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.

Sign up for Kiplinger’s Free E-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’?
Get Kiplinger Today newsletter — free
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.
-
‘Are You Better Off Than You Were 71 Days Ago?’ Cory Booker Marathon Senate Speech Highlights Tax Debate
Tax Policy A speech protesting Trump’s policies, including tax plans, breaks U.S. Senate records.
By Kelley R. Taylor Published
-
Stock Market Today: Stocks Are Mixed Before Liberation Day
Markets are getting into the freewheeling rhythm of a second Trump administration.
By David Dittman Published
-
Winning Strategies for Financial Advisers as Clients' Lives Evolve
How can the wealth management industry help make life transitions easier for the adviser and the client?
By David Conti, CPRC Published
-
How Advisers Can Establish Relationships With HNW Prospects
These strategies can help to build influence with high-net-worth individuals, who are often looking to an adviser for insight rather than solutions.
By Jeremy Green, CFP®, CTFA, CLU®, CEBS®, AEP®, EA, MSFS Published
-
When Your Car Is Fixed, But You've Still Got the Problem
This reader's experience with trying to get squealing brakes fixed under an extended warranty mirrors what others are experiencing these days.
By H. Dennis Beaver, Esq. Published
-
Seven Questions to Ask When Evaluating Personal Loan Options
Taking out a personal loan too hastily could lock you into unfavorable terms with an untrustworthy lender. Ask these questions before signing anything.
By David Kimball Published
-
The Three Biggest Fears Keeping Retirees Up at Night
Here are the steps you can take to put those fears to rest and retire with confidence so you can relax and enjoy the life you've planned.
By Pam Krueger Published
-
What Can a Donor-Advised Fund Do for You? (A Lot)
DAFs and private foundations go about helping charities (and those who donate) in different ways. Each comes with its own benefits and restrictions to navigate.
By Julia Chu Published
-
Estate Planning When You Have International Assets
Estate planning gets tricky when you have assets and/or beneficiaries outside the U.S. To avoid costly inheritance mistakes, it pays to understand the basics.
By Kelsey M. Simasko, Esq. Published
-
Three Essential Estate Planning Steps to Protect Your Nest Egg
After dedicating years to building your wealth and securing your future, make sure your assets are protected and your loved ones are provided for in the future.
By Nicole Farbo, CFP® Published