280G Cleansing Vote: Private Company Shareholder Vote Guide

What the shareholder approval exception does

Section 280G addresses certain compensation payments associated with a change in a corporation's ownership or control. For a qualifying corporation whose stock is not readily tradable, the statute and regulations provide an exception for a payment that satisfies specified shareholder approval and disclosure requirements. The exception applies to the payment under review; calling a transaction a private-company deal does not by itself establish eligibility.

The Internal Revenue Code, Section 280G and Treasury Regulation Section 1.280G-1, questions and answers 6 and 7 set out the framework. The IRS regulation describes the eligibility, voting and disclosure requirements in detail. This guide explains the questions a transaction team should take to tax and legal counsel. The outcome depends on the corporation, the payments and the ownership facts.

A parachute payment generally involves compensation to or for a disqualified individual that is contingent on a qualifying change in ownership or control and meets the statutory aggregate threshold. An excess parachute payment can affect the payer's deduction under Section 280G and the recipient's excise tax under Section 4999. The calculation and available exceptions require a separate analysis of each individual's arrangements. A vote should be designed around that analysis, not used as a substitute for it.

Is the corporation eligible for a shareholder vote?

The regulation describes an exception for a corporation, other than a qualifying small business corporation addressed separately in Q&A 6, if immediately before the change no stock in the corporation is readily tradable on an established securities market or otherwise and the shareholder approval requirements are met. The IRS final regulation also addresses how a readily tradable interest in an entity holding stock of the corporation, or stock of an affiliated group member, can affect the analysis. Ownership above the immediate corporation therefore matters.

Check the whole ownership structure

Provide tax counsel with the corporation's capitalization table, governing documents, ownership chart and information about shareholders that are entities. Identify the proposed transaction and the corporation whose change is being analyzed. The regulation includes special rules for entity ownership and readily tradable interests. Counsel should assess those rules using the corporation’s actual ownership facts.

The corporation's tax classification also deserves attention. Q&A 6 describes a separate rule for a corporation that would qualify as a small business corporation under its stated definition, whether or not an S corporation election is in effect. Counsel should test the actual requirements before assuming a vote is necessary or available. The rules for corporations without shareholders also require separate analysis; the shareholder-vote procedure should not be imported automatically into a particular LLC structure.

Identify the people and payments

Section 280G defines a disqualified individual by reference to services performed for the corporation and the person's status under the statute and regulations. A title alone may not resolve that question. Give counsel the relevant compensation, employment, equity, transaction and service agreements, along with information about the recipients and the proposed change.

Potentially relevant arrangements can include severance, bonuses, accelerated equity and other compensation. Whether an amount is contingent on the change, its value and any applicable exception depend on the governing rules and facts. Identify every material arrangement in the analysis, including payments made by another party where relevant. Keep a written list of assumptions and update it if a payment or deal term changes.

What must the vote decide?

The IRS regulation's Q&A 7 requires the shareholder vote to determine the disqualified individual's right to receive the payment or, for a payment already made, the right to retain it. The regulation permits a vote on less than the full amount and permits a single vote covering payments to one or more disqualified individuals, subject to its requirement that the total payments submitted receive separate shareholder approval.

A vote that merely acknowledges an existing unconditional right does not satisfy that condition. Deal teams often use a conditional waiver or amendment as a way to make the payment subject to the vote. The document's legal effect matters: counsel should confirm the actual right before and after the vote, the effect of a failed vote and the treatment of any payment already made. A form labeled “waiver” is not enough to establish that the condition has been met.

Keep the payment vote separate from approval of the deal

Q&A 7 says the requirements are not satisfied if approval of the change in ownership or control is contingent on, or otherwise conditioned on, approval of a payment that would be a parachute payment without the exception. The IRS gives an example of a combined ballot in which shareholders cannot approve the sale without approving the payment. That structure fails the rule described in the example.

Review the acquisition agreement, ballot and consent documents together. The payment approval should be separately presented in accordance with the regulation, and the deal documents should be examined for conditions that could undermine the required choice. Corporate law and governing documents may impose additional procedures; obtain the advice needed for the specific corporation and transaction.

What happens if the vote fails?

The answer depends on the enforceable payment arrangement. If the vote determines the right to receive or retain a submitted payment, the result must have the effect specified by that arrangement and the governing law. A failed vote does not automatically make every payment in the transaction an excess parachute payment. Counsel must assess what remains payable, whether another exception applies and the consequences of any payment that is actually made or retained.

Before asking shareholders to vote, determine who will explain the consequences to each recipient and who will confirm that the operative documents match the ballot. If terms change after disclosure or a vote, ask tax counsel whether the existing process still addresses the revised facts. Avoid treating an earlier consent as a blanket approval of later arrangements.

Who is entitled to vote and what is the threshold?

Q&A 7 requires approval by more than 75% of the voting power of all outstanding stock entitled to vote under the rule immediately before the change. Exactly 75% does not satisfy a “more than” threshold. The denominator is determined under the regulation, not simply by counting the votes returned or the shareholders attending a meeting.

Apply the attribution rules

The regulation excludes from the outstanding voting stock used for this calculation certain stock actually or constructively owned by or for a disqualified individual who would receive a parachute payment if the approval requirements were not met. It also addresses stock owned by certain related persons under Section 318 attribution rules. Q&A 7 contains an exception when all persons holding voting power are disqualified individuals or related persons described by the rule. Counsel should apply the text to the actual ownership and payment facts rather than excluding every employee or every disqualified individual by label alone.

Prepare a voting-power schedule that identifies each class of stock, the relevant ownership, the applicable voting rights and the proposed exclusions. Trace constructive ownership and related-person relationships with counsel. If an optionholder has no voting rights under the applicable rules, the optionholder generally does not vote merely because the person holds an option. Confirm the governing documents and the regulation before finalizing the schedule.

Entity shareholders and record dates

A shareholder that is an entity generally acts through a person authorized by that entity, subject to the regulation's special rules. When the target stock represents a substantial portion of the entity shareholder's assets, a separate vote of interests in the entity may be required, subject to the regulation's exception for a sufficiently small target-stock holding. The calculation and attribution rules can affect which interests are entitled to vote. Give counsel the ownership chain and asset information needed to apply the rule; a signature from an entity representative should not automatically be treated as sufficient.

Q&A 7 also has a record-date rule permitting a determination based on a date within the specified six-month period before and ending on the change date, provided the disclosure requirements are met. Coordinate the record date, delivery list and expected closing with counsel and the corporation's normal voting procedures. The vote should be documented with the actual denominator, voting power and result, rather than a headcount alone.

What must shareholders receive before voting?

Before the vote, Q&A 7 requires adequate disclosure to all persons entitled to vote of material facts concerning all material payments that would be parachute payments without the applicable exception. The regulation requires full and truthful disclosure and additional information needed to prevent the disclosure from being materially misleading when made.

For each relevant disqualified individual, the regulation identifies material facts including the event triggering payment, the total amount of the payments that would be parachute payments without approval and a brief description of each payment. The analysis can involve cash payments, equity acceleration or other compensation. A summary should be reconciled to the underlying calculation and agreements so that shareholders can understand what they are being asked to approve.

The disclosure requirement extends beyond the amount a party happens to put on a ballot. Q&A 7's examples address a vote on only part of a package while requiring disclosure of material payments. Give counsel the complete payment inventory and ask which amounts and assumptions must be disclosed. If the package or transaction changes, evaluate whether the earlier disclosure remains accurate at the time of the vote.

How should the deal team organize the process?

Prepare the analysis and documents

Start with the ownership and compensation records. Tax counsel can assess the corporation's eligibility, the individuals, the payments and the applicable calculations. Corporate and transaction counsel can review the payment rights, proposed waiver or amendment, authority to solicit approval and the relationship between the payment vote and the acquisition agreement.

Assign a person to maintain a single schedule of agreements, payments, assumptions, recipients and open issues. Reconcile the schedule to the disclosure, ballots and closing documents. If a document has changed, record which analysis and disclosures need a further review. This coordination helps the team avoid voting on a stale or incomplete package.

Obtain and record the vote

Identify every person entitled to vote under the regulation and deliver the disclosure before the vote. Determine the eligible voting power using the applicable ownership and attribution rules. Tabulate the approvals against that denominator and preserve the supporting ownership records, disclosures and signed consents or meeting records.

The record should show what payment was submitted, the choice presented, the voting power used and the result. It should also show the transaction timing and the operative agreement governing the recipient's right if the vote fails. Counsel should determine the appropriate corporate approvals and retention practices for the specific transaction; a generic file checklist cannot establish the tax result by itself.

Recheck changes before closing

A new payment, revised equity arrangement, ownership transfer or change in the expected transaction can affect the analysis. Give the deal team a clear process for escalating changes to tax counsel and the person responsible for the shareholder record. Confirm whether further disclosure, a revised vote or another action is required based on the actual facts and governing law.

The executive compensation and Section 280G guide covers the broader transaction context. The M&A due diligence checklist and representations and warranties guide address related diligence and purchase-agreement work. Review each document for the actual transaction rather than assuming a vote resolves every compensation or tax issue.