Section 409A Discounted Stock Option Penalty Calculator
Stock options issued at a strike price below FMV at grant trigger IRC §409A — adding a 20% federal surtax (plus state) and accelerating income recognition to year of vesting (not exercise). This is the worst tax trap in employee equity.
How 409A Penalty Works
Stock options priced below FMV at grant are deferred compensation under §409A. The discount accrues income to the employee at vesting (regardless of whether exercised). On top of regular income tax: 20% federal surtax plus 1% above-AFR interest penalty plus state surtax in many states (CA adds 5%).
How To Avoid 409A
Get a §409A-compliant independent valuation before any option grant. Price the strike at-or-above the determined FMV. Refresh the valuation at least annually and after any material financing event. The cost ($2,000-$8,000 per valuation) is far less than the penalty exposure.
Common Mistakes Triggering 409A
Three common errors: founders self-valuing without independent appraisal, granting options 'as-of' an earlier date when company was less valuable (gives discount to current FMV), and failing to refresh valuation after a priced round.
Source: IRC §409A; Treasury Regulation 1.409A-1; California Revenue and Taxation Code §17501. Last updated: May 2026.