Termination and Change-in-Control Payments
The new proxy disclosure rules mandate comprehensive disclosure of the payments that would have to be made to each Named Executive Officer upon a termination of employment.
Preparing these disclosures will require application of some of the most complex calculations contained in the Tax Code, the "golden parachute" rules. The required disclosures include:
- A description of the specific events that would trigger payments or benefits;
- An estimate of the payments that would be made under the various scenarios triggering such payments; and
- Any material conditions or obligations applicable to the receipt of the payments (e.g., restrictive covenants, like non-competes).
Most publicly traded companies maintain severance programs that could trigger parachute excise tax liabilities - even if the severance program is not specifically designed in response to potential change-in-control events.
Many organizations have not run parachute calculations since adoption of their severance programs. Given the complexity of the calculations few will have the tools necessary to perform these required calculations for the upcoming proxy season.
The ProxEASE™ Parachute Modeler is the only internet-based modeler that automates the golden parachute calculation process. Through the use of an interactive questionnaire, the model will assist you in gathering the data necessary to prepare parachute calculations and will run the calculations easily, efficiently, and accurately. In addition, EXEQUITY's experts are available to help you satisfy the proxy disclosure requirements.
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This 280G Webtool is intended to assist you in meeting new proxy disclosure requirements. Specifically, item 402(j) of Regulation S-K requires companies to disclose the payments and benefits that an NEO would be entitled to if the officer terminated employment on the last day of the fiscal year due to, among other things, a severance following a change in control. This model focuses on the severance benefits that an NEO would be entitled to if terminated following a CIC.
If severance benefits in connection with a CIC rise to a specified level, punitive tax implications arise under Internal Revenue Code ("IRC") Sections 280G and 4999. The governing tax rules are extremely complex, and the new proxy rules require disclosure of the potential payments, even if no severance or CIC event is anticipated.
Note: Even though NEOs may not have special CIC agreements, it is necessary to perform parachute calculations due to the broad application of 280G and its treatment of all types of change in control and other severance protections. For example, general severance amounts are still categorized as parachute payments; thus, for example, stock option and restricted stock vesting added to a more modest general severance benefit very often triggers IRC Section 280G excise taxes.
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Background on Internal Revenue Code Section 280G
IRC Section 280G applies to payments that are made due to, or in connection with, a CIC. In general, if payments exceed a safe harbor amount defined by the code, the NEO will be subject to a 20% excise tax. In short, IRC 280G works as follows:
- First, the safe harbor amount is based on the NEO's prior five-year average
taxable income (the "Base Amount"). Specifically, the Safe Harbor is equal to
three times the Base Amount minus $1. In the event that parachute payments
(generally "payments" triggered by the CIC or an event related to a CIC such
as an employment termination) exceed the Safe Harbor, then the 20% excise
tax applicable to the NEO is levied against Excess Parachute Payments.
- In addition, the Company loses a tax deduction on all Excess Parachute
Payments (this is generally not a focus of the model as the proxy rules
require a disclosure of the benefits provided the NEO, not the after-tax cost
of delivering those benefits). Excess Parachute Payments are the parachute
payments in excess of the Base Amount (not payments in excess of the
Safe Harbor). Thus, even if parachute payments exceed the Safe Harbor by
$1, a significant excise tax will be due (i.e., 20% times total parachute
payments minus one times the Base Amount).
- Calculating the amount of parachute payments is highly complex and subject to multiple interpretations. As a result, this Webtool is by necessity complex. However, we have strived to help you navigate through the required calculations in as intuitive and menu-driven a way as possible.
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Companies' Responses to IRC Section 280G
One of the key elements of this model is the impact that IRC Section 280G would have on the payments due following a CIC. For example, some companies opt to gross-up the NEO for the excise tax imposed under Section 280G. This gross-up amount (if any) must be quantified and disclosed as a payment under the proxy rules. On the other hand, some companies choose to cap benefits at the Safe Harbor amount. If benefits are capped at the safe harbor under Section 280G, the NEO may experience a forfeiture of certain benefits. The forfeiture amount (if any) must also be quantified and offset against the severance to which the officer would otherwise be entitled.
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There are many different CIC severance program designs in place, and this parachute modeler will accommodate the various features of about 90%+ of all plan designs currently in place. Due to the flexibility of the model and the complexity of IRC Section 280G, the model itself has some elements that are complex.
However, the complexity is necessary in order to accurately satisfy the SEC requirements that CIC benefits be quantified in the company's annual proxy statement. In this regard, note that the proxy disclosure rules require an accurate accounting of such potential benefits, regardless of the degree of difficulty in quantifying the benefits.
The model identifies the common areas that may require specific assistance from the staff at EXEQUITY. Our staff will be happy to assist you in modifying the model as necessary to accommodate your specific plan design. Further, to the extent the questions in the model are unclear (or to the extent your plan design features are not clear), our staff is available to assist in answering your questions. Finally, if, after having reviewed the questions herein, you conclude that you would rather have our staff complete the model questions based on your plan design, please call us and we would be happy to assist.
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A Few Inescapable Truths about the New Proxy Disclosures
Whether you decide to use the ProxEASE Parachute Modeler on your own, or with our assistance, or through other means, you will be faced with the following issues:
- If your company offers severance coverage, this disclosure will be required;
- The parachute tax rules are complex, and will need to be applied to the potential termination benefits in the great majority of severance calculations;
- Companies’ contractual severance protections are often complicated, and sometimes are provided through parallel and/or inconsistent vehicles;
- Performing the necessary calculations will require substantial data gathering (of pay numbers, outstanding equity award values and designs, employment and severance arrangements, etc.);
- In addition to gathering the data and various governing documents, a significant amount of contractual and statutory interpretation is required. EXEQUITY is a law firm focused on this area of the tax law, and our attorneys include some of the foremost experts on parachute taxation.
You can decide to:
- Use the ProxEASE Parachute Modeler on your own on a self-service
basis (this is the most efficient and economical method, and the model
has been developed to comprehensively support this process);
- Rely primarily upon the ProxEASE Parachute Modeler, but reach to our
staff to help answer some of the more challenging aspects of the
process; or
- Turn the entire process over to our staff (note, though, that we will
still need your assistance in gathering the source information such as
pay data and contractual arrangements).
- Your company's CEO and CFO are required to certify as to the accuracy of the proxy disclosures, including the termination and CIC severance benefits. Accordingly, any inaccuracy is potentially subject to punitive action against your CEO and CFO by the SEC.
As noted above, the model is complex because the tax code itself is complex. So, while your initial reaction after reviewing these questions may be that you would rather turn this entire project over to our staff, we must tell you up front that we will need to answer these exact same questions in order to complete the model (in truth, anyone who assumes the responsibility of quantifying these potential benefits will face the same volume and complexity of work). While this may be accomplished through our reading of significant documentation provided by you, we will need to rely on you to provide us all of the necessary documentation as well as the data inputs necessary to complete the model.
Regardless of who ultimately will assume the task of quantifying the potential benefits, some significant effort will be required on your part. Again, we are extremely flexible in how we can work with you on this project so please call with any questions.
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