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For both phantom stock and SARs, employees are taxed when the right to the benefit is exercised. At that point, the value of the award, minus any consideration paid for it (there usually is none) is taxed as ordinary income to the employee and is deductible by the employer.
It is possible to create a phantom stock plan that avoids the application of 409A rules. The key requirement would be to (a) use cliff vesting (any incremental vesting must trigger immediate payment), and (b) pay benefits within 2½ months of the end of the year in which the awards vest.
A phantom stock plan is an employee benefit plan that gives selected employees (senior management) many of the benefits of stock ownership without actually giving them any company stock. This type of plan is sometimes referred to as shadow stock. Rather than getting physical stock, the employee receives mock stock.
In an effort to motivate and retain key employees, some privately-held employers create phantom equity plans where the employees are given many of the benefits of stock ownership without actually being given any stock in the company.
A phantom stock plan is an employee compensation plan in which an employee is offered \u201cphantom shares\u201d that track the value of the company's actual stock. It's important to highlight that phantom shares are not actual equity, though their value does rise and fall in accordance with the value of the company's stock.
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Consequently, an S corporation may have a phantom stock plan without terminating its S corporation election. To avoid losing the "S election," the phantom stock plan must be structured carefully. Some of the criteria for an effective phantom stock plan for an S corporation includes: Liquidation rights must be limited.
Phantom Equity (Unit Appreciation Rights) One of the primary advantages of phantom equity is that its holders can still remain W-2 employees of the LLC, whereas holders of capital interests and profits interests are both considered \u201cpartners\u201d for tax purposes and, thus, receive a K-1 instead of a W-2.
As the phantom stock units become vested, the value of the phantom stock units is includible as wages subject to FICA taxes. This is the case even though the amounts are not subject to income tax until actually paid to the employee.
A phantom stock plan is a deferred compensation plan that awards the employee a unit measured by the value of a share of a company's common stock, or, in the case of a limited liability company, by the value of an LLC unit. However, unlike actual stock, the award does not confer equity ownership in the company.
As described, phantom shares are usually redeemed in cash\u2014the payment being treated like a bonus. However, should the plan agreement allow it, the payment obligation may be satisfied by distributing actual stock to the employees. A phantom stock plan must be supported by more than a verbal commitment.

phantom stock agreement sample