Phantom Income….. What?
Unless you’re an accountant or been a victim to phantom income, you’ve probably never heard of it. Phantom income is money that is never received by an individual but is still taxable. How is that possible? Let me explain.
Here are some examples of when phantom income may creep up on you and cause problems:
1. Debt Forgiveness
2. Non-Spousal Medical Benefits
3. Owning/Investing in an S Corp, LLC, or Partnership
4. Winning a Brand New Car or Other Physical Item of Value
1. Debt Forgiveness
Debt forgiveness is when a credit card company settles for a smaller amount of money than is owed to close the balance of the account. For example, let’s say you owe $10,000 to a credit card company but you reach a deal to pay $5,000 of it. The remaining $5,000 that was forgiven would still be considered income (aka phantom income) and must be reported on your income tax return. Imagine having $5,000 in credit card bills forgiven just to find out you are subject to taxes on that amount! There are some situations where this is not applicable and the forgiveness of debt is not classified as taxable income. Make sure and consult with your accounting professional to see if this situation applies to you or not.
2. Non-Spousal Medical Benefits
A large number of employers are now offering healthcare coverage to domestic partners (in addition to married spouses). A spouse’s medical benefits are not taxable, but when two people aren’t legally married, the non-employee’s benefits are taxable. In a domestic partnership, it is best to explore both individuals healthcare options and see which plan makes the most sense. In some cases, it may be the biggest benefit for each individual to have their own plan, so no extra taxes are incurred.
3. Owning/Investing in an S Corp, LLC, or Partnership
Let’s say you either own a business or invest in a business (not stocks, but actually giving cash to a business owner for a percentage in return). For example, your business reports $100,000 in earnings for a fiscal year but you immediately reinvest that money into your business, you will still be subject to paying taxes on the earnings even though you did not physically see any of the money in hand. If your business is a pass-through entity (partnership, s corp, LLC), you will have to pay taxes on your share of the earnings regardless if you received the cash!
4. Winning a Brand New Car or Other Physical Item of Value
(Rolls Royce Phantom – see what I did there??)
It’s your lucky day and you’ve just won a brand new car! The hidden side to winning a physical item of value is the fact that it is now considered taxable income (this also applies if you win a vacation package, house, diamond ring, etc). You are now subject to paying taxes on the fair market value of the item. With no cash winnings, you will soon wish you had never won the car.
Some individuals may never have to deal with phantom income, but for others, it lurks around every corner. If you ever feel like you may be subject to phantom income, make sure and schedule an appointment with Jenkins CPA and let us help you sort it all out!
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