Compliance

Don't Miss the 409A Valuation Deadline: What Happens and How to Fix It

Missing a 409A valuation deadline is more common than founders realize, and the consequences fall directly on employees. Here is what happens when you let a valuation lapse, what your options are to remediate the situation, and how to make sure it does not happen again.

By 409.ai team - 2025-07-24

Most founders understand that a [409A valuation](https://www.409.ai/articles/what-is-a-409a-valuation-a-comprehensive-guide) is required before issuing stock options, and that it expires after 12 months. What fewer founders understand is exactly what happens when that window closes and options are granted anyway, and what remediation paths are available once a compliance gap exists.

This post focuses on what the rules say, what the consequences are, and what you can actually do about it if you find yourself in a situation where grants were made without a valid valuation in place.

The 12-Month Window and What Happens When It Closes

A 409A valuation provides IRS safe harbor protection for option grants made during the 12 months following its effective measurement date. Once those 12 months pass, the protection expires automatically. There is no grace period, no extension, and no exception. The IRS provides no leniency for lapses, even brief ones.

If a company grants stock options after the valuation expires, even by a single day, those grants fall outside of safe harbor. A new valuation obtained after the fact covers only grants made after its effective date. It does not reach back to protect grants made during the lapse period. That exposure remains.

The same applies to material events. If a funding round closes, a significant revenue change occurs, or another material event takes place before the 12-month anniversary, the prior valuation becomes invalid for any grants made after that event. Companies that continue granting options between a material event and a new valuation create a compliance gap with every grant issued during that window.

What the Consequences Look Like

The consequences of a 409A compliance failure fall primarily on the employees who received the non-compliant options, not on the company itself. This is one of the most important and least understood aspects of Section 409A.

When options are determined to have been granted at a strike price below the FMV at the time of grant because there was no valid valuation in place, the IRS treats the difference between the strike price and the FMV as deferred compensation that is immediately taxable. The employee faces:

Immediate income inclusion on all vested deferred compensation, even if they have not exercised a single option and hold no liquid shares to cover the tax bill.

A 20% federal excise tax on the deferred amount, on top of ordinary income tax rates.

Interest charges calculated from the original vesting date, compounding the financial damage further.

For an employee who joined early and has a large number of vested options, this can represent a significant and entirely unexpected tax liability, arising from a compliance failure that was entirely outside their control.

How to Remediate a Compliance Gap

If your company has already granted options during a lapse period, the situation is serious but not necessarily irreparable. The appropriate remediation steps depend on the specific facts: how long the gap lasted, how many grants were made, whether the company is still private, and how much the FMV may have changed during the lapse period. This analysis should always involve your legal counsel and tax advisors alongside your valuation provider.

The following approaches are the most commonly used:

Retrospective valuation. An appraiser can conduct a valuation as of a historical date, establishing a defensible FMV for the period when grants were made without a current valuation. This is methodologically complex because the appraiser must reconstruct the company's financial position and market conditions as of a past date using contemporaneous data. A retrospective valuation does not provide the same safe harbor protection as a timely forward-looking valuation, but it can establish a reasonable and documented basis for the strike prices used, which is significantly better than having no support at all.

Option repricing. If the retrospective analysis determines that grants were made below FMV, the company may need to reprice the affected options. This means amending the option agreements to raise the exercise price to at or above the FMV as determined by the retrospective valuation. Repricing avoids the immediate tax consequences for employees but requires careful handling: new option agreements must be documented, board approval is required, and the accounting treatment under ASC 718 must be addressed with the company's auditors.

Forward-looking corrective valuation. Regardless of what happened in the past, the company must obtain a new, current valuation before issuing any additional grants. This stops the gap from widening and establishes a clean baseline going forward.

Legal and tax counsel review. In cases involving significant exposure, particularly where options with large in-the-money spreads were granted during the lapse period, the company should engage legal counsel with Section 409A expertise to assess the full scope of the issue, advise on disclosure obligations, and develop a remediation plan that addresses both the employee tax exposure and any corporate compliance considerations.

The Lapse That Cannot Be Fully Fixed

It is important to be honest about one limitation of all corrective procedures: a retrospective valuation does not restore safe harbor protection for grants made during the lapse. Safe harbor requires that a valuation be conducted before the grants are made and that no material events have occurred between the valuation date and the grant date. A valuation conducted after the fact cannot satisfy that timing requirement.

What a well-constructed retrospective valuation can do is establish a reasonable, documented basis for the FMV that was used, making it significantly harder for the IRS to demonstrate that the grants were made at a price that was grossly unreasonable. That is a meaningful improvement over having no support at all, but it is not the same as having been compliant from the start.

How to Prevent It From Happening Again

The most effective remediation is prevention. The companies that avoid 409A compliance gaps are the ones that treat the valuation program as an ongoing operational process rather than a reactive compliance task.

Practically, this means scheduling the annual renewal well before the 12-month anniversary, far enough in advance that the new valuation is in hand before any grants need to be made. Most providers take two to four weeks to complete an engagement, so initiating the process at the 10-month mark provides a reasonable buffer.

It also means treating every material event as a trigger for an immediate review. A new funding round, a significant revenue change, or an acquisition inquiry should prompt a conversation with your valuation provider before any new grants are approved. As covered in [409A Valuation Frequency](https://www.409.ai/articles/409a-valuation-frequency-how-often-should-you-get-one), the companies with the cleanest compliance histories are those that build valuation refreshes into their funding and hiring calendars rather than reacting to them after the fact.

Finally, before approving any batch of option grants, the board should confirm that the current valuation is both within its 12-month window and that no material events have occurred since the measurement date. This simple pre-grant check, documented in board minutes, is one of the most effective safeguards against inadvertent lapse exposure.

Conclusion

Missing a 409A valuation deadline creates real financial risk for the employees who trusted that their equity was being managed correctly. The consequences are immediate, significant, and difficult to fully undo. The good news is that remediation options exist and that experienced legal, tax, and valuation professionals can help assess and address the exposure. The better news is that with the right processes in place, it is entirely preventable. A disciplined approach to [409A compliance](https://www.409.ai/articles/the-need-for-409a-valuations/) is one of the most straightforward ways a founder can protect their team and build the kind of equity program that holds up under scrutiny at every stage of the company's growth.