incentive-phantom-stock-michae_10762769What is it?: Phantom stock is a form of compensation where a company promises to pay cash at some future date, in an amount equal to the market value of a number of shares of its stock.  The recipent does not receive actual stock.

How does it work?  The payout on Phantom Stock will increase if the stock price rises, and decrease if the stock falls, but without the recipient actually receiving any stock. Like other forms of stock-based compensation plans, phantom stock broadly serves to encourage employee retention, and to align the interests of recipients and shareholders.

Phantom stock is essentially a cash bonus plan, although some plans pay out the benefits in the form of shares. Phantom stock is favored by closely held or family-owned companies who want to provide incentives to management and other employees without granting them equity.

How is it taxed?  When the payout is made, it is taxed as ordinary income to the employee and is deductible to the employer. Generally, phantom plans require the employee to become vested, either through seniority or meeting a performance target.

Sources: 
The National Center of Employee Ownership, http://www.nceo.org/articles/phantom-stock-appreciation-rights-sars)
http://en.wikipedia.org/wiki/Phantom_stock
Pictures and images: http://slgsecurities.files.wordpress.com/2012/09/incentive-phantom-stock-michae_10762769.jpg