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I have been offered phantom stock in a closely held small tech corporation. Should I argue for stock options instead?

Mountain View, CA |

This is the first time I've been offered phantom stock for a key officer role and I have reservations.

Thanks for the input. So far, John P Corrigan's answer is helping me the most. Dana Shultz is correct in that arguing for stock options now will likely not be successful. I guess what I really am trying to understand, since this hasn't been the norm in my experience, is whether there are reasons why phantom stock is not in one's best interests relative to normal stock options. Am I better off looking at other opportunities with more traditional plans, or trading phantom stock for a higher salary in my negotiations? Yes, I realize it's a complicated topic (as the past hour searching via Google has made clear), so I was just looking more for the "gut check" here than anything else. I will speak to my CPA, but I do like to do a certain bit of homework with crowd-sourced wisdom. Thank you so far for the feedback.

Attorney Answers 4

  1. Best answer

    Biggest difference I that phantom tock is nothing more than deferred compensation that is aid to you in cash, therefore is always taxed as ordinary income when received no different than wages. The company gets a compensation deduction. You never have ownership in the business albeit your earnings are ownership-like given the value of the phantom stock will mirror real stock for valuation. Stock options allow the recipient to actually become an owner if option is exercised and "real" stock issued. Moreover, if the recipient makes an IRC Sec. 83(b) election at time the options are issued then any future appreciation in the stock will be taxed at the lower capital gain tax rate.

    My answer is not intended to be giving legal advice and this topic can be a complex area where the advice of a licensed attorney in your State should be obtained. Please click "helpful" or "best answer" if my answer added any value or add a "comment" if you have more info for me to help you get a better answer.

  2. You probably need an employment/business lawyer with experience in your industry up in Mountain View/Silicon Valley to review your agreement in its entirety. Both phantom stock and stock options are complex securities and have tax ramifications that need to be considered in conjunction with your overall tax picture. You seem to have prior experience in high level employment contracts in the industry and it is now time to have a ongoing CPA and lawyer on your team.

    The above is general legal and business analysis. It is not "legal advice" but analysis, and different lawyers may analyse this matter differently, especially if there are additional facts not reflected in the question. I am not your attorney until retained by a written retainer agreement signed by both of us. I am only licensed in California. See also terms and conditions item 9, incorporated as if it was reprinted here.

  3. I agree with Attorney Doland and will add the following:

    Does the corporation already have a stock option plan? If not, then arguing for options may not succeed, because a tax-qualified stock option plan is relatively expensive for a small corporation to establish and administer.

    Perhaps you can successfully argue for restricted stock, rather than phantom stock or options. Please see the post at the link below.

    This information does not constitute legal advice and does not establish an attorney-client relationship.

  4. Your reservations are well advised.

    You should consider making your case for options for the following reasons: (i) phantom rights will never afford you voting rights and you don't get the employee stockholder protections under the California Corporations Code as an equity holder (your interest can be diluted w/o consent); and (ii) options can qualify for lower tax treatment (as ISOs) and allow your to avoid income tax if the grant and your dispositions qualify (you're taxed as a capital gain vs. income tax rate). Phantom stock rights are taxed as supplemental income (bonus income) and do not have the right to vote on key changes to the company, and the company can keep granting phantom stock rights until your interests are meaningless. Be careful.

    The issue is whether the company has enough underlying authorized shares to grant you options. Many times phantom stock rights are granted when a company depletes its option pool. Sometimes you can force a re-organization of the company to re-create an option pool, some times you can't.

    Good luck.

    For legal advice and representation, consult an attorney. This response was provided for informational and marketing purposes only, and should not be relied upon as legal advice. No communication with the author of this comment through this website can establish an attorney-client relationship, as the attorney-client relationship can only be established by the mutual understanding of its creation by both the client and the attorney, each party intending to create such a relationship.

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