Golden Parachute Payments; Final Rule by bjp11375

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									                        Federal Register / Vol. 68, No. 149 / Monday, August 4, 2003 / Rules and Regulations                                         45745




                                                                                                                   DEPARTMENT OF THE TREASURY
                                                                                                                   Internal Revenue Service

                                                                                                                   26 CFR Parts 1
                                                                                                                   [TD 9083]
                                                                                                                   RIN 1545–AH49

                                                                                                                   Golden Parachute Payments
                                                                                                                   AGENCY: Internal Revenue Service (IRS),
                                                                                                                   Treasury.
                                                                                                                   ACTION: Final regulations.

                                                                                                                   SUMMARY: This document contains final
                                                                                                                   regulations relating to golden parachute
                                                                                                                   payments under section 280G of the
                                                                                                                   Internal Revenue Code. These
                                                                                                                   regulations incorporate changes and
                                                                                                                   clarifications to reflect comments
                                                                                                                   received concerning the proposed
                                                                                                                   regulations primarily concerning the
                                                                                                                   small corporation exemption,
                                                                                                                   prepayment of the excise tax, and the
                                                                                                                   definition of change in ownership or
                                                                                                                   control.
                                                                                                                   DATES: Effective Date: August 4, 2003.
                                                                                                                   These regulations apply to any payment
                                                                                                                   that is contingent on a change in
                                                                                                                   ownership or control if the change in
                                                                                                                   ownership or control occurs on or after
                                                                                                                   January 1, 2004.
                                                                                                                      Comments on the collection of
                                                                                                                   information in § 1.280G–1, Q/A–7(a),
                                                                                                                   should be received by October 3, 2003.
                                                                                                                   ADDRESSES: Comments on the collection
                                                                                                                   of information should be sent to the
                                                                                                                   Office of Management and Budget, Attn:
                                                                                                                   Desk Officer for the Department of the
                                                                                                                   Treasury, Office of Information and
                                                                                                                   Regulatory Affairs, Washington, DC
                                                                                                                   20503, with copies to the Internal
                                                                                                                   Revenue Service, Attn: IRS Reports
                                                                                                                   Clearance Officer, W:CAR:MP:T:T:SP,
                                                                                                                   Washington, DC 20224.
                                                                                                                   FOR FURTHER INFORMATION CONTACT:
                                                                                                                   Concerning the regulations, Erinn
                                                                                                                   Madden at (202) 622–6030 (not a toll-
                                                                                                                   free number).
                                                                                                                   SUPPLEMENTARY INFORMATION:

                                                                                                                   Paperwork Reduction Act
                                                                                                                      The collection of information in this
                                                                                                                   final rule has been reviewed and,
                                                                                                                   pending receipt and evaluation of
                                                                                                                   public comments, approved by the
                                                                                                                   Office of Management and Budget
                                                                                                                   (OMB) under 44 U.S.C. 3507 and
                                                                                                                   assigned control number 1545–1851.


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     45746              Federal Register / Vol. 68, No. 149 / Monday, August 4, 2003 / Rules and Regulations

        The collection of information in this                of any internal revenue law. Generally,               individual) an aggregate present value of
     regulation is in § 1.280G–1, Q/A–7(a).                  tax returns and tax return information                at least 3 times the individual’s base
     This information is a brief description of              are confidential, as required by 26                   amount. Section 280G(b)(2)(B) provides
     all material facts concerning all                       U.S.C. 6103.                                          that the term parachute payment also
     payments which would be parachute                                                                             includes any payment in the nature of
                                                             Background                                            compensation to, or for the benefit of, a
     payments (but for § 1.280G–1, Q/A–6).
     This information may be used by certain                   This document contains amendments                   disqualified individual if the payment is
     corporations with no readily tradeable                  to 26 CFR part 1 under section 280G of                pursuant to an agreement that violates
     stock (assuming certain shareholder                     the Internal Revenue Code (Code).                     any generally enforced securities laws
     approval requirements are also met) to                  Sections 280G and 4999 of the Code                    or regulations (securities violation
     determine if the payments to a                          were added to the Code by section 67                  parachute payment).
     disqualified individual are exempt from                 of the Deficit Reduction Act of 1984,                    Section 280G(b)(1) defines the term
     the definition of parachute payments.                   Public Law 98–369 (98 Stat. 585).                     excess parachute payment as an amount
     The collection of information is                        Section 280G was amended by section                   equal to the excess of any parachute
     voluntary. The likely respondents are                   1804(j) of the Tax Reform Act of 1986,                payment over the portion of the
     business or other for-profit institutions.              Public Law 99–514 (100 Stat. 2807),                   disqualified individual’s base amount
        Comments on the collection of                        section 1018(d) of the Technical and                  that is allocated to such payment. For
     information should be sent to the Office                Miscellaneous Revenue Act of 1988,                    this purpose, the portion of the base
     of Management and Budget, Attn: Desk                    Public Law 100–647 (102 Stat. 3581)                   amount allocated to a parachute
     Officer for the Department of the                       and section 1421 of the Small Business                payment is the amount that bears the
     Treasury, Office of Information and                     Job Protection Act of 1996, Public Law                same ratio to the base amount as the
     Regulatory Affairs, Washington, DC                      104–188 (110 Stat. 1755).                             present value of the parachute payment
     20503, with copies to the Internal                        Section 280G denies a deduction to a                bears to the aggregate present value of
     Revenue Service, Attn: IRS Reports                      corporation for any excess parachute                  all such payments to the same
     Clearance Officer, W:CAR:MP:T:T:SP,                     payment. Section 4999 imposes a 20-                   disqualified individual.
     Washington, DC 20224. Comments on                       percent excise tax on the recipient of                   Generally, excess parachute payments
     the collection of information should be                 any excess parachute payment. Related                 may be reduced by certain amounts of
     received by October 3, 2003. Comments                   provisions include section 275(a)(6),                 reasonable compensation. Section
     are specifically requested concerning:                  which denies the recipient a deduction                280G(b)(4)(B) provides that, except in
        Whether the collection[s] of                         for the section 4999 excise tax, and                  the case of securities violation
     information is necessary for the proper                 section 3121(v)(2)(A), which relates to               parachute payments, the amount of an
     performance of the functions of the                     the Federal Insurance Contributions                   excess parachute payment is reduced by
     Internal Revenue Service, including                     Act.                                                  any portion of the payment that the
     whether the information will have                         On February 20, 2002, a notice of                   taxpayer establishes by clear and
     practical utility;                                      proposed rulemaking (REG–209114–90,                   convincing evidence is reasonable
        The accuracy of the estimated burden                 2002–2 I.R.B. 576), was published in the              compensation for personal services
     associated with the collection of                       Federal Register at 67 FR 7630 (the                   actually rendered by the disqualified
     information (see below);                                2002 proposed regulations) and                        individual before the date of the change
        How the quality, utility, and clarity of             corrected in the Federal Register at 67               in ownership or control. Such
     the information to be collected may be                  FR 42210 on June 21, 2002. No hearing                 reasonable compensation is first offset
     enhanced;                                               was requested or held. The IRS received               against the portion of the base amount
        How the burden of complying with                     written and electronic comments                       allocated to the payment.
     the collection of information may be                    responding to the notice of proposed                  Exempt Payments
     minimized, including through the                        rulemaking. After consideration of the
     application of automated collection                     comments, the 2002 proposed                              Section 280G specifically exempts
     techniques or other forms of information                regulations are adopted as amended by                 from the definition of the term
     technology; and                                         this Treasury decision. The significant               parachute payment several types of
        Estimates of capital or start-up costs               revisions are discussed below.                        payments that would otherwise
     and costs of operation, maintenance,                                                                          constitute parachute payments.
     and purchase of service to provide                      Explanation of Provisions and                         Deductions for payments exempt from
     information.                                            Summary of Comments                                   the definition of parachute payment are
        Estimated total annual reporting and/                Overview                                              not disallowed by section 280G, and
     or recordkeeping burden: 12,000 hours.                                                                        such exempt payments are not subject to
        Estimated average annual burden                         Section 280G(b)(2)(A) defines a                    the 20-percent excise tax of section
     hours per respondent: 15 hours.                         parachute payment as any payment that                 4999. In addition, such exempt
        Estimated number of respondents                      meets all of the following four                       payments are not taken into account in
     and/or recordkeepers: 800                               conditions: (a) The payment is in the                 applying the 3-times-base-amount test of
        Estimated annual frequency of                        nature of compensation; (b) the payment               section 280G(b)(2)(A)(ii).
     responses: On occasion.                                 is to, or for the benefit of, a disqualified
        An agency may not conduct or                         individual; (c) the payment is                        1. Tax-Exempt Entities
     sponsor, and a person is not required to                contingent on a change in the                            Q/A–6 of the 2002 proposed
     respond to, a collection of information                 ownership of a corporation, the effective             regulations provides that a payment
     unless it displays a valid control                      control of a corporation, or the                      with respect to a tax-exempt entity that
     number assigned by the Office of                        ownership of a substantial portion of the             would otherwise constitute a parachute
     Management and Budget.                                  assets of a corporation (a change in                  payment is exempt from the definition
        Books or records relating to a                       ownership or control); and (d) the                    of the term parachute payment if certain
     collection of information must be                       payment has (together with other                      conditions are satisfied. First, the
     retained as long as their contents may                  payments described in (a), (b), and (c) of            payment must be made by a corporation
     become material in the administration                   this paragraph with respect to the same               undergoing a change in ownership or


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                        Federal Register / Vol. 68, No. 149 / Monday, August 4, 2003 / Rules and Regulations                                        45747

     control that is a tax-exempt                            6(a)(1) for any payments to a                         7(b). Thus, for example, because an
     organization. As defined in the 2002                    disqualified individual.                              individual who only holds options
     proposed regulations, a tax-exempt                         In addition, commentators                          generally would not be entitled to vote,
     organization is any organization                        recommended that the final regulations                such individual will not be considered
     described in section 501(c) that is                     provide that a corporation domiciled                  to hold outstanding stock entitled to
     subject to any express statutory                        outside the United States can qualify for             vote for purposes of Q/A–7.
     prohibition against inurement of net                    both the small business corporation                      Q/A–7(b)(2) of the 2002 proposed
     earnings to the benefit of any private                  exception and the shareholder approval                regulations includes a rule of
     shareholder or individual, an                           exception. With respect to the small                  administrative convenience allowing
     organization described in sections                      business corporation exception,                       the corporation to identify shareholders
     501(c)(1) or 501(c)(21), any religious or               Treasury and the IRS do not have the                  eligible to vote for this purpose using
     apostolic organization described in                     authority to expand this exception to                 the shareholders of record at the time of
     section 501(d), or any qualified tuition                include foreign corporations. Section                 any vote taken in connection with a
     program described in section 529.                       280G(b)(5)(A)(i) refers to ‘‘a small                  transaction or event giving rise to the
     Second, the organization must meet the                  business corporation (as defined in                   change in ownership or control within
     definition of tax-exempt organization,                  section 1361(b) but without regard to                 the three-month period ending on the
     as defined in the 2002 proposed                         paragraph (1)(C) thereof).’’ A small                  date of the change in ownership or
     regulations, both immediately before                    business corporation as defined in                    control.
     and immediately after the change in                     section 1361(b) must be a domestic                       Several commentators suggested that
     ownership or control.                                   corporation, and section 1361(b)(1)(C)                the final regulations permit corporations
        One commentator requested the                        merely addresses the existence of a                   to determine the shareholders of record
     elimination of the requirement that the                 nonresident alien as a shareholder. It is             at any time during the three months
     payment must be made by a tax-exempt                    clear from the statute that the small                 prior to the change in ownership or
     organization. Instead, the commentator                  business corporation exception cannot                 control. Other commentators requested
     suggested that the regulations require                  apply to a foreign corporation.                       that the time be expanded in the final
     only that the payment be approved by                       On the other hand, Treasury and the                regulations. In response to these
     the tax-exempt organization. The                        IRS believe that a foreign corporation                comments, these regulations expand
     exemption included in Q/A–6 of the                      may qualify for the shareholder                       this rule to allow corporations to
     2002 proposed regulations for certain                   approval exception, discussed below, if               determine the shareholders of record on
     tax-exempt entities described in section                all of the applicable requirements are                any day during the six-month period
     501(c) is premised on the fact that those               satisfied. Because the statute and                    ending on the date of the change in
     entities are subject to a statutory                     regulations permit this result, it is not             ownership or control, regardless of
     prohibition on private inurement.                       necessary to specify the treatment in the             whether there was a vote on that day.
     Requiring merely the approval of a tax-                 final regulations.                                       Q/A–7(b)(4) is revised to clarify that
     exempt organization would allow                                                                               stock held (directly or indirectly) by a
                                                             3. Shareholder Approval                               disqualified individual who would
     corporations not subject to the
     inurement prohibition to make the                          Additionally, under section 280G and               receive a parachute payment if the
     payments and, thus, to avoid the                        the 2002 proposed regulations, the term               shareholder approval requirements of
     application of section 280G. Thus, these                parachute payment does not include                    Q/A–7 are not met is not entitled to vote
     regulations retain the requirements                     any payment to a disqualified                         with respect to a payment to be made
     contained in the 2002 proposed                          individual with respect to a corporation              to any disqualified individual. For
     regulations.                                            if (i) immediately before the change in               example, assume E is a disqualified
                                                             ownership or control, no stock in such                individual with respect to Corporation
     2. Small Corporation Exemption                          corporation was readily tradeable on an               X. E’s base amount is $100,000, and on
        Under section 280G and the 2002                      established securities market or                      a change in ownership or control of X,
     proposed regulations, the term                          otherwise, and (ii) certain shareholder               E will receive contingent payments of
     parachute payment does not include                      approval requirements are met.                        $295,000. Corporation X undergoes a
     any payment to a disqualified                              Section 280G(b)(5)(B) provides that                change in ownership or control. In
     individual with respect to a corporation                the shareholder approval requirements                 determining the persons who are
     which (immediately before the change                    are met if two conditions are satisfied.              entitled to vote under Q/A–7(b), any
     in ownership or control) was a small                    First, the payment is approved by a vote              stock held by E is considered
     business corporation (as defined in                     of the persons who owned, immediately                 outstanding and E is entitled to vote. If
     section 1361(b) but without regard to                   before the change in ownership or                     E would receive contingent payments of
     section 1361(b)(1)(C) thereof). See also,               control, more than 75 percent of the                  $305,000 on the change in ownership or
     Q/A–6(a)(1).                                            voting power of all outstanding stock of              control, any stock held by E is not
        Commentators indicated that the 2002                 the corporation. Second, there is                     considered outstanding and is not
     proposed regulations do not clearly                     adequate disclosure to shareholders of                entitled to vote under Q/A–7 with
     address whether a corporation that does                 all material facts concerning all                     respect to payments to any disqualified
     not elect to be treated as an S                         payments which (but for this rule)                    individual.
     Corporation, but could make the                         would be parachute payments with                         An entity shareholder is not entitled
     election (because aside from the election               respect to a disqualified individual.                 to vote stock that it holds that is
     the corporation otherwise meets the                        Q/A–7(b) of the 2002 proposed                      constructively owned by a disqualified
     requirements to be treated as an S                      regulations provides rules to determine               person who would receive a parachute
     corporation), may use the exemption                     the shareholders who are entitled to                  payment if the shareholder approval
     under Q/A–6(a)(1). These regulations                    vote. In response to comments, Q/A–                   requirements of Q/A–7 are not met.
     clarify that a corporation that could                   7(b)(1) is revised to clarify that only               Additionally, these regulations provide
     elect to be treated as an S Corporation                 stock that would otherwise be entitled                in Q/A–7(b)(4) that if the person
     under the Code, but does not do so, may                 to vote is considered outstanding and is              authorized to vote the stock of an entity
     nevertheless use the exemption of Q/A–                  entitled to vote for purposes of Q/A–                 shareholder is a disqualified individual


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     45748              Federal Register / Vol. 68, No. 149 / Monday, August 4, 2003 / Rules and Regulations

     who would receive a parachute payment                   Payment of the Excise Tax Under                       coverage or health benefits for this
     if the requirements of Q/A–7 are not                    Section 4999                                          purpose. In the event that valuation
     met, such person is not permitted to                       Q/A–11(c) of the 2002 proposed                     methods change or there is otherwise
     vote any of the shares held by the entity               regulations provided a mechanism to                   greater certainty with respect to the
     shareholder. However, the entity                        allow a disqualified individual to                    valuation of such benefits, Treasury and
     shareholder is permitted to authorize                   prepay the excise tax under section                   the IRS may consider additional
     another equity interest holder in the                   4999 in certain circumstances. Thus, the              guidance that would make prepayment
     entity shareholder to vote the otherwise                requirements of section 4999 may be                   of the excise tax with respect to such
     eligible shares or, in the case of a trust,             satisfied in the year of the change in                benefits available.
     another person eligible to vote on behalf               ownership or control (or the first year               Treatment of Options
     of the trust. Thus, for example, assume                 for which a payment contingent on a                      Q/A–13 of the 2002 proposed
     a partner owns one-third of a                           change in ownership or control is                     regulations provides that the transfer of
     partnership; the partner is authorized to               certain to be made) even though the                   an option is treated as a payment when
     vote on behalf of the partnership; the                  payment is not yet includible in income               the option becomes substantially vested
     partnership owns stock in a corporation;                (or otherwise received).                              without regard to whether the option
     the partner is a disqualified individual                   These regulations continue to allow                has an ascertainable fair market value
     with respect to the corporation; and the                the prepayment of the excise tax in the               under § 1.83–7(b) of the regulations.
     corporation undergoes a change in                       year of the change in ownership or                    Thus, the vesting of an option is treated
     ownership or control. Under these                       control. These regulations also provide               as a payment in the nature of
     circumstances, none of the stock held by                that a taxpayer may prepay the excise                 compensation for purposes of section
     the partnership is entitled to vote under               tax in a later year. For purposes of                  280G. Vested is defined in these
     Q/A–7. However, the partnership is                      prepayment, these regulations require                 regulations as substantially vested
     permitted to appoint an equity interest                 the payor and disqualified individual to              within the meaning of § 1.83–3(b) and (j)
     holder in the entity shareholder (who is                treat the payment of the excise tax                   or the right to the payment is not
     not a disqualified individual who would                 consistently and require the payor to                 otherwise subject to a substantial risk of
     receive parachute payments if the                       satisfy its obligations under section                 forfeiture within the meaning of section
     shareholder approval requirements of                    4999. These regulations clarify that the              83(c).
     Q/A–7 are not met) to vote two-thirds of                prepayment of the excise tax is based on                 The 2002 proposed regulations, and
     the stock.                                              the present value of the excise tax that              the 1989 proposed regulations, provided
                                                             would be due in the year the excess                   that options must be valued under the
        More generally, several commentators
                                                             parachute payment would actually be                   facts and circumstances of a particular
     requested significant revisions to Q/A–
                                                             paid. For purposes of determining the                 case. Factors relevant to the
     7 to reflect certain business practices.                present value of the excise tax due, the
     The revisions suggested by                                                                                    determination include, but are not
                                                             discount rate is determined in                        limited to: The difference between the
     commentators include, among other                       accordance with Q/A–32.                               option’s exercise price and the value of
     things, treating approval of a                             Thus, for example, assume that E is a              the option property, the probability of
     compensation agreement when the                         disqualified individual with respect to               the value of the option property
     agreement is executed as sufficient for                 Corporation X, that X undergoes a                     increasing or decreasing, and the length
     Q/A–7 or deeming shareholders who                       change in ownership or control, and                   of the period during which the option
     acquire stock after approval of any                     that E receives parachute payments,                   can be exercised.
     compensation agreements to consent to                   including a series of annual payments to                 In coordination with the issuance of
     any parachute payments contained in                     be made for the next 10 years. Assume                 the 2002 proposed regulations, the
     these agreements. While the Treasury                    further that all other parachute                      Commissioner issued two revenue
     Department and IRS understand that the                  payments to E are made in the year of                 procedures under section 280G
     requirements of Q/A–7 may not                           the change in ownership or control                    providing additional guidance on the
     coincide with certain business practices,               (with payment of the excise tax and                   valuation of options, Rev. Proc. 2002–
     the requirements of Q/A–7 are based on                  compliance by X with section 4999(c)).                13, 2002–8 I.R.B. 549, and Rev. Proc.
     the statutory framework provided by                     Under these regulations, if three years               2002–45, 2002–27 I.R.B. 40. These
     Congress. The golden parachute                          after a change in ownership or control,               revenue procedures provide guidance
     provisions are intended to protect                      X and E agree that E will prepay the                  on the use of option valuation methods,
     equity shareholders whose interest in                   excise tax related to the remaining                   and provide that using only the spread
     the corporation could be impaired by                    annual payments, and that X will satisfy              between the exercise price and the value
     parachute payments to disqualified                      its obligations under section 4999(c)                 of the option property is not an
     individuals by discouraging these types                 related to these payments, E is                       adequate method for valuing an option.
     of payments. The basic structure of                     permitted to prepay the excise tax with               The revenue procedures also provide a
     section 280G does not permit any                        respect to the remaining payments.                    safe harbor method of valuation based
     approval or shareholder vote for a                         The 2002 proposed regulations                      on a table. Comments received in
     publicly traded corporation. The                        provided that the prepayment of the                   response to these revenue procedures
     exception for corporations that are not                 excise tax would not be available with                raised issues related to the difficulty of
     publicly traded is based on a vote of                   respect to certain payments, including                valuing options in the context of a
     those persons who hold shares                           payments related to health benefits or                change in ownership or control,
     immediately before the change in                        coverage. Commenters requested that                   particularly with respect to assumptions
     ownership or control after adequate                     the prepayment option be expanded to                  regarding the term of the option and the
     disclosure. The suggested revisions to                  include health benefits or coverage.                  volatility. In coordination with the
     the shareholder approval requirements                   Treasury and the IRS do not consider                  issuance of these regulations, the IRS is
     are inconsistent with these requirements                the available valuation methods                       issuing a revenue procedure restating
     and, accordingly, no changes are made                   sufficient to allow projections of                    the previous revenue procedures and
     in these regulations.                                   individual payments related to health                 addressing these comments.


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                        Federal Register / Vol. 68, No. 149 / Monday, August 4, 2003 / Rules and Regulations                                                  45749

     Disqualified Individuals                                services is 1 percent of the present value            regulations explicitly adopt the ‘‘one
       The 2002 proposed regulations                         of the future payment multiplied by the               change’’ rule that historically has been
     provide that an individual is a                         number of full months between the date                applied by the IRS. These regulations
     disqualified individual if, at any time                 that the individual’s right to receive the            provide that if a corporation undergoes
     during the disqualified individual                      payment is vested and the date that,                  a change in ownership or control as
     determination period, the individual is                 absent the acceleration, the payment                  described in either Q/A–27 or Q/A–29,
     an employee or independent contractor                   would have been vested. Under these                   the other corporation involved in the
     of the corporation and is, with respect                 final regulations, the total portion of               transaction does not undergo a change
                                                             such payment treated as contingent on                 in ownership or control.1 As these
     to the corporation, a shareholder (see Q/
                                                             the change in ownership or control                    regulations apply, in any transaction
     A–17), an officer (see Q/A–18), or (3) a
                                                             cannot exceed the present value of the                involving two corporations, if one has a
     highly-compensated individual (see Q/
                                                             accelerated payment.                                  change in ownership or control under
     A–19). The 2002 proposed regulations
                                                                                                                   Q/A–27 or 29, the other corporation
     provide that whether an individual is an                Change in Ownership or Control
                                                                                                                   does not also have a change in
     officer with respect to a corporation is                   A change in ownership or control is                ownership or control, under either Q/A–
     determined based on all the facts and                   defined in Q/A–27, 28, and 29 of the                  27 or 29. Under these regulations, Q/A–
     circumstances in the particular case                    2002 proposed regulations. Under Q/A–                 28, which relates to effective control,
     (such as the source of the individual’s                 27 of the 2002 proposed regulations, a                provides that there is no change in
     authority, the term for which the                       change in control of a corporation                    effective control of a corporation in a
     individual is elected or appointed, and                 occurs on the date that any one person                transaction in which the other
     the nature and extent of the individual’s               (or persons acting as a group) acquires               corporation has a change of control
     duties).                                                ownership or stock of the corporation                 under Q/A–27 or 29.
       These regulations retain this rule                    that, together with stock held by such                   Commentators also requested that the
     concerning officers. However, under Q/                  person or group, has more than 50                     final regulations define gross fair market
     A–18 of these regulations any                           percent of the total fair market value or             value for purposes of Q/A–29. Under Q/
     individual who has the title of officer is              total voting power of the corporation.                A–29 of these regulations, gross fair
     presumed to be an officer unless the                       Under Q/A–28 of the 2002 proposed                  market value is defined as the value of
     facts and circumstances demonstrate                     regulations, a change in the effective                the assets of the corporation, or the
     that the individual does not have the                   control of a corporation is presumed to               value of the assets being disposed of,
     authority of an officer. However, an                    occur on the date that either (1) any one             determined without regard to any
     individual who does not have the title                  person (or more than one person acting                liabilities associated with such assets.
     of officer may nevertheless be                          as a group) acquires (or has acquired                 This definition is used throughout these
     considered an officer if the facts and                  during the 12-month period ending on                  regulations.
     circumstances demonstrate that the                      the date of the most recent acquisition                  For purposes of determining whether
     individual should be considered to be                   by such person or persons) ownership of               there is a change in ownership or
     an officer.                                             stock of the corporation possessing 20                control under Q/A–27 through Q/A–29
     Nonvested Payments Under Q/A–24                         percent or more of the total voting                   of the 2002 proposed regulations, two or
                                                             power of the stock of such corporation,               more persons may be considered as
       Under Q/A–24(c) of the 2002                           or (2) a majority of members of the                   acting as a group. The 2002 proposed
     proposed regulations, only a portion of                 corporation’s board of directors is                   regulations provide that, for purposes of
     certain nonvested payments is treated as                replaced during any 12-month period by                determining whether two or more
     contingent on a change in ownership or                  directors whose appointment or election               persons are acting as a group, a person
     control. Specifically, Q/A–24(c) applies                is not endorsed by a majority of the                  who owns stock in both corporations
     to a payment that becomes vested as a                   members of the corporation’s board of                 involved in a transaction (an
     result of a change in ownership or                      directors prior to the date of the                    overlapping shareholder) is treated as
     control to the extent that (i) without                  appointment or election.                              acting as a group with respect to the
     regard to the change in ownership or                       Under Q/A–29 of the 2002 proposed                  other shareholders in a corporation only
     control, the payment was contingent                     regulations, a change in the ownership                to the extent of such person’s ownership
     only on the continued performance of                    of a substantial portion of a                         of stock in that corporation prior to the
     services for the corporation for a                      corporation’s assets occurs on the date               transaction, and not with respect to his
     specified period of time; and (ii) the                  that any one person (or more than one                 or her ownership in the other
     payment is attributable, at least in part,              person acting as a group) acquires (or                corporation. This rule is consistent with
     to the performance of services before the               has acquired during the 12-month                      the interpretation of the 1989 proposed
     date the payment is made or becomes                     period ending on the date of the most                 regulations by the IRS.
     certain to be made.                                     recent acquisition by such person)                       Commentators suggested different
       These regulations retain these rules                  assets from the corporation that have a               alternatives to the overlapping
     regarding the calculation of the amount                 total gross fair market value equal to or             shareholder rule of Q/A–27 through Q/
     of the payment that is considered                       more than one third of the total gross                A–29 of the 2002 proposed regulations.
     contingent on a change in ownership or                  fair market value of all of the assets of             One commentator suggested eliminating
     control, with one revision. Under the                   the corporation immediately prior to                  the overlapping shareholder rule and
     2002 proposed regulations, the payment                  such acquisition.                                     instead relying on the presumption of
     calculation under Q/A–24(c) could not                      These regulations generally follow the             Q/A–28 for all transactions. Under this
     exceed the amount of the accelerated                    same approach as the 2002 proposed                    approach it would be possible for a
     payment. A portion of a payment is                      regulations. Some commenters                          transaction to result in one, two, or no
     contingent on a change in ownership or                  suggested that these three provisions
     control if there is accelerated vesting,                explicitly address whether more than                     1 Because Q/A–46 provides that all members of an

     even if there is no accelerated payment.                one change in ownership or control can                affiliated group are treated as one corporation, even
                                                                                                                   transactions involving multiple entities generally
     In that case, the amount attributable to                occur in a single transaction. In                     are treated as only two corporations for purposes of
     the lapse of the obligation to perform                  response to these comments, these                     section 280G.



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     45750              Federal Register / Vol. 68, No. 149 / Monday, August 4, 2003 / Rules and Regulations

     change in ownership or control. Other                   effective date of the final regulations.              Adoption of Amendments to the
     commentators suggested replacing the                    Taxpayers are permitted to rely on the                Regulations
     overlapping shareholder rule of the                     1989 proposed regulations with respect
                                                                                                                   s Accordingly, 26 CFR part 1 is amended
     2002 proposed regulations with a new                    to payments contingent on a change in
                                                                                                                   as follows:
     rule based on section 355 or 382.                       ownership or control if that change
     Finally, another commentator requested                  occurs before January 1, 2004. A                      PART 1—INCOME TAX; TAXABLE
     clarification of the application of the                 clarification in the 2002 proposed                    YEARS BEGINNING AFTER
     overlapping shareholder rule of the                     regulations does not support reliance on              DECEMBER 31, 1986
     2002 proposed regulations under the                     the 1989 proposed regulations for a
     1989 proposed regulations.                              position contrary to the provisions of                s Paragraph 1. The authority citation for
        These regulations retain the                         the 1989 proposed regulations.                        part 1 is amended by adding the fol-
     overlapping shareholder rule of the                        Taxpayers are permitted to rely on the             lowing entry in numerical order to read
     2002 proposed regulations. The group                    2002 proposed regulations, including                  in part as follows:
     concepts in section 355 or 382 do not                   for purposes of amended returns with                      Authority: 26 U.S.C. 7805 * * *
     fit well with the overall purpose of                    respect to the following: (1) That a
     section 280G. Finally, these regulations                shareholder who owns stock with a fair                  Section 1.280G–1 also issued under
     are effective with respect to changes in                market value of $1 million is not a                   26 U.S.C. 280G(b) and (e). * * *
     ownership or control that occur after                   disqualified individual and (2) that the              s Par. 2. Section § 1.280G–1 is added to
     January 1, 2004, and to payments that                   base amount includes the amount of                    read as follows:
     are contingent on such changes. These                   compensation included in gross income                 § 1.280G–1    Golden parachute payments.
     regulations do not provide any                          under section 83(b).                                     The following questions and answers
     transitional rules for the application of               Special Analyses                                      relate to the treatment of golden
     the overlapping shareholder rules for                                                                         parachute payments under section 280G
     prior periods both because these                           It has been determined that this notice
                                                             of proposed rulemaking is not a                       of the Internal Revenue Code of 1986, as
     regulations are not effective for prior                                                                       added by section 67 of the Tax Reform
     periods and because the positions set                   significant regulatory action as defined
                                                             in Executive Order 12866. Therefore, a                Act of 1984 (Pub. L. No. 98–369; 98 Stat.
     forth in 2002 proposed regulations are                                                                        585) and amended by section 1804(j) of
     merely clarifications of the positions                  regulatory assessment is not required.
                                                             Section 1.280G–1 of these proposed                    the Tax Reform Act of 1986 (Pub. L. No.
     taken by the IRS under section 280G                                                                           99–514; 100 Stat. 2807), section
     (illustrated by the 1989 proposed                       regulations provides for the collection of
                                                             information. It is hereby certified that              1018(d)(6)–(8) of the Technical and
     regulations).                                                                                                 Miscellaneous Revenue Act of 1988
                                                             the collection of information in these
     International Issues                                    regulations will not have a significant               (Pub. L. No. 100–647; 102 Stat. 3581),
        Commentators recommended that the                    economic impact on a substantial                      and section 1421 of the Small Business
     final regulations provide that a                        number of small entities. This                        Job Protection Act of 1996 (Pub. L. No.
     disqualified individual who, during the                 certification is based on the fact that, as           104–188; 110 Stat. 1755). The following
     disqualified individual determination                   indicated in the Paperwork Reduction                  is a table of subjects covered in this
     period, was a nonresident alien and was                 Act section earlier in the preamble, only             section:
     not subject to income tax in the United                 800 small entities are expected to be
                                                                                                                   Overview
     States on wages earned from the                         affected by the regulations annually,
                                                             and it is unlikely that any small entity              Effect of section 280G—Q/A–1
     affiliated group, not be subject to the                                                                       Meaning of ‘‘parachute payment’’—Q/A–2
     excise tax. Treasury and the IRS do not                 would be affected by these regulations
                                                                                                                   Meaning of ‘‘excess parachute payment’’—Q/
     believe that they have the authority to                 more than once or twice in its existence.               A–3
     preclude application of the excise tax to               Therefore, an analysis under the                      Effective date of section 280G—Q/A–4
     a nonresident alien under these                         Regulatory Flexibility Act (5 U.S.C.
                                                             chapter 6) is not required. Pursuant to               Exempt Payments
     circumstances. Accordingly, the final
     regulations do not include any special                  section 7805(f) of the Code, the notice               Exempt payments generally—Q/A–5
                                                             of proposed rulemaking preceding these                Exempt payments with respect to certain
     rules for excess parachute payments                                                                             corporations—Q/A–6
     received by nonresident aliens.                         regulations was submitted to the Small
                                                                                                                   Shareholder approval requirements—Q/A–7
        Commentators also requested                          Business Administration for comment                   Exempt payments under a qualified plan—Q/
     clarification that, even though parachute               on its impact on small business.                        A–8
     payments made by a foreign subsidiary                   Drafting Information                                  Exempt payments of reasonable
     of a U.S. corporation may not be                                                                                compensation—Q/A–9
     deductible, such payments reduce the                      The principal author of these                       Payor of Parachute Payments—Q/A–10
     foreign subsidiary’s earnings and                       regulations is Erinn Madden, Office of
                                                             the Division Counsel/Associate Chief                  Payments in the Nature of Compensation
     profits. Because this issue has
                                                             Counsel (Tax Exempt and Government                    The nature of compensation—Q/A–11
     implications beyond section 280G and                                                                          Property transfers—Q/A–12
     foreign subsidiaries, it is not addressed               Entities). However, other personnel
                                                             from the IRS and Treasury Department                  Stock options—Q/A–13
     in these regulations.                                                                                         Reduction of amount of payment by
                                                             participated in their development.                      consideration paid—Q/A–14
     Effective Date and Reliance
                                                             List of Subjects                                      Disqualified Individuals
       These regulations apply to any
     payments that are contingent on a                       26 CFR Part 1                                         Meaning of ‘‘disqualified individual’’—Q/A–
     change in ownership or control if the                                                                           15
                                                               Income taxes, Reporting and                         Personal service corporation treated as
     change of ownership or control occurs                   recordkeeping requirements.                             individual—Q/A–16
     on or after January 1, 2004.                                                                                  Meaning of ‘‘shareholder’’—Q/A–17
       Under the 2002 proposed regulations,                  26 CFR Part 602
                                                                                                                   Meaning of ‘‘officer’’—Q/A–18
     taxpayers are permitted to rely on the                    Reporting and recordkeeping                         Meaning of ‘‘highly-compensated
     2002 proposed regulations until the                     requirements.                                           individual’’—Q/A–19



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     Meaning of ‘‘disqualified individual                    contingent on the disallowance of a                   discussion of the nonreduction of a
      determination period’’—Q/A–20                          deduction under section 280G, a payee                 securities violation parachute payment
     Meaning of ‘‘compensation’’—Q/A–21                      may be subject to the 20-percent excise               by reasonable compensation, see Q/A–
     Contingent on Change in Ownership or                    tax under section 4999 even though the                37. For a discussion of the computation
     Control                                                 disallowance of the deduction for the                 of excess parachute payments and their
     General rules for determining payments                  excess parachute payment may not                      reduction by reasonable compensation,
       contingent on change—Q/A–22                           directly affect the federal taxable                   see Q/A–38 through Q/A–44.
     Payments under agreement entered into after             income of the payor.                                    Q–4: What is the effective date of
       change—Q/A–23                                            Q–2: What is a parachute payment for               section 280G and this section?
     Amount of payment contingent on change—                 purposes of section 280G?                               A–4: In general, section 280G applies
       Q/A–24                                                   A–2: (a) The term parachute payment                to payments under agreements entered
     Presumption that payment is contingent on               means any payment (other than an                      into or renewed after June 14, 1984.
       change—Q/A–25, 26
                                                             exempt payment described in Q/A–5)                    Section 280G also applies to certain
     Change in ownership or control—Q/A–27,
       28, 29                                                that—                                                 payments under agreements entered
                                                                (1) Is in the nature of compensation;              into on or before June 14, 1984, and
     Three-Times-Base-Amount Test for                           (2) Is made or is to be made to (or for            amended or supplemented in significant
     Parachute Payments                                      the benefit of) a disqualified individual;            relevant respect after that date. This
     Three-times-base-amount test—Q/A–30                        (3) Is contingent on a change—                     section applies to any payment that is
     Determination of present value—Q/A–31, 32,                 (i) In the ownership of a corporation;             contingent on a change in ownership or
       33                                                       (ii) In the effective control of a                 control and the change in ownership or
     Meaning of ‘‘base amount’’—Q/A–34                       corporation; or                                       control occurs on or after January 1,
     Meaning of ‘‘base period’’—Q/A–35                          (iii) In the ownership of a substantial
     Special rule for determining base amount—                                                                     2004. For a discussion of the application
                                                             portion of the assets of a corporation;               of the effective date, see Q/A–47 and
       Q/A–36                                                and
     Securities Violation Parachute Payments—Q/                                                                    Q/A–48.
                                                                (4) Has (together with other payments
       A–37
                                                             described in paragraphs (a)(1), (2), and              Exempt Payments
     Computation and Reduction of Excess                     (3) of this A–2 with respect to the same                Q–5: Are some types of payments
     Parachute Payments                                      disqualified individual) an aggregate                 exempt from the definition of the term
     Computation of excess parachute payments—               present value of at least 3 times the                 parachute payment?
       Q/A–38                                                individual’s base amount.                               A–5: (a) Yes, the following five types
     Reduction by reasonable compensation—Q/                    (b) Hereinafter, a change referred to in           of payments are exempt from the
       A–39                                                  paragraph (a)(3) of this A–2 is generally             definition of parachute payment—
     Determination of Reasonable Compensation                referred to as a change in ownership or                  (1) Payments with respect to a small
     General criteria for determining reasonable             control. For a discussion of the                      business corporation (described in Q/A–
       compensation—Q/A–40                                   application of paragraph (a)(1), see                  6 of this section);
     Types of payments generally considered                  Q/A–11 through Q/A–14; paragraph                         (2) Certain payments with respect to
       reasonable compensation—Q/A–41, 42, 43                (a)(2), Q/A–15 through Q/A–21;                        a corporation no stock in which is
     Treatment of severance payments—Q/A–44                  paragraph (a)(3), Q/A–22 through Q/A–                 readily tradeable on an established
     Miscellaneous Rules                                     29; and paragraph (a)(4), Q/A–30                      securities market (or otherwise)
                                                             through                                               (described in Q/A–6 of this section);
     Definition of corporation—Q/A–45
                                                             Q/A–36.                                                  (3) Payments to or from a qualified
     Treatment of affiliated group as one
       corporation—Q/A–46
                                                                (c) The term parachute payment also                plan (described in Q/A–8 of this
                                                             includes any payment in the nature of                 section);
     Effective Date                                          compensation to (or for the benefit of)                  (4) Certain payments made by a
     General effective date of section 280G—Q/A–             a disqualified individual that is                     corporation undergoing a change in
       47                                                    pursuant to an agreement that violates a              ownership or control that is described
     Effective date of regulations—Q/A–48                    generally enforced securities law or                  in any of the following sections of the
                                                             regulation. This type of parachute                    Internal Revenue Code: section 501(c)
     Overview                                                payment is referred to in this section as             (but only if such organization is subject
       Q–1: What is the effect of Internal                   a securities violation parachute                      to an express statutory prohibition
     Revenue Code section 280G?                              payment. See Q/A–37 for the definition                against inurement of net earnings to the
       A–1: (a) Section 280G disallows a                     and treatment of securities violation                 benefit of any private shareholder or
     deduction for any excess parachute                      parachute payments.                                   individual, or if the organization is
     payment paid or accrued. For rules                         Q–3: What is an excess parachute                   described in section 501(c)(1) or section
     relating to the imposition of a                         payment for purposes of section 280G?                 501(c)(21)), section 501(d), or section
     nondeductible 20-percent excise tax on                     A–3: The term excess parachute                     529, collectively referred to as tax-
     the recipient of any excess parachute                   payment means an amount equal to the                  exempt organizations (described in
     payment, see Internal Revenue Code                      excess of any parachute payment over                  Q/A–6 of this section); and
     sections 4999, 275(a)(6), and                           the portion of the base amount allocated                 (5) Certain payments of reasonable
     3121(v)(2)(A).                                          to such payment. Subject to certain                   compensation for services to be
       (b) The disallowance of a deduction                   exceptions and limitations, an excess                 rendered on or after the change in
     under section 280G is not contingent on                 parachute payment is reduced by any                   ownership or control (described in
     the imposition of the excise tax under                  portion of the payment which the                      Q/A–9 of this section).
     section 4999. The imposition of the                     taxpayer establishes by clear and                        (b) Deductions for payments exempt
     excise tax under section 4999 is not                    convincing evidence is reasonable                     from the definition of parachute
     contingent on the disallowance of a                     compensation for personal services                    payment are not disallowed by section
     deduction under section 280G. Thus, for                 actually rendered by the disqualified                 280G, and such exempt payments are
     example, because the imposition of the                  individual before the date of the change              not subject to the 20-percent excise tax
     excise tax under section 4999 is not                    in ownership or control. For a                        of section 4999. In addition, such


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     exempt payments are not taken into                      corporation under A–46 of this section),              benefit of any private shareholder or
     account in applying the 3-times-base-                   the requirements of paragraph (a)(2)(i) of            individual. A transfers substantially all of its
     amount test of Q/A–30 of this section.                  this A–6 are not met if any stock in any              assets to another corporation resulting in a
        Q–6: Which payments with respect to                                                                        change in ownership or control. Contingent
                                                             member of such group is readily                       on the change in ownership or control, A
     a corporation referred to in paragraph                  tradeable on an established securities                makes a payment that, but for the potential
     (a)(1), (a)(2), or (a)(4) of Q/A–5 of this              market or otherwise.                                  application of the exemption described in A–
     section are exempt from the definition                     (d) For purposes of paragraph (a)(2)(i)            5(a)(4), would constitute a parachute
     of parachute payment?                                   of this A–6, the term stock does not                  payment. However, one or more aspects of
        A–6: (a) The term parachute payment                  include stock described in section                    the transaction that constitutes the change in
     does not include—                                       1504(a)(4) if the payment does not                    ownership or control causes A to fail to be
        (1) Any payment to a disqualified                    adversely affect the redemption and                   described in section 501(c)(3). Accordingly,
     individual with respect to a corporation                                                                      A fails to meet the definition of a tax-exempt
                                                             liquidation rights of any shareholder                 organization both immediately before and
     which (immediately before the change                    owning such stock.                                    immediately after the change in ownership or
     in ownership or control) would qualify                     (e) For purposes of paragraph (a)(2)(i)            control, as required by this A–6. As a result,
     as a small business corporation (as                     of this A–6, stock is treated as readily              the payment made by A that was contingent
     defined in section 1361(b) but without                  tradeable if it is regularly quoted by                on the change in ownership or control is not
     regard to section 1361(b)(1)(C) thereof),               brokers or dealers making a market in                 exempt from the definition of parachute
     without regard to whether the                           such stock.                                           payment under this A–6.
     corporation had an election to be treated                  (f) For purposes of paragraph (a)(2)(i)              Example 5. B is a corporation described in
     as a corporation under section 1361 in                  of this A–6, the term established                     section 501(c)(15). B does not meet the
     effect on the date of the change in                                                                           definition of a tax-exempt organization
                                                             securities market means an established                because section 501(c)(15) does not expressly
     ownership or control;                                   securities market as defined in § 1.897–              prohibit inurement of B’s net earnings to the
        (2) Any payment to a disqualified                    1(m).                                                 benefit of any private shareholder or
     individual with respect to a corporation                   (g) The following examples illustrate              individual. Accordingly, if B has a change in
     (other than a small business corporation                the application of this exemption:                    ownership or control and makes a payment
     described in paragraph (a)(1) of this                      Example 1. A small business corporation            that would otherwise meet the definition of
     A–6) if—                                                (within the meaning of paragraph (a)(1) of            a parachute payment, such payment is not
        (i) Immediately before the change in                 this A–6) operates two businesses. The                exempt from the definition of the term
     ownership or control, no stock in such                  corporation sells the assets of one of its            parachute payment for purposes of this
     corporation was readily tradeable on an                 businesses, and these assets represent a              A–6.
     established securities market or                        substantial portion of the assets of the                 Q–7: How are the shareholder
     otherwise; and                                          corporation. Because of the sale, the                 approval requirements referred to in
        (ii) The shareholder approval                        corporation terminates its employment                 paragraph (a)(2)(ii) of Q/A–6 of this
     requirements described in Q/A–7 of this                 relationship with persons employed in the
                                                                                                                   section met?
                                                             business the assets of which are sold. Several
     section are met with respect to such                                                                             A–7: (a) General rule. The shareholder
                                                             of these employees are highly-compensated
     payment; or                                             individuals to whom the owners of the                 approval requirements referred to in
        (3) Any payment to a disqualified                    corporation make severance payments in                paragraph (a)(2)(ii) of Q/A–6 of this
     individual made by a corporation which                  excess of 3 times each employee’s base                section are met with respect to any
     is a tax-exempt organization (as defined                amount. Since the corporation is a small              payment if—
     in paragraph (a)(4) of Q/A–5 of this                    business corporation immediately before the              (1) Such payment is approved by
     section), but only if the corporation                   change in ownership or control, the                   more than 75 percent of the voting
     meets the definition of a tax-exempt                    payments are not parachute payments.                  power of all outstanding stock of the
     organization both immediately before                       Example 2. Assume the same facts as in             corporation entitled to vote (as
     and immediately after the change in                     Example 1, except that the corporation is not         described in this A–7) immediately
                                                             a small business corporation within the
     ownership or control.                                   meaning of paragraph (a)(1) of this A–6. If no
                                                                                                                   before the change in ownership or
        (b) For purposes of paragraph (a)(1) of              stock in the corporation is readily tradeable         control; and
     this A–6, the members of an affiliated                  on an established securities market (or                  (2) Before the vote, there was
     group are not treated as one corporation.               otherwise) immediately before the change in           adequate disclosure to all persons
        (c) The requirements of paragraph                    ownership or control and the shareholder              entitled to vote (as described in this A–
     (a)(2)(i) of this A–6 are not met with                  approval requirements described in Q/A–7 of           7) of all material facts concerning all
     respect to a corporation if a substantial               this section are met, the payments are not            material payments which (but for Q/A–
     portion of the assets of any entity                     parachute payments.                                   6 of this section) would be parachute
     consists (directly or indirectly) of stock                 Example 3. Stock of Corporation S is               payments with respect to a disqualified
     in such corporation and any ownership                   owned by Corporation P, stock in which is             individual.
     interest in such entity is readily                      readily tradeable on an established securities           (b) Voting requirements—(1) General
                                                             market. The Corporation S stock equals or
     tradeable on an established securities                  exceeds one third of the total gross fair
                                                                                                                   rule. The vote described in paragraph
     market or otherwise. For this purpose,                  market value of the assets of Corporation P,          (a)(1) of this A–7 must determine the
     such stock constitutes a substantial                    and thus, represents a substantial portion of         right of the disqualified individual to
     portion of the assets of an entity if the               the assets of Corporation P. Corporation S            receive the payment, or, in the case of
     total fair market value of the stock is                 makes severance payments to several of its            a payment made before the vote, the
     equal to or exceeds one third of the total              highly-compensated individuals that are               right of the disqualified individual to
     gross fair market value of all of the                   parachute payments under section 280G and             retain the payment. Except as otherwise
     assets of the entity. For this purpose,                 Q/A–2 of this section. Because stock in               provided in this A–7, the normal voting
     gross fair market value means the value                 Corporation P is readily tradeable on an              rules of the corporation are applicable.
                                                             established securities market, the payments
     of the assets of the entity, determined                 are not exempt from the definition of
                                                                                                                   Thus, for example, an optionholder is
     without regard to any liabilities                       parachute payments under this A–6.                    generally not permitted to vote for
     associated with such assets. If a                          Example 4. A is a corporation described in         purposes of this A–7. For purposes of
     corporation is a member of an affiliated                section 501(c)(3), and accordingly, its net           this A–7, the vote can be on less than
     group (which group is treated as one                    earnings are prohibited from inuring to the           the full amount of the payment(s) to be


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                        Federal Register / Vol. 68, No. 149 / Monday, August 4, 2003 / Rules and Regulations                                              45753

     made. Shareholder approval can be a                     total fair market value of the stock held             include, but are not limited to, the event
     single vote on all payments to any one                  by the entity shareholder in the                      triggering the payment or payments, the
     disqualified individual, or on all                      corporation undergoing the change in                  total amount of the payments that
     payments to more than one disqualified                  ownership or control is equal to or                   would be parachute payments if the
     individual. The total payment(s)                        exceeds one third of the total gross fair             shareholder approval requirements
     submitted for shareholder approval,                     market value of all of the assets of the              described in paragraph (a) of this A–7
     however, must be separately approved                    entity shareholder. For this purpose,                 are not met, and a brief description of
     by the shareholders. The requirements                   gross fair market value means the value               each payment (e.g., accelerated vesting
     of this paragraph (b)(1) are not satisfied              of the assets of the entity, determined               of options, bonus, or salary). An omitted
     if approval of the change in ownership                  without regard to any liabilities                     fact is considered a material fact if there
     or control is contingent, or otherwise                  associated with such assets.                          is a substantial likelihood that a
     conditioned, on the approval of any                        (4) Disqualified individuals and                   reasonable shareholder would consider
     payment to a disqualified individual                    attribution of stock ownership. In                    it important.
     that would be a parachute payment but                   determining the persons entitled to vote                 (d) Corporation without shareholders.
     for Q/A–6 of this section.                              referred to in paragraph (a)(1) or (b)(3)             If a corporation does not have
        (2) Special rule. A vote to approve the              of this A–7, stock that would otherwise               shareholders, the exemption described
     payment does not fail to be a vote of the               be entitled to vote is not counted as                 in Q/A–6(a)(2) of this section and the
     outstanding stock of the corporation                    outstanding stock and is not considered               shareholder approval requirements
     entitled to vote immediately before the                 in determining whether the more than                  described in this A–7 do not apply.
     change in ownership or control merely                   75 percent vote has been obtained under               Solely for purposes of this paragraph
     because the determination of the                        this A–7 if the stock is actually owned               (d), a shareholder does not include a
     shareholders entitled to vote on the                    or constructively owned under section                 member in an association, joint stock
     payment is based on the shareholders of                 318(a) by or for a disqualified individual            company, or insurance company.
     record as of any day within the six-                    who receives (or is to receive) payments                 (e) Examples. The following examples
     month period immediately prior to and                   that would be parachute payments if the               illustrate the application of this A–7:
     ending on date of the change in                         shareholder approval requirements
                                                                                                                      Example 1. Corporation S has two
     ownership or control, provided the                      described in paragraph (a) of this A–7                shareholders—Corporation P, which owns 76
     disclosure requirements described in                    are not met. Likewise, stock is not                   percent of the stock of Corporation S, and A,
     paragraph (c) of this A–7 are met.                      counted as outstanding stock if the                   a disqualified individual who would receive
        (3) Entity shareholder. (i) Approval of              owner is considered under section                     a parachute payment if the shareholder
     a payment by any shareholder that is                    318(a) to own any part of the stock                   approval requirements of this A–7 are not
     not an individual (an entity                            owned directly or indirectly by or for a              met. No stock of Corporation P or S is readily
     shareholder) generally must be made by                  disqualified individual described in the              tradeable on an established securities market
     the person authorized by the entity                     preceding sentence. In addition, if the               (or otherwise). The value of the stock of
     shareholder to approve the payment.                                                                           Corporation S equals or exceeds one third of
                                                             person authorized to vote the stock of an             the gross fair market value of the assets of
     See paragraph (b)(4) of this A–7 if the                 entity shareholder is a disqualified                  Corporation P, and thus, represents a
     person so authorized by the entity                      individual who would receive a                        substantial portion of the assets of
     shareholder is a disqualified individual                parachute payment if the shareholder                  Corporation P. All of the stock of Corporation
     who would receive a parachute payment                   approval requirements described in this               S is sold to Corporation M. Contingent on the
     if the shareholder approval                             A–7 are not met, such person is not                   change in ownership of Corporation S,
     requirements of this A–7 are not met.                   permitted to vote such shares, but the                severance payments are made to certain
        (ii) However, if a substantial portion               entity shareholder is permitted to                    officers of Corporation S in excess of 3 times
     of the assets of an entity shareholder                  appoint an equity interest holder in the              each officer’s base amount. If the payments
     consists (directly or indirectly) of stock                                                                    are approved by a separate vote of the
                                                             entity shareholder, or in the case of a               persons who hold, immediately before the
     in the corporation undergoing the                       trust another person eligible to vote on              sale, more than 75 percent of the voting
     change in ownership or control,                         behalf of the trust, to vote the otherwise            power of the outstanding stock entitled to
     approval of the payment by that entity                  eligible shares. However, if all persons              vote of Corporation P and the disclosure
     shareholder must be made by a separate                  who hold voting power in the                          rules of paragraph (a)(2) of this A–7 are
     vote of the persons who hold,                           corporation undergoing the change in                  complied with, the shareholder approval
     immediately before the change in                        ownership or control are disqualified                 requirements of this A–7 are met, and the
     ownership or control, more than 75                      individuals or related persons described              payments are exempt from the definition of
     percent of the voting power of the entity               in this paragraph (b)(4), then such stock             parachute payment pursuant to A–6 of this
     shareholder entitled to vote. The                                                                             section.
                                                             is counted as outstanding stock and
     preceding sentence does not apply if the                                                                         Example 2. (i) Stock of Corporation X,
                                                             votes by such persons are considered in               none of which is traded on an established
     value of the stock of the corporation                   determining whether the more than 75                  market, is acquired by Corporation Y. In the
     owned, directly or indirectly, by or for                percent vote has been obtained.                       voting ballot concerning the sale, the
     the entity shareholder does not exceed                     (c) Adequate disclosure. To be                     Corporation X shareholders are asked to vote
     1 percent of the total value of the                     adequate disclosure for purposes of                   either ‘‘yes’’ on the sale and ‘‘yes’’ to paying
     outstanding stock of the corporation                    paragraph (a)(2) of this A–7, disclosure              parachute payments to A, a disqualified
     undergoing a change in ownership or                     must be full and truthful disclosure of               individual with respect to Corporation A, or
     control. Where approval of a payment                    the material facts and such additional                ‘‘no’’ on the sale and ‘‘no’’ to paying
     by an entity shareholder must be made                   information as is necessary to make the               parachute payments to A.
     by a separate vote of the owners of the                 disclosure not materially misleading at                  (ii) Because the approval of the change in
     entity shareholder, the normal voting                                                                         ownership or control is conditioned on the
                                                             the time the disclosure is made.
                                                                                                                   approval of the payments to A, the
     rights of the entity shareholder                        Disclosure of such information must be                shareholder approval requirements of this A–
     determine which owners shall vote. For                  made to every shareholder of the                      7 are not satisfied. If the payments are made
     purposes of this (b)(3)(ii), stock                      corporation entitled to vote under this               to A, the payments are not exempt from the
     represents a substantial portion of the                 A–7. For each disqualified individual,                definition of parachute payment pursuant to
     assets of an entity shareholder if the                  material facts that must be disclosed                 Q/A–6 of this section.



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       (iii) Assume the same facts as in                        Example 6. Assume the same facts as in             to be made to each individual and states that
     paragraph (i) of this Example 2, except                 Example 4 except that disclosure of all the           if the payment is not approved the payment
     that the acquisition agreement between                  material facts (within the meaning of                 will not be made. Adequate disclosure,
                                                             paragraph (a)(2) of this A–7) regarding the           within the meaning of this A–7 is made to
     Corporation X and Corporation Y states
                                                             payments to X and Y is made to two of                 each shareholder entitled to vote under this
     that the acquisition is approved only if                Corporation A’s shareholders, who                     A–7. More than 75 percent of the Corporation
     there are no parachute payments made                    collectively own 80 percent of Corporation            E shareholders who are entitled to vote under
     to A. If the shareholder approval and the               A’s stock entitled to vote and approve the            paragraph (a)(1) of this A–7 approve each
     disclosure requirements described in                    payment. Both shareholders approve the                payment to each individual. The shareholder
     this A–7 are met, the payments will not                 payments. Assume further that no adequate             approval requirements of this A–7 are met,
     be parachute payments. Alternatively, if                disclosure of the material facts regarding the        and the payments are exempt from the
     the shareholders do not approve the                     payments to X and Y is made to other                  definition of parachute payment pursuant to
                                                             Corporation A shareholders who are entitled           A–6 of this section.
     payments, the payments cannot be made
                                                             to vote within the meaning of this A–7.                  Example 9. Assume the same facts as in
     (or retained). Thus, the transaction is                 Notwithstanding that 80 percent of the                Example 8 except that the ballot does not
     not conditioned on the approval of the                  shareholders entitled to vote approve the             request approval of each total payment to
     parachute payments. If the payments are                 payments, because disclosure regarding the            each individual separately. Instead, the ballot
     made and the requirements of this A–7                   payments to X and Y is not made to all of             states that $2,000,000 in payments will be
     are met, the payments are exempt from                   Corporation A’s shareholders who were                 made to X, Y, and Z and requests approval
     the definition of parachute payment                     entitled to vote, the disclosure requirements         of the $2,000,000 payments. Assuming the
     pursuant to Q/A–6 of this section.                      of paragraph (a)(2) of this A–7 are not met,          triggering event and amount of the payments
        Example 3. Corporation M is wholly                   and the payments are not exempt from the              to X, Y, and Z are separately described to the
     owned by Partnership P. No interest in either           definition of parachute payment pursuant to           shareholders entitled to vote under this A–
     M or P is readily tradeable on an established           Q/A–6.                                                7, the shareholder approval requirements of
     securities market (or otherwise). The value of             Example 7. Corporation C has three                 paragraph (a)(1) of this A–7 are met, and the
     the stock of Corporation M equals or exceeds            shareholders—Partnership, which owns 20               payments are exempt from the definition of
     one third of the gross fair market value of the         percent of the stock of Corporation C; A, an          parachute payment pursuant to A–6 of this
     assets of Partnership P, and thus, represents           individual who owns 60 percent of the stock           section.
     a substantial portion of the assets of                  of Corporation C; and B, an individual who               Example 10. B, an employee of Corporation
     Partnership P. Corporation M undergoes a                owns 20 percent of Corporation C. Stock of            X, is a disqualified individual with respect to
     change in ownership or control. Partnership             Corporation C does not represent a                    Corporation X. Stock of Corporation X is not
     P has one general partner and 200 limited               substantial portion of the assets of                  readily tradeable on an established securities
     partners. The general partner is not a                  Partnership. No interest in either Partnership        market (or otherwise). Corporation X
     disqualified individual. None of the limited            or Corporation C is readily tradeable on an           undergoes a change in ownership or control.
     partners are entitled to vote on issues                 established securities market (or otherwise).         B’s base amount is $205,000. Under B’s
     involving the management of the partnership             P, a one-third partner in Partnership, is a           employment agreement with Corporation X,
     investments. If the payments that would be              disqualified individual with respect to               in the event of a change in ownership or
     parachute payments if the shareholder                   Corporation C. Corporation C undergoes a              control, B’s stock options will vest and B will
     approval requirements of this A–7 are not               change in ownership or control. Contingent            receive severance and bonus payments.
     met are approved by the general partner and             on the change, a severance payment is                 Contingent on the change in ownership or
     the disclosure rules of paragraph (a)(2) of this        payable to P in excess of 3 times P’s base            control, B’s stock options with a fair market
     A–7 are complied with, the shareholder                  amount. To determine the persons who are              value of $500,000 immediately vest, $200,000
     approval requirements of this A–7 are met,              entitled to vote referred to in paragraph (a)(1)      of which is contingent on the change, and B
     and the payments are exempt from the                    of this A–7, one-third of the stock held by           will receive a $200,000 bonus payment and
     definition of parachute payment pursuant to             Partnership is not considered outstanding             a $400,000 severance payment. Corporation
     A–6 of this section.                                    stock. If P is the person authorized by               X distributes a ballot to every shareholder of
        Example 4. Corporation A has several                 Partnership to approve the payment, none of           Corporation X who immediately before the
     shareholders including X and Y, who are                 the shares of Partnership are considered              change is entitled to vote as described in this
     disqualified individuals with respect to                outstanding stock. However, Partnership is            A–7. The ballot contains adequate disclosure
     Corporation A and would receive parachute               permitted to appoint an equity interest               of all material facts and lists the following
     payments if the shareholder approval                    holder in Partnership (who is not a                   payments to be made to B: The contingent
     requirements of this A–7 are not met. No                disqualified individual who would receive a           payment of $200,000 attributable to options,
     stock of Corporation A is readily tradeable on          parachute payment if the requirements of this         a $200,000 bonus payment, and a $400,000
     an established securities market (or                    A–7 are not met), to vote the two-thirds of           severance payment. The ballot requests
     otherwise). Corporation A undergoes a                   the shares held by Partnership that are               shareholder approval of the $200,000 bonus
     change in ownership or control. Contingent              otherwise entitled to be voted.                       payment to B and states that whether or not
     on the change in ownership or control,                     Example 8. X, Y, and Z are all employees           the $200,000 bonus payment is approved, B
     severance payments are payable to X and Y               and disqualified individuals with respect to          will receive $200,000 attributable to options
     that are in excess of 3 times each individual’s         Corporation E. No stock in Corporation E is           and a $400,000 severance payment. More
     base amount. To determine whether the                   readily tradeable on an established securities        than 75 percent of the shareholders entitled
     shareholder approval requirements of                    market (or otherwise). Each individual has a          to vote as described by this A–7 approve the
     paragraph (a)(1) of this A–7 are satisfied              base amount of $100,000. Corporation E                $200,000 bonus payment to B. The
     regarding the payments to X and Y, the stock            undergoes a change in ownership or control.           shareholder approval requirements of this A–
     of X and Y is not considered outstanding,               Contingent on the change, a severance                 7 are met, and the $200,000 payment is
     and X and Y are not entitled to vote.                   payment of $400,000 is payable to X;                  exempt from the definition of parachute
        Example 5. Assume the same facts as in               $600,000 is payable to Y; and $1,000,000 is           payment pursuant to A–6 of this section.
     Example 4, except that after adequate                   payable to Z. Corporation E provides each                Q–8: Which payments under a
     disclosure of all material facts (within the            Corporation E shareholder entitled to vote (as        qualified plan are exempt from the
     meaning of paragraph (a)(2) of this A–7) to             determined under this A–7) with a ballot
     all shareholders entitled to vote, 60 percent           listing and describing the payments of
                                                                                                                   definition of parachute payment?
     of the shareholders who are entitled to vote            $400,000 to X; $600,000 to Y; and $1,000,000
                                                                                                                      A–8: The term parachute payment
     approve the payments to X and Y. Because                to Z and the triggering event that generated          does not include any payment to or
     more than 75 percent of the shareholders                the payments. Next to each name and                   from—
     holding outstanding stock who were entitled             corresponding amount on the ballot,                      (a) A plan described in section 401(a)
     to vote did not approve the payments to X               Corporation E requests approval (with a               which includes a trust exempt from tax
     and Y, the payments cannot be made.                     ‘‘yes’’ and ‘‘no’’ box) of each total payment         under section 501(a);


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                        Federal Register / Vol. 68, No. 149 / Monday, August 4, 2003 / Rules and Regulations                                             45755

        (b) An annuity plan described in                     nature of compensation also includes                  published guidance of general
     section 403(a);                                         cash when paid, the value of the right                applicability under § 601.601(d)(2) of
        (c) A simplified employee pension (as                to receive cash, or a transfer of property.           this Chapter.
     defined in section 408(k)); or                          However, payments in the nature of                      (d) Transfers of property. Transfers of
        (d) A simple retirement account (as                  compensation do not include attorney’s                property are treated as payments for
     defined in section 408(p)).                             fees or court costs paid or incurred in               purposes of this A–11. See Q/A–12 of
        Q–9: Which payments of reasonable                    connection with the payment of any                    this section for rules on determining
     compensation are exempt from the                        amount described in paragraphs (a)(1),                when such payments are considered
     definition of parachute payment?                        (2), and (3) of Q/A–2 of this section or              made and the amount of such payments.
        A–9: Except in the case of securities                a reasonable rate of interest accrued on              See Q/A–13 of this section for special
     violation parachute payments, the term                  any amount during the period the                      rules on transfers of stock options.
     parachute payment does not include                      parties contest whether a payment will                  (e) The following example illustrates
     any payment (or portion thereof) which                  be made.                                              the principles of this A–11:
     the taxpayer establishes by clear and                      (b) When payment is considered to be                  Example. D is a disqualified individual
     convincing evidence is reasonable                       made. Except as otherwise provided in                 with respect to Corporation X. D has a base
     compensation for personal services to be                A–11 through Q/A–13 of this section, a                amount of $100,000 and is entitled to receive
     rendered by the disqualified individual                 payment in the nature of compensation                 two parachute payments, one of $200,000
     on or after the date of the change in                   is considered made (and is subject to the             and the other of $400,000. A change in
     ownership or control. See Q/A–37 of                     excise tax under section 4999) in the                 ownership or control of Corporation X occurs
     this section for the definition and                     taxable year in which it is includible in             on May 1, 2005, and the $200,000 payment
                                                                                                                   is made to D at the time of the change in
     treatment of securities violation                       the disqualified individual’s gross                   ownership or control. The $400,000 payment
     parachute payments. See Q/A–40                          income or, in the case of fringe benefits             is to be made on October 1, 2010.
     through Q/A–44 of this section for rules                and other benefits excludible from                    Corporation X and D agree that D will prepay
     on determining amounts of reasonable                    income, in the taxable year the benefits              the excise tax and X will satisfy its
     compensation.                                           are received.                                         obligations under section 4999(c) with
                                                                (c) Prepayment rule. Notwithstanding               respect to the $400,000 payment. Using
     Payor of Parachute Payments                             the general rule described in paragraph               discount rate determined under Q/A–32,
        Q–10: Who may be the payor of                        (b) of this A–11, a disqualified                      Corporation X and D determine that the
     parachute payments?                                     individual may, in the year of the                    present value of the $400,000 payment is
                                                                                                                   $300,000 on the date of the change in
        A–10: Parachute payments within the                  change in ownership or control, or any                ownership or control. The portions of the
     meaning of Q/A–2 of this section may                    later year, prepay the excise tax under               base amount allocated to these payments are
     be paid, directly or indirectly, by—                    section 4999, provided that the payor                 $40,000 (($200,000/$500,000) × $100,000)
        (i) The corporation referred to in                   and disqualified individual treat the                 and $60,000 (($300,000/$500,000 ×
     paragraph (a)(3) of Q/A–2 of this                       payment of the excise tax consistently                $100,000), respectively. Thus, the amount of
     section;                                                and the payor satisfies its obligations               the first excess parachute payment is
        (ii) A person acquiring ownership or                 under section 4999(c) in the year of                  $160,000 ($200,000¥$40,000) and that of the
     effective control of that corporation or                prepayment. The prepayment of the                     second excess parachute payment is
     ownership of a substantial portion of                                                                         $340,000 ($400,000¥$60,000). The excise tax
                                                             excise tax for purposes of section 4999
                                                                                                                   on the $400,000 payment is $68,000
     that corporation’s assets; or                           must be based on the present value of                 ($340,000 × 20 percent). Assume the present
        (iii) Any person whose relationship to               the excise tax that would be due in the               value (calculated in accordance with
     such corporation or other person is such                year the excess parachute payment                     paragraph (c) of this A–11) of $68,000 is
     as to require attribution of stock                      would actually be paid (calculated using              $50,000. To prepay the excise tax due on the
     ownership between the parties under                     the discount rate equal to 120 percent of             $400,000 payment, Corporation X must
     section 318(a).                                         the applicable Federal rate (determined               satisfy its obligations under section 4999
                                                             under section 1274(d) and regulations                 with respect to the $50,000, in addition to the
     Payments in the Nature of                                                                                     $32,000 withholding required with respect to
                                                             thereunder; see Q/A–32)). For purposes
     Compensation                                                                                                  the $200,000 payment.
                                                             of projecting the future value of a
       Q–11: What types of payments are in                   payment that provides for interest to be                 Q–12: If a property transfer to a
     the nature of compensation?                             credited at a variable interest rate, it is           disqualified individual is a payment in
       A–11: (a) General rule. For purposes                  permissible to make a reasonable                      the nature of compensation, when is the
     of this section, all payments—in                        assumption regarding this variable rate.              payment considered made (or to be
     whatever form—are payments in the                       A disqualified individual is not required             made), and how is the amount of the
     nature of compensation if they arise out                to adjust the excise tax paid under this              payment determined?
     of an employment relationship or are                    paragraph (c) merely because the                         A–12: (a) Except as provided in this
     associated with the performance of                      interest rates in the future are not the              A–12 and Q/A–13 of this section, a
     services. For this purpose, the                         same as the rate used for purposes of                 transfer of property is considered a
     performance of services includes                        projecting the future value of the                    payment made (or to be made) in the
     holding oneself out as available to                     payment. However, a disqualified                      taxable year in which the property
     perform services and refraining from                    individual may not apply this paragraph               transferred is includible in the gross
     performing services (such as under a                    (c) of this A–11 to a payment to be made              income of the disqualified individual
     covenant not to compete or similar                      in cash if the present value of the                   under section 83 and the regulations
     arrangement). Payments in the nature of                 payment would be considered not                       thereunder. Thus, in general, such a
     compensation include (but are not                       reasonably ascertainable under section                payment is considered made (or to be
     limited to) wages and salary, bonuses,                  3121(v) and § 31.3121(v)(2)–1(e)(4) of                made) when the property is transferred
     severance pay, fringe benefits, life                    this Chapter or to a payment related to               (as defined in § 1.83–3(a)) to the
     insurance, pension benefits, and other                  health benefits or coverage. The                      disqualified individual and becomes
     deferred compensation (including any                    Commissioner may provide additional                   substantially vested (as defined in
     amount characterized by the parties as                  guidance regarding the applicability of               § 1.83–3(b) and (j)) in such individual.
     interest thereon). A payment in the                     this paragraph (c) to certain payments in             The amount of the payment is


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     45756              Federal Register / Vol. 68, No. 149 / Monday, August 4, 2003 / Rules and Regulations

     determined under section 83 and the                     this A–13, vested means substantially                 Disqualified Individuals
     regulations thereunder. Thus, in                        vested within the meaning of § 1.83–3(b)                 Q–15: Who is a disqualified
     general, the amount of the payment is                   and (j) or the right to the payment is not            individual?
     equal to the excess of the fair market                  otherwise subject to a substantial risk of               A–15: (a) For purposes of this section,
     value of the transferred property                       forfeiture within the meaning of section              an individual is a disqualified
     (determined without regard to any lapse                 83(c). Thus, for purposes of this section,            individual with respect to a corporation
     restriction, as defined in § 1.83–3(i)) at              the vesting of such an option is treated              if, at any time during the disqualified
     the time that the property becomes                      as a payment in the nature of                         individual determination period (as
     substantially vested, over the amount (if               compensation. The value of an option at               defined in Q/A–20 of this section), the
     any) paid for the property.                             the time the option vests is determined               individual is an employee or
        (b) An election made by a disqualified               under all the facts and circumstances in              independent contractor of the
     individual under section 83(b) with                     the particular case. Factors relevant to              corporation and is, with respect to the
     respect to transferred property will not                such a determination include, but are                 corporation —
     apply for purposes of this A–12. Thus,                  not limited to: The difference between                   (1) A shareholder (but see Q/A–17 of
     even if such an election is made with                   the option’s exercise price and the value             this section);
     respect to a property transfer that is a                of the property subject to the option at                 (2) An officer (see Q/A–18 of this
     payment in the nature of compensation,                  the time of vesting; the probability of               section); or
     for purposes of this section, the                       the value of such property increasing or                 (3) A highly-compensated individual
     payment is generally considered made                    decreasing; and the length of the period              (see Q/A–19 of this section).
     (or to be made) when the property is                    during which the option can be                           (b) For purposes of this A–15, a
     transferred to and becomes substantially                exercised. Thus, an option is treated as              director is a disqualified individual
     vested in such individual.                                                                                    with respect to a corporation if, at any
                                                             a payment in the nature of
        (c) See Q/A–13 of this section for                                                                         time during the disqualified individual
                                                             compensation on the date of grant or
     rules on applying this A–12 to transfers                                                                      determination period, the director is,
                                                             vesting, as applicable, without regard to
     of stock options.                                                                                             with respect to the corporation, a
        (d) The following example illustrates                whether such option has an
                                                                                                                   shareholder (see Q/A–17 of this
     the principles of this A–12:                            ascertainable fair market value. For
                                                                                                                   section), an officer (see Q/A–18 of this
                                                             purposes of this A–13, valuation may be
       Example. On January 1, 2006, Corporation                                                                    section), or a highly-compensated
                                                             determined by any method prescribed                   individual (see Q/A–19 of this section).
     M gives to A, a disqualified individual, a
     bonus of 100 shares of Corporation M stock
                                                             by the Commissioner in published                         (c) For purposes of this A–15, an
     in connection with the performance of                   guidance of general applicability under               individual who is an employee or
     services to Corporation M. Under the terms              § 601.601(d)(2) of this Chapter.                      independent contractor of a corporation
     of the bonus arrangement A is obligated to                 (b) Any money or other property                    other than the corporation undergoing a
     return the Corporation M stock to                       transferred to the disqualified                       change in ownership or control is
     Corporation M unless the earnings of
                                                             individual on the exercise, or as                     disregarded for purposes of determining
     Corporation M double by January 1, 2009, or
     there is a change in ownership or control of            consideration on the sale or other                    who is a disqualified individual if such
     Corporation M before that date. A’s rights in           disposition, of an option described in                individual is employed by the
     the stock are treated as substantially                  paragraph (a) of this A–13 after the time             corporation undergoing the change in
     nonvested (within the meaning of § 1.83–                such option vests is not treated as a                 ownership or control only on the last
     3(b)) during that period because A’s rights in          payment in the nature of compensation                 day of the disqualified individual
     the stock are subject to a substantial risk of          to the disqualified individual under Q/               determination period. Thus, for
     forfeiture (within the meaning of § 1.83–3(c))                                                                example, assume that E is an employee
                                                             A–11 of this section. Nonetheless, the
     and are nontransferable (within the meaning                                                                   of Corporation X, that Y is acquired by
     of § 1.83–3(d)). On January 1, 2008, a change           amount of the otherwise allowable
                                                             deduction under section 162 or 212                    Corporation X, and that Y undergoes a
     in ownership or control of Corporation M
     occurs. On that day, the fair market value of           with respect to such transfer is reduced              change in ownership or control. If E
     the Corporation M stock is $250 per share.              by the amount of the payment described                becomes an employee of Y on the date
     Because A’s rights in the Corporation M stock           in paragraph (a) of this A–13 treated as              of the acquisition, in determining the
     become substantially vested (within the                 an excess parachute payment.                          disqualified individuals with respect to
     meaning of § 1.83–3(b)) on that day, the                                                                      Y, E is disregarded under this paragraph
     payment is considered made on that day, and                Q–14: Are payments in the nature of                (c).
     the amount of the payment for purposes of               compensation reduced by consideration                    Q–16: Is a personal service
     this section is equal to $25,000 (100 × $250).          paid by the disqualified individual?                  corporation treated as an individual?
     See Q/A–38 through 41 for rules relating to                                                                      A–16: (a) Yes. For purposes of this
                                                                A–14: Yes, to the extent not otherwise
     the reduction of the excess parachute                                                                         section, a personal service corporation
     payment by the portion of the payment                   taken into account under Q/A–12 and
     which is established to be reasonable                   Q/A–13 of this section, the amount of                 (as defined in section 269A(b)(1)), or a
     compensation for personal services actually             any payment in the nature of                          noncorporate entity that would be a
     rendered before the date of a change in                 compensation is reduced by the amount                 personal service corporation if it were a
     ownership or control.                                   of any money or the fair market value                 corporation, is treated as an individual.
                                                             of any property (owned by the                            (b) The following example illustrates
       Q–13: How are transfers of statutory
                                                             disqualified individual without                       the principles of this A–16:
     and nonstatutory stock options treated?
       A–13: (a) For purposes of this section,               restriction) that is (or will be)                       Example. Corporation N, a personal service
     an option (including an option to which                 transferred by the disqualified                       corporation (as defined in section
                                                             individual in exchange for the payment.               269A(b)(1)), has a single individual as its sole
     section 421 applies) is treated as
                                                                                                                   shareholder and employee. Corporation N
     property that is transferred when the                   For purposes of the preceding sentence,
                                                                                                                   performs personal services for Corporation
     option becomes vested (regardless of                    the fair market value of property is                  M. The compensation paid to Corporation N
     whether the option has a readily                        determined as of the date the property                by Corporation M puts Corporation N within
     ascertainable fair market value as                      is transferred by the disqualified                    the group of highly-compensated individuals
     defined in § 1.83–7(b)). For purposes of                individual.                                           of Corporation M as determined under A–19



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     of this section. Thus, Corporation N is treated         disqualified individual determination period,            (b) An individual who is an officer
     as a highly-compensated individual with                 E is not a disqualified individual within the         with respect to any member of an
     respect to Corporation M.                               meaning of Q&A–15 of this section with                affiliated group that is treated as one
                                                             respect to Corporation A.                             corporation pursuant to Q/A–46 of this
       Q–17: Are all shareholders of a
                                                                Example 2. Assume the same facts as in
     corporation considered shareholders for                 Example 1, except that Corporation A’s Stock          section is treated as an officer of such
     purposes of paragraphs (a)(1) and (b) of                Option Plan provides that all unvested                one corporation.
     Q/A–15 of this section?                                 options will vest immediately on a change in             (c) No more than 50 employees (or, if
       A–17: (a) No. Only an individual who                  ownership or control. Under paragraph (b) of          less, the greater of 3 employees, or 10
     owns stock of a corporation with a fair                 this A–17, the stock underlying the options           percent of the employees (rounded up to
     market value that exceeds 1 percent of                  that vest on the change in ownership or               the nearest integer)) of the corporation
     the fair market value of the outstanding                control is considered owned by E. If the stock        (in the case of an affiliated group treated
     shares of all classes of the corporation’s              considered owned by E exceeds 1 percent of            as one corporation, each member of the
                                                             the total fair market value of all of the             affiliated group) are treated as
     stock is treated as a disqualified
                                                             outstanding shares of all classes of
     individual with respect to the                                                                                disqualified individuals with respect to
                                                             Corporation A stock (including for this
     corporation by reason of stock                          purpose, all stock owned or constructively            a corporation by reason of being an
     ownership. An individual who owns a                     owned by all shareholders, provided that no           officer of the corporation. For purposes
     lesser amount of stock may, however, be                 share of stock is counted more than once), E          of the preceding sentence, the number
     a disqualified individual with respect to               is a disqualified individual within the               of employees of the corporation is the
     the corporation if such individual is an                meaning of Q/A–15 of this section with                greatest number of employees the
     officer (see Q/A–18) or highly-                         respect to Corporation A.                             corporation has during the disqualified
                                                                Example 3. Assume the same facts as in             individual determination period (as
     compensated individual (see Q/A–19)
                                                             Example 1 except that E received                      defined in Q/A–20 of this section). If the
     with respect to the corporation.                        nonstatutory stock options that are
       (b) For purposes of determining the                   exercisable for stock subject to a substantial
                                                                                                                   number of officers of the corporation
     amount of stock owned by an individual                  risk of forfeiture under section 83. Assume           exceeds the number of employees who
     for purposes of paragraph (a) of this A–                further that under Corporation A’s Stock              may be treated as officers under the first
     17, the constructive ownership rules of                 Option Plan, the nonstatutory options will            sentence of this paragraph (c), then the
     section 318(a) apply. Stock underlying a                vest on a change in ownership or control.             employees who are treated as officers
     vested option is considered owned by                    Under paragraph (b) of this A–17, E is not            for purposes of this section are the
     an individual who holds the vested                      considered to own the stock underlying the            highest paid 50 employees (or, if less,
                                                             options that vest on the change in ownership          the greater of 3 employees, or 10 percent
     option (and the stock underlying an
                                                             or control because the options are exercisable        of the employees (rounded up to the
     unvested option is not considered                       for stock subject to a substantial risk of
     owned by an individual who holds the                    forfeiture within the meaning of section 83.
                                                                                                                   nearest integer)) of the corporation
     unvested option). For purposes of the                   Because E is not considered to own                    when ranked on the basis of
     preceding sentence, however, if the                     Corporation A stock with a fair market value          compensation (as determined under Q/
     option is exercisable for stock that is not             exceeding 1 percent of the total fair market          A–21 of this section) paid during the
     substantially vested (as defined by                     value of all of the outstanding shares of all         disqualified individual determination
     §§ 1.83–3(b) and (j)), the stock                        classes of Corporation A stock and E is not           period.
                                                             an officer or highly compensated individual              (d) In determining the total number of
     underlying the option is not treated as
                                                             during the disqualified individual                    employees of a corporation for purposes
     owned by the individual who holds the                   determination period, E is not a disqualified
     option. Solely for purposes of                                                                                of this A–18, employees are not counted
                                                             individual within the meaning of Q/A–15 of            if they normally work less than 171⁄2
     determining the amount of stock owned                   this section with respect to Corporation A.
     by an individual for purposes of this A–                                                                      hours per week (as defined in section
                                                                Q–18: Who is an officer?                           414(q)(5)(B) and the regulations
     17, mutual and cooperative corporations                    A–18: (a) For purposes of this section,
     are treated as having stock.                                                                                  thereunder) or if they normally work
                                                             whether an individual is an officer with              during not more than 6 months during
       (c) The following examples illustrates
                                                             respect to a corporation is determined                any year (as defined in section
     the principles of this A–17:
                                                             on the basis of all the facts and                     414(q)(5)(C) and the regulations
        Example 1. E, an employee of Corporation             circumstances in the particular case                  thereunder). However, an employee
     A, received options under Corporation A’s               (such as the source of the individual’s
     Stock Option Plan. E’s stock options vest                                                                     who is not counted for purposes of the
                                                             authority, the term for which the                     preceding sentence may still be an
     three years after the date of grant. E is not an
     officer or highly compensated individual                individual is elected or appointed, and               officer.
     during the disqualified individual                      the nature and extent of the individual’s                Q–19: Who is a highly-compensated
     determination period. E does not own, and is            duties). Any individual who has the                   individual?
     not considered to own under section 318, any            title of officer is presumed to be an                    A–19: (a) For purposes of this section,
     other Corporation A stock. Two years after              officer unless the facts and                          a highly-compensated individual with
     the options are granted to E, all of                    circumstances demonstrate that the                    respect to a corporation is any
     Corporation A’s stock is acquired by                    individual does not have the authority                individual who is, or would be if the
     Corporation B. Under Corporation A’s Stock
     Option Plan, E’s options are converted to               of an officer. However, an individual                 individual were an employee, a member
     Corporation B options and the vesting                   who does not have the title of officer                of the group consisting of the lesser of
     schedule remains the same. Under paragraph              may nevertheless be considered an                     the highest paid 1 percent of the
     (b) of this A–17, the stock underlying the              officer if the facts and circumstances                employees of the corporation (rounded
     unvested options held by E on the date of the           demonstrate that the individual has the               up to the nearest integer), or the highest
     change in ownership or control is not                   authority of an officer. Generally, the               paid 250 employees of the corporation,
     considered owned by E. Because E is not                 term officer means an administrative                  when ranked on the basis of
     considered to own Corporation A stock with
     a fair market value exceeding 1 percent of the
                                                             executive who is in regular and                       compensation (as determined under Q/
     total fair market value of all of the                   continued service. The term officer                   A–21 of this section) earned during the
     outstanding shares of all classes of                    implies continuity of service and                     disqualified individual determination
     Corporation A and E is not an officer or                excludes those employed for a special                 period (as defined in Q/A–20 of this
     highly-compensated individual during the                and single transaction.                               section). For purposes of the preceding


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     45758              Federal Register / Vol. 68, No. 149 / Monday, August 4, 2003 / Rules and Regulations

     sentence, the number of employees of                    purchase or acquisition of property or                   (b)(1) For purposes of paragraph (a), a
     the corporation is the greatest number of               stock, corporate separation, or other                 payment is treated as contingent on a
     employees the corporation has during                    similar business transaction transfers                change in ownership or control if—
     the disqualified individual                             some or all of its employees to the                      (i) The payment is contingent on an
     determination period (as defined in Q/                  changed corporation or to a related                   event that is closely associated with a
     A–20 of this section). However, no                      entity or to a predecessor entity of the              change in ownership or control;
     individual whose annualized                             changed corporation. The term related                    (ii) A change in ownership or control
     compensation during the disqualified                    entity includes—                                      actually occurs; and
     individual determination period is less                    (1) All members of a controlled group                 (iii) The event is materially related to
     than the amount described in section                    of corporations (as defined in section                the change in ownership or control.
     414(q)(1)(B)(i) for the year in which the               414(b)) that includes the changed                        (2) For purposes of paragraph (b)(1)(i)
     change in ownership or control occurs                   corporation or a predecessor entity;                  of this A–22, a payment is treated as
     will be treated as a highly-compensated                                                                       contingent on an event that is closely
                                                                (2) All trades or businesses (whether
     individual.                                                                                                   associated with a change in ownership
                                                             or not incorporated) that are under
        (b) An individual who is not an                                                                            or control unless it is substantially
                                                             common control (as defined in section
     employee of the corporation is not                                                                            certain, at the time of the event, that the
                                                             414(c)) if such group includes the
     treated as a highly-compensated                                                                               payment would have been made
                                                             changed corporation or a predecessor                  whether or not the event occurred. An
     individual with respect to the                          entity;
     corporation on account of compensation                                                                        event is considered closely associated
                                                                (3) All members of an affiliated                   with a change in ownership or control
     received for performing services (such                  service group (as defined in section
     as brokerage, legal, or investment                                                                            if the event is of a type often
                                                             414(m)) that includes the changed                     preliminary or subsequent to, or
     banking services) in connection with a                  corporation or a predecessor entity; and
     change in ownership or control of the                                                                         otherwise closely associated with, a
                                                                (4) Any other entities required to be              change in ownership or control. For
     corporation, if the services are
                                                             aggregated with the changed corporation               example, the following events are
     performed in the ordinary course of the
                                                             or a predecessor entity pursuant to                   considered closely associated with a
     individual’s trade or business and the
                                                             section 414(o) and the regulations                    change in the ownership or control of a
     individual performs similar services for
                                                             thereunder (except leasing organizations              corporation: The onset of a tender offer
     a significant number of clients unrelated
                                                             as defined in section 414(n)).                        with respect to the corporation; a
     to the corporation.
        (c) The total number of employees of                    (c) For purposes of Q/A–18 and Q/A–                substantial increase in the market price
     a corporation for purposes of this A–19                 19 of this section, compensation that                 of the corporation’s stock that occurs
     is determined in accordance with Q/A–                   was contingent on the change in                       within a short period (but only if such
     18(d) of this section. However, an                      ownership or control and that was                     increase occurs prior to a change in
     employee who is not counted for                         payable in the year of the change is not              ownership or control); the cessation of
     purposes of the preceding sentence may                  treated as compensation.                              the listing of the corporation’s stock on
     still be a highly-compensated                           Contingent on Change in Ownership or                  an established securities market; the
     individual.                                             Control                                               acquisition of more than 5 percent of the
        Q–20: What is the disqualified                                                                             corporation’s stock by a person (or more
     individual determination period?                           Q–22: When is a payment contingent                 than one person acting as a group) not
        A–20: The disqualified individual                    on a change in ownership or control?                  in control of the corporation; the
     determination period is the twelve-                        A–22: (a) In general, a payment is                 voluntary or involuntary termination of
     month period prior to and ending on the                 treated as contingent on a change in                  the disqualified individual’s
     date of the change in ownership or                      ownership or control if the payment                   employment; a significant reduction in
     control of the corporation.                             would not, in fact, have been made had                the disqualified individual’s job
        Q–21: How is compensation defined                    no change in ownership or control                     responsibilities; and a change in
     for purposes of determining who is a                    occurred, even if the payment is also                 ownership or control as defined in the
     disqualified individual?                                conditioned on the occurrence of                      disqualified individual’s employment
        A–21: (a) For purposes of determining                another event. A payment generally is                 agreement (or elsewhere) that does not
     who is a disqualified individual, the                   treated as one which would not, in fact,              meet the definition of a change in
     term compensation means the                             have been made in the absence of a                    ownership or control described in Q/A–
     compensation which was earned by the                    change in ownership or control unless                 27, 28, or 29 of this section. Whether
     individual for services performed for the               it is substantially certain, at the time of           other events are treated as closely
     corporation with respect to which the                   the change, that the payment would                    associated with a change in ownership
     change in ownership or control occurs                   have been made whether or not the                     or control is based on all the facts and
     (changed corporation), for a predecessor                change occurred. (But see Q/A–23 of                   circumstances of the particular case.
     entity, or for a related entity. Such                   this section regarding payments under                    (3) For purposes of determining
     compensation is determined without                      agreements entered into after a change                whether an event (as described in
     regard to sections 125, 132(f)(4),                      in ownership or control.) A payment                   paragraph (b)(2) of this A–22) is
     402(e)(3), and 402(h)(1)(B). Thus, for                  that becomes vested as a result of a                  materially related to a change in
     example, compensation includes                          change in ownership or control is not                 ownership or control, the event is
     elective or salary reduction                            treated as a payment which was                        presumed to be materially related to a
     contributions to a cafeteria plan, cash or              substantially certain to have been made               change in ownership or control if such
     deferred arrangement or tax-sheltered                   whether or not the change occurred. For               event occurs within the period
     annuity, and amounts credited under a                   purposes of this A–22, vested means the               beginning one year before and ending
     nonqualified deferred compensation                      payment is substantially vested within                one year after the date of the change in
     plan.                                                   the meaning of § 1.83–3(b) and (j) or the             ownership or control. If such event
        (b) For purposes of this A–21, a                     right to the payment is not otherwise                 occurs outside of the period beginning
     predecessor entity is any entity which,                 subject to a substantial risk of forfeiture           one year before and ending one year
     as a result of a merger, consolidation,                 as defined by section 83(c).                          after the date of change in ownership or


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     control, the event is presumed not                      provides that a payment will be made to B                Example 5. A contract between a
     materially related to the change in                     if the corporation undergoes a change in              corporation and a disqualified individual, E,
     ownership or control. A payment does                    ownership or control and B’s employment               provides that a payment will be made to E
                                                             with the corporation is terminated at any             if the corporation’s level of product sales or
     not fail to be contingent on a change in                time over the succeeding 5 years. Eighteen            profits reaches a specified level. At the time
     ownership or control merely because it                  months later, a change in the ownership of            the contract was entered into, the parties had
     is also contingent on the occurrence of                 the corporation occurs. Two years after the           no reason to believe that such an increase in
     a second event (without regard to                       change in ownership, B’s employment is                the corporation’s level of product sales or
     whether the second event is closely                     terminated and the payment is made to B.              profits would be preliminary or subsequent
     associated with or materially related to                Because it was not substantially certain that         to, or otherwise closely associated with, a
     a change in ownership or control).                      the corporation would have made the                   change in ownership or control of the
     Similarly, a payment that is treated as                 payment to B on B’s termination of                    corporation. Eighteen months later, a change
                                                             employment if there had not been a change             in the ownership or control of the
     contingent on a change in ownership or                  in ownership, the payment is treated as               corporation occurs and within one year after
     control because it is contingent on a                   contingent on the change in ownership under           the date of the change of ownership or
     closely associated event does not fail to               paragraph (a) of this A–22. This is true even         control, the corporation’s level of product
     be treated as contingent on a change in                 though B’s termination of employment is               sales or profits reaches the specified level.
     ownership or control merely because it                  presumed not to be, and in fact may not be,           Under these facts and circumstances (and in
     is also contingent on the occurrence of                 materially related to the change in ownership         the absence of contradictory evidence), the
     a second event (without regard to                       or control.                                           increase in product sales or profits of the
     whether the second event is closely                        Example 3. A contract between a                    corporation is not an event closely associated
                                                             corporation and C, a disqualified individual,         with the change in ownership or control of
     associated with or materially related to                provides that a payment will be made to C
     a change in ownership or control).                                                                            the corporation. Accordingly, even if the
                                                             if C’s employment is terminated at any time           increase is materially related to the change in
        (c) A payment that would in fact have                over the succeeding 3 years (without regard           ownership or control, the payment will not
     been made had no change in ownership                    to whether or not there is a change in                be treated as contingent on a change in
     or control occurred is treated as                       ownership or control). Eighteen months after          ownership or control.
     contingent on a change in ownership or                  the contract is entered into, a change in the
     control if the change in ownership or                   ownership or control of the corporation                 Q–23: May a payment be treated as
     control (or the occurrence of an event                  occurs. Six months after the change in                contingent on a change in ownership or
     that is closely associated with and
                                                             ownership or control, C’s employment is               control if the payment is made under an
                                                             terminated and the payment is made to C.              agreement entered into after the change?
     materially related to a change in                       Termination of employment is considered an              A–23: (a) No. Payments are not treated
     ownership or control within the                         event closely associated with a change in             as contingent on a change in ownership
     meaning of paragraph (b)(1) of this A–                  ownership or control. Because the
                                                                                                                   or control if they are made (or are to be
     22), accelerates the time at which the                  termination occurred within one year after
                                                             the date of the change in ownership or                made) pursuant to an agreement entered
     payment is made. Thus, for example, if
                                                             control, the termination of C’s employment is         into after the change (a post-change
     a change in ownership or control
                                                             presumed to be materially related to the              agreement). For this purpose, an
     accelerates the time of payment of
                                                             change in ownership or control under                  agreement that is executed after a
     deferred compensation that is vested                    paragraph (b)(3) of this A–22. If this                change in ownership or control
     without regard to the change in                         presumption is not successfully rebutted, the         pursuant to a legally enforceable
     ownership or control, the payment may                   payment will be treated as contingent on the          agreement that was entered into before
     be treated as contingent on the change.                 change in ownership or control under
                                                                                                                   the change is considered to have been
     See Q/A–24 of this section regarding the                paragraph (b) of this A–22.
                                                                Example 4. A contract between a                    entered into before the change. (See
     portion of a payment that is so treated.
                                                             corporation and a disqualified individual, D,         Q/A–9 of this section regarding the
     See also Q/A–8 of this section regarding
                                                             provides that a payment will be made to D             exemption for reasonable compensation
     the exemption for certain payments
                                                             upon the onset of a tender offer for shares of        for services rendered on or after a
     under qualified plans and Q/A–40 of                     the corporation’s stock. A tender offer is            change in ownership or control.) If an
     this section regarding the treatment of a               made on December 1, 2008, and the payment             individual has a right to receive a
     payment as reasonable compensation.                     is made to D. Although the tender offer is
        (d) A payment is treated as contingent                                                                     payment that would be a parachute
                                                             unsuccessful, it leads to a negotiated merger
     on a change in ownership or control                                                                           payment if made under an agreement
                                                             with another entity on June 1, 2009, which
     even if the employment or independent                   results in a change in the ownership or               entered into prior to a change in
     contractor relationship of the                          control of the corporation. It was not                ownership or control (pre-change
     disqualified individual is not                          substantially certain, at the time of the onset       agreement) and gives up that right as
     terminated (voluntarily or involuntarily)               of the tender offer, that the payment would           bargained-for consideration for benefits
                                                             have been made had no tender offer taken              under a post-change agreement, the
     as a result of the change.                              place. The onset of a tender offer is
        (e) The following examples illustrate                                                                      agreement is treated as a post-change
                                                             considered closely associated with a change           agreement only to the extent the value
     the principles of this A–22:                            in ownership or control. Because the tender
                                                                                                                   of the payments under the agreement
        Example 1. A corporation grants a stock              offer occurred within one year before the date
                                                             of the change in ownership or control of the          exceed the value of the payments under
     appreciation right to a disqualified
     individual, A, more than one year before a              corporation, the onset of the tender offer is         the pre-change agreement. To the extent
     change in ownership or control. After the               presumed to be materially related to the              payments under the agreement have the
     stock appreciation right vests and becomes              change in ownership or control. If this               same value as the payments under the
     exercisable, a change in ownership or control           presumption is not rebutted, the payment              pre-change agreement, such payments
     of the corporation occurs, and A exercises the          will be treated as contingent on the change           retain their character as parachute
     right. Assuming neither the granting nor the            in ownership or control. If no change in              payments subject to this section.
     vesting of the stock appreciation right is              ownership or control had occurred, the                  (b) The following examples illustrate
     contingent on a change in ownership or                  payment would not be treated as contingent
                                                             on a change in ownership or control;
                                                                                                                   the principles of this A–23:
     control, the payment made on exercise is not
     contingent on the change in ownership or                however, the payment still could be a                   Example 1. Assume that a disqualified
     control.                                                parachute payment under Q/A–37 of this                individual is an employee of a corporation.
        Example 2. A contract between a                      section if the contract violated a generally          A change in ownership or control of the
     corporation and B, a disqualified individual,           enforced securities law or regulation.                corporation occurs, and thereafter the



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     individual enters into an employment                    time and if the payment is attributable,              corporation for a specified period of
     agreement with the acquiring company.                   at least in part, to services performed               time; and
     Because the agreement is entered into after             before the date the payment becomes                      (ii) The payment is attributable, at
     the change in ownership or control occurs,                                                                    least in part, to the performance of
                                                             vested. Paragraph (b) or (c) does not
     payments to be made under the agreement
     are not treated as contingent on the change.            apply to any payment (or portion                      services before the date the payment is
        Example 2. Assume the same facts as in               thereof) if the payment is treated as                 made or becomes certain to be made.
     Example 1, except that the agreement                    contingent on the change in ownership                    (2) The portion of the payment subject
     between the disqualified individual and the             or control pursuant to Q/A–25 of this                 to paragraph (c) of this A–24 that is
     acquiring company is executed after the                 section. For purposes of this A–24,                   treated as contingent on the change in
     change in ownership or control, pursuant to             vested has the same meaning as                        ownership or control is the amount
     a legally enforceable agreement entered into            provided in Q/A–22(a).                                described in paragraph (b) of this A–24,
     before the change. Payments to be made                     (2) Reduction by reasonable                        plus an amount, as determined in
     under the agreement may be treated as                                                                         paragraph (c)(4) of this A–24, to reflect
     contingent on the change in ownership or
                                                             compensation. The amount of a
     control pursuant to Q/A–22 of this section.             payment under paragraph (a)(1) of this                the lapse of the obligation to continue
     However, see Q/A–9 of this section regarding            A–24 is reduced by any portion of such                to perform services. In no event can the
     the exemption from the definition of                    payment that the taxpayer establishes by              portion of the payment treated as
     parachute payment for certain amounts of                clear and convincing evidence is                      contingent on the change in ownership
     reasonable compensation.                                reasonable compensation for personal                  or control under this paragraph (c)
        Example 3. Assume the same facts as in               services rendered by the disqualified                 exceed the amount of the accelerated
     Example 1, except that prior to the change in           individual on or after the date of the                payment, or, if the payment is not
     ownership or control, the individual and                                                                      accelerated, the present value of the
     corporation enter into an agreement under
                                                             change of control. See Q/A–9 and Q/A–
     which the individual will receive parachute             38 through 44 of this section for rules               payment.
     payments in the event of a change in                    concerning reasonable compensation.                      (3) For purposes of this paragraph (c)
     ownership or control of the corporation.                The portion of an amount treated as                   of this A–24, the acceleration of the
     After the change, the individual agrees to              contingent under paragraph (b) or (c) of              vesting of a stock option or the lapse of
     give up the right to payments under the pre-            this A–24 may not be reduced by                       a restriction on restricted stock is
     change agreement that would be parachute                reasonable compensation.                              considered to significantly increase the
     payments if made, in exchange for                          (b) Vested payments. This paragraph                value of a payment.
     compensation under a new agreement with                 (b) applies if a payment is vested,                      (4) The amount reflecting the lapse of
     the acquiring corporation. Because the                  without regard to the change in                       the obligation to continue to perform
     individual gave up the right to parachute                                                                     services (described in paragraph (c)(2) of
     payments under the pre-change agreement in              ownership or control, and is treated as
     exchange for other payments under the post-             contingent on the change in ownership                 this A–24) is 1 percent of the amount of
     change agreement, payments in an amount                 or control because the change                         the accelerated payment multiplied by
     equal to the parachute payments under the               accelerates the time at which the                     the number of full months between the
     pre-change agreement are treated as                     payment is made. In such a case, the                  date that the individual’s right to
     contingent on the change in ownership or                portion of the payment, if any, that is               receive the payment is vested and the
     control under this A–23. Because the post-              treated as contingent on the change in                date that, absent the acceleration, the
     change agreement was entered into after the             ownership or control is the amount by                 payment would have been vested. This
     change, payments in excess of this amount                                                                     paragraph (c)(4) applies to the
                                                             which the amount of the accelerated
     are not treated as parachute payments.                                                                        accelerated vesting of a payment in the
                                                             payment exceeds the present value of
        Q–24: If a payment is treated as                     the payment absent the acceleration. If               nature of compensation even if the time
     contingent on a change in ownership or                  the value of such a payment absent the                at which the payment is made is not
     control, is the full amount of the                      acceleration is not reasonably                        accelerated. In such a case, the amount
     payment so treated?                                     ascertainable, and the acceleration of                reflecting the lapse of the obligation to
        A–24: (a)(1) General rule. Yes. If the               the payment does not significantly                    continue to perform services is 1
     payment is a transfer of property, the                  increase the present value of the                     percent of the present value of the
     amount of the payment is determined                     payment absent the acceleration, the                  future payment multiplied by the
     under Q/A–12 or Q/A–13 of this                          present value of the payment absent the               number of full months between the date
     section. For all other payments, the                    acceleration is treated as equal to the               that the individual’s right to receive the
     amount of the payment is determined                     amount of the accelerated payment. If                 payment is vested and the date that,
     under Q/A–11 of this section. However,                  the value of the payment absent the                   absent the acceleration, the payment
     in certain circumstances, described in                  acceleration is not reasonably                        would have been vested.
     paragraphs (b) and (c) of this A–24, only               ascertainable, but the acceleration                      (d) Application of this A–24 to certain
     a portion of the payment is treated as                  significantly increases the present value             payments.— (1) Benefits under a
     contingent on the change. Paragraph (b)                 of the payment, the future value of such              nonqualified deferred compensation
     of this A–24 applies to a payment that                  payment is treated as equal to the                    plan. In the case of a payment of
     is vested, without regard to the change                 amount of the accelerated payment. For                benefits under a nonqualified deferred
     in ownership or control, and is treated                 rules on determining present value, see               compensation plan, paragraph (b) of this
     as contingent on the change in                          paragraph (e) of this A–24, Q/A–32, and               A–24 applies to the extent benefits
     ownership or control because the                        Q/A–33 of this section.                               under the plan are vested without
     change accelerates the time at which the                   (c)(1) Nonvested payments. This                    regard to the change in ownership or
     payment is made. Paragraph (c) of this                  paragraph (c) applies to a payment that               control. Paragraph (c) of this A–24
     A–24 applies to a payment that becomes                  becomes vested as a result of the change              applies to the extent benefits under the
     vested as a result of the change in                     in ownership or control to the extent                 plan become vested as a result of the
     ownership or control if, without regard                 that—                                                 change in ownership or control and are
     to the change in ownership or control,                     (i) Without regard to the change in                attributable, at least in part, to the
     the payment was contingent only on the                  ownership or control, the payment was                 performance of services prior to vesting.
     continued performance of services for                   contingent only on the continued                      Any other payment of benefits under a
     the corporation for a specified period of               performance of services for the                       nonqualified deferred compensation


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                        Federal Register / Vol. 68, No. 149 / Monday, August 4, 2003 / Rules and Regulations                                             45761

     plan is a payment in the nature of                         (ii) Because E was vested in $500,000 of           interest and other earnings on the plan assets
     compensation subject to the general rule                benefits under the SERP prior to the change           are credited to each account as earned before
     of paragraph (a) of this A–24 and the                   in ownership or control and the change                distribution. Investment of the plan assets is
                                                             merely accelerated the time at which the              not restricted in such a manner as would
     rules in Q/A–11 of this section.                                                                              prevent the earning of a market rate of return
                                                             payment was made to E, only a portion of the
        (2) Employment agreements. The                                                                             on the plan assets. The date on which D
                                                             payment, as determined under paragraph (b)
     general rule of paragraph (a) of this A–                of this A–24, is treated as contingent on the         would have received D’s vested account
     24 (and not the rules in paragraphs (b)                 change. Thus, the portion of the payment that         balance absent the change in ownership or
     or (c)) applies to the payment of                       is treated as contingent on the change is the         control is uncertain, and the rate of earnings
     amounts due under an employment                         amount by which the amount of the                     on the plan assets is not fixed. Thus, the
     agreement on a termination of                           accelerated payment ($500,000) exceeds the            amount of the payment absent the
     employment or a change in ownership                     present value of the payment absent the               acceleration is not reasonably ascertainable.
     or control that otherwise would be                      acceleration.                                         Under these facts, acceleration of the
                                                                (iii) Assume the same facts as in paragraph        payment does not significantly increase the
     attributable to the performance of
                                                             (i) of this Example 1, except that E’s account        present value of the payment absent the
     services (or refraining from the                                                                              acceleration, and the present value of the
                                                             balance of $500,000 is not vested. Instead,
     performance of services) during any                     assume that E will vest in E’s account                payment absent the acceleration is treated as
     period that begins after the date of                    balance of $500,000 in 2 years if E continues         equal to the amount of the accelerated
     termination of employment or change in                  to perform services for the next 2 years.             payment. Accordingly, no portion of the
     ownership or control, as applicable. For                Assume further that the SERP provides that            payment is treated as contingent on the
     purposes of this paragraph (d)(2) of this               all unvested SERP benefits vest immediately           change.
     A–24, an employment agreement means                     on a change in ownership or control and are              Example 3. (i) On January 15, 2006, a
     an agreement between an employee or                     paid to the participants. Because the vesting         corporation and a disqualified individual, F,
                                                             of the SERP payment, without regard to the            enter into a contract providing for a retention
     independent contractor and employer or
                                                             change, depends only on the performance of            bonus of $500,000 to be paid to F on January
     service recipient which describes,                                                                            15, 2011. The payment of the bonus will be
                                                             services for a specified period of time and the
     among other things, the amount of                       payment is attributable, in part, to the              forfeited by F if F does not remain employed
     compensation or remuneration payable                    performance of services before the change in          by the corporation for the entire 5-year
     to the employee or independent                          ownership or control, only a portion of the           period. However, the contract provides that
     contractor. See Q/A–42(b) and 44 of this                $500,000 payment, as determined under                 the full amount of the payment will be made
     section for the treatment of the                        paragraph (c) of this A–24, is treated as             immediately on a change in ownership or
     remaining amounts of salary under an                    contingent on the change. The portion of the          control of the corporation during the 5-year
     employment agreement.                                   payment that is treated as contingent on the          period. On January 15, 2009, a change in
        (3) Vesting due to an event other than               change is the lesser of the amount of the             ownership or control of the corporation
                                                             accelerated payment or the amount by which            occurs and the full amount of the payment
     services. Neither paragraph (b) nor (c) of                                                                    ($500,000) is made on that date to F. Under
     this A–24 applies to a payment if                       the accelerated payment exceeds the present
                                                             value of the payment absent the acceleration,         these facts, the payment of $500,000 was
     (without regard to the change in                                                                              contingent only on F’s performance of
                                                             plus an amount to reflect the lapse of the
     ownership or control) vesting of the                    obligation to continue to perform services.           services for a specified period and is
     payment depends on an event other                          (iv) Assume the same facts as in paragraph         attributable, in part, to the performance of
     than the performance of services, such                  (i) of this Example 1, except that in addition        services before the change in ownership or
     as the attainment of a performance goal,                to the pay out of the vested account balance          control. Therefore, only a portion of the
     and the event does not occur prior to the               of $500,000 on the change in ownership or             payment, as determined under paragraph (c)
     change in ownership or control. In such                 control, an additional $70,000 will be                of this A–24 is treated as contingent on the
                                                             credited to E’s account and included in the           change. The portion of the payment that is
     circumstances, the full amount of the                                                                         treated as contingent on the change is the
     accelerated payment is treated as                       payment to E. Because the $500,000 was
                                                             vested without regard to the change in                amount by which the amount of the
     contingent on the change in ownership                                                                         accelerated payment (i.e., $500,000, the
                                                             ownership or control, paragraph (b) of this
     or control under paragraph (a) of this A–                                                                     amount paid to the individual because of the
                                                             A–24 applies to the $500,000 payment.
     24. However, see Q/A–39 of this section                 Because the $70,000 is not vested, without            change in ownership) exceeds the present
     for rules relating to the reduction of the              regard to the change, and is not attributable         value of the payment that was expected to
     excess parachute payment by the                                                                               have been made absent the acceleration (i.e.,
                                                             to the performance of services prior to the
     portion of the payment which is                                                                               $406,838, the present value on January 15,
                                                             change, the entire $70,000 payment is
                                                                                                                   2009, of a $500,000 payment on January 15,
     established to be reasonable                            contingent on the change in ownership or
                                                                                                                   2011), plus $115,000 (1 percent × 23 months
     compensation for personal services                      control under paragraph (a) of this A–24.
                                                                                                                   × $500,000) which is the amount reflecting
     actually rendered before the date of a                     (v) Assume the same facts as in paragraph
                                                                                                                   the lapse of the obligation to continue to
     change in ownership or control.                         (i) of this Example 1, except that the benefit
                                                                                                                   perform services. Accordingly, the amount of
        (e) Present value. For purposes of this              under the SERP is calculated using a
                                                                                                                   the payment treated as contingent on the
                                                             percentage of final average compensation
     A–24, the present value of a payment is                                                                       change in ownership or control is $208,162,
                                                             multiplied by years of service. If, contingent
     determined as of the date on which the                                                                        the sum of $93,162 ($500,000¥$406,838) +
                                                             on the change in ownership or control, E is           $115,000). This result does not change if F
     accelerated payment is made.                            credited with additional years of service, an
        (f) Examples. The following examples                                                                       actually remains employed until the end of
                                                             adjustment to final average compensation, or          the 5-year period.
     illustrate the principles of this A–24:                 an increase in the applicable percentage, any
       Example 1. (i) Corporation maintains a                increase in the benefit payable under the                (ii) Assume the same facts as in
     qualified plan and a nonqualified                       SERP is not attributable to the performance           paragraph (i) of this Example 3, except
     supplemental retirement plan (SERP) for its             of services prior to the change, and the entire       that the retention bonus will vest on the
     executives. Benefits under the SERP are not             increase in the benefit is contingent on the          change in ownership or control, but will
     paid to participants until retirement. E, a             change in ownership or control under                  not be paid until January 15, 2011 (the
     disqualified individual with respect to                 paragraph (a) of this A–24.                           original date in the contract). Because
     Corporation, has a vested account balance of               Example 2. As a result of a change in the
                                                             effective control of a corporation D, a
                                                                                                                   the payment of $500,000 was contingent
     $500,000 under the SERP. A change in
     ownership or control of Corporation occurs.             disqualified individual with respect to the           only on F’s performance of services for
     The SERP provides that in the event of a                corporation, receives accelerated payment of          a specified period and is attributable, in
     change in ownership or control, all vested              D’s vested account balance in a nonqualified          part, to the performance of services
     accounts will be paid to SERP participants.             deferred compensation account plan. Actual            before the change in ownership or


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     control, only a portion of the $500,000                 individual if he fails to perform personal            reasonably ascertained what the value of the
     payment is treated as contingent on the                 services for the corporation until January 15,        options would have been on January 15,
     change in ownership or control as                       2009. The options will, however, vest in the          2009. The acceleration of vesting in the
                                                             individual at an earlier date if there is a           options is treated as significantly increasing
     determined under paragraph (c) of this
                                                             change in ownership or control of the                 the value of the payment. Therefore, the
     A–24. Because there is accelerated                      corporation. On January 16, 2008, a change            value of such options on January 15, 2009,
     vesting of the bonus, the portion of the                in the ownership or control of the                    is deemed to be $200,000, the amount of the
     payment treated as contingent on the                    corporation occurs and the options become             accelerated payment. The present value on
     change is the amount described in                       vested in the individual. The value of the            January 16, 2008, of a $200,000 payment to
     paragraph (b) of this A–27, which is $0                 options on January 16, 2008, determined in            be made on January 15, 2009, is $183,328.38.
     under these facts, plus an amount                       accordance with Q/A–13, is $600,000.                  Thus, the portion of the payment treated as
     reflecting the lapse of the obligation to                  (ii) The payment of the options to purchase        contingent on the change is $38,671.62, the
                                                             30,000 shares was contingent only on                  sum of $16,671.62 ($200,000¥$183,328.38),
     continue to perform services which is
                                                             performance of services for the corporation           plus an amount reflecting the lapse of the
     $93,573 (1 percent × 23 months ×                        until January 15, 2009, and is attributable, in       obligation to continue to perform services
     $406,838 (the present value of a                        part, to the performance of services before the       which is $22,000 (1 percent × 11 months ×
     $500,000 payment).                                      change in ownership or control. Therefore,            $200,000).
        Example 4. (i) On January 15, 2006, a                only a portion of the payment is treated as              Example 7. Assume the same facts as in
     corporation gives to a disqualified                     contingent on the change. The portion of the          Example 5, except that the option agreement
     individual, in connection with her                      payment that is treated as contingent on the          provides that the options will vest either on
     performance of services to the corporation, a           change is the amount by which the                     the corporation’s level of profits reaching a
     bonus of 1,000 shares of the corporation’s              accelerated payment on January 16, 2008               specified level, or if earlier, on the date on
     stock. Under the terms of the bonus                     ($600,000) exceeds the present value on               which there is a change in ownership or
     arrangement, the individual is obligated to             January 16, 2008, of the payment that was             control of the corporation. The corporation’s
     return the stock to the corporation if she              expected to have been made on January 15,             level of profits do not reach the specified
     terminates her employment for any reason                2009, absent the acceleration, plus an amount         level prior to January 16, 2008. In such case,
     prior to January 15, 2011. However, if there            reflecting the lapse of the obligation to             the full amount of the payment, $600,000, is
     is a change in the ownership or effective               continue to perform services. At the time of          treated as contingent on the change in
     control of the corporation prior to January 15,         the change, it cannot be reasonably                   ownership or control under paragraph (a) of
     2011, she ceases to be obligated to return the          ascertained what the value of the options             this A–24. Because the payment was not
     stock. The individual’s rights in the stock are         would have been on January 15, 2009. The              contingent only on the performance of
     treated as substantially nonvested (within the          acceleration of vesting in the options is             services for the corporation for a specified
     meaning of § 1.83–3(b) and (j)) during that             treated as significantly increasing the value         period, the rules of paragraph (b) and (c) of
     period. On January 15, 2009, a change in the            of the payment. Therefore, the value of such          this A–24 do not apply. See Q/A–39 of this
     ownership of the corporation occurs. On that            options on January 15, 2009, is deemed to be          section for rules relating to the reduction of
     day, the fair market value of the stock is              $600,000, the amount of the accelerated               the excess parachute payment by the portion
     $500,000.                                               payment. The present value on January 16,             of the payment which is established to be
        (ii) Under these facts, the payment was              2008, of a $600,000 payment to be made on             reasonable compensation for personal
     contingent only on performance of services              January 15, 2009, is $549,964. Thus, the              services actually rendered before the date of
     for a specified period and is attributable, in          portion of the payment treated as contingent          a change in ownership or control.
     part, to the performance of services before the         on the change is $116,036, the sum of                    Example 8. On January 1, 2005, E, a
     change in ownership or control. Thus, only              $50,036 ($600,000¥$549,964), plus an                  disqualified individual with respect to
     a portion of the payment, as determined                 amount reflecting the lapse of the obligation         Corporation X, enters into an employment
     under paragraph (c) of this A–24, is treated            to continue to perform services which is              agreement with Corporation X under which
     as contingent on the change in ownership or             $66,000 (1 percent × 11 months × $600,000).           E will be paid wages of $200,000 each year
     control. The portion of the payment that is                Example 6. (i) Assume the same facts as in         during the 5-year employment agreement.
     treated as contingent on the change is the              Example 5, except that the options become             The employment agreement provides that if
     amount by which the present value of the                vested periodically (absent a change in               a change in ownership or control of
     accelerated payment on January 15, 2009                 ownership or control), with one-third of the          Corporation X occurs, E will be paid the
     ($500,000), exceeds the present value of the            options vesting on January 15, 2007, 2008,            present value of the remaining salary under
     payment that was expected to have been                  and 2009, respectively. Thus, options to              the employment agreement. On January 1,
     made on January 15, 2011, plus an amount                purchase 20,000 shares vest independently of          2006, a change in ownership or control of
     reflecting the lapse of the obligation to               the January 16, 2008, change in ownership or          Corporation X occurs, E is terminated, and E
     continue to perform services. At the time of            control and the options to purchase the               receives a payment of the present value of
     the change, it cannot be reasonably                     remaining 10,000 shares vest as a result of           $200,000 for each of the 4 years remaining
     ascertained what the value of the stock                 the change in ownership or control.                   under the employment agreement. Because
     would have been on January 15, 2011. The                   (ii) The payment of the options to purchase        the payment represents future salary under
     acceleration of the lapse of a restriction on           10,000 shares was contingent only on                  an employment agreement (i.e., amounts
     stock is treated as significantly increasing the        performance of services for the corporation           otherwise attributable to the performance of
     value of the payment. Therefore, the value of           until January 15, 2009, and is attributable, in       services for periods that begin after the
     such stock on January 15, 2011, is deemed to            part, to the performance of services before the       termination of employment), the general rule
     be $500,000, the amount of the accelerated              change in ownership or control. Therefore,            of paragraph (a) of this A–24 applies to the
     payment. The present value on January 15,               only a portion of the payment as determined           payment and not the rules of paragraphs (b)
     2009, of a $500,000 payment to be made on               under paragraph (c) of this A–24 is treated as        and (c) of this A–24. See Q/A–42(c) and 44
     January 15, 2011, is $406,838. Thus, the                contingent on the change in ownership or              of this section for the treatment of the
     portion of the payment treated as contingent            control. The portion of the payment that is           remaining payments under an employment
     on the change is $208,162, the sum of                   treated as contingent on the change in                agreement.
     $93,162 ($500,000¥$406,838), plus $115,000              ownership or control is the amount by which
     (1 percent × 23 months × $500,000), the                 the accelerated payment on January 16, 2008           Presumption That Payment Is
     amount reflecting the lapse of the obligation           ($200,000) exceeds the present value on               Contingent on Change
     to continue to perform services.                        January 16, 2008, of the payment that was
        Example 5. (i) On January 15, 2006, a                expected to have been made on January 15,
                                                                                                                     Q–25: Is there a presumption that
     corporation grants to a disqualified                    2009, absent the acceleration, plus an amount         certain payments are contingent on a
     individual nonqualified stock options to                reflecting the lapse of the obligation to             change in ownership or control?
     purchase 30,000 shares of the corporation’s             perform services. At the time of the change             A–25: Yes, for purposes of this
     stock. The options will be forfeited by the             in ownership or control, it cannot be                 section, any payment is presumed to be


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     contingent on such a change unless the                  the payment of amounts due at a future                stock had commenced and it was likely that
     contrary is established by clear and                    time, or modify (to the individual’s                  a change in ownership or control would
     convincing evidence if the payment is                   benefit) the terms or conditions under                occur and the contract provides for a
                                                                                                                   substantial bonus payment to the individual
     made pursuant to—                                       which payments will be made; or
                                                                                                                   upon his signing the contract. The individual
        (a) An agreement entered into within                    (3) A contract between a corporation               has performed services for the corporation for
     one year before the date of a change in                 and an individual who did not perform                 many years, but previous employment
     ownership or control; or                                services for the corporation prior to the             contracts between the corporation and the
        (b) An amendment that modifies a                     one year period before the change in                  individual did not provide for a similar
     previous agreement in any significant                   ownership or control occurs, if the                   signing bonus. One month after the contract
     respect, if the amendment is made                       contract does not provide for payments                is entered into, a change in the ownership or
     within one year before the date of a                    that are significantly different in                   control of the corporation occurs. All
     change in ownership or control. In the                                                                        payments under the contract are presumed to
                                                             amount, timing, terms, or conditions
     case of an amendment described in                                                                             be contingent on the change in ownership or
                                                             from those provided under contracts                   control even though the bonus payment
     paragraph (b) of this A–25, only the                    entered into by the corporation (other                would have been legally required even if no
     portion of any payment that exceeds the                 than contracts that themselves were                   change had occurred. Clear and convincing
     amount of such payment that would                       entered into within one year before the               evidence of these facts rebuts the
     have been made in the absence of the                    change in ownership or control and in                 presumption described in A–25 of this
     amendment is presumed, by reason of                     contemplation of the change) with                     section with respect to all of the payments
     the amendment, to be contingent on the                  individuals performing comparable                     under the contract with the exception of the
     change in ownership or control.                                                                               bonus payment (which is treated as
                                                             services.
        Q–26: How may the presumption                                                                              contingent on the change). However,
                                                                (c) For purposes of this section, the              payments other than the bonus under the
     described in Q/A–25 of this section be                  term nondiscriminatory employee plan
     rebutted?                                                                                                     contract still may be contingent on the
                                                             or program means: a group term life                   change in ownership or control pursuant to
        A–26: (a) To rebut the presumption
                                                             insurance plan that meets the                         Q/A–22 of this section.
     described in Q/A–25 of this section, the
                                                             requirements of section 79(d); a self                    Example 3. A corporation and a
     taxpayer must establish by clear and                                                                          disqualified individual, who is an employee
                                                             insured medical reimbursement plan
     convincing evidence that the payment is                                                                       of the corporation, enter into an employment
                                                             that meets the requirements of section
     not contingent on the change in                                                                               contract within one year of a change in
     ownership or control. Whether the                       105(h); a cafeteria plan (within the
                                                                                                                   ownership or control of the corporation.
     payment is contingent on such change                    meaning of section 125); an educational               Under the contract, in the event of a change
     is determined on the basis of all the                   assistance program (within the meaning                in ownership or control and subsequent
     facts and circumstances of the particular               of section 127); a dependent care                     termination of employment, certain
     case. Factors relevant to such a                        assistance program (within the meaning                payments will be made to the individual. A
     determination include, but are not                      of section 129); a no-additional-cost                 change in ownership or control occurs, but
                                                             service (within the meaning of section                the individual is not terminated until 2 years
     limited to, the content of the agreement                                                                      after the change in ownership or control. If
     or amendment and the circumstances                      132(b)) or qualified employee discount
                                                             (within the meaning of section 132(c));               clear and convincing evidence does not rebut
     surrounding the execution of the                                                                              the presumption described in A–25 of this
     agreement or amendment, such as                         a qualified retirement planning services              section, because the payment is made
     whether it was entered into at a time                   program under section 132(m); an                      pursuant to an agreement entered into within
     when a takeover attempt had                             adoption assistance program (within the               one year of the date of the change in
     commenced and the degree of                             meaning of section 137); and such other               ownership or control, the payment is
     likelihood that a change in ownership or                items as provided by the Commissioner                 presumed contingent on the change under A–
                                                             in published guidance of general                      25 of this section. This is true even though
     control would actually occur. However,                                                                        A’s termination of employment is presumed
     even if the presumption is rebutted with                applicability under § 601.601(d)(2).
                                                             Payments under certain other plans are                not to be materially related to the change in
     respect to an agreement, some or all of                                                                       ownership or control under Q/A–22 of this
     the payments under the agreement may                    exempt from the definition of parachute
                                                                                                                   section.
     still be contingent on the change in                    payment under Q/A–8 of this section.
                                                                (d) The following examples illustrate              Change in Ownership or Control
     ownership or control pursuant to Q/A–
     22 of this section.                                     the application of the presumption:                     Q–27: When does a change in the
        (b) In the case of an agreement                         Example 1. A corporation and a                     ownership of a corporation occur?
     described in Q/A–25 of this section,                    disqualified individual who is an employee              A–27: (a) For purposes of this section,
     clear and convincing evidence that the                  of the corporation enter into an employment           a change in the ownership of a
     agreement is one of the three following                 contract. The contract replaces a prior               corporation occurs on the date that any
                                                             contract entered into by the same parties             one person, or more than one person
     types will generally rebut the                          more than one year before the change in
     presumption that payments under the                                                                           acting as a group (as defined in
                                                             ownership or control and the new contract
     agreement are contingent on the change                  does not provide for any increased payments
                                                                                                                   paragraph (b) of this A–27), acquires
     in ownership or control—                                other than a cost of living adjustment, does          ownership of stock of the corporation
        (1) A nondiscriminatory employee                     not accelerate the payment of amounts due             that, together with stock held by such
     plan or program as defined in paragraph                 at a future time, and does not modify (to the         person or group, has more than 50
     (c) of this A–26;                                       individual’s benefit) the terms or conditions         percent of the total fair market value or
        (2) A contract between a corporation                 under which payments will be made. Clear              total voting power of the stock of such
     and an individual that replaces a prior                 and convincing evidence of these facts rebuts         corporation. However, if any one
     contract entered into by the same parties               the presumption described in A–25 of this             person, or more than one person acting
     more than one year before the change in                 section. However, payments under the                  as a group, is considered to own more
                                                             contract still may be contingent on the
     ownership or control, if the new                        change in ownership or control pursuant to
                                                                                                                   than 50 percent of the total fair market
     contract does not provide for increased                 Q/A–22 of this section.                               value or total voting power of the stock
     payments (apart from normal increases                      Example 2. Assume the same facts as in             of a corporation, the acquisition of
     attributable to increased responsibilities              Example 1, except that the contract is entered        additional stock by the same person or
     or cost of living adjustments), accelerate              into after a tender offer for the corporation’s       persons is not considered to cause a


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     change in the ownership of the                          Corporation M acquires additional stock with          ownership of Corporation O occurs on the
     corporation (or to cause a change in the                a fair market value equal to 15 percent of the        date of the merger. See Q/A–29, Example 3,
     effective control of the corporation                    value of the stock of Corporation N on                regarding whether there is a change in
                                                             January 1, 2006, and an additional 18 percent         ownership or control of P.
     (within the meaning of Q/A–28 of this                                                                            Example 5. A, an individual, owns stock
                                                             on February 21, 2007. As of February 21,
     section)). An increase in the percentage                2007, Corporation M has acquired stock with           with a fair market value equal to 20 percent
     of stock owned by any one person, or                    a fair market value greater than 50 percent of        of the value of the stock of Corporation Q. On
     persons acting as a group, as a result of               the value of the stock of Corporation N. Thus,        January 1, 2007, Corporation Q acquires in a
     a transaction in which the corporation                  a change in the ownership of Corporation N            redemption for cash all of the stock held by
     acquires its stock in exchange for                      is considered to occur on February 21, 2007           shareholders other than A. Thus, A is left as
     property will be treated as an                          (assuming that Corporation M did not have             the sole shareholder of Corporation O. A
     acquisition of stock for purposes of this               effective control of Corporation N                    change in ownership of Corporation O is
                                                             immediately prior to the acquisition on that          considered to occur on January 1, 2007
     section. This A–27 applies only when                                                                          (assuming that A did not have effective
                                                             date).
     there is a transfer of stock of a                                                                             control of Corporation Q immediately prior
                                                                Example 2. All of the corporation’s stock
     corporation (or issuance of stock of a                  is owned by the founders of the corporation.          to the redemption).
     corporation) and stock in such                          The board of directors of the corporation                Example 6. Assume the same facts as in
     corporation remains outstanding after                   decides to offer shares of the corporation to         Example 5, except that A owns stock with a
     the transaction. (See Q/A–29 for rules                  the public. After the public offering, the            fair market value equal to 51 percent of the
     regarding the transfer of assets of a                   founders of the corporation own a total of 40         value of all the stock of Corporation Q
     corporation).                                           percent of the corporation’s stock, and               immediately prior to the redemption. There
        (b) For purposes of paragraph (a) of                 members of the public own 60 percent. If no           is no change in the ownership of Corporation
                                                             one person (or more than one person acting            Q as a result of the redemption.
     this A–27, persons will not be
     considered to be acting as a group                      as a group) owns more than 50 percent of the             Q–28: When does a change in the
                                                             corporation’s stock (by value or voting               effective control of a corporation occur?
     merely because they happen to purchase
                                                             power) after the public offering, there is no            A–28: (a) Notwithstanding that a
     or own stock of the same corporation at                 change in the ownership of the corporation.
     the same time, or as a result of the same                                                                     corporation has not undergone a change
                                                                Example 3. Corporation P merges into
     public offering. However, persons will                  Corporation O (a previously unrelated                 in ownership under Q/A–27, for
     be considered to be acting as a group if                corporation). In the merger, the shareholders         purposes of this section, a change in the
     they are owners of a corporation that                   of Corporation P receive Corporation O stock          effective control of a corporation is
     enters into a merger, consolidation,                    in exchange for their Corporation P stock.            presumed to occur on the date that
     purchase or acquisition of stock, or                    Immediately after the merger, the former              either—
     similar business transaction with the                   shareholders of Corporation P own stock                  (1) Any one person, or more than one
     corporation. If a person, including an                  with a fair market value equal to 60 percent          person acting as a group (as determined
                                                             of the value of the stock of Corporation O,           under paragraph (e) of this A–28),
     entity shareholder, owns stock in both
                                                             and the former shareholders of Corporation O          acquires (or has acquired during the 12-
     corporations that enter into a merger,                  own stock with a fair market value equal to
     consolidation, purchase or acquisition                                                                        month period ending on the date of the
                                                             40 percent of the value of the stock of
     of stock, or similar transaction, such                  Corporation O. The former shareholders of             most recent acquisition by such person
     shareholder is considered to be acting as               Corporation P will be treated as acting as a          or persons) ownership of stock of the
     a group with other shareholders in a                    group in their acquisition of Corporation O           corporation possessing 20 percent or
     corporation only with respect to the                    stock. Thus, a change in the ownership of             more of the total voting power of the
     ownership in that corporation prior to                  Corporation O occurs on the date of the               stock of such corporation; or
     the transaction giving rise to the change               merger. See Q/A–29, Example 3, regarding                 (2) A majority of members of the
     and not with respect to the ownership                   whether there is a change in ownership or             corporation’s board of directors is
                                                             control of P.                                         replaced during any 12-month period by
     interest in the other corporation.                         Example 4. Assume the same facts as in
        (c) For purposes of this A–27 (and Q/                                                                      directors whose appointment or election
                                                             Example 3, except that immediately after the
     A–28 and 29), section 318(a) applies to                 change, the former shareholders of
                                                                                                                   is not endorsed by a majority of the
     determine stock ownership. Stock                        Corporation P own stock with a fair market            members of the corporation’s board of
     underlying a vested option is                           value of 51 percent of the value of                   directors prior to the date of the
     considered owned by the individual                      Corporation O stock and the former                    appointment or election.
     who holds the vested option (and the                    shareholders of Corporation O own stock                  (b) The presumption of paragraph (a)
     stock underlying an unvested option is                  with a fair market value equal to 49 percent          of this A–28 may be rebutted by
     not considered owned by the individual                  of the value of Corporation O stock. Assume           establishing that such acquisition or
     who holds the unvested option). For                     further that prior to the merger several              acquisitions of the corporation’s stock,
                                                             Corporation O shareholders also owned                 or such replacement of the majority of
     purposes of the preceding sentence,                     Corporation P stock (overlapping
     however, if the option is exercisable for                                                                     the members of the corporation’s board
                                                             shareholders). In the merger, those O
     stock that is not substantially vested (as              shareholders received additional O stock by
                                                                                                                   of directors, does not transfer the power
     defined by sections 1.83–3(b) and (j)),                 virtue of their ownership of P stock with a           to control (directly or indirectly) the
     the stock underlying the option is not                  fair market value of 5 percent of the value of        management and policies of the
     treated as owned by the individual who                  Corporation O stock. Including the O stock            corporation from any one person (or
     holds the option. In addition, mutual                   attributable to the P shares, the O                   more than one person acting as a group)
     and cooperative corporations are treated                shareholders hold 54 percent of O after the           to another person (or group). For
     as having stock for purposes of this A–                 transaction. However, those overlapping               purposes of this section, in the absence
                                                             shareholders that owned both Corporation O            of an event described in paragraph (a)(1)
     27.                                                     stock and Corporation P stock prior to the
        (d) The following examples illustrate                                                                      or (2) of this A–28, a change in the
                                                             merger are treated as acting as a group with
     the principles of this A–27:                            the Corporation O shareholders only with
                                                                                                                   effective control of a corporation is
       Example 1. Corporation M has owned                    respect to their ownership interest in                presumed not to have occurred.
     stock with a fair market value equal to 19              Corporation O prior to the transaction.                  (c) In no event does a change in
     percent of the value of the stock of                    Therefore, because the Corporation O                  effective control under this A–28 occur
     Corporation N (an otherwise unrelated                   shareholders owned 49 percent of the value            in any transaction in which either of the
     corporation) for many years prior to 2006.              of Corporation O stock, a change in the               two corporations involved in the


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                        Federal Register / Vol. 68, No. 149 / Monday, August 4, 2003 / Rules and Regulations                                             45765

     transaction has a change in ownership                   change in effective control of Corporation M          in exchange for or with respect to its
     or control under Q/A–27 or 29 of this                   is treated as occurring prior to March 10,            stock;
     section. Thus, for example, assume                      2007), a change in the ownership of                      (ii) An entity, 50 percent or more of
                                                             Corporation M is treated as having occurred
     Corporation P transfers more than one-                  on March 10, 2007 (pursuant to Q/A–27 of
                                                                                                                   the total value or voting power of which
     third of the total gross fair market value              this section) because A had acquired more             is owned, directly or indirectly, by the
     of its assets to Corporation O in                       than 50 percent of Corporation M’s voting             corporation;
     exchange for 20 percent of O’s stock.                   stock as of that date.                                   (iii) A person, or more than one
     Because P has undergone a change in                        Example 2. A minority group of                     person acting as a group, that owns,
     ownership of a substantial portion of its               shareholders of a corporation opposes the             directly or indirectly, 50 percent or
     assets under Q/A–29 of this section, O                  practices and policies of the corporation’s           more of the total value or voting power
                                                             current board of directors. A proxy contest
     does not have a change in effective                                                                           of all the outstanding stock of the
                                                             ensues. The minority group presents its own
     control under Q/A–28.                                   slate of candidates for the board at the next         corporation; or
        (d) If any one person, or more than                  annual meeting of the corporation’s                      (iv) An entity, at least 50 percent of
     one person acting as a group, is                        shareholders, and candidates of the minority          the total value or voting power is
     considered to effectively control a                     group are elected to replace a majority of the        owned, directly or indirectly, by a
     corporation (within the meaning of this                 current members of the board. A change in             person described in paragraph (b)(1)(iii)
     A–28), the acquisition of additional                    the effective control of the corporation is           of this A–29.
     control of the corporation by the same                  presumed to have occurred on the date the                (2) For purposes of paragraph (b) and
                                                             election of the new board of directors
     person or persons is not considered to                                                                        except as otherwise provided, a person’s
                                                             becomes effective.
     cause a change in the effective control                                                                       status is determined immediately after
     of the corporation (or to cause a change                   Q–29: When does a change in the                    the transfer of the assets. For example,
     in the ownership of the corporation                     ownership of a substantial portion of a               a transfer to a corporation in which the
     within the meaning of Q/A–27 of this                    corporation’s assets occur?                           transferor corporation has no ownership
     section).                                                  A–29: (a) For purposes of this section,            interest in before the transaction, but
        (e) For purposes of this A–28, persons               a change in the ownership of a                        which is a majority-owned subsidiary of
     will not be considered to be acting as a                substantial portion of a corporation’s                the transferor corporation after the
     group merely because they happen to                     assets occurs on the date that any one                transaction is not treated as a change in
     purchase or own stock of the same                       person, or more than one person acting                the ownership of the assets of the
     corporation at the same time, or as a                   as a group (as determined in paragraph                transferor corporation.
     result of the same public offering.                     (c) of this A–29), acquires (or has
                                                                                                                      (c) For purposes of this A–29, persons
     However, persons will be considered to                  acquired during the 12-month period
                                                                                                                   will not be considered to be acting as a
     be acting as a group if they are owners                 ending on the date of the most recent
                                                                                                                   group merely because they happen to
     of a corporation that enters into a                     acquisition by such person or persons)
                                                                                                                   purchase assets of the same corporation
     merger, consolidation, purchase or                      assets from the corporation that have a
                                                                                                                   at the same time, or as a result of the
     acquisition of stock, or similar business               total gross fair market value equal to or
                                                                                                                   same public offering. However, persons
     transaction with the corporation. If a                  more than one-third of the total gross
                                                                                                                   will be considered to be acting as a
     person, including an entity shareholder,                fair market value of all of the assets of
                                                                                                                   group if they are owners of a
     owns stock in both corporations that                    the corporation immediately prior to
                                                                                                                   corporation that enters into a merger,
     enter into a merger, consolidation,                     such acquisition or acquisitions. For
                                                             this purpose, gross fair market value                 consolidation, purchase or acquisition
     purchase or acquisition of stock, or                                                                          of assets, or similar business transaction
     similar transaction, such shareholder is                means the value of the assets of the
                                                             corporation, or the value of the assets               with the corporation. If a person,
     considered to be acting as a group with                                                                       including an entity shareholder, owns
     other shareholders in a corporation only                being disposed of, determined without
                                                             regard to any liabilities associated with             stock in both corporations that enter
     with respect to the ownership in that                                                                         into a merger, consolidation, purchase
     corporation prior to the transaction                    such assets. This A–29 applies in any
                                                             situation other than one involving the                or acquisition of stock, or similar
     giving rise to the change and not with                                                                        transaction, such shareholder is
                                                             transfer of stock (or issuance of stock) in
     respect to the ownership interest in the                                                                      considered to be acting as a group with
                                                             a parent corporation and stock in such
     other corporation.                                                                                            other shareholders in a corporation only
        (f) For purposes of determining stock                corporation remains outstanding after
                                                             the transaction. Thus, this A–29 applies              to the extent of the ownership in that
     ownership, see Q/A–27(c).                                                                                     corporation prior to the transaction
        (g) The following examples illustrate                to the sale of stock in a subsidiary
                                                             (when that subsidiary is treated as a                 giving rise to the change and not with
     the principles of this A–28:                                                                                  respect to the ownership interest in the
                                                             single corporation with the parent
       Example 1. Shareholder A acquired the                 pursuant to Q/A–46) and to mergers                    other corporation.
     following percentages of the voting stock of                                                                     (d) For purposes of determining stock
     Corporation M (an otherwise unrelated                   involving the creation of a new
                                                             corporation or with respect to the                    ownership, see Q/A–27(c).
     corporation) on the following dates: 16                                                                          (e) The following examples illustrate
     percent on January 1, 2005; 10 percent on               corporation that is not surviving entity.
     January 10, 2006; 8 percent on February 10,                (b) (1) There is no change in                      the principles of this A–29:
     2006; 11 percent on March 1, 2007; and 8                ownership or control under this A–29                     Example 1. Corporation M acquires assets
     percent on March 10, 2007. Thus, on March               when there is a transfer to an entity that            having a gross fair market value of $500,000
     10, 2007, A owns a total of 53 percent of M’s           is controlled by the shareholders of the              from Corporation N (an unrelated
     voting stock. Because A did not acquire 20              transferring corporation immediately                  corporation) on January 1, 2006. The total
     percent or more of M’s voting stock during              after the transfer, as provided in this               gross fair market value of Corporation N’s
     any 12-month period, there is no                                                                              assets immediately prior to the acquisition
     presumption of a change in effective control
                                                             paragraph (b). A transfer of assets by a              was $3 million. Since the value of the assets
     pursuant to paragraph (a)(1) of this A–28. In           corporation is not treated as a change in             acquired by Corporation M is less than one-
     addition, under these facts there is a                  the ownership of such assets if the                   third of the total gross fair market value of
     presumption that no change in the effective             assets are transferred to—                            Corporation N’s total assets immediately
     control of Corporation M occurred. If this                 (i) A shareholder of the corporation               prior to the acquisition, the acquisition does
     presumption is not rebutted (and thus no                (immediately before the asset transfer)               not represent a change in the ownership of



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     45766              Federal Register / Vol. 68, No. 149 / Monday, August 4, 2003 / Rules and Regulations

     a substantial portion of Corporation N’s                   A–30: (a) No. To determine whether                 with Q/A–32 of this section and based
     assets.                                                 such payments are parachute payments,                 on reasonable actuarial assumptions.
        Example 2. Assume the same facts as in               they must be tested against the                          (2) If the payment in the nature of
     Example 1. Also assume that on November                 individual’s base amount (as defined in               compensation is an obligation to
     1, 2006, Corporation M acquires from                                                                          provide health care, then for purposes of
     Corporation N additional assets having a fair
                                                             Q/A–34 of this section). To do this, the
     market value of $700,000. Thus, Corporation             aggregate present value of all payments               this A–31 and for applying the 3-times-
     M has acquired from Corporation N assets                in the nature of compensation that are                base-amount test under Q/A–30 of this
     worth a total of $1.2 million during the 12-            made or to be made to (or for the benefit             section, the present value of such
     month period ending on November 1, 2006.                of) the same disqualified individual and              obligation should be calculated in
     Since $1.2 million is more than one-third of            are contingent on the change in                       accordance with generally accepted
     the total gross fair market value of all of             ownership or control must be                          accounting principles. For purposes of
     Corporation N’s assets immediately prior to             determined. If this aggregate present                 Q/A–30 and this A–31, the obligation to
     the earlier of these acquisitions ($3 million),         value equals or exceeds the amount                    provide health care is permitted to be
     a change in the ownership of a substantial                                                                    measured by projecting the cost of
     portion of Corporation N’s assets is
                                                             equal to 3 times the individual’s base
                                                             amount, the payments are parachute                    premiums for purchased health care
     considered to have occurred on November 1,
     2006.                                                   payments. If this aggregate present value             insurance, even if no health care
        Example 3. (i) All of the assets of                  is less than the amount equal to 3 times              insurance is actually purchased. If the
     Corporation P are transferred to Corporation            the individual’s base amount, no                      obligation to provide health care is
     O (an unrelated corporation). In exchange,              portion of the payment is a parachute                 made in coordination with a health care
     the shareholders of Corporation P receive               payment. See Q/A–31, Q/A–32, and                      plan that the corporation makes
     Corporation O stock. Immediately after the              Q/A–33 of this section for rules on                   available to a group, then the premiums
     transfer, the former shareholders of                    determining present value. Parachute                  used for this purpose may be group
     Corporation P own 60 percent of the fair                                                                      premiums.
     market value of the outstanding stock of
                                                             payments that are securities violation
                                                             parachute payments are not included in                   Q–32: What discount rate is to be
     Corporation O and the former shareholders of                                                                  used to determine present value?
     Corporation O own 40 percent of the fair                the foregoing computation if they are
                                                                                                                      A–32: For purposes of this section,
     market value of the outstanding stock of                not contingent on a change in
                                                                                                                   present value generally is determined by
     Corporation O. Because Corporation O is an              ownership or control. See Q/A–37 of
     entity more than 50 percent of the fair market                                                                using a discount rate equal to 120
                                                             this section for the definition and
     value of the outstanding stock of which is                                                                    percent of the applicable Federal rate
                                                             treatment of securities violation
     owned by the former shareholders of                                                                           (determined under section 1274(d) and
                                                             parachute payments.
     Corporation P (based on ownership of                       (b) The following examples illustrate              the regulations thereunder)
     Corporation P prior the change), the transfer
                                                             the principles of this A–30:                          compounded semiannually. The
     of assets is not treated as a change in                                                                       applicable Federal rate to be used for
     ownership of a substantial portion of the                 Example 1. A is a disqualified individual           this purpose is the Federal rate that is
     assets of Corporation P. However, a change              with respect to Corporation M. A’s base               in effect on the date as of which the
     in the ownership (within the meaning of                 amount is $100,000. Payments in the nature
                                                             of compensation that are contingent on a
                                                                                                                   present value is determined, using the
     Q/A–27) of Corporation O occurs.
                                                             change in the ownership or control of                 period until the payment would have
       (ii) The result in paragraph (i) would                Corporation M totaling $400,000 are made to           been made without regard to the change
     be the same if immediately after the                    A on the date of the change in ownership or           in ownership or control as the term of
     change, the former shareholders of                      control. The payments are parachute                   the debt instrument under section
     Corporation P own stock with a fair                     payments because they have an aggregate               1274(d). See Q/A–24 and 31 of this
     market value of 51 percent of the value                 present value at least equal to 3 times A’s           section. However, for any payment, the
     of Corporation O stock because                          base amount of $100,000 (3 x $100,000 =               corporation and the disqualified
     Corporation O is an entity more than 50                 $300,000).
                                                                                                                   individual may elect to use the
                                                               Example 2. Assume the same facts as in
     percent of the fair market value of the                                                                       applicable Federal rate that is in effect
                                                             Example 1, except that the payments
     outstanding stock of which is owned by                  contingent on the change in the ownership or          on the date that the contract which
     the former shareholders of Corporation                  control of Corporation M total $290,000.              provides for the payment is entered
     P. See Q/A–27, Example 4, regarding                     Because the payments do not have an                   into, if such election is made in the
     whether there is a change in ownership                  aggregate present value at least equal to 3           contract.
     or control of O.                                        times A’s base amount, no portion of the                 Q–33: If the present value of a
        Example 4. Corporation P sells all of the            payments is a parachute payment.                      payment to be made in the future is
     stock of its wholly-owned subsidiary, S, to                Q–31: As of what date is the present               contingent on an uncertain future event
     Corporation Y. The fair market value of the                                                                   or condition, how is the present value
                                                             value of a payment determined?
     affiliated group, determined without regard
                                                                A–31: (a) Except as provided in this               of the payment determined?
     to its liabilities, is $210 million. The fair
                                                             section, the present value of a payment                  A–33: (a) In certain cases, it may be
     market value of S, determined without regard
     to its liabilities, is $80 million. Because there       is determined as of the date on which                 necessary to apply the 3-times-base-
     is a change in more than one-third of the               the change in ownership or control                    amount test of Q/A–30 of this section,
     gross fair market value of the total assets of          occurs, or, if a payment is made prior                or to allocate a portion of the base
     the affiliated group, there is a change in the          to such date, the date on which the                   amount to a payment described in
     ownership of a substantial portion of the               payment is made.                                      paragraphs (a)(1), (2), and (3) of Q/A–2
     assets of the affiliated group.                            (b)(1) For purposes of determining                 of this section, at a time when the
     Three-Times-Base-Amount Test for                        whether a payment is a parachute                      aggregate present value of all such
     Parachute Payments                                      payment, if a payment in the nature of                payments cannot be determined with
                                                             compensation is the right to receive                  certainty because the time, amount, or
       Q–30: Are all payments that are in the                payments in a year (or years) subsequent              right to receive one or more such
     nature of compensation, are made to a                   to the year of the change in ownership                payments is contingent on the
     disqualified individual, and are                        or control, the value of the payment is               occurrence of an uncertain future event
     contingent on a change in ownership or                  the present value of such payment (or                 or condition. For example, a
     control, parachute payments?                            payments) calculated in accordance                    disqualified individual’s right to receive


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                        Federal Register / Vol. 68, No. 149 / Monday, August 4, 2003 / Rules and Regulations                                            45767

     a payment may be contingent on the                      agreement provides that if A’s employment is          base-amount test is not reapplied and the
     involuntary termination of such                         terminated within 1 year after the change in          base amount is not reallocated to include the
     individual’s employment with the                        ownership or control, A will receive an               $500,000 payment. The entire $500,000
                                                             additional payment in the nature of                   payment is treated as an excess parachute
     corporation. In such a case, it must be
                                                             compensation in the amount of $150,000,               payment.
     reasonably estimated whether the                        payable 1 year after the date of the change
     payment will be made. If it is reasonably               in ownership or control. A change in                     Q–34: What is the base amount?
     estimated that there is a 50-percent or                 ownership or control of Corporation M                    A–34: (a) The base amount of a
     greater probability that the payment will               occurs and A receives the first payment of            disqualified individual is the average
     be made, the full amount of the payment                 $250,000. Corporation M reasonably                    annual compensation for services
     is considered for purposes of the                       estimates that there is a 50-percent                  performed for the corporation with
     3-times-base-amount test and the                        probability that, as a result of the change, A’s      respect to which the change in
                                                             employment will be terminated within 1 year           ownership or control occurs (or for a
     allocation of the base amount.
                                                             of the date of the change. For purposes of            predecessor entity or a related entity as
     Conversely, if it is reasonably estimated               applying the 3-times-base-amount test (and if
     that there is a less than 50-percent                                                                          defined in Q/A–21 of this section)
                                                             the first payment is determined to be a
     probability that the payment will be                    parachute payment, for purposes of                    which was includible in the gross
     made, the payment is not considered for                 allocating a portion of A’s base amount to            income of such individual for taxable
     either purpose.                                         that payment), because M reasonably                   years in the base period (including
        (b) If the estimate made under                       estimates that there is a 50-percent or greater       amounts that were excluded under
     paragraph (a) of this A–33 is later                     probability that, as a result of the change, A’s      section 911), or which would have been
     determined to be incorrect, the 3-times-                employment will be terminated within 1 year           includible in such gross income if such
                                                             of the date of the change, Corporation M              person had been a United States citizen
     base-amount test described in Q/A–30
                                                             must assume that the $150,000 payment will            or resident. See Q/A–35 of this section
     of this section must be reapplied (and                  be made to A as a result of the change in
     the portion of the base amount allocated                ownership or control. The present value of
                                                                                                                   for the definition of base period and for
     to previous payments must be                            the additional payment is determined under            examples of base amount computations.
     reallocated (if necessary) to such                      Q/A–31 and Q/A–32 of this section.                       (b) If the base period of a disqualified
     payments) to reflect the actual time and                   Example 2. Assume the same facts as in             individual includes a short taxable year
     amount of the payment. Whenever the                     Example 1, except that Corporation M                  or less than all of a taxable year,
     3-times-base-amount test is applied (or                 reasonably estimates that there is a less than        compensation for such short or
     whenever the base amount is allocated),                 50-percent probability that, as a result of the       incomplete taxable year must be
                                                             change, A’s employment will be terminated             annualized before determining the
     the aggregate present value of the
                                                             within 1 year of the date of the change. For          average annual compensation for the
     payments received or to be received by                  purposes of applying the 3-times-base-
     the disqualified individual is                                                                                base period. In annualizing
                                                             amount test, because Corporation M
     redetermined as of the date described in                reasonably estimates that there is a less than        compensation, the frequency with
     A–31 of this section, using the discount                50-percent probability that, as a result of the       which payments are expected to be
     rate described in A–32 of this section.                 change, A’s employment will be terminated             made over an annual period must be
     This redetermination may affect the                     within 1 year of the date of the change,              taken into account. Thus, any amount of
     amount of any excess parachute                          Corporation M must assume that the                    compensation for such a short or
     payment for a prior taxable year.                       $150,000 payment will not be made to A as             incomplete taxable year that represents
                                                             a result of the change in ownership or                a payment that will not be made more
     Alternatively, if, based on the
                                                             control.                                              often than once per year is not
     application of the 3-times-base-amount                     Example 3. B, a disqualified individual
     test without regard to the payment                                                                            annualized.
                                                             with respect to Corporation P, has a base
     described in paragraph (a) of this A–33,                amount of $200,000. Under B’s employment
                                                                                                                      (c) Because the base amount includes
     a disqualified individual is determined                 agreement with Corporation P, if there is a           only compensation that is includible in
     to have an excess parachute payment or                  change in ownership or control of                     gross income, the base amount does not
     payments, then the 3-times-base-amount                  Corporation P, B will receive a severance             include certain items that constitute
     test does not have to be reapplied when                 payment of $600,000 and a bonus payment               parachute payments. For example,
     a payment described in paragraph (a) of                 of $400,000. In addition, the agreement               payments in the form of excludible
                                                             provides that if B’s employment is                    fringe benefits are not included in the
     this A–33 is made (or becomes certain
                                                             terminated within 1 year after the change, B          base amount but may be treated as
     to be made) if no base amount is                        will receive an additional payment in the
     allocated to such payment.                                                                                    parachute payments.
                                                             nature of compensation of $500,000. A
        (c) To the extent provided in                                                                                 (d) The base amount includes the
                                                             change in ownership or control of
     published guidance of general                           Corporation P occurs, and B receives the              amount of compensation included in
     applicability under § 601.601(d)(2) of                  $600,000 and $400,000 payments. At the                income under section 83(b) during the
     this Chapter, an initial estimate of the                time of the change in ownership or control,           base period. See Q/A–35 for the
     value of an option subject to Q/A–13 of                 Corporation P reasonably estimates that there         definition of base period.
     this section is permitted to be made,                   is a less than 50-percent probability that B’s           (e) The following example illustrates
     with the valuation subsequently                         employment will be terminated within 1 year           the principles of this A–34:
                                                             of the change. For purposes of applying the             Example. A disqualified individual, D,
     re-determined, and the 3-times-base-
                                                             3-times-base-amount test, because                     receives an annual salary of $500,000 per
     amount test reapplied.                                  Corporation P reasonably estimates that there         year during the 5-year base period. D defers
        (d) The following examples illustrate                is a less than 50-percent probability that B’s        $100,000 of D’s salary each year under the
     the principles of this A–33:                            employment will be terminated within 1 year           corporation’s nonqualified deferred
       Example 1. A, a disqualified individual               of the date of the change, Corporation P              compensation plan. D’s base amount is
     with respect to Corporation M, has a base               assumes that the $500,000 payment will not            $400,000 ($400,000 × (5/5)).
     amount of $100,000. Under A’s employment                be made to B. Eleven months after the change
     agreement with Corporation M, A is entitled             in ownership or control, B’s employment is              Q–35: What is the base period?
     to receive a payment in the nature of                   terminated, and the $500,000 payment is                 A–35: (a) The base period of a
     compensation in the amount of $250,000                  made to B. Because B was determined to                disqualified individual is the most
     contingent on a change in ownership or                  have excess parachute payments without                recent 5 taxable years of the individual
     control of Corporation M. In addition, the              regard to the $500,000 payment, the 3-times-          ending before the date of the change in


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     ownership or control. For this purpose,                 such change, of the individual’s taxable                 A–37: (a) No, the term parachute
     the date of the change in ownership or                  year in which the change occurred                     payment also includes any payment
     control is the date the corporation                     (including amounts that were excluded                 (other than a payment exempted under
     experiences one of the events described                 under section 911), or would have been                Q/A–6 or Q/A–8 of this section) that is
     in Q/A–27, Q/A–28, or Q/A–29 of this                    includible in such gross income if such               in the nature of compensation and is to
     section. However, if the disqualified                   person had been a United States citizen               (or for the benefit of) a disqualified
     individual was not an employee or                       or resident;                                          individual, if such payment is a
     independent contractor of the                              (2) Was not contingent on the change               securities violation payment. A
     corporation with respect to which the                   in ownership or control; and                          securities violation payment is a
     change in ownership or control occurs                      (3) Was not a securities violation                 payment made or to be made—
     (or a predecessor entity or a related                   parachute payment.                                       (1) Pursuant to an agreement that
     entity as defined in Q/A–21 of this                        (b) The following examples illustrate              violates any generally enforced Federal
     section) for this entire 5-year period, the             the principles of this A–36:                          or state securities laws or regulations;
     individual’s base period is the portion                    Example 1. On January 1, 2006, A, an               and
     of such 5-year period during which the                  individual whose taxable year is the calendar            (2) In connection with a potential or
     individual performed personal services                  year, enters into a 4-year employment                 actual change in ownership or control.
     for the corporation or predecessor entity               contract with Corporation M as an officer of             (b) A violation is not taken into
                                                             the corporation. A has not previously                 account under paragraph (a)(1) of this
     or related entity.                                      performed services for Corporation M (or any
       (b) The following examples illustrate                                                                       A–37 if it is merely technical in
                                                             predecessor entity or related entity as defined       character or is not materially prejudicial
     the principles of Q/A–34 of this section                in Q/A–21 of this section). Under the
     and this Q/A–35:                                                                                              to shareholders or potential
                                                             employment contract, A is to receive an
                                                             annual salary of $120,000 for each of the 4           shareholders. Moreover, a violation will
       Example 1. A disqualified individual, D,                                                                    be presumed not to exist unless the
     was employed by a corporation for 2 years               years that he remains employed by
                                                             Corporation M with any remaining unpaid               existence of the violation has been
     and 4 months preceding the taxable year in
     which a change in ownership or control of               balance to be paid immediately in the event           determined or admitted in a civil or
                                                             that A’s employment is terminated without             criminal action (or an administrative
     the corporation occurs. D’s includible
                                                             cause. On July 1, 2006, after A has received          action by a regulatory body charged
     compensation income from the corporation
                                                             compensation of $60,000, a change in the              with enforcing the particular securities
     was $30,000 for the 4-month period,
                                                             ownership or control of Corporation M
     $120,000 for the first full year, and $150,000                                                                law or regulation) which has been
                                                             occurs. Because of the change, A’s
     for the second full year. D’s base amount is            employment is terminated without cause,               resolved by adjudication or consent.
     $120,000, ((3 × $30,000) + $120,000 +                   and he receives a payment of $420,000. It is          Parachute payments described in this
     $150,000)/3.                                            established by clear and convincing evidence          A–37 are referred to in this section as
       Example 2. Assume the same facts as in                that the $60,000 in compensation is not               securities violation payments.
     Example 1, except that D also received a                contingent on the change in ownership or                 (c) Securities violation parachute
     $60,000 signing bonus when D’s employment               control, but the presumption that the                 payments that are not contingent on a
     with the corporation commenced at the                   $420,000 payment is contingent on the
     beginning of the 4-month period. D’s base                                                                     change in ownership or control within
                                                             change is not rebutted. Thus, the payment of          the meaning of Q/A–22 of this section
     amount is $140,000, (($60,000 + (3 ×                    $420,000 is treated as contingent on the
     $30,000)) + $120,000 + $150,000) / 3. Since             change in ownership or control of
                                                                                                                   are not taken into account in applying
     the bonus will not be paid more often than              Corporation M. In this case, A’s base amount          the 3-times-base-amount test of Q/A–30
     once per year, the amount of the bonus is not           is $120,000 (2 × $60,000). Since the present          of this section. Such payments are
     increased in annualizing D’s compensation               value of the payment which is contingent on           considered parachute payments
     for the 4-month period.                                 the change in ownership of Corporation M              regardless of whether such test is met
       Example 3. E is a disqualified individual             ($420,000) is more than 3 times A’s base              with respect to the disqualified
     with respect to Corporation X who was not               amount of $120,000 (3 × $120,000 =                    individual (and are included in
     an employee or independent contractor for               $360,000), the payment is a parachute                 allocating base amount under Q/A–38 of
     the full 5-year base period. In 2004 and 2005,          payment.
     E is a director of X and receives $30,000 per              Example 2. Assume the same facts as in
                                                                                                                   this section). Moreover, the amount of a
     year for E’s services. In 2006, E becomes an            Example 1, except that A also receives a              securities violation parachute payment
     officer of X. E’s includible compensation               signing bonus of $50,000 from Corporation M           treated as an excess parachute payment
     from Corporation X is $250,000 for 2006 and             on January 1, 2006. It is established by clear        shall not be reduced by the portion of
     2007, and $300,000 for 2008. In 2008, X                 and convincing evidence that the bonus is             such payment that is reasonable
     undergoes a change in ownership or control.             not contingent on the change in ownership             compensation for personal services
     E’s base amount is $140,000 ((2 × $250,000)             or control. When the change in ownership or           actually rendered before the date of a
     + (2 × $30,000)/4).                                     control occurs on July 1, 2006, A has
                                                                                                                   change in ownership or control if such
                                                             received compensation of $110,000 (the
       Q–36: How is the base amount                          $50,000 bonus plus $60,000 in salary). In this        payment is not contingent on such
     determined in the case of a disqualified                case, A’s base amount is $170,000 ($50,000            change. Likewise, the amount of a
     individual who did not perform services                 + (2 × $60,000)). Because the $50,000 bonus           securities violation parachute payment
     for the corporation (or a predecessor                   will not be paid more than once per year, the         includes the portion of such payment
     entity or a related entity as defined in                amount of the bonus is not increased in               that is reasonable compensation for
     Q/A–21 of this section), prior to the                   annualizing A’s compensation. The present             personal services to be rendered on or
                                                             value of the potential parachute payment              after the date of a change in ownership
     individual’s taxable year in which the
                                                             ($420,000) is less than 3 times A’s base
     change in ownership or control occurs?                  amount of $170,000 (3 × $170,000 =                    or control if such payment is not
       A–36: (a) In such a case, the                         $510,000), and therefore no portion of the            contingent on such change.
     individual’s base amount is the                         payment is a parachute payment.                          (d) The rules in paragraph (b) of this
     annualized compensation for services                                                                          A–37 also apply to securities violation
     performed for the corporation (or a                     Securities Violation Parachute                        parachute payments that are contingent
     predecessor entity or related entity)                   Payments                                              on a change in ownership or control if
     which—                                                    Q–37: Must a payment be contingent                  the application of these rules results in
       (1) Was includible in the individual’s                on a change in ownership or control in                greater total excess parachute payments
     gross income for that portion, prior to                 order to be a parachute payment?                      with respect to the disqualified


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     individual than would result if the                     base amount. However, if the first payment            excess parachute payment is $160,000
     payments were treated simply as                         is treated as a securities violation parachute        ($200,000¥$40,000) and that of the second is
     payments contingent on a change in                      payment, the amount of B’s total excess               $340,000 ($400,000¥$60,000).
     ownership or control (and hence were                    parachute payments is 3 times B’s base                   Q–39: May the amount of an excess
                                                             amount. Thus, the first payment is treated as         parachute payment be reduced by
     taken into account in applying the 3-                   a securities violation parachute payment.
     times-base-amount test and were                                                                               reasonable compensation for personal
                                                                Example 4. Assume the same facts as in             services actually rendered before the
     reduced by, or did not include, any                     Example 3, except that B does not receive the
     applicable amount of reasonable                                                                               change in ownership or control?
                                                             second payment and B establishes by clear
                                                                                                                      A–39: (a) Generally, yes. Except in the
     compensation).                                          and convincing evidence that the first
       (e) The following examples illustrate                 payment is reasonable compensation for                case of payments treated as securities
     the principles of this A–37:                            services actually rendered before the change          violation parachute payments or when
                                                             in the control of Corporation N. If the               the portion of a payment that is treated
        Example 1. A, a disqualified individual                                                                    as contingent on the change in
                                                             payment is treated simply as a payment
     with respect to Corporation M, receives two
     payments in the nature of compensation that
                                                             contingent on a change in ownership or                ownership or control is determined
                                                             control, the amount of B’s excess parachute           under paragraph (b) or (c) of Q/A–24 of
     are contingent on a change in the ownership
                                                             payment is zero because the amount treated            this section, the amount of an excess
     or control of Corporation M. The present
     value of the first payment is equal to A’s base         as an excess parachute payment is reduced             parachute payment is reduced by any
                                                             by the amount that B establishes as
     amount and is not a securities violation                                                                      portion of the payment that the taxpayer
     parachute payment. The present value of the             reasonable compensation. However, if the
                                                             payment is treated as a securities violation          establishes by clear and convincing
     second payment is equal to 1.5 times A’s base                                                                 evidence is reasonable compensation for
     amount and is a securities violation                    parachute payment, the amount of B’s excess
                                                             parachute payment is 3 times B’s base                 personal services actually rendered by
     parachute payment. Neither payment
     includes any reasonable compensation. If the            amount. Thus, the payment is treated as a             the disqualified individual before the
     second payment is treated simply as a                   securities violation parachute payment.               date of the change in ownership or
     payment contingent on a change in                                                                             control. Services reasonably
                                                             Computation and Reduction of Excess
     ownership or control, the amount of A’s total                                                                 compensated for by payments that are
                                                             Parachute Payments
     excess parachute payments is zero because                                                                     not parachute payments (for example,
     the aggregate present value of the payments                Q–38: How is the amount of an excess               because the payments are not contingent
     does not equal or exceed 3 times A’s base               parachute payment computed?                           on a change in ownership or control and
     amount. If the second payment is treated as                A–38: (a) The amount of an excess                  are not securities violation parachute
     a securities violation parachute payment                parachute payment is the excess of the
     subject to the rules of paragraph (b) of this
                                                                                                                   payments, or because the payments are
                                                             amount of any parachute payment over                  exempt from the definition of parachute
     A–37, the amount of A’s total excess
                                                             the portion of the disqualified                       payment under Q/A–6 through Q/A–9
     parachute payments is 0.5 times A’s base
     amount. Thus, the second payment is treated             individual’s base amount that is                      of this section) are not taken into
     as a securities violation parachute payment.            allocated to such payment. For this                   account for this purpose. The portion of
        Example 2. Assume the same facts as in               purpose, the portion of the base amount               any parachute payment that is
     Example 1, except that the present value of             allocated to any parachute payment is                 established as reasonable compensation
     the first payment is equal to 2 times A’s base          the amount that bears the same ratio to               is first reduced by the portion of the
     amount. If the second payment is treated                the base amount as the present value of
     simply as a payment contingent on a change
                                                                                                                   disqualified individual’s base amount
                                                             such parachute payment bears to the                   that is allocated to such parachute
     in ownership or control, the total present
                                                             aggregate present value of all parachute              payment; any remaining portion of the
     value of the payments is 3.5 times A’s base
     amount, and the amount of A’s total excess              payments made or to be made to (or for                parachute payment established as
     parachute payments is 2.5 times A’s base                the benefit of) the same disqualified                 reasonable compensation then reduces
     amount. If the second payment is treated as             individual. Thus, the portion of the base             the excess parachute payment.
     a securities violation parachute payment, the           amount allocated to any parachute                        (b) The following examples illustrate
     amount of A’s total excess parachute                    payment is determined by multiplying                  the principles of this A–39:
     payments is 0.5 times A’s base amount. Thus,            the base amount by a fraction, the
     the second payment is treated simply as a                                                                       Example 1. Assume that a parachute
                                                             numerator of which is the present value               payment of $600,000 is made to a
     payment contingent on a change in
                                                             of such parachute payment and the                     disqualified individual, and the portion of
     ownership or control.
        Example 3. B, a disqualified individual              denominator of which is the aggregate                 the individual’s base amount that is allocated
     with respect to Corporation N, receives two             present value of all such payments. See               to the parachute payment is $100,000. Also
     payments in the nature of compensation that             Q/A–31, Q/A–32, and Q/A–33 of this                    assume that $300,000 of the $600,000
     are contingent on a change in the control of            section for rules on determining present              parachute payment is established as
     Corporation N. The present value of the first           value and Q/A–34 of this section for the              reasonable compensation for personal
     payment is equal to 4 times B’s base amount             definition of base amount.                            services actually rendered by the disqualified
     and is a securities violation parachute                    (b) The following example illustrates              individual before the date of the change in
     payment. The present value of the second                                                                      ownership or control. Before the reasonable
                                                             the principles of this A–38:                          compensation is taken into account, the
     payment is equal to 2 times B’s base amount
     and is not a securities violation parachute                Example. An individual with a base                 amount of the excess parachute payment is
     payment. B establishes by clear and                     amount of $100,000 is entitled to receive two         $500,000 ($600,000—$100,000). In reducing
     convincing evidence that the entire amount              parachute payments, one of $200,000 and the           the excess parachute payment by reasonable
     of the first payment is reasonable                      other of $400,000. The $200,000 payment is            compensation, the portion of the parachute
     compensation for personal services to be                made at the time of the change in ownership           payment that is established as reasonable
     rendered after the change in ownership or               or control, and the $400,000 payment is to be         compensation ($300,000) is first reduced by
     control. If the first payment is treated simply         made at a future date. The present value of           the portion of the disqualified individual’s
     as a payment contingent on a change in                  the $400,000 payment is $300,000 on the               base amount that is allocated to the
     ownership or control, it is exempt from the             date of the change in ownership or control.           parachute payment ($100,000), and the
     definition of parachute payment pursuant to             The portions of the base amount allocated to          remainder ($200,000) then reduces the excess
     Q/A–9 of this section. Thus, the amount of              these payments are $40,000 (($200,000/                parachute payment. Thus, in this case, the
     B’s total excess parachute payment is zero              $500,000) × $100,000) and $60,000                     excess parachute payment of $500,000 is
     because the present value of the second                 (($300,000/$500,000) × $100,000),                     reduced by $200,000 of reasonable
     payment does not equal or exceed 3 times B’s            respectively. Thus, the amount of the first           compensation.



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        Example 2. Assume the same facts as in               compensation for personal services to be              date of change in ownership or
     Example 1, except that the full amount of the           rendered on or after the date of a change             control—
     $600,000 parachute payment is established as            in ownership or control?                                 (1) The contract was not entered into,
     reasonable compensation. In this case, the                 A–42: (a) Yes, if payments are made                amended, or renewed in contemplation
     excess parachute payment of $500,000 is                 or to be made to (or on behalf of) a                  of the change in ownership or control;
     reduced to zero by $500,000 of reasonable
                                                             disqualified individual for personal                     (2) The compensation the individual
     compensation. As a result, no portion of any
     deduction for the payment is disallowed by              services to be rendered on or after the               would have received under the contract
     section 280G, and no portion of the payment             date of a change in ownership or                      would have qualified as reasonable
     is subject to the 20-percent excise tax of              control, a showing of the following                   compensation under section 162;
     section 4999.                                           generally is considered to be clear and                  (3) The damages do not exceed the
                                                             convincing evidence that the payments                 present value (determined as of the date
     Determination of Reasonable                             are reasonable compensation for                       of receipt) of the compensation the
     Compensation                                            services to be rendered on or after the               individual would have received under
        Q–40: How is it determined whether                   date of the change in ownership or                    the contract if the individual had
     payments are reasonable compensation?                   control—                                              continued to perform services for the
        A–40: (a) In general, whether                           (1) The payments were made or are to               employer until the end of the contract
     payments are reasonable compensation                    be made only for the period the                       term;
     for personal services actually rendered,                individual actually performs such                        (4) The damages are received because
     or to be rendered, by the disqualified                  personal services; and                                an offer to provide personal services
     individual is determined on the basis of                   (2) If the individual’s duties and                 was made by the disqualified individual
     all the facts and circumstances of the                  responsibilities are substantially the                but was rejected by the employer
     particular case. Factors relevant to such               same after the change in ownership or                 (including involuntary termination or
     a determination include, but are not                    control, the individual’s annual                      constructive discharge); and
     limited to, the following—                              compensation for such services is not                    (5) The damages are reduced by
        (1) The nature of the services                       significantly greater than such                       mitigation. Mitigation will be treated as
     rendered or to be rendered;                             individual’s annual compensation prior                occurring when such damages are
        (2) The individual’s historic                        to the change in ownership or control,                reduced (or any payment of such
     compensation for performing such                        apart from normal increases attributable              damages is returned) to the extent of the
     services; and                                           to increased responsibilities or cost of              disqualified individual’s earned income
        (3) The compensation of individuals                  living adjustments. If the scope of the               (within the meaning of section
     performing comparable services in                       individual’s duties and responsibilities              911(d)(2)(A)) during the remainder of
     situations where the compensation is                    are not substantially the same, the                   the period in which the contract would
     not contingent on a change in                           annual compensation after the change is               have been in effect. See Q/A–44 of this
     ownership or control.                                   not significantly greater than the annual             section for rules regarding damages for
        (b) For purposes of section 280G,                    compensation customarily paid by the                  a failure to make severance payments.
     reasonable compensation for personal                    employer or by comparable employers                      (d) The following examples illustrate
     services includes reasonable                            to persons performing comparable                      the principles of this A–42:
     compensation for holding oneself out as                 services. However, except as provided                    Example 1. A, a disqualified individual,
     available to perform services and                       in paragraph (b) and (c) of this A–42,                has a three-year employment contract with
     refraining from performing services                     such clear and convincing evidence will               Corporation M, a publicly traded corporation.
     (such as under a covenant not to                        not exist if the individual does not, in              Under this contract, A is to receive a salary
     compete).                                               fact, perform the services contemplated               for $100,000 for the first year of the contract
        Q–41: Is any particular type of                      in exchange for the compensation.                     and, for each succeeding year, an annual
     evidence generally considered clear and                    (b) Generally, an agreement under                  salary that is 10 percent higher than the prior
     convincing evidence of reasonable                       which the disqualified individual must                year’s salary. During the third year of the
     compensation for personal services?                     refrain from performing services (e.g., a             contract, Corporation N acquires all the stock
                                                                                                                   of Corporation M. Prior to the change in
        A–41: Yes. A showing that payments                   covenant not to compete) is an                        ownership, Corporation N arranges to retain
     are made under a nondiscriminatory                      agreement for the performance of                      A’s services by entering into an employment
     employee plan or program (as defined in                 personal services for purposes of this                contract with A that is essentially the same
     Q/A–26 of this section) generally is                    A–42 to the extent that it is                         as A’s contract with Corporation M. Under
     considered to be clear and convincing                   demonstrated by clear and convincing                  the new contract, Corporation N is to fulfill
     evidence that the payments are                          evidence that the agreement                           Corporation M’s obligations for the third year
     reasonable compensation. This is true                   substantially constrains the individual’s             of the old contract, and, for each of the
     whether the personal services for which                 ability to perform services and there is              succeeding years, pay A an annual salary that
                                                                                                                   is 10 percent higher than A’s prior year’s
     the payments are made are actually                      a reasonable likelihood that the                      salary. Amounts are payable under the new
     rendered before, or are to be rendered                  agreement will be enforced against the                contract only for the portion of the contract
     on or after, the date of the change in                  individual. In the absence of clear and               term during which A remains employed by
     ownership or control. Q/A–46 of this                    convincing evidence, payments under                   Corporation N. A showing of the facts
     section (relating to the treatment of an                the agreement are treated as severance                described above (and in the absence of
     affiliated group as one corporation) does               payments under Q/A–44 of this section.                contradictory evidence) is regarded as clear
     not apply for purposes of this A–41. No                    (c) If the employment of a disqualified            and convincing evidence that all payments
     determination of reasonable                             individual is involuntarily terminated                under the new contract are reasonable
     compensation is needed for payments                     before the end of a contract term and the             compensation for personal services to be
                                                             individual is paid damages for breach of              rendered on or after the date of the change
     under qualified plans to be exempt from                                                                       in ownership. Therefore, the payments under
     the definition of parachute payment                     contract, a showing of the following                  this agreement are exempt from the
     under Q/A–8 of this section.                            factors generally is considered clear and             definition of parachute payment pursuant to
        Q–42: Is any particular type of                      convincing evidence that the payment is               Q/A–9 of this section.
     evidence generally considered clear and                 reasonable compensation for personal                     Example 2. Assume the same facts as in
     convincing evidence of reasonable                       services to be rendered on or after the               Example 1, except that A does not perform



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                        Federal Register / Vol. 68, No. 149 / Monday, August 4, 2003 / Rules and Regulations                                         45771

     the services described in the new contract,             reasonable compensation for personal                  § 301.7701–2(b) of this Chapter. For
     but receives payment under the new contract.            services actually rendered before the                 example, a corporation, for purposes of
     Because services were not rendered after the            date of a change in ownership or                      this section, includes a publicly traded
     change, the payments under this contract are                                                                  partnership treated as a corporation
                                                             control?
     not exempt from the definition of parachute
     payment pursuant to Q/A–9 of this section.
                                                                A–43: Yes, payments of compensation                under section 7704(a); an entity
        Example 3. Assume the same facts as in               earned before the date of a change in                 described in § 301.7701–3(c)(1)(v)(A) of
     Example 1, except that under the new                    ownership or control generally are                    this Chapter; a real estate investment
     contract A agrees to perform consulting                 considered reasonable compensation for                trust under section 856(a); a corporation
     services to Corporation N, when and if                  personal services actually rendered                   that has mutual or cooperative (rather
     Corporation N requires A’s services. Assume             before the date of a change in ownership              than stock) ownership, such as a mutual
     further that when Corporation N does not                or control if they qualify as reasonable              insurance company, a mutual savings
     require A’s services, the contract provides             compensation under section 162.                       bank, or a cooperative bank (as defined
     that A must not perform services for any                   Q–44: May severance payments be                    in section 7701(a)(32)), and a foreign
     other competing company. Corporation N
     previously enforced similar contracts against
                                                             treated as reasonable compensation?                   corporation as defined under section
     former employees of Corporation N. Because                 A–44: (a) No, severance payments are               7701(a)(5).
     A is substantially constrained under this               not treated as reasonable compensation                   Q–46: How is an affiliated group
     contract and Corporation N is reasonably                for personal services actually rendered               treated?
     likely to enforce the contract against A, the           before, or to be rendered on or after, the               A–46: For purposes of this section,
     agreement is an agreement for the                       date of a change in ownership or                      and except as otherwise provided in this
     performance of services under paragraph (b)             control. Moreover, any damages paid for               section, all members of the same
     of this A–42. Assuming the requirements of              a failure to make severance payments                  affiliated group (as defined in section
     paragraph (a) of this A–42 are met and there            are not treated as reasonable                         1504, determined without regard to
     is clear and convincing evidence that all                                                                     section 1504(b)) are treated as one
     payments under the new contract are                     compensation for personal services
     reasonable compensation for personal                    actually rendered before, or to be                    corporation. Rules affected by this
     services to be rendered on or after the date            rendered on or after, the date of such                treatment of an affiliated group include
     of the change in ownership, the payments                change. For purposes of this section, the             (but are not limited to) rules relating to
     under this contract are exempt from the                 term severance payment means any                      exempt payments of certain
     definition of parachute payment pursuant to             payment that is made to (or for the                   corporations (Q/A–6, Q/A–7 of this
     Q/A–9 of this section.                                  benefit of) a disqualified individual on              section (except as provided therein)),
        Example 4. Assume the same facts as in               account of the termination of such                    payor of parachute payments (Q/A–10
     Example 1, except that instead of agreeing                                                                    of this section), disqualified individuals
     not to compete with Corporation N, under
                                                             individual’s employment prior to the
     the new agreement A agrees not to disparage             end of a contract term, but does not                  (Q/A–15 through Q/A–21 of this section
     either Corporation M or Corporation N.                  include any payment that otherwise                    (except as provided therein)), rebuttal of
     Because the nondisparagement agreement                  would be made to (or for the benefit of)              the presumption that payments are
     does not substantially constrain A’s ability to         such individual on the termination of                 contingent on a change (Q/A–26 of this
     perform services, no amount of the payments             such individual’s employment,                         section (except as provide therein)),
     under this contract are reasonable                      whenever occurring.                                   change in ownership or control (Q/A–
     compensation for the nondisparagement                      (b) The following example illustrates              27, 28, and 29 of this section), and
     agreement.                                              the principles of this A–44:                          reasonable compensation (Q/A–42, 43,
        Example 5. Assume the same facts as in
     Example 1, except that the employment                      Example. A, a disqualified individual, has         and 44 of this section).
     contract with Corporation N does not provide            a three-year employment contract with                 Effective Date
     that amounts are payable under the contract             Corporation X. Under the contract, A will
     only for the portion of the term for which A            receive a salary of $200,000 for the first year          Q–47: What is the general effective
     remains employed by Corporation N. Shortly              of the contract, and for each succeeding year,        date of section 280G?
     after the change in ownership, and despite              an annual salary that is $100,000 higher than            A–47: (a) Generally, section 280G
     A’s request to remain employed by                       the previous year. In the event of A’s                applies to payments under agreements
     Corporation N, A’s employment with                      termination of employment following a                 entered into or renewed after June 14,
     Corporation N is involuntarily terminated.              change in ownership or control, the contract          1984. Any agreement that is entered into
     Shortly thereafter, A obtains employment                provides that A will receive the remaining            before June 15, 1984, and is renewed
     with Corporation O. A commences a civil                 salary due under the employment contract.
                                                             At the beginning of the second year of the
                                                                                                                   after June 14, 1984, is treated as a new
     action against Corporation N, alleging breach
     of the employment contract. In settlement of            contract, Corporation Y acquires all of the           contract entered into on the day the
     the litigation, A receives an amount equal to           stock of Corporation X, A’s employment is             renewal takes effect.
     the present value of the compensation A                 terminated, and A receives $700,000                      (b) For purposes of paragraph (a) of
     would have received under the contract with             ($300,000 for the second year of the contract         this A–47, a contract that is terminable
     Corporation N, reduced by the amount of                 plus $400,000 for the third year of the               or cancellable unconditionally at will by
     compensation A otherwise receives from                  contract) representing the remaining salary           either party to the contract without the
     Corporation O during the period that the                due under the employment contract. Because            consent of the other, or by both parties
     contract would have been in effect. A                   the $700,000 payment is treated as a                  to the contract, is treated as a new
     showing of the facts described above (and in            severance payment, it is not reasonable
                                                                                                                   contract entered into on the date any
     the absence of contradictory evidence) is               compensation for personal services on or
     regarded as clear and convincing evidence               after the date of the change in ownership or          such termination or cancellation, if
     that the amount A receives as damages is                control. Thus, the full amount of the                 made, would be effective. However, a
     reasonable compensation for personal                    $700,000 is a parachute payment.                      contract is not treated as so terminable
     services to be rendered on or after the date                                                                  or cancellable if it can be terminated or
     of the change in ownership. Therefore, the              Miscellaneous Rules                                   cancelled only by terminating the
     amount received by A is exempt from the                   Q–45: How is the term corporation                   employment relationship or
     definition of parachute payment pursuant to             defined?                                              independent contractor relationship of
     Q/A–9 of this section.                                    A–45: For purposes of this section,                 the disqualified individual.
       Q–43: Is any particular type of                       the term corporation has the meaning                     (c) Section 280G applies to payments
     payment generally considered                            prescribed by section 7701(a)(3) and                  under a contract entered into on or


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     45772              Federal Register / Vol. 68, No. 149 / Monday, August 4, 2003 / Rules and Regulations

     before June 14, 1984, if the contract is                adjustment and those members of that
     amended or supplemented after June 14,                  group who are the beneficiaries of pre-
     1984, in significant relevant respect. For              June 15, 1984, parachute contracts; and
     this purpose, a supplement to a contract                  (5) The size of the adjustment, both in
     is defined as a new contract entered into               absolute terms and in comparison with
     after June 14, 1984, that affects the                   the benefits provided to other members
     trigger, amount, or time of receipt of a                of the group receiving the benefits of the
     payment under an existing contract.                     adjustment.
        (d)(1) Except as otherwise provided in                 Q–48: What is the effective date of
     paragraph (e) of this A–47, a contract is               this section?
     considered to be amended or                               A–48: This section applies to any
     supplemented in significant relevant                    payments that are contingent on a
     respect if provisions for payments                      change in ownership or control if the
     contingent on a change in ownership or                  change in ownership or control occurs
     control (parachute provisions), or                      on or after January 1, 2004.
     provisions in the nature of parachute                   s Par 3. In § 602.101, paragraph (b) is
     provisions, are added to the contract, or               amended by adding an entry in numer-
     are amended or supplemented to                          ical order to the table to read as follows:
     provide significant additional benefits
                                                             § 602.101      OMB Control numbers.
     to the disqualified individual. Thus, for
     example, a contract generally is treated                *       *    *          *       *
     as amended or supplemented in                               (b) * * *
     significant relevant respect if it is
                                                                   CFR part or section
     amended or supplemented—                                      where identified and          Current OMB con-
        (i) To add or modify, to the                                                                  trol No.
                                                                       described
     disqualified individual’s benefit, a
     change in ownership or control trigger;
        (ii) To increase amounts payable that                   *         *              *          *         *
     are contingent on a change in ownership                 1.280G–1 ........................          1545–1851
     or control (or, where payment is to be
     made under a formula, to modify the                     *        *      *       *       *
     formula to the disqualified individual’s                Robert E. Wenzel,
     advantage); or                                          Deputy Commissioner for Services and
        (iii) To accelerate, in the event of a               Enforcement.
     change in ownership or control, the
                                                               Approved: July 14, 2003.
     payment of amounts otherwise payable
                                                             Pamela F. Olson,
     at a later date.
        (2) For purposes of paragraph (a) of                 Assistant Secretary of the Treasury.
     this A–47, a payment is not treated as                  [FR Doc. 03–19274 Filed 8–1–03; 8:45 am]
     being accelerated in the event of a                     BILLING CODE 4830–01–P
     change in ownership or control if the
     acceleration does not increase the
     present value of the payment.
        (e) A contract entered into on or
     before June 14, 1984, is not treated as
     amended or supplemented in significant
     relevant respect merely by reason of
     normal adjustments in the terms of
     employment relationship or
     independent contractor relationship of
     the disqualified individual. Whether an
     adjustment in the terms of such a
     relationship is considered normal for
     this purpose depends on all of the facts
     and circumstances of the particular
     case. Relevant factors include, but are
     not limited to, the following—
        (1) The length of time between the
     adjustment and the change in
     ownership or control;
        (2) The extent to which the
     corporation, at the time of the
     adjustment, viewed itself as a likely
     takeover candidate;
        (3) A comparison of the adjustment
     with historical practices of the
     corporation;
        (4) The extent of overlap between the
     group receiving the benefits of the


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