Notice 2006-4 Valuation Issues
On December 23, 2005, the IRS issued Notice 2006-4 which provides interim guidance
with respect to the application of the new rules for non-qualified deferred compensation
under Section 409A to stock options granted by private companies. Under Section
409A, there are adverse tax consequences for optionees holding options that have
exercise prices below fair market value and that become exercisable after December
31, 2004. The guidance provides transitional relief for private company stock options
and the determination of fair market value.
With respect to stock options granted before January 1, 2005, until further guidance
is issued, where there was a good faith attempt to set the exercise price at fair
market at the time of grant, such options will be treated as being excluded from
the requirements of Section 409A. This relief applies to both incentive and
non-qualified stock options that do not otherwise provide a deferral feature. Whether
there was a good faith attempt to set the option price at fair market value depends
on the relevant facts and circumstances. In light of this transitional relief, companies
that satisfy this good faith standard do not have to be concerned about the application
of Section 409A to pre-2005 option grants unless those options were intentionally
granted at a discount or provide a deferral feature.
With respect to stock options granted on or after January 1, 2005 and before the
effective date of final regulations (originally expected to be January 1, 2007 but
recently extended to January 1, 2008),
taxpayers
may use any reasonable valuation method to determine fair market value. Therefore,
private companies now have more flexibility to determine fair market value, and
until the issuance of final regulations, do not necessarily have to follow the proposed
regulations which require a consistent application of a reasonable method that takes
into consideration all relevant facts and circumstances.
GROCO advises all private companies to be conservative in their approach to determining
the fair market value of their stock in connection with option grants. By obtaining
a valuation report by an independent appraiser now, a company can establish the
consistent methods of valuation to ensure that they will be in place when the final
regulations under Section 409A become effective in early 2007.
Relevant Links:
Notice 2005-1: http://www.irs.gov/pub/irs-drop/n-05-01.pdf
Notice 2006-4:
http://www.irs.gov/pub/irs-drop/n-06-04.pdf
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