With the introduction of the MARE to the small business world, many employers have questions about what the tool does and does not provide. The MARE includes phantom equity and profit sharing tools that provide both long and short-term employee incentives. This blog post focuses on the phantom stock component.
What The MARE Is
Employee Benefit
The MARE is a way for employees to receive some of the benefits of stock ownership without actually owning stock. It is a promise for future cash equivalent to the value of a certain number of company shares. This is beneficial for both the employee and the business owner. For employees, there is no immediate tax burden because there is no official distribution of stock. Similarly for the owner, because there is no official distribution of stock yet, there are few tax and legal complexities (and the high costs that follow).
Employee Alignment
The MARE is a means of aligning business owner and employee interests. Without a phantom stock agreement, the owner may be the only person very concerned with growing the business and finding continued financial success. With the MARE, this responsibility naturally becomes of interest to both the owner and the employees. In general, people put more effort into preserving the things they own; their place of employment is no different. They will also want to see the business grow and see their phantom stock actually materialize into cash in the future.
Employee Retention
The MARE is an incentive plan that serves as a way to tell staff that they are valuable and that the owners want them to stick around for the long haul. With owner and employee values more in alignment (as mentioned above), a new level of trust is established. Owners trust their employees enough to give them a piece of the pie and help drive the business forward. This will not be lost on the key staff and they will be more likely to remain with the business to have a direct impact in ensuring its success.
What The MARE Is Not
Actual Equity
Phantom stock doesn’t provide employees with any ownership rights in the business, unless otherwise stated in the agreement. There are generally no voting rights or dividends associated with this type of stock ownership. This arrangement does, however, lessen the immediate tax and legal burdens for both owners and employees.
A Short-Term Cash Bonus
Phantom stock is not a promise for cash today. It’s a future financial benefit, triggered by a specific milestone like business performance or a future event (like the sale of the business). However, many owners choose to add a profit sharing clause to their phantom stock agreement as a way to balance out the long-term nature of phantom shares.
Tax Advantaged
While many forms of employee equity (including ESOPs) have “capital gains” tax advantages for employees, phantom stock is taxed as ordinary income. This is due to the deferred compensation status of this benefit, and the fact that there is no actual transfer of stock at any point. After a triggering event like the sale of the business, the phantom stock is converted to the cash that was promised, and depending on the employee’s income bracket, the employee may find themselves in a higher tax bracket.
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