Profit sharing plans and phantom stock plans were explained

Stimulation mechanisms that do not transfer ownership of the shares.

Sharing the ownership of a small company with employees can create many conflicts. It is often wise to look at other incentive mechanisms that reward employees for increasing the company’s profit without sharing ownership. Two such alternatives are profit-sharing plans and phantom action plans.

Profit sharing plan.

A profit-sharing plan is one that provides annual contributions from the employer (which can be zero) and allocation to employees’ accounts according to a formula. The amount of the employer’s contribution can be specified by a formula or left to the discretion of the employer (possibly within the specified limits).

A profit-sharing plan can be a “qualified plan.” A qualified plan offers tax benefits because the contributions to the plan are currently deductible by the employer. The employee’s tax liability is deferred, however, until the funds are distributed from the plan to the employee. To qualify, the plan must meet numerous requirements. There can be no discrimination in terms of coverage or investment. There are also disclosure and reporting requirements.

Contributions to an unqualified plan are currently deductible by the employer and are currently included in the employee’s income. However, the employee can have immediate access to funds.

Phantom Stock Plan.

Phantom action plans are designed to give the employee the same economic result as ownership of the company’s shares. However, the employee does not actually have a property right or non-economic rights that come with a property right.

In a phantom action plan, an employee’s bonus is immediately converted into phantom stock shares. Phantom stocks track the value of the underlying stock. The value of phantom shares will increase each time there is an increase in the value of the underlying shares. At the time of distribution, the employee will receive cash equal to the liquidated value of the shares in his account. If the underlying stock is not traded on an established market, the value may be determined by a predetermined formula.

For example, suppose the GM employee receives a $ 10,000 bonus in the first year. The value of GM shares is $ 100 per share. Under a phantom action plan, the employee would receive 100 phantom shares in the first year (ie $ 10,000 / $ 100 bonus per share). The plan would require distribution to the employee in a later year (for example, year five). If the value of the shares was $ 200 in the fifth year at the time of distribution, the employee would receive $ 20,000.

Generally, a phantom stock plan will be a deferred compensation plan. This means that the employee would not be taxed until he actually received a cash distribution. Assuming this is an “unqualified” plan, the employer does not receive a deduction until there is an actual distribution to the employee.

Employers can receive a current deduction even if the employee’s tax liability is deferred if the plan is qualified. To be qualified, the plan must meet many requirements. These requirements relate to who is to be covered, when benefits, funding, reporting and disclosure obligations are granted.

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