Some compensation arrangements can cause headaches during a merger or acquisition or even derail a deal if they trigger the golden parachute rule under the Internal Revenue Code and possibly related excise taxes. So how do you know if your bank has such arrangements? It’s best to review compensation plans well ahead of striking a deal with another bank to plan for the possibility of the application of the golden parachute rules, otherwise known as exceeding the §280G limit. This is the second in a two-part series about what constitutes a golden parachute payment and what a bank can do about it. Check out the first article to see what constitutes a parachute payment.

Is there anything the bank can do to avoid the creation of parachute payments in a change of control?

Yes. There are several potential options:

1. Accelerate vesting prior to the change in control (CIC). The bank can accelerate vesting of a Supplemental Executive Retirement Plan (SERP) or some other non-qualified deferred compensation arrangement at least 12 months in advance of the change in control to avoid triggering the “golden parachute” excise taxes. The downside is that the bank would have to accrue a liability for the increase in the vested benefit. In addition, if the executive terminated employment, the bank would be obligated to pay the executive the increased benefit. (This is a positive to the executive but may be a negative to the bank.)
2. Classify payments as part of a non-compete. If the executive’s separation agreement provides that the executive cannot compete with the company for a period of time, then a portion of the payments may be attributable to the non-compete and therefore excludable from the parachute payment amount. There is no bright line test for how much can be excluded as it is based on facts and circumstances. The excludable amount will vary by bank and by individual within a bank. Any amount paid that does not represent reasonable value for the non-compete will be part of the parachute payment.
3. Provide a retention agreement. The buying bank could enter into retention agreements with one or more executives. There is value to the buying bank in retaining key executives for some period of time after the merger to protect its investment. The amount paid to the executive for retention (including salary, bonuses, stock options or other) must represent reasonable compensation for the services rendered or it will be considered a parachute payment.
4. Accelerate income. If it is anticipated that the bank may experience a CIC in the foreseeable future, it could take steps to increase the executive’s base amount by accelerating income (through bonuses or the exercise of stock options). In addition, the executive may want to discontinue deferrals under any voluntary deferred compensation plans. Lastly, it may be possible to increase the base amount by terminating the bank’s non-qualified deferred compensation arrangements and distributing the proceeds (being careful to follow the guidance under IRC section 409A).

What are the bank’s alternatives, when designing a plan, to address §280G?

There are three basic strategies:

1. Cutback. The agreement provides that if the total parachute payments exceed the §280G limit, they will be reduced so as not to trigger an excise tax.
2. Gross up. The executive is to receive the total payments and the bank will pay the executive additional compensation to cover his excise taxes.
3. Neither cutback nor gross up. The executive receives his payments, even if they trigger an excise tax, but the bank does not cover his excise taxes. This one should include a filter that would cutback the parachute payments if the excise taxes cause the executive to receive less on a net after tax basis.

Do we have to apply the same strategy for all covered executives?

No. As with other nonqualified benefit plans, you can have different CIC provisions for each executive.

What happens after the CIC is completed?

Typically the timing and amount due the executive is paid pursuant to the CIC provisions in the plan agreement. However, Section 409A of the Internal Revenue Code allows the buying bank to terminate the plan and pay a lump sum to each executive in the plan. The buying bank may only do so if it follows the specific criteria detailed in §409A. Boards and executives should take this into consideration in designing or updating their plan.

Equias Alliance offers securities through ProEquities, Inc. member FINRA & SIPC. Equias Alliance is independent of ProEquities, Inc.). IRS Circular 230 Disclosure: As required by U.S. Treasury Regulations, we advise you that any tax advice contained in this communication is not intended to be used, and cannot be used, for the purpose of avoiding penalties under the Internal Revenue Code.