Td 9083

108(a)(1) did not reduce the net operating loss. Accordingly, as a result of the reorganization, there is no
net operating loss to which Y succeeds under section
381. Pursuant to section 361, X recognizes no gain
or loss on the transfer of its property to Y. Pursuant to
section 362(b), Y’s basis in the asset acquired from X
is $45,000.
Example 4. (i) Facts. The facts are the same
as in Example 3, except that X elects under section
108(b)(5) to reduce first the basis of its depreciable
asset.
(ii) Analysis. As in Example 3, on the distribution of Y stock to X’s creditors, under section
108(a)(1)(A), X is entitled to exclude from gross
income the debt discharge amount of $100,000. In
addition, in Year 2, X has no taxable income or loss
because its gross income is exactly offset by the
depreciation deduction. As a result of the depreciation deduction, X’s basis in the asset is reduced by
$10,000 to $65,000. Pursuant to paragraph (c) of
this section, the amount of X’s net operating loss to
which Y succeeds pursuant to section 381 and the
basis of X’s property transferred to Y must take into
account the reductions required by section 108(b).
As a result of the election under section 108(b)(5),
X’s basis in the asset is reduced by $65,000 to $0.
In addition, X’s net operating loss is reduced by
$35,000, the extent to which the amount excluded
from income under section 108(a)(1)(A) does not
reduce X’s asset basis. Accordingly, as a result of
the reorganization, Y succeeds to X’s net operating
loss in the amount of $45,000 under section 381.
Pursuant to section 361, X recognizes no gain or
loss on the transfer of its property to Y. Pursuant to
section 362(b), Y’s basis in the asset acquired from
X is $0.

(e) Effective date. This section applies
to discharges of indebtedness occurring after July 17, 2003.
Par. 3. Section 1.1017–1 is amended by
adding paragraph (b)(4) to read as follows:
§1.1017–1 Basis reductions following a
discharge of indebtedness.
*****
(b) * * *
(4) For further
§1.1017–1T(b)(4).

guidance,

Robert E. Wenzel,
Deputy Commissioner for
Services and Enforcement.
Approved July 9, 2003.
Pamela F. Olson,
Assistant Secretary of the Treasury.
(Filed by the Office of the Federal Register on July 17, 2003,
8:45 a.m., and published in the issue of the Federal Register
for July 18, 2003, 68 F.R. 42590)

Section 280G.—Golden
Parachute Payments
26 CFR 280G–1: Golden parachute payments.

T.D. 9083
DEPARTMENT OF
THE TREASURY
Internal Revenue Service
26 CFR Parts 1

see

*****
Par. 4. Section 1.1017–1T is added to
read as follows:
§1.1017–1T Basis reductions following a
discharge of indebtedness (temporary).
(a) through (b)(3) [Reserved]. For further guidance, see §1.1017–1(a) through
(b)(3).
(4) Transactions to which section 381
applies. In the case of a transaction
described in section 381(a) that ends a
taxable year in which the distributor or

2003-40 I.R.B.

transferor corporation excludes COD income from gross income under section
108(a), the basis of property acquired by
the acquiring corporation in the transaction shall reflect the reductions required
by section 1017 and this section. For
this purpose, the basis of property of the
distributor or transferor corporation immediately prior to the transaction described in
section 381(a), but after the determination
of tax for the year of the discharge, shall
be available for reduction under section
108(b)(2). See §1.108–7T. This paragraph
(b)(4) applies to discharges of indebtedness occurring after July 17, 2003.
(c) through (i) [Reserved]. For further
guidance, see §1.1017–1(c) through (i).

Golden Parachute Payments
AGENCY: Internal
(IRS), Treasury.

Revenue

Service

ACTION: Final regulations.
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.

700

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 §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.
The collection of information in this
regulation is in §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 §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

October 6, 2003

20224. Comments on the collection of
information in §1.280G–1, Q/A–7(a)
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

October 6, 2003

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,
2002–1 C.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 (Ann. 2002–65, 2002–2 C.B.
182). 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

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

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

701

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

2003-40 I.R.B.

be made by a corporation undergoing a
change in ownership or 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.

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.

2. Small Corporation Exemption

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

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

2003-40 I.R.B.

3. Shareholder Approval

702

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

October 6, 2003

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 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

October 6, 2003

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

703

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 §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 §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

2003-40 I.R.B.

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, 2002–1 C.B. 549,
and Rev. Proc. 2002–45, 2002–2 C.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.
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 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

2003-40 I.R.B.

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

704

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

October 6, 2003

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.
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 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 January
1, 2004. 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 2002 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

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.

October 6, 2003

705

2003-40 I.R.B.

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.
*****
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR is amended as follows:
PART I — INCOME TAX; TAXABLE
YEARS BEGINNING AFTER
DECEMBER 31, 1986.
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). * * *
Par. 2. Section §1.280G–1 is added to
read as follows:
§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 (Public Law No. 98–369; 98 Stat.
585) and amended by section 1804(j) of
the Tax Reform Act of 1986 (Public Law
No. 99–514; 100 Stat. 2807), section
1018(d)(6)–(8) of the Technical and Miscellaneous Revenue Act of 1988 (Public
Law No. 100–647; 102 Stat. 3581), and
section 1421 of the Small Business Job
Protection Act of 1996 (Public Law No.
104–188; 110 Stat. 1755). The following
is a table of contents of subjects in this section:
Overview
Effect of section 280G . . . Q/A–1
Meaning of “parachute payment” . . .
Q/A–2

2003-40 I.R.B.

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
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

706

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 —

October 6, 2003

(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

October 6, 2003

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 exempt payments are
not taken into account in applying the
3-times-base-amount test of Q/A–30 of
this section.

707

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

2003-40 I.R.B.

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 §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.

2003-40 I.R.B.

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

708

the full amount of the payment(s) to be
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

October 6, 2003

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.

October 6, 2003

(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

709

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.
(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 can not 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

2003-40 I.R.B.

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

2003-40 I.R.B.

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);
(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)).

710

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

October 6, 2003

nature of compensation also includes cash
when paid, the value of the right to receive
cash (including the value of accelerated
vesting under Q/A–24(c)), 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

October 6, 2003

payment would be considered not reasonably ascertainable under section 3121(v)
and §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 §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

711

regulations thereunder. Thus, in general,
such a payment is considered made (or to
be made) when the property is transferred
(as defined in §1.83–3(a)) to the disqualified individual and becomes substantially
vested (as defined in §1.83–3(b) and (j)) in
such individual. The amount of the payment is 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 §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 §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 §1.83–3(c)) and are nontransferable (within
the meaning of §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 §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?

2003-40 I.R.B.

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 §1.83–7(b)).
For purposes of this A–13, vested means
substantially vested within the meaning
of §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 §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

2003-40 I.R.B.

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).

712

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 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
§§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.

October 6, 2003

(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

October 6, 2003

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
171/2 hours per week (as defined in section
414(q)(5)(B) and the regulations thereunder) or if they normally work during

713

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 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 highlycompensated 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?

2003-40 I.R.B.

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

2003-40 I.R.B.

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 §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

714

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 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

October 6, 2003

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

October 6, 2003

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

715

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 postchange 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 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

2003-40 I.R.B.

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 postchange 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 postchange 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

2003-40 I.R.B.

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,

716

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 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

October 6, 2003

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

October 6, 2003

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

717

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 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

2003-40 I.R.B.

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 §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

2003-40 I.R.B.

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

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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 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

October 6, 2003

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

October 6, 2003

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
§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.

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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
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

2003-40 I.R.B.

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

2003-40 I.R.B.

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 —

720

(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 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).

October 6, 2003

(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?

October 6, 2003

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

721

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
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.

2003-40 I.R.B.

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

2003-40 I.R.B.

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

722

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 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

October 6, 2003

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-baseamount 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 §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 be made, with the valuation subsequently redetermined, and the
three-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

October 6, 2003

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

723

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 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

2003-40 I.R.B.

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;

2003-40 I.R.B.

(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 —

724

(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 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

October 6, 2003

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 three 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

October 6, 2003

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?

725

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.
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

2003-40 I.R.B.

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.

2003-40 I.R.B.

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.

726

(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.

October 6, 2003

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 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

October 6, 2003

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 threeyear 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

727

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
§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
§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

2003-40 I.R.B.

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 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. Taxpayers may rely on these regulations after August 4, 2003, for the treatment of any parachute payment.
Par 3. In §602.101, paragraph (b) is
amended by adding an entry in numerical
order to the table to read as follows:
§602.101 OMB Control numbers.
*****
(b) * * *

CFR part or section where
identified and described

Current OMB
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.
(Filed by the Office of the Federal Register on August 1,
2003, 8:45 a.m., and published in the issue of the Federal
Register for August 4, 2003, 68 F.R. 45745)

2003-40 I.R.B.

Section 301.—Distributions
of Property

Section 316.—Dividend
Defined

26 CFR 1.301-1: Rules applicable with respect to
distributions of money and other property.

26 CFR 1.316-1: Dividends.

Certain previously published revenue rulings are
obsolete with respect to the taxation of split-dollar
life insurance arrangements entered into or materially modified after September 17, 2003.See Rev. Rul.
2003-105, page 696.

728

Certain previously published revenue rulings are
obsolete with respect to the taxation of split-dollar
life insurance arrangements entered into or materially
modified after September 17, 2003. See Rev. Rul.
2003-105, page 696.

October 6, 2003