Section 409a Valuation

The final regulations adopt a presumption in specified circumstances that for purposes of section 409a a valuation of stock reflects the fair market value of the stock rebuttable only by a showing that the valuation is grossly unreasonable.

Section 409a valuation. In other words a reasonable valuation considers the cost income and market approaches and considers the specific control and liquidity characteristics of the subject interest. The section 409a regulations provide for three safe harbor methods. Failure to obtain a 409a valuation can result in penalties for both the company and the employee.

These rules are designed to objectively value the deferred compensation and make it easier for the irs to tax it properly. This valuation is recommended before issuing any stock to employees. The fair market value of an option on common stock is defined as the fair market value of the common stock the underlying security on the date of issuance.

Why do you need a 409a valuation. A 409a is an independent appraisal of the fair market value fmv of a private company s common stock or the stock reserved for founders and employees. Enter the irs section 409a valuation.

Qualified independent appraiser method. Therefore the valuation of common stock is critical. The section requires that the company value or appraise the fair market value of the stock of the company.

Section 409a safe harbor valuation methods. The irs is also concerned that the valuation of common stock for purposes of section 409a be consistent with valuations performed for other purposes. However with respect to stock that is not traded on an exchange such an appraisal provided it is fresh i e the valuation date of the appraisal is within 12 months of the date the option is granted is the section 409a safe harbor valuation approach that is most commonly used.

Last section 409a valuations generally expire after 12 months if not already expired due to new information material to the value of the company. A 409a valuation will determine a strike price the price at which your employees can buy equity in your company that must be at or above fair market value. However if a company issues options to a service provider at a valuation below fair market value section 409a will apply.