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"As Internal Revenue Service Gets Serious About Discounted Stock Options, Safe Harbors for Closely Held Stock Valuation Even More Important"

By: Sandy Murphy, Esquire and Lynn Clarke, Esquire
Banking Alert
October 24, 2013

In a recent case, a shareholder/employee unsuccessfully challenged an Internal Revenue Service (IRS) assessment against him of a $3.1 million penalty, plus $304,456 in interest, under Internal Revenue Code Section 409A, for exercising company stock options that the IRS said had a strike price below fair market value on the date of grant. Sutardja v. United States, (Federal Claims No.11-724 T227-13).

The case was remanded for additional fact finding concerning the closely held company stock's fair market value on the date of grant.

The size of the penalty highlights the importance of the use of IRS fair market value "safe harbors" for valuing closely held stock under 409A. One important safe harbor allows companies, under certain circumstances, to use an independent appraisal. Sometimes clients think independent appraisals are too expensive, but the appraisal cost is, of course, much less than the 409A penalty and interest assessed in the Sutardja case.