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Internal Revenue Code section 409a

Internal Revenue Code section 409a

Section 409A applies to compensation that workers earn in one year, but that is paid in a future year. This is referred to as nonqualified deferred compensation.

This is different from deferred compensation in the form of elective deferrals to qualified plans (such as a 401(k) plan) or to a 403(b) or 457(b) plan.

If deferred compensation meets the requirements of Section 409A, then there is no effect on the employee’s taxes. The compensation is taxed in the same manner as it would be taxed if it were not covered by Section 409A. If the arrangement does not meet the requirements of Section 409A, the compensation is subject to certain additional taxes, including a 20% additional income tax. Section 409A has no effect on FICA (Social Security and Medicare) tax. 

Silicon Valley startups often target having their 409a valuation come in around 1/5th the price of the most recently sold Preferred Stock.

 

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