Executive Summary
What is Section 409A Valuation: Understanding Your Stock's Fair Market Value?
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Section 409A Valuation: Determining Fair Market Value of Common Stock
Section 409A of the Internal Revenue Code (IRC) requires private companies to determine the fair market value (FMV) of their common stock when granting deferred compensation like stock options, to avoid immediate taxation and penalties. This valuation ensures the exercise price equals or exceeds FMV at grant, with IRS safe harbors providing presumption of reasonableness if specific methods are used.26 USC §409A
Statutory Basis and Purpose
IRC Section 409A, added by the American Jobs Creation Act of 2004 (effective 2005), governs nonqualified deferred compensation, including equity awards to service providers.26 USC §409A It mandates FMV determination for common stock underlying options, defined as "the price at which the stock would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts." 26 CFR §1.409A-1(b)(5)(iv)(B)(1)
Failure to comply triggers: (1) immediate inclusion of deferred amounts in income; (2) 20% additional tax on underpayments; and (3) interest at the federal underpayment rate plus 1%. 26 USC §409A(a)(1)(B); 26 CFR §1.409A-1(a)(3)
IRS Safe Harbor Methods for FMV
Treasury Regulations provide three safe harbors presuming FMV reasonableness, shifting burden to IRS to prove "grossly unreasonable":
- Independent Appraisal Safe Harbor (§1.409A-1(b)(5)(iv)(B)(1)): Valuation by qualified independent appraiser using customary methods (e.g., market, income, asset approaches). Valid for 12 months from valuation date unless material facts change. Appraiser must have r
Footnotes
Primary Sources
| Source | Type | URL |
|---|---|---|
| 26 USC §409A | Reference | https://www.law.cornell.edu/uscode/text/26/409A |
| 26 USC §409A | Reference | https://www.law.cornell.edu/uscode/text/26/409A |
| 26 CFR §1.409A-1(b)(5)(iv)(B)(1) | Reference | https://www.law.cornell.edu/cfr/text/26/1.409A-1#b_5_iv_B_1 |
| 26 USC §409A(a)(1)(B) | Reference | https://www.law.cornell.edu/uscode/text/26/409A#a_1_B |
| 26 CFR §1.409A-1(a)(3) | Reference | https://www.law.cornell.edu/cfr/text/26/1.409A-1#a_3 |
Disclaimer: This guide discusses legal tax optimization strategies only. Tax evasion is illegal and is never recommended. This content is for educational purposes and does not constitute tax, legal, or financial advice. Tax laws vary by jurisdiction and change frequently. Always consult a qualified tax professional (CPA, tax attorney, enrolled agent) before making decisions based on this information. The authors accept no liability for actions taken based on this content.