Since the IRS issued Notice 2006-4 on December 23, 2005 many companies feel that they have continued flexibility in determining fair market value for stock option grant purposes and that they do not need to take action until the issuance of the final regulations, expected to be January 1, 2007. Is this really the case?
Since the IRS issued Notice 2006-4 on December 23, 2005 many companies feel that they have continued flexibility in determining fair market value for stock option grant purposes and that they do not need to take action until the issuance of the final regulations, expected to be January 1, 2007. Is this really the case?
Background
Under Section 409A, there are adverse tax consequences for option holders that have exercise prices below fair market value and that become exercisable after December 31, 2004. To avoid this tax, 409A will require “a consistent application of a reasonable method that takes into consideration all relevant facts and circumstances.”
Timing
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. 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 the 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, Notice 2006-4 stated that companies could use any reasonable valuation method to determine fair market value. The guidance provides transitional relief for private company stock options and the determination of fair market value.
Transition
Greenstein, Rogoff, Olsen & Co., LLP strongly suggests that private companies be conservative in their approach to determining the fair market value of their stock in connection with option grants and use this “transitional period” to establish their “consistent” methods of valuation.
By obtaining a valuation report by an independent appraiser now, a company can ensure that their valuation methods will be in place when the final regulations under Section 409A become effective in early 2007.
Employee Stock Ownership Plan (ESOP) Valuation Issues Q&A
ESOPs have become an effective tool in corporate finance and tax planning. Not only do they provide retirement benefits and incentives to employees but an ESOP can provide unique ways to transition company management in tax favored environments. An ESOP can even be used to increase cash flow or convert debt to a pre-tax environment.
The Importance of an Independent Valuation
Not only is an independent valuation a good idea when getting involved in a transaction, it is also a statutory requirement in many circumstances that involve Employee Stock Ownership Plans, Estate/Gift Taxes, Charitable Contributions or, most recently, the granting of Stock Options.
Strategies For Aging ESOPs (Employee Stock Ownership Plans)
In view of the complexities of the financial accounting and federal tax rules governing ESOPs, many ESOP sponsoring companies lose sight of larger issues and become buried in the technical details of their ESOP and remain fixed on a single use for their ESOP. Short term benefits of a particular ESOP strategy should not overshadow longer term objectives of the company and alternative uses for their ESOP should be addressed every couple of years.
