How Mergers Can Impact Deferred Compensation Plans: Part I

9-20-13-Equias.pngMany bank boards during merger discussions find themselves confronting the question of severance benefits and how that will impact the merger. What if the bank being sold has a Supplemental Executive Retirement Plan (SERP)? Could that trigger a so-called golden parachute clause with tax consequences for the acquiring bank? The answer is yes. In some cases, this could impact the negotiations. In a series of articles, Equias Alliance explains how Internal Revenue Service rules are triggered and what to do about it. This first article describes when a change-of-control triggers a parachute payment and subsequent excise taxes.

If our bank has a Supplemental Executive Retirement Plan (SERP) or other non-qualified deferred compensation (NQDC) arrangement, what is the potential impact on a merger with another bank?

If the plan agreement provides for accelerated vesting of the benefit upon a change in control (CIC), two things happen:

  1. The increase in the vested benefit must be immediately accrued as a liability.
  2. The acceleration, referred to as a parachute payment, must be included in the calculation of total parachute payments under Section 280G of the Internal Revenue Code (§280G). (Note: §280G does not apply to Subchapter S banks.)

But if the buyer pays for it, why should we be concerned?

These provisions can impact the price the buyer pays for your bank. A general rule of thumb is that if the cost of all severance benefits is less than 5 percent of the purchase price, it should not impact the price paid for the bank. When the cost exceeds 5 percent, it may impact the price, depending on many other factors. The board should be knowledgeable of the total impact compensation costs might have in the event of a CIC.

If the executive(s) plan on continuing to work for the buyer, does that reduce the impact?

No, both generally accepted accounting principles (GAAP) and §280G require that the present value of the vested benefits be measured and recognized at the date the CIC occurs, even if payments are to be made at a later date.

How do we determine the impact?

First, §280G is very detailed and complex. The bank should seek advice from its accountants and legal counsel.

That said, the income and excise taxes become payable if the total parachute payments equal or exceed three times the executives average W-2 compensation for the past five years. Be careful here as parachute payments are comprised of all forms of compensation, including severance payments, as well as the incremental value of stock options, restricted stock, medical benefits, and incremental accelerated vesting of SERPs and other NQDC arrangements.

Example #1:
The executive’s five-year average W-2 compensation is $100,000 and his parachute payments total $250,000.Three times his compensation is $300,000, so he is under the §280G limit. No excise taxes are due and the payments are fully deductible by the bank, but the present value of the additional benefit obligations created by the CIC still must be accrued for GAAP purposes.

Example #2:
Assume the same facts as #1, except the executive’s parachute payments total $500,000. Since the executive’s payments exceed the allowable amount, payments in excess of one times his salary will be subject to excise taxes. The excise taxes would total $80,000 ($500,000-$100,000) x 20 percent. In addition, he would also pay regular income taxes on the $500,000. The bank would only be able to deduct $100,000 of the compensation paid.

Can we reduce what’s considered to be a parachute payment by deferring payment?

No, the measurement for purposes of §280G is what he is entitled to after the CIC. The present value of the incremental increase in his vested SERP benefit has to be included even if he is to receive the money at a later date. For example, assume the executive is vested in an annual SERP benefit of $25,000 for 15 years, but upon a CIC he becomes entitled to an annual benefit of $60,000 per year. If the CIC occurs, he receives an incremental vested benefit of $35,000 per year, a total payment increase of $525,000, but using present value calculations, the increased value for parachute payment purposes would be around $395,000.

The intricacies associated with the implications of §280G are complex and not easily covered in limited space. Stay tuned for Part II of our series, which will explore what to do if your bank is impacted by §280G.

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.

Why It’s Important to Calculate Your Change-In-Control Payouts Now

iStock_000019351044XSmall.jpgBusiness planning is a key bank responsibility, but many institutions fail to adequately address a critical element of planning:  clarifying and understanding the impact of severance and change-in-control benefits in the event of a potential future transaction.  

Deal offers are often unexpected or need to be quickly evaluated. Negotiations go much more smoothly if the bank has already defined and detailed its change-in-control (CIC) terms and fully considered their potential impact on the executive team.  Why? 

Consider this scenario.  Let’s say the bank’s board and management have agreed on fairly standard and, they believed, fair CIC severance packages:  two times base salary + bonus along with equity acceleration and benefits continuation.  In the process of setting terms, however, the bank made what is actually a common error: It failed to consider the potentially significant impact of the golden parachute excise tax.  

When the bank did the tax calculations, it discovered executives would be subject to an excise tax that would reduce their net severance payout by more than half. Only when the deal became real did it become clear that the benefit structure and ultimate payout would be significantly different than what was intended.   

This unplanned outcome forces two negotiations.  First, the target’s management and board will try to resolve the difference between the intended and the actual value.  But with an offer already on the table, there will need to be a second negotiation with the buyer to get agreement on any changes to the terms.  As a result, the target and the buyer are distracted from the primary objective, which is to evaluate and approve a deal that will create value for both banks’ shareholders.

I will be discussing this and other topics impacting mergers and acquisitions at the Bank Director Acquire or Be Acquired conference in Scottsdale, Arizona, Jan. 27 to Jan 29, including the following: 

  • What are banks doing about CIC benefits?
  • What are some of the “hidden” negative consequences?
  • What can banks do to help mitigate these unintended consequences?