Examples of Phantom Income and Its Definition
Phantom is recognized as an allotment of resources that the individual doesn’t receive as cash or cash equivalents. In other words, the individual does not realize a positive cash flow, but is deemed to have benefited in other ways. Here are some examples:
Zero coupon bonds – Also called discount or deep discount bonds, zero coupon bonds are instruments that do not pay interest on a periodic basis. Instead, the bonds are purchased at a discounted rate (less than their face or redemption value) and the increase (compounded interest) is realized when the full face value is paid to the bondholder at maturity.
Forgiven debt – These include loans, such as mortgages, auto loans and credit card debt that were forgiven by a creditor. By forgiving a debt, the creditor is in effect giving the debtor the forgiven amount. There may be exceptions, however, as in the case of transactions that are addressed under the Mortgage Forgiveness Debt Relief Act of 2007 that was signed into law by President Bush.
The Act was a means of stemming the rate of foreclosures in the mortgage market. Under the act, the homeowner has no liability to pay federal income tax on the debt that was forgiven in relation to a loan that was secured by a qualified principal residence, but this was allowed only if the debt was forgiven for the sake of avoiding a foreclosure on the property.
Income distribution in a partnership – Income tax may become due on income that is distributed to shareholders (i.e. in S corporations) regardless of whether or not they receive the money. For example, if Bob and Rick own a business (51% to 49% respectively), but Bob takes a decision to not distribute the profits, both parties may still be liable to pay taxes based on the undistributed income. This is why it is a good idea to include a clause in the partnership agreement that requires that at least enough money should be distributed among the shareholders to cover taxes.