Internal Revenue Code Section 280G (280G) (commonly referred to as the golden parachute provision) is intended to discourage the payment of excessive compensation to certain shareholders, officers and highly compensated service providers of companies undergoing a change in control. In general, when transaction-related payments or benefits to a covered individual equal or exceed three times the individual’s average compensation for the previous five years, the individual may be subject to a 20% excise tax, and the company’s deduction for such payments or benefits may be disallowed (in each case, with respect to amounts in excess of the average compensation).
280G commonly applies when a C-corporation undergoes a corporate transaction. However, in certain circumstances, 280G can also apply when the only entity being sold is an LLC. Note: Although this post focuses on the applicability of 280G to LLCs, 280G can also apply to the sale of a partnership in the circumstance described in #2 below.
A sale of an LLC may trigger the application of 280G in two specific circumstances:
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280G could be triggered if the LLC has elected to be taxed as a C-corporation
Section 280G applies to corporations including an LLC that has elected to be taxed as a C-corporation and any transaction-related payments or benefits made in connection with a change in control of the LLC (e.g., a change in ownership, change in effective control, or change in the ownership of a substantial portion of the assets of the LLC) should be reviewed for 280G purposes.
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280G may be triggered if the LLC is owned by a C-corporation and the sale of the LLC represents a sale of a substantial portion of the assets of the corporation
The sale of an LLC that is not taxed as a C-corporation (e.g., an LLC taxed as a partnership) may trigger 280G if the LLC is owned by a C-corporation and the sale of the LLC constitutes a sale of a substantial portion of the corporation’s assets (i.e., the LLC constitutes equal to or more than one-third of the total gross fair market value of all assets of the C-corporation). In this case, whether or not 280G applies to a transaction-based payment depends on whether the recipient is a shareholder, officer and/or a highly compensated service provider to the C-Corporation. It is advisable to consult with a 280G practitioner to determine whether the officers of the LLC are subject to 280G based on their relationship with the C-Corporation.
As noted above, although LLCs (and partnerships) are generally exempt from 280G, there are circumstances in which 280G can apply to a transaction involving the LLC (or partnership). It is important to identify the potential applicability of 280G early in the transaction so that appropriate steps may be taken to avoid the excise tax and loss of deduction (shareholder cleansing vote) before the transaction closes.
