IRC 409A - Equity-Based Deferred Compensation
Section 409A (Internal Revenue Code) was enacted in 2004 as part of the American Jobs Creation Act. In 2007, the final regulations were issued by the IRS treating certain stock options as deferred compensation. These regulations impact every private company that has issued or plans to issue equity-based compensation, including stock options, restricted stock, stock appreciation rights, etc. For options granted with an exercise price less than fair market value as of the award date, treatment as deferred compensation subjects the awardee/optionee to income tax as of the date of vesting (as opposed to when exercised), and interest plus a 20% penalty. The IRS states that it is the responsibility of the awardee, who will look to the Company, to prove compliance with IRC 409A. An opinion from an independent appraiser is a safe harbor method which satisfies the requirements of the IRS.
What to Expect
The businesses awarding equity based incentives run the gamut from venture/private equity funded companies expecting rapid growth to family businesses, which may issue non-voting equity appreciation rights to non-family professional management. The valuation approach is the same – using the appraisal industry accepted methodologies of income, market (guideline public companies and guideline transactions) and cost approaches. The value of the common equity is determined after concluding with an enterprise value, deducting the market value of liabilities and addressing the particular characteristics of the more senior equity securities in the Company's capital structure.
Our clients typically award stock options annually or semi-annually. Valuation updates coincide with option award dates or the fiscal year end and preparation of the financial statements.