Deep Dive into Profit-Sharing Plans: Phantom Stock

Phantom stock is a type of profit-sharing plan, which means that employees can enjoy the benefits of contributing to the financial success of their employer. Profit-sharing plans are mainly used by companies to incentivize employee performance by rewarding select employees or all staff members. Phantom stock, in particular, is usually part of a benefits package offered to those working in upper-level management. With that said, if you’re looking to achieve financial objectives and growth through your workforce, here is are some helpful information about this profit-sharing plan and whether it might be the right fit for your company.

Defining Phantom Stock

Also known as “shadow stock,” phantom stock mimics actual stock, in that it still follows the price movement of company stock and pays eligible employees out in resulting profits. However, employees do not own shares of the company as no equity is distributed through shares of phantom stock. Furthermore, shares of phantom stock only have value once specific contingencies or vesting conditions have been met. This reality means that employees harboring phantom stock do not have the voting rights typically associated with owning real shares of stock.

With that said, employees still gain from this investment option, as they continue to profit from company stock performing well on the market. Meanwhile, companies can even track the economic benefits of owning company stock without having to distribute equity through the allocation of real shares.

The Advantages and Disadvantages of Phantom Stock

The phantom stock profit-sharing plan has various tax benefits, including the fact that employers do not have to claim phantom stock until they pay an employee any profits earned per the plan agreement. The plan is also flexible, in that employers can use it how they see fit and change the parameters at their discretion since no equity is being distributed. Also, since no real shares are being allocated, companies can avoid diluting their stock, thereby boosting their stock’s value.

However, plan payments can potentially disrupt a company’s cash flow since they are considered an expense. Also, employees must list any payments received from their phantom stock as ordinary income. This requirement means that payments made to employees will be taxed as income, as opposed to capital gains, which often has a higher taxation rate.

Plan Creation and Implementation

If you do wish to proceed with adding phantom stock to your employee benefits package, creating a robust plan to help ensure that both you and your team benefit from this option is crucial. Highlighted below are a few steps you can take to establish and implement this profit-sharing plan.

• Recognize your company objectives. All phantom stock plans should help realize a company’s short and long-term business goals. Therefore, it’s imperative that you identify or review your company objectives to ensure the plan you’re establishing will help further them.

• Select the type of plan you would like to follow. Companies have two options they must choose from regarding what phantom stock plan they would like to implement. Appreciation-only plans involve payments that do not include the value of the actual company shares and can only pay out resulting profits over a specific period beginning from the date the plan goes into effect. Full-value plans pay both the value of the stock along with appreciation.

• Create a plan that addresses the relevant factors. Formulate a document that lays out the details of your plan along with how payments will be determined. These details should include considerations like eligibility requirements, a vesting schedule, a valuation formula, and payout details and circumstances.

• Roll out the plan. After forming your plan, you can put it into action by first informing eligible parties of the plan’s availability and offering access to it. You can then remind your team of the company objectives before officially executing the plan.

Phantom stock provides flexibility that other profit-sharing plans do not, and many businesses and organizations can use it to their advantage. With that said, issuing this benefit option to every employee is not recommended because it can make for a costly cash flow situation as employees are paid out when they leave or retire. It is also imperative to remember that this stock is only useful if the company grows. Therefore, if you’re looking to maintain your company’s current size, this might not be the ideal plan for you. Meanwhile, for business leaders looking to invest in growing their company, this particular plan might be the ideal option. 

At Summit CPA we offer multiple resources to assist and help your business grow. If you’re ready to get an edge on your competitors? Contact our office at (866) 497-9761to schedule an appointment with our advisors