Can You Use a 409A Valuation for Gift Tax Purposes?

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So far, a 409A valuation is very important for employees to get the stock options of their employers at a discount to the stock’s market price. If this is how it is, you may wonder whether or not you can use a 409A Valuation for gift tax purposes.

Generally, the companies need to conduct a 409A valuation at least once every 12 months. Certainly, it triggers people’s question whether a regular 409A valuation aims for gift tax purposes. To know more about whether you can use a 409A Valuation for gift tax purposes, let’s figure out about it through our post below!

Can You Use a 409A Valuation for Gift Tax Purposes?

Of course, yes! A 409A valuation is basically performed to prevent shareholders from having to pay tax penalties that may be assessed by the IRS. This is the only one method to grant options on a tax-free basis to employees.

A 409A valuation can be used for gift tax purposes, as long as a company’s common stock is worth 20% of the last round’s price. However, if a company does not get the 409A Valuation report, it would trigger an issue for the employees, since the IRS would impose tax penalties.

Assuming you have a startup and really want to issue stock options to your employees, so that they will be happy and make a serious effort to help your company grow faster. Of course, if you only guess a reasonable share price and start the issuance process, you will get an inaccurate 409A valuation.

Assuming the IRS audits your company’s valuation and gets a 409A valuation report from what value you gave the stock. Of course, it would hurt you and your employee a o lot, as your employees will be taxed at the ordinary income rate for all the vested options.

Aside from that, there will be a 20% penalty on your employee. Furthermore, your employee may also need to pay interest on unpaid taxes, some state penalties and other changes.

That’s why an actual 409A valuation is very important for employees, since it will impact them in two ways, as follow:

  1. An accurate 409A Valuation will help the company to get the strike price of the options that are given to employees. Furthermore, the company can set the strike price as the current 409A valuation amount, because they cannot issue the options at a lower strike price.
  2. A 409A valuation will also influence the tax bill of the employee. The employees will be taxed on the difference between the strike price and the current 409A, when they exercise their options.

We take an example, assuming that you’re an employee in a company and are given options with a strike price of $2 where the 409A valuation is also $2. If you exercise the options instantly, you may not need to pay the taxes as the difference between the strike price and the current 409A will be $0.

On the other hand, when you exercise the options once the 409A valuation is $4 at some point in the future, you may need to pay tax over the $2 difference per option that you exercise.

So far, stock options are beneficial, allowing the employees to buy the stock of the employer at a discount to the stock’s market price that is the fair market value (FMV) of the stock. The FMV here is the price where the property will sell in the market. This price is basically agreed on between seller and buyer, with both having a reasonable knowledge of the relevant facts.

Tax Penalties on Employees, Cause by Inaccurate 409A Valuation

In fact, there are three standard methodologies that the providers use during performing a 409A valuation, including the market approach, income approach and asset approach. If your valuation is not performed with one of the approved methods, you may fall outside of the 409A safe harbour.

According to Carta.com, if penalties are given, they may be substantial for employees and shareholders. In this case, the penalties include:

  • All deferred compensation from the current and preceding years become taxable immediately
  • Accrued interest on the revised taxable amount
  • Add additional tax of 20$ on all deferred compensations

You should know that tax valuations will need special considerations for market comparable transactions as evaluating the company and specific items which the IRS deems necessary for the valuation of a business.

Another problem you may face is when you are closing the period where your tax returns are subject to audit. If the IRS does not consider the valuation of your business interests acceptable, the audit period will be open indefinitely unless there’s an adequate tax appraisal that is submitted to the IRS.

According to ibusinessvalue.com, the section 409A valuation requirements do not have the same specific guidelines from the IRS as Estate and Gift Tax valuation requirements. In this case, the IRS does direct the public to its Estate and Gift Tax guidance for Section 409A.

So, a section 409A valuation is definitely a plain vanilla Estate and Gift Tax Valuation. Of course, there are several problems which arise when the company has a complex capital structure and needs option valuation models that really require more expertise than the typical valuation for federal taxation.

Learn More Taxable Income to Employees

Gifts to employees are a common way to spread thanks to people important to your business during the holiday season. However, the IRS reveals certain types of gifts are taxable, ensuring the employers follow the rule to avoid a high tax period.

There are some types of taxable income of employees, including:

  • All cash and gift cards redeemable for cast will be taxable to the employee, even when the gifts are given as a holiday gift.
  • Monetary prizes like achievement awards and non-monetary bonuses like vacation trips that are awarded for meeting sales goals will be taxable compensation. It is not just for income taxes, but also for FICA.
  • Gifts worth more than $75 will be taxable
  • Non-cash employee gifts of minimal value under $75 per year including a holiday Turkey will not be taxable.
  • The tax-free value is limited to $1,600 for all awards to one employee in one year. The gifts that are awarded for length of service or safety achievement will not be taxable, as long as they are not gift certificates, cash or points redeemable for merchandise.

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