By Channing Hamlet
Managing Director, Objective Capital Partners
In the wake of a number of accounting scandals in the early 2000s (Enron, Tyco, WorldCom), the IRS enacted new legislation, Section 409a, to curb perceived abuses in deferred compensation. This was mainly a reaction to executives of these companies withdrawing significant cash from their deferred compensation plans at a time when the companies were failing and shareholders were left holding the bag.
In typical IRS fashion, the reaction was significant and far-reaching. As a result, Section 409a is a large and relatively complex body of legislation. To boil it down to a simple concept: if a company provides guaranteed compensation to a recipient, taxes are due at the time the agreement is made rather than when the compensation is paid.
As part of 409a, beginning December 31, 2008 the IRS required private companies to perform formal valuation analysis when granting stock options to ensure that the strike price of the option is granted at or above fair market value of the Common Stock. Going back to the spirit of 409a described above, if the strike price is below fair market value, the recipient is supposed to recognize income. As part of the 409a regulation, the IRS provides a safe harbor for companies that choose to work with a qualified appraiser. (more…)