A Phantom Stock Plan is an Employee Benefit plan that gives the Employee the right to receive future compensation tied specifically to the value of the Company. The quantification of value is determined by the difference between the starting price (usually determined at the initial date of the award) and the vesting price, usually determined upon sale or such other time as deemed appropriate by the Employer. A Phantom Stock Plan is akin to Stock Appreciation Rights (SARs).
A Phantom Stock Plan is usually structured as an Executive Retention Plan by tying the vesting of the bonus to the Employee’s continued employment with the Company. Typically, acceleration of the bonus would be available on the sale of the Company. When the Company is sold (or at a set date in the future if no sale occurs) the Executive would be paid a bonus based on their share of the Company (phantom units of stock) multiplied by the increase in value of those units from the initial date of the award to the date of sale or vesting.
Much like a SERP, these plans can be informally funded with life insurance to provide the promised benefit in the event the alternate vesting date is reached prior to a sale of the Company.
Advantages of a Phantom Stock Plan:
To the Company:
- The plan can be discriminatory inasmuch as the Employer can determine which Employees participate in the Plan.
- It serves as a retention tool to the Employer by tying the award to a term of service or sale of the Company—whichever comes first.
- The Plan aligns the Employer’s economic and growth goals with the goals of the Employee.
- The Employee has a “stake” in the Company without any of the issues to the Employer associated with actual stock ownership.
- There are no ERISA or IRS filing requirements.
- The Company will receive a full tax deduction on payment of the award to the Employee.
To the Executive:
- A Phantom Stock Plan allows Employees to feel they have an economic stake in the Company and are aligned with the owners in terms of Company growth.
- There is no cost or tax to the Employee on “buying in” to the award, as there would be with an actual stock ownership award.
Disadvantages of a Phantom Stock Plan:
To the Company: If the Plan is funded, the Employer does not receive a tax deduction for amounts contributed to the plan until such time as those benefits are paid out.
To the Executive:
- Much like a SERP, in order for the award not to be taxed to the Employee as the value grows, the Employee must accept the “risk of substantial forfeiture” in the event the Company enters bankruptcy or becomes insolvent.
- When the award is paid out to the Employee, it is taxable as ordinary income.