Federal, and at least one state?s, tax laws make it especially important for companies granting stock options as compensation to set the exercise price of the underlying shares at or above the price that can be shown by a reasonable valuation method to be fair market value (FMV) at the time of grant. Employees, officers, directors and consultants who receive stock options with exercise prices that cannot be shown to be at or above the reasonably-determined FMV on the date of grant face immediate tax on vesting at a combined federal and state tax rate as high as 85% or more. Companies can establish a defensible FMV by using an IRS-approved valuation method. This shifts the burden from the company to prove the FMV determination is reasonable to the Internal Revenue Service to prove the FMV determination is unreasonable, reducing the likelihood of a successful challenge.

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