The Short Answer: Only 409A Is Law
When founders and startup employees search for "409A vs 409B," they are often trying to understand whether their equity compensation arrangements are subject to one rule, the other, or both. The answer is straightforward: only Section 409A is enacted law. Section 409B was a proposed legislative extension that was discussed but never passed by Congress. It has no legal force.
For all practical purposes, there is no "409B" that affects your startup's equity compensation. Every conversation about startup stock options, strike prices, and IRS compliance is a conversation about Section 409A exclusively.
What Is Section 409A?
Section 409A of the Internal Revenue Code was enacted as part of the American Jobs Creation Act of 2004 and became effective in 2005. It establishes comprehensive rules for nonqualified deferred compensation — including stock options granted to employees, directors, and certain contractors of private companies.
The core requirement under 409A is that stock options must be granted with a strike price at or above the fair market value (FMV) of the underlying stock on the grant date. For private companies, FMV must be determined by an independent qualified appraiser — the 409A valuation. Options granted below FMV trigger immediate income tax on the spread at vesting, plus a 20% federal excise tax.
What Was Proposed Section 409B?
Section 409B was proposed in the context of legislative efforts to close perceived tax loopholes for independent contractors. The proposal would have applied rules similar to 409A's timing and payment restrictions to nonqualified deferred compensation arrangements with independent contractors.
Key points about proposed Section 409B:
- It was never passed — it appeared in committee discussions and draft legislation but was not enacted
- It would have targeted large deferred compensation arrangements with independent contractors, not startup employees
- It had nothing to do with stock option pricing or fair market value appraisals
- Even if it had been enacted, it would not have replaced or modified 409A
Why Does the Confusion Exist?
- Numerical proximity: 409A and 409B sound like part of the same regulatory framework
- Contractor coverage gap: 409A does apply to some contractor arrangements, and some advisers incorrectly invoke "409B" when discussing it
- Outdated content: Some older articles from the mid-2000s discussed 409B as a pending proposal and continue to circulate
Section 409A and Independent Contractors
While Section 409B never became law, Section 409A does apply to certain deferred compensation arrangements with independent contractors:
- Stock options granted to contractors must still be priced at FMV to avoid 409A penalties
- Deferred payment arrangements with contractors may be subject to 409A's six permissible payment triggers
- Contractors who are significant equity holders may face additional 409A complexity
Summary: Focus on 409A
| Feature | Section 409A | Proposed Section 409B |
|---|---|---|
| Legal status | Enacted law (since 2005) | Never passed — not law |
| Applies to | Employees, directors, some contractors | Would have applied to independent contractors |
| Covers stock options | Yes — strike price must equal FMV | No — not about option pricing |
| Compliance required | Yes — 409A valuation required | No — nothing to comply with |
| Penalties for violation | 20% excise tax + ordinary income tax | N/A — not enacted |