Part IV. Items of General Interest

the deduction under section 280G is not contingent on the imposition of the excise tax under section 4999, and the imposition of the excise tax under section 4999 is not contingent on the disallowance of the deduction under section 280G. For example, an individual may be subject to the 20-percent excise tax under section 4999 even though the payor is a foreign corporation not subject to United States income tax.

Section 280G(b)(2)(A) defines a para- chute 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 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

Notice of Proposed Rulemaking and Notice of Public Hearing

Golden Parachute Payments

REG–209114–90

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

SUMMARY: This document contains proposed regulations relating to golden parachute payments to provide guidance to taxpayers who must comply with section 280G. Proposed regulations under section 280G (PS–217–84, 1989–1 C.B. 1038) were previously published in the Federal Register on May 5, 1989, and corrected in 54 FR 25879 (June 20, 1989) and 54 FR 29061 (July 11, 1989) (the 1989 proposed regulations). These proposed regulations are proposed to apply to any payments that are contingent on a change in ownership or control that occurs on or after January 1, 2004. Taxpayers may rely on these proposed regulations until the effective date of the final regulations. Alternatively, taxpayers may rely on the 1989 regulations for any payment contingent on a change in ownership or control that occurs prior to January 1, 2004.

DATES: Written or electronic comments must be received by June 5, 2002. Requests to speak and outlines of topics to be discussed at the public hearing scheduled for June 26, 2002, must be received by June 5, 2002.

ADDRESSES: Send submissions to CC:ITA:RU (REG–209114–90), room 5226, Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be hand delivered Monday through Friday between the hours of 8 a.m. and 5 p.m. to: CC:ITA:RU (REG–209114–90), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue, NW, Washington, DC or sent electronically, via the IRS Internet site www.irs.gov/regs . The public

hearing will be held in the IRS Auditorium, Internal Revenue Building, 1111 Constitution Avenue, NW, Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Erinn Madden at (202) 622–6060 (not a tollfree number). To be placed on the attendance list for the hearing, please contact LaNita M. Vandyke at (202) 622–7180.

SUPPLEMENTARY INFORMATION:

Background

This document contains proposed 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 sec. 67 of the Deficit Reduction Act, Public Law 98–369 (98 Stat. 585). Section 280G was amended by sec. 1804(j) of the Tax Reform Act of 1986, Public Law 99–514 (100 Stat. 2807), sec. 1018(d) of the Technical and Miscellaneous Revenue Act of 1988, Public Law 100–647 (102 Stat. 3581) and sec. 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. Proposed regulations (PS–217–84) under section 280G were previously published in the Federal Register at 54 FR 19390 on May 5, 1989, and corrected in 54 FR 25879 (June 20, 1989) and 54 FR 29061 (July 11, 1989) (the 1989 proposed regulations).

Explanation of Provisions

Overview

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. The disallowance of

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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 change in ownership or control. Such reasonable compensation is first offset against the portion of the base amount allocated to the payment.

The 1989 proposed regulations provided guidance regarding the application of section 280G to corporations and individuals. Although many aspects of the 1989 proposed regulations were wellreceived, the IRS has received numerous comments requesting modification and clarification of the 1989 proposed regulations. In response, these proposed regulations clarify and revise, as described below, the 1989 proposed regulations. Many aspects of the 1989 proposed regulations are preserved, and these proposed regulations retain the same organizational structure as the 1989 proposed regulations. Major modifications to the 1989 proposed regulations are described below.

Disqualified Individuals

A payment constitutes a parachute payment only if the payment is made to (or for the benefit of) a disqualified individual. Section 280G(c) defines the term disqualified individual to include any individual who (a) is an employee or independent contractor who performs personal services for a corporation, and (b) is an officer, shareholder, or highlycompensated individual.

The determination of whether an individual is a disqualified individual under these proposed regulations is substantially the same as under the 1989 proposed regulations, with three significant changes. First, Q/A-17 of the 1989 regulations provides a de minimis rule for purposes of identifying which shareholders of a corporation are disqualified individuals. Under the 1989 proposed regulations, an individual is a shareholder for purposes of section 280G if the individual, at any time during the disqualified individual determination period, owns stock of a corporation with a fair market value exceeding the lesser of $1 million or 1 percent of the total fair market value of the outstanding shares of all classes of the corporation’s stock. Since the issuance of the 1989 proposed regulations, it has

become apparent that this rule may include individuals who do not possess significant influence over the corporation. Therefore, under Q/A-17 of these proposed regulations, the $1 million test is eliminated. Under these proposed regulations, an individual is a shareholder only if, during the disqualified individual determination period, the individual owns stock of a corporation with a fair market value that exceeds 1 percent of the total fair market value of the outstanding shares of all classes of the corporation’s stock. The constructive ownership rules of section 318(a) continue to apply for purposes of determining the amount of stock owned by the individual. Under these rules, for example, to determine the amount of stock owned by an individual, the stock underlying vested stock options is considered constructively owned by that individual.

Second, these proposed regulations modify the annualized compensation method for determining who is a highlycompensated individual under Q/A-19. Under the 1989 proposed regulations, no individual whose annualized compensation during the disqualified individual determination period is less than $75,000 is treated as a highly-compensated individual, even if the individual otherwise satisfies the definition of a highlycompensated individual. Q/A-19 is modified to provide that an individual must have annualized compensation equal to at least the amount described in section 414(q)(1)(B)(i). This amount for 2002 is $90,000 and is adjusted periodically for cost-of-living increases. This modification both updates the amount provided in the 1989 proposed regulations and provides a mechanism to update this amount periodically without further amendment of these regulations.

Finally, these proposed regulations change the disqualified individual determination period under Q/A-20. Under the 1989 proposed regulations, the disqualified individual determination period is the portion of the year of the corporation ending on the date of the change in ownership or control and the immediately preceding twelve months (with an option to use the calendar year or the corporation’s fiscal year). Q/A-20 of these proposed regulations is modified to change this period to the twelve months prior to and

ending on the date of the change in ownership or control of the corporation. Under this rule, the disqualified individual determination period is the same length for any change in ownership or control and is not affected by the date of the change in ownership or control.

Payment in the Nature of Compensation

A payment may be a parachute payment only if it is a payment in the nature of compensation. All payments, in whatever form, are payments in the nature of compensation if the payments arise out of the employment relationship or are associated with the performance of services. In Q/A-11, these proposed regulations clarify that payments in the nature of compensation include cash, the right to receive cash, or a transfer of property.

Q/A-13 of the 1989 proposed regulations provides that the transfer of a nonstatutory option is treated as a payment in the nature of compensation (even if the option does not have a readily ascertainable fair market value within the meaning of § 1.83–7(b)). The 1989 proposed regulations reserve the issue of the treatment of statutory options ( i.e., options to which section 421 applies). These proposed regulations revise Q/A-13 to address the treatment of statutory stock options to provide that nonstatutory stock options and statutory stock options are treated the same. Because both the transfer of a statutory option and the transfer of a nonstatutory stock option are payments in the nature of compensation, there is no basis for distinguishing between these two types of options for purposes of section 280G. In addition, these proposed regulations revise Q/A-13 with respect to the valuation of both statutory and nonstatutory stock options. Under the 1989 proposed regulations, the value of an option with an ascertainable fair market value is determined under all the facts and circumstances, including the difference between the option’s exercise price and the value of the property at the time of vesting, the probability of an increase or decrease in the value of such property, and the length of the option exercise period.

Since the issuance of the 1989 proposed regulations, commentators have indicated that Q/A-13 does not provide

March 4, 2002 577 2002–9 I.R.B.

sufficient guidance about the determination of the value of a stock option. In particular, commentators question whether the intrinsic value of the option (the difference between the exercise price and the value of the property, or spread) determined at the time of the change in ownership or control, or a value determined under a valuation model such as BlackScholes, should be used for purposes of section 280G. Using the factors listed in the 1989 proposed regulations results in a value different from the value obtained from using only the difference between the exercise price and the value of the property. Commentators have also noted that valuation methods other than spread are often complicated and difficult to apply in some circumstances, particularly when the stock underlying the option is not publicly traded.

These proposed regulations continue to provide for the use of the factors described in the 1989 proposed regulations. To provide further guidance on acceptable and administrable methods for valuing stock options, these proposed regulations delegate authority to the Commissioner to provide methods for valuation of stock options through published guidance. Rev. Proc. 2002–13 (2002–8 I.R.B. 549) (February 25, 2002) published in conjunction with these proposed regulations, provides several valuation methods. One of the methods permitted under this revenue procedure is a simplified safe harbor approach modeled after the Black-Scholes valuation method. The safe harbor allows a corporation to establish a value for stock options based on spread at the time of the change in ownership or control, the remaining term of the option, and a basic assumption regarding the volatility of the underlying stock. Other factors relevant to the BlackScholes valuation model, including a riskfree rate of return and dividend yield, are addressed in the table contained in the revenue procedure. The safe harbor valuation method provided in the revenue procedure may be used without regard to whether the underlying stock is publicly traded.

Contingent on Change

To be a parachute payment, a payment in the nature of compensation to a disqualified individual must be contingent

on a change in ownership or control. Q/A-22 of the 1989 proposed regulations provides guidance on when a payment is contingent on a change in ownership or control. Generally, 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. 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 in ownership or control occurred.

These proposed regulations clarify in Q/A-22 that a payment is contingent on a change in ownership or control if the payment would not have been made absent the change in ownership or control, even if the payment is also contingent on a second event, such as termination of employment within a period following the change in ownership or control. In addition, as under the 1989 proposed regulations, a payment generally is treated as contingent on a change in ownership or control if (a) the payment is contingent on an event that is closely associated with such a change, (b) a change in ownership or control actually occurs, and (c) the event is materially related to the change in ownership or control. The fact that a payment that is contingent on an event closely associated with a change in ownership or control is also conditioned on the occurrence of a second event does not affect the determination that the payment is contingent on a change in ownership or control as the result of the occurrence of the first event.

Under Q/A-24 of the 1989 proposed regulations, the entire amount of a payment is generally treated as contingent on a change in ownership or control. These proposed regulations clarify that the general rule of Q/A-24(a) (and not the special rules in either Q/A-24(b) or (c), discussed below) applies to the payment of amounts due under an employment agreement on a termination of employment or change in ownership or control that, without regard to the change, would have been paid for the performance of services after the termination of employment or change in ownership or control, as applicable. Also, the general rules of Q/A-24(a) apply to

the accelerated payment of an amount that is otherwise payable only on the attainment of a performance goal or contingent on an event or condition other than the continued performance of services for a specified period of time. In situations governed by Q/A-24(a), the determination of whether a portion of the payment is reasonable compensation for services rendered before, on, or after the change in ownership or control is determined under Q/As-38 through 44. With respect to amounts due under an employment agreement, however, in most situations, a reduction for reasonable compensation for services rendered before the change in ownership or control is inappropriate, given the general expectation that an individual is not undercompensated for services rendered before a change in ownership or control. See Conf. Rep. No. 98–861, at 852 (1984).

Q/A-24(b) and (c) provide an objective method for determining the portion of a payment that is treated as contingent on a change in ownership or control for certain types of payments. These rules are not appropriate in situations such as the acceleration of salary payments under an employment agreement, when the periodic nature of the payments for services means that there is no issue in determining the amount of the payment that is accelerated, or in situations where a payment is conditioned on achievement of a performance goal or other event.

As under the 1989 proposed regulations, these proposed regulations provide that a payment is treated as contingent on a change in ownership or control if the change accelerates the time at which the payment is made or accelerates the vesting of a payment. Q/A-24(b) and (c) provide rules for determining the portion of such payment that is treated as contingent on the change in ownership or control. These proposed regulations clarify when Q/A-24(b) and (c) apply to a contingent payment.

These proposed regulations clarify that Q/A-24(b) applies if a payment is vested, without regard to the change in ownership or control, and is treated as contingent on a change in ownership or control because the change accelerates the time the payment is made. For example, if an individual has a vested right to a payment at

2002–9 I.R.B. 578 March 4, 2002

normal retirement age under a nonqualified deferred compensation plan, but instead that payment is made immediately following a change in ownership or control, Q/A-24(b) applies to determine the portion, if any, of the payment that is treated as contingent on the change in ownership or control.

These regulations clarify that Q/A24(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, the payment was contingent only on the 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. For example, if an individual will receive a bonus if employed at the end of a 3-year period, but the bonus is paid immediately on the date of the change of control, Q/A-24(c) applies to determine the portion of the payment that is treated as contingent on the change in ownership or control.

Q/A-24(b) provides that, when a payment is accelerated, the portion of the payment that is contingent on the change is the amount by which the accelerated payment exceeds the present value of the payment absent acceleration. Q/A-24(b) further provides that if the amount of a payment without acceleration is not reasonably ascertainable, and the acceleration does not significantly increase the value of the payment, then the present value of the payment absent the acceleration is equal to the amount of the accelerated payment. As a result, the value of the accelerated payment is equal to the value of the payment absent acceleration and no portion of the payment is treated as contingent on a change in control. If the value of a payment absent acceleration is not reasonably ascertainable and the acceleration significantly increases the value of the payment, the future value of the payment is equal to the amount of the accelerated payment. When the future value (as opposed to the present value) of the payment is deemed to be the amount of the accelerated payment, then there is an excess and, therefore, a portion of the payment is treated as contingent on the change.

Q/A-24(c) provides that the portion of the payment treated as contingent on the change when both vesting and payment are accelerated is the lesser of (1) the payment or (2) the amount determined under Q/A-24(b) plus an additional amount to reflect the lapse of the obligation to perform additional services. Q/A24(c) provides that for purposes of determining the amount under paragraph (b), the acceleration of the vesting of a stock option or the lapse of a restriction on restricted stock is considered to increase significantly the value of the payment.

Because Q/A-24(b) and (c) operate to provide an objective basis for determining the portion of a payment that is earned as of the date of a change in ownership or control, and therefore, not contingent on a change in ownership or control, these proposed regulations clarify that the rules in Q/As-38 through 44 (which provide rules related to reasonable compensation for services rendered), are inapplicable if the special rules in Q/A24(b) or (c) apply to a payment.

Change in Ownership or Control

These proposed regulations follow the same approach as the 1989 proposed regulations for determining when a change in ownership or control occurs. However, these proposed regulations clarify that, for purposes of determining whether two or more persons acting as a group are considered to own more than 50 percent of the total fair market value or total voting power of the stock of a corporation on the date of a merger, acquisition, or similar transaction involving that corporation, a person who owns stock in both corporations involved in the transaction 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. For example, assume individual A owns stock in both Corporations X and Y when Corporation X acquires stock in Y in exchange for X stock. In determining whether Corporation Y has undergone a change in ownership or control, individual A is considered to be acting as a group with other shareholders in Corporation Y only to the extent of A’s holdings in Corporation Y

prior to the transaction, and not with respect to A’s ownership in X. In determining whether Corporation X has undergone a change in ownership or control, individual A is considered to be acting as a group with other shareholders in Corporation X only to the extent of individual A’s holdings in Corporation X prior to the transaction, and not with respect to individual A’s ownership interest in Corporation Y. This rule applies without regard to the type of shareholder involved ( i.e., whether the shareholder is an individual or an institutional shareholder, such as a corporation, mutual fund, or trust).

Comments are requested with respect to whether the change in ownership or control rules in these proposed regulations should be further revised. Comments are also requested with respect to whether additional guidance is necessary regarding the application of the change in ownership or control provisions, and these proposed regulations in general, in the context of specific business situations such as bankruptcy.

Shareholder Approval Requirements

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).

The most significant revisions made by these proposed regulations with respect to exempt payments are clarifications to the shareholder approval requirements which must be met for payments with respect to a corporation in which no stock is readily tradeable on an established securities market or otherwise immediately before the change in ownership or control.

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

March 4, 2002 579 2002–9 I.R.B.

holders with 75% of the voting power entitled to vote.

Reasonable Compensation

The determination of whether amounts are reasonable compensation is relevant for two purposes. First, an excess parachute payment is reduced by any portion of the payment that constitutes reasonable compensation for services actually rendered before a change in ownership or control. Second, amounts that are reasonable compensation for services to be rendered after a change in ownership or control are exempt from the definition of parachute payment. In both situations, reasonable compensation for services must be demonstrated by clear and convincing evidence.

These proposed regulations clarify two issues with respect to reasonable compensation for services performed after a change in ownership or control. The proposed regulations clarify that clear and convincing evidence that a payment is reasonable compensation for services rendered after a change in ownership or control exists if the individual’s annual compensation after the change in ownership or control (apart from normal increases) is not significantly greater then the individual’s annual compensation before the change in ownership or control, provided that the individual’s duties and responsibilities are substantially the same after the change in ownership or control as they were before the change in ownership or control. If the individual’s duties and responsibilities have changed, then the clear and convincing evidence must demonstrate that the individual’s annual compensation after the change in ownership or control is not significantly greater than the compensation customarily paid by the employer, or by comparable employers, to persons performing comparable services.

Payments to an individual under an agreement that requires the individual to refrain from providing services (such as under a covenant not to compete) may also constitute reasonable compensation for services to be rendered on or after the date of the change in ownership or control. Under Q/A-42 of these proposed regulations, an agreement is treated as an

than 75% of the voting power of all outstanding stock of the corporation. Second, there is adequate disclosure to shareholders of all material facts concerning all payments which (but for this rule) would be parachute payments with respect to a disqualified individual. Since the issuance of the 1989 proposed regulations, commentators have indicated that the 1989 proposed regulations do not fully explain how the shareholder approval requirements operate or accurately reflect business practices connected with a change in ownership or control.

The proposed regulations clarify the process of obtaining shareholder approval within the structure provided by section 280G(b)(5)(B). Under this section, a shareholder approval vote is valid only if (1) it is a vote of more than 75% of the shareholders entitled to vote based on ownership in the corporation immediately before the change in ownership or control, and (2) disclosure is made with respect to all payments that would otherwise be parachute payments for an individual.

The first step in obtaining shareholder approval is to identify the shareholders entitled to vote. Q/A-7 is revised to clarify that stock held by a disqualified individual (or by certain entity shareholders) is not entitled to vote with respect to a payment to be made to any disqualified individual and that this stock is disregarded in determining whether the more than 75% approval requirement has been met. Once the stock entitled to vote is determined, more than 75% of the voting power of such stock must approve the payment. Q/A-7 also includes a rule of administrative convenience providing that a vote to approve the payment does not fail to be a vote of the shareholders who own stock immediately before the change in ownership or control if eligibility to vote is based on 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. This rule only applies if the disclosure requirements are also met.

These proposed regulations further clarify that not all parachute payments must be subject to a shareholder vote to

satisfy the shareholder approval requirements with respect to a payment. It is permissible for only a portion of the payments that would otherwise be made to a disqualified individual to be subject to vote. For example, assume that a disqualified individual with a base amount of $150,000 would receive payments that (but for the exemption for a corporation with no readily tradeable stock) would be parachute payments including (i) a bonus payment of $200,000, (ii) vesting in stock options with a fair market value of $500,000, $200,000 of which is contingent on the change in ownership or control, and (iii) severance payments of $100,000. In this situation, assuming all of the payments are disclosed, the corporation may submit to the shareholders for approval (1) all of the payments, (2) any one of the three payments, or (3) $50,001 of any one of the payments ( e.g., options with a value of $50,001). The issue submitted to a shareholder vote must be whether the payment will be made to the disqualified individual, not whether the corporation will be able to deduct the payment. In addition, the vote must be a separate vote of the shareholders. Therefore, the merger, acquisition, or other transaction cannot be conditioned on the shareholders’ approval of the payment.

These proposed regulations also clarify that the shareholder approval requirements are met by a single vote on all payments submitted to the vote, including payments to more than one disqualified individual (assuming the disclosure requirements, described below, are also met).

The shareholder approval requirements also require adequate disclosure of all material facts concerning the amount of all parachute payments. For this purpose, the proposed regulations clarify that the amount of all parachute payments to be made to each disqualified individual, and not just the amount of the payments subject to vote, is a material fact. These proposed regulations also clarify that shareholders should be provided with basic information about the type of payments involved ( e.g., vesting of stock options or severance payments). This disclosure of information must be made to all shareholders entitled to vote, not just to share

2002–9 I.R.B. 580 March 4, 2002

tion provides, in general, that an entity that claims to be, or is determined to be, an entity that is exempt from taxation under section 501(a) is treated as an association for purposes of the Code. Because the definition of corporation includes an association, any entity described in § 301.7701–3(c)(1)(v)(A) is a corporation for purposes of sections 7701 and 280G.

Determination of Excess Parachute Payments

Once all parachute payments are identified, the determination of what portion, if any, of each parachute payment is an excess parachute payment is made. This determination is based on the aggregate present value of all parachute payments. These proposed regulations modify the method described in Q/A-33 of the 1989 proposed regulations for determining the present value of a payment contingent on an uncertain future event or condition. Under Q/A-33 of these proposed regulations, if there is at least a 50-percent probability that the payment will be made, the entire present value of a contingent payment should be included for purposes of determining if there are excess parachute payments. If there is less than a 50-percent probability, then the present value of the contingent payment is not included. Once it is certain whether or not the payment will be made, the 3-timesbase amount test in Q/A-30 is reapplied if the initial determination as to whether to include the payment was incorrect. If the inclusion or exclusion of the payment for purposes of Q/A-30 at the time of the change in ownership or control was correct, there is no need to reapply the 3-times-base-amount test. In addition, if it is reasonably estimated that there is a less than 50-percent probability that the payment will be made and the payment is not included in the 3-times-base-amount test, but the payment is later made, the 3-times-base-amount test is not reapplied if the test without regard to the contingent payment resulted in a determination that the individual received (or would receive) excess parachute payments and no base amount is allocated to the contingent payment.

Finally, Q/A-31 provides guidance on determining the present value of an obligation to provide health care over a period of years. Under these proposed

agreement to refrain from services (rather than an agreement for severance pay) if it is demonstrated with 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. If, under the facts and circumstances, the agreement does not satisfy these criteria, the payments under the agreement are instead treated as severance payments under Q/A-44. If the agreement does satisfy these criteria, then the agreement is treated as an agreement for the performance of services, and the payments are exempt from the definition of parachute payment to the extent the payments are shown to be reasonable compensation under Q/A-42(a)(2).

Application to Tax-Exempt Organizations

Commentators have asked whether a payment with respect to a tax-exempt entity is exempt from the definition of the term parachute payment . These proposed regulations clarify 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 the following two conditions are satisfied.

First, the payment must be made by a corporation undergoing a change in ownership or control that is a tax-exempt organization, as defined in these proposed regulations. A tax-exempt organiza- tion is defined as any organization described in section 501(c) that is subject to an express statutory prohibition against inurement of net earnings to the benefit of any private shareholder or individual, an organization described in subsections 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 these regulations, both immediately before and immediately after the change in ownership or control. If this second condition is not met, a payment made by a tax-exempt organization is not exempt from the definition of parachute payment .

As noted above, the term tax-exempt organization includes organizations that

are described in section 501(c) that already are subject to express statutory rules that prohibit the inurement of the net earnings of such organizations to the benefit of “any private shareholder or individual.” Organizations described in the following subsections of 501(c) are tax-exempt organization s under application of this rule: 501(c)(3) (including any organization described in subsections 501(e), (f), or (k)), 501(c)(4), 501(c)(6), 501(c)(9), 501(c)(11), 501(c)(13) (but only with respect to those organizations subject to the express anti-inurement provision), 501(c)(19), and 501(c)(26). In light of the existing restrictions on these organizations, the Service and the Treasury Department believe the additional protections of section 280G are unnecessary. In addition, the term tax-exempt organization in the proposed regulations includes federal instrumentalities organized under Act of Congress (described in section 501(c)(1)), black lung trusts (described in section 501(c)(21)), certain religious and apostolic organizations (described in section 501(d)) and qualified tuition programs (described in section 529). The Service and the Treasury Department recognize that it may be appropriate to exempt payments made by other types of tax-exempt organizations. Comments are requested on whether any additional categories of organizations should be included in the definition of tax-exempt organization for purposes of section 280G.

Definition of Corporation

Under the 1989 proposed regulations, corporation is defined by reference to section 7701(a)(3) of the Code. These proposed regulations clarify that the term corporation, for purposes of section 280G and the regulations thereunder, includes any entity described in § 301.7701–2(b) such as, for example, 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 in section 7701(a)(5)). Accordingly, the term corporation also includes any entity described in § 301.7701–3(c)(1)(v)(A). That regula

March 4, 2002 581 2002–9 I.R.B.

enue Building, 1111 Constitution Avenue, NW, Washington, DC. All visitors must present photo identification to enter the building. Because of access restrictions, visitors will not be admitted beyond the immediate entrance area more than 15 minutes before the hearing starts. For information about having your name placed on the building access list to attend the hearing, see the “FOR FURTHER INFORMATION CONTACT” section of this preamble.

The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who wish to present oral comments at the hearing must submit written comments and an outline of the topics to be discussed and the time to be devoted to each topic (signed original and eight (8) copies) by June 5, 2002. A period of 10 minutes will be allotted to each person for making comments. An agenda showing the schedule of speakers will be prepared after the deadline for receiving outlines has passed. Copies of the agenda will be available free of charge at the hearing.

Drafting Information

The principal author of these proposed 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.

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Proposed Amendments to the Regulations

The proposed amendments to 26 CFR part 1 are as follows: