Have You Received “Phantom” Stock from Your Company? Here’s How It Works

By Michael Torney, CFP, J.D., LL.M. 

Key executives at privately-owned or public companies may receive shares of stock in their employer. Sometimes the shares of stock are synthetic stock, otherwise known as “phantom stock”. This kind of stock can give many benefits of ownership and tangible value to an executive, yet is different than owning actual shares of the company.  Phantom stock can potentially be valuable for executives and managers as a part of a long-term incentive program to help propel the company’s growth. 

Unlike other types of stock grants, “phantom” stock does not include actual shares in the company or any type of ownership or voting rights. Its value and stock price are usually determined by an independent firm employed by the company. As the value of the stock increases, so does the value of the phantom stock.  

Owners of companies need to retain talented people. They know that any potential buyer will want a strong management team in place, so offering the issuance of phantom stock is one possible way to help a company retain its key management team. These plans are intended to provide significant rewards so that the executive does not, for example, move to a competitor or start their own company.  These plans can also help align senior executives’ interests with the interests of the company. 

Types of Phantom Stock 

While companies have plenty of flexibility in how they structure a phantom stock plan, there are generally two kinds: full value and appreciation-only. 

An executive receiving stock at “full value” gets both the current value of the stock when it is granted, plus any appreciation. For example, if an executive receives 10,000 shares at $5 per share, and the share price grows to $20 a share when a key event triggers payment, they would receive $200,000 before taxes.  Some phantom stock plans allow for the payment of dividends. 

Appreciation-only means the executive does not receive the current value of the stock. Instead, as their company stock price rises, they earn the amount the stock increases before a key event triggers payment.  In the example above, 10,000 shares of stock would have appreciated by $15 per share, or $150,000 before taxes.  These plans are sometimes called “stock appreciation rights.” 

Vesting

To quality for phantom stock grants, companies usually require that executives meet specific performance metrics over a number of years or the vesting may be time-based. Companies have flexibility in setting a vesting schedule. The vesting usually occurs over a number of years. Instead of receiving compensation periodically, the executive may need a key event to occur before they receive any compensation. 

Taxes

If the phantom stock plan is a valid deferred compensation plan, Social Security and Medicare taxes are owed at the time of vesting. Income tax is owed once the cash is received. Just like an annual bonus, this amount becomes part of the executive’s annual income in the year it is received.  Compensation related to phantom stock is taxed at ordinary income rates; the income is reported on the executive’s W-2.   

Summary

Phantom stock may be valuable for executives and can add a significant amount to your wealth. Because each company sets its own rules for how these plans work, it’s critical to understand all the plans details, including which events trigger payment. If you have been granted shares of phantom stock and would like to discuss them as part of an overall financial strategy, contact our team at Duffteam@monetagroup.com. We are happy to discuss how we can help people maximize their wealth. 

 

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