Section 409 A Internal Revenue Code
Section 409A
Internal Revenue Code
Section 409(A) – What is it?
Section 409(A) applies to non-qualified deferred compensation; ie. compensation that is earned by employees, directors, officers, consultants, etc. in one tax year but is paid by the company in a future tax year. Section 409(A), and certain state tax laws, require that stock options are granted with such exercise price that “reasonably” values the underlying stock of the company as the fair market value (FMV) of the stock at the time of grant.
Rule of thumb: At every instance a close corporation grants stock options, there should be a “reasonable” and valid FMV valuation of the company’s common stock upon which such grants are based.
Rationale for the 2004 Enactment – Enron and Section 409(A)
In the many ways that Enron taught us about corporate malpractice that had long been unregulated,
Enron also shed valuable light on deferred compensation acceleration. As is common amongst large companies, Enron operated non-qualified deferred compensation programs, allowing senior employees and executives to defer portions of their salaries or bonuses. When Enron filed for Chapter 11 protection in late 2002, around 400 senior employees and executives under the program became unsecured creditors of the company, ultimately losing all the money in their accounts under the deferred compensation programs. However, days before the Chapter 11 filing, a handful of Enron executives were able to withdraw millions of dollars from their accounts as (i) the exercise price of their options had been set below FMV or (ii) withdrawals from the deferred accounts were not limited to predetermined dates. In a knee-jerk reaction to the outrageous Enron situation, Section 409(A) was enacted and incorporated into the Internal Revenue Code as part of the American Jobs Creation Act of 2004.
Section 409(A) was enacted with the objectives of (i) limiting the flexibility in timing of elections to defer compensation in non-qualified
Internal Revenue Code
Section 409(A) – What is it?
Section 409(A) applies to non-qualified deferred compensation; ie. compensation that is earned by employees, directors, officers, consultants, etc. in one tax year but is paid by the company in a future tax year. Section 409(A), and certain state tax laws, require that stock options are granted with such exercise price that “reasonably” values the underlying stock of the company as the fair market value (FMV) of the stock at the time of grant.
Rule of thumb: At every instance a close corporation grants stock options, there should be a “reasonable” and valid FMV valuation of the company’s common stock upon which such grants are based.
Rationale for the 2004 Enactment – Enron and Section 409(A)
In the many ways that Enron taught us about corporate malpractice that had long been unregulated,
Enron also shed valuable light on deferred compensation acceleration. As is common amongst large companies, Enron operated non-qualified deferred compensation programs, allowing senior employees and executives to defer portions of their salaries or bonuses. When Enron filed for Chapter 11 protection in late 2002, around 400 senior employees and executives under the program became unsecured creditors of the company, ultimately losing all the money in their accounts under the deferred compensation programs. However, days before the Chapter 11 filing, a handful of Enron executives were able to withdraw millions of dollars from their accounts as (i) the exercise price of their options had been set below FMV or (ii) withdrawals from the deferred accounts were not limited to predetermined dates. In a knee-jerk reaction to the outrageous Enron situation, Section 409(A) was enacted and incorporated into the Internal Revenue Code as part of the American Jobs Creation Act of 2004.
Section 409(A) was enacted with the objectives of (i) limiting the flexibility in timing of elections to defer compensation in non-qualified