Your Complete Guide to Accident Claims. A phantom stock plan is an employee benefit plan that gives selected employees (senior management) many of the benefits of stock ownership without actually giving them any company stock.
In addition, the plan should state whether payment of the determined value should be made in a single lump sum or in installments over a period of years. If made in installments, the plan should also specify whether interest will accrue on the unpaid installments. Phantom stock plans are deferred compensation plans and, as such, the plans must be designed and documented to conform to the requirements of section A.
For income tax purposes, if the plan is compliant with section A, the deferred compensation attributable to the phantom stock will not be subject to income taxation to the employee until it is actually paid to, and received by, the executive. At the time the payment becomes taxable, the company can deduct a corresponding amount subject to general limitations with respect to the amount being reasonable and not excessive.
However, unlike actual stock for which the increase in value on a disposition may be eligible for favorable capital gains taxation, the value of the phantom stock paid to the employee is taxable as ordinary income. Companies should ensure compliance with section A prior to a plan becoming effective to ensure these tax results occur. A violation of the rules could cause taxation of and the assessment of penalties related to the income prior to actual receipt by the employee. For Federal Insurance Contributions Act FICA and Medicare tax purposes, deferred compensation is includible as wages in the later of 1 the year in which the related services are performed, or 2 the year in which the deferred compensation becomes vested.
As the phantom stock units become vested, the value of the phantom stock units is includible as wages subject to FICA and Medicare taxes. This is the case even though the amounts are not subject to income tax until actually paid to the employee. However, the company and the employee would each be subject to the 1.
Although partnerships do not have common stock, entities taxed as partnerships can implement plans very similar to phantom stock plans. In the case of a partnership, however, the value of a phantom unit would be tied to partnership equity value rather than common stock value. All other aspects of the plan would be the same. Because the phantom units are not actual equity in the partnership, such a plan should not raise any concerns over partners being considered employees. Because a phantom stock plan is a nonqualified deferred compensation plan, companies have a lot of flexibility in plan design.
Companies should address the following when formulating aspects of the written plan:. Various equity compensation methods , including phantom stock, can provide great incentive to both employees receiving them and the employer providing them through increased engagement that can boost company performance. The member firms of RSM International collaborate to provide services to global clients, but are separate and distinct legal entities that cannot obligate each other.
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Understanding your entire financial picture. Capabilities Contact our professionals. VIDEO 5 trends in manufacturing to watch in What is a phantom stock plan? Why might a company want to issue phantom equity instead of actual equity? What will be the cutoff or triggering events requiring payment i. How is the payment of the benefit to be made? Generally it will be made in cash as opposed to the company stock. Will the company have sufficient cash to pay the benefit? Should the obligation of the company be informally funded through the acquisition of life insurance policies on the lives of those individuals covered by the phantom stock plan or with other investments?
Will there be any crediting for the equivalent of any cash dividends, stock dividends, or stock splits which would be attributable to the phantom shares? How will the valuation of the company be conducted in order to determine the value of the shares? The associated costs of the valuation need to be incorporated into the decision to implement a phantom stock plan. To promote key employee performance and activity, the business grants the participant phantom stock units, which fluctuate in value based on the growth of the business.
Participants can be awarded periodic grants of units as part of their regular compensation program. As a result, the employee has the ability to share in the success of the company without capital investment or shareholder liability.
Any type of business form, including sole proprietorships, partnerships, limited liability companies, subchapter S corporations, and subchapter C corporations can set up and implement a phantom stock plan.
Care must be taken with a subchapter S corporation to ensure a second class of stock is not being created. If created, the corporation can lose its S status and significant tax consequences may result. To implement a phantom stock plan, the employer selects a group of key employees who will be participants in the plan.
Units may be rewarded in one of two forms:
On the other hand, if employees are given shares, the shares can be paid for by capital markets if the company goes public or by acquirers if the company is sold.
Plan Structure SARs are one of the simplest forms of stock compensation in use today.