How then do owners of mid-size companies incentivize top-performers to stay put and drive revenue without giving up stock and diluting control? A stock appreciation right (SAR, in short) is a lot like phantom stock. When the shares were granted, they were worth $60.50 each. Even if the formula provides a value identical to the stock's value, it is not considered a SAR, as its benefit is based upon the . For information on how to exercise them at the best time, heres a guide on. For example, a company can set the issuing price of their phantom shares at $10, $20, or $30 without regard to its share price at the time. The phantom stock plan provides a formula to value the benefit. By closing this banner, scrolling this page, clicking a link, or continuing to browse this site, you agree to this use. Contributors are members of or associated with Cohen & Company Ltd. We do not manage client funds or hold custody of assets, we help users connect with relevant financial advisors. However, they also have volatile income tax implications. For example, let's say that Mary is granted 500 phantom shares on June 5, 2020, for the company she works for. The vesting and forfeiture provisions contained in the phantom stock plan or individual grant agreement determine whether and when the executives rights are vested. You can even begin to imagine what your future company might look like and how much value can be shared . What Is Phantom Stock? - The Balance "Full value" plans pay both the value of the underlying stock as well as any appreciation. In the case of a partnership, however, the value of a phantom stock unit is tied to partnership equity value rather than common stock value. A company may wish that former employees do not own company stock after they separate from service. Sometimes awarding phantom stock, especially if given to a large percentage of employees, may be seen as a non-qualified plan under ERISA. Phantom Stock - What exactly is it and How does it work? Its an interactive tool, and with a minimum of inputs, youll access illustrations of basic issues associated with plan design, and expand your thinking on how these plans can meet the strategic and financial goals of your company. 0000065798 00000 n How to Create a Phantom Stock Program That Works Smaller companies use innovative, fast-paced cultures and ground-floor IPOs to attract and hold talent. This system also encourages loyalty to a company: employees feel invested, which makes it less likely that they'll seek new opportunities elsewhere. 0000001977 00000 n 409A penalizes the phantom stock structure but does not affect a stock option or SAR structure. An author, teacher & investing expert with nearly two decades experience as an investment portfolio manager and chief financial officer for a real estate holding company. RSM US LLP is a limited liability partnership and the U.S. member firm of RSM International, a global network of independent audit, tax and consulting firms. If the employees base pay (before adding in the phantom stock unit payment) exceeds the Social Security wage base, no additional Social Security tax would be assessed on the phantom stock payments. Long term incentives in private companies are primarily offered to senior level employees. However, unlike Bob's phantom shares, Mary's are worth the full value which means she's paid out the full $85.25 per share and gets a bonus of $42,625. Each phantom stock plan has a plan charter. Phantom stock is a way for you to reward high-performing executive employees for the work they're doing. Although partnerships do not have common stock, as noted above, entities taxed as partnerships, including LLCs, can implement plans very similar to phantom stock plans. The two types of phantom stock plans are "appreciation only," which doesn't include the value of the underlying shares, just the increase in stock over the amount of time the shares are held; and "full value," which pays the underlying value and the amount the stock increased while it was held. 0000003471 00000 n Appreciation-only plans pay according to how much the companys stock price has increased. Then, enjoy learning how you can take your private company to the next level of excellence in employee performance. These features motivate senior-level staff but require companies to have cash on hand for plan payouts. 131 0 obj <> endobj Here's a quick overview of some of the key aspects of their program: Participants are issued shares on a quarterly basis Participants receive one, tenure share per month Participants receive bonus shares as determined by the executive team for going above and beyond the call of duty For example, if the company has a bad year and the value of its stock decreases, the value of the phantom stock also decreases. Employee stock options are a similar yet distinct benefit for senior-level employees. 0000003197 00000 n on partner redemptions, Personal income tax: The other-state tax credit, State tax considerations for financial institutions. According to a 2019 WorldatWork survey of private companies, 2019 Incentive Pay Practices: Privately Held Companies 6th Edition, the prevalence of private companies using long term incentives has been increasing over time. Phantom Stock: The Ideal Plan for Growing Private Companies At redemption, the companys common share price was $30. There are two main types ofphantom stock plans. The phantom stock plan provides a formula to value the benefit. A fixed-dollar value collar is a strategy where a company that may be acquired can protect itself from the stock price fluctuations of the acquiring firm. The Phantom Stock Plan. Will special vesting rules apply in the case of death, disability, or attainment of specified normal retirement age? Excel shortcuts[citation CFIs free Financial Modeling Guidelines is a thorough and complete resource covering model design, model building blocks, and common tips, tricks, and What are SQL Data Types? To prevent diluting stock by giving it to many employees, which may influence voting control. Sec. 0000003010 00000 n A company might have to pay a third party to verify its stock valuation. To keep learning and developing your knowledge of financial analysis, we highly recommend the additional resources below: Within the finance and banking industry, no one size fits all. When the company sells, the executive will have capital gain income of $100,000 ($200,000 less cost basis of $100,000). Learn more about how they work. As a result, you would receive $25 per phantom share as compensation. by Tom Wilson One of Peter Druckers notable expression was: Culture eats strategy for breakfast. In fact, culture shapes behaviors, [], by Tom Wilson A dime aint worth a nickel anymore. Yogi Berra The current Covid-19 pandemic is creating significant [], 100 Powdermill Rd, Suite 115 Implementing phantom stock pros the company in terms of its human resource in two ways: The employees work with renewed enthusiasm which leads to an increase in overall productivity. Even though it's not real, the phantom stock follows the price movement of the company's actual stock, paying out any resulting profits. There are several other alternatives to establish unit value, but this is an effective and relatively easy to understand. Visit rsmus.com/about for more information regarding RSM US LLP and RSM International. How phantom equity works The basic idea behind phantom stock is simple: reward a key employee with the financial benefits of stock ownership without giving them actual shares of company stock. This type of incentive compensation program provides employees with a financial benefit based on the company's performance. The phantom stock plan must specify when the phantom stock unit payments should commence and at what point a valuation of the units is generally required, as described above. Employers must ensure their plans follow federal laws in section 409A of the Internal Revenue Code (IRC). 409A. Instead of receiving the $25 increase, employees with full-value plans would receive $30 per phantom share on June 1. If the phantom stock can be converted to actual shares in the company upon payout, the charter will outline how this is done. Valuing Phantom Stock - Mercer Capital 409A traps that affect private businesses. Phantom stock plans offer a high degree of flexibility in their design, allowing companies to tailor the plans to meet their specific needs and objectives. For company owners, phantom stock can help grow their business offering top employees a reason to stay and help the company succeed for the long-term. Types of Plans and Taxation, What Are Stock Options? Lion Street Financial https://lionstreet.com/wp-content/uploads/2021/05/Lion-Street-Financial-Form-CRS.pdf, Executive Benefit Planning for Privately Held Companies, https://lionstreet.com/wp-content/uploads/2021/05/Lion-Street-Financial-Form-CRS.pdf. Phantom stock qualifies as a deferred compensation plan. Coincidentally, the stock for her company is also worth $60.50 a share, and she also has to wait five years for them to mature. document.getElementById( "ak_js_1" ).setAttribute( "value", ( new Date() ).getTime() ); Susan brings over 25 years in consulting and leadership positions in compensation and human resources to her clients. When should the value of the phantom stock units be paid out in cash (e.g., periodically every three to five years, upon termination of employment, only upon a future change in control, or, perhaps, other events)? Other adjustments that might be considered include subtractions for capital investments made by the shareholders during the course of the plan, additions for any dividends paid to shareholders during this period, and the amount of accrued deferred compensation attributable to the phantom stock units themselves. A phantom stock plan and stock option plan both award employees from the share appreciation of the companys stock price. (If based only on the appreciation, this is commonly referred to as a stock appreciation right.) She works with a broad range of public, private and non-profit clients in technology, industrial, and service sectors throughout the country in the assessment, design and implementation of sales, executive and employee compensation programs. Email: info@wilsongroup.com. Therefore, at the date of conversion, the executive exercises her option and recognizes $90,000 of taxable income ($100,000 value less exercise price of $10,000). Simply contact Trevor Lattin (949.514.8738), Don Curristan (760.788.1321), or Chris Rich (617-904-9444 x112). To check the background of any investment professional associated with EBS, useFINRAs BrokerCheckwebsite. The cash payment per phantom stock would be $30. 409A is causing private businesses, and it seems to be far from the intent of the law. Multiply that by 500 shares, and Bob's bonus ends up being $12,375. A phantom stock plan could be a potential, uncapped liability for the issuing company due to the fact that the payment is tied to the share price at redemption. If youre ready to find an advisor who can help you achieve your financial goals. Sec. An employee stock ownership plan (ESOP) enables employees to gain an ownership interest in their employer in the form of shares of company stock. 0000098207 00000 n Phantom Stock and Stock Appreciation Rights (SARs) | NCEO Stock Appreciation Rights (SARs) are a form of phantom stock. %%EOF Once those five years have passed, the shares are (strangely enough) also worth $85.25. 0000002013 00000 n This is the case even though the amounts are not subject to income tax until actually paid to the employee. In the example, the options or SARs will be taxable at the time of exercise as ordinary income since a Sec. Phantom shares (phantom stock agreements) are an employee benefit where selected employees receive the benefits of stock ownership without receiving actual stock from the company. (Consider current and future positions). Employees pay income tax when receiving payouts, drastically increasing their tax bracket. No need to spend hours finding a lawyer, post a job and get custom quotes from experienced lawyers instantly.