IRC 409A Now in Effect
IRC 409A went into full effect on January 1, 2009, after several rounds of draft regulations and years of delayed implementation. Between 2005 and 2009 compliance was optional, but now it is required for any private company issuing stock options or similar equity incentives.
IRC 409A requires that a company issuing stock options price the options at or above the fair market value of the underlying common stock. But IRC 409A goes on to state that a company can move into a safe harbor by following one of three methods to establish fair market value: (a) independent appraisal; (b) binding formula; or (c) internal appraisal.
The consequences for non-compliance are severe: for California employees, taxes of nearly 90%*; for employers, increased withholding obligations and unhappy employees; and for investors, potential difficulty in obtaining additional financing or selling the company. Most companies will want to obtain a valuation report from a qualified independent appraiser.
Teknos is a qualified independent appraiser and has provided hundreds of emerging growth companies with valuation reports. These reports have a substantial advantage over many other reports because they meet the requirements of both IRC 409A and ASC 718 (formerly FAS 123R). Companies which are preparing audited financials must comply with ASC 718.
Compliance with ASC 718 is more difficult that compliance with just IRC 409A. And, frankly, it is a bigger issue. Very few companies will ever face the IRS, but almost every company will have to deal with a financial auditor – either its own auditor or the auditor of an acquiring company.
Unlike many smaller valuation firms which do not have our experience or firms which outsource work offshore, Teknos professionals interact in daily with their peers at audit firms. Teknos has been through the audit review process hundreds of times with all of the Big Four and many other accounting firms. For more information about about issuing stock options click here.
For assistance with IRC 409A and ASC 718 reporting, please contact us: .(JavaScript must be enabled to view this email address)
* IRC 409A requires an individual who received a stock option priced below fair market value to pay: (a) tax on the entire difference between the original grant price and the ultimate sale price (i) at the highest marginal rate (currently 35%) plus (ii) a 20% penalty tax; and (b) interest of (i) the IRS “late payment” rate plus (ii) 1% from (iii) the date of the option grant to the sale. California mirrors this arrangement for state taxes, including an additional 20% penalty tax. (federal taxes 35% + 20% and CA taxes 10% + 20% and interest = 90%)