Retaining key employees with Phantom stock

Vintage Stock Certificate

An improving labor market often forces employers, especially smaller, privately held companies to look for creative ways to reward and retain key talent – especially if your candidates are considering larger, fortune 500 companies with robust benefits plans that often include stock option plans and equity ownership. So, how can a smaller firm reward key staff without facing the expenses and complexities of alternatives used by the Alphabets (Google’s parent company) of the world? The answer for many firms may be Phantom Stock.

Rewarding key employees

Stock ownership can be one of the most effective ways to retain and reward top talent as it tends to better align the interests of key employees and ownership. However, stock ownership plans can create additional complexities and unintended consequences such as the right to examine books and records, involvement in the management of the company and the participation in day to day profits.  Shareholders even have the right to dissent against mergers and other transactions too.

Phantom Stock, on the other hand, is essentially a compensation plan tied to the economic value of a company or division. According to Peter A. Greenbaum. Esq., shareholder of Wilentz, Goldman & Spitzer, P.A. on the corporate team, “Phantom stock is not true stock ownership. Rather, it is a contractual right typically granted to an employee. Thus, it allows the company to grant the economic rights of ownership to the employee, which is typically what both the company and the employee desire, without granting true statutory rights of a legal owner such as management input and the right to review books and records, which typically is contrary to the wishes of the company.”

The mechanics

The process starts with ownership determining who they want to reward and retain. Phantom Stock is typically offered to a limited number of key personnel and it is important to be strategic about who will share an economic interest in the company.  After determining who their key players are that offer upside potential for the company, ownership must then work with their attorney to draft the agreement.  The value of each unit of Phantom stock is typically tied to a calculation of the value of the company and paid out after a triggering event such as the sale of the company or a time horizon.  Triggering events must be carefully specified within the plan.  For example, a company may draft an agreement with Jane, stating that she will receive a payment every 3 years based upon the increase in the equity value of the company.  Alternatively, the company could change the triggering event to the company sale.

Participation is tied to employment and ceases upon termination of the employee. Since the value of the stock units typically increase as the overall company value increases, key team members are encouraged to increase enterprise value, ultimately pulling in the same direction as ownership.

Misconceptions and pitfalls

Since Phantom stock is not the same as traditional stock ownership or options, it is important to understand the differences in tax treatment. Greenbaum states, “When receiving phantom stock, an employee may believe he or she will receive capital gains treatment on payments received. However, typically the payments are deemed compensation which is taxed at an ordinary income rate to the employee.  Conversely, from an employer’s perspective, such treatment is favorable as it allows the employer to deduct all payments.”  The tax deductibility of the employer contribution makes this plan efficient in both incentivizing employees and minimizing taxes for the company.

While Phantom stock does not represent true equity ownership, owners must be also be careful with how many units are given to employees. Greenbaum adds, “Employers often provide phantom stock to more than one employee and thus it must make sure it is not unintentionally giving away too much of the pie.”  It is especially important for companies to be careful to leave room for future employees that they may want to add to the plan in the future.

While attracting, rewarding and retaining top employees can be challenging, Phantom stock plans can provide a mechanism for equity participation without many of the costs and challenges that come from adding additional shareholders. Since each situation is unique, consider speaking to your tax, legal and financial advisers to determine the most appropriate approach for you.


Kurt J. Rossi, MBA, CFP®, CRPC®, AIF® is a CERTIFIED FINANCIAL PLANNERtm Practitioner & Wealth Advisor.  He can be reached for questions at 732-280-7550,, & LPL Financial Member FINRA/SIPC.