Phantom income is a financial gain where investors or business owners are taxed on the value of their stake in an agreement but do not receive any cash benefit for the same. It is revenue that is taxed despite the receiver not receiving any actual cash from the revenue.

It becomes a tangle for taxpayers from such an unplanned income as it results in a surprising tax burden.

In other words, it can be termed as unrealized profit because Phantom income needs to be accounted for resulting in a tax burden for business owners especially when the income amount is considerable.

Phantom income happens seldom however its incidence makes tax designing difficult.

It is exactly similar to an additional tax liability obligatory on the profit generated that is nonetheless to be received.

Phantom Income occurs in business profits, business capitalization, zero-coupon bonds, partnerships, LLCs.

As per the law, equity holders need to report gains of their share regardless of whether they have received the proceeds or not and will consequently have to pay tax on it.

In some cases, such income is considered as retained earnings or sometimes distributed as dividends among stockholders.

Phantom Incomes sometimes cause a burden for people because when reporting a considerable amount of phantom income, it can also mean a considerable amount of tax burden.

For example:

A zero-coupon bond does not pay interest payment during the life of the bond to the bondholders. Despite not receiving the periodic coupon payments like other bonds, bondholders are entitled to pay federal, state, and local income taxes on the accrued interest yearly.

Here the accrued interest is a Phantom Income.

In this case, investors prefer to invest in municipal zero-coupon bonds or corporate zero-coupon bonds that possess a tax-exempt factor in order to get rid of the tax factor on the phantom income.

Hence, Phantom income creates a tax burden for investors and business owners, and tax professionals are approached to seek help and ensure to overcome the tax burden on the phantom income.