What is within the 409A stock options extension?

Section 409A of the Internal Revenue Code regulates deferred compensation that includes stock options.

Whenever an option is granted or subsequently modified, it is considered as deferred compensation. Deferred compensation in the 409A stock options extension includes both stock options and stock appreciation rights (SARs).

Consequently, if the option does not meet the standards of the law the end receiver of the option will be taxed. The tax will be based on the fair market value of the stock and the exercise price of the option.

An excise tax of 20% can also be included as penalty for non-compliance of what is required. Another possible addition is interest, which will run from the date compensation, is deferred.

Subjects of the 409A stock options extension include:

• Option grants below fair market value to employees like directors and some consultants
• Option grants with extended period
• Option grants on stock of non-controlled group companies
• Amended option grants that was given when the fair market value is above the exercise price of the option
• Option grants other than common stock like preferred stock or other stock that gives dividends
• Preference or liquidation rights and option grants that do not fix the shares subject to the option on the date of grant.

In case of an amended stock option subject to 409A stock options extension, any amendment is considered a modification. It is deemed as the same for analysis as the latest grant.

If the value of the underlying stock on the date of modification is greater than the price of the option then the option will be subject to the 409A stock options extension.

Said modifications do not include adding the ability to utilize formerly acquired stock to purchase the exercise price, accelerating the grant of an option and reduction of the period to exercise the option.

Assumption or substitution is deemed a modification if the transaction is greater than the ratio of the exercise of price to the fair market value before the transaction.

Another is that the option satisfies the requirements of the law. Short of these two requirements, the assumption or substitution will be outside the ambit of 409A stock options extension.

The extension contains new exceptions and rules. These include the expanded exception for non-discounted SARs and the new valuation rules for stock rights. The former holds exception to both public and private companies that have no other deferral features.

The latter, on the other hand, speaks of the company stock rights. Public companies may apply various valuation methods such as the last sale or first sale subsequent to the grant, the closing price on the trading day before or on the day of grant and the likes. Concerning private companies, a valuation, which is equal to the fair market value, is presumed.

409A stock options extension also contains new guidance for put and call repurchases rights. It provides that the determination must meet the consistency requirements for the methods used to determine the fair market value.

There are also three presumptions given for corporations. The first is the Illiquid start-up presumption, which is a special presumption for start-up corporations. These corporations do not have publicly traded stocks and do business for less than 10 years. Another presumption is the binding formula presumption.

The valuation in this presumption is based on a formula used in all transactions in a company’s stock. The last presumption is called the independent appraisal presumption. This is a valuation performed by a competent individual appraiser.

The latter uses conventional appraisal techniques to come up with a reasonable value. Between the three presumptions, independent appraisal program is the most secured yet most costly.