Created in 2004 as a reaction to the Enron and Worldcom scandals, Section 409a — requiring the valuation of company stock plans — takes effect this year. Even though the additional regulatory cost is annoying, 409a valuation will help you avoid onerous penalties on the company and participating executives.
409a valuation must incorporate the financial features of a company’s capital structure to allocate the value of the equity among different classes of shareholders.
Noncompliance with IRC 409a can lead to acceleration of taxable income, penalty taxes, company withholding tax issues and potential exposure for board members. Additionally, non-compliance could impact the marketability of a business to investors and/or acquirers.
The Going Concern blog (a great resource for CFO's) voted 409a the Worst Tax of the Decade because it attacks companies large and small in two ways:
1. It taxes employees on their deferred comp balances when the plan is out of compliance.
2. It hits them again with a 20% excise tax.
Section 409a is so complicated that it took 3 years to complete the 200-page regulations, and is so complicated and intrusive that accidental noncompliance must be rampant. We're begining to see some of the first case law (Slater v US) involving 409a.
Undeterred, however, the IRS promises to increase 409a Audits beginning in 2010, forcing companies to divert capital that would be better used to fuel corporate growth.
I'll continue to monitor developments on this blog and hope IRS will provide more detailed guidance on 409a valuation and reporting requirements.