IRC 409A OverviewThe practice of issuing nonqualified deferred compensation changed dramatically with the enactment of Section 409A of the Internal Revenue Code. At the heart of this change is the increased scrutiny placed on firms issuing employee stock options. Under Section 409A, firms issuing employee stock options, or similar units, must ensure that the strike price, or exercise price, of these units is never less than the fair-market value of the their equity on the day of grant. For public firms this process is straight forward, barring of course any illegal back-dating. For private firms on the other hand, this process is much more complicated. Due to the fact that these firms have no market prices of their own, the determination of fair-value is dependent upon another "method". However, making the chosen method all the more critical are the additional income tax penalties and 20% excise tax on all discounted or "in-the-money" units. So, in light of these penalties, what compliant methods for determining fair-market value are available to non-public firms? According to the final version of Section 409A, the "reasonable application of a reasonable valuation method" meets to requirement of fair market value. This still begs the question as to what methods are indeed reasonable and who should perform them?
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