A 409A appraisal dated within 12 months is presumed reasonable, absent a material event
A 409A valuation supports the strike price for startup options.
The regulation sets a benchmark for that price. An option on service recipient stock is outside the deferred-compensation rules only if its exercise price may never be less than the stock's fair market value on the grant date, among other conditions.
Section 409A of the Internal Revenue Code and its regulations set the rules for option stock rights and the consequences when a plan fails them. This explainer draws on the statute, the regulation and one practitioner guide. Where those sources differ, or where a page read did not reach the point, the text says so.
Why the strike price depends on the grant-date value
The regulation asks whether the method used to value the company's stock is reasonable, and it gives certain methods a presumption that they are.
The stock-right rule is the reason the grant date matters. Under the regulation, an option is not a deferral of compensation if, among other conditions, the number of shares is fixed on the original date of grant and the exercise price may never be less than the fair market value of the underlying stock on the date the option is granted. The stock must also be service recipient stock, which generally means common stock for section 305 purposes on the grant date. A class with a distribution preference, other than distributions of service recipient stock and liquidation distributions, does not qualify.
The regulation also says a calculated value is not reasonable as of a later date if it fails to reflect information available after the date of the calculation that may materially affect the value.
The independent appraisal presumption and the 12-month date
The regulation presumes a valuation is reasonable when it is an independent appraisal that meets the requirements of section 401(a)(28)(C), and when it is dated no more than 12 months before the relevant transaction to which the valuation is applied. The Commissioner may rebut that presumption on a showing that the valuation method or its application was grossly unreasonable.
Section 401(a)(28)(C) requires that valuations of employer securities not readily tradable on an established securities market be made by an independent appraiser. It defines that appraiser by reference to requirements similar to those in the regulations under section 170(a)(1). The regulation's excerpt cross-references that section rather than defining independence itself. The page read did not reproduce the section 170(a)(1) regulations, so the standard itself is not stated in the sources reviewed.
A practitioner guide from Cake Equity says a 409A is valid for 12 months from the date it was completed. That wording is shorter than the regulation, which measures the 12 months against the transaction the valuation supports. The two phrasings are close but not identical, and the regulation's wording is the one to follow.
Material events that can make an older valuation unreliable
Inside the 12 months, a valuation does not stand unchanged. The regulation says a previously calculated value is not reasonable as of a later date if it fails to reflect information available after the date of the calculation that may materially affect value. Its examples are the resolution of material litigation and the issuance of a patent.
The Cake Equity guide lists events it says require a new valuation before the 12 months end. They include closing a priced financing round, entering into or completing an acquisition, achieving a significant change in revenue or operations, and entering into discussions that could result in a change of control. The guide describes a material event as anything that would significantly change the fair market value of the common stock.
The regulation text does not name financing rounds. The round appears in the practitioner guide's list, so this article treats it as that guide's reading rather than the regulation's.
What a failed deferred-compensation plan can trigger
Under subsection (a)(1), when a nonqualified deferred compensation plan fails the distribution, acceleration or election requirements, or is not operated in accordance with them, the compensation deferred under it for that year and earlier years becomes includible in gross income. That applies only to amounts not subject to a substantial risk of forfeiture and not already included, and only to participants affected by the failure. The tax for that year rises by 20% of the amount required to be included.
The statute also adds interest at the underpayment rate plus one percentage point. Interest is computed on the underpayments that would have occurred had the compensation been includible in the taxable year in which it was first deferred or, if later, the first taxable year in which it was no longer subject to a substantial risk of forfeiture. The statute sets no calendar date for that rate, and this article did not pull the current figure.
The statute's consequences are written for nonqualified deferred compensation plans. The stock-right rule above exempts an option that meets its conditions, including an exercise price never below grant-date fair market value. The sources read did not say how these consequences apply to an option whose exercise price falls below that value. Readers should check that point against the regulation and current IRS guidance before relying on it.
“Inside the 12 months, a valuation does not stand unchanged.”
What to check before each grant
The rules point to two checks for each grant. The first is the date of the most recent valuation, measured against the grant date and the 12-month presumption. The second is whether anything has happened since that valuation that may materially affect value.
The events the practitioner guide lists, such as closing a priced financing round, entering into or completing an acquisition, a significant change in revenue or operations, or discussions that could result in a change of control, are the ones to review. A valuation that lacks the independence the statute describes falls outside the presumption as written.
The regulation also treats a change that may give the holder a reduction in the exercise price as a modification, which counts as the grant of a new stock right. An extension of the exercise period is treated as adding a deferral feature from the original grant date, but if the stock's fair market value is below the exercise price when the extension is made, the change is treated as a modification instead. Changes to an existing option therefore need their own review, since the regulation treats them differently.
What the current sources do not settle
The sources reviewed here show no 2026 change to the 409A regulation or to the 20% additional tax. Research did not turn up current IRS guidance on option valuation, so the statute and the regulation are the anchors for this explainer.
Three points remain open: the current underpayment rate, how the penalties reach underpriced options, and whether a financing round is a material event under the regulation itself. A tax adviser or the company's valuation provider can address those points for a specific grant.
