“Phantom income” often comes as an unpleasant surprise for business owners who have hastily chosen a business entity with pass-through tax treatment.
To illustrate, let’s say the business has profits that are taxable to its owners and, for some reason, chooses to retain those profits in the business rather than distributing them to the owners. Result: owners will have to pay income taxes on this “phantom income” which they have not actually received. This can create obvious problems for some owners.
Since the corporate tax rate is typically lower than an individual’s tax rate and profits retained in the corporation will not be double taxed as dividends, there are frequent situations where being taxed as a corporation is preferable to pass-through tax treatment.
Before determining the business entity that’s right for you, let your tax advisor help you consider all of the many complex tax questions.