A plan sponsor may be inclined to allow participants to choose the date on which they would redeem their phantom shares (see Redemptions/Distributions). Generally, under current tax law, this option is not available.
This feature may seem unclear for employees who are accustomed to stock option programs in public companies. In such a plan, employees are given control over when they will choose to exercise their vested options (up to a maximum period such as ten years).
However, phantom stock plans are subject to different rules than stock option programs. Since the adoption of Internal Revenue Code Section 409A, employee control over timing of payments has been severely limited.
The law states that employees must pay income taxes on amounts that are available to them under nonqualified plans. Thus, if an employee is in control of the decision to receive the funds at a certain date the funds become taxable on that date. The employee’s choice to further defer payment would not defer the taxes.
It is possible to allow for limited employee choice—as long as that choice precedes the date the funds become available. One approach would be to give employees the choice of settlement date when they receive their awards. For example, a plan sponsor could grant an employee 100 PSO units on a given date and inform them that they can select the date of payment in the future (e.g., between 4 and 8 years). If the employee is allowed to change that date again, they must do so at least one year in advance of the scheduled payment date and the new payment date must be after the original payment date. These types of allowances should only be adopted after careful guidance from an advisor well-versed in the IRS rules.
For the sake of simplicity, and to avoid accidental violation of the tax code, most plans specify the date of payment without allowing for alteration by employee-participants.