Where Did IRC Section 409A Come From?

Internal Revenue Section 409A was the government’s response to events that happened over a decade ago leading up to the collapse of Enron, an energy and commodities company headquartered in Houston, Texas. Enron’s name has been immortalized because of the scandalous actions taken by its key staff members in the final years before Enron filed for bankruptcy in 2001. A number of laws have been enacted since in an attempt to address the various methods of fraud that Enron executives got away with— the first of which was the Sarbanes–Oxley Act of 2002. In 2004, the American Jobs Creation Act was passed with an included provision that was titled Internal Revenue Code 409A.

Deferred Income and Taxation

One of the greatest mistakes made by lawmakers in 2004 was to leave many of the details of IRC 409A to the IRS, which has since made various adaptations to the code. The foul that was committed by Enron executives was to accelerate the payout of all of their deferred compensation before the company went under. As a result, the IRS is beginning to pay attention to all forms of deferred income and how they are to be taxed.

Under the old tax code, any deferred compensation could only be taxed when the person finally received it and not on the date when it was awarded. When a company awards its employees with stock options, it is at the sole discretion of the employee to exercise the options and under the old law; the value of those options was not taxable until they were exercised. By 2007, the IRS had decided that stock options were not an exempt form of deferred income and could be taxed immediately— meaning that employees who were awarded options that were issued by the company at a value below the fair market value now needed to pay taxes and a 20% penalty under some circumstances.

409A Valuations as a Safe Harbor

If a company wishes to issue stock options or a deferred compensation program to its employees, it can implement one of several safe harbor measures that allow it to do so without making employees susceptible to tax penalties. One of these methods is to get a company appraisal, known as a 409A valuation, which places an estimated value on the company that is determined by unbiased professionals who have evaluated the company by comparing it to similar companies, looking at financial statements and projections and taken risk into account. A 409A evaluation protects the company from the IRS by forcing it to prove that the company was out of line in determining its value before awarding the stock options to employees.

One of the best ways to protect your company is to get a business valuation from Simple409A. We provide you with an easy, fast, and affordable 409A valuation, and our unbiased appraisal of your company will protect you and your employees from any of the negative tax implications that could arise when you issue stock options.

Get Your Professional Valuation Started Now

The above information does not constitute advice, and does not create a client relationship