Phantom income arises by virtue of the way that the tax rules are written.

That could leave the investors owing taxes on sizable phantom income.

The 1986 tax law required shareholders to pay taxes on so-called phantom income from their mutual fund investments.

In the interim, however, phantom income accrues at ever-increasing amounts each year.

Tax lawyers say the dozen or so funds operating as partnerships will not qualify for the reprieve on phantom income.

Shareholders have started to become upset, particularly because many companies include the phantom income in determining whether executives qualify for performance bonuses.

Quarterly estimated taxes must be paid by the individual to avoid tax penalties, even if this income is "phantom income".

Even though no interest is actually paid, it is imputed, and investors owe taxes on this phantom income.

If the zero is neither tax-free nor in a tax-deferred account, "people must pay tax on the 'phantom income' during its life," he said.

Taxpayers who do not itemize, however, would still be liable for taxes on the "phantom income" from their mutual fund investments.

Early in its life, a residual produces "phantom income," or taxable income that exists only on paper.

This "phantom income" is apparently too scary even for Mr. Spor.

If you find yourself in that position, however, you can avoid paying tax on this phantom income by selling the fund before the end of the year.

The phantom income stems from the complex, varying rates used to calculate income from the actual mortgage payments made by property holders.

The new law threatens to force companies, and in some cases bondholders, to pay taxes on "phantom income" created when troubled companies restructure their debt to survive.

Instruments issued with OID generally impute the receipt of interest (sometimes called phantom income), even though these bonds don't pay periodic interest.

Under the old law, it was easy for the company in question to avoid paying tax on the phantom income that was, in effect, generated when a loan was forgiven.

That same law allows a tax credit of up to $5,000 for taxpayers who had to pay alternative minimum tax on what has been called phantom income, Ms. LeValley said.

Investors have also avoided the securities because of a tax on the so-called phantom income that accrues in the notes but is not passed on to investors until the security matures.

To avoid this "phantom income" scenario, S corporations commonly use shareholder agreements that stipulate at least enough distribution must be made for shareholders to pay the taxes on their distributive shares.

The drawback is that you must pay income tax on the interest that accumulates each year, even though you don't receive the phantom income until you sell the bonds or they mature.

"The investor can therefore have the worst of all results - current tax on phantom income and a capital loss whose use is limited to offsetting capital gains plus $3,000 a year of other income."

The result is that a company with publicly traded bonds would pay taxes on phantom income, whereas an identical company with bonds that are not publicly traded would not.

And to add insult to injury, the holder of the bonds, like an individual or a junk bond mutual fund, will have to report phantom income each year totaling $300 over the life of the bond.

And with depreciation write-offs close to expiration, the partners will soon have to pay taxes on the revenue that the housing company uses to repay principal on the first mortgage - "phantom income" for investors.