IRS Clarifies Valuation Rule For Options and SARs Under Section 409A

In a welcome gesture of holiday cheer, the IRS issued Notice 2006-4 on December 23, 2005 and clarified that the highly controversial valuation rules for options and stock appreciation rights (SARs) set forth in proposed regulations under section 409A of the Internal Revenue Code (Code) will become effective prospectively, when and if contained in final regulations.

As a practical matter, this clarification will allow privately held employers to continue the current practice of having the board of directors determine the fair market value of the stock based on a reasonable valuation method, when setting the exercise price for stock options and SARs. Privately held employers will be able to avoid, at least until 2007, the cost and administrative inconvenience of obtaining a third party valuation for section 409A purposes (although, depending on the circumstances, a third party valuation may still be advisable for accounting or other reasons).

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