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What Is a Phantom Stock Plan, and How Does It Work?
A phantom stock plan is an employee benefit plan that provides senior management with many of the advantages of stock ownership without actually providing them any company stock. Shadow stock is a term used to describe this type of plan.
Instead of physical stock, the employee is given faux stock. Despite the fact that it isn’t real, the phantom stock tracks the price of the company’s real shares and pays out any earnings.
Important Points
A phantom stock plan, often known as “shadow stock,” is a type of executive remuneration that provides the benefits of holding firm stock without requiring the actual ownership or transfer of any shares.
Management ensures that equity is not diluted for other shareholders by mimicking stock ownership without really delivering it.
Large cash payments to employees, on the other hand, must be taxed as regular income rather than capital gains to the receiver, which can wreak havoc on the company’s cash flow.
What is the Function of Phantom Stock Plans?
Phantom stock schemes are divided into two categories. “Appreciation only” plans do not include the value of the underlying shares and may only pay out the value of any improvement in the business stock price over a specified period of time beginning on the plan’s grant date. “Full value” plans pay both the underlying stock’s value as well as any growth.
Both types of plans are similar to traditional nonqualified plans in that they can be discriminatory and are typically subject to a significant risk of forfeiture that ends when the benefit is actually paid to the employee, at which point the employee recognizes income and the employer can deduct the amount paid.
Although a phantom stock is fictional, it can nonetheless pay dividends and experience price fluctuations just like a real stock.
The cash worth of the phantom stock is dispersed to the participating employees after a period of time.
Phantom stock, also known as synthetic equity, has no built-in criteria or limitations, allowing the organization to use it anyway it sees fit. Phantom stock can also be altered at the discretion of the leadership.
A deferred compensation plan that uses phantom stock qualifies as a deferred compensation plan. The Internal Revenue Service (IRS) code 409 specifies the regulations for phantom stock programs.
An attorney must thoroughly review the plan, and all-important aspects must be established in writing.
Organizational Benefits of Using Phantom Stock
Some companies may employ phantom stock plans as a form of compensation for top executives. Phantom stock plans connect a monetary benefit to a company’s success statistic.
It can also be utilized as a bonus or reward for employees who achieve specific criteria. Every employee can be given phantom stock, which can be dispersed uniformly or based on performance, seniority, or other considerations.
Organizations can also use phantom stock to give incentives connected to stock value by putting certain limits in place.
This can apply to an LLC, a sole proprietorship, or S-corporations that are subject to the 100-owner rule.
Rights to Appreciation in Stocks
A phantom stock plan is analogous to stock appreciation rights (SARs). SARs are a type of bonus compensation given to employees that is equal to the increase in the value of the company’s shares over a set period of time.
Employee stock options (ESO) and SARs are similar in that they benefit employees when firm stock prices rise; the difference is that SARs do not require employees to pay the exercise price and instead receive the sum of the increase in shares or cash.
SARs are often exclusively offered to high management, but they can also be used as part of a retirement plan. It gives higher incentives as the company’s worth rises.
This can also aid employee retention, particularly during times of internal turmoil, such as a change of ownership or a personal emergency.
It gives employees a sense of security because phantom stock programs are usually backed by cash.
If a prospective buyer considers the upper management team as stable, this might result in higher selling prices for a corporation.