Phantom Stock Incentive Plan
Business owners have been challenged to find the best ways to attract, retain, recruit and reward executives. In addition to providing an executive with a traditional compensation and benefits package, a business owner may also want to provide equity and/or an equity related interest in the value of the enterprise.
What is it?
An incentive compensation arrangement where the executive receives benefits measured by the value or increase in value of the employer’s stock. The executive is awarded units of phantom stock, which is not real stock, but in many respects it may be designed to resemble many of the features of actual ownership and the executive is entitled to receive deferred compensation in the form of cash, stock, or a combination of both. Payment is commonly subject to conditions and restrictions, such as completion of a minimum length of service and/or agreements regarding non-competition.
Why use it?
Phantom stock plans protect against the loss of value of deferred compensation as a result of inflation or the time value of money by tying the value to increases in the value of company stock. The plan encourages employees to work harder and make the company more productive, since they will benefit if the stock increases in value. There are occasional unique conditions that might normally prohibit or discourage the owners of a business from granting real shares of stock. The worth of these phantom units “may” but is not “required” to reflect the real and full value of the enterprise. The legal agreement that accompanies this type of arrangement will reflect the means of determining or limiting the value of the phantom units or shares.
- Allows the employer to provide additional compensation based on the value of the company without diluting actual stock ownership.
- Gives the executive a means of sharing in the value or in the appreciation in value of the company as if he were a shareholder.
- Employee enjoys benefits of stock ownership without having to risk his money to finance the purchase of stock.
- Selection of plan participants can be discriminatory.
- Stock price increases may not parallel the executive’s job performance.
- Benefit is an unsecured obligation of the company.
- Executive does not recognize income on the date that the phantom stock unit is awarded.
- Executive does recognize ordinary income on the date that he has the right to receive the value of the underlying stock and the amount of income is equal to the cash and/or value of stock received.
- Employer is entitled to a deduction when the executive recognizes income.
- Plans that award rights to a fixed payment equal to the value of a specified number of shares are subject to special withholding rules (i.e. FICA withholding when earned and vested to income tax withholding when paid).
Valuation of Units
Plan can base benefits on the entire value of the employer’s stock or limit benefits to only the increase in the value after the date of grant. Benefits can be based on:
- Book value
- Fair market value
- Earnings per share
- Other formulas