Phantom Income – Definition

Cite this article as:"Phantom Income – Definition," in The Business Professor, updated October 10, 2019, last accessed October 19, 2020,


Phantom Income Definition

Phantom income refers to money, income or investmnet gain that an individual is yet to receive but is still subjected to taxes by the Internal Revenue Service. Money, profit or income that is never received but is still taxable by the IRS is called a phantom income.

Phantom income is otherwise called phantom revenue. Such income poses a lot of problems for the taxpayers because they have to scramble to pay tax on an income they did not receive. Phantom income can occur in limited partnerships but are not common. It can also occur in real estate, zero-coupon bonds and many other business arrangements, the IRS treat phantom income as taxable income.

A Little More on What is Phantom Income

No single taxpayer likes phantom income, this is because this type of income creates extra tax burdens for the taxpayer. In a limited partnership, a phantom income is the income that a partner or individual has not received but is taxed by the IRS. Partners in Limited Liability Companies (LLCs) or joint owners in small businesses can encounter problems with phantom income, especially if they are not planned for. Despite that phantom income are noy received by individuals, income of this nature are reported in Schedule K-1 (Form 1065) to the IRS.

Regardless of how huge phantom income of an individual is, taxes must be paid on them. In a limited liability partnership for instance, if a partner holds 20% of the share in the partnership, it means that if $200,000 is reported as the income of the business for a year, the partner has to pay tax on $40,000 even though he did not receive this income. In a case whereby a partner has exitted the partnership and has no shares in the profits, if the Schedule K-1 report for the year still indicates the partner, he has to tax taxes for his share even if he has left.

Phantom Income: More Examples

Phantom income is not restricted to LLCs or joint owners of small businesses, it is also applicable to individuals. For instance, fi an individual gives money to a startup on an agreement that he will receive no cash reward but has a stake in the partnership, such an individual will still pay taxes for profits reported by the partnership. Another example of phantom income is that of zero-coupon bonds where investors receive no interest payments until the bonds mature but investors are liable for taxes on the phantom income or imputed interest of the bonds.

Canceled or forgiven debt is another instance of phantom income. When a creditor forgives a borrower of a debt, this is taken as though the creditor ‘pays’ the amount owed to the deficient borrower which is also subject to tax.

Phantom income can also occur in real estate, this may be as a result of the taxable income exceeding the proceeds realized from the sale of a property. Oftentimes, real estate companies encounter phantom income due to depreciation. Aside from the examples listed above, other instances where phantom income can occur are  domestic partnerships, it also applies to medical benefits for non-married couples.

References for “Phantom Income › Finances & Taxes › Income Taxes

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