Stock Options & 409A
Section 409A is a part of the tax code covering the taxation of equity compensation. 409A is designed to ensure that companies paying their employees with stock and stock options are fairly valuing the compensation, so that all parties involved pay the appropriate taxes. 409A has strict penalties for non-compliance, so many firms work hard to ensure that they are following the appropriate rules.
Other People Are Reading
-
What Rule 409A Covers
-
Rule 409A covers any situation in which employees get deferred compensation. Many companies try to give their employees deferred compensation, especially early on. Companies with low profits and high future growth potential may find this advantageous. Rule 409A was designed to ensure that these companies are fairly valuing their future compensation. This means that companies can continue to pay their workers with deferred compensation, but prevents companies from using deferred compensation to hide or shift their taxable compensation.
Deferred Compensation
-
Stock options are one of the most popular kinds of deferred compensation. Options allow an investor to buy stock at a particular price, on a certain date. This date is often many years in the future, especially for options in smaller companies. A software company, for example, may grant its employees five-year stock options, so they will benefit from the value that their work produces in the long term. 409A ensures that these options are structured in a tax-efficient way.
-
Restrictions
-
According to rule 409A, stock options granted as incentive compensation have some limits on their characteristics. Primarily, they cannot allow deferral of share delivery after being exercised, which could allow employees to reduce their tax burden when they exercise options. In addition, these options must be in the stock of the parent company. In other words, a company could not grant employees options in a competitor or a supplier as part of an equity option incentive package.
Market Value
-
One key rule from 409A is that options must be priced at the fair market value for the stock. In other words, a company whose stock is worth $10 per share cannot grant options to buy the stock for $5 per share, since this would give employees an instant profit. Instead, they must grant the options at $10 per share. For private companies, this involves valuing the company independently to determine its fair market value, which can be an expensive task.
-
References
- Photo Credit Abstract colorful 3D chart columns against chart background image by Stasys Eidiejus from Fotolia.com
