A rough economy has made retaining key management employees difficult, unless you know your way through the trap-line…

A weak economy has placed many business owners at risk of losing key management personnel.  Most “golden handcuff” techniques involve employee tax burdens which adversely affect their overall desirably to your valued personnel.  And, current cash payments can be risky for you in an uncertain economy.

A favored technique among closely held businesses is a “phantom stock” program.  This program transfers the incremental increase in value of a defined number of shares to your valued personnel.  Phantom stock programs’ acknowledged drawback is their benefits (increase in share value) taxed as ordinary income.  While many planners contort themselves converting this benefit (or a similar benefit) into long-term capital gains, we’re aware of a small window of opportunity for making that benefit essentially tax-free!

A seldom recognized tax code investment incentive provision permits this highly coveted result for plans (and benefits issued) before the end of 2011.  Like all “almost too good to be true” tax opportunities, Congress and the IRS has grafted numerous “leg-hold traps” into the law.

The program entails issuing newly, previously not issued, shares to the valued employee which are held by the issuer as security (subject to both a pledge agreement and a shareholder agreement) for the purchase price loan (at the lowest available applicable federal interest rate).  Interest accrues until the 5^th anniversary of the shares’ issuance.  Immediately after that anniversary, the valued employee requests, and the issuer agrees, that your company purchase the shares from him/her at their then fair market value (usually determined under a formula in the shareholder agreement).  Your valued employee satisfies his purchase obligation, as well as accrued interest, out of the proceeds and retains the excess tax-free (not only federally but also in Ohio)!

Bearing in mind the “leg-hold traps” attendant with this opportunity, you should consult your H&M tax advisor before attempting this program.  He/she can (a) provide with a fulsome description that fills in many gaps and (b) help you navigate those traps and arrive at this coveted result.

TAGS: deferred compensation; small business stock; gains and losses; corporation tax