Introduction
Your startup’s 409A valuation isn’t just about issuing stock options it’s a due diligence magnet for investors and auditors alike. But here’s the twist for 2025: California investors are combing through state tax footnotes, especially for valuation discounts.
In this guide, we cover how 409A valuation discounts affect California state tax reporting and how to draft footnotes that pass investor scrutiny and reduce your tax exposure.
IRS and California Tax Code References
- IRC §409A – Nonqualified deferred compensation valuation rules
- California R&TC §17041 – PIT sourcing and apportionment
- FTB Legal Ruling 2006-01 – Characterization of compensation and deferred comp
What Is a 409A Valuation Discount?
A 409A valuation discount is applied when:
- Shares have limited liquidity (lack of marketability discount)
- There are transfer restrictions (minority discount)
- Your startup is pre-revenue or pre-VC
In 2025, these discounts may:
- Lower the exercise price of stock options
- Be examined during Series A diligence
- Be flagged by CA FTB if footnotes are missing or vague
Example: CA-Based AI Startup Pre-Seed Round
Example: AIVision Inc., based in San Jose, issues options at $0.20/share with a 30% discount due to pre-revenue status.
- Their 409A provider issues a report with minimal footnote explanation
- CA-based investor requires detailed justification for the 30% discount
- FTB notices the vague language during a PIT audit
Result: The founders had to revise financials and explain valuation assumptions retroactively.
Step-by-Step: Reporting 409A Discounts for California Startups
- Get a Professional 409A Report
Use a qualified valuation provider ensure the final report includes detailed footnotes. - Document the Discount Basis
Include supporting logic: revenue stage, comps, marketability, control. - Reference Footnotes in State Filings
When submitting California PIT or Franchise Tax returns, include valuation basis in equity disclosures if audited. - Maintain Shareholder Disclosures
Ensure investors and employees have clear memos that explain the valuation methodology. - Prepare for FTB Scrutiny in 2025
Expect more attention to early-stage option issuances and underpriced equity.
Conclusion
In California’s 2025 tax landscape, 409A valuation discounts are no longer invisible footnotes they’re audit flags and investor decision points.
Document your valuation thoroughly, reference your logic in filings if needed, and prepare for FTB’s increased review of deferred compensation structures.
Call to Action
Launching or fundraising as a California startup in 2025?
Book a valuation strategy session with Anshul Goyal, CPA, EA, FCA
Anshul assists:
- Reviewing and interpreting 409A valuation reports
- Drafting investor-facing financial footnotes
- Minimizing FTB audit risks and ensuring PIT/franchise compliance
Protect your cap table and investor trust:
https://calendly.com/anshulcpa/
Anshul Goyal, CPA, EA, FCA
Anshul brings 15+ years of U.S. and international tax experience. He specializes in helping online sellers, foreign founders, and U.S. residents with IRS and multi-state compliance. Known for his deep knowledge in Shopify and Amazon seller tax strategy, Anshul has helped hundreds of entrepreneurs minimize taxes and scale legally.
Disclaimer
This blog is for informational purposes only and does not constitute legal or tax advice. Please consult a qualified tax professional regarding your individual tax situation.
Top 5 High-Searched FAQs for 2025
1. Does California audit 409A valuations?
Yes, especially when stock options or PIT-exempt income is involved.
2. What’s the average 409A discount in early-stage startups?
Ranges between 20 -40% depending on control, revenue, and liquidity.
3. Can FTB adjust my option income valuation?
Yes. If the discount basis is poorly documented, they may recharacterize the income.
4. Are footnotes required on California returns?
Not directly, but poor documentation may trigger audits or inquiries.
5. How often should I update a 409A valuation?
Every 12 months or after a material event (e.g., funding round, IP license).