Creating a Phantom Stock Agreement

Note: Want to skip the guide and go straight to the free templates? No problem - scroll to the bottom.
Also note: This is not legal advice.

Introduction

Phantom stock agreements are becoming increasingly popular among business owners, executives, and startup founders, as well as financial professionals. This type of stock agreement gives employees the right to receive a portion of the company’s profits in the form of phantom stock, thereby providing an incentive for them to stay with the company and continue to contribute towards its success. However, it is important for those considering entering into such an agreement to understand all of the risks and rewards associated with it, as well as its tax implications and legal requirements.

When looking at a phantom stock agreement, one must first consider that it is not a substitute for equity in the company and thus does not confer any ownership rights or voting rights upon employees. Also important is understanding how ordinary income taxes and capital gains taxes will be calculated and paid. The specifics of such a contract should also be carefully considered – conditions may be established which dictate when an employee can gain access to their phantom stock profits; for example, it may require that they remain employed with the company for a certain length of time first.

Finally, it is essential that any phantom stock agreement drafted adheres to applicable laws and regulations; this includes ensuring that the details are tailored specifically to meet the needs of both employer and employee. Fortunately there are plenty of resources available online which provide guidance on creating such agreements - including Genie AI’s community template library featuring millions upon millions of datapoints teaching its AI-driven system what constitutes a market-standard contract - so help is at hand even if you don’t have any prior legal experience! No Genie AI account required either - we just want to help! So why not read on below for our step-by-step guidance on creating your own phantom stock agreement?

Definitions (feel free to skip)

Vesting Schedule: A predetermined schedule used to determine when phantom stock will become fully vested. It is usually set by the amount of phantom shares that must be held for a certain period of time.
Deferred Compensation: A form of compensation in which a portion of an employee’s salary is paid at a later date.
Dividend: A payment made by a company to its shareholders from the profits it has earned.
Capital Gains: The difference between the original purchase price of an investment and its current price, resulting in a profit or loss.
Tax Implications: The legal consequences of an action in terms of the amount of taxes that must be paid.

Contents

• Definition of Phantom Stock Agreement
• Reasons for Establishing a Phantom Stock Agreement
• Key Elements of a Phantom Stock Agreement
• Definition of Phantom Shares
• Vesting Schedule
• Determination of Phantom Stock Value
• Tax Implications of a Phantom Stock Agreement
• Dividends
• Payroll Taxes
• Short-Term vs. Long-Term Capital Gains
• How to Draft a Phantom Stock Agreement
• Identify Participants
• Determine Phantom Share Value
• Address Vesting Schedule
• Define Payout Procedure
• Executing and Administering a Phantom Stock Agreement
• Executing Documents
• Tracking Stock Value
• Distributing Payouts
• Tips for Implementing a Phantom Stock Agreement
• Define a Clear Purpose
• Consider Employee Morale
• Track Value Accurately
• Consider Alternative Incentive Structures
• Common Problems with Phantom Stock Agreements and Solutions
• Valuation Disputes
• Unanticipated Tax Consequences
• Misalignment of Incentive Structures
• Misinterpretation of Agreement Terms

Get started

Definition of Phantom Stock Agreement

• Understand what a Phantom Stock Agreement is and how it works - research the concept of a Phantom Stock Agreement and the different types of agreements available
• Develop a set of rules and regulations for the Phantom Stock Agreement - ensure that the rules and regulations are tailored to the company’s unique needs
• Determine the number of shares to be awarded under the Phantom Stock Agreement - also decide the type, class, or series of the shares
• Specify the vesting period and any other conditions related to the Phantom Stock Agreement - include any restrictions or limitations on the Phantom Stock Agreement
• Develop a method for determining the payout of the Phantom Stock Agreement - decide on a formula for calculating the payout
• Draft the Phantom Stock Agreement document - include all relevant details that were determined in the steps above

When you can check this off your list and move on to the next step:
Once the Phantom Stock Agreement document has been drafted, the next step is to proceed to the Reasons for Establishing a Phantom Stock Agreement.

Reasons for Establishing a Phantom Stock Agreement

• Identify the type of employees who should be eligible for the phantom stock plan
• Determine the value of the phantom stock grants
• Decide how and when phantom stock is granted
• Determine who is responsible for administering the plan
• Set the vesting period, if any, for the phantom stock grants
• Consider the tax implications associated with phantom stock
• Decide how the phantom stock will be settled upon termination of employment

When you have established the reasons for setting up a phantom stock agreement, you can move on to the next step.

Key Elements of a Phantom Stock Agreement

• Analyze the corporate structure to determine which entity should enter into the phantom stock agreement
• Draft the agreement which will include:
• The terms of the agreement, including vesting periods, types of phantom shares, and the method of payment
• The number of phantom shares to be issued
• The rights and obligations of the parties
• Any applicable tax rules
• Get the agreement reviewed and approved by your legal counsel
• Execute the agreement

Once you have completed these steps, you can move on to the next step which is defining phantom shares.

Definition of Phantom Shares

• Define how much the phantom shares are worth - this can be in terms of a fixed dollar amount or a percentage of the company’s stock value
• Outline the terms for how and when the phantom shares can be redeemed or sold
• Specify when the phantom shares will be granted to the employee, including any conditions or restrictions
• Once you have outlined the terms of the phantom shares, the agreement should be reviewed and signed by the employer and employee
• When you are done, you can check this off your list and move on to the next step, which is outlining the vesting schedule.

Vesting Schedule

• Determine the vesting period length (ex. 3 years)
• Establish the vesting schedule as it applies to the phantom stock (ex. 25% will vest after 1 year, 50% will vest after 2 years, and the remaining 25% will vest after 3 years)
• Specify how vesting will be tracked (ex. based on the calendar year, or based on the vesting periods)
• Note the conditions in which vesting will be accelerated (ex. death, disability, retirement, or termination of employment)
• Specify any conditions that could cause a forfeiture of vested shares (ex. employee violates company policy or leaves the company before the vesting period is complete)

Once you have determined the vesting period length and established the vesting schedule, you can check off this step and move on to the next one.

Determination of Phantom Stock Value

• Determine the value of the phantom stock, i.e. the amount of money that the employee would receive when the phantom stock is vested.
• This can be done through a variety of methods, such as a fixed price, or tying it to the company’s performance, such as a certain percentage of the company’s earnings or value.
• Consider the impact of inflation and other factors that may affect the value of the phantom stock over time.
• Once you have determined the value of the phantom stock, document this information in the phantom stock agreement.

You can check this off your list once you have determined the value of the phantom stock and documented it in the phantom stock agreement.

Tax Implications of a Phantom Stock Agreement

• Understand the tax implications of establishing a phantom stock agreement, including potential tax consequences for the company and the employee.
• Determine if the company will be taxed on the phantom stock, and at what rate.
• Consider potential tax consequences for the employee, such as capital gains taxes and income taxes.
• Investigate if any additional taxes or fees need to be paid and how they should be paid.

When you can check this off your list and move on to the next step:

• When you have a full understanding of the tax implications of establishing a phantom stock agreement and have determined what taxes and fees need to be paid.

Dividends

• Determine the amount of any dividends to be paid to phantom stockholders
• Decide on the frequency of payment for dividends
• Specify if the dividends will be paid in cash or in additional phantom shares
• Include in the agreement language that describes the company’s right to change the amount or frequency of dividends
• Check off this step when all the details on dividends have been determined and added to the agreement.

Payroll Taxes

• Determine whether phantom stock is eligible for payroll taxes.
• Research the types of payroll taxes that must be paid for phantom stock agreements.
• Calculate the payroll taxes due for the phantom stock agreement.
• Set up a system for collecting and paying payroll taxes for the phantom stock agreement.
• Make sure to keep track of all payroll taxes collected and paid for the phantom stock agreement.

Once you have determined whether phantom stock is eligible for payroll taxes, researched the types of payroll taxes that must be paid, calculated the payroll taxes due, set up a system for collecting and paying payroll taxes, and kept track of all payroll taxes collected and paid, you can check this off your list and move on to the next step.

Short-Term vs. Long-Term Capital Gains

• Understand the difference between short-term and long-term capital gains and how they are taxed differently
• Determine the holding period for the phantom stock and whether the gains should be taxed as short-term or long-term
• Consider the implications of taxing short-term or long-term capital gains for the organization and the employee
• When you have determined the holding period and the taxation of the gains, you can move on to the next step in creating the phantom stock agreement.

How to Draft a Phantom Stock Agreement

• Consult with a lawyer or other qualified professional to make sure your agreement complies with all applicable laws.
• Draft the agreement, taking into account the company’s goals, the vesting period, and the distribution schedule.
• Outline the rules and restrictions for phantom stockholders in the agreement, such as the right to vote and the requirement to pay taxes on any gains.
• Spell out the company’s rights and obligations, including the requirement to purchase phantom stock from the stockholder if specified in the agreement.
• Put the agreement in writing and have it reviewed and signed by all parties involved.

How you’ll know when you can check this off your list and move on to the next step:
Once you have consulted a qualified professional, drafted the agreement, outlined the rules and restrictions, specified the company’s rights and obligations, and put the agreement in writing and have it reviewed and signed by all parties involved, you can check this off your list and move on to the next step.

Identify Participants

• Identify the company and the individuals who will be participating in the phantom stock agreement.
• Identify the number of phantom shares to be issued and the terms of the phantom stock agreement.
• Determine the vesting period and other restrictions that may be placed on the phantom stock agreement.
• Clarify the terms of the phantom stock agreement, including the tax implications, the rights of the participants, and the conditions for the issuance of the phantom stock.

Check off list:

• You can check off this step when you have identified the participants, determined the number of phantom shares to be issued, and clarified the terms of the phantom stock agreement.

Determine Phantom Share Value

• Calculate the per-share value of the phantom stock awards.
• Consider factors such as the company’s stock price, the size of the pool of phantom shares, and the number of awards to be granted.
• Take into account the company’s performance to date and any changes to the business or industry that may affect the value of the phantom stock awards in the future.
• Ensure that the phantom stock awards are priced fairly in relation to the company’s stock price and other factors.
• When the per-share value of the phantom stock awards has been determined, you can move on to the next step.

Address Vesting Schedule

• Establish a vesting schedule for the phantom stock agreement.
• A vesting schedule is the timeline in which the phantom stock will vest, such as over a period of three years.
• Consider whether vesting should occur on a monthly or yearly basis.
• Ensure that the vesting schedule is clearly defined in the agreement.
• Once you have established the vesting schedule, this step will be complete.

Define Payout Procedure

• Decide when the phantom stock plan will terminate, and what will trigger the payout of the phantom stocks
• Establish the method of determining the value of the phantom shares when they are paid out (e.g. the average price of the company’s stock over the last six months)
• Decide whether the phantom stock payout will be in cash or in the form of actual company stock
• Specify a date or event when the phantom stock will be paid out

You can check this step off your list when you have determined the termination date and trigger, established the method of determining the value of the phantom shares, decided on whether the phantom stock payout will be in cash or in the form of actual company stock, and specified a date or event when the phantom stock will be paid out.

Executing and Administering a Phantom Stock Agreement

• Draft the agreement and have both parties sign the agreement
• Obtain a signed agreement from both parties
• Distribute copies of the agreement to all relevant parties
• Establish a system to track and monitor the vesting of phantom stock awards
• Set up a recordkeeping system to document changes and activity related to the phantom stock agreement
• Make sure to follow all disclosure regulations when communicating information about the phantom stock agreement
• Monitor the performance of the phantom stock awards and ensure the payouts are delivered according to the agreement
• Keep all relevant documents and records related to the phantom stock agreement in an organized filing system

Once each of these steps has been completed, you can check this off your list and move on to the next step of executing documents.

Executing Documents

• Work with a lawyer to draft a Phantom Stock Agreement
• Create a Phantom Stock Plan document that outlines the rules and specifications of the phantom stock agreement
• Have all parties involved sign the agreement
• File all executed documents with the appropriate governing body
• When all documents have been signed and filed, you can move on to the next step.

Tracking Stock Value

• Determine the phantom stock agreement’s vesting period.
• Establish the vesting schedule and when the stock will be distributed.
• Set the phantom stock value at the start of the agreement.
• Monitor the company’s stock value on the stock market or through other means throughout the vesting period.
• At the end of the vesting period, calculate the difference between the stock value at the start and the stock value at the end of the vesting period.
• Record the difference to determine the phantom stock payouts.

Checklist item for this step:

• Established vesting period.
• Set the phantom stock value at the start of the agreement.
• Monitored company stock value throughout the vesting period.
• Recorded the difference between the stock value at the start and end of the vesting period.

Distributing Payouts

• Decide on a payout frequency (e.g. annually, bi-annually, etc.)
• Establish a vesting schedule for the phantom stock awards
• Set up a bank account for the phantom stock plan and transfer funds to it
• Decide who will be responsible for tracking the payouts
• Figure out how the payouts will be taxed and determine who will be responsible for filing the appropriate paperwork
• Create a schedule for making the payouts
• Once all the details have been sorted out, make sure to document the payout process in the phantom stock agreement

You can check this off your list once you’ve made sure the payout process is documented in the phantom stock agreement.

Tips for Implementing a Phantom Stock Agreement

• Consult with a lawyer to ensure the agreement is legally sound and meets all applicable laws and regulations.
• Draft the agreement to clearly outline the terms and conditions of the phantom stock plan.
• Create a vesting schedule to determine when participants will become eligible to receive phantom stock.
• Establish a plan for distributing payouts and make sure all parties are aware of the terms.
• Create a tracking system for monitoring phantom stock performance and payouts.
• When all the details of the phantom stock agreement are finalized, distribute copies to all plan participants and make sure they understand the terms and conditions.

You’ll know you can check this off your list when all plan participants have received and understood the agreement and the tracking system is in place.

Define a Clear Purpose

• Determine what you want the phantom stock agreement to accomplish, such as rewarding employees for their performance or incentivizing them to stay with the company
• Decide what type of phantom stock you wish to use, such as traditional phantom stock or restricted stock units
• Consider who will be eligible for the phantom stock agreement, such as all employees, senior management, or specific individuals
• Set a timeline for the phantom stock agreement, including when the shares will vest and when the phantom stock agreement will end
• You know you can move on to the next step when you have a clear purpose and timeline for the phantom stock agreement determined.

Consider Employee Morale

• Consider the morale of the employees when setting up the phantom stock agreement.
• Take into account any potential effects the phantom stock agreement could have on the motivation and morale of employees.
• Assess how the agreement could affect their job satisfaction and motivation.
• Consider how the phantom stock agreement could help to increase employee engagement and loyalty.

When you can check this off your list and move on to the next step:

• Once you’ve considered the morale of the employees and determined the potential effects of the phantom stock agreement, you can move on to the next step of accurately tracking the value of the phantom stock agreement.

Track Value Accurately

• Determine a formula for calculating the value of the phantom stock, such as the average of the closing price of the stock on the grant date and the last day of the grant period
• Set up a system that can track the value of the phantom stock throughout the grant period
• Monitor the phantom stock’s value regularly to ensure it is accurately tracked
• Ensure the value is calculated in accordance with the formula established for the phantom stock
• Once the phantom stock’s value is accurately tracked, move on to considering alternative incentive structures for the agreement.

Consider Alternative Incentive Structures

• Research different types of incentive structures, such as stock options and restricted stock units, and compare their advantages and disadvantages
• Consider whether a phantom stock plan is the most beneficial option for your company and its employees
• Make sure to consider both the short-term and long-term implications of any incentive structure you decide to implement
• When you have chosen the incentive structure that best fits your company’s needs, you can move on to the next step in creating your phantom stock agreement.

Common Problems with Phantom Stock Agreements and Solutions

• Understand the common problems with Phantom Stock Agreements, such as the difficulty in determining the value of the company, the lack of liquidity, the potential for manipulation, and the lack of legal protection
• Identify potential solutions to these problems, such as setting a valuation formula, providing a cash payment option, providing a repurchase right, and including legal protection
• Review the options and decide on the best solution for your business
• Draft the agreement and include the solution you have chosen
• Check off this step when the agreement is completed and ready to be reviewed

Valuation Disputes

• Create a formula or procedure to determine the value of the phantom stock award.
• Investigate any potential valuation disputes, such as whether the phantom stock will be valued on the basis of the fair market value of the company or the book value of the company.
• Agree on a method for resolving any valuation disputes that may arise.
• Include a clause in the agreement that sets out the method for resolving valuation disputes.

You will know that you can check this off your list and move on to the next step when you have included a clause in the agreement that sets out the method for resolving valuation disputes.

Unanticipated Tax Consequences

• Consult with your accountant or tax advisor to analyze the tax implications of issuing phantom stock.
• Evaluate your company’s tax strategies and determine whether phantom stock would fit in with them.
• Consider any potential tax burdens and benefits of issuing phantom stock and how they would apply to your company.
• Make sure any phantom stock agreement clearly defines how taxes will be paid, who will pay them, and when.
• When all questions regarding unanticipated tax consequences have been answered, the step of unanticipated tax consequences can be checked off the list and the next step can be addressed.

Misalignment of Incentive Structures

• Draft a document that outlines the rights and obligations of employees and the company in relation to phantom stock.
• Develop a vesting schedule and other relevant provisions to ensure both parties are in agreement regarding the terms of the phantom stock agreement.
• Set out the vesting period, performance criteria for vesting, and any special conditions for vesting that may apply.
• Ensure that the agreement is compliant with applicable tax and employment laws.
• When all parties are in agreement and the document is properly executed, the misalignment of incentive structures phase of creating a phantom stock agreement is complete.

Misinterpretation of Agreement Terms

• Consult a lawyer to ensure that all terms of the agreement are clearly understood and agreed upon
• Have the manager and employees review the agreement to confirm its accuracy
• Clarify any discrepancies or miscommunications that may arise from the agreement
• Ask questions to verify that all parties understand the agreement and its implications
• Obtain written confirmation from all parties that they agree to the terms of the agreement
• Once all parties have signed the agreement, have a copy of it placed in the employee’s personnel file
• You know you can check this off your list and move on to the next step when all parties have signed the agreement and it has been placed in the employee’s personnel file.

FAQ:

Q: Does creating a Phantom Stock Agreement require hiring a lawyer?

Asked by Jocelyn on February 3rd, 2022.
A: A Phantom Stock Agreement is an agreement between a company and an employee or investor which allows the parties involved to have a stake in the company’s success without actually owning any shares in the company. The agreement outlines the terms of the arrangement, including the amount of money that will be paid out to the employee or investor based on the performance of the company. While it is not necessary to hire a lawyer to create such an agreement, it is highly recommended to ensure everything is done correctly and legally binding. A lawyer can also help you to ensure that all parties involved understand their rights and obligations and can provide valuable advice on how to structure the agreement.

Q: What are the consequences if a Phantom Stock Agreement is not properly structured?

Asked by Mariana on March 8th, 2022.
A: If a Phantom Stock Agreement is not structured correctly, there could be serious legal and financial ramifications for all parties involved. This is because phantom stock agreements are legally binding contracts that must be set up properly in order for them to be valid. If they are not properly structured, it can leave the company open to liability if they do not fulfil their obligations or if they fail to meet their promised payouts. It is therefore important to make sure that all terms and conditions of the agreement are clearly outlined and understood by all parties before signing it.

Q: Are there any tax considerations when creating a Phantom Stock Agreement?

Asked by Isabella on April 14th, 2022.
A: Yes, there are tax considerations when creating a Phantom Stock Agreement as this type of agreement can be subject to certain taxes depending on where it was created and who was involved in its creation. Generally speaking, phantom stock agreements can be subject to capital gains taxes at both federal and state levels as well as other taxes depending on where it was created and who was involved in its creation. It is important to consult with a qualified tax advisor for more information specific to your situation.

Q: Are there differences between UK, USA and EU jurisdictions when creating a Phantom Stock Agreement?

Asked by Noah on May 20th, 2022.
A: Yes, there are differences between UK, USA and EU jurisdictions when creating a Phantom Stock Agreement as each jurisdiction has its own set of laws and regulations which must be adhered to when creating such an agreement. In the UK, for example, there are certain restrictions on how much money can be paid out under such an arrangement whereas in the US, phantom stock agreements can be used for both equity-based compensation plans as well as incentive compensation plans. Additionally, different countries may have different requirements for disclosure of information related to phantom stock agreements or may require additional paperwork before such an agreement can be legally binding. It is therefore important to familiarise yourself with the laws of your jurisdiction before proceeding with any such agreements.

Example dispute

Phantom Stock Agreement Lawsuit

• A plaintiff may raise a lawsuit referencing a phantom stock agreement if they believe they have been wrongfully treated by a company and have suffered damages as a result.
• The lawsuit may be based on civil law, such as breach of contract, or violations of securities regulations.
• The plaintiff must be able to prove damages, such as lost wages, lost stock value, or other financial losses due to the phantom stock agreement.
• The lawsuit must also be able to prove that the company violated the terms of the agreement and that the plaintiff is eligible for damages.
• In order to win the lawsuit, the plaintiff must be able to present evidence that the company did not abide by its agreement.
• The court may then decide to award damages to the plaintiff, depending on the severity of the case and the evidence presented.
• Settlement can also be reached between the two parties if they are willing to negotiate a fair settlement.
• If damages are awarded, they can be calculated based on the amount of the phantom stock agreement and the losses the plaintiff suffered.

Templates available (free to use)

Phantom Stock Agreement

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