Hiring and retaining good employees is critical to the success of any business enterprise. It
is also important to properly incentivize these key individuals to both help the business grow and
also to retain those individuals long term. This white paper includes general information regarding
three different plans that can be used to compensate and create incentives for key employees,
directors and consultants.
STOCK APPRECIATION RIGHTS
A stock appreciation right (“SAR”) is a right to receive the appreciation in the value of one
or more shares of stock in a business (the “Company”). The appreciation is usually measured from
the date the SAR is granted to the date it is exercised. The SAR might be payable in cash, in stock,
or in a combination of cash and stock.
By exercising a SAR, an executive can receive the appreciation that would be realized by
exercise of a stock option; however, the SAR relieves the executive of the need to raise the funds
(or stock) to pay the option exercise price. In addition, exercise of a SAR may be desirable for an
optionee who would not intend to hold the optioned shares after exercise of the option.
Example. An executive is granted a SAR covering 100 shares with a fair market
value of $10 per share. The exercise price is $10. The share value subsequently increases
to $15. If the executive exercises the SAR, the executive would receive the $500.
The holder of a SAR does not recognize income upon the grant of a SAR or upon the
appreciation of the underlying shares. Upon exercise, the holder recognizes ordinary income in the
amount of the cash (or fair market value of the stock) acquired. The employer is allowed a deduction
equal to the amount of the income included in the holder’s income on exercise.
In order to put together a SAR plan, the Company would need to value the stock on an annual
basis. The SAR plan would outline what happens to the SARs in the event the Company is sold or
the employee dies, becomes disabled, retires, or his/her employment is otherwise terminated.
Phantom stock really is very much like SARs. It generally is an incentive arrangement
whereby an employer contracts to make future payments to an employee in an amount measured by
the value (or increase in value) of the employer’s stock. The employee is not granted actual shares of
stock (and therefore has no voting rights), and normally does not have to pay anything for the
phantom stock. Instead, the employee is credited with units that are valued in terms of actual share
values. Typically, the units are ultimately settled in cash, although they could be settled in stock.
In accordance with the phantom stock plan or agreement, actual payment to the employee in
respect of the phantom units might be made after a specified number of years or following termination
of employment. Alternatively, employees might be given the right to determine when the units will
Example. An employer enters into an agreement crediting an employee with 1,000
phantom stock units corresponding to 1,000 shares of stock. The agreement provides for cash
settlement of the phantom stock units in 2019. The payment will be equal to the appreciation
in the value of the 1,000 underlying shares of employer stock between the date of grant and
Phantom stock plans are often of interest to closely-held companies that intend to stay
privately held and so prefer not to issue actual shares to employees. The phantom units may be valued
based on the market value or book value of the underlying shares or on a valuation formula specified
in the agreement.
In addition to participating in the proceeds of the sale of the Company, often times phantom
stock comes with “dividends” tied to a certain percentage of the net earnings of the Company. These
“dividends” are paid in the form of compensation, so the employee is not taxed on any earnings of
the Company unless he/she actually receives a payment, in which case any amounts paid will be
taxable as compensation income. The employer will be allowed a deduction for the amount and in
the year during which such income is taxable to the employee.
Like SARs, a phantom stock plan would need to outline what happens to in the event the
Company is sold or the employee dies, becomes disabled, retires, or his/her employment is otherwise
LONG-TERM PERFORMANCE PLANS.
Performance plans are contractual incentive compensation arrangements providing awards
measured by the achievement of corporate performance objectives other than (or not limited to)
appreciation in the value of company stock.
Executives typically are credited with units that are valued based on the growth in earnings
per share, return on equity, sales, or other performance measures, over a three-to-five-year period.
Performance targets can be established at a divisional (rather than Company) level or can be
established based on performance relative to competitors. At the end of the performance cycle, if the
performance target has been achieved, the executive receives cash or stock equal to the value of the
As an alternative to “performance units,” executives might be credited with a specified
number of “performance shares” of the company’s stock. Depending on the extent to which
performance targets are achieved, at the end of the performance cycle executives would receive
some, all or none of their performance shares in the form of actual shares of stock (or cash of equal
Where the executive has no right to payment unless and until performance goals are achieved
at the end of a specified period, neither the grant of performance units or performance shares, nor the
interim achievement of goals prior to completion of the performance cycle, should be a taxable event.
The executive would recognize ordinary income upon receipt (actual or constructive) of the
payment. The employer is allowed a corresponding deduction at the time the executive recognizes
Long-Term Performance Plans typically require that the employee is currently employed
when the event(s) outlined in the plan occur.
As you can see there are numerous options available to the Company in structuring a
alternative compensation arrangement with employees. These options help align the interests of the
Company with the interests of the employee as all of them have their best benefit when the Company
grows and prospers.
York Howell & Guymon is boutique law firm focused on estate planning, asset protection,
business planning, and real property. York Howell & Guymon has estate planning attorneys
licensed to practice in Alaska, Arizona, California, Idaho, Nevada, Texas, Utah, Washington and
This White Paper is designed to provide general information and is not intended to replace
specific legal advice.
IRS CIRCULAR (230) DISCLOSURE: To ensure compliance with requirements imposed
by the IRS, we inform you that any tax advice contained in this communication, unless
expressly stated otherwise, was not intended or written to be used, and cannot be used, for
the purpose of (I) avoiding tax-related penalties under the Internal Revenue Code or (ii)
promoting, marketing or recommending to another party any tax-related matter(s)