The strike floor that
rules every option grant

What a 409A actually is

It's a fair market value opinion for private-company common stock, written by an independent appraiser, that the IRS will presume correct as long as you follow the rules. That's it. The rules live in IRC §409A and Treas. Reg. §1.409A-1(b)(5)(iv), added after Enron, so the tax code would stop treating cheap options as a way to route deferred comp around normal payroll tax. Congress decided: if you grant an option below FMV, we're calling it deferred compensation and taxing it like one.

The safe harbor is what makes the 409A worth paying for. Without it, the burden of proving FMV sits on you at audit. With it, the IRS has to prove your valuation was "grossly unreasonable" — a much higher bar than showing they'd have picked a different number. So companies pay $2k to $25k for an appraisal that shifts the evidentiary burden. Cheap insurance.

A 409A opinion typically runs 30 to 60 pages. It walks through cap-table analysis, allocates enterprise value across preferred and common under an Option Pricing Model, applies a discount for lack of marketability, and prints a per-share number for the common stock. That number becomes the strike floor for every option granted until the 409A expires.

Why founders and employees care

Two audiences, two reasons.

For founders and boards, the 409A is a legal shield. Grant options at or above the last board-approved 409A price, inside the 12-month window with no material event in the middle, and the IRS presumes the grant complied. Grant them below, or on a stale 409A, and you're the party responsible for the §409A violation that lands on your employees' W-2s.

For employees, the penalty stack is the point. If a grant is out of compliance, the employee owes ordinary income at each vesting on the spread between FMV and strike, plus a 20% additional federal tax under §409A(a)(1)(B)(i)(II), plus §409A underpayment interest. California adds another 5% at the state level. So a $200k spread can generate a $130k tax bill on money the employee never received — because vested options aren't cash, they're a right to buy shares at the strike.

The three safe-harbor valuation methods

Treas. Reg. §1.409A-1(b)(5)(iv)(B) is the section that lists them. In practice only one gets used at any real company.

1. Independent appraisal

The one everyone actually uses. A qualified independent appraiser — Carta, Scalar, Aranca, Pulley, and a long tail of boutiques — issues a written opinion. The appraiser has to be "qualified," which the reg defines as five years of relevant experience plus the usual professional certifications (ABV, ASA, CFA). The company pays the fee, gets a report, and the board approves it as the new 409A. Safe harbor holds for 12 months absent a material event.

2. Illiquid startup formula

A safe-harbor path specifically for early-stage companies with no material trade in their stock. The formula has to be applied consistently and disclosed to every option holder. In practice, nobody uses this — the moment you take institutional venture money, the illiquid-startup carve-out gets thin and independent appraisal costs are trivial compared with a botched IPO cheap-stock review. Skip.

3. Founder-generated valuation (presumption)

Technically legal. A founder with five years of relevant business experience can produce their own valuation and it'll hold as a safe harbor. The catch is that no Big Four audit partner accepts it during the IPO cheap-stock review, and no acquirer will rely on it during closing diligence. Fine for a garage-stage company with three employees and no institutional investors. Anything past that, you're paying for an appraisal.

The events that reset the 12-month clock

The 12-month presumption only holds if nothing material happens. When something does, the old 409A dies and grants made after the event have to be priced against a fresh appraisal. Here's what counts as material.

• A new priced round. The classic trigger. New preferred at a higher (or lower) price per share makes the previous common valuation stale by definition. Refresh either right before close (so grants price against the pre-round FMV) or right after (so grants price against the post-round FMV). Don't wait 90 days.
• A term sheet with material terms. Even before a round closes, a signed term sheet at a materially different price is arguably a triggering event. Auditors have been split on this — the safer read is to refresh once the term sheet's binding, not wait for wire transfer.
• Tender offer or secondary sale. Facilitated by the company or not, a transaction at a price that differs materially from the last 409A is market evidence. Company-facilitated tenders almost always require a new 409A modeling the tender price. One-off employee-to-employee sales at trivial volume might not — ask the appraiser.
• S-1 filing. Once you're on the IPO track, the 409A cadence shifts to quarterly and the values start walking toward the expected IPO price on a defensible curve. The SEC's cheap-stock comment letter is the enforcement mechanism.
• Signed acquisition LOI or merger agreement. If a deal price is on paper and it's materially different from the last 409A, that price becomes market evidence. Grants issued after signing but before close usually require a refreshed opinion or the audit will unwind them at close.

How the 409A FMV flows into ISO, NSO, and 83(b) math

The FMV number sets three things at once: the minimum strike price for new grants, the AMT preference item at ISO exercise, and the value used for §83 income recognition on early exercise plus 83(b). Each of those is a different tax outcome. Here's the wrinkle for each treatment.

NSOs — the straightforward path

Exercise an NSO and the spread between FMV (from the 409A) and strike is ordinary compensation income the day you exercise. W-2 income, payroll tax, withholding at supplemental rates. Then hold the shares 12+ months and further appreciation gets LTCG treatment. The math is honest — you pay ordinary tax now on the bargain, capital gain later on the growth. No AMT trap, no qualifying holding period nonsense.

ISOs — the qualifying disposition and the AMT trap

ISOs are the tax-favored ones. Exercise an ISO and there's no regular tax at exercise. Hold 2 years from grant AND 1 year from exercise and the full (exit price - strike) is long-term capital gain. Beautiful in theory. In practice, the spread between FMV and strike is an AMT preference item on Form 6251 line 2i — so if the spread's big and you're in AMT territory, you owe AMT that year on paper gains you can't sell. If the company then folds, you paid AMT on money you never got. The fix people use: exercise up to the AMT crossover, no more, and spread the rest across multiple tax years.

Early exercise + 83(b) — the founder move

If the plan allows early exercise (before vesting), and you exercise when the 409A FMV equals the strike, the spread's zero. File the §83(b) election within 30 days of exercise and you've frozen the compensation income at $0. Every dollar of future appreciation is capital gain, and if you hold 12+ months it's LTCG. This is why early employees at Series A companies who can afford to write the exercise check almost always do — the tax outcome dominates. The risk is the exercise cash walks away if the company folds.

The gotchas that get people

Everyone messes at least one of these up on their first option grant. Better to see them now than at audit.

1. The stale 409A that expires on a Sunday

The 12-month clock runs to the calendar day. If your board approves grants on the same schedule as your 409A refresh, the math gets tight. Boards that grant options five days before the new 409A lands sometimes discover they've priced against a 409A that expired on day one of the grant. The old grant now sits on a stale valuation. Cheaper to delay the grant a week than to unwind it.

2. The material event nobody flagged

A single insider sells $5M of common on a private secondary market in June. HR keeps issuing option grants against the January 409A. Come the S-1 review in October, the auditor spots the trade in the cap-table diligence and asks whether the 409A was refreshed. It wasn't. The cheap-stock adjustment hits the P&L. The company restates. Ownership of tracking material events sits with legal + finance — establish who owns the flag before you need it.

3. The 30-day 83(b) window that closed

§83(b) elections are unforgiving. 30 calendar days from exercise. Postmarked, not received. Miss it and you're on the default §83(a) treatment: ordinary income at each vesting on the current FMV. On a company that goes 10x between exercise and vesting, this converts the entire gain from LTCG to ordinary income. Nobody feels the pain until year 4 when the W-2 comes in and it's $2M of ordinary comp instead of $2M of LTCG.

Where private equity and options fit in a total net worth

Options and vested private-company shares are a big share of net worth for anyone who's been at a Series B+ startup for three years. They're also the hardest part of the balance sheet to track. The 409A FMV changes twice a year at best. Vesting schedules trigger monthly. RSU refresh grants layer on top. If you're modeling your household balance sheet in a spreadsheet, the options tab gets stale within a quarter and the total net worth number drifts.

The reason a consolidated view helps here isn't the tax decision — you can run that in the calculator above. It's the tracking. Options, LP interests in direct investments, and private equity stakes all need a place to sit alongside the public brokerage and 401(k) balances so the total net worth number stays honest. wlthy holds private positions at the latest 409A you feed in, marks them alongside public assets, and gives you the single number you'd otherwise be maintaining by hand.