My company is based outside of the United States, do I need to worry about IRS Section 409A?

Are you looking to hire a U.S. citizen? Are you thinking of opening an office in the U.S.? If you answered yes to either of these questions and are considering issuing deferred compensation (for example stock options or restricted stock units) then IRS Section 409A should be on your radar.

What is a 409A valuation? A 409A valuation is a determination of the fair market value of your company, using IRS and AICPA standards of valuation, at a specific point in time.  IRS Section 409A stems from the American Jobs Creation Act of 2004. The rationale behind implementing the 409A provision was the necessity to have tighter standards for stock option reporting and to ensure the government received its share of taxable income. In a nutshell Section 409A means that when you issue stock options or other deferred compensation arrangements to employees, you must ensure the targeted exercise price is compared with an accurate fair market value of your company’s common stock as of the option grant date (or other compensation agreement date).

How do I comply with Section 409A? Before you issue any deferred compensation you need to determine the fair market value of your company and the stock you are going to issue. There is safe harbor that is provided when you hire an independent firm to perform a 409A valuation for your company. The independent firm will gather information about your company and determine a recommendation of the fair market value of your company and stock as of a specific date, the ‘valuation date’. You can then use the recommendation to help your Board determine at what price the deferred compensation should be issued. Ultimately, it is up to the company and its Board to determine the issue price, but if the IRS audits your company or your employees and asks how the issue price was determined you can show them the 409A valuation report as a piece of supporting evidence.

What happens if I do not get a 409A valuation before issuing deferred compensation? If you issue deferred compensation below your company’s fair market value then the penalties and charges include:

• 20 percent federal penalty
• The IRS tax underpayment penalty plus an additional 1 percent (premium underpayment penalty)
• Certain state penalties and taxes (for instance, California also imposes a 20 percent state tax, interest, and penalties)

In addition to the direct, out of pocket expenses, your funding and businesses partners may be put off by the penalties. On the other hand, if you overestimate the fair market value, your employees receive less income than they otherwise would have and will be unhappy.

Who can I talk to about my company’s 409A requirements? We would be happy to give you a free consultation to see if your company needs a 409A valuation. At Simple409A, we employ the approved valuation methods using our expert appraisers’ experience to ensure you get the right valuation for your company. We work hard to make the process easy on you so you can spend more time doing what you do best, and we have industry leading prices. Contact us and we can see if Simple409A is right for your company.