Phantom Stock
Encyclopedia
Phantom stock is a method for companies to give their management or employees a bonus
if the company performs well financially. Phantom stock provides a cash or stock bonus based on the value of a stated number of share
s, to be paid out at the end of a specified period of time.
Phantom stock is essentially a cash bonus plan, although some plans pay out the benefits in the form of shares. Phantom stock is favored by closely held or family-owned companies who want to incentivize
management and other employees without granting them equity
. Phantom stock grants align employees' motives with owners' motives (that is, profit growth, increased stock prices) without granting employees an actual ownership stake in the company.
Phantom stock can, but usually does not, pay dividend
s. When the payout is made, it is taxed as ordinary income
to the employee and is deductible to the employer. Generally, phantom plans require the employee to become vested
, either through seniority or meeting a performance target.
Normally, phantom stock is taxable upon vesting, even if not paid out. Use of a "rabbi trust
" that subjects the payout to significant risk, such as the company not being able to pay creditor
s, may solve this problem.
Phantom stock accounting is straightforward. These plans are treated in the same way as deferred cash compensation. As the amount of the liability changes each year, an entry is made for the amount accrued. A decline in value would reduce the liability. These entries are not contingent on vesting. Phantom stock payouts are taxable to the employee as ordinary income and deductible to the company. However, they are also subject to complex rules governing deferred compensation that, if not properly followed, can lead to penalty taxes.
Bonus
The word Bonus refers to extra pay due to good performance.Bonus may also refer to:- People :* Lawrence Bonus, a Filipino basketball player* Petrus Bonus, a physician* Bonus , a Byzantine general, active in the reign of Justin II...
if the company performs well financially. Phantom stock provides a cash or stock bonus based on the value of a stated number of share
Share (finance)
A joint stock company divides its capital into units of equal denomination. Each unit is called a share. These units are offered for sale to raise capital. This is termed as issuing shares. A person who buys share/shares of the company is called a shareholder, and by acquiring share or shares in...
s, to be paid out at the end of a specified period of time.
Phantom stock is essentially a cash bonus plan, although some plans pay out the benefits in the form of shares. Phantom stock is favored by closely held or family-owned companies who want to incentivize
Incentive
In economics and sociology, an incentive is any factor that enables or motivates a particular course of action, or counts as a reason for preferring one choice to the alternatives. It is an expectation that encourages people to behave in a certain way...
management and other employees without granting them equity
Ownership equity
In accounting and finance, equity is the residual claim or interest of the most junior class of investors in assets, after all liabilities are paid. If liability exceeds assets, negative equity exists...
. Phantom stock grants align employees' motives with owners' motives (that is, profit growth, increased stock prices) without granting employees an actual ownership stake in the company.
Phantom stock can, but usually does not, pay dividend
Dividend
Dividends are payments made by a corporation to its shareholder members. It is the portion of corporate profits paid out to stockholders. When a corporation earns a profit or surplus, that money can be put to two uses: it can either be re-invested in the business , or it can be distributed to...
s. When the payout is made, it is taxed as ordinary income
Ordinary income
Under the United States Internal Revenue Code, the type of income is defined by its character. Ordinary income is usually characterized as income other than capital gain...
to the employee and is deductible to the employer. Generally, phantom plans require the employee to become vested
Vesting
In law, vesting is to give an immediately secured right of present or future enjoyment. One has a vested right to an asset that cannot be taken away by any third party, even though one may not yet possess the asset. When the right, interest or title to the present or future possession of a legal...
, either through seniority or meeting a performance target.
Normally, phantom stock is taxable upon vesting, even if not paid out. Use of a "rabbi trust
Rabbi trust
In the United States a Rabbi trust is a type of trust used by businesses or other entities to defer the taxability to the person or entity receiving such payments as employee compensation or purchase payments in the acquisition of another business....
" that subjects the payout to significant risk, such as the company not being able to pay creditor
Creditor
A creditor is a party that has a claim to the services of a second party. It is a person or institution to whom money is owed. The first party, in general, has provided some property or service to the second party under the assumption that the second party will return an equivalent property or...
s, may solve this problem.
Phantom stock accounting is straightforward. These plans are treated in the same way as deferred cash compensation. As the amount of the liability changes each year, an entry is made for the amount accrued. A decline in value would reduce the liability. These entries are not contingent on vesting. Phantom stock payouts are taxable to the employee as ordinary income and deductible to the company. However, they are also subject to complex rules governing deferred compensation that, if not properly followed, can lead to penalty taxes.