Benefits of Phantom Stock

Introduction

Entrepreneurs generally share the ownership with crucial members of management in order to provide them with a stake in the organisation’s success, so as to keep them in the organisation for longer and also to add to their benefit i.e. compensation without adding to payroll. The executive board takes pride in ownership, it also strives hard to build the value of the enterprise and to also enjoy a tax-deferred wealth improvement. However, sharing ownership with others ain’t easy at all as it comes at a cost and with a lot of risk. The solution to this is: ‘Phantom Stock Plans’ as they can easily mitigate these risks. 

Phantom Stock

The units of an organisation’s stock can be circulated in exchange for money, property or even past services. In cases when shares are made public as a result of past services, the beneficiary must identify taxable income, just like W-2 wages. Crucial employees are often saddened to know that they must either ought to pay a fair market value of their shares or face the brunt of taxable income.

Stock options are a well known type of equity repayment and a crucial constituent of corporate finance in today’s high-tech economy. Various organisations in Silicon Valley usually plan for an initial public offering. Assumption of aggressive early growth in the stock price justifies the cost of accurately enforcing a stock option plan with tax-favored incentive stock options (ISOs). In the year 2013, most businesses did not anticipate to go public, taking some of the spark out of ISOs. Eventually, stock options must be improved, needing a cash payment for purchasing shares.

Advantages of phantom stock:

• No voting rights – Phantom stocks are never owned by the employees, thus, they do not have the privilege of voting rights in the organisation. Therefore, the crucial decision making as well as planning of the company remains with the management.
• Invested employees – Even when the employees are not given the voting rights, they remain devoted in the development and progress of the organisation as the cash settlement they obtain on the exercise of the option is related to the appreciated value of the shares. It is simple as the higher the appreciation, higher is their entitlement.
• Flexibility– As the phantom stock scheme doesn’t actually deal with purchasing or subscribing shares, this option can still be used by LLPs, companies owned privately, publicly and even partnerships.
• Less complicated- Phantom stock is only paid to the employees if the employee is able to meet the plan, which in turn may be appreciating the value of the stock over a specified period of time or meeting of specific targets. In case, the terms of the plan are not fulfilled then in that case, the employer is under no obligation to pay out the entitlement. In a case where the employee leaves the organisation before meeting the terms, the phantom stock would automatically disappear. If compared to ESOPs where the right to the options lies with the employee even after he leaves the company, phantom stocks are comparatively less complicated.

• No taxes owed till the stock matures– Unlike equity shares, that are held by the employees for a specific period of time and fall under the taxable income on the company for the entire term, phantom stock is only taxed once the stock is matured and the cash settlement is paid to the staff member. Even then it is taxed under the salary income head as perquisites.
• Less Expensive– As compared to ESOPs, Phantom Stocks are much less expensive because they are paid out as a cash bonus.

Conclusion

Even though the phantom stock is considered to be highly advantageous and is a popular practice globally, it has not evolved much as a practice in our country. Employees usually prefer ESOPs as it provides them a stake in the organisation thus, a higher impetus to be involved in the company’s growth.