The fair market value of stock is the price a willing buyer would pay a willing seller when neither is forced to act and both know the relevant facts. For shares that trade on an exchange, the IRS treats fair market value as the average of the highest and lowest selling prices on the valuation date. For private company shares, fair market value has to be established by a formal appraisal. This number matters because the IRS uses it every time equity changes hands: when compensation vests, when you gift or inherit shares, when you donate them, and when you sell.
The IRS Definition
The IRS defines fair market value as the price at which property would change hands between a willing buyer and a willing seller, with neither under pressure to act and both having reasonable knowledge of the relevant facts. That language appears in Publication 561 and has been reinforced by the Supreme Court in United States v. Cartwright.1Internal Revenue Service. Publication 561 – Determining the Value of Donated Property
The standard is meant to filter out noise. A panic sell-off, a forced liquidation, or a rumor-driven spike doesn’t set FMV; the informed, rational transaction does. In practice, that abstract test cashes out into two very different procedures depending on whether the stock is public or private.
How FMV Is Calculated for Publicly Traded Stock
For stock trading on an exchange like the NYSE or Nasdaq, FMV is the average of the highest and lowest quoted selling prices on the valuation date. If the day’s high was $52 and the low was $48, FMV is $50.1Internal Revenue Service. Publication 561 – Determining the Value of Donated Property
If no trades occurred on the valuation date, you take the average of the high and low on the nearest trading days before and after, weighted inversely by how many days separate them from the valuation date. The closer date carries more weight. If there were no sales in a reasonable window at all, FMV falls back to the midpoint between the best bid and asked prices.
It’s tempting to use the closing price as a shortcut. That’s often close enough for conversation, but the IRS method uses the full day’s range, and on a volatile day the difference on a large block of shares can be meaningful.
How FMV Is Set for Private Company Stock
Private shares have no ticker, so there’s no price to average. FMV for stock in a startup, a family business, or any closely held company requires a formal appraisal. The IRS expects that appraisal to follow the framework in Revenue Ruling 59-60, which directs the appraiser to consider the company’s history, industry outlook, financial condition, earning capacity, dividend-paying ability, goodwill, prior stock sales, and comparable public companies.
Appraisers typically triangulate a number using three approaches: a market approach that compares the company to similar businesses, an income approach that discounts projected cash flows back to present value, and an asset approach that nets liabilities from asset FMV. The income approach usually carries the most weight for operating businesses. The asset approach fits holding companies and liquidations better.
Once an enterprise value is set, the appraiser adjusts it for the specific ownership stake being valued. A minority holder in a private company can’t force a sale and can’t control management, so the value is reduced by a Discount for Lack of Marketability and, where applicable, a Discount for Lack of Control. A controlling stake may get a premium instead. The IRS scrutinizes these percentages closely, and unsupported discounts are a common audit target.
409A Valuations for Startup Stock
Private companies that grant stock options to employees face a specific FMV rule under Section 409A. The company must obtain an independent appraisal of its common stock’s FMV before setting an option’s exercise price, and it must refresh that appraisal at least every 12 months or sooner if a material event, like a new funding round, occurs.
Getting this wrong is punishing, and the pain lands on the employee, not the company. If options are granted below FMV, the option holder faces immediate taxation on the deferred compensation, a 20% penalty tax on top of that, and interest at the underpayment rate plus one percentage point, running back to the year the compensation was first deferred.2Office of the Law Revision Counsel. 26 USC 409A – Inclusion in Gross Income of Deferred Compensation If you work at a startup, confirm your employer has a current 409A valuation before exercising anything.
FMV and Equity Compensation
Every form of equity pay uses FMV as the yardstick for taxable income. The mechanics differ by award type.
Restricted stock units. When RSUs vest, the FMV of the shares on the vesting date is ordinary income. Your employer reports it on your W-2 and withholds federal income tax, Social Security, and Medicare. Your basis in the shares equals the FMV on the vesting date, so any later sale is measured from there.
Non-qualified stock options. When you exercise NQSOs, the spread between the FMV on the exercise date and your exercise price is ordinary income. Options granted at $10 exercised when the stock is worth $40 produce $30 per share of W-2 wages, subject to income tax, Social Security, and Medicare.3Office of the Law Revision Counsel. 26 USC 83 – Property Transferred in Connection With Performance of Services
Incentive stock options. ISOs skip regular income tax at exercise, but the spread between FMV and exercise price is an adjustment item for the Alternative Minimum Tax. Exercising a large ISO block in a year of heavy appreciation can produce an AMT bill that catches people off guard. You also need to track a separate AMT basis to calculate future gain correctly.
Section 83(b) election. If you receive restricted stock (actual shares subject to vesting, not RSUs), you can file an 83(b) election within 30 days of receiving the shares and pay ordinary income tax now on the difference between FMV at grant and what you paid.3Office of the Law Revision Counsel. 26 USC 83 – Property Transferred in Connection With Performance of Services For early-stage startup employees with a very low grant-date FMV, that upfront tax can be tiny, and all future appreciation is then a capital gain instead of ordinary income. Miss the 30-day window and the election is gone permanently. If you leave and forfeit unvested shares after electing, you can’t deduct the income you already reported.4Internal Revenue Service. Instructions for Form 15620, Section 83(b) Election
FMV When You Gift Stock
The FMV of stock on the transfer date determines whether the gift triggers a filing requirement. For 2026, you can give up to $19,000 per recipient without filing a gift tax return; married couples electing gift-splitting can double that to $38,000 per recipient.5Internal Revenue Service. What’s New – Estate and Gift Tax
Anything above the annual exclusion goes on Form 709 and chips away at your lifetime exemption, which for 2026 is $15,000,000 per person.6Internal Revenue Service. Revenue Procedure 2025-32 No gift tax is actually owed until that lifetime amount is used up.
The Dual-Basis Trap on Depreciated Stock
A recipient of gifted stock generally inherits the donor’s original cost basis. But if FMV on the gift date is below the donor’s basis, a split-basis rule kicks in: for calculating a loss, your basis is the FMV at the time of the gift, not the donor’s higher basis.7Office of the Law Revision Counsel. 26 USC 1015 – Basis of Property Acquired by Gifts and Transfers in Trust
That creates a no-gain, no-loss zone. Suppose your uncle paid $50 for shares worth $30 the day he gifted them. If you sell at $40, your gain basis is $50 and your loss basis is $30. $40 sits between the two, so you report nothing. The practical takeaway: gifting stock that has dropped destroys the loss. A donor holding depreciated shares is usually better off selling, claiming the loss personally, and gifting the cash.
FMV for Inherited Stock
Inherited stock gets a step-up in basis to FMV on the date of the decedent’s death. A parent who paid $10 for shares worth $200 at death leaves an heir with a $200 basis, and all the appreciation during the parent’s lifetime disappears for capital gains purposes.8Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent The rule cuts both ways. If the stock declined, the basis steps down, and no built-in loss survives.
An executor can elect to value estate assets as of six months after death instead of the date of death, but only if that election reduces both the total gross estate and the total estate tax owed.9Office of the Law Revision Counsel. 26 USC 2032 – Alternate Valuation Anything sold or distributed within that six-month window is valued as of the disposition date.
In the nine community property states, both halves of community property stock step up when one spouse dies, not just the decedent’s half, provided at least half of the community interest was included in the decedent’s gross estate.8Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent In common-law states, only the decedent’s half of jointly held stock steps up; the survivor’s half keeps its original basis. For couples with big unrealized gains, that difference can be worth a lot in future capital gains tax.
FMV When You Donate Stock
Donating appreciated publicly traded stock held longer than a year is one of the few double benefits left in the tax code. You deduct the full FMV on the gift date, and neither you nor the charity pays capital gains tax on the appreciation. The deduction for long-term appreciated securities is capped at 30% of your adjusted gross income, with a five-year carryforward for any excess.
FMV for donated publicly traded stock uses the same high-low average as any other valuation date.1Internal Revenue Service. Publication 561 – Determining the Value of Donated Property For donations of private company stock valued above $5,000, you need a qualified independent appraisal and must attach Form 8283 (Section B) to your return.10Internal Revenue Service. Charitable Organizations – Substantiating Noncash Contributions Publicly traded stock is exempt from the appraisal requirement regardless of amount, but donations of publicly traded stock over $500 still require Form 8283 (Section A).11Internal Revenue Service. Instructions for Form 8283
Penalties for a Bad Valuation
The IRS doesn’t just reject bad valuations; it scales penalties to how far off they are. Under Section 6662, if the value you claimed is 150% or more of the correct value, you owe an accuracy-related penalty of 20% of the resulting tax underpayment. If the claimed value is 200% or more of the correct value, the penalty doubles to 40%.12Office of the Law Revision Counsel. 26 USC 6662 – Imposition of Accuracy-Related Penalty on Underpayments
You can escape those penalties by showing reasonable cause and good faith. The strongest defense is that you hired a competent, independent appraiser, gave them complete information, and followed their conclusion. For private stock, a qualified appraisal isn’t just best practice; it’s the record that protects you if the IRS challenges the number.