Section 280G does not apply to most LLCs. The golden parachute rules reach “corporations,” so an LLC taxed as a partnership or treated as a disregarded entity sits outside them entirely. The picture changes when the LLC has elected to be taxed as a C-corporation, or when it sits inside a corporate affiliated group, because federal tax law then treats the LLC as a corporation and the full weight of Section 280G and the companion 20% excise tax under Section 4999 can land on deal-related pay.
Why Partnership and Disregarded LLCs Are Outside the Rules
Section 280G attaches to payments contingent on a change in ownership or control of a corporation. An LLC that has not elected corporate tax treatment is not a corporation for federal tax purposes, so there is nothing for the statute to grab.
Under the check-the-box regulations, a domestic LLC with two or more members defaults to partnership classification, and a single-member LLC defaults to being disregarded as an entity separate from its owner.1eCFR. 26 CFR 301.7701-3 – Classification of Certain Business Entities Neither form pays corporate income tax. A partnership-taxed LLC passes income through to its members, so there is no entity-level deduction for Section 280G to deny in the first place. The excise tax on the recipient, which piggybacks on the parachute payment definition, has no parachute payment to sit on.
An LLC that has elected S-corporation status is also outside the penalty. Section 280G(b)(5) carves out payments made with respect to any corporation that qualifies as a “small business corporation” under Section 1361(b) immediately before the ownership change.2Office of the Law Revision Counsel. 26 USC 280G – Golden Parachute Payments Qualification requires no more than 100 shareholders, only individual shareholders (with limited exceptions for certain trusts and tax-exempt organizations), no nonresident alien shareholders, and only one class of stock.3Office of the Law Revision Counsel. 26 USC 1361 – S Corporation Defined The exemption depends on the entity meeting those requirements, not on an S election actually being in place.
When an LLC Does Fall Under Section 280G
The exemption goes away in several situations that are more common than the default rule suggests.
The LLC Has Elected C-Corporation Taxation
An LLC can file Form 8832 to elect classification as an association taxable as a corporation.1eCFR. 26 CFR 301.7701-3 – Classification of Certain Business Entities Once the election takes effect, the LLC is a C-corporation for all federal tax purposes, Section 280G included. Every payment contingent on a future change in ownership is now a potential parachute payment carrying both the deduction denial for the company and the 20% excise tax for the recipient.
The LLC Is Part of a Corporate Affiliated Group
An LLC taxed as a partnership can still be pulled in when it sits inside a corporate group. The Treasury Regulations treat all members of the same affiliated group as a single corporation for Section 280G purposes.4eCFR. 26 CFR 1.280G-1 – Golden Parachute Payments When a C-corporation parent undergoes a change in control, payments flowing through a subsidiary LLC can be aggregated with the parent’s payments and treated as though the corporation itself made them.
Conversion Timed Around a Deal
Converting an LLC from partnership taxation to C-corporation status shortly before or after a transaction invites scrutiny. The IRS looks at whether the conversion was designed to sidestep Section 280G. An entity that was a partnership for years and then converts just before closing should expect transaction-related payments to be examined as though the corporate form had been in place the whole time.
An Asset Sale to a Corporation
Section 280G is triggered by a change in ownership of a “substantial portion of the assets” of a corporation, defined as the acquisition of assets with a gross fair market value of at least one-third of the total gross fair market value of all corporate assets immediately before the transaction.2Office of the Law Revision Counsel. 26 USC 280G – Golden Parachute Payments When a C-corporation sells assets that it holds through an LLC subsidiary, that test can be satisfied even though the LLC itself is not a corporation. This is the trap that catches LLCs most often: partnership tax treatment does not save you if the assets being sold belong, further up the chain, to a corporation.
What the Penalties Look Like When 280G Applies
If a covered individual receives payments tied to a change in ownership or control, and the total present value of those payments reaches at least three times the individual’s “base amount,” the entire package is treated as a “parachute payment.”2Office of the Law Revision Counsel. 26 USC 280G – Golden Parachute Payments The base amount is the individual’s annualized includible compensation for the five tax years ending before the year of the ownership change.
Once the three-times threshold is crossed, the “excess parachute payment” is everything above one times the base amount. Two penalties follow. The company loses its tax deduction for the excess. The individual owes a 20% excise tax on the same excess, on top of ordinary income taxes.5Office of the Law Revision Counsel. 26 USC 4999 – Golden Parachute Payments An executive expecting a $2 million deal-closing bonus can lose more than 60% of it to combined income tax and the excise tax while the company writes off none of it.
Payments that count include cash severance, transaction bonuses, and the acceleration of equity awards. Any compensation that would not have been paid but for the ownership change is contingent on that change and enters the calculation.
One boundary worth flagging: the penalties reach only “disqualified individuals,” meaning officers determined by actual authority, shareholders holding more than 1% of the corporation’s stock by fair market value, and the highest-paid 1% of the workforce capped at 250 people.4eCFR. 26 CFR 1.280G-1 – Golden Parachute Payments Rank-and-file employees are not in scope even when 280G otherwise applies.
Exemptions Available to LLCs Taxed as C-Corporations
An LLC that has been swept into Section 280G because of its corporate tax status is not necessarily stuck with the penalties. Three routes matter.
The Small Business Corporation Exemption
Payments with respect to a corporation that would qualify as a small business corporation under Section 1361(b) are completely excluded from the parachute payment definition. No shareholder vote is needed.2Office of the Law Revision Counsel. 26 USC 280G – Golden Parachute Payments The test is measured immediately before the change in ownership: no more than 100 shareholders, only individual shareholders (with limited trust and tax-exempt exceptions), no nonresident alien shareholders, and one class of stock.3Office of the Law Revision Counsel. 26 USC 1361 – S Corporation Defined Many LLCs that have elected C-corporation treatment will meet these criteria, particularly venture-backed startups with a limited investor base. Multiple classes of equity or a fund investor typically knock this exemption out.
The Private Company Shareholder Approval Exemption
For C-corporations that do not meet the small business test, Section 280G(b)(5)(A)(ii) opens a second path. If no stock in the corporation was readily tradable on an established securities market immediately before the change, the penalties can be avoided by shareholder approval.6GovInfo. 26 USC 280G – Golden Parachute Payments An LLC taxed as a C-corporation will virtually never have publicly traded interests, so this exemption is the primary planning tool.
The mechanics have to be followed precisely or the penalties stay in place. The payment must be approved by holders of more than 75% of the voting power of all outstanding stock immediately before the change, with shares held by the disqualified individual receiving the payment excluded from the vote. Before the vote, every voting shareholder must receive adequate disclosure covering the triggering event, the total amount at stake, and a description of each payment that would otherwise be a parachute payment.4eCFR. 26 CFR 1.280G-1 – Golden Parachute Payments
The catch for the executive is the waiver. The disqualified individual must waive the right to receive any payment that would trigger the penalties before the shareholder vote takes place. If shareholders do not approve, the waiver holds and the compensation is forfeited. The vote must also be separate from the deal vote itself.
The Reasonable Compensation Exception
Even when Section 280G applies and no full exemption is available, the reasonable compensation rule under Section 280G(b)(4) can reduce the amount exposed to penalties. Compensation for services the individual will perform after the ownership change can be excluded from the parachute calculation entirely, keeping it out of the three-times threshold test. Compensation for services actually performed before the change can reduce the excess parachute amount after the threshold is crossed. In both directions the taxpayer must demonstrate reasonableness by “clear and convincing evidence,” a higher standard than the usual preponderance test.2Office of the Law Revision Counsel. 26 USC 280G – Golden Parachute Payments
The IRS evaluates reasonableness against the nature of the services, the individual’s historical pay for similar work, and what comparable people earn in situations not tied to an ownership change.4eCFR. 26 CFR 1.280G-1 – Golden Parachute Payments Non-compete agreements are a common vehicle. The fair market value of a non-compete can be subtracted from the parachute amount, but the valuation has to reflect actual enforceability under the relevant state’s law, including limits on duration and geographic scope.