Selling an LLC? Don’t Forget about Section 280G!

Internal Revenue Code section 280G (280G) (commonly referred to as the “golden parachute” provision) was designed to discourage the payment of excessive compensation to certain shareholders, officers, and highly compensated service providers of companies undergoing a change in control. When transaction-related payments or benefits to these individuals exceed a specified threshold, the individuals may be subject to a 20 percent excise tax, and the company’s deduction for such payments or benefits may be disallowed.

280G commonly applies when a C corporation undergoes a corporate transaction. However, in certain circumstances, 280G can also apply when the only entity being sold is an LLC. (Note: Although this practice point focuses on the applicability of 280G to LLCs, 280G can also apply to the sale of a partnership in the circumstance described in #2 below.)

LLCs and Application of 280G

A sale of an LLC may trigger the application of 280G in two specific circumstances:

1. 280G could be triggered if the LLC has elected to be taxed as a C corporation.
   
   Although by definition 280G applies to corporations, an LLC that has elected to be taxed as a C corporation will be considered a corporation for 280G purposes and will be subject to 280G if engaging in a corporate transaction that constitutes a change in ownership, change in effective control, or change in the ownership of a substantial portion of the assets of the LLC.
2. 280G could be triggered if the LLC is owned by a C corporation and the sale of the LLC represents a sale of a substantial portion of the assets of the corporation. 
   
   The sale of an LLC that is not taxed as a C corporation (e.g., an LLC taxed as a partnership) can trigger 280G if the LLC is owned by a C corporation and the sale of the LLC constitutes a sale of a substantial portion of the corporation’s assets (i.e., the LLC constitutes more than one-third of the total gross fair market value of all assets of the C corporation). Even when 280G applies in this context, additional analysis is needed to determine which individuals are subject to the provisions of 280G. This requires consultation with a 280G practitioner to determine whether the officers of the LLC are subject to 280G based on their relationship with the C corporation.

Conclusion

As noted above, although LLCs are generally exempt from 280G, there are circumstances in which 280G can apply to a transaction involving an LLC. It is important to identify the potential applicability of 280G early in the transaction so that the LLC can take appropriate steps to avoid the excise tax and loss of deduction (shareholder cleansing vote) before the transaction closes.