Someone is proposing that one of my clients accept phantom stock in a company as compensation for future services. He claims that there will be no tax effect now, and in fact none at all until the corporation is later sold at the phantom stock kicks in. Does anyone know about this stuff? To me it seems an awful lot like an option, which would have some market value when given, and thus would be taxable income at that time. Stu
Moderator: I had such offers when I was a consultant. Never accepted a single one. Sounded to much like buying a pig-in-poke to me. It also sounds like 1099 income taxable in the current year.
I may have heard the term before, but the definition of "phantom" stock just doesn't come to me right now. Does it wear a mask? Is the corporation chartered by the Republic of Bengalla? Is a lithograph of the Skull Cave imprinted thereon? Where is Diana?
Yeah, that was my reaction too - it's either taxable when received, or it's so uncertain that it may never happen. In either case there are apparently better options. Stu
That leads me to an interesting hypothetical idea (which may fall to "form over substance"). I have a company, whose stock is worth something. I give an employee 10,000 shares, taking back an option to buy them for $1/share; 2000 options expire each year for the next 5. Clearly, the market value of what I give him is under $10,000, and that value is taxable. Over the next 5 years, I decide he's been a good and valuable employee, so even though the stock is worth $50/share, I let the options expire without exercising them. Now he owns the stock free and clear. On my side, there's no expense for letting the option expire unexercised; there would be a capital loss for the price I paid for it, only I didn't. On his side, there's capital gain for the option expiring, but that's based on the amount he received for the option, and he didn't. So apparently (though I expect some of you to shoot this down) by some advance planning, I get to reward him free of taxes. Seth
The way I understand it, phantom stock is an agreement that at some point in the future the company will find someone to buy it out. At that time the person will be give (and taxed on) a certain amount of stock, which will immediately be bought away from him. To me it looks a lot like stock options, but the CPA claims that it is not taxable when set up, only when the actual stock is given and then sold. That doesn't make any sense to me unless the promise to grant the stock before sale of the business is not at all enforceable. Or maybe it's not taxable because pegging it to a future sale that is not currently contemplated, is too speculative to value. I'd just like to find out more about it, but haven't been able to find any information in the normal sources. Stu
I guess I should have done this in the first place, but wikipedia is not the first thing I think of when I want information that is really authoritative. Here's what they have to say - "Phantom stock is essentially a cash bonus plan, although some plans pay out the benefits in the form of shares. Phantom stock provides a cash or stock bonus based on the value of a stated number of shares, to be paid out at the end of a specified period of time. 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 (i.e. profit growth, increased stock prices) without granting employees an actual ownership stake in the company. Phantom stock can, but usually does not, pay dividends. 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 employ 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 "rabii trust" that subjects the payout to significant risk, such as the company not being able to pay creditors, 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." Stu
Some time ago when I was working and playing in Silicon Valley (Santa Clara, CA) Phantom Stock and SARs (Stock Appreciation Rights) were popular methods of executive compensation. From memory: The company issues the employee virtual shares of stock valued at the then market price of the real stock. The grant comes with restrictions and there is a vesting date. If and when the grant vests, the market price is compared to the grant price and any increase is paid to the employee as taxable compensation subject to tax withholdings.
So if I do the accounting work to set up a new company short on cash, and get "paid" in phantom stock to be issued at some future date, I'm really being given an IOU for my services. IOW, I'm getting a note receivable and there must be some value for that "note" (phantom note?) and that value is taxable because it is for my services. ChEAr$, Harlan Lunsford, EA n LA
Question: WHY did you "give" the employee stock to begin with? Was it compensation for services? a bonus? If so, taxable at inception. The so called options would be a separate event. ChEAr$, Harlan Lunsford, EA n LA
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