Phantom Stock Plan
Phantom Stock Plan
Introduction

A phantom stock plan is an employee benefit plan that gives selected employees (specially the senior management) many of the benefits of stock ownership without actually giving them any company stock. This is also called phantom shares, simulated stock, or shadow stock.

Rather than getting physical stock, the employee receives mock stock. Even though it's not real, the Phantom stock is worth money, and its value increases and decreases just like a normal stock. Employees get profit gained from a phantom stock plan after the defined time is completed.

Each phantom stock plan has an agreement which includes,
  • The goals or tasks that a participant needs to accomplish before the Phantom Stocks can vest.
  • Outline the rules, whether the phantom stock can be converted to actual shares upon payout.
  • Any voting rights, those rights are also mentioned.

WHY DO COMPANIES USE PHANTOM STOCK?

Employee compensation in the form of equity can offer a lot of benefits. Motivating employees to work harder and creating loyal employees by aligning their interests with the companies. Phantom stock is great for certain situations, such as:

  • When the organization is grudging to issue additional shares.
  • When there are legal concerns.
  • To offset the effect of stock dilution.

How Phantom Stock Plans Work?

A phantom stock plan is a deferred compensation plan that provides the employee an award measured by the employer’s common.

There are two main types of phantom stock plans.
  • Appreciation only.
  • Full value.
Appreciation only

The Employee will only get the value of any increase in the company’s stock price during the amount of time the Phantom Stocks are held.

Full value

Plans pay both the full value of the stock.

How Does A Phantom Stock Plan Work?

The compensation plan provides the employee an award measured by the employer's common stock value. Companies can be about stock valuable to issue phantom stock to employees; both parties need to agree. Unlike actual stock, the award does not confer equity ownership in the company and also there is no actual stock given to the employee.

The employees will receive a payment is calculated based on:
  • The number of vested shares they hold.
  • The value of the shares at the time of payment.
  • Whether or not they own stock in full or just the appreciation in value since it was received.

TAXATION OF PHANTOM STOCK

The gains are considered as ordinary income and the employer shall be liable to deduct tax on the same as a tax on salary income.

The tax is paid on the total stock price received at the end of the deal.

Phantom stock is that it does not get any special tax treatment or benefit from any deferral of tax beyond the time of payment.

Pros and Cons of Phantom Stock

ProsCons
Highly Flexible: Private and public companies are both eligible for phantom stocksAppreciate-only: The plan may gain only if the share price increase
A Phantom Stocks plan is lot cheaper save the employer a lot of money.In case of a decrease in share price, the employee either terminates the deal or offers only a small amount of the total valuation 
No taxes have to be paid by the employees getting phantom stocks until the stocks matures.After the vesting period is over, taxes are levied as ordinary income.
Even with no voting rights, the employee stays invested in the company's revenue and share priceThe employer must have cash on hand at the time of payout to pay the employees
The plan is based on cash rather than the actual stocks. If an employee retires, the company will have no issue handling half of the vested equity.If the company is publicly traded, employer's must declare the status of the phantom stock program to all participant annually.
A phantom stocks program has fewer complications, as the employees are paid only if they meet all the conditions.

The employer has to pay an extra amount if a third party does the stock valuation. 

KEY TAKEAWAYS
  • A phantom stock plan, or 'shadow stock' is a form of compensation offered to upper management that confers the benefits of owning company stock without the actual ownership or transfer of any shares.
  • By simulating stock ownership, without actually providing it, management ensures that equity does not become diluted for other shareholders.
  • Large cash payments to employees, however, must be taxed as ordinary income rather than capital gains to the recipient and may disrupt the firm's cash flow in some cases.

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