409(a) Business Valuations

Issuing options? Equity Compensation? 
Learn about 409(a) business valuation requirements. 

409(a) Valuation Considerations

409(a) valuations are an important part of tax planning and employee compensation planning for any company thinking of issuing options or other equity based compensation.

409(a) Explained

409(a) refers to the IRS Revenue Code section 409(a). Often referred to as a “non-qualified plan,” this section provides for certain taxes that are payable based upon the issuance of employee stock options or stock appreciation rights (SARs).

If the instrument has an exercise price less than the Fair Market Value (FMV) of the underlying stock as of the grant date could result in adverse tax consequences for the option recipient. The gain is subject to taxation at the time of option vesting rather than the date of exercise, with potentially devastating penalties and interest charges.

The consequences for noncompliance, which affect the individual who holds the options and not the issuing company, are significant.

Valuation for 409(a)

These issues can be mitigated by issuing options with an exercise price at FMV, and section 409A provides clear approaches on how to develop compliant policies. These safe harbors shift the burden of proof of noncompliance to the IRS. That simply means that if a company employs a safe harbor method to value the price of its stock options, the IRS must show that the company was grossly unreasonable in calculating the FMV.

If Section 409A applies to stock option grants because of the failure to meet the fair market value rule, there are adverse tax consequences for the option recipient (“grantee”) and tax withholding responsibilities for the granting entity (“company”). The grantee is taxed when the option vests rather than on the date of exercise, and there is an additional 20% tax as well as a potential increased interest charge. By using a qualified third party valuation, the company can shift the burden onto the IRS to prove that the option exercise price was not set at or above fair market value, or that the presumptive valuation method used was not reasonable. In all other cases, the company has the burden of proving that its stock valuation method was reasonable and complied with the regulations.

Tax Consequences. Failure to comply with 409(a) valuation requirements can have serious consequences. If you’ve already issued options or SAR’s without a valuation… contact us now.

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Examples

  • Options Grants

  • Preferred Financing

  • Stock Appreciation Rights

  • Other

More Types of
Business Valuation Purposes

BUY-SELL AGREEMENTS

Quantive performs business valuations in support of buy-sell agreements, to include buy-ins and -outs, as well as shareholder disputes.

VALUATIONS FOR DIVORCE

We perform business valuations in support of divorce proceedings, working either jointly retained or on behalf of one spouse.

PURCHASE AND SALE

Smart entrepreneurs routinely retain Quantive to understand price early and gain a roadmap for impending price negotiations.

LITIGATION SUPPORT

We provide litigation support for shareholder disputes, lost profits, shareholder oppression, commercial litigation, and various other reasons.

ESTATE AND GIFT

We perform valuations in support of various gifting strategies, as well as in support of probate requirements.

SBA LOANS

Quantive is qualified to perform valuations in support of SBA financing. Our reports are compliant with all SBA SOP’s.

INSURANCE

Quantive values companies for a variety of reasons related to insurance to include establishing values for funding buy-sell agreements.

OTHER

We perform valuations for business planning, gap analysis, lost profits and damages, and a variety of other reasons.

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