The 20% Golden Parachute Tax and Who It Applies To.

If your company is being acquired, your tax questions are probably about timing. You want to know when your RSUs get taxed, what happens to your options, and whether any of it lands this year or next. There’s another tax in some deals that has nothing to do with timing. It reaches only a short list of people, and for them it can mean an extra 20% on part of what the deal pays them, on top of regular income tax.

The tax code calls those golden parachute payments, which sounds like a problem for the CEO and maybe the CFO. The list is longer than that. The rules call the people on it disqualified individuals, and in plain terms that means officers, anyone working there who owns more than 1% of the company, and the highest paid 1% of employees, capped at 250 people. Whether you’re on it depends on the 12 months before the deal closes, and your title alone doesn’t settle it.

Here’s how the test works. The rules add up the value of what the deal pays you because of the deal, which can include grants that vest early, a bonus for staying through closing and severance that’s tied to the deal. They compare that total with your base amount, which is your average taxable pay from the company over the five calendar years before the year the deal closes, or over the years you’ve worked there if that’s fewer. Stay under three times your base amount and this tax doesn’t apply. Reach three times, even by a dollar, and the 20% applies to everything above your base amount, not just the part over the line. The company also loses its tax deduction on that same amount, and when the payment runs through payroll, the extra tax is generally withheld right from it.

That’s why the surprise isn’t only for the highest paid person in the room. It can land on people whose deal payments are big next to their history. A recent promotion can do it, because your base still averages in the years before the bigger job. Joining with a big grant can do it too, since your base only counts the years you’ve been there. And pay that comes mostly in stock can push you closer, because RSUs that haven’t vested and options you haven’t exercised haven’t shown up in your taxable pay yet.

Not everything counts in full, either. When a deal speeds up RSUs or options that were vesting on a schedule, the rules usually count only part of their value, based on how much sooner they vest. Pay that’s reasonable for work you’ll do after closing can come out of the count. Details like these can move the answer a long way.

And the time to find out is before closing, while there’s still room to do something about it. Some agreements include a cutback, which trims the payments to just under the line, often only when that leaves you with more after tax. Some have a gross-up instead, where the company pays the tax for you. At a private company, a shareholder vote held before closing can take the payments out of this tax entirely, as long as the vote clears a high bar and you agree ahead of time to give up whatever it doesn’t approve. A public company can’t use this vote.

Many of my clients started as a conversation in the middle of a deal, and this is one of the questions I’d want answered early, next to everything else the deal does to your money. It’s fair to ask the company whether you’re on its list. The math belongs with a CPA or tax attorney who has run these calculations before. What the answer means for your grants, your taxes and the rest of your plan is worth going over with someone who works for you, not the company.

The 20% has been in the tax code for decades. The surprise is meeting it after closing, when far less can be done about it.

This is the fifth letter in a short series on what a deal does to your money. Tuesday is about the deadlines that can come due before your company’s deal closes.

Talk Tuesday.

Mateo

P.S. If your company is in the middle of a deal right now, there’s a deal checklist at bfawealth.com/deals.