Navigating Change in Control Tax Liabilities: Alternatives to Excise Tax Gross Ups for Executives

Navigating Change in Control Tax Liabilities: Alternatives to Excise Tax Gross Ups for Executives

In the realm of executive compensation, change in control events such as mergers, acquisitions or corporate restructurings can trigger significant tax liabilities for executives. In the past, companies have used excise tax gross ups to indemnify executives against these taxes, but the prevalence of this practice has been diminishing in recent years due to shareholder scrutiny and regulatory changes. In this article, we explore the reasons behind the decline of excise tax gross ups and alternative solutions that can mitigate tax liabilities for executives in change in control situations.

The Decline of Excise Tax Gross Ups

Excise tax gross ups, also known as tax reimbursement provisions, have long been a common feature of executive employment agreements and severance packages. These provisions ensure that executives are fully compensated for any excise taxes imposed on excess parachute payments triggered by a change in control event.

However, excise tax gross ups have come under increased scrutiny from shareholders, proxy advisory firms and regulatory agencies. Critics argue that gross ups can lead to excessive executive pay, dilute shareholder value and create perverse incentives for executives to pursue transactions solely for personal gain.

In response to these concerns, many companies have opted to eliminate or limit excise tax gross ups in executive contracts. Some companies have also faced pressure from institutional investors and proxy advisors to adopt more shareholder-friendly compensation practices, including the elimination of gross ups.

Alternative Solutions for Mitigating Tax Liabilities

In the case of private companies, this seldom poses a concern. Usually, the strategy to sidestep excise tax and the loss of tax deductions for excess parachute payments involves securing substantial shareholder approval for these payments.

For public companies or where approvals are not received, there are several alternative solutions that companies and executives can explore to mitigate tax liabilities in change in control situations:

  1. Modified Gross Ups: Instead of providing full indemnification for excise taxes, companies may opt for modified gross ups that limit the amount of reimbursement or cap the total payout to executives.
  2. Cutback Provisions: Also known as a “Net-Best Provision,” this provision ensures that the executive receives the maximum after-tax benefit from their CIC payments, taking into account the excise taxes imposed under Section 280G. This means structuring payments in a manner that minimizes the executive's tax liabilities while still providing fair and reasonable compensation.
  3. Valley Provisions: The provision may delay or defer the timing of certain payments to executives, such as severance payments, bonuses, or equity awards, to future tax years. By spreading out the payments over multiple years, the total amount received by the executive may fall below the threshold for excise taxes under Section 280G.
  4. Increasing the Numerator: The determination of whether the excise tax is triggered is based on a formula. That formula allows for up to 3 times the previous 5 years W2 wages to be paid without paying the 20% excise tax. So, the numerator in this equation is very important. Per IRS guidelines, there is concept known as compensation for prior years services analysis, which allows a company to review historical compensation paid to an executive as compared to the market. If compensation is determined to be less than what a justified amount could have been, the company can apply this value to the average calculation, thereby increasing the threshold for the excise tax.

As excise tax gross ups become less prevalent in executive compensation arrangements, companies and executives must explore alternative solutions for mitigating tax liabilities in change in control situations. By adopting more shareholder-friendly compensation practices and implementing tax planning strategies, companies can align executive pay with shareholder interests while still providing executives with fair and competitive compensation packages. Likewise, executives can take proactive steps to protect their financial interests and minimize tax burdens through careful negotiation and tax planning. As the landscape of executive compensation continues to evolve, it is essential for companies and executives to stay informed about best practices and regulatory developments in this area.


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Navigating Change in Control Tax Liabilities: Alternatives to Excise Tax Gross Ups for Executiveshttps://www.cbiz.com/Portals/0/Images/Image_Navigating Change in Control Tax Liabilities Alternatives to Excise Tax Gross Ups for Executives -1.png?ver=FWhNkMehhJensYRDkdMMGQ%3d%3dhttps://www.cbiz.com/Portals/0/Images/Image_Navigating Change in Control Tax Liabilities Alternatives to Excise Tax Gross Ups for Executives .png?ver=KrDyAexTbwTQWVySDnGgnw%3d%3d2025-01-20T18:00:00-05:00Learn about the decline of excise tax gross ups in executive compensation during change in control events like mergers and acquisitions. Explore alternative solutions to mitigate tax liabilities for executives facing these situations.Planning & Tax MinimizationCompensation ConsultingYes