Stock Option Issuance: IRC 409A and ASC 718
Tax Compliance: IRC 409A
Since January 1, 2009, Internal Revenue Code 409A (IRC 409A) has been in full effect and any new stock option must be priced at or above “fair market value” (FMV). Pricing stock options below FMV will cause adverse tax consequences for both the issuing company and the option holder. The combination of federal and state taxes, penalties, and interest can reach 90% (in California).
To avoid potential penalties and withholding requirements for both employer and employees, companies need to establish FMV in a way that satisfies the IRS. IRC 409A provides “safe harbors” and most companies have chosen to obtain a valuation report from an “independent appraiser.” It has been our experience that companies commonly get an independent appraisal after obtaining the first round of outside capital and thereafter get appraisals every 12 months or after a material change, as required by the law.
GAAP Compliance: ASC 718
In addition to the tax requirements of IRC 409A, companies must consider the GAAP requirements of ASC 718 (formerly FAS 123R). Since 2006, GAAP has required that even private companies report the value of stock options issued as compensation. The requirements of ASC 718 are more stringent than the requirements of IRC 409A and audit firms have been very thorough—some would say “demanding”—in their review of valuation reports.
A report prepared for the lower requirements of IRC 409A probably will not meet the higher standard of ASC 718 and can lead to difficulties during a financial audit. The professionals at Teknos anticipated this issue as early as 2006 and we only provide a dual-use report that meets both the tax and GAAP standards. Our reports have been reviewed by all of the Big Four and other major accounting firms, plus most regional firms, and routinely pass scrutiny (a SAS 73 review) without any difficulty. Our reports also have been utilized in the preparation of S-1 and other registration materials for the SEC.
Teknos can rapidly prepare a dual use IRC 409A and ASC 718 valuation report for your company at a reasonable fee and will provide support for any subsequent interaction with the IRS or with financial auditors reviewing the report. For assistance with IRC 409A and ASC 718 reporting, please contact us: .(JavaScript must be enabled to view this email address)