What Does “Fantum Tax” Mean? A Look at Phantom Tax
Correct "fantum tax" to "phantom tax." Discover what phantom tax means: owing taxes on income or gains you haven't physically received.
The term “fantum tax” is a common misspelling of “phantom tax.” A phantom tax refers to a tax liability that arises even when an individual or entity has not received a corresponding cash payment. This situation often creates a challenge because taxpayers owe money on income or gains that are not readily available in liquid form.
Understanding “Phantom Tax”
Phantom tax is not a distinct type of tax, but a consequence of specific tax rules and accounting methods. These rules can cause a taxable event without a corresponding cash inflow, leading to a mismatch between recognized income and actual cash. For example, income may be recognized for tax purposes based on accrual accounting principles, even if the cash has not been distributed. This creates a cash flow burden, as the tax liability must be paid in cash despite no direct cash receipt.
Common Scenarios Leading to Phantom Tax
One common scenario involves “imputed income,” where the Internal Revenue Service (IRS) considers the value of certain non-cash benefits as taxable income. For example, if an employer provides group-term life insurance coverage exceeding $50,000, the value of the excess coverage is treated as taxable income to the employee, even though no cash is received. This imputed value is added to an employee’s gross wages and reported on their Form W-2.
Another instance occurs with pass-through entities like partnerships or limited liability companies (LLCs). Partners are taxed on their allocated share of the business’s profits, as reported on Schedule K-1 (Form 1065), regardless of whether those profits are actually distributed to them in cash. The entity might reinvest profits back into the business for growth, but the individual partners still incur a tax obligation on their share of these “paper profits.”
Original Issue Discount (OID) bonds also frequently result in phantom tax. These bonds are typically issued at a price lower than their face value, and the difference represents accrued interest. For tax purposes, this interest is generally considered taxable annually as it accrues over the bond’s life, even if the bondholder does not receive any cash payments until the bond matures. Bondholders receive a Form 1099-OID detailing the amount of OID to include as income each year.