Is An Independent, Third Party Valuation Required By Section 409A To Grant Stock Options?
I was recently asked if a company had to obtain an independent, third party appraisal in order to grant stock options in compliance with Internal Revenue Code Section 409A, which generally requires that stock options be granted at fair market value or be subject to a 20% excise tax. The answer is no, a third party appraisal is not required.
"The final regulations adopt the provisions in the proposed regulations relating to the valuation of stock not readily tradable on an established securities market, subject to the modifications discussed in this section III.C.4.c. Accordingly, a valuation of stock based upon a reasonable application of a reasonable valuation method is treated as reflecting the fair market value of the stock. To meet this standard, it is not necessary that a taxpayer demonstrate that the value was determined by an independent appraiser. Where the taxpayer can otherwise demonstrate that the valuation was determined by the reasonable application of a reasonable valuation method, the standard will be met."
See the Final Regulations. That is not to say that an independent appraisal may not be advisable or worthwhile. In fact, if done in the manner specified in the final regulations, a valuation will create a presumption that the valuation of the stock reflects the fair market value of the stock, which presumption is only rebuttable by a showing that the valuation is grossly unreasonably.
"The final regulations adopt a presumption in specified circumstances that, for purposes of section 409A, a valuation of stock reflects the fair market value of the stock, rebuttable only by a showing that the valuation is grossly unreasonable. The presumption applies where the valuation is based upon an independent appraisal, a generally applicable repurchase formula (applicable for both compensatory and noncompensatory purposes) that would be treated as fair market value under section 83, or, in the case of illiquid stock of a start-up corporation, a valuation by a qualified individual or individuals applied at a time that the corporation did not otherwise anticipate a change in control event or public offering of the stock."
