Are Stock Options Exempt From 409A?

Yes, if the strike price is at least the fair market value of the stock on the grant date. An option priced at fair market value, with no extra deferral feature, falls outside the Section 409A deferred compensation rules. A 409A valuation is how you set and support that number.

What does it mean to be exempt from 409A?

Section 409A governs deferred compensation. It sets strict rules on when deferred pay can be paid out. Pay that breaks those rules is taxed early, with an additional 20% tax and interest on top.

A stock option can look like deferred pay. The employee earns value now and collects it later. The rules carve out options that are priced fairly. If the strike price is not below fair market value on the grant date, the option is not treated as deferred compensation. It is exempt.

The exemption depends on the price.

How does the exemption work?

Three conditions matter for a typical startup grant.

• The strike price is at least fair market value on the grant date.
• The option is on common stock of the company the person works for.
• The option has no added feature that defers income past exercise.

The first condition is the one founders control. Fair market value of private company stock is not obvious. That is why the IRS rules allow a presumption of reasonableness, called safe harbor, when value is set by an independent appraisal dated within 12 months of the grant.

A 409A valuation is that appraisal. It gives your board a supportable fair market value for the common stock. The board sets the strike price at or above it.

What happens if an option is not exempt?

If the strike price is below fair market value, the option is a discounted option. Discounted options are deferred compensation and usually fail Section 409A.

The cost lands on the option holder. The spread can become taxable as the option vests, not when it is exercised. The additional 20% tax and interest apply on top of ordinary income tax. The company can also face reporting and withholding problems.

This is why the safe harbor matters. With a current independent valuation, the burden shifts to the IRS to show the value was grossly unreasonable. Without one, the company has to defend its own number.

Safe harbor is a presumption, not a promise. This is not legal, tax, or accounting advice. Talk to your counsel about your specific grants.

When does this apply?

It applies every time you grant options. That includes employees, advisors, contractors, and directors.

It matters most at these moments.

• Your first option grant.
• The first grants after a new round, since a financing is a material event.
• Any grant more than 12 months after your last valuation.
• Grants after a major change in the business.

How do I keep my options exempt?

Get a 409A before your first grant. Update it at least every 12 months and after any material event. Price every grant at or above the current fair market value.

409A.io is built for this. It is $99/month, billed monthly on a 12-month term, with everything included.

• An audit-ready report within 48 hours of receiving your documents.
• OPM backsolve to your most recent financing, cross-checked with guideline public companies.
• Every report reviewed by a valuation professional from the MELD team before delivery.
• Updates upon request and material-event coverage during your term.
• Direct auditor support.

409A.io was spun out of MELD Valuation, which has completed 10,000+ valuations. It is built for pre-seed through Series A. If your cap table has non-standard instruments or a complex waterfall, you graduate to MELD. Tell us your situation and we will point you the right way.

What is the next step?

If a grant is coming up, start at get-started. Subscribe, complete the short onboarding form, and upload your cap table and documents. Cap table upload takes under 5 minutes, and CSV is supported.

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