Monthly Archives: August 2026

If you are five years away from retiring or selling your business, you are standing in the only window that still gives you real leverage. Not the twelve months before a letter of intent — by then the buyer sets the terms, the tax structure is largely locked, and your key people have already figured out that something is happening. Five years out, almost everything is still adjustable. The exit planning checklist below is built for exactly that window.

The owners who capture the highest multiples and keep the most after tax are not the ones who negotiate hardest at the closing table. They are the ones who spent five years quietly engineering the business so the closing table was a formality. Here is what that looks like.

The Five-Year Exit Planning Checklist

Years 5 to 4: Establish a Baseline You Can Actually Defend

• Get a real valuation, not a rule of thumb. "Three times EBITDA" is not a plan. You need a defensible number built from normalized earnings — adjusted for owner compensation, personal expenses running through the company, one-time items, and related-party rent.


• Clean up the financials. Buyers pay a premium for three years of consistent, reviewed or audited statements. Start the clock now.


• Identify your value killers. Customer concentration above 20 percent, a single key supplier, expiring leases, missing contracts, deferred capital expenditures, and — the big one — owner dependency.


• Answer the honest question: can this business run for 90 days without you? If the answer is no, you do not own a business. You own a job that will be discounted at sale.


• Set the target number. Work backward from the after-tax proceeds you need to fund the rest of your life. That number, not the market, defines whether you are ready.

Years 4 to 3: Build the Retention Architecture

Nothing destroys deal value faster than a key executive walking during due diligence. Buyers pay for a management team that stays.

• Name your critical few. Usually three to six people. Not the org chart — the people whose departure would change the purchase price.


• Put a plan in place that pays for staying through the transaction. A nonqualified deferred compensation plan or SERP with vesting tied to a change in control aligns your executives' payday with yours.


• Consider equity-feel without equity. Phantom stock lets a key executive share in the growth in enterprise value — and get paid at the sale — without diluting your ownership, complicating your cap table, or handing a minority holder consent rights over your own deal.


• Or make it simple and portable. A Restricted Executive Bonus Arrangement gives the executive a benefit they can see and touch, funded with employer dollars, with a restriction that keeps them in the seat.


• Mind the 409A trap. Deferred compensation that accelerates on a sale must fit within the change-in-control rules of Section 409A. Get the definition of "change in control" and the payment triggers right in the document — not in a side letter three weeks before closing. A 20 percent penalty tax on your best executive is a terrible closing gift.


• If you fund with company-owned life insurance, satisfy 101(j) first. Employer-owned life insurance requires written notice and consent before the policy is issued. Miss it, and the death benefit that was supposed to be tax-free becomes taxable income. This is not fixable after the fact.

Years 3 to 2: Engineer the Tax Structure

• Revisit your entity choice while you still can. S corporation, C corporation, and partnership each produce a very different after-tax result on the same headline price.


• Look hard at qualified small business stock. For C corporation stock, Section 1202 can exclude a substantial share of your gain from federal tax. Under the 2025 changes, stock issued after July 4, 2025 gets a 50 percent exclusion at three years, 75 percent at four, and 100 percent at five — with a per-taxpayer cap of $15 million and a $75 million gross asset ceiling at issuance. Note the symmetry: a five-year runway is exactly the holding period for the full exclusion. Miss the window by a quarter and the cost is measured in millions.


• Front-load deductions in your highest-income years. A cash balance plan can generate six-figure annual deductions for an owner in the final high-earning years before a sale, moving money out of the corporate wrapper and into a protected retirement bucket at a discount.


• Model asset sale versus stock sale versus installment sale. Buyers want an asset sale for the step-up; you usually want stock. That gap is negotiable — but only if you know what it is worth to each side before the LOI.


• Evaluate personal goodwill. In the right facts, a portion of the purchase price allocated to personal goodwill is taxed once, not twice.

Years 2 to 1: Residency and Estate Tax Positioning

This is the step most owners skip, and it is frequently the most expensive one.

• Understand where you are domiciled — and what it costs. The federal estate tax exemption in 2026 is $15 million per person, $30 million for a married couple, at a 40 percent top rate. That leads a lot of owners to assume estate tax is someone else's problem. Then they look at the state.


• The state thresholds are dramatically lower. Massachusetts starts at $2 million. Oregon at $1 million. Illinois at $4 million. Washington near $3 million. New York sits at roughly $7.35 million with a "cliff" that eliminates the entire exemption if you exceed it by more than 5 percent.


• Inheritance taxes are a separate problem. Pennsylvania taxes transfers to adult children at 4.5 percent, siblings at 12 percent, and others at 15 percent — with no meaningful exemption. New Jersey, Kentucky, Nebraska, and Maryland have their own versions.


• If you plan to move, move early. Changing domicile is a facts-and-circumstances test, and high-tax states audit it aggressively. Establishing residency two years before a sale is a plan. Establishing it two months before is an invitation.


• Do your gifting before the business is worth what it is about to be worth. Transferring non-voting interests to a trust while the valuation is lower — and while discounts for lack of control and marketability still apply — moves future appreciation out of your estate at a fraction of the eventual cost. Once a letter of intent is signed, that window closes.


• Fund the liquidity. An irrevocable life insurance trust holding a properly structured policy keeps the death benefit outside the taxable estate and gives your heirs cash to pay the tax without a fire sale.

The Final Year: Stress-Test the "What Ifs"

Every plan above assumes the sale happens as designed, on schedule, with you alive and healthy. Run the other scenarios: you die before closing, you become disabled, your co-owner dies, your buyer walks, your key executive leaves, the multiple compresses by two turns. Confirm your buy-sell agreement is funded, current, and consistent with your estate plan. A twelve-year-old buy-sell with a fixed price on the first page is a lawsuit waiting to happen.

Where RISR Fits

Most of this work stalls at the same place: the owner does not have a current, credible number for what the business is worth today, so every downstream decision — how much to gift, whether the retention plan is sized right, whether the after-tax proceeds actually fund retirement — rests on a guess.

We use RISR to close that gap. RISR pulls directly from tax returns and accounting data, normalizes earnings for owner compensation and one-time items, and produces an equity value using capitalization of earnings, EBITDA multiples, and revenue multiples. From there it becomes a planning instrument rather than a report:

• What does this business need to be worth for me to walk away and never worry about money?


• How much of my net worth is trapped in one illiquid asset — and what happens to my family if that asset stops working?


• What is the gap between today's value and my target, and which specific levers close it in five years?


• What is at risk if I die, become disabled, or lose a partner before the exit?

That last set of questions is the whole point. Planning for all of life's "What Ifs" is not a slogan — it is the difference between a valuation that sits in a drawer and a plan that survives contact with reality. Once the number is real, the retention plan, the tax structure, the gifting strategy, and the estate liquidity all get sized correctly instead of approximately.

Start the Clock

Five years is enough time to do all of this well. Two years is enough time to do some of it badly. If you are inside that window, the most useful thing you can do this month is work through this exit planning checklist and get a defensible baseline valuation and a written list of what stands between that number and the one you need.

Schedule a five-year readiness review and we will build your RISR valuation and What-If analysis together. You can also download our executive benefits planning guides or listen to The Perfect Plan® Podcast, where we walk through how these structures get reverse-engineered for real companies.

Schiff Executive Benefits has spent nearly two decades designing nonqualified deferred compensation, SERP, split dollar, phantom stock, and COLI-funded retention structures for closely held businesses. This article is for general education and is not legal, tax, or investment advice. Consult your own advisors before acting.

All you need to know about Long Term Care Products: how traditional LTC insurance, life insurance with an LTC rider, asset-based hybrids like Nationwide CareMatters and Lincoln MoneyGuard, and annuity-based LTC each work — plus how C corporations, S corporations and individuals deduct LTC premiums, and how to set it up.

If you have already decided that giving away real equity is off the table, you are asking a different question than most articles answer. You do not need another explanation of what phantom stock is. You need to know how to build one that survives an IRS review, does not wreck your cash flow, and actually keeps your right-hand person from taking a call from your competitor.

This guide is that build. Below is the design sequence we walk business owners through when we create a phantom stock plan for business owners inside The Perfect Plan® framework — from picking the plan type, to setting the valuation formula, to funding the future liability so the payout does not come out of operating cash.

If you are still deciding between structures, start with our free Phantom Stock vs. Stock Options vs. Real Equity Checklist (PDF) and come back here when you are ready to build.

Step 1: Pick the Plan Type — Full Value or Appreciation Only

This is the single decision that drives everything downstream, and most owners get it wrong by defaulting to whichever one their attorney drafted last.

Full-value phantom shares pay out the entire value of each unit at the triggering event. Grant an executive 1,000 units when the company is worth $500 per share, and if the company is worth $800 per share at payout, they receive $800,000. The full value transfers, including the value you already built before they arrived.

Appreciation-only units — functionally stock appreciation rights — pay only the growth above the value on the grant date. Same 1,000 units, same $500-to-$800 move, and the payout is $300,000. The executive is rewarded for the value they helped create, not the two decades of work you did before hiring them.

For most closely held companies, appreciation-only is the correct answer. It costs less, it is easier to defend to your other executives, and it aligns the incentive precisely where you want it: forward growth. Full-value grants make sense when you are recruiting against a public company that is dangling real RSUs, or when the recipient is a successor you genuinely intend to enrich.

A third option worth knowing: hybrid plans that pay appreciation on an ongoing basis and full value at a change of control. These reward year-over-year performance while reserving the life-changing number for the exit.

Step 2: Define the Valuation Formula Before Anyone Is Emotional

Here is where phantom stock plans die. The plan document says the payout is based on “fair market value of the company,” and five years later, the executive’s attorney and your CPA are $4 million apart on what that phrase means.

Your plan document must specify a repeatable, mechanical valuation method. The common approaches:

Formula valuation. A multiple of EBITDA, revenue, or book value, defined in the document. Example: 5.5x trailing twelve-month EBITDA, less funded debt, plus cash. Simple, cheap, predictable, and it lets the executive calculate their own number, which is a retention feature in itself.

Independent appraisal. A credentialed third-party valuation performed annually. More expensive, more defensible, and generally required if your plan is large enough to attract IRS attention.

Board determination with a defined methodology. Flexible, but the weakest position if it is ever challenged. If you use it, document the methodology, not just the conclusion.

Whichever you choose, address the edge cases in writing: What happens if you take on debt for an acquisition? If you sell a division? If a bad year drops the value below the grant price? A plan that does not answer these questions is a plan that will be renegotiated at the worst possible moment.

For help establishing a defensible number, see our business valuation resources.

Step 3: Build the Vesting Schedule — Your Actual Golden Handcuffs

Vesting is the retention mechanism. Everything else is compensation design; this is the part that keeps people.

Time-based (cliff or graded). Five-year cliff vesting is the most aggressive retention tool available — nothing vests until year five, and walking away in year four forfeits everything. Graded vesting, say 20% per year, is gentler and more common, but it creates a smaller reason to stay in any given year.

Performance-based. Units vest when the company hits defined milestones: a revenue threshold, an EBITDA target, a successful acquisition. This ties the reward to outcomes rather than tenure.

Rolling or evergreen grants. New units are granted each year with their own vesting clock, so the executive is always leaving something on the table. This is the design that produces the strongest long-term hold, and it is what we most often recommend for a key executive you intend to keep through your exit.

A note owners consistently underestimate: your vesting schedule needs to match your succession timeline. If you plan to sell in six years, a ten-year cliff is meaningless to a 58-year-old CFO and insulting to a 42-year-old VP of Sales. Work backward from your exit date. Our guide to how executive benefit needs evolve from startup to succession maps this out by company stage.

Step 4: Choose Your Triggering Events — Carefully, Because 409A Is Watching

A phantom stock plan is nonqualified deferred compensation, which means Internal Revenue Code Section 409A governs when payment can occur. This is not a formality. A 409A failure taxes the executive immediately on all vested amounts, adds a 20% additional federal tax, and adds premium interest — and it is the employee who gets hit, which makes it a retention catastrophe rather than a retention plan.

Under 409A, payment may generally be triggered only by a permitted event:

• Separation from service


• A specified fixed date or fixed schedule set at the time of deferral


• Change in control of the company


• Death


• Disability


• Unforeseeable emergency

Notice what is not on that list: “whenever the board decides,” “when the executive asks,” or “when cash flow allows.” Discretion is the enemy. Build the payment triggers into the document at the outset and follow them.

There is one meaningful exception worth designing around — the short-term deferral rule. If the payment is made within two and a half months after the end of the year in which it vests, it may fall outside 409A entirely. That works for annual appreciation payouts. It does not work for a plan designed to pay at a sale five years from now.

Also decide upfront how a payout is made: lump sum or installments. Installments over three to five years soften the cash flow hit and create a post-employment non-compete incentive, but the schedule must be locked in the original document.

For the full compliance picture, see our complete guide to IRC 409A compliance in 2026. If you suspect an existing plan already has a problem, we handle 409A corrections.

Step 5: Understand the Tax Treatment on Both Sides of the Table

For your executive: Phantom stock payouts are ordinary W-2 income, subject to federal, state, and payroll withholding. This is the honest trade-off you should disclose in the recruiting conversation — real equity held long enough can produce capital gains treatment, and phantom stock cannot. What phantom stock offers instead is no purchase price, no capital at risk, no personal guarantee, and no illiquid minority stake in a private company they cannot sell.

For you, the company: You receive a compensation deduction in the same year the executive recognizes the income, and in the same amount. This is a genuine structural advantage over an ESOP or a direct equity grant, and it is worth modeling. A $1 million payout at a 21% corporate rate is a $210,000 deduction landing in the same year as the expense.

Payroll tax timing deserves its own conversation with your CPA. Depending on how the plan is structured, FICA may be due at vesting rather than at payment under the special timing rule — which can produce a payroll tax bill years before any cash changes hands. Get this modeled before you sign, not after.

One item almost no one flags in advance: under ASC 718, phantom stock is a liability-classified award, remeasured at fair value every reporting period. As your company’s value rises, so does the compensation expense running through your P&L — and it moves with your valuation, not with a fixed schedule. If you have a bank covenant tied to EBITDA or net income, model this before you sign. We have seen well-designed retention plans create genuinely awkward lender conversations.

Step 6: Solve the Funding Problem Before It Becomes a Cash Flow Problem

This is the question every owner eventually asks: if this works, I will owe my executives a large pile of cash at exactly the moment I most want cash. Where does it come from?

An unfunded phantom stock plan is a promise backed by future operating cash. That is fine at a $50,000 liability and genuinely dangerous at $3 million — particularly if the trigger is a sale, because a buyer will treat that obligation as a reduction of your proceeds, dollar for dollar.

The most common institutional answer is Corporate Owned Life Insurance (COLI). The company purchases and owns policies on the covered executives, with cash value accumulating on a tax-deferred basis. When the payout comes due, the company has an asset sitting against the liability instead of a hole in the operating account. Because the company owns the policy, the death benefit can also recover the plan’s total cost over time — which is the difference between a benefit that is an expense and a benefit that is an investment. Designed well, the plan approaches full cost recovery.

Two compliance items are non-negotiable if you go this route: IRC 101(j) notice and consent requirements must be satisfied before the policy is issued, and the funding vehicle must remain a general corporate asset — informally funded, not formally set aside — or you create constructive receipt and lose the tax deferral you were trying to protect.

Learn more about how COLI works as a cost recovery vehicle.

Step 7: Get the Documentation and Filings Right

The plan document is the whole plan. Verbal understandings and term sheets are how disputes start. At minimum, your document needs:

• Number of units granted and the grant date value


• Full-value or appreciation-only designation


• The valuation methodology, stated with enough specificity to be replicated


• Vesting schedule and forfeiture conditions


• Permitted payment triggers and the payment form


• Treatment on death, disability, termination for cause, and voluntary resignation


• Anti-dilution and adjustment provisions for recapitalizations or distributions


• Amendment and termination authority — and its limits

Do not skip the ERISA analysis. Depending on structure, a phantom stock plan may be treated as a top-hat plan that primarily benefits a select group of management or highly compensated employees, which carries a Department of Labor filing obligation within 120 days of adoption. It is a short filing. Missing it is an unforced error with real consequences. See our guide to the top hat plan filing deadline.

The Five Mistakes We See Most Often

1. Vague valuation language. “Fair market value as determined by the board” is not a formula. It is a future lawsuit.


2. Granting too widely. Phantom stock is a top-hat tool for a select group. Extending it broadly can jeopardize the ERISA exemption and dilute the psychological value for the people who actually matter.


3. No funding plan. The liability grows precisely as fast as your success does. That is the design working, and it needs an asset behind it.


4. Ignoring the P&L impact. Liability-classified awards create earnings volatility. Your lender and your CFO should both see the model before adoption.


5. Treating it as a document instead of a conversation. An executive who does not understand the plan is not retained by it. Research on executive benefits consistently shows a wide comprehension gap — a benefit your key people cannot explain is a benefit that is not doing its job. Build an annual statement that shows each participant their current unit value.

Is a Phantom Stock Plan Right for Your Company?

The profile that fits: a privately held company with meaningful enterprise value, one to five genuinely key executives whose departure would materially damage the business, an owner who wants to retain full voting control, and a succession or sale horizon within roughly three to ten years.

The profile that does not fit: companies looking to reward broad-based employee populations, businesses with no reliable way to establish enterprise value, or owners who are actually ready to transfer real ownership — in which case you should be evaluating an ESOP or a direct equity sale.

Phantom stock also does not have to stand alone. It sits well alongside a SERP for retirement security, a Section 162 bonus plan for portable death benefit, or a REBA when you want golden handcuffs with a personally owned asset attached. Most of the plans we design are combinations, because most retention problems have more than one moving part. Our executive benefits guide for business owners covers how the pieces fit together.

Frequently Asked Questions

How much does it cost to set up a phantom stock plan?

Design and documentation costs vary with complexity, but the meaningful cost is the future payout itself — which is why the funding conversation matters more than the setup fee. A well-designed plan using COLI as a cost recovery vehicle can approach full cost recovery over the life of the arrangement.

Does phantom stock dilute my ownership?

No. No shares are issued, your cap table is unchanged, and participants receive no voting rights, no board seats, no inspection rights, and no claim on ownership. You retain complete control.

How is phantom stock taxed?

Payouts are ordinary income to the executive, subject to normal withholding. The company takes a compensation deduction in the same year and the same amount. There is no capital gains treatment, because no capital asset is transferred. Payroll tax timing depends on plan structure and should be modeled in advance.

What happens to phantom stock if I sell the company?

That depends entirely on how you drafted it. Most plans define a change of control as a triggering event, accelerating vesting and paying participants out of the transaction proceeds. Buyers will treat this as a reduction in what you receive, so the number belongs in your exit model years before the letter of intent.

Can an S corporation offer phantom stock?

Yes — and it is one of the strongest arguments for the structure. Because no second class of stock is created and no additional shareholder is added, phantom stock lets an S corp reward key people without threatening its S election or its shareholder limit.

What is the difference between phantom stock and stock appreciation rights?

The terms overlap heavily in practice. Phantom stock most often refers to full-value units, while SARs pay only appreciation above the grant date value. Many advisors, including us, use “phantom stock” as the umbrella term and specify full-value or appreciation-only in the document.

Do I have to give participants access to my financial statements?

No. This is one of the quieter advantages. Because participants are not shareholders, they have no statutory inspection rights. You control exactly what you disclose — though we recommend an annual unit statement, because a benefit no one can see is a benefit that is not retaining anyone.

Build It Right the First Time

A phantom stock plan is not a form you download. It is a valuation methodology, a vesting strategy, a 409A compliance structure, a funding vehicle, and a communication plan — and getting any one of them wrong turns a retention tool into a liability.

At Schiff Executive Benefits, we have spent nearly 65 combined years designing these plans for privately held companies and banks. We start with your goal, then reverse engineer the structure, then make sure the “feel” of the plan matches your culture and your intent. And we work alongside your CPA and attorney rather than replacing them.

Take the next step:

Schedule your Perfect Plan® initial meeting — a straightforward conversation about your key people, your timeline, and what a plan would actually cost.

Call (610) 292-9330 or email info@schiffbenefits.com

Free download: Phantom Stock vs. Stock Options vs. Real Equity — Comparison Checklist (PDF). Eighteen design questions answered side by side, plus a decision checklist you can work through with your CPA and attorney.

You built the company. Let’s make sure the people who help you run it have a very good reason to stay — without giving away a single share.

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Matt Schiff is President of Schiff Executive Benefits and host of The Perfect Plan® Podcast. He specializes in helping business owners navigate executive retention, nonqualified deferred compensation, and benefit security.

This article is for informational purposes only and does not constitute tax or legal advice. Plan design should be reviewed with your CPA and attorney. Securities offered through The Leaders Group, Inc. Member FINRA/SIPC.