409A safe harbor and valuation requirements: what the regulation says

Published October 25, 2026 · Rules checked against SBA and IRS sources as of October 2026

Two traps

• Stale values: using a value calculated for a date more than 12 months earlier is not reasonable under (B)(1).
• Material news: a prior valuation is not reasonable if it fails to reflect later information that may materially affect value, such as a new financing, resolution of material litigation or issuance of a patent (the regulation's own examples include the last two).

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The baseline requirement: a reasonable method

For private company stock, Treasury Regulation 1.409A-1(b)(5)(iv)(B)(1) requires fair market value to be determined by "the reasonable application of a reasonable valuation method", judged on the facts as of the valuation date. It lists factors to consider, says a method isn't reasonable if it ignores available material information, and says a prior value isn't reasonable if it's more than 12 months old or misses later material information. Separate presumptions in (B)(2) make certain methods presumptively reasonable.

The factors listed in (B)(1)

As applicable, a reasonable method considers:

• The value of tangible and intangible assets.
• The present value of anticipated future cash flows.
• The market value of stock or equity interests in similar companies whose value can be readily determined by objective means.
• Recent arm's-length transactions in the company's stock.
• Other relevant factors, such as control premiums or discounts for lack of marketability.
• Whether the method is used for other purposes with a material economic effect on the company, its stockholders or creditors.

Where the presumptions come in

Paragraph (B)(2) makes three methods presumptively reasonable: an independent appraisal no more than 12 months before the grant, a consistently used binding formula, and a qualified written valuation for an illiquid start-up. See the safe harbor guide.

What fair market value means under 409A

Under Section 409A, fair market value is the value of the stock underlying an option on the grant date, which sets the minimum exercise price. For public companies, the regulation allows prices from actual trades, such as the closing price. For private companies, it means a value determined by the reasonable application of a reasonable valuation method. In practice the 409A value is for common stock, which is usually worth less than the preferred stock investors buy.

Strike price: never below fair market value

For a nonstatutory stock option to avoid being treated as deferred compensation under Section 409A, the regulation requires that the exercise price may never be less than the fair market value of the underlying stock on the date the option is granted, and that the number of shares is fixed on the grant date. That's why private companies set strike prices from a current 409A valuation. A discounted option risks immediate taxation plus an additional 20% tax for the holder.

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LLCs, partnerships and profits interests

Section 409A's stock right exemption is written around "service recipient stock", which the regulation defines as common stock of a corporation; other entities' interests count only to the extent the IRS designates in published guidance, and the regulation's section on arrangements between partnerships and partners is marked "[Reserved]". So an LLC taxed as a partnership is in less settled territory. Many LLCs use profits interests instead of options, which raise their own valuation questions. Get tax counsel before granting.

This is general information, not tax advice. See 409A basics.

Choosing which presumption to rely on

Most venture-backed companies rely on the independent appraisal presumption, because it's available at any stage and is the most widely understood by auditors and acquirers. The illiquid start-up presumption can suit very early companies, but its conditions are narrower: no material trade or business conducted for 10 years or more, no traded equity, no put or call rights over the stock beyond the regulation's exceptions, no change in control expected within 90 days or IPO within 180 days, and a preparer the company reasonably determines is qualified, generally with at least five years of relevant experience. The binding formula presumption is rare outside companies whose buy-sell arrangements already fix a formula price used consistently for transfers. Whichever you choose, document why it applies at each grant date.

What can still go wrong with a presumption

A presumption protects the method, not a careless application. The IRS can rebut it by showing the valuation method or its application was grossly unreasonable. More commonly, companies lose the benefit by using a valuation past 12 months, granting after a material event the valuation didn't reflect, or pricing grants below the concluded value. Keep the report, the board's adoption of it, and the grant records together.

None of this is tax advice. Section 409A failures fall on the option holder as well as the company, so it is worth getting the documentation right before the first grant rather than after an audit or an acquirer's diligence questions it.

Related reading: the 409A pillar guide on this site covers methods and how funding rounds feed the value.

Common questions

Related guides

• 409A valuations: what they are and how they work
• The 409A valuation process: steps, cost, report and timing
• Fair market value of a business: what it means and how it differs
• SOP 50 10 8.1 change-of-ownership rules, explained section by section

This guide explains rules and practice in plain English. It isn't legal, tax or credit advice, and SBA and IRS rules change. Check the current SOP, regulations and your lender's requirements before you rely on anything here. Examples with made-up businesses are illustrations, not real deals.