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Phantom Income and The Tax Issues Surrounding It

There are many people that have heard of phantom income, but they may not understand exactly what that is, who is affected by it, and what steps can be taken in order to remedy the situation. The idea of phantom income comes from the basis that this is an allotment of money that an individual does not necessarily see, but that is taxed. It is reportable on a person's taxes as a piece of the person's income, but that individual may not actually see the cash flow associated with the reported income.

There are certain examples of this that can be listed. For example, a very general type of phantom income would be income that is received from zero coupon bonds. These are bonds that are sold at a deep discount when it is compared to the face value on the bond. This bond appreciates in value over time, when it finally reaches its face value.

There are also many businesses that complain about having to deal with phantom income, in that they need to pay taxes on income that the individuals have not actually received at the time during which the taxes are due. This is frustrating for these individuals. These people are typically owners and partners who have limited liability corporations and S-corporations. There is taxable income that passes through the corporations and goes into the hands of the owners. These owners are responsible for paying all of the taxes on the income. This is different when compared to corporations, because in those cases the corporation is the taxpayer, not the individual business owners. The individuals that own the corporation do not need to pay taxes on the phantom income then.

There are several different causes when it comes to phantom income. Some of the simplest explanations include that there is a discrepancy between when the cash is received as opposed to when the amount is actually paid. There is also a limit of how much a business can get deducted. This includes 50% of meals and their entertainment, as well as any fines and penalties, which are all considered non-deductible. Principle repayments on certain debts of a company are non-deductible as opposed to the interest, which is considered to be deductible. The principle payment is not allowed to be deducted because the company is simply returning the borrowed money to the financial institution.

There are certain remedies that a company can implement in order to try to combat phantom income for the business. Some of these are more effective than other methods, but all of them are helpful in subtle ways. While some companies are able to adopt all methods, some can only adopt one of two, but the important thing is that every little bit can help the companies and business owners when it comes to paying taxes on the phantom income.

It is encouraged that employees and business owners should minimize the amount of expenses they incur that are considered to be non-deductible. It is also important that the individuals in charge stay aware of the debt that they are amassing. This is important because it helps to keep track of the interest and how much money cannot be deducted, that being the principle sum. Many companies can also benefit from working with accountants to help them stay aware of the methods that the company is using and in order to stay ahead on different financial matters that the company is involved in throughout the year. It is important to occasionally review the accounting methods that are used in order to ensure that the company is using the most effective methods.