualified individual, D, provides that a payment will be made to D upon the onset of a tender offer for shares of the corporation's stock

ge in ownership under paragraph (b)(3) of this A-22. If this presumption is not successfully rebutted, the payment will be treated as contingent on the change in ownership under paragraph (b) of this A-22.

Example 4.

A contract between a corporation and a disqualified individual, D, provides that a payment will be made to D upon the onset of a tender offer for shares of the corporation's stock. A tender offer is made on December 1, 2008, and the payment is made to D. Although the tender offer is unsuccessful, it leads to a negotiated merger with another entity on June 1, 2009, which results in a change in the ownership of the corporation. It was not substantially certain, at the time of the onset of the tender offer, that the payment would have been made had no tender offer taken place. The onset of a tender offer is considered closely associated with a change in ownership or control. Because the tender offer occurred within one year before the date of the change in ownership of the corporation, the onset of the tender offer is presumed to be materially related to the change in ownership. If this presumption is not rebutted, the payment will be treated as contingent on the change in ownership. If no change in ownership or control had occurred, the payment would not be treated as contingent on a change in ownership or control; however, the payment still could be a parachute payment under Q/A-37 of this section if the contract violated a generally enforced securities law or regulation.

Example 5.

A contract between a corporation and a disqualified individual, E, provides that a payment will be made to E if the corporation's level of product sales or profits reaches a specified level. At the time the contract was entered into, the parties had no reason to believe that such an increase in the corporation's level of product sales or profits would be preliminary or subsequent to, or otherwise closely associated with, a change in ownership or control of the corporation

that a payment will be made to E if the corporation's level of product sales or profits reaches a specified level. At the time the contract was entered into, the parties had no reason to believe that such an increase in the corporation's level of product sales or profits would be preliminary or subsequent to, or otherwise closely associated with, a change in ownership or control of the corporation. Eighteen months later, a change in the ownership of the corporation occurs and within one year after the date of the change, the corporation's level of product sales or profits reaches the specified level. Under these facts and circumstances (and in the absence of contradictory evidence), the increase in product sales or profits of the corporation is not an event closely associated with the change in ownership or control of the corporation. Accordingly, even if the increase is materially related to the change, the payment will not be treated as contingent on a change in ownership or control.

Q-23: May a payment be treated as contingent on a change in ownership or control if the payment is made under an agreement entered into after the change?

A-23: (a) No., payments are not treated as contingent on a change in ownership or control if they are made (or to be made) pursuant to an agreement entered into after the change (a post-change agreement). For this purpose, an agreement that is executed after a change in ownership or control pursuant to a legally enforceable agreement that was entered into before the change is considered to have been entered into before the change

reated as contingent on a change in ownership or control if they are made (or to be made) pursuant to an agreement entered into after the change (a post-change agreement). For this purpose, an agreement that is executed after a change in ownership or control pursuant to a legally enforceable agreement that was entered into before the change is considered to have been entered into before the change. (See Q/A-9 of this section regarding the exemption for reasonable compensation for services rendered on or after a change in ownership or control.) If an individual has a right to receive a parachute payment under an agreement entered into prior to a change in ownership or control (pre-change agreement) and gives up that right as bargained-for consideration for benefits under a post-change agreement, the agreement is treated as a post-change agreement only to the extent the value of the payments under the agreement exceed the value of the payments under the pre-change agreement. To the extent payments under the agreement have the same value as the parachute payments under the pre-change agreement, such payments retain their character as parachute payments subject to this section.

(b) The following examples illustrate the principles of this A-23:

Example 1.

Assume that a disqualified individual is an employee of a corporation. A change in ownership or control of the corporation occurs, and thereafter the individual enters into an employment agreement with the acquiring company. Because the agreement is entered into after the change in ownership or control occurs, payments to be made under the agreement are not treated as contingent on the change.

Example 2.

Assume the same facts as in Example 1, except that the agreement

Example 3.

Assume the same facts as in Example 1 except that prior to the change in ownership or control, the individual and corporation enter into an agreement under which the individual will receive parachute payments in the event of a change in ownership or control of the corporation

as contingent on the change.

Example 2.

Assume the same facts as in Example 1, except that the agreement

Example 3.

Assume the same facts as in Example 1 except that prior to the change in ownership or control, the individual and corporation enter into an agreement under which the individual will receive parachute payments in the event of a change in ownership or control of the corporation. After the change, the individual agrees to give up the right to parachute payments under the pre-change agreement in exchange for compensation under a new agreement with the acquiring corporation. Because the individual gave up the right to parachute payments under the pre-change agreement in exchange for other payments under the post-change agreement, payments in an amount equal to the parachute payments under the pre-change agreement are treated as contingent on the change in ownership or control under this A-23. Because the post-change agreement was entered into after the change, payments in excess of this amount are not treated as parachute payments.

Q-24: If a payment is treated as contingent on a change in ownership or control, is the full amount of the payment so treated?

A-24: (a)(1) General rule. Yes, if the payment is a transfer of property, the amount of the payment is determined under Q/A-12 or Q/A-13 of this section. For all other payments, the amount of the payment is determined under Q/A-11 of this section. However, in certain circumstances, described in paragraphs (b) and (c) of this A-24, only a portion of the payment is treated as contingent on the change. Paragraph (b) of this A-24 applies to a payment that is vested, without regard to the change in ownership or control, and is treated as contingent on the change in ownership or control because the change accelerates the time at which the payment is made

in certain circumstances, described in paragraphs (b) and (c) of this A-24, only a portion of the payment is treated as contingent on the change. Paragraph (b) of this A-24 applies to a payment that is vested, without regard to the change in ownership or control, and is treated as contingent on the change in ownership or control because the change accelerates the time at which the payment is made. Paragraph (c) of this A-24 applies to a payment that becomes vested as a result of the change in ownership or control if, without regard to the change in ownership or control, the payment was contingent only on the continued performance of services for the corporation for a specified period of time and if the payment is attributable, at least in part, to services performed before the date the payment becomes vested. For purposes of this A-24, for the definition of vested see Q/A-22(a).

(2) Reduction by reasonable compensation. The amount of a payment under paragraph (a)(1) of this A-24 is reduced by any portion of such payment that the taxpayer establishes by clear and convincing evidence is reasonable compensation for personal services rendered by the disqualified individual on or after the date of the change of control. See Q/A-9 and Q/A-38 through 44 of this section for rules concerning reasonable compensation. The portion of an amount treated as contingent under paragraph (b) or (c) of this A-24 may not be reduced by reasonable compensation.

es by clear and convincing evidence is reasonable compensation for personal services rendered by the disqualified individual on or after the date of the change of control. See Q/A-9 and Q/A-38 through 44 of this section for rules concerning reasonable compensation. The portion of an amount treated as contingent under paragraph (b) or (c) of this A-24 may not be reduced by reasonable compensation.

(b) Vested payments. This paragraph (b) applies if a payment is vested, without regard to the change in ownership or control, and is treated as contingent on the change in ownership or control because the change accelerates the time at which the payment is made. In such case, the portion of the payment, if any, that is treated as contingent on the change in ownership or control is the amount by which the amount of the accelerated payment exceeds the present value of the payment absent the acceleration. If the value of such a payment absent the acceleration is not reasonably ascertainable, and the acceleration of the payment does not significantly increase the present value of the payment absent the acceleration, the present value of the payment absent the acceleration is treated as equal to the amount of the accelerated payment. If the value of the payment absent the acceleration is not reasonably ascertainable, but the acceleration significantly increases the present value of the payment, the future value of such payment is treated as equal to the amount of the accelerated payment. For rules on determining present value, see paragraph (e) of this A-24, Q/A-32, and Q/A-33 of this section.

(c)(1) Nonvested payments. This paragraph (c) applies to a payment that becomes vested as a result of the change in ownership or control to the extent that—

ses the present value of the payment, the future value of such payment is treated as equal to the amount of the accelerated payment. For rules on determining present value, see paragraph (e) of this A-24, Q/A-32, and Q/A-33 of this section.

(c)(1) Nonvested payments. This paragraph (c) applies to a payment that becomes vested as a result of the change in ownership or control to the extent that—

(i) Without regard to the change in ownership or control, the payment was contingent only on the continued performance of services for the corporation for a specified period of time; and

(ii) The payment is attributable, at least in part, to the performance of services before the date the payment is made or becomes certain to be made.

(2) The portion of the payment subject to paragraph (c) of this A-24 that is treated as contingent on the change in ownership or control is the lesser of—

(i) The amount of the accelerated payment; or

(ii) The amount described in paragraph (b) of this A-24, plus an amount, as determined in paragraph (c)(4) of this A-24, to reflect the lapse of the obligation to continue to perform services.

(3) For purposes of this paragraph (c) of this A-24, the acceleration of the vesting of a stock option or the lapse of a restriction on restricted stock is considered to significantly increase the value of a payment.

(4) The amount reflecting the lapse of the obligation to continue to perform services (described in paragraph (c)(2)(ii) of this A-24) is 1 percent of the amount of the accelerated payment multiplied by the number of full months between the date that the individual's right to receive the payment is vested and the date that, absent the acceleration, the payment would have been vested. This paragraph (c)(4) applies to the accelerated vesting of a payment in the nature of compensation even if the time at which the payment is made is not accelerated.

e amount of the accelerated payment multiplied by the number of full months between the date that the individual's right to receive the payment is vested and the date that, absent the acceleration, the payment would have been vested. This paragraph (c)(4) applies to the accelerated vesting of a payment in the nature of compensation even if the time at which the payment is made is not accelerated.

(d) Application of this A-24 to certain payments .—(1) Benefits under a nonqualified deferred compensation plan . In the case of a payment of benefits under a nonqualified deferred compensation plan, paragraph (b) of this A-24 applies to the extent benefits under the plan are vested without regard to the change in ownership or control. Paragraph (c) of this A-24 applies to the extent benefits under the plan become vested as a result of the change in ownership or control and are attributable, at least in part, to the performance of services prior to vesting. Any other payment of benefits under a nonqualified deferred compensation plan is a payment in the nature of compensation subject to the general rule of paragraph (a) of this A-24 and the rules in Q/A-11 of this section.

(2) Employment agreements . The general rule of paragraph (a) of this A-24 applies to the payment of amounts due under an employment agreement on a termination of employment or a change in ownership or control that otherwise would be attributable to the performance of services (or refraining from the performance of services) during any period that begins after the date of termination of employment or change in ownership or control, as applicable. For purposes of this paragraph (d)(2) of this A-24, an employment agreement means an agreement between an employee or independent contractor and employer or service recipient which describes, among other things, the amount of compensation or remuneration payable to the employee or independent

that begins after the date of termination of employment or change in ownership or control, as applicable. For purposes of this paragraph (d)(2) of this A-24, an employment agreement means an agreement between an employee or independent contractor and employer or service recipient which describes, among other things, the amount of compensation or remuneration payable to the employee or independent

(3) Vesting due to an event other than services . Neither paragraph (b) nor (c) of this A-24 applies to a payment if (without regard to the change in ownership or control) vesting of the payment depends on an event other than the performance of services, such as the attainment of a performance goal, and the event does not occur prior to the change in ownership or control. In such circumstances, the full amount of the accelerated payment is treated as contingent on the change in ownership or control under paragraph (a) of this A-24. However, see Q/A-39 of this section for rules relating to the reduction of the excess parachute payment by the portion of the payment which is established to be reasonable compensation for personal services actually rendered before the date of a change in ownership or control.

(e) Present value . For purposes of this A-24, the present value of a payment is determined as of the date on which the accelerated payment is made.

(f) Examples . The following examples illustrate the principles of this A-24:

Example 1 . (i) Corporation maintains a qualified plan and a nonqualified supplemental retirement plan (SERP) for its executives. Benefits under the SERP are not paid to participants until retirement. E, a disqualified individual with respect to Corporation, has a vested account balance of $500,000 under the SERP. A change in ownership or control of Corporation occurs. The SERP provides that in the event of a change in ownership or control, all vested accounts will be paid to SERP participants.

an (SERP) for its executives. Benefits under the SERP are not paid to participants until retirement. E, a disqualified individual with respect to Corporation, has a vested account balance of $500,000 under the SERP. A change in ownership or control of Corporation occurs. The SERP provides that in the event of a change in ownership or control, all vested accounts will be paid to SERP participants.

(ii) Because E was vested in $500,000 of benefits under the SERP prior to the change in ownership or control and the change merely accelerated the time at which the payment was made to E, only a portion of the payment, as determined under paragraph (b) of this A-24, is treated as contingent on the change. Thus, the portion of the payment that is treated as contingent on the change is the amount by which the amount of the accelerated payment ($500,000) exceeds the present value of the payment absent the acceleration.

(iii) Assume that instead of having a vested account balance of $500,000 on the date of the change in ownership or control, E will vest in his account balance of $500,000 in 2 years if E continues to perform services for the next 2 years. Assume further that the SERP provides that all unvested SERP benefits vest immediately on a change in ownership or control and are paid to the participants. Because the vesting of the SERP payment, without regard to the change, depends only on the performance of services for a specified period of time and the payment is attributable, in part, to the performance of services before the change in ownership or control, only a portion of the $500,000 payment, as determined under paragraph (c) of this A-24, is treated as contingent on the change. The portion of the payment that is treated as contingent on the change is the lesser of the amount of the accelerated payment or the amount by which the accelerated payment exceeds the present value of the payment absent the acceleration, plus an amount to reflect the lapse of the obligation to continue to perform services.

under paragraph (c) of this A-24, is treated as contingent on the change. The portion of the payment that is treated as contingent on the change is the lesser of the amount of the accelerated payment or the amount by which the accelerated payment exceeds the present value of the payment absent the acceleration, plus an amount to reflect the lapse of the obligation to continue to perform services.

(iv) Assume further that under the SERP E's vested account balance of $500,000 will be paid to E on the change in ownership or control and an additional $70,000 will be credited to E's account. Because the $500,000 was vested without regard to the change in ownership or control, paragraph (b) of this A-24 applies to the $500,000 payment. Because the $70,000 is not vested, without regard to the change, and is not attributable to the performance of services prior to the change, the entire $70,000 payment is contingent on the change in ownership or control under paragraph (a) of this A-24.

Example 2. As a result of a change in the effective control of a corporation, a disqualified individual with respect to the corporation, D, receives accelerated payment of D's vested account balance in a nonqualified deferred compensation account plan. Actual interest and other earnings on the plan assets are credited to each account as earned before distribution. Investment of the plan assets is not restricted in such a manner as would prevent the earning of a market rate of return on the plan assets. The date on which D would have received D's vested account balance absent the change in ownership or control is uncertain, and the rate of earnings on the plan assets is not fixed. Thus, the amount of the payment absent the acceleration is not reasonably ascertainable. Under these facts, acceleration of the payment does not significantly increase the present value of the payment absent the acceleration, and the present value of the payment absent the acceleration is treated as equal to the amount of the accelerated payment

he rate of earnings on the plan assets is not fixed. Thus, the amount of the payment absent the acceleration is not reasonably ascertainable. Under these facts, acceleration of the payment does not significantly increase the present value of the payment absent the acceleration, and the present value of the payment absent the acceleration is treated as equal to the amount of the accelerated payment. Accordingly, no portion of the payment is treated as contingent on the change.

Example 3. (i) On January 15, 2006, a corporation and a disqualified individual, F, enter into a contract providing for a retention bonus of $500,000 to be paid to F on January 15, 2011. The payment of the bonus will be forfeited by F if F does not remain employed by the corporation for the entire 5-year period. However, the contract provides that the full amount of the payment will be made immediately on a change in ownership or control of the corporation during the 5-year period. On January 15, 2009, a change in ownership or control of the corporation occurs and the full amount of the payment ($500,000) is made on that date to F. Under these facts, the payment of $500,000 was contingent only on F's performance of services for a specified period and is attributable, in part, to the performance of services before the change in ownership or control. Therefore, only a portion of the payment is treated as contingent on the change. The portion of the payment that is treated as contingent on the change is the amount by which the amount of the accelerated payment (i.e., $500,000, the amount paid to the individual because of the change in ownership) exceeds the present value of the payment that was expected to have been made absent the acceleration (i.e., $406,838, the present value on January 15, 2009, of a $500,000 payment on January 15, 2011), plus $115,000 (1% × 23 months × $500,000) which is the amount reflecting the lapse of the obligation to continue to perform services

amount paid to the individual because of the change in ownership) exceeds the present value of the payment that was expected to have been made absent the acceleration (i.e., $406,838, the present value on January 15, 2009, of a $500,000 payment on January 15, 2011), plus $115,000 (1% × 23 months × $500,000) which is the amount reflecting the lapse of the obligation to continue to perform services. Accordingly, the amount of the payment treated as contingent on the change in ownership or control is $208,162, the sum of $93,162 ($500,000 ^ $406,838) ^ $115,000). This result is not changed if F actually remains employed until the end of the 5-year period.

(ii) Assume that the contract provides that the retention bonus will vest on a change in ownership or control, but will not be paid until January 15, 2011 (the original date in the contract). Because the payment of $500,000 was contingent only on F's performance of services for a specified period and is attributable, in part, to the performance of services before the change in ownership or control, only a portion of the $500,000 payment is treated as contingent on the change. Because there is no accelerated payment, the portion of the payment treated as contingent on the change is an amount reflecting the lapse of the obligation to continue to perform services which is $115,000 (1% × 23 months × $500,000).

Example 4.

(i) On January 15, 2006, a corporation gives to a disqualified individual, in connection with her performance of services to the corporation, a bonus of 1,000 shares of the corporation's stock. Under the terms of the bonus arrangement, the individual is obligated to return the stock to the corporation if she terminates her employment for any reason prior to January 15, 2011. However, if there is a change in the ownership or effective control of the corporation prior to January 15, 2011, she ceases to be obligated to return the stock

on, a bonus of 1,000 shares of the corporation's stock. Under the terms of the bonus arrangement, the individual is obligated to return the stock to the corporation if she terminates her employment for any reason prior to January 15, 2011. However, if there is a change in the ownership or effective control of the corporation prior to January 15, 2011, she ceases to be obligated to return the stock. The individual's rights in the stock are treated as substantially nonvested (within the meaning of § 1.83-3(b) and (j)) during that period. On January 15, 2008, a change in the ownership of the corporation occurs. On that day, the fair market value of the stock is $500,000.

(ii) Under these facts, the payment was contingent only on performance of services for a specified period and is attributable, in part, to the performance of services before the change in ownership or control. Thus, only a portion of the payment is treated as contingent on the change in ownership or control. The portion of the payment that is treated as contingent on the change is the amount by which the present value of the accelerated payment on January 15, 2009 ($500,000), exceeds the present value of the payment that was expected to have been made on January 15, 2011, plus an amount reflecting the lapse of the obligation to continue to perform services. At the time of the change, it cannot be reasonably ascertained what the value of the stock would been on January 15, 2011. The acceleration of the lapse of a restriction on stock is treated as significantly increasing the

Example 5.

value of the payment that was expected to have been made on January 15, 2011, plus an amount reflecting the lapse of the obligation to continue to perform services. At the time of the change, it cannot be reasonably ascertained what the value of the stock would been on January 15, 2011. The acceleration of the lapse of a restriction on stock is treated as significantly increasing the

Example 5.

(i) On January 15, 2006, a corporation grants to a disqualified individual nonqualified stock options to purchase 30,000 shares of the corporation's stock. The options do not have a readily ascertainable fair market value at the time of grant. The options will be forfeited by the individual if he fails to perform personal services for the corporation until January 15, 2009. The options will, however, vest in the individual at an earlier date if there is a change in ownership or control of the corporation. On January 16, 2008, a change in the ownership of the corporation occurs and the options become vested in the individual. On January 16, 2008, the options have an ascertainable fair market value of $600,000.

(ii) The payment of the options to purchase 30,000 shares was contingent only on performance of services for the corporation until January 15, 2009, and is attributable, in part, to the performance of services before the change in ownership or control. Therefore, only a portion of the payment is treated as contingent on the change. The portion of the payment that is treated as contingent on the change is the amount by which the accelerated payment on January 16, 2008 ($600,000) exceeds the present value on January 16, 2008, of the payment that was expected to have been made on January 15, 2009, absent the acceleration, plus an amount reflecting the lapse of the obligation to continue to perform services. At the time of the change, it cannot be reasonably ascertained what the value of the options would have been on January 15, 2009

d payment on January 16, 2008 ($600,000) exceeds the present value on January 16, 2008, of the payment that was expected to have been made on January 15, 2009, absent the acceleration, plus an amount reflecting the lapse of the obligation to continue to perform services. At the time of the change, it cannot be reasonably ascertained what the value of the options would have been on January 15, 2009. The acceleration of vesting in the options is treated as significantly increasing the value of the payment. Therefore, the value of such options on January 15, 2009, is deemed to be $600,000, the amount of the accelerated payment. The present value on January 16, 2008 of a $600,000 payment to be made on January 15, 2009, is $549,964.13. Thus, the portion of the payment treated as contingent on the change is $116,035.87, the sum of $50,035.87 ($600,000 ^ $549,964.13), plus an amount reflecting the lapse of the obligation to continue to perform services which is $66,000 (1% × 11 months × $600,000).

Example 6.

(i) The facts are the same as in Example 5, except that the options become vested periodically (absent a change in ownership of control), with one-third of the options vesting on January 15, 2007, 2008, and 2009, respectively. Thus, options to purchase 20,000 shares vest independently of the January 16, 2008, change in ownership and the options to purchase the remaining 10,000 shares vest as a result of the change.

he same as in Example 5, except that the options become vested periodically (absent a change in ownership of control), with one-third of the options vesting on January 15, 2007, 2008, and 2009, respectively. Thus, options to purchase 20,000 shares vest independently of the January 16, 2008, change in ownership and the options to purchase the remaining 10,000 shares vest as a result of the change.

(ii) The payment of the options to purchase 10,000 shares was contingent only on performance of services for the corporation until January 15, 2009, and is attributable, in part, to the performance of services before the change in ownership or control. Therefore, only a portion of the payment is treated as contingent on the change. The portion of the payment that is treated as contingent on the change is the amount by which the accelerated payment on January 16, 2008 ($200,000) exceeds the present value on January 16, 2008, of the payment that was expected to have been made on January 15, 2009, absent the acceleration, plus an amount reflecting the lapse of the obligation to perform services. At the time of the change, it cannot be reasonably ascertained what the value of the options would have been on January 15, 2009. The acceleration of vesting in the options is treated as significantly increasing the value of the payment. Therefore, the value of such options on January 15, 2009, is deemed to be $200,000, the amount of the accelerated payment. The present value on January 16, 2008, of a $200,000 payment to be made on January 15, 2009, is $183,328.38. Thus, the portion of the payment treated as contingent on the change is $38,671.62, the sum of $16,671.62 ($200,000 ^ $183,328.38), plus an amount reflecting the lapse of the obligation to continue to perform services which is $22,000 (1% × 11 months × $200,000).

Example 7

erated payment. The present value on January 16, 2008, of a $200,000 payment to be made on January 15, 2009, is $183,328.38. Thus, the portion of the payment treated as contingent on the change is $38,671.62, the sum of $16,671.62 ($200,000 ^ $183,328.38), plus an amount reflecting the lapse of the obligation to continue to perform services which is $22,000 (1% × 11 months × $200,000).

Example 7.

Assume the same facts as in Example 5 , except that the option agreement provides that the options will vest either on the corporation's level of profits reaching a specified level, or if earlier, on the date on which there is a change in ownership or control of the corporation. The corporation's level of profits do not reach the specified level prior to January 16, 2008. In such case, the full amount of the payment, $600,000, is treated as contingent on the change because it was not contingent only on performance of services for the corporation for a specified period. See Q/A-39 of this section for rules relating to the reduction of the excess parachute payment by the portion of the payment which is established to be reasonable compensation for personal services actually rendered before the date of a change in ownership or control.

Example 8.

On January 1, 2002, E, a disqualified individual with respect to Corporation X, enters into an employment agreement with Corporation X under which E will be paid wages of $200,000 each year during the 5-year employment agreement. The employment agreement provides that if a change in ownership or control of Corporation X occurs, E will be paid the present value of the remaining salary under the employment agreement. On January 1, 2003, a change in ownership or control of Corporation X occurs, E is terminated, and E receives a payment of the present value of $200,000 for each of the 4 years remaining under the employment agreement

ployment agreement provides that if a change in ownership or control of Corporation X occurs, E will be paid the present value of the remaining salary under the employment agreement. On January 1, 2003, a change in ownership or control of Corpor

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