If an employee has company stock as her only investment, she may face a disadvantage when planning for retirement. For example, the “owner” of phantom shares may receive a predetermined amount of money when the company issuing the phantom shares goes public. This field is for validation purposes and should be left unchanged. As such, phantom equity plans provide a flexible alternative to equity ownership plans for employers. C. Which of the following is the primary advantage of using a combination of salary and commission as compensation for salespeople? For example, the phantom stock may take the form of allocating to an employee the full value of a hypothetical share of stock and all of its economic attributes. (4) Additional equity-based performance incentives (stock option, bonus, phantom stock plans) can be structured. Phantom stock … Unlike other types of stock plans, phantom stock plans do not have an exercise feature, per se; they only grant the participant into the plan according to its terms and then confer either the cash or an equivalent amount into actual stock when vesting is complete. Under stock appreciation rights plans, rather than employees exercising an option to purchase stock of the company, they award the employee with the profit reaped from any increase in the price of the shares between the grant and exercise dates after a certain vesting period. Participants must recognize ordinary income on the spread at exercise, and most employers will withhold supplemental federal income tax of 22% (or 37% for the very wealthy) along with state and local taxes, Social Security and Medicare. Pros and Cons of Phantom Stock. Phantom stock plans can be a valuable incentive compensation method for companies looking for a way to tie compensation to changes in company value, but that do not want to directly award company stock.Following are answers to nine frequently asked questions to give you further insights into phantom stock plans and what they could mean for your company. This typically happens in case any stock valuation overview needs to be achieved by an outside accounting firm. Ltd.) Disadvantages of Phantom Stock Executive does not recognize income on the date that the phantom stock unit is awarded. Those who have accumulated substantial amounts of stock or options can see their net worths decline sharply in very short periods of time in some cases, such as during severe market downturns and corporate upheaval. Investopedia uses cookies to provide you with a great user experience. HBL offers employers comprehensive legal guidance on benefits in mergers and acquisitions, Employee Stock Ownership Plans (ESOPs), executive compensation, health and welfare benefits, healthcare reform, and retirement plans. It’s the secret that pushes the stock price higher.”-Isha Malik (Company Secretary, MUDS Management Pvt. Usually, SARs are paid-out in cash, but sometimes stock is awarded instead. Phantom stock plans are similar to stock appreciation rights plans in that the employee receives cash as the stock of the company appreciates. A stock appreciation right (SAR) is much like phantom stock, except it provides the right to the monetary equivalent of the increase in the value of a specified number of shares over a specified period of time. Phantom stock plans frequently contain vesting schedules that are based on either tenure or the accomplishment of certain goals or tasks as covered in the plan charter. There is no cost or tax to the Employee on “buying in” to the award, as there would be with an actual stock ownership award. © 2020 Hall Benefits Law, All Rights Reserved   |   Created by. There are two main types of phantom stock plans. Phantom stock plans usually provide for vesting of benefits so as to avoid the complex and broad rules found in Internal Revenue Code section 409A. Generally, a phantom equity plan grants rights to receive the value of the appreciation in a specified number of company shares. As a result, it is used as a long-term compensation incentive. Phantom shares are typically stand-alone rights granted to executives and are not granted in tandem with stock options. Ownership rights: There are two types of phantom stock: 1) appreciation-only and 2) full-value. Upon exercise of phantom equity, the executive recognizes ordinary income equal to the value of the phantom equity at exercise minus the value of the phantom equity at grant. Avoids tax leakage associated with direct stock ownership . Upon vesting, you receive either the cash value of the phantom shares or they convert into actual shares. As an example, employers can use them to reward employees without having to shift a … Advantages: 1. Phantom stock is incentive compensation or an employee benefit where the employee receives the benefit of owning a stock without the company giving them the stock in reality. The challenges of retaining the best and brightest employees and attracting top talent are strategic concerns for many businesses. Phantom equity plans are particularly useful for private companies without publicly traded shares of stock. If you mean actually putting "phantom stock" into the 401(k) as a match, that's impossible. Nonqualified stock options (NSOs) in which the employee must pay infome tax on the 'spread' between the value of the stock and the amount paid for the option. The variable liability that comes with the normal fluctuation in the company stock price can be a drawback on the corporate balance sheet in many cases. A privately held company is a company that does not have equity securities registered under the Securities Exchange Act of 1934. Phantom stock is not tax-qualified, so it does not have to follow the rules that employee stock ownership plans and 401(k)s must follow. Disadvantages For Employees. Some plans also convert their phantom units into actual stock shares at the time of payout in order to avoid paying the employee in cash. Phantom stock, which is sometimes referred to as shadow stock, gives selected employees (e.g., senior management) all of the economic benefits of stock ownership except voting rights, without delivering actual shares of company stock. Employers like SARs because the accounting rules for them are now much more favorable than in the past; they receive fixed accounting treatment instead of variable and are treated in much the same manner as conventional stock option plans. The number of shares that the private equity enterprise gives the management team may be limited, or shares may only be in the form of stock options. Also known as "shadow" stock, this type of stock plan pays a cash award to an employee that equals a set number or fraction of company shares times the current share price. ... Phantom Stock and Stock Appreciation Rights (SARs) Phantom stock is named as such because there may be no real shares of stock issued or transferred. A Phantom Stock Plan allows Employees to feel they have an economic stake in the Company and are aligned with the owners in terms of Company growth. Both types of plans resemble traditional nonqualified plans in many respects, as they can be discriminatory in nature and are also typically subject to a substantial risk of forfeiture that ends when the benefit is actually paid to the employee, at which time the employee recognizes income for the amount paid and the employer can take a deduction. What is the tax treatment of a phantom equity plan? It also discusses the strong parallels between phantom stock and non-voting common stock, which does carry fiduciary duties. Phantom Stock Performance Share Plan Other Non-Stock Related Long-Term Incentives Performance Unit Plans Sabbatical Performance Criteria Weights Gates Thresholds Performance Escalators Payment Frequency Performance Period Divestiture Dilution What happens when employees leave? For this reason, these plans are used primarily by closely-held corporations, although they are used by some publicly-traded firms as well. Phantom stock plans often are a perfect solution to growing companies. Award mirrors the value (or increase in value) of equity-based plans without using real equity. The offers that appear in this table are from partnerships from which Investopedia receives compensation. Restricted stock units are similar to phantom stocks. Advantages and Disadvantages of Phantom Stock Each of these methods has its own advantages and disadvantages, and there is no one-size-fits-all solution. Phantom stock enables your key employees to share in the increase in company value over a time period. The previous examples illustrate why SARs make it easy for employees to exercise their rights and calculate their gains. A) resist attempts to modify production standards B) focus on production quantity instead of quality ... phantom stock C) restricted stock D) premium priced options. Advantages of Stock Plan: i. Case Studies in ERISA: Why It Matters And How It Benefits You, A Plan Sponsor's Guide To Employee Benefits Legal Compliance. SARs do not pay dividends, however, and holders receive no voting rights. Phantom Stock/Phantom Units n Possible Disadvantages: u Requires accounting charge to earnings and perhaps variable accounting treatment (i.e., where units are payable in cash instead of or alternatively to stock) u Employee has little or no flexibility in determining time of payment. If you mean allocating phantom stock to employees based on their elective deferrals to a qualified plan, doesn't that violate the "contingent benefits" prohibition? ... What are the disadvantages? Phantom stock plans can appeal to employers for several reasons. Phantom Stock. Phantom stocks are generally known as Shadow Stocks. We understand both the benefits and the potential disadvantages of numerous types of plans, including phantom stock plans. SARs resemble nonqualified stock options in many respects, such as how they are taxed, but differ in the sense that holders of stock options are actually given shares of stock that they must sell and then use a portion of the proceeds to cover the amount that was originally granted. Advantages and Disadvantages Phantom stock plans can appeal to employers for several reasons. Shares are not actually issued or transferred to the option-holder when an option is exercised, but rather the right to receive an award based on the value of the company’s shares. The disadvantages of stock purchase plans are that (1) virtually all employees must be covered; (2) stock purchases are limited to $25,000 worth of stock (based on fair market value at time of grant); and (3) 5% or more shareholders cannot participate in the plan. d. Phantom stock is an employee benefit where selected employees receive benefits of stock ownership without the company giving them actual stock. Stock appreciation rights (SARs) plans are one of the simplest forms of equity compensation for employees. Also, like any other type of employee stock plan, phantom plans can serve to encourage employee motivation and tenure, and can discourage key employees from leaving the company with the use of a "golden handcuff" clause. It is an amount that the employer promises to pay to its employees in the near future. Phantom equity plans are not subject to many of the restrictions or risks that are inherent to the actual transfer of a company’s shares. Both essentially are bonus plans that grant the right to receive an award based on the value of the company’s stock. It may take different forms. Phantom Stock / SARs. If the value of the company’s stock declines, then so do the values of the options or shares. Perhaps most importantly, many tech employees in today’s job market expect equity-based packages (including stock grants, restricted stock grants, and phantom stock … Advantages and Disadvantages Phantom stock plans can appeal to employers for several reasons. Advantages and Disadvantages Phantom stock plans can appeal to employers for several reasons. All of the following are disadvantages associated with piecework plans EXCEPT that workers _____. As with NSOs, the amount of income that is recognized upon exercise then becomes the participant's cost basis for tax computation when the shares are sold. As with phantom stock, this is normally paid out in cash, but it could be paid in shares. Typically, the valuation will follow an event that triggers payment of the amount tied to the phantom units. All that said, to be absolutely certain that implementing an ESOP is the right decision for a company, CFOs must also consider the following disadvantages of an ESOP. It is worth money just like real stock, and its value rises and falls with the company's actual stock (or what the company is valued at, if it's not a publicly traded company). SARs typically provide the employee with a cash or stock payment based on the increase in the value of a stated number of shares over a specific period of time. The benefit is based upon the performance of the business, typically using some type of formula or metric. The large cash payments that employers must make to employees, however, are always taxed as ordinary income to the recipient and may disrupt the firm's cash flow in some cases. For the company, a phantom equity appreciation payment is a compensation deduction from its computation of taxable income. All of the following are disadvantages of straight commission plans EXCEPT _____. Here we discuss the types of equity compensation and purpose along with examples, advantages, and disadvantages. Often, executive compensation arrangements that are appropriate in a publicly traded organization (i.e., incentive stock options) are not appropriate in privately held companies. There is no cost or tax to the Employee on “buying in” to the award, as there would be with an actual stock ownership award. Under appreciation-only phantom stock, employees get paid the … Disadvantages. For executives, phantom stock rights do not represent a true ownership position in privately held companies that do not have publicly traded shares. Tax Consequences. Allows employees to share in the growth of the company’s value without being shareholders. Benefit is an unsecured obligation of the company. If paid in cash, can be … As the name implies, this type of equity compensation gives participants the right to the appreciation in the price of their company stock, but not the stock itself. All that said, to be absolutely certain that implementing an ESOP is the right decision for a company, CFOs must also consider the following disadvantages of an ESOP. The phantom stock plan should specify what events should trigger, or give rise to, a valuation (i.e., what events should entitle the employee to receive benefits under the plan) and at what precise point the value of the phantom stock units should be determined. Phantom stock is the right to be paid, in cash, at a specified date, in an amount equal to the then-fair market value of a specified number of shares of company stock. Phantom equity plans are one of the most frequently used long-term incentives in privately held companies. Stock bonus plans don't translate into a guaranteed amount of money for an employee. Phantom stock is a special type of stock option scheme that protects the holder against any depreciation in the value of stocks. These plans can accomplish many of the same objectives while avoiding certain disadvantages of restricted stock programs. Phantom stock is often used as a way to compensate certain individuals with a form of equity participation in a startup in lieu of stock options. Here we discuss the types of equity compensation and purpose along with examples, advantages, and disadvantages. A phantom stock plan is an employee benefit plan that gives select employees many benefits of stock ownership without giving them any company stock. Advantages and Disadvantages . Disadvantages. 2. PHANTOM STOCK AWARD AGREEMENT . Alexa, please elaborate. Phantom stock, which is sometimes referred to as shadow stock, gives selected employees (e.g., senior management) all of the economic benefits of stock ownership except voting rights, without delivering actual shares of company stock. Employee remains loyal and committed to the company. An employee stock option (ESO) is a grant to an employee giving the right to buy a certain number of shares in the company's stock for a set price. Executive does not recognize income on the date that the phantom stock unit is awarded. (4) Additional equity-based performance incentives (stock option, bonus, phantom stock plans) can be structured. I was recently asked to describe the advantages and disadvantages of a phantom equity plan. The benefits are paid … Most companies give these kind of stocks to its employees as a cash reward. RECITALS . SARS are also frequently awarded according to a vesting schedule that is tied to performance goals set by the company. Phantom stock (also commonly referred to as “shadow stock”) represents an The shadow stocks given are equivalent to the company's existing share market price at the time it is offered to the employees. Additionally, phantom equity shares do not carry voting rights or similar rights associated with stock ownership. A phantom stock option is a bonus tax treatment plan where the amount of the bonus is determined by reference to the increase in value of the shares subject to the option. Phantom or virtual stock and stock appreciation rights (SARs) are similar in many respects. The company does not receive a tax deduction for this type of option. Profits interest refers to an equity right based on the future value of a partnership awarded to an individual for their service to the partnership. Benefit is an unsecured obligation of the company. Like Phantom Stock, gives limited employees the benefits of owning stock but does not actually give them stock Phantom stock is a form of deferred compensation by which a company calculates and tracks a cash benefit to be paid at a future point in time. All three types of plan have advantages and disadvantages, depending on factors including the company's cash situation, capital structure, expected growth curve, and desired exit strategy. “Phantom stocks are lucrative offers given to the employees which act as a tool for the reward policy and in turn boosts the productivity. "Full value" plans pay both the value of the underlying stock as well as any appreciation. Stock price increases may not parallel the executive’s job performance. Unlike SARs, however, phantom stock is purely a bonus issued at regular intervals based on the performance of company share price. By using Investopedia, you accept our. Also, these plans do not allow for diversification. Privately held companies have unique organizational traits that require a substantially different approach to executive compensation. As an example, employers can use them to reward employees without having to shift a portion of ownership to their participants. As an example, employers can use them to reward employees without having to shift a portion of ownership to their participants. Private equity owns the company. Editor's Note: C. Joseph DelPapa is a member of the Business and Tax Practice Groups at Ward and Smith, P.A. These plans are typically geared for senior executives and key employees and can be very flexible in nature. All of the following is true about phantom stocks except: A) They are expensed over the vesting period B) They give employees the right to own equity C) The company needs cash when phantom stocks are exercised D) They grant the holders additional voting power E) They lower the dilution effect phantom stock accumulate wealth through the continuing success of the company, and employers are able to encourage employees ... and disadvantages for both employers and employees. Organizations that enforce Phantom Stock plans tend to bring upon themselves an additional cost. Unlike "real" stock, phantom stock does not convey any actual ownership in the business. Stock Appreciation Rights (SARs) Definition, company stock can provide numerous benefits, without the need to materially dilute their stock. Stock price increases may not parallel the executive’s job performance. They can be a powerful tool to motivate key employees, while limiting company exposure. The amount of the award is usually tracked in the form of hypothetical units (known as "phantom" shares) which mimic the price of the stock. But SARs require the issuance of fewer company shares and, therefore, dilute the share price less than conventional stock plans. These kinds of shares are accorded to senior-most officers and loyal employees of the company. Advantages and Disadvantages of … SARs essentially mirror non-qualified stock options (NSOs) in how they are taxed. units, profits interests, phantom equity or interests (also known as “synthetic equity”), and non-qualified options. Disadvantages of Phantom Stock. Advantages and Disadvantages Phantom stock plans can appeal to employers for several reasons. As a result, it is used as a long-term compensation incentive. Phantom Stock: Phantom Stock is a promise to make a cash payment to an employee at a specified time in the future equal to the value of a certain number of company shares. Many employers will also withhold these taxes in the form of shares. Additionally, phantom equity plans are advantageous to companies because they provide long-term income opportunities without diluting the private company stock holdings of current owners. Develops long-term relations between employer and employee. and disadvantages for both employers and employees. Stock values can fall, leaving the employee with shares of little value. Phantom equity plans are particularly useful for private companies without publicly traded shares of stock. Phantom stock plans can appeal to employers for several reasons. As an example, employers can use them to reward employees without having to shift a portion of ownership to their participants. The following two tabs change content below. Below we’ll break down some of the most common advantages and disadvantages for equity-based compensation to help determine if it’s ... restricted stock grants, and phantom stock … "Appreciation only" plans do not include the value of the actual underlying shares themselves, and may only pay out the value of any increase in the company stock price over a certain period of time that begins on the date the plan is granted. In any event, the potential deployment of stock option plans should be discussed at the early stage, and certainly before beginning to recruit key employees. Employers may consider stock options or other variable compensation awards as parts of an effective compensation package for key team members. Stock appreciation rights (SARs) are a type of employee compensation linked to the company's stock price during a predetermined period. Like several other forms of stock compensation, SARs are transferable and are often subject to clawback provisions (conditions under which the company may take back some or all of the income received by employees under the plan, such as if the employee goes to work for a competitor within a certain time period or the company becomes insolvent). Phantom stock plans used by privately held companies can be exactly like those used by publicly traded companies, except that executives are only able sell their shares back to the company. For this reason, these plans are used primarily by closely-held corporations, although they are used by some publicly-traded firms as well. Advantages and Disadvantages … A Phantom Stock Plan allows Employees to feel they have an economic stake in the Company and are aligned with the owners in terms of Company growth. Corporate governance. SARs are an option that the employee has the right to exercise at will within the grant period. Corporate governance. Phantom stock is an employee benefit where selected employees receive benefits of stock ownership without the company giving them actual stock. Tax Consequences. This document also dictates whether participants will receive cash equivalents that match dividends or any type of voting rights. Phantom stock plans are typically used … The information you obtain at this site is not, nor is it intended to be, legal advice. For example, the “owner” of phantom shares may receive a predetermined amount of money when the company issuing the phantom … What are the advantages and disadvantages of a phantom equity plan? An advantage of a phantom equity plan is that, for a company with significant growth in net worth potential, a phantom equity plan provides a cashless alternative for receiving income as the phantom share appreciates in value. We counsel a wide spectrum of clients including small, mid-sized, and large companies, 401(k) investment advisors, health insurance brokers, accountants, attorneys, and HR consultants, just to name a few. Advantages and Disadvantages of Phantom Stock Here are several reasons to use phantom stock: Aligns interest of management team with owners to increase the share price. Advantages to phantom stock are that they provide retentive value, because they are tied to the full fair market value of the company’s stock and are only taxed when the award is cashed in. A) salespeople avoid pushing hard-to-sell items B) salespeople fail to service small accounts C) payments are complicated to calculate D) significant variations in pay exist. There are no tax consequences of any kind on either the grant date or when they are vested. Stock compensation refers to the practice of rewarding employees with stock options that will vest, or become available for purchase, at a later date. Receive Our Complimentary Newsletter in Your Inbox Each Month! Disadvantages For Employees. There is no taxation upon the grant of phantom stock because the executive is not in constructive receipt of any value at that time. Phantom stock can buy time by retaining the team while the owner discerns who will receive actual shares in the future. Disadvantages. You can learn more about from the following articles – Phantom Stock Definition Phantom stock is a form of deferred compensation by which a company calculates and tracks a cash benefit to be paid at a future point in time. Disadvantages: 1. I was recently asked to describe the advantages and disadvantages of a phantom equity plan. You can learn more about from the following articles – Phantom Stock Definition; Diluted Shares; Stock Appreciation Rights; Option Chain; Commodity vs Equity iv. Employees can receive a benefit that does not require an initial cash outlay of any kind and also does not cause them to become overweighted with company stock in their investment portfolios. Companies must also disclose the status of the plan to all participants on an annual basis and may need to hire an independent appraiser to periodically value the plan. SARs often can be exercised any time after they vest. One disadvantage of a phantom equity plan for a company is that phantom equity is a costly form of long-term incentive in that it requires a charge against the company’s income statement and is potentially an “uncapped liability” to the company. Although these programs have some limitations, industry pundits predict that both types of plans will likely become more widespread in the future. Stock- and Other Equity-Based Compensation Philip H. Moïse SUTHERLAND ASBILL & BRENNAN LLP July 2001. Privately held companies have unique organizational traits that require a substantially different approach to executive compensation. The plan allows for benefits to accrue to a participant. Employees are paid out profits at the end of a pre-determined length of time. Although rewarding employees with company stock can provide numerous benefits for both employees and employers, there are times when either legal concerns or an unwillingness to issue additional shares or shift partial control of the company to an employee can cause companies to use an alternative form of compensation that does not require the issuance of actual stock shares. Provides equity-like value. Phantom stock plans and stock appreciation rights (SARs) are two types of stock plans that don't really use stock at all, but still reward employees with compensation that is tied to the company's stock performance. It is worth money just like real stock, and its value rises and falls with the company's actual stock (or what the company is valued at, if … Another employee compensation program, phantom stocks constitute the promise to pay a bonus at a future date of equal value to a set number of company shares. Acts as a “golden handcuff” (during vesting period) or retention tool to keep the management team in place while shares vest. HBL is passionate about advising clients, and we are dedicated to our mission: to provide comprehensive, personalized, and practical ERISA and benefits legal solutions that exceed client expectations. 21. Any phantom equity appreciation payment is subject to federal and state income tax withholding. ii. This Phantom Stock Award Agreement (the “Agreement”) has been made as of , (the “Date of Grant”) between Spectra Energy Corp, a Delaware corporation, with its principal offices in Houston, Texas (the “Company”), and (the “Grantee”). If the value of the company’s stock declines, then so do the values of the options or shares. Incentive stock options (ISOs) in which the employee is able to defer taxation until the shares bought with the option are sold. Click to share on Twitter (Opens in new window), Click to share on Facebook (Opens in new window), COVID-19 and Employee Benefits Legal Compliance, 3 Tips to Manage Pay Equity Risk in Hiring and Onboarding, Post Pandemic Employee Benefits Considerations – A Closer Look at the ‘New Normal’ for Employers. To a participant 's Guide to employee benefits Legal Compliance stock bonus plans that grant right... Plans ) can be structured where selected employees receive benefits of stock.... Performance incentives ( stock option scheme that protects the holder against any in! Investment, she may face a disadvantage when planning for retirement plans can appeal employers... To their participants no one-size-fits-all solution 's impossible they convert into actual shares as parts an. Workers _____ flexible in nature 2 ) full-value match, that 's impossible units, interests. Make it easy for employees to a participant accorded to senior-most officers loyal... Predict that both types of plans, including phantom stock is awarded and attracting top talent strategic... Until the shares bought with the option are sold dilute the share price also, these plans n't! Equity securities registered under the securities Exchange Act of 1934 should be unchanged. Provide numerous benefits, without the company 's stock price increases may not the! Similar to stock appreciation rights ( SARs ) are similar to stock appreciation rights ( SARs plans. Equity-Based performance incentives ( stock option scheme that protects the holder against any depreciation in increase... 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