A Phantom Stock Plan is an arrangement under which deferred amounts are determined by a reference to hypothetical “phantom” shares of the employer’s stock without ever issuing the actual shares to the employee. Depending on the terms of the arrangement, the employee may be entitled to receive only the growth in the value of the stock between the time the employer awards the phantom shares and the time the employee cashes out the shares. Alternatively, the employee may be entitled to receive the entire value of the stock as well as any dividends paid from the time the employer grants the phantom shares. The employer does not hold actual shares of stock for the employee, but depending on the terms of the plan, the employee may be paid in actual shares or in cash at the time of the cash-out.
Despite their name, Phantom Stock Plans are Non-Qualified Deferred Compensation (NQDC) arrangements, not stock arrangements. IRC §3121(v)(2) provides that an arrangement is a NQDC if the employee has a legally binding right in a calendar year to the cash value of a certain number of shares that is to be paid in a later calendar year. Typically, the individual is entitled to receive the cash value of the number of phantom shares that have been credited to the individual’s account upon termination of employment. See the final regulations under IRC §409A.
IRC §3121(v)(2) deals with treatment of certain deferred compensation & salary reduction arrangements specifically the treatment of certain nonqualified deferred compensation plans. Treas. Reg. § 31.3121(v)(2)-1(b)(4)(ii) discusses plans, arrangements, and benefits that do not provide for the deferral of compensation such as stock options, stock appreciation rights, and other stock value rights. Treas. Reg. § 31.3121(v)(2)-1(b)(5) example 8 provides a special timing rule for nonqualified deferred compensation, which may include phantom stock. Under the special timing rule the FMV of the phantom stock is wages at the time credited to the employee’s account (when it is vested). If “taken into account” when credited to the employee’s account, then any appreciation in the value of the stock is not FICA wages when the executive cashes-out the phantom stock. However, such appreciation is income to the employee and subject to FITW.