Phantom Stock

A phantom stock plan, also known as a shadow or unit stock plan, is a type of stock-based incentive compensation, used primarily for executives, that has many of the same characteristics and tax deferral advantages of stock option plans. Although many variations exist, the typical plan creates deferred compensation units and tax deferral advantages that are assigned a base value equivalent to the value of a company's common stock. An administrative committee then awards these compensation units to key employees. However, the plan usually places a limit on the total number of units that may be outstanding at any one time and the number that may be awarded to any one employee.

Tip Dividends and changes to a corporation's capital structure are also taken into account under a phantom stock plan. If a dividend is awarded on the corporate stock, an equal amount is credited to each unit held by a participant. If a corporation's stock splits or there is a stock dividend, the number of units held by each participant are adjusted accordingly in proportion to the change.

A phantom stock plan provides advantages to both the employer and the executives participating in it. This arrangement gives executives a strong personal interest in raising the corporation's profits.

There is a down side, however, for employees participating in a phantom stock plan. Participants are usually required to agree to remain employed by the company for a certain number of years or until retirement. Also, participants must agree not to compete with the employer or to become a competitor's employee after their retirement. Therefore, an executive must carefully weigh the benefits of participating in the plan and the associated decreased career mobility.

Tax treatment. Phantom stock plans are treated the same as unfunded deferred compensation plans when it comes to taxes. When a triggering event occurs, like retirement, the plan participant is usually paid compensation in installments over a period of years. The participant is not taxed until the actual receipt of benefit payments. Similarly, the corporation will receive a deduction only in the year payment is actually made. There is no taxable income reported or deduction taken at the time contingent credits are made to a unit-holder's account.

Warning Corporate stockholders, through derivative suits, have attacked the validity of phantom stock plans claiming they are a waste of corporate assets. Courts that have considered this issue have reached conflicting decisions given similar facts. However, courts do generally agree that a phantom stock plan arrangement is valid if: the corporation receives some type of adequate consideration for the payments to the plan participants there is a reasonable relationship between the value of the services rendered by the participant and the benefits granted to the participant under the compensation plan