280G Calculation Example: Base Amount, Excise Tax Calculation, and the Best-Net Cutback for Executives

A 280G calculation compares your change in control payments against three times your base amount, which is your average annual W-2 compensation over the five years before the deal. Reach that line and everything above one times the base amount is taxed at an extra 20 percent. On a $500,000 base amount, $1,495,000 of payments leaves you about $906,700 after federal tax, while $1,500,000 leaves you about $709,800. One extra dollar costs you roughly $197,000, and the full package does not beat the capped one again until payments pass about 3.98 times the base amount.

That gap is why the clause in your agreement matters more than the number in it. If you are an executive whose company is being acquired and you are negotiating, or renegotiating, your change in control terms, this is the arithmetic to run before you sign. You can price your own package, including the parachute test, with our executive severance package calculator.

How the 280G base amount calculation works

The base amount under 26 USC 280G(b)(3) is your "annualized includible compensation for the base period", and the base period is the most recent five taxable years ending before the change in control. In practice it is the average of Box 1 on your last five W-2s, with a partial first year annualized and a shorter period used if you have been there less than five years.

Three things catch executives out here. First, it looks backward, so a large raise in the year of the deal does not lift it. Second, a new hire with one or two short years often has a low base amount relative to current pay, which pushes them over the line with a package that would be routine for a longer-serving peer. Third, years in which you exercised a lot of options push the average up, so the timing of past exercises can change your threshold by a meaningful amount.

What counts as a parachute payment

A parachute payment is compensation contingent on the change in control. For most executives that means the cash severance triggered by a termination after the deal, any transaction bonus, a prorated or accelerated bonus, benefits continuation, and accelerated vesting of equity. The test uses the present value of those payments, not their headline amount.

Accelerated vesting is the item with the most room in it. The Treasury regulations at 26 CFR 1.280G-1, Q&A-24, count only part of the value of an award that would have vested anyway if you had stayed, so a large accelerated grant often contributes much less to the parachute total than its face value suggests. Amounts that are reasonable compensation for services you perform after the change can also be carved out under Q&A-9. Both need a proper valuation from the company's advisers, which is exactly why you should ask to see the calculation rather than accept a conclusion.

A 280G calculation example, worked through

Take a base amount of $500,000. The safe harbor is anything under three times that, so $1,499,999. The table below applies the 20 percent excise tax under 26 USC 4999 to everything above one times the base amount once the line is crossed, and the top federal wage rate of 39.35 percent (37 percent income tax plus 1.45 percent Medicare and the additional 0.9 percent) to the whole payment. State tax is left out.

The excise tax is not charged on the slice above three times the base amount. It is charged on everything above one times it. That is what creates the cliff at 3.00x: crossing the line suddenly exposes two full base amounts to the extra 20 percent. From 3.00x to roughly 3.98x you are better off taking less. Above that, the extra payment outruns the tax.

State tax moves the breakeven further out, because it shrinks what you keep on the full payment while the excise stays the same size. With about 5 percent of state tax on top, the full package only wins above roughly 4.12 times the base amount. With about 10 percent, it is closer to 4.32 times.

Best-net cutback or pay the excise tax: which clause to ask for

Your agreement will usually handle this in one of four ways, and they are not equally good for you.

• Gross-up. The company pays you enough to cover the excise tax and the tax on the gross-up. It is the best outcome for the executive and it has become uncommon, because shareholder advisers treat it as a poor pay practice and the company loses the deduction on the whole amount.
• Best-net cutback. Also called a valley or better-of provision. The company works out what you keep if paid in full and what you keep if cut to just under the safe harbor, and pays whichever is larger. It is the most commonly negotiated position in mid-market deals.
• Mandatory cutback. Payments are always reduced to the safe harbor. At 5.00x in the table above that costs you about $206,500 compared with taking the full amount.
• Silence. The agreement says nothing, you are paid in full and you owe the excise tax. At 3.20x that is the worst place to be.

If you can get a gross-up, take it, but for most executives the realistic ask is a best-net provision. It costs the company very little, because the company only loses its deduction on payments it actually makes above the line, and it protects you from both ends of the table. Ask for it in writing, along with the right to see the calculation and the order in which payments are reduced, since cutting cash first rather than equity can change what you keep.

How to keep more of the package under the line

There are four levers, and a good adviser will test all of them before the deal closes.

Push payments into reasonable compensation. A consulting agreement for genuine post-closing work, at a market rate, can be excluded. So can some payments for a real non-compete, if they are properly valued. Both have to hold up to scrutiny, so they need to reflect work or restrictions that actually exist.

Value the equity carefully. Because the regulations count only part of the value of accelerated vesting in many cases, a precise valuation can bring the parachute total well below a rough estimate. Ask which method the company's advisers used.

Use the private company exemption. Under 280G(b)(5), a company whose stock is not readily tradeable can exempt payments approved by shareholders holding more than 75 percent of the voting power, after adequate disclosure. S corporations are exempt entirely. If your company is private, ask whether a shareholder vote is planned, because it can make the whole calculation irrelevant. A vote only works if you first agree to waive the payments that exceed the safe harbor unless shareholders approve them. When a smaller software company is sold, often after being listed on a marketplace where acquirers compare verified recurring revenue and multiples, this vote is routinely forgotten until days before closing, so raise it early.

Negotiate the base amount inputs. You cannot change your W-2 history, but you can check it. Make sure the company is using the right five years, the right Box 1 figures and the right annualization for a partial first year. Mistakes here are more common than executives expect.

Frequently asked questions

How is the 280G excise tax calculated?

The excise tax is 20 percent of the excess parachute payment, which is everything above one times your base amount, once total parachute payments reach three times the base amount. It is imposed on you under 26 USC 4999, on top of ordinary income tax, and the company also loses its deduction for the same excess. Below three times the base amount there is no excise tax at all.

What is the 280G safe harbor?

The safe harbor is total parachute payments below three times your base amount, which is why agreements that cap payments usually cap them at 2.99 times. Staying one dollar under keeps the whole package free of the excise tax. Crossing it exposes everything above one times the base amount, which is why the jump from 2.99x to 3.00x costs so much.

Is a best-net cutback better than a gross-up?

No. A gross-up leaves you whole, while a best-net cutback only picks the better of two taxed outcomes. But gross-ups are now rare, and between the options most companies will actually offer, a best-net provision is the one to push for. It protects you from paying the excise tax in the zone between three and roughly four times the base amount.

Does 280G apply to private companies?

Yes, with two important exceptions. S corporations are exempt, and a private company can exempt payments that are approved by shareholders holding more than 75 percent of the voting power after full disclosure. Private C corporations that skip the vote are subject to the same rules as public companies.

Get the number before the deal closes

The worst time to discover a 280G problem is the week of closing, when the only answer on offer is a cutback. Run your package through the executive severance package calculator, check the equity terms against our RSU and equity negotiation guide, and if the offer is tied to a retention arrangement, read how to negotiate a retention bonus through an acquisition. Counteroffer turns the agreement you were handed into a specific counter and the email to send. This is career coaching, not tax or legal advice, and a change in control package deserves review by a tax adviser and an employment attorney before you sign.