[Federal Register Volume 68, Number 149 (Monday, August 4, 2003)]
[Rules and Regulations]
[Pages 45745-45772]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-19274]


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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.

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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 Sec.  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.

[[Page 45746]]

    The collection of information in this regulation is in Sec.  
1.280G-1, Q/A-7(a). This information is a brief description of all 
material facts concerning all payments which would be parachute 
payments (but for Sec.  1.280G-1, Q/A-6). This information may be used 
by certain corporations with no readily tradeable stock (assuming 
certain shareholder approval requirements are also met) to determine if 
the payments to a disqualified individual are exempt from the 
definition of parachute payments. The collection of information is 
voluntary. The likely respondents are business or other for-profit 
institutions.
    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. Comments on the collection of information should be received by 
October 3, 2003. Comments are specifically requested concerning:
    Whether the collection[s] of information is necessary for the 
proper performance of the functions of the Internal Revenue Service, 
including whether the information will have practical utility;
    The accuracy of the estimated burden associated with the collection 
of information (see below);
    How the quality, utility, and clarity of the information to be 
collected may be enhanced;
    How the burden of complying with the collection of information may 
be minimized, including through the application of automated collection 
techniques or other forms of information technology; and
    Estimates of capital or start-up costs and costs of operation, 
maintenance, and purchase of service to provide information.
    Estimated total annual reporting and/or recordkeeping burden: 
12,000 hours.
    Estimated average annual burden hours per respondent: 15 hours.
    Estimated number of respondents and/or recordkeepers: 800
    Estimated annual frequency of responses: On occasion.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless it displays a valid 
control number assigned by the Office of Management and Budget.
    Books or records relating to a collection of information must be 
retained as long as their contents may become material in the 
administration of any internal revenue law. Generally, tax returns and 
tax return information are confidential, as required by 26 U.S.C. 6103.

Background

    This document contains amendments to 26 CFR part 1 under section 
280G of the Internal Revenue Code (Code). Sections 280G and 4999 of the 
Code were added to the Code by section 67 of the Deficit Reduction Act 
of 1984, Public Law 98-369 (98 Stat. 585). Section 280G was amended by 
section 1804(j) of the Tax Reform Act of 1986, Public Law 99-514 (100 
Stat. 2807), section 1018(d) of the Technical and Miscellaneous Revenue 
Act of 1988, Public Law 100-647 (102 Stat. 3581) and section 1421 of 
the Small Business Job Protection Act of 1996, Public Law 104-188 (110 
Stat. 1755).
    Section 280G denies a deduction to a corporation for any excess 
parachute payment. Section 4999 imposes a 20-percent excise tax on the 
recipient of any excess parachute payment. Related provisions include 
section 275(a)(6), which denies the recipient a deduction for the 
section 4999 excise tax, and section 3121(v)(2)(A), which relates to 
the Federal Insurance Contributions Act.
    On February 20, 2002, a notice of proposed rulemaking (REG-209114-
90, 2002-2 I.R.B. 576), was published in the Federal Register at 67 FR 
7630 (the 2002 proposed regulations) and corrected in the Federal 
Register at 67 FR 42210 on June 21, 2002. No hearing was requested or 
held. The IRS received written and electronic comments responding to 
the notice of proposed rulemaking. After consideration of the comments, 
the 2002 proposed regulations are adopted as amended by this Treasury 
decision. The significant revisions are discussed below.

Explanation of Provisions and Summary of Comments

Overview

    Section 280G(b)(2)(A) defines a parachute payment as any payment 
that meets all of the following four conditions: (a) The payment is in 
the nature of compensation; (b) the payment is to, or for the benefit 
of, a disqualified individual; (c) the payment is contingent on a 
change in the ownership of a corporation, the effective control of a 
corporation, or the ownership of a substantial portion of the assets of 
a corporation (a change in ownership or control); and (d) the payment 
has (together with other payments described in (a), (b), and (c) of 
this paragraph with respect to the same individual) an aggregate 
present value of at least 3 times the individual's base amount. Section 
280G(b)(2)(B) provides that the term parachute payment also includes 
any payment in the nature of compensation to, or for the benefit of, a 
disqualified individual if the payment is pursuant to an agreement that 
violates any generally enforced securities laws or regulations 
(securities violation parachute payment).
    Section 280G(b)(1) defines the term excess parachute payment as an 
amount equal to the excess of any parachute payment over the portion of 
the disqualified individual's base amount that is allocated to such 
payment. For this purpose, the portion of the base amount allocated to 
a parachute payment is the amount that bears the same ratio to the base 
amount as the present value of the parachute payment bears to the 
aggregate present value of all such payments to the same disqualified 
individual.
    Generally, excess parachute payments may be reduced by certain 
amounts of reasonable compensation. Section 280G(b)(4)(B) provides 
that, except in the case of securities violation parachute payments, 
the amount of an excess parachute payment is reduced by any portion of 
the payment that the taxpayer establishes by clear and convincing 
evidence is reasonable compensation for personal services actually 
rendered by the disqualified individual before the date of the change 
in ownership or control. Such reasonable compensation is first offset 
against the portion of the base amount allocated to the payment.

Exempt Payments

    Section 280G specifically exempts from the definition of the term 
parachute payment several types of payments that would otherwise 
constitute parachute payments. Deductions for payments exempt from the 
definition of parachute payment are not disallowed by section 280G, and 
such exempt payments are not subject to the 20-percent excise tax of 
section 4999. In addition, such exempt payments are not taken into 
account in applying the 3-times-base-amount test of section 
280G(b)(2)(A)(ii).
1. Tax-Exempt Entities
    Q/A-6 of the 2002 proposed regulations provides that a payment with 
respect to a tax-exempt entity that would otherwise constitute a 
parachute payment is exempt from the definition of the term parachute 
payment if certain conditions are satisfied. First, the payment must be 
made by a corporation undergoing a change in ownership or

[[Page 45747]]

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

[[Page 45748]]

who would receive a parachute payment if the requirements of Q/A-7 are 
not met, such person is not permitted to vote any of the shares held by 
the entity shareholder. However, the entity shareholder is permitted to 
authorize another equity interest holder in the entity shareholder to 
vote the otherwise eligible shares or, in the case of a trust, another 
person eligible to vote on behalf of the trust. Thus, for example, 
assume a partner owns one-third of a partnership; the partner is 
authorized to vote on behalf of the partnership; the partnership owns 
stock in a corporation; the partner is a disqualified individual with 
respect to the corporation; and the corporation undergoes a change in 
ownership or control. Under these circumstances, none of the stock held 
by the partnership is entitled to vote under Q/A-7. However, the 
partnership is permitted to appoint an equity interest holder in the 
entity shareholder (who is not a disqualified individual who would 
receive parachute payments if the shareholder approval requirements of 
Q/A-7 are not met) to vote two-thirds of the stock.
    More generally, several commentators requested significant 
revisions to Q/A-7 to reflect certain business practices. The revisions 
suggested by commentators include, among other things, treating 
approval of a compensation agreement when the agreement is executed as 
sufficient for Q/A-7 or deeming shareholders who acquire stock after 
approval of any compensation agreements to consent to any parachute 
payments contained in these agreements. While the Treasury Department 
and IRS understand that the requirements of Q/A-7 may not coincide with 
certain business practices, the requirements of Q/A-7 are based on the 
statutory framework provided by Congress. The golden parachute 
provisions are intended to protect equity shareholders whose interest 
in the corporation could be impaired by parachute payments to 
disqualified individuals by discouraging these types of payments. The 
basic structure of section 280G does not permit any approval or 
shareholder vote for a publicly traded corporation. The exception for 
corporations that are not publicly traded is based on a vote of those 
persons who hold shares immediately before the change in ownership or 
control after adequate disclosure. The suggested revisions to the 
shareholder approval requirements are inconsistent with these 
requirements and, accordingly, no changes are made in these 
regulations.

Payment of the Excise Tax Under Section 4999

    Q/A-11(c) of the 2002 proposed regulations provided a mechanism to 
allow a disqualified individual to prepay the excise tax under section 
4999 in certain circumstances. Thus, the requirements of section 4999 
may be satisfied in the year of the change in ownership or control (or 
the first year for which a payment contingent on a change in ownership 
or control is certain to be made) even though the payment is not yet 
includible in income (or otherwise received).
    These regulations continue to allow the prepayment of the excise 
tax in the year of the change in ownership or control. These 
regulations also provide that a taxpayer may prepay the excise tax in a 
later year. For purposes of prepayment, these regulations require the 
payor and disqualified individual to treat the payment of the excise 
tax consistently and require the payor to satisfy its obligations under 
section 4999. These regulations clarify that the prepayment of the 
excise tax is based on the present value of the excise tax that would 
be due in the year the excess parachute payment would actually be paid. 
For purposes of determining the present value of the excise tax due, 
the discount rate is determined in accordance with Q/A-32.
    Thus, for example, assume that E is a disqualified individual with 
respect to Corporation X, that X undergoes a change in ownership or 
control, and that E receives parachute payments, including a series of 
annual payments to be made for the next 10 years. Assume further that 
all other parachute payments to E are made in the year of the change in 
ownership or control (with payment of the excise tax and compliance by 
X with section 4999(c)). Under these regulations, if three years after 
a change in ownership or control, X and E agree that E will prepay the 
excise tax related to the remaining annual payments, and that X will 
satisfy its obligations under section 4999(c) related to these 
payments, E is permitted to prepay the excise tax with respect to the 
remaining payments.
    The 2002 proposed regulations provided that the prepayment of the 
excise tax would not be available with respect to certain payments, 
including payments related to health benefits or coverage. Commenters 
requested that the prepayment option be expanded to include health 
benefits or coverage. Treasury and the IRS do not consider the 
available valuation methods sufficient to allow projections of 
individual payments related to health coverage or health benefits for 
this purpose. In the event that valuation methods change or there is 
otherwise greater certainty with respect to the valuation of such 
benefits, Treasury and the IRS may consider additional guidance that 
would make prepayment of the excise tax with respect to such benefits 
available.

Treatment of Options

    Q/A-13 of the 2002 proposed regulations provides that the transfer 
of an option is treated as a payment when the option becomes 
substantially vested without regard to whether the option has an 
ascertainable fair market value under Sec.  1.83-7(b) of the 
regulations. Thus, the vesting of an option is treated as a payment in 
the nature of compensation for purposes of section 280G. Vested is 
defined in these regulations as substantially vested within the meaning 
of Sec.  1.83-3(b) and (j) or the right to the payment is not otherwise 
subject to a substantial risk of forfeiture within the meaning of 
section 83(c).
    The 2002 proposed regulations, and the 1989 proposed regulations, 
provided that options must be valued under the facts and circumstances 
of a particular case. Factors relevant to the determination include, 
but are not limited to: The difference between the option's exercise 
price and the value of the option property, the probability of the 
value of the option property increasing or decreasing, and the length 
of the period during which the option can be exercised.
    In coordination with the issuance of the 2002 proposed regulations, 
the Commissioner issued two revenue procedures under section 280G 
providing additional guidance on the valuation of options, Rev. Proc. 
2002-13, 2002-8 I.R.B. 549, and Rev. Proc. 2002-45, 2002-27 I.R.B. 40. 
These revenue procedures provide guidance on the use of option 
valuation methods, and provide that using only the spread between the 
exercise price and the value of the option property is not an adequate 
method for valuing an option. The revenue procedures also provide a 
safe harbor method of valuation based on a table. Comments received in 
response to these revenue procedures raised issues related to the 
difficulty of valuing options in the context of a change in ownership 
or control, particularly with respect to assumptions regarding the term 
of the option and the volatility. In coordination with the issuance of 
these regulations, the IRS is issuing a revenue procedure restating the 
previous revenue procedures and addressing these comments.

[[Page 45749]]

Disqualified Individuals

    The 2002 proposed regulations provide that an individual is a 
disqualified individual if, at any time during the disqualified 
individual determination period, the individual is an employee or 
independent contractor of the corporation and is, with respect to the 
corporation, a shareholder (see Q/A-17), an officer (see Q/A-18), or 
(3) a highly-compensated individual (see Q/A-19). The 2002 proposed 
regulations provide that whether an individual is an officer with 
respect to a corporation is determined based on all the facts and 
circumstances in the particular case (such as the source of the 
individual's authority, the term for which the individual is elected or 
appointed, and the nature and extent of the individual's duties).
    These regulations retain this rule concerning officers. However, 
under Q/A-18 of these regulations any individual who has the title of 
officer is presumed to be an officer unless the facts and circumstances 
demonstrate that the individual does not have the authority of an 
officer. However, an individual who does not have the title of officer 
may nevertheless be considered an officer if the facts and 
circumstances demonstrate that the individual should be considered to 
be an officer.

Nonvested Payments Under Q/A-24

    Under Q/A-24(c) of the 2002 proposed regulations, only a portion of 
certain nonvested payments is treated as contingent on a change in 
ownership or control. Specifically, Q/A-24(c) applies to a payment that 
becomes vested as a result of a change in ownership or control to the 
extent that (i) without regard to the change in ownership or control, 
the payment was contingent only on the continued performance of 
services for the corporation for a specified period of time; and (ii) 
the payment is attributable, at least in part, to the performance of 
services before the date the payment is made or becomes certain to be 
made.
    These regulations retain these rules regarding the calculation of 
the amount of the payment that is considered contingent on a change in 
ownership or control, with one revision. Under the 2002 proposed 
regulations, the payment calculation under Q/A-24(c) could not exceed 
the amount of the accelerated payment. A portion of a payment is 
contingent on a change in ownership or control if there is accelerated 
vesting, even if there is no accelerated payment. In that case, the 
amount attributable to the lapse of the obligation to perform services 
is 1 percent of the present value of the future payment multiplied by 
the number of full months between the date that the individual's right 
to receive the payment is vested and the date that, absent the 
acceleration, the payment would have been vested. Under these final 
regulations, the total portion of such payment treated as contingent on 
the change in ownership or control cannot exceed the present value of 
the accelerated payment.

Change in Ownership or Control

    A change in ownership or control is defined in Q/A-27, 28, and 29 
of the 2002 proposed regulations. Under Q/A-27 of the 2002 proposed 
regulations, a change in control of a corporation occurs on the date 
that any one person (or persons acting as a group) acquires ownership 
or stock of the corporation that, together with stock held by such 
person or group, has more than 50 percent of the total fair market 
value or total voting power of the corporation.
    Under Q/A-28 of the 2002 proposed regulations, a change in the 
effective control of a corporation is presumed to occur on the date 
that either (1) any one person (or more than one person acting as a 
group) acquires (or has acquired during the 12-month period ending on 
the date of the most recent acquisition by such person or persons) 
ownership of stock of the corporation possessing 20 percent or more of 
the total voting power of the stock of such corporation, or (2) a 
majority of members of the corporation's board of directors is replaced 
during any 12-month period by directors whose appointment or election 
is not endorsed by a majority of the members of the corporation's board 
of directors prior to the date of the appointment or election.
    Under Q/A-29 of the 2002 proposed regulations, a change in the 
ownership of a substantial portion of a corporation's assets occurs on 
the date that any one person (or more than one person acting as a 
group) acquires (or has acquired during the 12-month period ending on 
the date of the most recent acquisition by such person) assets from the 
corporation that have a total gross fair market value equal to or more 
than one third of the total gross fair market value of all of the 
assets of the corporation immediately prior to such acquisition.
    These regulations generally follow the same approach as the 2002 
proposed regulations. Some commenters suggested that these three 
provisions explicitly address whether more than one change in ownership 
or control can occur in a single transaction. In response to these 
comments, these regulations explicitly adopt the ``one change'' rule 
that historically has been applied by the IRS. These regulations 
provide that if a corporation undergoes a change in ownership or 
control as described in either Q/A-27 or Q/A-29, the other corporation 
involved in the transaction does not undergo a change in ownership or 
control.\1\ As these regulations apply, in any transaction involving 
two corporations, if one has a change in ownership or control under Q/
A-27 or 29, the other corporation does not also have a change in 
ownership or control, under either Q/A-27 or 29. Under these 
regulations, Q/A-28, which relates to effective control, provides that 
there is no change in effective control of a corporation in a 
transaction in which the other corporation has a change of control 
under Q/A-27 or 29.
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    \1\ Because Q/A-46 provides that all members of an affiliated 
group are treated as one corporation, even transactions involving 
multiple entities generally are treated as only two corporations for 
purposes of section 280G.
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    Commentators also requested that the final regulations define gross 
fair market value for purposes of Q/A-29. Under Q/A-29 of these 
regulations, gross fair market value is defined as the value of the 
assets of the corporation, or the value of the assets being disposed 
of, determined without regard to any liabilities associated with such 
assets. This definition is used throughout these regulations.
    For purposes of determining whether there is a change in ownership 
or control under Q/A-27 through Q/A-29 of the 2002 proposed 
regulations, two or more persons may be considered as acting as a 
group. The 2002 proposed regulations provide that, for purposes of 
determining whether two or more persons are acting as a group, a person 
who owns stock in both corporations involved in a transaction (an 
overlapping shareholder) is treated as acting as a group with respect 
to the other shareholders in a corporation only to the extent of such 
person's ownership of stock in that corporation prior to the 
transaction, and not with respect to his or her ownership in the other 
corporation. This rule is consistent with the interpretation of the 
1989 proposed regulations by the IRS.
    Commentators suggested different alternatives to the overlapping 
shareholder rule of Q/A-27 through Q/A-29 of the 2002 proposed 
regulations. One commentator suggested eliminating the overlapping 
shareholder rule and instead relying on the presumption of Q/A-28 for 
all transactions. Under this approach it would be possible for a 
transaction to result in one, two, or no

[[Page 45750]]

change in ownership or control. Other commentators suggested replacing 
the overlapping shareholder rule of the 2002 proposed regulations with 
a new rule based on section 355 or 382. Finally, another commentator 
requested clarification of the application of the overlapping 
shareholder rule of the 2002 proposed regulations under the 1989 
proposed regulations.
    These regulations retain the overlapping shareholder rule of the 
2002 proposed regulations. The group concepts in section 355 or 382 do 
not fit well with the overall purpose of section 280G. Finally, these 
regulations are effective with respect to changes in ownership or 
control that occur after January 1, 2004, and to payments that are 
contingent on such changes. These regulations do not provide any 
transitional rules for the application of the overlapping shareholder 
rules for prior periods both because these regulations are not 
effective for prior periods and because the positions set forth in 2002 
proposed regulations are merely clarifications of the positions taken 
by the IRS under section 280G (illustrated by the 1989 proposed 
regulations).

International Issues

    Commentators recommended that the final regulations provide that a 
disqualified individual who, during the disqualified individual 
determination period, was a nonresident alien and was not subject to 
income tax in the United States on wages earned from the affiliated 
group, not be subject to the excise tax. Treasury and the IRS do not 
believe that they have the authority to preclude application of the 
excise tax to a nonresident alien under these circumstances. 
Accordingly, the final regulations do not include any special rules for 
excess parachute payments received by nonresident aliens.
    Commentators also requested clarification that, even though 
parachute payments made by a foreign subsidiary of a U.S. corporation 
may not be deductible, such payments reduce the foreign subsidiary's 
earnings and profits. Because this issue has implications beyond 
section 280G and foreign subsidiaries, it is not addressed in these 
regulations.

Effective Date and Reliance

    These regulations apply to any payments that are contingent on a 
change in ownership or control if the change of ownership or control 
occurs on or after January 1, 2004.
    Under the 2002 proposed regulations, taxpayers are permitted to 
rely on the 2002 proposed regulations until the effective date of the 
final regulations. Taxpayers are permitted to rely on the 1989 proposed 
regulations with respect to payments contingent on a change in 
ownership or control if that change occurs before January 1, 2004. A 
clarification in the 2002 proposed regulations does not support 
reliance on the 1989 proposed regulations for a position contrary to 
the provisions of the 1989 proposed regulations.
    Taxpayers are permitted to rely on the 2002 proposed regulations, 
including for purposes of amended returns with respect to the 
following: (1) That a shareholder who owns stock with a fair market 
value of $1 million is not a disqualified individual and (2) that the 
base amount includes the amount of compensation included in gross 
income under section 83(b).

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in Executive Order 
12866. Therefore, a regulatory assessment is not required. Section 
1.280G-1 of these proposed regulations provides for the collection of 
information. It is hereby certified that the collection of information 
in these regulations will not have a significant economic impact on a 
substantial number of small entities. This certification is based on 
the fact that, as indicated in the Paperwork Reduction Act section 
earlier in the preamble, only 800 small entities are expected to be 
affected by the regulations annually, and it is unlikely that any small 
entity would be affected by these regulations more than once or twice 
in its existence. Therefore, an analysis under the Regulatory 
Flexibility Act (5 U.S.C. chapter 6) is not required. Pursuant to 
section 7805(f) of the Code, the notice of proposed rulemaking 
preceding these regulations was submitted to the Small Business 
Administration for comment on its impact on small business.

Drafting Information

    The principal author of these regulations is Erinn Madden, Office 
of the Division Counsel/Associate Chief Counsel (Tax Exempt and 
Government Entities). However, other personnel from the IRS and 
Treasury Department participated in their development.

List of Subjects

26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 602

    Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

0
Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAX; TAXABLE YEARS BEGINNING AFTER DECEMBER 31, 1986

0
Paragraph 1. The authority citation for part 1 is amended by adding the 
following entry in numerical order to read in part as follows:

    Authority: 26 U.S.C. 7805 * * *

    Section 1.280G-1 also issued under 26 U.S.C. 280G(b) and (e). * * *

0
Par. 2. Section Sec.  1.280G-1 is added to read as follows:


Sec.  1.280G-1  Golden parachute payments.

    The following questions and answers relate to the treatment of 
golden parachute payments under section 280G of the Internal Revenue 
Code of 1986, as added by section 67 of the Tax Reform Act of 1984 
(Pub. L. No. 98-369; 98 Stat. 585) and amended by section 1804(j) of 
the Tax Reform Act of 1986 (Pub. L. No. 99-514; 100 Stat. 2807), 
section 1018(d)(6)-(8) of the Technical and Miscellaneous Revenue Act 
of 1988 (Pub. L. No. 100-647; 102 Stat. 3581), and section 1421 of the 
Small Business Job Protection Act of 1996 (Pub. L. No. 104-188; 110 
Stat. 1755). The following is a table of subjects covered in this 
section:

Overview

Effect of section 280G--Q/A-1
Meaning of ``parachute payment''--Q/A-2
Meaning of ``excess parachute payment''--Q/A-3
Effective date of section 280G--Q/A-4

Exempt Payments

Exempt payments generally--Q/A-5
Exempt payments with respect to certain corporations--Q/A-6
Shareholder approval requirements--Q/A-7
Exempt payments under a qualified plan--Q/A-8
Exempt payments of reasonable compensation--Q/A-9

Payor of Parachute Payments--Q/A-10

Payments in the Nature of Compensation

The nature of compensation--Q/A-11
Property transfers--Q/A-12
Stock options--Q/A-13
Reduction of amount of payment by consideration paid--Q/A-14

Disqualified Individuals

Meaning of ``disqualified individual''--Q/A-15
Personal service corporation treated as individual--Q/A-16
Meaning of ``shareholder''--Q/A-17
Meaning of ``officer''--Q/A-18
Meaning of ``highly-compensated individual''--Q/A-19

[[Page 45751]]

Meaning of ``disqualified individual determination period''--Q/A-20
Meaning of ``compensation''--Q/A-21

Contingent on Change in Ownership or Control

General rules for determining payments contingent on change--Q/A-22
Payments under agreement entered into after change--Q/A-23
Amount of payment contingent on change--Q/A-24
Presumption that payment is contingent on change--Q/A-25, 26
Change in ownership or control--Q/A-27, 28, 29

Three-Times-Base-Amount Test for Parachute Payments

Three-times-base-amount test--Q/A-30
Determination of present value--Q/A-31, 32, 33
Meaning of ``base amount''--Q/A-34
Meaning of ``base period''--Q/A-35
Special rule for determining base amount--Q/A-36
Securities Violation Parachute Payments--Q/A-37

Computation and Reduction of Excess Parachute Payments

Computation of excess parachute payments--Q/A-38
Reduction by reasonable compensation--Q/A-39

Determination of Reasonable Compensation

General criteria for determining reasonable compensation--Q/A-40
Types of payments generally considered reasonable compensation--Q/A-
41, 42, 43
Treatment of severance payments--Q/A-44

Miscellaneous Rules

Definition of corporation--Q/A-45
Treatment of affiliated group as one corporation--Q/A-46

Effective Date

General effective date of section 280G--Q/A-47
Effective date of regulations--Q/A-48

Overview

    Q-1: What is the effect of Internal Revenue Code section 280G?
    A-1: (a) Section 280G disallows a deduction for any excess 
parachute payment paid or accrued. For rules relating to the imposition 
of a nondeductible 20-percent excise tax on the recipient of any excess 
parachute payment, see Internal Revenue Code sections 4999, 275(a)(6), 
and 3121(v)(2)(A).
    (b) The disallowance of a deduction under section 280G is not 
contingent on the imposition of the excise tax under section 4999. The 
imposition of the excise tax under section 4999 is not contingent on 
the disallowance of a deduction under section 280G. Thus, for example, 
because the imposition of the excise tax under section 4999 is not 
contingent on the disallowance of a deduction under section 280G, a 
payee may be subject to the 20-percent excise tax under section 4999 
even though the disallowance of the deduction for the excess parachute 
payment may not directly affect the federal taxable income of the 
payor.
    Q-2: What is a parachute payment for purposes of section 280G?
    A-2: (a) The term parachute payment means any payment (other than 
an exempt payment described in Q/A-5) that--
    (1) Is in the nature of compensation;
    (2) Is made or is to be made to (or for the benefit of) a 
disqualified individual;
    (3) Is contingent on a change--
    (i) In the ownership of a corporation;
    (ii) In the effective control of a corporation; or
    (iii) In the ownership of a substantial portion of the assets of a 
corporation; and
    (4) Has (together with other payments described in paragraphs 
(a)(1), (2), and (3) of this A-2 with respect to the same disqualified 
individual) an aggregate present value of at least 3 times the 
individual's base amount.
    (b) Hereinafter, a change referred to in paragraph (a)(3) of this 
A-2 is generally referred to as a change in ownership or control. For a 
discussion of the application of paragraph (a)(1), see Q/A-11 through 
Q/A-14; paragraph (a)(2), Q/A-15 through Q/A-21; paragraph (a)(3), Q/A-
22 through Q/A-29; and paragraph (a)(4), Q/A-30 through Q/A-36.
    (c) The term parachute payment also includes any payment in the 
nature of compensation to (or for the benefit of) a disqualified 
individual that is pursuant to an agreement that violates a generally 
enforced securities law or regulation. This type of parachute payment 
is referred to in this section as a securities violation parachute 
payment. See Q/A-37 for the definition and treatment of securities 
violation parachute payments.
    Q-3: What is an excess parachute payment for purposes of section 
280G?
    A-3: The term excess parachute payment means an amount equal to the 
excess of any parachute payment over the portion of the base amount 
allocated to such payment. Subject to certain exceptions and 
limitations, an excess parachute payment is reduced by any portion of 
the payment which the taxpayer establishes by clear and convincing 
evidence is reasonable compensation for personal services actually 
rendered by the disqualified individual before the date of the change 
in ownership or control. For a discussion of the nonreduction of a 
securities violation parachute payment by reasonable compensation, see 
Q/A-37. For a discussion of the computation of excess parachute 
payments and their reduction by reasonable compensation, see Q/A-38 
through Q/A-44.
    Q-4: What is the effective date of section 280G and this section?
    A-4: In general, section 280G applies to payments under agreements 
entered into or renewed after June 14, 1984. Section 280G also applies 
to certain payments under agreements entered into on or before June 14, 
1984, and amended or supplemented in significant relevant respect after 
that date. This section applies to any payment that is contingent on a 
change in ownership or control and the change in ownership or control 
occurs on or after January 1, 2004. For a discussion of the application 
of the effective date, see Q/A-47 and Q/A-48.

Exempt Payments

    Q-5: Are some types of payments exempt from the definition of the 
term parachute payment?
    A-5: (a) Yes, the following five types of payments are exempt from 
the definition of parachute payment--
    (1) Payments with respect to a small business corporation 
(described in Q/A-6 of this section);
    (2) Certain payments with respect to a corporation no stock in 
which is readily tradeable on an established securities market (or 
otherwise) (described in Q/A-6 of this section);
    (3) Payments to or from a qualified plan (described in Q/A-8 of 
this section);
    (4) Certain payments made by a corporation undergoing a change in 
ownership or control that is described in any of the following sections 
of the Internal Revenue Code: section 501(c) (but only if such 
organization is subject to an express statutory prohibition against 
inurement of net earnings to the benefit of any private shareholder or 
individual, or if the organization is described in section 501(c)(1) or 
section 501(c)(21)), section 501(d), or section 529, collectively 
referred to as tax-exempt organizations (described in Q/A-6 of this 
section); and
    (5) Certain payments of reasonable compensation for services to be 
rendered on or after the change in ownership or control (described in 
Q/A-9 of this section).
    (b) Deductions for payments exempt from the definition of parachute 
payment are not disallowed by section 280G, and such exempt payments 
are not subject to the 20-percent excise tax of section 4999. In 
addition, such

[[Page 45752]]

exempt payments are not taken into account in applying the 3-times-
base-amount test of Q/A-30 of this section.
    Q-6: Which payments with respect to a corporation referred to in 
paragraph (a)(1), (a)(2), or (a)(4) of Q/A-5 of this section are exempt 
from the definition of parachute payment?
    A-6: (a) The term parachute payment does not include--
    (1) Any payment to a disqualified individual with respect to a 
corporation which (immediately before the change in ownership or 
control) would qualify as a small business corporation (as defined in 
section 1361(b) but without regard to section 1361(b)(1)(C) thereof), 
without regard to whether the corporation had an election to be treated 
as a corporation under section 1361 in effect on the date of the change 
in ownership or control;
    (2) Any payment to a disqualified individual with respect to a 
corporation (other than a small business corporation described in 
paragraph (a)(1) of this A-6) if--
    (i) Immediately before the change in ownership or control, no stock 
in such corporation was readily tradeable on an established securities 
market or otherwise; and
    (ii) The shareholder approval requirements described in Q/A-7 of 
this section are met with respect to such payment; or
    (3) Any payment to a disqualified individual made by a corporation 
which is a tax-exempt organization (as defined in paragraph (a)(4) of 
Q/A-5 of this section), but only if the corporation meets the 
definition of a tax-exempt organization both immediately before and 
immediately after the change in ownership or control.
    (b) For purposes of paragraph (a)(1) of this A-6, the members of an 
affiliated group are not treated as one corporation.
    (c) The requirements of paragraph (a)(2)(i) of this A-6 are not met 
with respect to a corporation if a substantial portion of the assets of 
any entity consists (directly or indirectly) of stock in such 
corporation and any ownership interest in such entity is readily 
tradeable on an established securities market or otherwise. For this 
purpose, such stock constitutes a substantial portion of the assets of 
an entity if the total fair market value of the stock is equal to or 
exceeds one third of the total gross fair market value of all of the 
assets of the entity. For this purpose, gross fair market value means 
the value of the assets of the entity, determined without regard to any 
liabilities associated with such assets. If a corporation is a member 
of an affiliated group (which group is treated as one corporation under 
A-46 of this section), the requirements of paragraph (a)(2)(i) of this 
A-6 are not met if any stock in any member of such group is readily 
tradeable on an established securities market or otherwise.
    (d) For purposes of paragraph (a)(2)(i) of this A-6, the term stock 
does not include stock described in section 1504(a)(4) if the payment 
does not adversely affect the redemption and liquidation rights of any 
shareholder owning such stock.
    (e) For purposes of paragraph (a)(2)(i) of this A-6, stock is 
treated as readily tradeable if it is regularly quoted by brokers or 
dealers making a market in such stock.
    (f) For purposes of paragraph (a)(2)(i) of this A-6, the term 
established securities market means an established securities market as 
defined in Sec.  1.897-1(m).
    (g) The following examples illustrate the application of this 
exemption:

    Example 1. A small business corporation (within the meaning of 
paragraph (a)(1) of this A-6) operates two businesses. The 
corporation sells the assets of one of its businesses, and these 
assets represent a substantial portion of the assets of the 
corporation. Because of the sale, the corporation terminates its 
employment relationship with persons employed in the business the 
assets of which are sold. Several of these employees are highly-
compensated individuals to whom the owners of the corporation make 
severance payments in excess of 3 times each employee's base amount. 
Since the corporation is a small business corporation immediately 
before the change in ownership or control, the payments are not 
parachute payments.
    Example 2. Assume the same facts as in Example 1, except that 
the corporation is not a small business corporation within the 
meaning of paragraph (a)(1) of this A-6. If no stock in the 
corporation is readily tradeable on an established securities market 
(or otherwise) immediately before the change in ownership or control 
and the shareholder approval requirements described in Q/A-7 of this 
section are met, the payments are not parachute payments.
    Example 3. Stock of Corporation S is owned by Corporation P, 
stock in which is readily tradeable on an established securities 
market. The Corporation S stock equals or exceeds one third of the 
total gross fair market value of the assets of Corporation P, and 
thus, represents a substantial portion of the assets of Corporation 
P. Corporation S makes severance payments to several of its highly-
compensated individuals that are parachute payments under section 
280G and Q/A-2 of this section. Because stock in Corporation P is 
readily tradeable on an established securities market, the payments 
are not exempt from the definition of parachute payments under this 
A-6.
    Example 4. A is a corporation described in section 501(c)(3), 
and accordingly, its net earnings are prohibited from inuring to the 
benefit of any private shareholder or individual. A transfers 
substantially all of its assets to another corporation resulting in 
a change in ownership or control. Contingent on the change in 
ownership or control, A makes a payment that, but for the potential 
application of the exemption described in A-5(a)(4), would 
constitute a parachute payment. However, one or more aspects of the 
transaction that constitutes the change in ownership or control 
causes A to fail to be described in section 501(c)(3). Accordingly, 
A fails to meet the definition of a tax-exempt organization both 
immediately before and immediately after the change in ownership or 
control, as required by this A-6. As a result, the payment made by A 
that was contingent on the change in ownership or control is not 
exempt from the definition of parachute payment under this A-6.
    Example 5. B is a corporation described in section 501(c)(15). B 
does not meet the definition of a tax-exempt organization because 
section 501(c)(15) does not expressly prohibit inurement of B's net 
earnings to the benefit of any private shareholder or individual. 
Accordingly, if B has a change in ownership or control and makes a 
payment that would otherwise meet the definition of a parachute 
payment, such payment is not exempt from the definition of the term 
parachute payment for purposes of this A-6.

    Q-7: How are the shareholder approval requirements referred to in 
paragraph (a)(2)(ii) of Q/A-6 of this section met?
    A-7: (a) General rule. The shareholder approval requirements 
referred to in paragraph (a)(2)(ii) of Q/A-6 of this section are met 
with respect to any payment if--
    (1) Such payment is approved by more than 75 percent of the voting 
power of all outstanding stock of the corporation entitled to vote (as 
described in this A-7) immediately before the change in ownership or 
control; and
    (2) Before the vote, there was adequate disclosure to all persons 
entitled to vote (as described in this A-7) of all material facts 
concerning all material payments which (but for Q/A-6 of this section) 
would be parachute payments with respect to a disqualified individual.
    (b) Voting requirements--(1) General rule. The vote described in 
paragraph (a)(1) of this A-7 must determine the right of the 
disqualified individual to receive the payment, or, in the case of a 
payment made before the vote, the right of the disqualified individual 
to retain the payment. Except as otherwise provided in this A-7, the 
normal voting rules of the corporation are applicable. Thus, for 
example, an optionholder is generally not permitted to vote for 
purposes of this A-7. For purposes of this A-7, the vote can be on less 
than the full amount of the payment(s) to be

[[Page 45753]]

made. Shareholder approval can be a single vote on all payments to any 
one disqualified individual, or on all payments to more than one 
disqualified individual. The total payment(s) submitted for shareholder 
approval, however, must be separately approved by the shareholders. The 
requirements of this paragraph (b)(1) are not satisfied if approval of 
the change in ownership or control is contingent, or otherwise 
conditioned, on the approval of any payment to a disqualified 
individual that would be a parachute payment but for Q/A-6 of this 
section.
    (2) Special rule. A vote to approve the payment does not fail to be 
a vote of the outstanding stock of the corporation entitled to vote 
immediately before the change in ownership or control merely because 
the determination of the shareholders entitled to vote on the payment 
is based on the shareholders of record as of any day within the six-
month period immediately prior to and ending on date of the change in 
ownership or control, provided the disclosure requirements described in 
paragraph (c) of this A-7 are met.
    (3) Entity shareholder. (i) Approval of a payment by any 
shareholder that is not an individual (an entity shareholder) generally 
must be made by the person authorized by the entity shareholder to 
approve the payment. See paragraph (b)(4) of this A-7 if the person so 
authorized by the entity shareholder is a disqualified individual who 
would receive a parachute payment if the shareholder approval 
requirements of this A-7 are not met.
    (ii) However, if a substantial portion of the assets of an entity 
shareholder consists (directly or indirectly) of stock in the 
corporation undergoing the change in ownership or control, approval of 
the payment by that entity shareholder must be made by a separate vote 
of the persons who hold, immediately before the change in ownership or 
control, more than 75 percent of the voting power of the entity 
shareholder entitled to vote. The preceding sentence does not apply if 
the value of the stock of the corporation owned, directly or 
indirectly, by or for the entity shareholder does not exceed 1 percent 
of the total value of the outstanding stock of the corporation 
undergoing a change in ownership or control. Where approval of a 
payment by an entity shareholder must be made by a separate vote of the 
owners of the entity shareholder, the normal voting rights of the 
entity shareholder determine which owners shall vote. For purposes of 
this (b)(3)(ii), stock represents a substantial portion of the assets 
of an entity shareholder if the total fair market value of the stock 
held by the entity shareholder in the corporation undergoing the change 
in ownership or control is equal to or exceeds one third of the total 
gross fair market value of all of the assets of the entity shareholder. 
For this purpose, gross fair market value means the value of the assets 
of the entity, determined without regard to any liabilities associated 
with such assets.
    (4) Disqualified individuals and attribution of stock ownership. In 
determining the persons entitled to vote referred to in paragraph 
(a)(1) or (b)(3) of this A-7, stock that would otherwise be entitled to 
vote is not counted as outstanding stock and is not considered in 
determining whether the more than 75 percent vote has been obtained 
under this A-7 if the stock is actually owned or constructively owned 
under section 318(a) by or for a disqualified individual who receives 
(or is to receive) payments that would be parachute payments if the 
shareholder approval requirements described in paragraph (a) of this A-
7 are not met. Likewise, stock is not counted as outstanding stock if 
the owner is considered under section 318(a) to own any part of the 
stock owned directly or indirectly by or for a disqualified individual 
described in the preceding sentence. In addition, if the person 
authorized to vote the stock of an entity shareholder is a disqualified 
individual who would receive a parachute payment if the shareholder 
approval requirements described in this A-7 are not met, such person is 
not permitted to vote such shares, but the entity shareholder is 
permitted to appoint an equity interest holder in the entity 
shareholder, or in the case of a trust another person eligible to vote 
on behalf of the trust, to vote the otherwise eligible shares. However, 
if all persons who hold voting power in the corporation undergoing the 
change in ownership or control are disqualified individuals or related 
persons described in this paragraph (b)(4), then such stock is counted 
as outstanding stock and votes by such persons are considered in 
determining whether the more than 75 percent vote has been obtained.
    (c) Adequate disclosure. To be adequate disclosure for purposes of 
paragraph (a)(2) of this A-7, disclosure must be full and truthful 
disclosure of the material facts and such additional information as is 
necessary to make the disclosure not materially misleading at the time 
the disclosure is made. Disclosure of such information must be made to 
every shareholder of the corporation entitled to vote under this A-7. 
For each disqualified individual, material facts that must be disclosed 
include, but are not limited to, the event triggering the payment or 
payments, the total amount of the payments that would be parachute 
payments if the shareholder approval requirements described in 
paragraph (a) of this A-7 are not met, and a brief description of each 
payment (e.g., accelerated vesting of options, bonus, or salary). An 
omitted fact is considered a material fact if there is a substantial 
likelihood that a reasonable shareholder would consider it important.
    (d) Corporation without shareholders. If a corporation does not 
have shareholders, the exemption described in Q/A-6(a)(2) of this 
section and the shareholder approval requirements described in this A-7 
do not apply. Solely for purposes of this paragraph (d), a shareholder 
does not include a member in an association, joint stock company, or 
insurance company.
    (e) Examples. The following examples illustrate the application of 
this A-7:

    Example 1. Corporation S has two shareholders--Corporation P, 
which owns 76 percent of the stock of Corporation S, and A, a 
disqualified individual who would receive a parachute payment if the 
shareholder approval requirements of this A-7 are not met. No stock 
of Corporation P or S is readily tradeable on an established 
securities market (or otherwise). The value of the stock of 
Corporation S equals or exceeds one third of the gross fair market 
value of the assets of Corporation P, and thus, represents a 
substantial portion of the assets of Corporation P. All of the stock 
of Corporation S is sold to Corporation M. Contingent on the change 
in ownership of Corporation S, severance payments are made to 
certain officers of Corporation S in excess of 3 times each 
officer's base amount. If the payments are approved by a separate 
vote of the persons who hold, immediately before the sale, more than 
75 percent of the voting power of the outstanding stock entitled to 
vote of Corporation P and the disclosure rules of paragraph (a)(2) 
of this A-7 are complied with, the shareholder approval requirements 
of this A-7 are met, and the payments are exempt from the definition 
of parachute payment pursuant to A-6 of this section.
    Example 2. (i) Stock of Corporation X, none of which is traded 
on an established market, is acquired by Corporation Y. In the 
voting ballot concerning the sale, the Corporation X shareholders 
are asked to vote either ``yes'' on the sale and ``yes'' to paying 
parachute payments to A, a disqualified individual with respect to 
Corporation A, or ``no'' on the sale and ``no'' to paying parachute 
payments to A.
    (ii) Because the approval of the change in ownership or control 
is conditioned on the approval of the payments to A, the shareholder 
approval requirements of this A-7 are not satisfied. If the payments 
are made to A, the payments are not exempt from the definition of 
parachute payment pursuant to Q/A-6 of this section.

[[Page 45754]]

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

    Q-8: Which payments under a qualified plan are exempt from the 
definition of parachute payment?
    A-8: The term parachute payment does not include any payment to or 
from--
    (a) A plan described in section 401(a) which includes a trust 
exempt from tax under section 501(a);

[[Page 45755]]

    (b) An annuity plan described in section 403(a);
    (c) A simplified employee pension (as defined in section 408(k)); 
or
    (d) A simple retirement account (as defined in section 408(p)).
    Q-9: Which payments of reasonable compensation are exempt from the 
definition of parachute payment?
    A-9: Except in the case of securities violation parachute payments, 
the term parachute payment does not include any payment (or portion 
thereof) which the taxpayer establishes by clear and convincing 
evidence is reasonable compensation for personal services to be 
rendered by the disqualified individual on or after the date of the 
change in ownership or control. See Q/A-37 of this section for the 
definition and treatment of securities violation parachute payments. 
See Q/A-40 through Q/A-44 of this section for rules on determining 
amounts of reasonable compensation.

Payor of Parachute Payments

    Q-10: Who may be the payor of parachute payments?
    A-10: Parachute payments within the meaning of Q/A-2 of this 
section may be paid, directly or indirectly, by--
    (i) The corporation referred to in paragraph (a)(3) of Q/A-2 of 
this section;
    (ii) A person acquiring ownership or effective control of that 
corporation or ownership of a substantial portion of that corporation's 
assets; or
    (iii) Any person whose relationship to such corporation or other 
person is such as to require attribution of stock ownership between the 
parties under section 318(a).

Payments in the Nature of Compensation

    Q-11: What types of payments are in the nature of compensation?
    A-11: (a) General rule. For purposes of this section, all 
payments--in whatever form--are payments in the nature of compensation 
if they arise out of an employment relationship or are associated with 
the performance of services. For this purpose, the performance of 
services includes holding oneself out as available to perform services 
and refraining from performing services (such as under a covenant not 
to compete or similar arrangement). Payments in the nature of 
compensation include (but are not limited to) wages and salary, 
bonuses, severance pay, fringe benefits, life insurance, pension 
benefits, and other deferred compensation (including any amount 
characterized by the parties as interest thereon). A payment in the 
nature of compensation also includes cash when paid, the value of the 
right to receive cash, or a transfer of property. However, payments in 
the nature of compensation do not include attorney's fees or court 
costs paid or incurred in connection with the payment of any amount 
described in paragraphs (a)(1), (2), and (3) of Q/A-2 of this section 
or a reasonable rate of interest accrued on any amount during the 
period the parties contest whether a payment will be made.
    (b) When payment is considered to be made. Except as otherwise 
provided in A-11 through Q/A-13 of this section, a payment in the 
nature of compensation is considered made (and is subject to the excise 
tax under section 4999) in the taxable year in which it is includible 
in the disqualified individual's gross income or, in the case of fringe 
benefits and other benefits excludible from income, in the taxable year 
the benefits are received.
    (c) Prepayment rule. Notwithstanding the general rule described in 
paragraph (b) of this A-11, a disqualified individual may, in the year 
of the change in ownership or control, or any later year, prepay the 
excise tax under section 4999, provided that the payor and disqualified 
individual treat the payment of the excise tax consistently and the 
payor satisfies its obligations under section 4999(c) in the year of 
prepayment. The prepayment of the excise tax for purposes of section 
4999 must be based on the present value of the excise tax that would be 
due in the year the excess parachute payment would actually be paid 
(calculated using the discount rate equal to 120 percent of the 
applicable Federal rate (determined under section 1274(d) and 
regulations thereunder; see Q/A-32)). For purposes of projecting the 
future value of a payment that provides for interest to be credited at 
a variable interest rate, it is permissible to make a reasonable 
assumption regarding this variable rate. A disqualified individual is 
not required to adjust the excise tax paid under this paragraph (c) 
merely because the interest rates in the future are not the same as the 
rate used for purposes of projecting the future value of the payment. 
However, a disqualified individual may not apply this paragraph (c) of 
this A-11 to a payment to be made in cash if the present value of the 
payment would be considered not reasonably ascertainable under section 
3121(v) and Sec.  31.3121(v)(2)-1(e)(4) of this Chapter or to a payment 
related to health benefits or coverage. The Commissioner may provide 
additional guidance regarding the applicability of this paragraph (c) 
to certain payments in published guidance of general applicability 
under Sec.  601.601(d)(2) of this Chapter.
    (d) Transfers of property. Transfers of property are treated as 
payments for purposes of this A-11. See Q/A-12 of this section for 
rules on determining when such payments are considered made and the 
amount of such payments. See Q/A-13 of this section for special rules 
on transfers of stock options.
    (e) The following example illustrates the principles of this A-11:

    Example. D is a disqualified individual with respect to 
Corporation X. D has a base amount of $100,000 and is entitled to 
receive two parachute payments, one of $200,000 and the other of 
$400,000. A change in ownership or control of Corporation X occurs 
on May 1, 2005, and the $200,000 payment is made to D at the time of 
the change in ownership or control. The $400,000 payment is to be 
made on October 1, 2010. Corporation X and D agree that D will 
prepay the excise tax and X will satisfy its obligations under 
section 4999(c) with respect to the $400,000 payment. Using discount 
rate determined under Q/A-32, Corporation X and D determine that the 
present value of the $400,000 payment is $300,000 on the date of the 
change in ownership or control. The portions of the base amount 
allocated to these payments are $40,000 (($200,000/$500,000) x 
$100,000) and $60,000 (($300,000/$500,000 x $100,000), respectively. 
Thus, the amount of the first excess parachute payment is $160,000 
($200,000-$40,000) and that of the second excess parachute payment 
is $340,000 ($400,000-$60,000). The excise tax on the $400,000 
payment is $68,000 ($340,000 x 20 percent). Assume the present value 
(calculated in accordance with paragraph (c) of this A-11) of 
$68,000 is $50,000. To prepay the excise tax due on the $400,000 
payment, Corporation X must satisfy its obligations under section 
4999 with respect to the $50,000, in addition to the $32,000 
withholding required with respect to the $200,000 payment.

    Q-12: If a property transfer to a disqualified individual is a 
payment in the nature of compensation, when is the payment considered 
made (or to be made), and how is the amount of the payment determined?
    A-12: (a) Except as provided in this A-12 and Q/A-13 of this 
section, a transfer of property is considered a payment made (or to be 
made) in the taxable year in which the property transferred is 
includible in the gross income of the disqualified individual under 
section 83 and the regulations thereunder. Thus, in general, such a 
payment is considered made (or to be made) when the property is 
transferred (as defined in Sec.  1.83-3(a)) to the disqualified 
individual and becomes substantially vested (as defined in Sec.  1.83-
3(b) and (j)) in such individual. The amount of the payment is

[[Page 45756]]

determined under section 83 and the regulations thereunder. Thus, in 
general, the amount of the payment is equal to the excess of the fair 
market value of the transferred property (determined without regard to 
any lapse restriction, as defined in Sec.  1.83-3(i)) at the time that 
the property becomes substantially vested, over the amount (if any) 
paid for the property.
    (b) An election made by a disqualified individual under section 
83(b) with respect to transferred property will not apply for purposes 
of this A-12. Thus, even if such an election is made with respect to a 
property transfer that is a payment in the nature of compensation, for 
purposes of this section, the payment is generally considered made (or 
to be made) when the property is transferred to and becomes 
substantially vested in such individual.
    (c) See Q/A-13 of this section for rules on applying this A-12 to 
transfers of stock options.
    (d) The following example illustrates the principles of this A-12:

    Example. On January 1, 2006, Corporation M gives to A, a 
disqualified individual, a bonus of 100 shares of Corporation M 
stock in connection with the performance of services to Corporation 
M. Under the terms of the bonus arrangement A is obligated to return 
the Corporation M stock to Corporation M unless the earnings of 
Corporation M double by January 1, 2009, or there is a change in 
ownership or control of Corporation M before that date. A's rights 
in the stock are treated as substantially nonvested (within the 
meaning of Sec.  1.83-3(b)) during that period because A's rights in 
the stock are subject to a substantial risk of forfeiture (within 
the meaning of Sec.  1.83-3(c)) and are nontransferable (within the 
meaning of Sec.  1.83-3(d)). On January 1, 2008, a change in 
ownership or control of Corporation M occurs. On that day, the fair 
market value of the Corporation M stock is $250 per share. Because 
A's rights in the Corporation M stock become substantially vested 
(within the meaning of Sec.  1.83-3(b)) on that day, the payment is 
considered made on that day, and the amount of the payment for 
purposes of this section is equal to $25,000 (100 x $250). See Q/A-
38 through 41 for rules relating to the reduction of the excess 
parachute payment by the portion of the payment which is established 
to be reasonable compensation for personal services actually 
rendered before the date of a change in ownership or control.

    Q-13: How are transfers of statutory and nonstatutory stock options 
treated?
    A-13: (a) For purposes of this section, an option (including an 
option to which section 421 applies) is treated as property that is 
transferred when the option becomes vested (regardless of whether the 
option has a readily ascertainable fair market value as defined in 
Sec.  1.83-7(b)). For purposes of this A-13, vested means substantially 
vested within the meaning of Sec.  1.83-3(b) and (j) or the right to 
the payment is not otherwise subject to a substantial risk of 
forfeiture within the meaning of section 83(c). Thus, for purposes of 
this section, the vesting of such an option is treated as a payment in 
the nature of compensation. The value of an option at the time the 
option vests is determined under all the facts and circumstances in the 
particular case. Factors relevant to such a determination include, but 
are not limited to: The difference between the option's exercise price 
and the value of the property subject to the option at the time of 
vesting; the probability of the value of such property increasing or 
decreasing; and the length of the period during which the option can be 
exercised. Thus, an option is treated as a payment in the nature of 
compensation on the date of grant or vesting, as applicable, without 
regard to whether such option has an ascertainable fair market value. 
For purposes of this A-13, valuation may be determined by any method 
prescribed by the Commissioner in published guidance of general 
applicability under Sec.  601.601(d)(2) of this Chapter.
    (b) Any money or other property transferred to the disqualified 
individual on the exercise, or as consideration on the sale or other 
disposition, of an option described in paragraph (a) of this A-13 after 
the time such option vests is not treated as a payment in the nature of 
compensation to the disqualified individual under Q/A-11 of this 
section. Nonetheless, the amount of the otherwise allowable deduction 
under section 162 or 212 with respect to such transfer is reduced by 
the amount of the payment described in paragraph (a) of this A-13 
treated as an excess parachute payment.
    Q-14: Are payments in the nature of compensation reduced by 
consideration paid by the disqualified individual?
    A-14: Yes, to the extent not otherwise taken into account under Q/
A-12 and Q/A-13 of this section, the amount of any payment in the 
nature of compensation is reduced by the amount of any money or the 
fair market value of any property (owned by the disqualified individual 
without restriction) that is (or will be) transferred by the 
disqualified individual in exchange for the payment. For purposes of 
the preceding sentence, the fair market value of property is determined 
as of the date the property is transferred by the disqualified 
individual.

Disqualified Individuals

    Q-15: Who is a disqualified individual?
    A-15: (a) For purposes of this section, an individual is a 
disqualified individual with respect to a corporation if, at any time 
during the disqualified individual determination period (as defined in 
Q/A-20 of this section), the individual is an employee or independent 
contractor of the corporation and is, with respect to the corporation 
--
    (1) A shareholder (but see Q/A-17 of this section);
    (2) An officer (see Q/A-18 of this section); or
    (3) A highly-compensated individual (see Q/A-19 of this section).
    (b) For purposes of this A-15, a director is a disqualified 
individual with respect to a corporation if, at any time during the 
disqualified individual determination period, the director is, with 
respect to the corporation, a shareholder (see Q/A-17 of this section), 
an officer (see Q/A-18 of this section), or a highly-compensated 
individual (see Q/A-19 of this section).
    (c) For purposes of this A-15, an individual who is an employee or 
independent contractor of a corporation other than the corporation 
undergoing a change in ownership or control is disregarded for purposes 
of determining who is a disqualified individual if such individual is 
employed by the corporation undergoing the change in ownership or 
control only on the last day of the disqualified individual 
determination period. Thus, for example, assume that E is an employee 
of Corporation X, that Y is acquired by Corporation X, and that Y 
undergoes a change in ownership or control. If E becomes an employee of 
Y on the date of the acquisition, in determining the disqualified 
individuals with respect to Y, E is disregarded under this paragraph 
(c).
    Q-16: Is a personal service corporation treated as an individual?
    A-16: (a) Yes. For purposes of this section, a personal service 
corporation (as defined in section 269A(b)(1)), or a noncorporate 
entity that would be a personal service corporation if it were a 
corporation, is treated as an individual.
    (b) The following example illustrates the principles of this A-16:

    Example. Corporation N, a personal service corporation (as 
defined in section 269A(b)(1)), has a single individual as its sole 
shareholder and employee. Corporation N performs personal services 
for Corporation M. The compensation paid to Corporation N by 
Corporation M puts Corporation N within the group of highly-
compensated individuals of Corporation M as determined under A-19

[[Page 45757]]

of this section. Thus, Corporation N is treated as a highly-
compensated individual with respect to Corporation M.

    Q-17: Are all shareholders of a corporation considered shareholders 
for purposes of paragraphs (a)(1) and (b) of Q/A-15 of this section?
    A-17: (a) No. Only an individual who owns stock of a corporation 
with a fair market value that exceeds 1 percent of the fair market 
value of the outstanding shares of all classes of the corporation's 
stock is treated as a disqualified individual with respect to the 
corporation by reason of stock ownership. An individual who owns a 
lesser amount of stock may, however, be a disqualified individual with 
respect to the corporation if such individual is an officer (see Q/A-
18) or highly-compensated individual (see Q/A-19) with respect to the 
corporation.
    (b) For purposes of determining the amount of stock owned by an 
individual for purposes of paragraph (a) of this A-17, the constructive 
ownership rules of section 318(a) apply. Stock underlying a vested 
option is considered owned by an individual who holds the vested option 
(and the stock underlying an unvested option is not considered owned by 
an individual who holds the unvested option). For purposes of the 
preceding sentence, however, if the option is exercisable for stock 
that is not substantially vested (as defined by Sec. Sec.  1.83-3(b) 
and (j)), the stock underlying the option is not treated as owned by 
the individual who holds the option. Solely for purposes of determining 
the amount of stock owned by an individual for purposes of this A-17, 
mutual and cooperative corporations are treated as having stock.
    (c) The following examples illustrates the principles of this A-17:

    Example 1. E, an employee of Corporation A, received options 
under Corporation A's Stock Option Plan. E's stock options vest 
three years after the date of grant. E is not an officer or highly 
compensated individual during the disqualified individual 
determination period. E does not own, and is not considered to own 
under section 318, any other Corporation A stock. Two years after 
the options are granted to E, all of Corporation A's stock is 
acquired by Corporation B. Under Corporation A's Stock Option Plan, 
E's options are converted to Corporation B options and the vesting 
schedule remains the same. Under paragraph (b) of this A-17, the 
stock underlying the unvested options held by E on the date of the 
change in ownership or control is not considered owned by E. Because 
E is not considered to own Corporation A stock with a fair market 
value exceeding 1 percent of the total fair market value of all of 
the outstanding shares of all classes of Corporation A and E is not 
an officer or highly-compensated individual during the disqualified 
individual determination period, E is not a disqualified individual 
within the meaning of Q&A-15 of this section with respect to 
Corporation A.
    Example 2. Assume the same facts as in Example 1, except that 
Corporation A's Stock Option Plan provides that all unvested options 
will vest immediately on a change in ownership or control. Under 
paragraph (b) of this A-17, the stock underlying the options that 
vest on the change in ownership or control is considered owned by E. 
If the stock considered owned by E exceeds 1 percent of the total 
fair market value of all of the outstanding shares of all classes of 
Corporation A stock (including for this purpose, all stock owned or 
constructively owned by all shareholders, provided that no share of 
stock is counted more than once), E is a disqualified individual 
within the meaning of Q/A-15 of this section with respect to 
Corporation A.
    Example 3. Assume the same facts as in Example 1 except that E 
received nonstatutory stock options that are exercisable for stock 
subject to a substantial risk of forfeiture under section 83. Assume 
further that under Corporation A's Stock Option Plan, the 
nonstatutory options will vest on a change in ownership or control. 
Under paragraph (b) of this A-17, E is not considered to own the 
stock underlying the options that vest on the change in ownership or 
control because the options are exercisable for stock subject to a 
substantial risk of forfeiture within the meaning of section 83. 
Because E is not considered to own Corporation A stock with a fair 
market value exceeding 1 percent of the total fair market value of 
all of the outstanding shares of all classes of Corporation A stock 
and E is not an officer or highly compensated individual during the 
disqualified individual determination period, E is not a 
disqualified individual within the meaning of Q/A-15 of this section 
with respect to Corporation A.

    Q-18: Who is an officer?
    A-18: (a) For purposes of this section, whether an individual is an 
officer with respect to a corporation is determined on the basis of all 
the facts and circumstances in the particular case (such as the source 
of the individual's authority, the term for which the individual is 
elected or appointed, and the nature and extent of the individual's 
duties). Any individual who has the title of officer is presumed to be 
an officer unless the facts and circumstances demonstrate that the 
individual does not have the authority of an officer. However, an 
individual who does not have the title of officer may nevertheless be 
considered an officer if the facts and circumstances demonstrate that 
the individual has the authority of an officer. Generally, the term 
officer means an administrative executive who is in regular and 
continued service. The term officer implies continuity of service and 
excludes those employed for a special and single transaction.
    (b) An individual who is an officer with respect to any member of 
an affiliated group that is treated as one corporation pursuant to Q/A-
46 of this section is treated as an officer of such one corporation.
    (c) No more than 50 employees (or, if less, the greater of 3 
employees, or 10 percent of the employees (rounded up to the nearest 
integer)) of the corporation (in the case of an affiliated group 
treated as one corporation, each member of the affiliated group) are 
treated as disqualified individuals with respect to a corporation by 
reason of being an officer of the corporation. For purposes of the 
preceding sentence, the number of employees of the corporation is the 
greatest number of employees the corporation has during the 
disqualified individual determination period (as defined in Q/A-20 of 
this section). If the number of officers of the corporation exceeds the 
number of employees who may be treated as officers under the first 
sentence of this paragraph (c), then the employees who are treated as 
officers for purposes of this section are the highest paid 50 employees 
(or, if less, the greater of 3 employees, or 10 percent of the 
employees (rounded up to the nearest integer)) of the corporation when 
ranked on the basis of compensation (as determined under Q/A-21 of this 
section) paid during the disqualified individual determination period.
    (d) In determining the total number of employees of a corporation 
for purposes of this A-18, employees are not counted if they normally 
work less than 17\1/2\ hours per week (as defined in section 
414(q)(5)(B) and the regulations thereunder) or if they normally work 
during not more than 6 months during any year (as defined in section 
414(q)(5)(C) and the regulations thereunder). However, an employee who 
is not counted for purposes of the preceding sentence may still be an 
officer.
    Q-19: Who is a highly-compensated individual?
    A-19: (a) For purposes of this section, a highly-compensated 
individual with respect to a corporation is any individual who is, or 
would be if the individual were an employee, a member of the group 
consisting of the lesser of the highest paid 1 percent of the employees 
of the corporation (rounded up to the nearest integer), or the highest 
paid 250 employees of the corporation, when ranked on the basis of 
compensation (as determined under Q/A-21 of this section) earned during 
the disqualified individual determination period (as defined in Q/A-20 
of this section). For purposes of the preceding

[[Page 45758]]

sentence, the number of employees of the corporation is the greatest 
number of employees the corporation has during the disqualified 
individual determination period (as defined in Q/A-20 of this section). 
However, no individual whose annualized compensation during the 
disqualified individual determination period is less than the amount 
described in section 414(q)(1)(B)(i) for the year in which the change 
in ownership or control occurs will be treated as a highly-compensated 
individual.
    (b) An individual who is not an employee of the corporation is not 
treated as a highly-compensated individual with respect to the 
corporation on account of compensation received for performing services 
(such as brokerage, legal, or investment banking services) in 
connection with a change in ownership or control of the corporation, if 
the services are performed in the ordinary course of the individual's 
trade or business and the individual performs similar services for a 
significant number of clients unrelated to the corporation.
    (c) The total number of employees of a corporation for purposes of 
this A-19 is determined in accordance with Q/A-18(d) of this section. 
However, an employee who is not counted for purposes of the preceding 
sentence may still be a highly-compensated individual.
    Q-20: What is the disqualified individual determination period?
    A-20: The disqualified individual determination period is the 
twelve-month period prior to and ending on the date of the change in 
ownership or control of the corporation.
    Q-21: How is compensation defined for purposes of determining who 
is a disqualified individual?
    A-21: (a) For purposes of determining who is a disqualified 
individual, the term compensation means the compensation which was 
earned by the individual for services performed for the corporation 
with respect to which the change in ownership or control occurs 
(changed corporation), for a predecessor entity, or for a related 
entity. Such compensation is determined without regard to sections 125, 
132(f)(4), 402(e)(3), and 402(h)(1)(B). Thus, for example, compensation 
includes elective or salary reduction contributions to a cafeteria 
plan, cash or deferred arrangement or tax-sheltered annuity, and 
amounts credited under a nonqualified deferred compensation plan.
    (b) For purposes of this A-21, a predecessor entity is any entity 
which, as a result of a merger, consolidation, purchase or acquisition 
of property or stock, corporate separation, or other similar business 
transaction transfers some or all of its employees to the changed 
corporation or to a related entity or to a predecessor entity of the 
changed corporation. The term related entity includes--
    (1) All members of a controlled group of corporations (as defined 
in section 414(b)) that includes the changed corporation or a 
predecessor entity;
    (2) All trades or businesses (whether or not incorporated) that are 
under common control (as defined in section 414(c)) if such group 
includes the changed corporation or a predecessor entity;
    (3) All members of an affiliated service group (as defined in 
section 414(m)) that includes the changed corporation or a predecessor 
entity; and
    (4) Any other entities required to be aggregated with the changed 
corporation or a predecessor entity pursuant to section 414(o) and the 
regulations thereunder (except leasing organizations as defined in 
section 414(n)).
    (c) For purposes of Q/A-18 and Q/A-19 of this section, compensation 
that was contingent on the change in ownership or control and that was 
payable in the year of the change is not treated as compensation.

Contingent on Change in Ownership or Control

    Q-22: When is a payment contingent on a change in ownership or 
control?
    A-22: (a) In general, a payment is treated as contingent on a 
change in ownership or control if the payment would not, in fact, have 
been made had no change in ownership or control occurred, even if the 
payment is also conditioned on the occurrence of another event. A 
payment generally is treated as one which would not, in fact, have been 
made in the absence of a change in ownership or control unless it is 
substantially certain, at the time of the change, that the payment 
would have been made whether or not the change occurred. (But see Q/A-
23 of this section regarding payments under agreements entered into 
after a change in ownership or control.) A payment that becomes vested 
as a result of a change in ownership or control is not treated as a 
payment which was substantially certain to have been made whether or 
not the change occurred. For purposes of this A-22, vested means the 
payment is substantially vested within the meaning of Sec.  1.83-3(b) 
and (j) or the right to the payment is not otherwise subject to a 
substantial risk of forfeiture as defined by section 83(c).
    (b)(1) For purposes of paragraph (a), a payment is treated as 
contingent on a change in ownership or control if--
    (i) The payment is contingent on an event that is closely 
associated with a change in ownership or control;
    (ii) A change in ownership or control actually occurs; and
    (iii) The event is materially related to the change in ownership or 
control.
    (2) For purposes of paragraph (b)(1)(i) of this A-22, a payment is 
treated as contingent on an event that is closely associated with a 
change in ownership or control unless it is substantially certain, at 
the time of the event, that the payment would have been made whether or 
not the event occurred. An event is considered closely associated with 
a change in ownership or control if the event is of a type often 
preliminary or subsequent to, or otherwise closely associated with, a 
change in ownership or control. For example, the following events are 
considered closely associated with a change in the ownership or control 
of a corporation: The onset of a tender offer with respect to the 
corporation; a substantial increase in the market price of the 
corporation's stock that occurs within a short period (but only if such 
increase occurs prior to a change in ownership or control); the 
cessation of the listing of the corporation's stock on an established 
securities market; the acquisition of more than 5 percent of the 
corporation's stock by a person (or more than one person acting as a 
group) not in control of the corporation; the voluntary or involuntary 
termination of the disqualified individual's employment; a significant 
reduction in the disqualified individual's job responsibilities; and a 
change in ownership or control as defined in the disqualified 
individual's employment agreement (or elsewhere) that does not meet the 
definition of a change in ownership or control described in Q/A-27, 28, 
or 29 of this section. Whether other events are treated as closely 
associated with a change in ownership or control is based on all the 
facts and circumstances of the particular case.
    (3) For purposes of determining whether an event (as described in 
paragraph (b)(2) of this A-22) is materially related to a change in 
ownership or control, the event is presumed to be materially related to 
a change in ownership or control if such event occurs within the period 
beginning one year before and ending one year after the date of the 
change in ownership or control. If such event occurs outside of the 
period beginning one year before and ending one year after the date of 
change in ownership or

[[Page 45759]]

control, the event is presumed not materially related to the change in 
ownership or control. A payment does not fail to be contingent on a 
change in ownership or control merely because it is also contingent on 
the occurrence of a second event (without regard to whether the second 
event is closely associated with or materially related to a change in 
ownership or control). Similarly, a payment that is treated as 
contingent on a change in ownership or control because it is contingent 
on a closely associated event does not fail to be treated as contingent 
on a change in ownership or control merely because it is also 
contingent on the occurrence of a second event (without regard to 
whether the second event is closely associated with or materially 
related to a change in ownership or control).
    (c) A payment that would in fact have been made had no change in 
ownership or control occurred is treated as contingent on a change in 
ownership or control if the change in ownership or control (or the 
occurrence of an event that is closely associated with and materially 
related to a change in ownership or control within the meaning of 
paragraph (b)(1) of this A-22), accelerates the time at which the 
payment is made. Thus, for example, if a change in ownership or control 
accelerates the time of payment of deferred compensation that is vested 
without regard to the change in ownership or control, the payment may 
be treated as contingent on the change. See Q/A-24 of this section 
regarding the portion of a payment that is so treated. See also Q/A-8 
of this section regarding the exemption for certain payments under 
qualified plans and Q/A-40 of this section regarding the treatment of a 
payment as reasonable compensation.
    (d) A payment is treated as contingent on a change in ownership or 
control even if the employment or independent contractor relationship 
of the disqualified individual is not terminated (voluntarily or 
involuntarily) as a result of the change.
    (e) The following examples illustrate the principles of this A-22:

    Example 1. A corporation grants a stock appreciation right to a 
disqualified individual, A, more than one year before a change in 
ownership or control. After the stock appreciation right vests and 
becomes exercisable, a change in ownership or control of the 
corporation occurs, and A exercises the right. Assuming neither the 
granting nor the vesting of the stock appreciation right is 
contingent on a change in ownership or control, the payment made on 
exercise is not contingent on the change in ownership or control.
    Example 2. A contract between a corporation and B, a 
disqualified individual, provides that a payment will be made to B 
if the corporation undergoes a change in ownership or control and 
B's employment with the corporation is terminated at any time over 
the succeeding 5 years. Eighteen months later, a change in the 
ownership of the corporation occurs. Two years after the change in 
ownership, B's employment is terminated and the payment is made to 
B. Because it was not substantially certain that the corporation 
would have made the payment to B on B's termination of employment if 
there had not been a change in ownership, the payment is treated as 
contingent on the change in ownership under paragraph (a) of this A-
22. This is true even though B's termination of employment is 
presumed not to be, and in fact may not be, materially related to 
the change in ownership or control.
    Example 3.  A contract between a corporation and C, a 
disqualified individual, provides that a payment will be made to C 
if C's employment is terminated at any time over the succeeding 3 
years (without regard to whether or not there is a change in 
ownership or control). Eighteen months after the contract is entered 
into, a change in the ownership or control of the corporation 
occurs. Six months after the change in ownership or control, C's 
employment is terminated and the payment is made to C. Termination 
of employment is considered an event closely associated with a 
change in ownership or control. Because the termination occurred 
within one year after the date of the change in ownership or 
control, the termination of C's employment is presumed to be 
materially related to the change in ownership or control under 
paragraph (b)(3) of this A-22. If this presumption is not 
successfully rebutted, the payment will be treated as contingent on 
the change in ownership or control under paragraph (b) of this A-22.
    Example 4. A contract between a corporation and a disqualified 
individual, D, provides that a payment will be made to D upon the 
onset of a tender offer for shares of the corporation's stock. A 
tender offer is made on December 1, 2008, and the payment is made to 
D. Although the tender offer is unsuccessful, it leads to a 
negotiated merger with another entity on June 1, 2009, which results 
in a change in the ownership or control of the corporation. It was 
not substantially certain, at the time of the onset of the tender 
offer, that the payment would have been made had no tender offer 
taken place. The onset of a tender offer is considered closely 
associated with a change in ownership or control. Because the tender 
offer occurred within one year before the date of the change in 
ownership or control of the corporation, the onset of the tender 
offer is presumed to be materially related to the change in 
ownership or control. If this presumption is not rebutted, the 
payment will be treated as contingent on the change in ownership or 
control. If no change in ownership or control had occurred, the 
payment would not be treated as contingent on a change in ownership 
or control; however, the payment still could be a parachute payment 
under Q/A-37 of this section if the contract violated a generally 
enforced securities law or regulation.
    Example 5. A contract between a corporation and a disqualified 
individual, E, provides that a payment will be made to E if the 
corporation's level of product sales or profits reaches a specified 
level. At the time the contract was entered into, the parties had no 
reason to believe that such an increase in the corporation's level 
of product sales or profits would be preliminary or subsequent to, 
or otherwise closely associated with, a change in ownership or 
control of the corporation. Eighteen months later, a change in the 
ownership or control of the corporation occurs and within one year 
after the date of the change of ownership or control, the 
corporation's level of product sales or profits reaches the 
specified level. Under these facts and circumstances (and in the 
absence of contradictory evidence), the increase in product sales or 
profits of the corporation is not an event closely associated with 
the change in ownership or control of the corporation. Accordingly, 
even if the increase is materially related to the change in 
ownership or control, the payment will not be treated as contingent 
on a change in ownership or control.

    Q-23: May a payment be treated as contingent on a change in 
ownership or control if the payment is made under an agreement entered 
into after the change?
    A-23: (a) No. Payments are not treated as contingent on a change in 
ownership or control if they are made (or are to be made) pursuant to 
an agreement entered into after the change (a post-change agreement). 
For this purpose, an agreement that is executed after a change in 
ownership or control pursuant to a legally enforceable agreement that 
was entered into before the change is considered to have been entered 
into before the change. (See Q/A-9 of this section regarding the 
exemption for reasonable compensation for services rendered on or after 
a change in ownership or control.) If an individual has a right to 
receive a payment that would be a parachute payment if made under an 
agreement entered into prior to a change in ownership or control (pre-
change agreement) and gives up that right as bargained-for 
consideration for benefits under a post-change agreement, the agreement 
is treated as a post-change agreement only to the extent the value of 
the payments under the agreement exceed the value of the payments under 
the pre-change agreement. To the extent payments under the agreement 
have the same value as the payments under the pre-change agreement, 
such payments retain their character as parachute payments subject to 
this section.
    (b) The following examples illustrate the principles of this A-23:

    Example 1. Assume that a disqualified individual is an employee 
of a corporation. A change in ownership or control of the 
corporation occurs, and thereafter the

[[Page 45760]]

individual enters into an employment agreement with the acquiring 
company. Because the agreement is entered into after the change in 
ownership or control occurs, payments to be made under the agreement 
are not treated as contingent on the change.
    Example 2. Assume the same facts as in Example 1, except that 
the agreement between the disqualified individual and the acquiring 
company is executed after the change in ownership or control, 
pursuant to a legally enforceable agreement entered into before the 
change. Payments to be made under the agreement may be treated as 
contingent on the change in ownership or control pursuant to Q/A-22 
of this section. However, see Q/A-9 of this section regarding the 
exemption from the definition of parachute payment for certain 
amounts of reasonable compensation.
    Example 3. Assume the same facts as in Example 1, except that 
prior to the change in ownership or control, the individual and 
corporation enter into an agreement under which the individual will 
receive parachute payments in the event of a change in ownership or 
control of the corporation. After the change, the individual agrees 
to give up the right to payments under the pre-change agreement that 
would be parachute payments if made, in exchange for compensation 
under a new agreement with the acquiring corporation. Because the 
individual gave up the right to parachute payments under the pre-
change agreement in exchange for other payments under the post-
change agreement, payments in an amount equal to the parachute 
payments under the pre-change agreement are treated as contingent on 
the change in ownership or control under this A-23. Because the 
post-change agreement was entered into after the change, payments in 
excess of this amount are not treated as parachute payments.

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

[[Page 45761]]

plan is a payment in the nature of compensation subject to the general 
rule of paragraph (a) of this A-24 and the rules in Q/A-11 of this 
section.
    (2) Employment agreements. The general rule of paragraph (a) of 
this A-24 (and not the rules in paragraphs (b) or (c)) applies to the 
payment of amounts due under an employment agreement on a termination 
of employment or a change in ownership or control that otherwise would 
be attributable to the performance of services (or refraining from the 
performance of services) during any period that begins after the date 
of termination of employment or change in ownership or control, as 
applicable. For purposes of this paragraph (d)(2) of this A-24, an 
employment agreement means an agreement between an employee or 
independent contractor and employer or service recipient which 
describes, among other things, the amount of compensation or 
remuneration payable to the employee or independent contractor. See Q/
A-42(b) and 44 of this section for the treatment of the remaining 
amounts of salary under an employment agreement.
    (3) Vesting due to an event other than services. Neither paragraph 
(b) nor (c) of this A-24 applies to a payment if (without regard to the 
change in ownership or control) vesting of the payment depends on an 
event other than the performance of services, such as the attainment of 
a performance goal, and the event does not occur prior to the change in 
ownership or control. In such circumstances, the full amount of the 
accelerated payment is treated as contingent on the change in ownership 
or control under paragraph (a) of this A-24. However, see Q/A-39 of 
this section for rules relating to the reduction of the excess 
parachute payment by the portion of the payment which is established to 
be reasonable compensation for personal services actually rendered 
before the date of a change in ownership or control.
    (e) Present value. For purposes of this A-24, the present value of 
a payment is determined as of the date on which the accelerated payment 
is made.
    (f) Examples. The following examples illustrate the principles of 
this A-24:

    Example 1. (i) Corporation maintains a qualified plan and a 
nonqualified supplemental retirement plan (SERP) for its executives. 
Benefits under the SERP are not paid to participants until 
retirement. E, a disqualified individual with respect to 
Corporation, has a vested account balance of $500,000 under the 
SERP. A change in ownership or control of Corporation occurs. The 
SERP provides that in the event of a change in ownership or control, 
all vested accounts will be paid to SERP participants.
    (ii) Because E was vested in $500,000 of benefits under the SERP 
prior to the change in ownership or control and the change merely 
accelerated the time at which the payment was made to E, only a 
portion of the payment, as determined under paragraph (b) of this A-
24, is treated as contingent on the change. Thus, the portion of the 
payment that is treated as contingent on the change is the amount by 
which the amount of the accelerated payment ($500,000) exceeds the 
present value of the payment absent the acceleration.
    (iii) Assume the same facts as in paragraph (i) of this Example 
1, except that E's account balance of $500,000 is not vested. 
Instead, assume that E will vest in E's account balance of $500,000 
in 2 years if E continues to perform services for the next 2 years. 
Assume further that the SERP provides that all unvested SERP 
benefits vest immediately on a change in ownership or control and 
are paid to the participants. Because the vesting of the SERP 
payment, without regard to the change, depends only on the 
performance of services for a specified period of time and the 
payment is attributable, in part, to the performance of services 
before the change in ownership or control, only a portion of the 
$500,000 payment, as determined under paragraph (c) of this A-24, is 
treated as contingent on the change. The portion of the payment that 
is treated as contingent on the change is the lesser of the amount 
of the accelerated payment or the amount by which the accelerated 
payment exceeds the present value of the payment absent the 
acceleration, plus an amount to reflect the lapse of the obligation 
to continue to perform services.
    (iv) Assume the same facts as in paragraph (i) of this Example 
1, except that in addition to the pay out of the vested account 
balance of $500,000 on the change in ownership or control, an 
additional $70,000 will be credited to E's account and included in 
the payment to E. Because the $500,000 was vested without regard to 
the change in ownership or control, paragraph (b) of this A-24 
applies to the $500,000 payment. Because the $70,000 is not vested, 
without regard to the change, and is not attributable to the 
performance of services prior to the change, the entire $70,000 
payment is contingent on the change in ownership or control under 
paragraph (a) of this A-24.
    (v) Assume the same facts as in paragraph (i) of this Example 1, 
except that the benefit under the SERP is calculated using a 
percentage of final average compensation multiplied by years of 
service. If, contingent on the change in ownership or control, E is 
credited with additional years of service, an adjustment to final 
average compensation, or an increase in the applicable percentage, 
any increase in the benefit payable under the SERP is not 
attributable to the performance of services prior to the change, and 
the entire increase in the benefit is contingent on the change in 
ownership or control under paragraph (a) of this A-24.
    Example 2. As a result of a change in the effective control of a 
corporation D, a disqualified individual with respect to the 
corporation, receives accelerated payment of D's vested account 
balance in a nonqualified deferred compensation account plan. Actual 
interest and other earnings on the plan assets are credited to each 
account as earned before distribution. Investment of the plan assets 
is not restricted in such a manner as would prevent the earning of a 
market rate of return on the plan assets. The date on which D would 
have received D's vested account balance absent the change in 
ownership or control is uncertain, and the rate of earnings on the 
plan assets is not fixed. Thus, the amount of the payment absent the 
acceleration is not reasonably ascertainable. Under these facts, 
acceleration of the payment does not significantly increase the 
present value of the payment absent the acceleration, and the 
present value of the payment absent the acceleration is treated as 
equal to the amount of the accelerated payment. Accordingly, no 
portion of the payment is treated as contingent on the change.
    Example 3. (i) On January 15, 2006, a corporation and a 
disqualified individual, F, enter into a contract providing for a 
retention bonus of $500,000 to be paid to F on January 15, 2011. The 
payment of the bonus will be forfeited by F if F does not remain 
employed by the corporation for the entire 5-year period. However, 
the contract provides that the full amount of the payment will be 
made immediately on a change in ownership or control of the 
corporation during the 5-year period. On January 15, 2009, a change 
in ownership or control of the corporation occurs and the full 
amount of the payment ($500,000) is made on that date to F. Under 
these facts, the payment of $500,000 was contingent only on F's 
performance of services for a specified period and is attributable, 
in part, to the performance of services before the change in 
ownership or control. Therefore, only a portion of the payment, as 
determined under paragraph (c) of this A-24 is treated as contingent 
on the change. The portion of the payment that is treated as 
contingent on the change is the amount by which the amount of the 
accelerated payment (i.e., $500,000, the amount paid to the 
individual because of the change in ownership) exceeds the present 
value of the payment that was expected to have been made absent the 
acceleration (i.e., $406,838, the present value on January 15, 2009, 
of a $500,000 payment on January 15, 2011), plus $115,000 (1 percent 
x 23 months x $500,000) which is the amount reflecting the lapse of 
the obligation to continue to perform services. Accordingly, the 
amount of the payment treated as contingent on the change in 
ownership or control is $208,162, the sum of $93,162 ($500,000-
$406,838) + $115,000). This result does not change if F actually 
remains employed until the end of the 5-year period.

    (ii) Assume the same facts as in paragraph (i) of this Example 3, 
except that the retention bonus will vest on the change in ownership or 
control, but will not be paid until January 15, 2011 (the original date 
in the contract). Because the payment of $500,000 was contingent only 
on F's performance of services for a specified period and is 
attributable, in part, to the performance of services before the change 
in ownership or

[[Page 45762]]

control, only a portion of the $500,000 payment is treated as 
contingent on the change in ownership or control as determined under 
paragraph (c) of this A-24. Because there is accelerated vesting of the 
bonus, the portion of the payment treated as contingent on the change 
is the amount described in paragraph (b) of this A-27, which is $0 
under these facts, plus an amount reflecting the lapse of the 
obligation to continue to perform services which is $93,573 (1 percent 
x 23 months x $406,838 (the present value of a $500,000 payment).

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

Presumption That Payment Is Contingent on Change

    Q-25: Is there a presumption that certain payments are contingent 
on a change in ownership or control?
    A-25: Yes, for purposes of this section, any payment is presumed to 
be

[[Page 45763]]

contingent on such a change unless the contrary is established by clear 
and convincing evidence if the payment is made pursuant to--
    (a) An agreement entered into within one year before the date of a 
change in ownership or control; or
    (b) An amendment that modifies a previous agreement in any 
significant respect, if the amendment is made within one year before 
the date of a change in ownership or control. In the case of an 
amendment described in paragraph (b) of this A-25, only the portion of 
any payment that exceeds the amount of such payment that would have 
been made in the absence of the amendment is presumed, by reason of the 
amendment, to be contingent on the change in ownership or control.
    Q-26: How may the presumption described in Q/A-25 of this section 
be rebutted?
    A-26: (a) To rebut the presumption described in Q/A-25 of this 
section, the taxpayer must establish by clear and convincing evidence 
that the payment is not contingent on the change in ownership or 
control. Whether the payment is contingent on such change is determined 
on the basis of all the facts and circumstances of the particular case. 
Factors relevant to such a determination include, but are not limited 
to, the content of the agreement or amendment and the circumstances 
surrounding the execution of the agreement or amendment, such as 
whether it was entered into at a time when a takeover attempt had 
commenced and the degree of likelihood that a change in ownership or 
control would actually occur. However, even if the presumption is 
rebutted with respect to an agreement, some or all of the payments 
under the agreement may still be contingent on the change in ownership 
or control pursuant to Q/A-22 of this section.
    (b) In the case of an agreement described in Q/A-25 of this 
section, clear and convincing evidence that the agreement is one of the 
three following types will generally rebut the presumption that 
payments under the agreement are contingent on the change in ownership 
or control--
    (1) A nondiscriminatory employee plan or program as defined in 
paragraph (c) of this A-26;
    (2) A contract between a corporation and an individual that 
replaces a prior contract entered into by the same parties more than 
one year before the change in ownership or control, if the new contract 
does not provide for increased payments (apart from normal increases 
attributable to increased responsibilities or cost of living 
adjustments), accelerate the payment of amounts due at a future time, 
or modify (to the individual's benefit) the terms or conditions under 
which payments will be made; or
    (3) A contract between a corporation and an individual who did not 
perform services for the corporation prior to the one year period 
before the change in ownership or control occurs, if the contract does 
not provide for payments that are significantly different in amount, 
timing, terms, or conditions from those provided under contracts 
entered into by the corporation (other than contracts that themselves 
were entered into within one year before the change in ownership or 
control and in contemplation of the change) with individuals performing 
comparable services.
    (c) For purposes of this section, the term nondiscriminatory 
employee plan or program means: a group term life insurance plan that 
meets the requirements of section 79(d); a self insured medical 
reimbursement plan that meets the requirements of section 105(h); a 
cafeteria plan (within the meaning of section 125); an educational 
assistance program (within the meaning of section 127); a dependent 
care assistance program (within the meaning of section 129); a no-
additional-cost service (within the meaning of section 132(b)) or 
qualified employee discount (within the meaning of section 132(c)); a 
qualified retirement planning services program under section 132(m); an 
adoption assistance program (within the meaning of section 137); and 
such other items as provided by the Commissioner in published guidance 
of general applicability under Sec.  601.601(d)(2). Payments under 
certain other plans are exempt from the definition of parachute payment 
under Q/A-8 of this section.
    (d) The following examples illustrate the application of the 
presumption:

    Example 1. A corporation and a disqualified individual who is an 
employee of the corporation enter into an employment contract. The 
contract replaces a prior contract entered into by the same parties 
more than one year before the change in ownership or control and the 
new contract does not provide for any increased payments other than 
a cost of living adjustment, does not accelerate the payment of 
amounts due at a future time, and does not modify (to the 
individual's benefit) the terms or conditions under which payments 
will be made. Clear and convincing evidence of these facts rebuts 
the presumption described in A-25 of this section. However, payments 
under the contract still may be contingent on the change in 
ownership or control pursuant to Q/A-22 of this section.
    Example 2. Assume the same facts as in Example 1, except that 
the contract is entered into after a tender offer for the 
corporation's stock had commenced and it was likely that a change in 
ownership or control would occur and the contract provides for a 
substantial bonus payment to the individual upon his signing the 
contract. The individual has performed services for the corporation 
for many years, but previous employment contracts between the 
corporation and the individual did not provide for a similar signing 
bonus. One month after the contract is entered into, a change in the 
ownership or control of the corporation occurs. All payments under 
the contract are presumed to be contingent on the change in 
ownership or control even though the bonus payment would have been 
legally required even if no change had occurred. Clear and 
convincing evidence of these facts rebuts the presumption described 
in A-25 of this section with respect to all of the payments under 
the contract with the exception of the bonus payment (which is 
treated as contingent on the change). However, payments other than 
the bonus under the contract still may be contingent on the change 
in ownership or control pursuant to Q/A-22 of this section.
    Example 3. A corporation and a disqualified individual, who is 
an employee of the corporation, enter into an employment contract 
within one year of a change in ownership or control of the 
corporation. Under the contract, in the event of a change in 
ownership or control and subsequent termination of employment, 
certain payments will be made to the individual. A change in 
ownership or control occurs, but the individual is not terminated 
until 2 years after the change in ownership or control. If clear and 
convincing evidence does not rebut the presumption described in A-25 
of this section, because the payment is made pursuant to an 
agreement entered into within one year of the date of the change in 
ownership or control, the payment is presumed contingent on the 
change under A-25 of this section. This is true even though A's 
termination of employment is presumed not to be materially related 
to the change in ownership or control under Q/A-22 of this section.

Change in Ownership or Control

    Q-27: When does a change in the ownership of a corporation occur?
    A-27: (a) For purposes of this section, a change in the ownership 
of a corporation occurs on the date that any one person, or more than 
one person acting as a group (as defined in paragraph (b) of this A-
27), acquires ownership of stock of the corporation that, together with 
stock held by such person or group, has more than 50 percent of the 
total fair market value or total voting power of the stock of such 
corporation. However, if any one person, or more than one person acting 
as a group, is considered to own more than 50 percent of the total fair 
market value or total voting power of the stock of a corporation, the 
acquisition of additional stock by the same person or persons is not 
considered to cause a

[[Page 45764]]

change in the ownership of the corporation (or to cause a change in the 
effective control of the corporation (within the meaning of Q/A-28 of 
this section)). An increase in the percentage of stock owned by any one 
person, or persons acting as a group, as a result of a transaction in 
which the corporation acquires its stock in exchange for property will 
be treated as an acquisition of stock for purposes of this section. 
This A-27 applies only when there is a transfer of stock of a 
corporation (or issuance of stock of a corporation) and stock in such 
corporation remains outstanding after the transaction. (See Q/A-29 for 
rules regarding the transfer of assets of a corporation).
    (b) For purposes of paragraph (a) of this A-27, persons will not be 
considered to be acting as a group merely because they happen to 
purchase or own stock of the same corporation at the same time, or as a 
result of the same public offering. However, persons will be considered 
to be acting as a group if they are owners of a corporation that enters 
into a merger, consolidation, purchase or acquisition of stock, or 
similar business transaction with the corporation. If a person, 
including an entity shareholder, owns stock in both corporations that 
enter into a merger, consolidation, purchase or acquisition of stock, 
or similar transaction, such shareholder is considered to be acting as 
a group with other shareholders in a corporation only with respect to 
the ownership in that corporation prior to the transaction giving rise 
to the change and not with respect to the ownership interest in the 
other corporation.
    (c) For purposes of this A-27 (and Q/A-28 and 29), section 318(a) 
applies to determine stock ownership. Stock underlying a vested option 
is considered owned by the individual who holds the vested option (and 
the stock underlying an unvested option is not considered owned by the 
individual who holds the unvested option). For purposes of the 
preceding sentence, however, if the option is exercisable for stock 
that is not substantially vested (as defined by sections 1.83-3(b) and 
(j)), the stock underlying the option is not treated as owned by the 
individual who holds the option. In addition, mutual and cooperative 
corporations are treated as having stock for purposes of this A-27.
    (d) The following examples illustrate the principles of this A-27:

    Example 1. Corporation M has owned stock with a fair market 
value equal to 19 percent of the value of the stock of Corporation N 
(an otherwise unrelated corporation) for many years prior to 2006. 
Corporation M acquires additional stock with a fair market value 
equal to 15 percent of the value of the stock of Corporation N on 
January 1, 2006, and an additional 18 percent on February 21, 2007. 
As of February 21, 2007, Corporation M has acquired stock with a 
fair market value greater than 50 percent of the value of the stock 
of Corporation N. Thus, a change in the ownership of Corporation N 
is considered to occur on February 21, 2007 (assuming that 
Corporation M did not have effective control of Corporation N 
immediately prior to the acquisition on that date).
    Example 2. All of the corporation's stock is owned by the 
founders of the corporation. The board of directors of the 
corporation decides to offer shares of the corporation to the 
public. After the public offering, the founders of the corporation 
own a total of 40 percent of the corporation's stock, and members of 
the public own 60 percent. If no one person (or more than one person 
acting as a group) owns more than 50 percent of the corporation's 
stock (by value or voting power) after the public offering, there is 
no change in the ownership of the corporation.
    Example 3. Corporation P merges into Corporation O (a previously 
unrelated corporation). In the merger, the shareholders of 
Corporation P receive Corporation O stock in exchange for their 
Corporation P stock. Immediately after the merger, the former 
shareholders of Corporation P own stock with a fair market value 
equal to 60 percent of the value of the stock of Corporation O, and 
the former shareholders of Corporation O own stock with a fair 
market value equal to 40 percent of the value of the stock of 
Corporation O. The former shareholders of Corporation P will be 
treated as acting as a group in their acquisition of Corporation O 
stock. Thus, a change in the ownership of Corporation O occurs on 
the date of the merger. See Q/A-29, Example 3, regarding whether 
there is a change in ownership or control of P.
    Example 4. Assume the same facts as in Example 3, except that 
immediately after the change, the former shareholders of Corporation 
P own stock with a fair market value of 51 percent of the value of 
Corporation O stock and the former shareholders of Corporation O own 
stock with a fair market value equal to 49 percent of the value of 
Corporation O stock. Assume further that prior to the merger several 
Corporation O shareholders also owned Corporation P stock 
(overlapping shareholders). In the merger, those O shareholders 
received additional O stock by virtue of their ownership of P stock 
with a fair market value of 5 percent of the value of Corporation O 
stock. Including the O stock attributable to the P shares, the O 
shareholders hold 54 percent of O after the transaction. However, 
those overlapping shareholders that owned both Corporation O stock 
and Corporation P stock prior to the merger are treated as acting as 
a group with the Corporation O shareholders only with respect to 
their ownership interest in Corporation O prior to the transaction. 
Therefore, because the Corporation O shareholders owned 49 percent 
of the value of Corporation O stock, a change in the ownership of 
Corporation O occurs on the date of the merger. See Q/A-29, Example 
3, regarding whether there is a change in ownership or control of P.
    Example 5. A, an individual, owns stock with a fair market value 
equal to 20 percent of the value of the stock of Corporation Q. On 
January 1, 2007, Corporation Q acquires in a redemption for cash all 
of the stock held by shareholders other than A. Thus, A is left as 
the sole shareholder of Corporation O. A change in ownership of 
Corporation O is considered to occur on January 1, 2007 (assuming 
that A did not have effective control of Corporation Q immediately 
prior to the redemption).
    Example 6. Assume the same facts as in Example 5, except that A 
owns stock with a fair market value equal to 51 percent of the value 
of all the stock of Corporation Q immediately prior to the 
redemption. There is no change in the ownership of Corporation Q as 
a result of the redemption.

    Q-28: When does a change in the effective control of a corporation 
occur?
    A-28: (a) Notwithstanding that a corporation has not undergone a 
change in ownership under Q/A-27, for purposes of this section, a 
change in the effective control of a corporation is presumed to occur 
on the date that either--
    (1) Any one person, or more than one person acting as a group (as 
determined under paragraph (e) of this A-28), acquires (or has acquired 
during the 12-month period ending on the date of the most recent 
acquisition by such person or persons) ownership of stock of the 
corporation possessing 20 percent or more of the total voting power of 
the stock of such corporation; or
    (2) A majority of members of the corporation's board of directors 
is replaced during any 12-month period by directors whose appointment 
or election is not endorsed by a majority of the members of the 
corporation's board of directors prior to the date of the appointment 
or election.
    (b) The presumption of paragraph (a) of this A-28 may be rebutted 
by establishing that such acquisition or acquisitions of the 
corporation's stock, or such replacement of the majority of the members 
of the corporation's board of directors, does not transfer the power to 
control (directly or indirectly) the management and policies of the 
corporation from any one person (or more than one person acting as a 
group) to another person (or group). For purposes of this section, in 
the absence of an event described in paragraph (a)(1) or (2) of this A-
28, a change in the effective control of a corporation is presumed not 
to have occurred.
    (c) In no event does a change in effective control under this A-28 
occur in any transaction in which either of the two corporations 
involved in the

[[Page 45765]]

transaction has a change in ownership or control under Q/A-27 or 29 of 
this section. Thus, for example, assume Corporation P transfers more 
than one-third of the total gross fair market value of its assets to 
Corporation O in exchange for 20 percent of O's stock. Because P has 
undergone a change in ownership of a substantial portion of its assets 
under Q/A-29 of this section, O does not have a change in effective 
control under Q/A-28.
    (d) If any one person, or more than one person acting as a group, 
is considered to effectively control a corporation (within the meaning 
of this A-28), the acquisition of additional control of the corporation 
by the same person or persons is not considered to cause a change in 
the effective control of the corporation (or to cause a change in the 
ownership of the corporation within the meaning of Q/A-27 of this 
section).
    (e) For purposes of this A-28, persons will not be considered to be 
acting as a group merely because they happen to purchase or own stock 
of the same corporation at the same time, or as a result of the same 
public offering. However, persons will be considered to be acting as a 
group if they are owners of a corporation that enters into a merger, 
consolidation, purchase or acquisition of stock, or similar business 
transaction with the corporation. If a person, including an entity 
shareholder, owns stock in both corporations that enter into a merger, 
consolidation, purchase or acquisition of stock, or similar 
transaction, such shareholder is considered to be acting as a group 
with other shareholders in a corporation only with respect to the 
ownership in that corporation prior to the transaction giving rise to 
the change and not with respect to the ownership interest in the other 
corporation.
    (f) For purposes of determining stock ownership, see Q/A-27(c).
    (g) The following examples illustrate the principles of this A-28:

    Example 1. Shareholder A acquired the following percentages of 
the voting stock of Corporation M (an otherwise unrelated 
corporation) on the following dates: 16 percent on January 1, 2005; 
10 percent on January 10, 2006; 8 percent on February 10, 2006; 11 
percent on March 1, 2007; and 8 percent on March 10, 2007. Thus, on 
March 10, 2007, A owns a total of 53 percent of M's voting stock. 
Because A did not acquire 20 percent or more of M's voting stock 
during any 12-month period, there is no presumption of a change in 
effective control pursuant to paragraph (a)(1) of this A-28. In 
addition, under these facts there is a presumption that no change in 
the effective control of Corporation M occurred. If this presumption 
is not rebutted (and thus no change in effective control of 
Corporation M is treated as occurring prior to March 10, 2007), a 
change in the ownership of Corporation M is treated as having 
occurred on March 10, 2007 (pursuant to Q/A-27 of this section) 
because A had acquired more than 50 percent of Corporation M's 
voting stock as of that date.
    Example 2. A minority group of shareholders of a corporation 
opposes the practices and policies of the corporation's current 
board of directors. A proxy contest ensues. The minority group 
presents its own slate of candidates for the board at the next 
annual meeting of the corporation's shareholders, and candidates of 
the minority group are elected to replace a majority of the current 
members of the board. A change in the effective control of the 
corporation is presumed to have occurred on the date the election of 
the new board of directors becomes effective.

    Q-29: When does a change in the ownership of a substantial portion 
of a corporation's assets occur?
    A-29: (a) For purposes of this section, a change in the ownership 
of a substantial portion of a corporation's assets occurs on the date 
that any one person, or more than one person acting as a group (as 
determined in paragraph (c) of this A-29), acquires (or has acquired 
during the 12-month period ending on the date of the most recent 
acquisition by such person or persons) assets from the corporation that 
have a total gross fair market value equal to or more than one-third of 
the total gross fair market value of all of the assets of the 
corporation immediately prior to such acquisition or acquisitions. For 
this purpose, gross fair market value means the value of the assets of 
the corporation, or the value of the assets being disposed of, 
determined without regard to any liabilities associated with such 
assets. This A-29 applies in any situation other than one involving the 
transfer of stock (or issuance of stock) in a parent corporation and 
stock in such corporation remains outstanding after the transaction. 
Thus, this A-29 applies to the sale of stock in a subsidiary (when that 
subsidiary is treated as a single corporation with the parent pursuant 
to Q/A-46) and to mergers involving the creation of a new corporation 
or with respect to the corporation that is not surviving entity.
    (b) (1) There is no change in ownership or control under this A-29 
when there is a transfer to an entity that is controlled by the 
shareholders of the transferring corporation immediately after the 
transfer, as provided in this paragraph (b). A transfer of assets by a 
corporation is not treated as a change in the ownership of such assets 
if the assets are transferred to--
    (i) A shareholder of the corporation (immediately before the asset 
transfer) in exchange for or with respect to its stock;
    (ii) An entity, 50 percent or more of the total value or voting 
power of which is owned, directly or indirectly, by the corporation;
    (iii) A person, or more than one person acting as a group, that 
owns, directly or indirectly, 50 percent or more of the total value or 
voting power of all the outstanding stock of the corporation; or
    (iv) An entity, at least 50 percent of the total value or voting 
power is owned, directly or indirectly, by a person described in 
paragraph (b)(1)(iii) of this A-29.
    (2) For purposes of paragraph (b) and except as otherwise provided, 
a person's status is determined immediately after the transfer of the 
assets. For example, a transfer to a corporation in which the 
transferor corporation has no ownership interest in before the 
transaction, but which is a majority-owned subsidiary of the transferor 
corporation after the transaction is not treated as a change in the 
ownership of the assets of the transferor corporation.
    (c) For purposes of this A-29, persons will not be considered to be 
acting as a group merely because they happen to purchase assets of the 
same corporation at the same time, or as a result of the same public 
offering. However, persons will be considered to be acting as a group 
if they are owners of a corporation that enters into a merger, 
consolidation, purchase or acquisition of assets, or similar business 
transaction with the corporation. If a person, including an entity 
shareholder, owns stock in both corporations that enter into a merger, 
consolidation, purchase or acquisition of stock, or similar 
transaction, such shareholder is considered to be acting as a group 
with other shareholders in a corporation only to the extent of the 
ownership in that corporation prior to the transaction giving rise to 
the change and not with respect to the ownership interest in the other 
corporation.
    (d) For purposes of determining stock ownership, see Q/A-27(c).
    (e) The following examples illustrate the principles of this A-29:

    Example 1. Corporation M acquires assets having a gross fair 
market value of $500,000 from Corporation N (an unrelated 
corporation) on January 1, 2006. The total gross fair market value 
of Corporation N's assets immediately prior to the acquisition was 
$3 million. Since the value of the assets acquired by Corporation M 
is less than one-third of the total gross fair market value of 
Corporation N's total assets immediately prior to the acquisition, 
the acquisition does not represent a change in the ownership of

[[Page 45766]]

a substantial portion of Corporation N's assets.
    Example 2. Assume the same facts as in Example 1. Also assume 
that on November 1, 2006, Corporation M acquires from Corporation N 
additional assets having a fair market value of $700,000. Thus, 
Corporation M has acquired from Corporation N assets worth a total 
of $1.2 million during the 12-month period ending on November 1, 
2006. Since $1.2 million is more than one-third of the total gross 
fair market value of all of Corporation N's assets immediately prior 
to the earlier of these acquisitions ($3 million), a change in the 
ownership of a substantial portion of Corporation N's assets is 
considered to have occurred on November 1, 2006.
    Example 3. (i) All of the assets of Corporation P are 
transferred to Corporation O (an unrelated corporation). In 
exchange, the shareholders of Corporation P receive Corporation O 
stock. Immediately after the transfer, the former shareholders of 
Corporation P own 60 percent of the fair market value of the 
outstanding stock of Corporation O and the former shareholders of 
Corporation O own 40 percent of the fair market value of the 
outstanding stock of Corporation O. Because Corporation O is an 
entity more than 50 percent of the fair market value of the 
outstanding stock of which is owned by the former shareholders of 
Corporation P (based on ownership of Corporation P prior the 
change), the transfer of assets is not treated as a change in 
ownership of a substantial portion of the assets of Corporation P. 
However, a change in the ownership (within the meaning of Q/A-27) of 
Corporation O occurs.
    (ii) The result in paragraph (i) would be the same if immediately 
after the change, the former shareholders of Corporation P own stock 
with a fair market value of 51 percent of the value of Corporation O 
stock because Corporation O is an entity more than 50 percent of the 
fair market value of the outstanding stock of which is owned by the 
former shareholders of Corporation P. See Q/A-27, Example 4, regarding 
whether there is a change in ownership or control of O.
    Example 4. Corporation P sells all of the stock of its wholly-
owned subsidiary, S, to Corporation Y. The fair market value of the 
affiliated group, determined without regard to its liabilities, is 
$210 million. The fair market value of S, determined without regard 
to its liabilities, is $80 million. Because there is a change in 
more than one-third of the gross fair market value of the total 
assets of the affiliated group, there is a change in the ownership 
of a substantial portion of the assets of the affiliated group.

Three-Times-Base-Amount Test for Parachute Payments

    Q-30: Are all payments that are in the nature of compensation, are 
made to a disqualified individual, and are contingent on a change in 
ownership or control, parachute payments?
    A-30: (a) No. To determine whether such payments are parachute 
payments, they must be tested against the individual's base amount (as 
defined in Q/A-34 of this section). To do this, the aggregate present 
value of all payments in the nature of compensation that are made or to 
be made to (or for the benefit of) the same disqualified individual and 
are contingent on the change in ownership or control must be 
determined. If this aggregate present value equals or exceeds the 
amount equal to 3 times the individual's base amount, the payments are 
parachute payments. If this aggregate present value is less than the 
amount equal to 3 times the individual's base amount, no portion of the 
payment is a parachute payment. See Q/A-31, Q/A-32, and Q/A-33 of this 
section for rules on determining present value. Parachute payments that 
are securities violation parachute payments are not included in the 
foregoing computation if they are not contingent on a change in 
ownership or control. See Q/A-37 of this section for the definition and 
treatment of securities violation parachute payments.
    (b) The following examples illustrate the principles of this A-30:

    Example 1. A is a disqualified individual with respect to 
Corporation M. A's base amount is $100,000. Payments in the nature 
of compensation that are contingent on a change in the ownership or 
control of Corporation M totaling $400,000 are made to A on the date 
of the change in ownership or control. The payments are parachute 
payments because they have an aggregate present value at least equal 
to 3 times A's base amount of $100,000 (3 x $100,000 = $300,000).
    Example 2. Assume the same facts as in Example 1, except that 
the payments contingent on the change in the ownership or control of 
Corporation M total $290,000. Because the payments do not have an 
aggregate present value at least equal to 3 times A's base amount, 
no portion of the payments is a parachute payment.

    Q-31: As of what date is the present value of a payment determined?
    A-31: (a) Except as provided in this section, the present value of 
a payment is determined as of the date on which the change in ownership 
or control occurs, or, if a payment is made prior to such date, the 
date on which the payment is made.
    (b)(1) For purposes of determining whether a payment is a parachute 
payment, if a payment in the nature of compensation is the right to 
receive payments in a year (or years) subsequent to the year of the 
change in ownership or control, the value of the payment is the present 
value of such payment (or payments) calculated in accordance with Q/A-
32 of this section and based on reasonable actuarial assumptions.
    (2) If the payment in the nature of compensation is an obligation 
to provide health care, then for purposes of this A-31 and for applying 
the 3-times-base-amount test under Q/A-30 of this section, the present 
value of such obligation should be calculated in accordance with 
generally accepted accounting principles. For purposes of Q/A-30 and 
this A-31, the obligation to provide health care is permitted to be 
measured by projecting the cost of premiums for purchased health care 
insurance, even if no health care insurance is actually purchased. If 
the obligation to provide health care is made in coordination with a 
health care plan that the corporation makes available to a group, then 
the premiums used for this purpose may be group premiums.
    Q-32: What discount rate is to be used to determine present value?
    A-32: For purposes of this section, present value generally is 
determined by using a discount rate equal to 120 percent of the 
applicable Federal rate (determined under section 1274(d) and the 
regulations thereunder) compounded semiannually. The applicable Federal 
rate to be used for this purpose is the Federal rate that is in effect 
on the date as of which the present value is determined, using the 
period until the payment would have been made without regard to the 
change in ownership or control as the term of the debt instrument under 
section 1274(d). See Q/A-24 and 31 of this section. However, for any 
payment, the corporation and the disqualified individual may elect to 
use the applicable Federal rate that is in effect on the date that the 
contract which provides for the payment is entered into, if such 
election is made in the contract.
    Q-33: If the present value of a payment to be made in the future is 
contingent on an uncertain future event or condition, how is the 
present value of the payment determined?
    A-33: (a) In certain cases, it may be necessary to apply the 3-
times-base-amount test of Q/A-30 of this section, or to allocate a 
portion of the base amount to a payment described in paragraphs (a)(1), 
(2), and (3) of Q/A-2 of this section, at a time when the aggregate 
present value of all such payments cannot be determined with certainty 
because the time, amount, or right to receive one or more such payments 
is contingent on the occurrence of an uncertain future event or 
condition. For example, a disqualified individual's right to receive

[[Page 45767]]

a payment may be contingent on the involuntary termination of such 
individual's employment with the corporation. In such a case, it must 
be reasonably estimated whether the payment will be made. If it is 
reasonably estimated that there is a 50-percent or greater probability 
that the payment will be made, the full amount of the payment is 
considered for purposes of the 3-times-base-amount test and the 
allocation of the base amount. Conversely, if it is reasonably 
estimated that there is a less than 50-percent probability that the 
payment will be made, the payment is not considered for either purpose.
    (b) If the estimate made under paragraph (a) of this A-33 is later 
determined to be incorrect, the 3-times-base-amount test described in 
Q/A-30 of this section must be reapplied (and the portion of the base 
amount allocated to previous payments must be reallocated (if 
necessary) to such payments) to reflect the actual time and amount of 
the payment. Whenever the 3-times-base-amount test is applied (or 
whenever the base amount is allocated), the aggregate present value of 
the payments received or to be received by the disqualified individual 
is redetermined as of the date described in A-31 of this section, using 
the discount rate described in A-32 of this section. This 
redetermination may affect the amount of any excess parachute payment 
for a prior taxable year. Alternatively, if, based on the application 
of the 3-times-base-amount test without regard to the payment described 
in paragraph (a) of this A-33, a disqualified individual is determined 
to have an excess parachute payment or payments, then the 3-times-base-
amount test does not have to be reapplied when a payment described in 
paragraph (a) of this A-33 is made (or becomes certain to be made) if 
no base amount is allocated to such payment.
    (c) To the extent provided in published guidance of general 
applicability under Sec.  601.601(d)(2) of this Chapter, an initial 
estimate of the value of an option subject to Q/A-13 of this section is 
permitted to be made, with the valuation subsequently re-determined, 
and the 3-times-base-amount test reapplied.
    (d) The following examples illustrate the principles of this A-33:

    Example 1. A, a disqualified individual with respect to 
Corporation M, has a base amount of $100,000. Under A's employment 
agreement with Corporation M, A is entitled to receive a payment in 
the nature of compensation in the amount of $250,000 contingent on a 
change in ownership or control of Corporation M. In addition, the 
agreement provides that if A's employment is terminated within 1 
year after the change in ownership or control, A will receive an 
additional payment in the nature of compensation in the amount of 
$150,000, payable 1 year after the date of the change in ownership 
or control. A change in ownership or control of Corporation M occurs 
and A receives the first payment of $250,000. Corporation M 
reasonably estimates that there is a 50-percent probability that, as 
a result of the change, A's employment will be terminated within 1 
year of the date of the change. For purposes of applying the 3-
times-base-amount test (and if the first payment is determined to be 
a parachute payment, for purposes of allocating a portion of A's 
base amount to that payment), because M reasonably estimates that 
there is a 50-percent or greater probability that, as a result of 
the change, A's employment will be terminated within 1 year of the 
date of the change, Corporation M must assume that the $150,000 
payment will be made to A as a result of the change in ownership or 
control. The present value of the additional payment is determined 
under Q/A-31 and Q/A-32 of this section.
    Example 2. Assume the same facts as in Example 1, except that 
Corporation M reasonably estimates that there is a less than 50-
percent probability that, as a result of the change, A's employment 
will be terminated within 1 year of the date of the change. For 
purposes of applying the 3-times-base-amount test, because 
Corporation M reasonably estimates that there is a less than 50-
percent probability that, as a result of the change, A's employment 
will be terminated within 1 year of the date of the change, 
Corporation M must assume that the $150,000 payment will not be made 
to A as a result of the change in ownership or control.
    Example 3. B, a disqualified individual with respect to 
Corporation P, has a base amount of $200,000. Under B's employment 
agreement with Corporation P, if there is a change in ownership or 
control of Corporation P, B will receive a severance payment of 
$600,000 and a bonus payment of $400,000. In addition, the agreement 
provides that if B's employment is terminated within 1 year after 
the change, B will receive an additional payment in the nature of 
compensation of $500,000. A change in ownership or control of 
Corporation P occurs, and B receives the $600,000 and $400,000 
payments. At the time of the change in ownership or control, 
Corporation P reasonably estimates that there is a less than 50-
percent probability that B's employment will be terminated within 1 
year of the change. For purposes of applying the 3-times-base-amount 
test, because Corporation P reasonably estimates that there is a 
less than 50-percent probability that B's employment will be 
terminated within 1 year of the date of the change, Corporation P 
assumes that the $500,000 payment will not be made to B. Eleven 
months after the change in ownership or control, B's employment is 
terminated, and the $500,000 payment is made to B. Because B was 
determined to have excess parachute payments without regard to the 
$500,000 payment, the 3-times-base-amount test is not reapplied and 
the base amount is not reallocated to include the $500,000 payment. 
The entire $500,000 payment is treated as an excess parachute 
payment.

    Q-34: What is the base amount?
    A-34: (a) The base amount of a disqualified individual is the 
average annual compensation for services performed for the corporation 
with respect to which the change in ownership or control occurs (or for 
a predecessor entity or a related entity as defined in Q/A-21 of this 
section) which was includible in the gross income of such individual 
for taxable years in the base period (including amounts that were 
excluded under section 911), or which would have been includible in 
such gross income if such person had been a United States citizen or 
resident. See Q/A-35 of this section for the definition of base period 
and for examples of base amount computations.
    (b) If the base period of a disqualified individual includes a 
short taxable year or less than all of a taxable year, compensation for 
such short or incomplete taxable year must be annualized before 
determining the average annual compensation for the base period. In 
annualizing compensation, the frequency with which payments are 
expected to be made over an annual period must be taken into account. 
Thus, any amount of compensation for such a short or incomplete taxable 
year that represents a payment that will not be made more often than 
once per year is not annualized.
    (c) Because the base amount includes only compensation that is 
includible in gross income, the base amount does not include certain 
items that constitute parachute payments. For example, payments in the 
form of excludible fringe benefits are not included in the base amount 
but may be treated as parachute payments.
    (d) The base amount includes the amount of compensation included in 
income under section 83(b) during the base period. See Q/A-35 for the 
definition of base period.
    (e) The following example illustrates the principles of this A-34:
    Example. A disqualified individual, D, receives an annual salary 
of $500,000 per year during the 5-year base period. D defers 
$100,000 of D's salary each year under the corporation's 
nonqualified deferred compensation plan. D's base amount is $400,000 
($400,000 x (5/5)).

    Q-35: What is the base period?
    A-35: (a) The base period of a disqualified individual is the most 
recent 5 taxable years of the individual ending before the date of the 
change in

[[Page 45768]]

ownership or control. For this purpose, the date of the change in 
ownership or control is the date the corporation experiences one of the 
events described in Q/A-27, Q/A-28, or Q/A-29 of this section. However, 
if the disqualified individual was not an employee or independent 
contractor of the corporation with respect to which the change in 
ownership or control occurs (or a predecessor entity or a related 
entity as defined in Q/A-21 of this section) for this entire 5-year 
period, the individual's base period is the portion of such 5-year 
period during which the individual performed personal services for the 
corporation or predecessor entity or related entity.
    (b) The following examples illustrate the principles of Q/A-34 of 
this section and this Q/A-35:

    Example 1. A disqualified individual, D, was employed by a 
corporation for 2 years and 4 months preceding the taxable year in 
which a change in ownership or control of the corporation occurs. 
D's includible compensation income from the corporation was $30,000 
for the 4-month period, $120,000 for the first full year, and 
$150,000 for the second full year. D's base amount is $120,000, ((3 
x $30,000) + $120,000 + $150,000)/3.
    Example 2. Assume the same facts as in Example 1, except that D 
also received a $60,000 signing bonus when D's employment with the 
corporation commenced at the beginning of the 4-month period. D's 
base amount is $140,000, (($60,000 + (3 x $30,000)) + $120,000 + 
$150,000) / 3. Since the bonus will not be paid more often than once 
per year, the amount of the bonus is not increased in annualizing 
D's compensation for the 4-month period.
    Example 3. E is a disqualified individual with respect to 
Corporation X who was not an employee or independent contractor for 
the full 5-year base period. In 2004 and 2005, E is a director of X 
and receives $30,000 per year for E's services. In 2006, E becomes 
an officer of X. E's includible compensation from Corporation X is 
$250,000 for 2006 and 2007, and $300,000 for 2008. In 2008, X 
undergoes a change in ownership or control. E's base amount is 
$140,000 ((2 x $250,000) + (2 x $30,000)/4).

    Q-36: How is the base amount determined in the case of a 
disqualified individual who did not perform services for the 
corporation (or a predecessor entity or a related entity as defined in 
Q/A-21 of this section), prior to the individual's taxable year in 
which the change in ownership or control occurs?
    A-36: (a) In such a case, the individual's base amount is the 
annualized compensation for services performed for the corporation (or 
a predecessor entity or related entity) which--
    (1) Was includible in the individual's gross income for that 
portion, prior to such change, of the individual's taxable year in 
which the change occurred (including amounts that were excluded under 
section 911), or would have been includible in such gross income if 
such person had been a United States citizen or resident;
    (2) Was not contingent on the change in ownership or control; and
    (3) Was not a securities violation parachute payment.
    (b) The following examples illustrate the principles of this A-36:

    Example 1. On January 1, 2006, A, an individual whose taxable 
year is the calendar year, enters into a 4-year employment contract 
with Corporation M as an officer of the corporation. A has not 
previously performed services for Corporation M (or any predecessor 
entity or related entity as defined in Q/A-21 of this section). 
Under the employment contract, A is to receive an annual salary of 
$120,000 for each of the 4 years that he remains employed by 
Corporation M with any remaining unpaid balance to be paid 
immediately in the event that A's employment is terminated without 
cause. On July 1, 2006, after A has received compensation of 
$60,000, a change in the ownership or control of Corporation M 
occurs. Because of the change, A's employment is terminated without 
cause, and he receives a payment of $420,000. It is established by 
clear and convincing evidence that the $60,000 in compensation is 
not contingent on the change in ownership or control, but the 
presumption that the $420,000 payment is contingent on the change is 
not rebutted. Thus, the payment of $420,000 is treated as contingent 
on the change in ownership or control of Corporation M. In this 
case, A's base amount is $120,000 (2 x $60,000). Since the present 
value of the payment which is contingent on the change in ownership 
of Corporation M ($420,000) is more than 3 times A's base amount of 
$120,000 (3 x $120,000 = $360,000), the payment is a parachute 
payment.
    Example 2. Assume the same facts as in Example 1, except that A 
also receives a signing bonus of $50,000 from Corporation M on 
January 1, 2006. It is established by clear and convincing evidence 
that the bonus is not contingent on the change in ownership or 
control. When the change in ownership or control occurs on July 1, 
2006, A has received compensation of $110,000 (the $50,000 bonus 
plus $60,000 in salary). In this case, A's base amount is $170,000 
($50,000 + (2 x $60,000)). Because the $50,000 bonus will not be 
paid more than once per year, the amount of the bonus is not 
increased in annualizing A's compensation. The present value of the 
potential parachute payment ($420,000) is less than 3 times A's base 
amount of $170,000 (3 x $170,000 = $510,000), and therefore no 
portion of the payment is a parachute payment.

Securities Violation Parachute Payments

    Q-37: Must a payment be contingent on a change in ownership or 
control in order to be a parachute payment?
    A-37: (a) No, the term parachute payment also includes any payment 
(other than a payment exempted under Q/A-6 or Q/A-8 of this section) 
that is in the nature of compensation and is to (or for the benefit of) 
a disqualified individual, if such payment is a securities violation 
payment. A securities violation payment is a payment made or to be 
made--
    (1) Pursuant to an agreement that violates any generally enforced 
Federal or state securities laws or regulations; and
    (2) In connection with a potential or actual change in ownership or 
control.
    (b) A violation is not taken into account under paragraph (a)(1) of 
this A-37 if it is merely technical in character or is not materially 
prejudicial to shareholders or potential shareholders. Moreover, a 
violation will be presumed not to exist unless the existence of the 
violation has been determined or admitted in a civil or criminal action 
(or an administrative action by a regulatory body charged with 
enforcing the particular securities law or regulation) which has been 
resolved by adjudication or consent. Parachute payments described in 
this A-37 are referred to in this section as securities violation 
payments.
    (c) Securities violation parachute payments that are not contingent 
on a change in ownership or control within the meaning of Q/A-22 of 
this section are not taken into account in applying the 3-times-base-
amount test of Q/A-30 of this section. Such payments are considered 
parachute payments regardless of whether such test is met with respect 
to the disqualified individual (and are included in allocating base 
amount under Q/A-38 of this section). Moreover, the amount of a 
securities violation parachute payment treated as an excess parachute 
payment shall not be reduced by the portion of such payment that is 
reasonable compensation for personal services actually rendered before 
the date of a change in ownership or control if such payment is not 
contingent on such change. Likewise, the amount of a securities 
violation parachute payment includes the portion of such payment that 
is reasonable compensation for personal services to be rendered on or 
after the date of a change in ownership or control if such payment is 
not contingent on such change.
    (d) The rules in paragraph (b) of this A-37 also apply to 
securities violation parachute payments that are contingent on a change 
in ownership or control if the application of these rules results in 
greater total excess parachute payments with respect to the 
disqualified

[[Page 45769]]

individual than would result if the payments were treated simply as 
payments contingent on a change in ownership or control (and hence were 
taken into account in applying the 3-times-base-amount test and were 
reduced by, or did not include, any applicable amount of reasonable 
compensation).
    (e) The following examples illustrate the principles of this A-37:

    Example 1. A, a disqualified individual with respect to 
Corporation M, receives two payments in the nature of compensation 
that are contingent on a change in the ownership or control of 
Corporation M. The present value of the first payment is equal to 
A's base amount and is not a securities violation parachute payment. 
The present value of the second payment is equal to 1.5 times A's 
base amount and is a securities violation parachute payment. Neither 
payment includes any reasonable compensation. If the second payment 
is treated simply as a payment contingent on a change in ownership 
or control, the amount of A's total excess parachute payments is 
zero because the aggregate present value of the payments does not 
equal or exceed 3 times A's base amount. If the second payment is 
treated as a securities violation parachute payment subject to the 
rules of paragraph (b) of this A-37, the amount of A's total excess 
parachute payments is 0.5 times A's base amount. Thus, the second 
payment is treated as a securities violation parachute payment.
    Example 2. Assume the same facts as in Example 1, except that 
the present value of the first payment is equal to 2 times A's base 
amount. If the second payment is treated simply as a payment 
contingent on a change in ownership or control, the total present 
value of the payments is 3.5 times A's base amount, and the amount 
of A's total excess parachute payments is 2.5 times A's base amount. 
If the second payment is treated as a securities violation parachute 
payment, the amount of A's total excess parachute payments is 0.5 
times A's base amount. Thus, the second payment is treated simply as 
a payment contingent on a change in ownership or control.
    Example 3. B, a disqualified individual with respect to 
Corporation N, receives two payments in the nature of compensation 
that are contingent on a change in the control of Corporation N. The 
present value of the first payment is equal to 4 times B's base 
amount and is a securities violation parachute payment. The present 
value of the second payment is equal to 2 times B's base amount and 
is not a securities violation parachute payment. B establishes by 
clear and convincing evidence that the entire amount of the first 
payment is reasonable compensation for personal services to be 
rendered after the change in ownership or control. If the first 
payment is treated simply as a payment contingent on a change in 
ownership or control, it is exempt from the definition of parachute 
payment pursuant to Q/A-9 of this section. Thus, the amount of B's 
total excess parachute payment is zero because the present value of 
the second payment does not equal or exceed 3 times B's base amount. 
However, if the first payment is treated as a securities violation 
parachute payment, the amount of B's total excess parachute payments 
is 3 times B's base amount. Thus, the first payment is treated as a 
securities violation parachute payment.
    Example 4. Assume the same facts as in Example 3, except that B 
does not receive the second payment and B establishes by clear and 
convincing evidence that the first payment is reasonable 
compensation for services actually rendered before the change in the 
control of Corporation N. If the payment is treated simply as a 
payment contingent on a change in ownership or control, the amount 
of B's excess parachute payment is zero because the amount treated 
as an excess parachute payment is reduced by the amount that B 
establishes as reasonable compensation. However, if the payment is 
treated as a securities violation parachute payment, the amount of 
B's excess parachute payment is 3 times B's base amount. Thus, the 
payment is treated as a securities violation parachute payment.

Computation and Reduction of Excess Parachute Payments

    Q-38: How is the amount of an excess parachute payment computed?
    A-38: (a) The amount of an excess parachute payment is the excess 
of the amount of any parachute payment over the portion of the 
disqualified individual's base amount that is allocated to such 
payment. For this purpose, the portion of the base amount allocated to 
any parachute payment is the amount that bears the same ratio to the 
base amount as the present value of such parachute payment bears to the 
aggregate present value of all parachute payments made or to be made to 
(or for the benefit of) the same disqualified individual. Thus, the 
portion of the base amount allocated to any parachute payment is 
determined by multiplying the base amount by a fraction, the numerator 
of which is the present value of such parachute payment and the 
denominator of which is the aggregate present value of all such 
payments. See Q/A-31, Q/A-32, and Q/A-33 of this section for rules on 
determining present value and Q/A-34 of this section for the definition 
of base amount.
    (b) The following example illustrates the principles of this A-38:

    Example. An individual with a base amount of $100,000 is 
entitled to receive two parachute payments, one of $200,000 and the 
other of $400,000. The $200,000 payment is made at the time of the 
change in ownership or control, and the $400,000 payment is to be 
made at a future date. The present value of the $400,000 payment is 
$300,000 on the date of the change in ownership or control. The 
portions of the base amount allocated to these payments are $40,000 
(($200,000/$500,000) x $100,000) and $60,000 (($300,000/$500,000) x 
$100,000), respectively. Thus, the amount of the first excess 
parachute payment is $160,000 ($200,000-$40,000) and that of the 
second is $340,000 ($400,000-$60,000).
    Q-39: May the amount of an excess parachute payment be reduced by 
reasonable compensation for personal services actually rendered before 
the change in ownership or control?
    A-39: (a) Generally, yes. Except in the case of payments treated as 
securities violation parachute payments or when the portion of a 
payment that is treated as contingent on the change in ownership or 
control is determined under paragraph (b) or (c) of Q/A-24 of this 
section, the amount of an excess parachute payment is reduced by any 
portion of the payment that the taxpayer establishes by clear and 
convincing evidence is reasonable compensation for personal services 
actually rendered by the disqualified individual before the date of the 
change in ownership or control. Services reasonably compensated for by 
payments that are not parachute payments (for example, because the 
payments are not contingent on a change in ownership or control and are 
not securities violation parachute payments, or because the payments 
are exempt from the definition of parachute payment under Q/A-6 through 
Q/A-9 of this section) are not taken into account for this purpose. The 
portion of any parachute payment that is established as reasonable 
compensation is first reduced by the portion of the disqualified 
individual's base amount that is allocated to such parachute payment; 
any remaining portion of the parachute payment established as 
reasonable compensation then reduces the excess parachute payment.
    (b) The following examples illustrate the principles of this A-39:

    Example 1. Assume that a parachute payment of $600,000 is made 
to a disqualified individual, and the portion of the individual's 
base amount that is allocated to the parachute payment is $100,000. 
Also assume that $300,000 of the $600,000 parachute payment is 
established as reasonable compensation for personal services 
actually rendered by the disqualified individual before the date of 
the change in ownership or control. Before the reasonable 
compensation is taken into account, the amount of the excess 
parachute payment is $500,000 ($600,000--$100,000). In reducing the 
excess parachute payment by reasonable compensation, the portion of 
the parachute payment that is established as reasonable compensation 
($300,000) is first reduced by the portion of the disqualified 
individual's base amount that is allocated to the parachute payment 
($100,000), and the remainder ($200,000) then reduces the excess 
parachute payment. Thus, in this case, the excess parachute payment 
of $500,000 is reduced by $200,000 of reasonable compensation.

[[Page 45770]]

    Example 2. Assume the same facts as in Example 1, except that 
the full amount of the $600,000 parachute payment is established as 
reasonable compensation. In this case, the excess parachute payment 
of $500,000 is reduced to zero by $500,000 of reasonable 
compensation. As a result, no portion of any deduction for the 
payment is disallowed by section 280G, and no portion of the payment 
is subject to the 20-percent excise tax of section 4999.

Determination of Reasonable Compensation

    Q-40: How is it determined whether payments are reasonable 
compensation?
    A-40: (a) In general, whether payments are reasonable compensation 
for personal services actually rendered, or to be rendered, by the 
disqualified individual is determined on the basis of all the facts and 
circumstances of the particular case. Factors relevant to such a 
determination include, but are not limited to, the following--
    (1) The nature of the services rendered or to be rendered;
    (2) The individual's historic compensation for performing such 
services; and
    (3) The compensation of individuals performing comparable services 
in situations where the compensation is not contingent on a change in 
ownership or control.
    (b) For purposes of section 280G, reasonable compensation for 
personal services includes reasonable compensation for holding oneself 
out as available to perform services and refraining from performing 
services (such as under a covenant not to compete).
    Q-41: Is any particular type of evidence generally considered clear 
and convincing evidence of reasonable compensation for personal 
services?
    A-41: Yes. A showing that payments are made under a 
nondiscriminatory employee plan or program (as defined in Q/A-26 of 
this section) generally is considered to be clear and convincing 
evidence that the payments are reasonable compensation. This is true 
whether the personal services for which the payments are made are 
actually rendered before, or are to be rendered on or after, the date 
of the change in ownership or control. Q/A-46 of this section (relating 
to the treatment of an affiliated group as one corporation) does not 
apply for purposes of this A-41. No determination of reasonable 
compensation is needed for payments under qualified plans to be exempt 
from the definition of parachute payment under Q/A-8 of this section.
    Q-42: Is any particular type of evidence generally considered clear 
and convincing evidence of reasonable compensation for personal 
services to be rendered on or after the date of a change in ownership 
or control?
    A-42: (a) Yes, if payments are made or to be made to (or on behalf 
of) a disqualified individual for personal services to be rendered on 
or after the date of a change in ownership or control, a showing of the 
following generally is considered to be clear and convincing evidence 
that the payments are reasonable compensation for services to be 
rendered on or after the date of the change in ownership or control--
    (1) The payments were made or are to be made only for the period 
the individual actually performs such personal services; and
    (2) If the individual's duties and responsibilities are 
substantially the same after the change in ownership or control, the 
individual's annual compensation for such services is not significantly 
greater than such individual's annual compensation prior to the change 
in ownership or control, apart from normal increases attributable to 
increased responsibilities or cost of living adjustments. If the scope 
of the individual's duties and responsibilities are not substantially 
the same, the annual compensation after the change is not significantly 
greater than the annual compensation customarily paid by the employer 
or by comparable employers to persons performing comparable services. 
However, except as provided in paragraph (b) and (c) of this A-42, such 
clear and convincing evidence will not exist if the individual does 
not, in fact, perform the services contemplated in exchange for the 
compensation.
    (b) Generally, an agreement under which the disqualified individual 
must refrain from performing services (e.g., a covenant not to compete) 
is an agreement for the performance of personal services for purposes 
of this A-42 to the extent that it is demonstrated by clear and 
convincing evidence that the agreement substantially constrains the 
individual's ability to perform services and there is a reasonable 
likelihood that the agreement will be enforced against the individual. 
In the absence of clear and convincing evidence, payments under the 
agreement are treated as severance payments under Q/A-44 of this 
section.
    (c) If the employment of a disqualified individual is involuntarily 
terminated before the end of a contract term and the individual is paid 
damages for breach of contract, a showing of the following factors 
generally is considered clear and convincing evidence that the payment 
is reasonable compensation for personal services to be rendered on or 
after the date of change in ownership or control--
    (1) The contract was not entered into, amended, or renewed in 
contemplation of the change in ownership or control;
    (2) The compensation the individual would have received under the 
contract would have qualified as reasonable compensation under section 
162;
    (3) The damages do not exceed the present value (determined as of 
the date of receipt) of the compensation the individual would have 
received under the contract if the individual had continued to perform 
services for the employer until the end of the contract term;
    (4) The damages are received because an offer to provide personal 
services was made by the disqualified individual but was rejected by 
the employer (including involuntary termination or constructive 
discharge); and
    (5) The damages are reduced by mitigation. Mitigation will be 
treated as occurring when such damages are reduced (or any payment of 
such damages is returned) to the extent of the disqualified 
individual's earned income (within the meaning of section 911(d)(2)(A)) 
during the remainder of the period in which the contract would have 
been in effect. See Q/A-44 of this section for rules regarding damages 
for a failure to make severance payments.
    (d) The following examples illustrate the principles of this A-42:

    Example 1. A, a disqualified individual, has a three-year 
employment contract with Corporation M, a publicly traded 
corporation. Under this contract, A is to receive a salary for 
$100,000 for the first year of the contract and, for each succeeding 
year, an annual salary that is 10 percent higher than the prior 
year's salary. During the third year of the contract, Corporation N 
acquires all the stock of Corporation M. Prior to the change in 
ownership, Corporation N arranges to retain A's services by entering 
into an employment contract with A that is essentially the same as 
A's contract with Corporation M. Under the new contract, Corporation 
N is to fulfill Corporation M's obligations for the third year of 
the old contract, and, for each of the succeeding years, pay A an 
annual salary that is 10 percent higher than A's prior year's 
salary. Amounts are payable under the new contract only for the 
portion of the contract term during which A remains employed by 
Corporation N. A showing of the facts described above (and in the 
absence of contradictory evidence) is regarded as clear and 
convincing evidence that all payments under the new contract are 
reasonable compensation for personal services to be rendered on or 
after the date of the change in ownership. Therefore, the payments 
under this agreement are exempt from the definition of parachute 
payment pursuant to Q/A-9 of this section.
    Example 2. Assume the same facts as in Example 1, except that A 
does not perform

[[Page 45771]]

the services described in the new contract, but receives payment 
under the new contract. Because services were not rendered after the 
change, the payments under this contract are not exempt from the 
definition of parachute payment pursuant to Q/A-9 of this section.
    Example 3. Assume the same facts as in Example 1, except that 
under the new contract A agrees to perform consulting services to 
Corporation N, when and if Corporation N requires A's services. 
Assume further that when Corporation N does not require A's 
services, the contract provides that A must not perform services for 
any other competing company. Corporation N previously enforced 
similar contracts against former employees of Corporation N. Because 
A is substantially constrained under this contract and Corporation N 
is reasonably likely to enforce the contract against A, the 
agreement is an agreement for the performance of services under 
paragraph (b) of this A-42. Assuming the requirements of paragraph 
(a) of this A-42 are met and there is clear and convincing evidence 
that all payments under the new contract are reasonable compensation 
for personal services to be rendered on or after the date of the 
change in ownership, the payments under this contract are exempt 
from the definition of parachute payment pursuant to Q/A-9 of this 
section.
    Example 4. Assume the same facts as in Example 1, except that 
instead of agreeing not to compete with Corporation N, under the new 
agreement A agrees not to disparage either Corporation M or 
Corporation N. Because the nondisparagement agreement does not 
substantially constrain A's ability to perform services, no amount 
of the payments under this contract are reasonable compensation for 
the nondisparagement agreement.
    Example 5. Assume the same facts as in Example 1, except that 
the employment contract with Corporation N does not provide that 
amounts are payable under the contract only for the portion of the 
term for which A remains employed by Corporation N. Shortly after 
the change in ownership, and despite A's request to remain employed 
by Corporation N, A's employment with Corporation N is involuntarily 
terminated. Shortly thereafter, A obtains employment with 
Corporation O. A commences a civil action against Corporation N, 
alleging breach of the employment contract. In settlement of the 
litigation, A receives an amount equal to the present value of the 
compensation A would have received under the contract with 
Corporation N, reduced by the amount of compensation A otherwise 
receives from Corporation O during the period that the contract 
would have been in effect. A showing of the facts described above 
(and in the absence of contradictory evidence) is regarded as clear 
and convincing evidence that the amount A receives as damages is 
reasonable compensation for personal services to be rendered on or 
after the date of the change in ownership. Therefore, the amount 
received by A is exempt from the definition of parachute payment 
pursuant to Q/A-9 of this section.

    Q-43: Is any particular type of payment generally considered 
reasonable compensation for personal services actually rendered before 
the date of a change in ownership or control?
    A-43: Yes, payments of compensation earned before the date of a 
change in ownership or control generally are considered reasonable 
compensation for personal services actually rendered before the date of 
a change in ownership or control if they qualify as reasonable 
compensation under section 162.
    Q-44: May severance payments be treated as reasonable compensation?
    A-44: (a) No, severance payments are not treated as reasonable 
compensation for personal services actually rendered before, or to be 
rendered on or after, the date of a change in ownership or control. 
Moreover, any damages paid for a failure to make severance payments are 
not treated as reasonable compensation for personal services actually 
rendered before, or to be rendered on or after, the date of such 
change. For purposes of this section, the term severance payment means 
any payment that is made to (or for the benefit of) a disqualified 
individual on account of the termination of such individual's 
employment prior to the end of a contract term, but does not include 
any payment that otherwise would be made to (or for the benefit of) 
such individual on the termination of such individual's employment, 
whenever occurring.
    (b) The following example illustrates the principles of this A-44:

    Example. A, a disqualified individual, has a three-year 
employment contract with Corporation X. Under the contract, A will 
receive a salary of $200,000 for the first year of the contract, and 
for each succeeding year, an annual salary that is $100,000 higher 
than the previous year. In the event of A's termination of 
employment following a change in ownership or control, the contract 
provides that A will receive the remaining salary due under the 
employment contract. At the beginning of the second year of the 
contract, Corporation Y acquires all of the stock of Corporation X, 
A's employment is terminated, and A receives $700,000 ($300,000 for 
the second year of the contract plus $400,000 for the third year of 
the contract) representing the remaining salary due under the 
employment contract. Because the $700,000 payment is treated as a 
severance payment, it is not reasonable compensation for personal 
services on or after the date of the change in ownership or control. 
Thus, the full amount of the $700,000 is a parachute payment.

Miscellaneous Rules

    Q-45: How is the term corporation defined?
    A-45: For purposes of this section, the term corporation has the 
meaning prescribed by section 7701(a)(3) and Sec.  301.7701-2(b) of 
this Chapter. For example, a corporation, for purposes of this section, 
includes a publicly traded partnership treated as a corporation under 
section 7704(a); an entity described in Sec.  301.7701-3(c)(1)(v)(A) of 
this Chapter; a real estate investment trust under section 856(a); a 
corporation that has mutual or cooperative (rather than stock) 
ownership, such as a mutual insurance company, a mutual savings bank, 
or a cooperative bank (as defined in section 7701(a)(32)), and a 
foreign corporation as defined under section 7701(a)(5).
    Q-46: How is an affiliated group treated?
    A-46: For purposes of this section, and except as otherwise 
provided in this section, all members of the same affiliated group (as 
defined in section 1504, determined without regard to section 1504(b)) 
are treated as one corporation. Rules affected by this treatment of an 
affiliated group include (but are not limited to) rules relating to 
exempt payments of certain corporations (Q/A-6, Q/A-7 of this section 
(except as provided therein)), payor of parachute payments (Q/A-10 of 
this section), disqualified individuals (Q/A-15 through Q/A-21 of this 
section (except as provided therein)), rebuttal of the presumption that 
payments are contingent on a change (Q/A-26 of this section (except as 
provide therein)), change in ownership or control (Q/A-27, 28, and 29 
of this section), and reasonable compensation (Q/A-42, 43, and 44 of 
this section).

Effective Date

    Q-47: What is the general effective date of section 280G?
    A-47: (a) Generally, section 280G applies to payments under 
agreements entered into or renewed after June 14, 1984. Any agreement 
that is entered into before June 15, 1984, and is renewed after June 
14, 1984, is treated as a new contract entered into on the day the 
renewal takes effect.
    (b) For purposes of paragraph (a) of this A-47, a contract that is 
terminable or cancellable unconditionally at will by either party to 
the contract without the consent of the other, or by both parties to 
the contract, is treated as a new contract entered into on the date any 
such termination or cancellation, if made, would be effective. However, 
a contract is not treated as so terminable or cancellable if it can be 
terminated or cancelled only by terminating the employment relationship 
or independent contractor relationship of the disqualified individual.
    (c) Section 280G applies to payments under a contract entered into 
on or

[[Page 45772]]

before June 14, 1984, if the contract is amended or supplemented after 
June 14, 1984, in significant relevant respect. For this purpose, a 
supplement to a contract is defined as a new contract entered into 
after June 14, 1984, that affects the trigger, amount, or time of 
receipt of a payment under an existing contract.
    (d)(1) Except as otherwise provided in paragraph (e) of this A-47, 
a contract is considered to be amended or supplemented in significant 
relevant respect if provisions for payments contingent on a change in 
ownership or control (parachute provisions), or provisions in the 
nature of parachute provisions, are added to the contract, or are 
amended or supplemented to provide significant additional benefits to 
the disqualified individual. Thus, for example, a contract generally is 
treated as amended or supplemented in significant relevant respect if 
it is amended or supplemented--
    (i) To add or modify, to the disqualified individual's benefit, a 
change in ownership or control trigger;
    (ii) To increase amounts payable that are contingent on a change in 
ownership or control (or, where payment is to be made under a formula, 
to modify the formula to the disqualified individual's advantage); or
    (iii) To accelerate, in the event of a change in ownership or 
control, the payment of amounts otherwise payable at a later date.
    (2) For purposes of paragraph (a) of this A-47, a payment is not 
treated as being accelerated in the event of a 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 adjustment and those members of that group who are the 
beneficiaries of pre-June 15, 1984, parachute contracts; and
    (5) The size of the adjustment, both in absolute terms and in 
comparison with the benefits provided to other members of the group 
receiving the benefits of the adjustment.
    Q-48: What is the effective date of this section?
    A-48: This section applies to any payments that are contingent on a 
change in ownership or control if the change in ownership or control 
occurs on or after January 1, 2004.

0
Par 3. In Sec.  602.101, paragraph (b) is amended by adding an entry in 
numerical order to the table to read as follows:


Sec.  602.101  OMB Control numbers.

* * * * *
    (b) * * *

------------------------------------------------------------------------
                                                          Current OMB
  CFR part or section where identified and described      control No.
------------------------------------------------------------------------
 
                                * * * * *
1.280G-1.............................................          1545-1851
------------------------------------------------------------------------

* * * * *

Robert E. Wenzel,
Deputy Commissioner for Services and Enforcement.
    Approved: July 14, 2003.
Pamela F. Olson,
Assistant Secretary of the Treasury.
[FR Doc. 03-19274 Filed 8-1-03; 8:45 am]
BILLING CODE 4830-01-P