This Halloween, Consider a Phantom Stock Plan
Business owners could use a phantom stock plan to incentivize key employees without having to share control of the company.
A phantom stock plan is a tool that may be used to transfer equity to key employees or valued team members while maintaining complete dictatorial control over your company. Virtually absolute protection is available from claims against the issuing corporation or company for claims related to management or operations by participants in the phantom stock plan.
I first designed and utilized a phantom stock plan in the mid-1990s. I assisted a company that manufactured metal racks, stands and other items with a particular emphasis on the wire industry. To complete the sale, the buyers obtained bank financing. However, the buyers needed to utilize an outside investor at the last minute when a transaction term change caused the bank to withdraw financing.
They reached out to a very successful investor, who negotiated a very favorable interest rate along with an option to acquire 20% of the company for a stated amount. The sale closed just before a big boom in the wine industry. The company was way more profitable than anyone ever expected.
From just $107.88 $24.99 for Kiplinger Personal Finance
Be a smarter, better informed investor.
Sign up for Kiplinger’s Free Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
The outside investor who provided financing exercised his option to acquire his 20% interest in the much-improved company. At the same time, he objected to the “excessive” salaries being paid to the two other owners. This began an expensive, emotionally draining shareholder dispute that was eventually settled for a substantial sum. One of the shareholders was so affected that he retired and sold to his partner.
The remaining partner vowed never to have another partner or co-owner. However, he wanted to compensate and more fully engage a key salesman critical to the company’s continuing success. We utilized a phantom stock plan to provide this salesman an ownership interest if the company was sold to a third party.
How a phantom stock plan works
The phantom stock plan is a form of deferred compensation providing an incentive, which increases as the company value increases and falls when the company value decreases. The participant has a binding contractual right to become a shareholder if the stated triggering event occurs, such as the sale of the company or a change in control of the company.
The participant is not a shareholder, member or owner prior to the occurrence of the event. The participant does not have any voting rights or say whatsoever in the management of the company. The IRS recognizes that the participant is not a shareholder in an S corporation, so there is no effect on a corporation’s subchapter S election. Similarly, because the participant holds only a contractual right to obtain actual shares in the future, there are no payroll tax consequences, and a participant is not considered to be an employee due to his or her participation in the phantom stock plan.
The phantom stock plan can be drafted to provide the participant direct ownership in the company upon the occurrence of the triggering event. The plan can also be drafted to provide an amount, such as the value of the increase in the stock value after the participant joined the plan.
What to keep in mind
When drafting, consider who first would be desired participants and the behavior and performance that the company seeks to incentivize. Consider whether participants should receive direct ownership or units with some base value. Should the participant share in only the growth with share or membership value or the total value? A specific vesting term or schedule should also be spelled out in the phantom stock plan document.
The phantom stock plan provides a unique, safe way to incentivize key team members or employees with an equity interest without giving away any of the day-to-day or long-term control of the company.
related content
- A Tax Planning Cautionary Tale: Timing and Formalities Are Critical
- Business Owners Should Review Their Buy-Sell Agreements
- How Does an Employee Stock Ownership Plan, or ESOP, Work?
- Risk Management in the Digital Age: Protecting Your Business’ Finances
- What Happens When Bosses Heap Praise Only on Their ‘Stars’?
Profit and prosper with the best of Kiplinger's advice on investing, taxes, retirement, personal finance and much more. Delivered daily. Enter your email in the box and click Sign Me Up.

Founder of The Goralka Law Firm, John M. Goralka assists business owners, real estate owners and successful families to achieve their enlightened dreams by better protecting their assets, minimizing income and estate tax and resolving messes and transitions to preserve, protect and enhance their legacy. John is one of few California attorneys certified as a Specialist by the State Bar of California Board of Legal Specialization in both Taxation and Estate Planning, Trust and Probate. You can read more of John's articles on the Kiplinger Advisor Collective.
-
How Prepaid Verizon Phone Service Works and When It's a Smart ChoiceExplore the differences between Verizon Prepaid and Verizon Postpaid plans—costs, perks, flexibility, and when going prepaid makes sense.
-
Try This One-Minute Test to Uncover Hidden Health RisksFinding out this little-known fact about your body could reveal your risk of heart disease and more. It's a simple, free check for healthy aging.
-
Social Security Wisdom From a Financial Adviser Receiving Benefits HimselfYou don't know what you don't know, and with Social Security, that can be a costly problem for retirees — one that can last a lifetime.
-
Take It From a Tax Expert: The True Measure of Your Retirement Readiness Isn't the Size of Your Nest EggA sizable nest egg is a good start, but your plan should include two to five years of basic expenses in conservative, liquid accounts as a buffer against market volatility, inflation and taxes.
-
New Opportunity Zone Rules Triple Tax Benefits for Rural Investments: Here's Your 2027 StrategyNew IRS guidance just reshaped the opportunity zone landscape for 2027. Here's what high-net-worth investors need to know about the enhanced rural benefits.
-
The OBBB Ushers in a New Era of Energy Investing: What You Need to Know About Tax Breaks and MoreThe new tax law has changed the energy investing landscape with expanded incentives and permanent tax benefits for oil and gas production.
-
Ten Ways Family Offices Can Build Resilience in a Volatile WorldFamily offices are shifting their global investment priorities and goals in the face of uncertainty, volatile markets and the influence of younger generations.
-
Should Your Brokerage Firm Be Your Bookie? A Financial Professional Weighs InSome brokerage firms are promoting 'event contracts,' which are essentially yes-or-no wagers, blurring the lines between investing and gambling.
-
Supermarkets Have Become a Pickpockets' Paradise: How to Avoid Falling VictimSome stores regularly rearrange inventory with the aim of increasing purchases, and they're creating opportunities for thieves to steal from customers.
-
I'm a Wealth Adviser: These Are the Pros and Cons of Alternative Investments in Workplace Retirement AccountsWhile alternatives offer diversification and higher potential returns, including them in your workplace retirement plan would require careful consideration.