Rule 409A is a provision of the United States Internal Revenue Code that governs nonqualified deferred compensation. It was implemented to ensure that compensation is not deferred to avoid taxes. Under this rule, nonqualified deferred compensation must meet strict timing and form requirements to avoid being subject to income taxes, penalties, and interest. Failure to comply with Rule 409A can result in significant financial consequences for both employers and employees.
For example, under Rule 409A, companies must grant stock options equal to the fair market value of such options at the date of grant. Failure to do so could result in an immediate recognition of income on the difference between the fair market value and the exercise price of such options for the recipient (irrespective of vesting), plus a 20% penalty tax on such amounts to the recipient.
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