top of page
  • Writer's pictureRobert M. Fields

8. Phantom Stock

a. Design:

i. “Phantom Stock” is provided under a long-term plan pursuant to which a cash payment of a specific amount is made to non-owner executives upon (i) a “liquidation event” (e.g., a stock or asset sale of the company) and (ii) only if the owners desire, (x) upon the death of the executive (where the amount of the payment may be recovered from a key man life insurance policy held by the company on the life of the executive) or (y) in certain cases, upon the termination of employment of the non-owner executive on or after a certain date or event (such as retirement). In rare circumstances, owners have allowed payments to be made upon a termination of employment at any time.

ii. The amount of the payment is usually a small percentage of the amount realized upon a liquidation event, but only if the sales price is equal to or greater than a predetermined target amount. If the sales price is greater than the target amount, the percentage of such amount paid to the executive can be increased; provided, however, that any increase will be regulated so that the owners will always come out ahead even after the payment to the executive. For example, the increase in the sales price of the company is often twice the increase in the amount of the payment to the executive. If the sales price is below the target amount, no payment (or an extremely reduced percentage) will be paid to the non-owner executive. Similarly, a Phantom Stock plan can be drafted so that the amount of the payment made to a participant will only equal a percentage of the excess (if any) of the sales price over the fair market value of the company on the date the individual becomes a participant in the plan.

iii. If the owners desire, payments under a Phantom Stock plan can be restricted only to those executives who are employed upon the liquidation event or who remained employed to a specific date or event, such as retirement on or after age 65. A “redemption” of Phantom Stock made upon termination of employment at retirement or upon death usually is based upon a formula (often a multiple of EBITDA or book value). In the event of a payment triggered upon an event other than the liquidation of the owners’ interests in the company, I usually draft the Phantom Stock program to provide that the payment will be stretched out over a number of years (which can be extended so that each annual payment is limited to the lesser of (i) available cash or (ii) a specific dollar amount; thus, guaranteeing that the payment will not put the company into a cash-strapped position).

iv. Payments on Phantom Stock can be conditioned upon the executive completing a minimum number of years of employment with the company and are often withheld upon a termination of employment for “cause” or, as mentioned above, a termination of employment for any reason before a certain date (such as normal retirement date under the company’s pension plan), or before a liquidation event. These restrictions place “golden handcuffs” on the executive as they give him or her an incentive to remain employed for the long haul. It is very important that, however designed, Phantom Stock plans must comply with the rules governing deferred compensation set forth under Section 409A of the Internal Revenue Code. I would be pleased to discuss these with you at your convenience.

b. Federal Income Tax Implications:

i. Impact on the Individual:

1. Under current law, cash payments made pursuant to a grant of Phantom Stock generally are included in the gross income of the individual at the time paid.

ii. Impact on the Company:

1. At the time the individual recognizes ordinary income upon the receipt of cash under a Phantom Stock plan, the company generally will be entitled to a federal income tax deduction in the amount of the ordinary income so recognized.

30 views0 comments

Recent Posts

See All

1. Stock Options

a. Design: i. A stock option consists of the right of an employee, director or independent contractor to purchase stock of the company at certain times by paying a pre-set exercise price. Although opt

2. Stock Appreciation Rights

a. Design: i. Generally, stock appreciation rights (“SARs”) consist of the right of the individual to elect (within a certain period of time set forth in the award) to acquire cash (or an equivalent v

3. Restricted Stock

a. Design: i. Restricted stock is composed of shares of stock of a corporation (regardless of whether a “C” or “S” corporation). The shares of stock are subject to forfeiture back to the company in th


bottom of page