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Phantom stock plan.

Phantom stock plans are a form of nonqualified deferred compensation made available to select employees. They are also referred to as "shadow stock plans" or "as if" deferred compensation (i.e., the amount deferred is treated as if invested in the employer's stock).

The advantage to the employee is that his efforts and loyalty are rewarded by having an economic interest or stake in the business similar to that of the owners. The advantage to the owners of a small and closely held family business is that they are able to retain a valued employee without diminishing their percentage of ownership. Phantom stock plans are used in both regular C corporations and S corporations, limited liability companies, partnerships, and sole proprietorships.

To implement a phantom stock plan, a bookkeeping account in the name of the employee is established. This account is then credited with hypothetical shares of stock (when used with a noncorporate employer, the business equity credited to the employee is referred to as a "participation unit"). Periodically, the account can be credited with additional stock, as well as with dividends and stock splits. The deferral period is usually set at a specific number of years or upon the employee's retirement. At the end of the deferral period, the employee is entitled to receive cash payments equal to the excess of the market value of the stock on that date over its value on the date awarded. If appropriate, a vesting schedule can be used that provides for nonforfeitable appreciation rights prior to the end of the deferral period.

The terms "stock appreciation right" and SAR have been used to describe a benefit under which the employee receives only the appreciation of the stock, but not the stock value itself. For example, assume that ten shares of stock are awarded to an employee, with a current value of $150 each. If, at the end of the deferral period, the stock has increased in value to $275 per share, the employee is entitled to a payment of $1,250 ($275--$150 = $125 appreciation per share; $125 x 10 shares = $1,250). Alternatively, in addition to any appreciation, the plan could provide for the employee to receive the underlying value of the stock. Assuming such a design, the employee would be entitled to a payment of $2,750 ($1,500 initial stock value plus $1,250 appreciation).

As with other nonqualified deferred compensation plans, the employer's obligation to the employee is unsecured. Income is not recognized by the employee until the benefits are actually paid or made available. The employer then deducts the payment made to the employee (assuming compensation is reasonable, see page 563). Phantom stock plans are often informally funded with cash value life insurance. Life insurance also allows the employer to provide a preretirement death benefit payable to the employee's family (see chart entitled Deferred Compensation on page 251, and footnotes 6 and 7 on page 253).

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Copyright 2010 Gale, Cengage Learning. All rights reserved.

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Title Annotation:Terms & Concepts
Publication:Field Guide to Estate, Employee, & Business Planning
Date:Jan 1, 2010
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