Does 409A Apply to Independent Contractors?

Yes, in most startup cases. Section 409A covers anyone who provides services to the company, including contractors, advisors, and directors, so options you grant them need a strike price at or above fair market value on the grant date. A 409A valuation is how you set and support that number.

Who does Section 409A cover?

Section 409A governs deferred compensation. It applies to service providers, not only employees. That includes:

• Employees.
• Independent contractors and consultants.
• Advisors.
• Non-employee directors.

There is a narrow exception for some contractors who run an independent business serving many unrelated clients. Most startup contractors and advisors are not set up that way. Treat contractor grants the same as employee grants unless your counsel tells you otherwise.

How does 409A apply to a contractor's options?

The rules are the same as for an employee. An option with a strike price at or above fair market value on the grant date is not treated as deferred compensation. It falls outside Section 409A.

An option priced below fair market value is a discounted option. Discounted options usually fail Section 409A. The spread can become taxable as the option vests, with an additional 20% tax and interest on top of ordinary income tax. The contractor carries that cost.

One difference is the type of option. Contractors and advisors cannot receive incentive stock options. They receive non-qualified stock options. The 409A pricing rule applies to both.

Why does a valuation matter for contractor grants?

Fair market value of private company stock is not obvious. 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.

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

When does this come up?

It comes up any time you pay a contractor or advisor in equity. Common moments:

• Your first advisor grant, often before any employee grants.
• Equity for a fractional executive or early engineer on a contract.
• Grants after a new round, since a financing is a material event.
• Any grant more than 12 months after your last valuation.

Many founders grant advisor equity early and assume it does not need a valuation. It does. The same pricing rule applies.

How do I grant options to contractors the right way?

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

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 contractor or advisor 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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