A 409A valuation is a requirement from the Internal Revenue Code (IRC), identified as Section 409A. A 409A valuation provides a company with a report that states a suggested value for the company’s common stock. The purpose of finding this value is for the company to issue deferred compensation to employees at fair market value, which includes issuing stock options with an exercise price at fair market value. Newer companies that issue deferred compensation often have complex equity structures with varying classes of stock. Often, complex methods are required to value common stock in the context of diverse capitalization.

The Purpose

Any company that wishes to issue deferred compensation to employees needs a 409A valuation. Deferred compensation that is not issued at fair market value can incur significant consequences, including a 20 percent federal income tax penalty and varying state tax penalties. A 409A valuation helps protect your employees from future tax problems with the IRS. The fair market value must also be calculated by applying a suitable valuation methodology. A new 409A valuation must be performed if any of the following trigger events occur.