Construction Update

Compensating With Stock That Isn’t

The principle of tying employee compensation to overall company performance is a well-established one, and company stock is its most common currency. When a significant part of an executive’s potential pay consists of the ownership of a company, that employee can be expected to exercise a strong personal interest in raising the company’s profits.

But sometimes employers who want to incent and reward performance in this way don’t want to dilute their ownership of the corporation, not even with minority shareholders. One alternative is a qualified profit-sharing plan — but such plans tend to favor younger, lower-compensated employees who leave the company before retirement. These, of course, are often the opposite of the qualities and behavior the owner wants to encourage in the first place.

The Phantom to the Rescue

Phantom stock plans, also called shadow or unit stock plans, offer some advantages in situations like this.

Phantom stock is not stock — it’s a deferred monetary award that’s indexed to stock. The usual phantom stock plan sets up compensation units that derive their base value from the value of a company’s common stock. When awarded, these units carry tax advantages similar to those of other deferred compensation.

Such a plan also adjusts to changes in the company’s capital structure that take place over the life of the phantom stock. A two-for-one split in a company’s common stock, for example, has the same effect on its phantom stock. A phantom stock’s value also increases to reflect dividends paid on common stock.

Upside for Employees

Employees derive some advantages from phantom stock as well. They receive cash, not stock with an uncertain future value. They aren’t forced to invest in their employer’s company, but they benefit by its success. As long as they avoid constructive receipt (that is, control of the funds represented by the phantom stock), they avoid reporting taxable income. Some stock options, by contrast, can require recipients to report income — and pay taxes on it — before the income is actually in hand.

Employees also incur some restrictions when they receive phantom stock, which primarily affect career mobility. The compensation is often contingent upon their remaining with the company for a period of years, or until retirement, and they are routinely required to sign broad noncompete agreements.

Phantom stock is taxed like unfunded deferred compensation. The employee reports no taxable income and the employer takes no deduction when the phantom stock is assigned to the recipient’s account.

After a triggering event such as retirement, the recipient is paid in installments over a number of years and not taxed before actual receipt. The employer likewise claims a deduction in the year payment is made.

To talk over the pros and cons of phantom stock, as well as other compensation choices, please give us a call.

For more information about our services to the construction industry, Contact:
Mark Lund, Parter-in-Charge of Construction Services at 713.297.6907.

The articles in this newsletter are general in nature and are not a substitute for accounting, legal, or other professional services. We assume no liability for the reader's reliance on this information. Before implementing any of the ideas contained in this publication, consult a professional advisor to determine whether they apply to your unique circumstances.