An independent valuation or appraisal may be needed to determine the fair market value (FMV) of a privately held company’s certain nonqualified deferred compensation plans such as stock appreciation rights (SARS) or stock options. Whether such plans are subject to section 409A depends on the rules and features designed in a compensation plan including the effective date, initial and subsequent deferral elections, the time and form of payment etc. In general, if any of the conditions below are not satisfied, the stock options will be regarded as deferred compensation subject to section 409A:

  1. Stock options that qualify as incentive stock options (ISOs)
  2. Non-qualified stock options that meet each of the following conditions:
  • The number of shares subject to the stock option must be fixed on the initial date of grant.
  • The stock option is a right to purchase ‘service recipient’ common stock (not preferred stock).
  • The strike price can never be less than the fair market value (FMV) of the underlying stock on the date the option is granted.
  • The transfer or exercise of the option is subject to taxation.
  • The option does not include any feature for the deferral of compensation beyond the later of:
    • The exercise or disposition of the option
    • The time the stock acquired pursuant to the exercise of the option first becomes substantially vested

If the stock options are subject to section 409A and are not readily tradable on an established securities market, an appraisal is recommended. According to section 409A, “The fair market value of the stock as of a valuation date means a value determined by the reasonable application of a reasonable valuation method.” An appraisal is not reasonable if the use of a valuation method does not take into consideration all available information material to the value of the corporation. 

A&C’s qualified and experienced professionals are here to assist in reaching a supportable and reasonable valuation in compliance with section 409A. If you have questions regarding this topic, please reach out to us at (469) 467-4660, or