Section 409A of the United States Internal Revenue Code is a complex and often counterintuitive set of tax rules applicable to non-qualified deferred compensation.  Deferred compensation exists when an employee, consultant or board member has a contractual right to compensation that may be paid in later taxable years. Compensation subject to 409A can also include severance benefits, certain stock options and other equity awards but excludes amounts deferred under qualified plans, such as 401(k).  If deferred compensation arrangements are not exempt from or compliant with Section 409A, there are draconian adverse tax consequences, even for unintentional violations.

Stock options are exempt from Section 409A if they are granted with an exercise price that is at least equal to (or greater than) the fair market value (FMV) of the underlying shares on the grant date. For that reason, most private companies granting compensatory stock options obtain regular independent third party valuations of their stock, commonly referred to as a “Section 409A valuations,” to ensure that their stock option grants are exempt from application of Section 409A.