Payroll in Practice: 6.12.2023

Question: What are the reporting and withholding requirements for golden parachute payments?

Answer: Generally, golden parachute payments are contractual payments made to key personnel by a corporation. The agreement specifies amounts to be paid to those individuals in the event of a change in ownership or control of the corporation.

A parachute payment is defined in Internal Revenue Code §280G and Treas. Reg. §1.280G-1 as a payment that meets all of four conditions:

1. The payment is in the nature of compensation.
2. The payment is made to a disqualified individual. A disqualified individual is anyone who at any time during the disqualified individual determination period was an employee or independent contractor and was, for that corporation, a shareholder, an officer or a highly compensated individual. The determination period is the 12-month period ending on the date of the change in ownership or control.
3. The payment is contingent upon a change in ownership or effective control of the corporation or ownership of a substantial portion of the corporation’s assets.
4. The aggregate present value of the payment is at least three times the recipient individual’s base amount. The base amount is the average annual compensation for service includible in the recipient’s gross income over the most recent five tax years.

Parachute payments to employees are subject to Social Security and Medicare taxes (or railroad retirement tax), additional Medicare tax, state and federal unemployment taxes, and state and federal income tax. Taxes are withheld according to the usual withholding rules.

On Form W-2, Wage and Tax Statement, the payments are reported in Boxes 1, 3, and 5 and withheld taxes are reported in Boxes 2, 4, and 6. Railroad retirement compensation, Tier 1 and Tier 2 railroad retirement taxes, Medicare taxes, and additional Medicare taxes should be reported in Box 14 as per the Box 14 instructions. State and local payment and tax withholding information is reported in Boxes 15 through 18.

Corporate officers are treated as employees unless they provide few or no services to the corporation. Highly compensated individuals are often employees, but some are independent contractors. Corporate directors and shareholders are generally treated as independent contractors unless they qualify as employees under common-law rules.

Parachute payments to independent contractors are reported on Form 1099-NEC, Nonemployee Compensation. The payments are subject to self-employment tax and may be subject to backup withholding. The compensation is reported in Box 1 of the form. Backup withholding, if any, is reported in Box 4, and state compensation and tax information is reported in Boxes 5, 6, and 7.

An excess parachute payment amount is the amount of any parachute payment in excess of the individual’s base amount. The corporation is not allowed a deduction for any excess parachute payment. The recipient of an excess parachute payment is subject to a 20% nondeductible excise tax on the excess payment amount.

If the recipient of an excess parachute payment is an employee, the corporation is to withhold the 20% excise tax. On the employee’s Form W-2, the amount of the excise tax should be combined with the income tax withheld in Box 2, and the amount of the tax is reported in Box 12 with Code K. Any difference between the amount of excise tax and the amount withheld will be resolved on the employee’s income tax return.

If the recipient is a nonemployee, the total compensation paid to the individual, including any excess parachute payment is reported on Form 1099-NEC in Box 1. Generally, taxes are not withheld for independent contractors, but any backup withholding is reported in Box 4. The excess parachute payment is reported on Form 1099-MISC, Miscellaneous Information, in Box 14. The corporation does not withhold the 20% excise tax.

Both employees and nonemployees report the 20% tax as an additional tax on Schedule 2 of Form 1040, US Individual Income Tax Return, on Line 17k. This should be the 20% tax reported by the employer on Form W-2 in Box 12 with Code K or 20% of the excess parachute payment amount reported on Form 1099-MISC in Box 14.

This column does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Patrick Haggerty is the owner of a tax practice in Chapel Hill, North Carolina, and an enrolled agent licensed to practice before the Internal Revenue Service. The author may be contacted at phaggerty@prodigy.net.

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