A 409A safe harbor is a rebuttable presumption, not a shield

The record

Treasury's final regulations under Internal Revenue Code Section 409A, codified at 26 CFR 1.409A-1(b)(5)(iv), set out three methods of valuing privately held stock that carry a presumption of reasonableness for 409A purposes: a valuation from an independent appraisal meeting Section 401(a)(28)(C)'s requirements, dated no more than twelve months before the transaction it values; a formula-based valuation used consistently for both compensatory and non-compensatory transfers; and, for illiquid stock of a start-up corporation, a written valuation by a person with at least five years of relevant experience, made when the company does not reasonably anticipate a change in control within 90 days or a public offering within 180 days. The regulation states the presumption is 'rebuttable only by a showing that either the valuation method or the application of such method was grossly unreasonable.'

What the documents establish

The regulatory text is Treasury's own operative rule; the preamble to the final regulations, published in Internal Revenue Bulletin 2007-19 on 7 May 2007, explains why the start-up method carries the shorter 90- and 180-day anticipation windows the final text adopted, after commenters argued for windows as short as 15 or 30 days: the Treasury Department and IRS concluded that 'a person should reasonably be able to anticipate' a transaction further out than that. The preamble is the agency's own reasoning for the rule, not a valuation firm's marketing description of a '409A valuation service.' Separately, the SEC's own Financial Reporting Manual reviews the same private-company stock for a different purpose, comparing pre-IPO compensation valuations to the eventual offering price, which the 409A presumption does not resolve.

The operating read

Editorially, a founder relying on an independent appraisal or a start-up valuation report should read the presumption for what the regulation actually grants: protection against the IRS second-guessing a reasonable valuation method reasonably applied, not protection against an examiner who can show the method or its application was grossly unreasonable. The 90-day change-in-control and 180-day public-offering windows in the start-up method mean a valuation performed while a term sheet or acquisition is already in serious discussion may fall outside the presumption entirely, independent of whether the number itself was fair.

What to check before you decide

Before relying on a valuation as 409A-safe-harbor-qualified, check the following against the valuation report and the company's own timeline.

• Which of the three presumption methods does the valuation actually rely on, and does the report document that method's specific conditions?
• Was the valuation performed while a change in control or public offering was already reasonably anticipated within the regulation's 90- or 180-day windows?
• Is the valuer's experience documented in a way that supports the five-year relevant-experience standard the regulation describes for the start-up method?

This is not tax advice; whether a specific valuation meets the safe harbor depends on facts a qualified valuation professional and tax adviser should confirm.