Sadly, yes. We have covered in other articles the importance of companies meeting safe harbor requirements for 409A by getting a qualified third party 409A valuation, but this regulation is also of great concern to employees. The implications for non-compliance can be severe, including significant 409A penalties. The following is an example of the kind of hot water an employee can get themselves in when their company doesn’t make the effort to be 409A compliant.

An Example of IRC 409A Penalties

An executive in California received 50,000 stock options valued by the company’s board. The company had a recent round of funding in which the preference shares were valued at $20/share. bid vs ask . The board decided that a fair price for the stock options would be $2 – 10% of the value of the preferred shares.

The actual ‘fair value’ of the shares, when properly valued, was $5/share. Therefore, the options the executive received were undervalued by $3/share, which results in her receiving a $150,000 benefit on paper.

The executive would then be assessed for

  • 35% tax on the $150,000 ($52,500) plus a
  • 20% federal penalty ($30,000), and a further
  • 20% California state penalty ($30,000)

meaning she would have to pay out $112,500 of the theoretical $150,000 benefit in taxes and 409A penalties. She may even be required to pay the tax and penalties before she cashes out her options.

To make matters worse, if the value the common stock is less than $2/share when the company goes public or gets acquired, then the executive may have had to pay out $112,500 and won’t receive a penny from the ‘benefit’ that was assessed.

But Wait, That’s Not Fair!

I hear you, but we don’t make the rules. We do, however, help companies all over the USA avoid getting into issues with IRC 409A, and help their employees avoid 409A penalties, by providing a fast, easy, and affordable 409A valuation service. Had the company hired Simple409A, they would have only had to pay $2498 for a qualified, independent valuation. That would have saved the executive $110,000!

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