If your business is looking for a way to incentivize employees’ performance and allow them to share in the company’s success, issuing phantom stocks (aka phantom stock plans) could be right for you.
With a phantom stock plan, your company can grant key employees, or all employees, a right to share in the company’s value without granting the rights that normally come with the ownership of stock (e.g., management and voting rights).
What is a phantom stock plan?
A phantom stock plan is a type of equity-based compensation, usually offered to senior management, that provides employees with some of the benefits of owning stock without actually owning the company’s stock.
In short, they receive extra financial benefits when the company succeeds, without the owner(s) having to sacrifice any of their control over the company. Phantom stock plans work great for companies of all sizes, but are more commonly used by companies that are already cashflow positive. Phantom stock plans are a popular alternative for LLCs that want to issue stock options.
With a phantom stock plan, employees receive synthetic equity—which is sometimes referred to as “mock stock” or “shadow stock,” but most commonly referred to as “phantom stock.” Although phantom stock is not real stock, it follows the price movement of the company’s actual stock and pays out profits to holders.
Phantom stock plans: Appreciation only vs. full value
There are two forms of phantom stock plans: appreciation only and full value. Under an appreciation only plan, the phantom stock plan may only pay out the value of any increase in the company stock price from the time phantom stock is granted to recipients.
On the contrary, a full value phantom stock plan pays both appreciation and the value of the underlying stock while held by the recipient. The date that the phantom stocks can be cashed out is pre-determined by the company.
For example, say that ABC Inc. grants Megan, one of their key employees, 100 phantom stocks that are valued at $10 each at the time of the agreement (total value of $1,000). 5 years later, when it’s time to cash out, the company’s stock is now valued at $30 per share (total value of $3,000).
In this example, if Megan has an appreciation only plan, she will receive $2,000—the difference between the current phantom stock value and the value when it was granted. If she has a full value plan, she will receive $3,000.
One of the most important aspects of phantom stock plans for businesses is flexibility. Phantom stock plans pay dividends and experience price changes the same way standard stock does. Phantom stock can be used at the company’s discretion and can be used to incentivize all or some of the company’s employees.
Phantom stock taxation
Phantom stock taxation is not terribly complex if you are working with competent tax counsel. Phantom stock plans are considered deferred compensation plans.
Employees who receive compensation from phantom stocks will not be taxed on that income until the phantom stocks are cashed out and the funds actually received. The company will also receive a tax deduction for the payment if the plan is compliant with 26 U.S. Code § 409A. Unlike actual stock, the value of phantom stock is taxed as ordinary income.
Need help creating phantom stock plans?
If your company is interested in incentivizing employee performance, you should consider a phantom stock plan today. Issuing shadow stock or phantom stock to employees can help your company achieve its goals, motivate employees, and afford your company the flexibility it needs to align the goals of all involved parties.
Contact an experienced startup lawyer at Gordon Law Group today to schedule a consultation and discuss how a phantom stock plan can help your business!