Question

DAVID IS THE CEO FOR MID ATLANTIC COMPUTER ASSOCIATES. AS PART OF HIS COMPENSATION AGREEMENT, HE NEGOTIATES GOLDEN PARACHUTE PACKAGE THAT PAYS HIM 3.5 MILLION IN THE EVENT THE COMPANY IS ACQUIRED OR HE IS TERMINATED. MID ATLANTIC WAS TAKEN OVER BY BRILLIANT MICRO COMPANY, AND DAVID WAS TERMINATED AND PAID 3.5 MILLION. HIS BASE AMT OF COMPENSATION IS $1 MILLION. WHAT IS TAX CONSEQUENCES TO DAVID

TAXABLE INCOME OF 2.5 MILLION AND EXCISE TAX OF 200,000

TAXABLE INCOME OF 2.5 MILLION AND EXCISE TAX OF 500,000

TAXABLE INCOME OF 3.5 MILLION AND EXCISE TAX IF 500,000

TAXABLE INCOME OF 3.5 MILLION AND EXCISE TAX OF 700,000

Answer 1

Answer: The correct answer to the question is third option (Taxable income of $3.5 million and excise tax of $5,00,000). As per section 280 G of the Internal revenue code, a penalty is attracted in the form of excise tax on the parachute payment, if the same is more than or equal to 3 times of the base amount that the individual receives from the company in the form of compensation.

Calculation

Base amount - $ 1 million

Maximum Parachute payment without tax liability = $1 million * 3 = $3 million

Parachute payment received = $3.5 million

As per the provision, the excess parachute payment received will be taxed @ 20 %.

Therefore, $3.5 - $1 million = $2.5 million will be taxed @ 20% = $5,00,000

This tax of 20% is together with the regular taxation liability on the whole amount received, hence regular taxation will be attracted on $3.5 million and $5,00,000 worth of excise tax will be applicable on $2.5 million.