Phantom income
Taxable income with no matching cash gain, which can arise under the post-2025 rule limiting gambling-loss deductions to 90 percent of winnings. A roughly breakeven bettor can still owe tax.
If only 90 percent of losses offset winnings, a gambler who wins and loses equal amounts on paper still has 10 percent of losses stranded, producing taxable income with no real profit. Avoiding gambling treatment, where possible, is what keeps prediction-market traders out of this trap.
Phantom income is income you owe tax on without having received corresponding cash. In trading, the classic source is mark-to-market: if you hold an open Section 1256 position that has gained value at year-end, you can owe tax on that paper gain even though you have not sold and have no cash in hand from it.
The mismatch is purely about timing. The gain is real on paper and the tax is owed for that year, but the cash to pay it only arrives when you actually close the position, possibly in a later year, and possibly at a different price. If the position then reverses, you may have paid tax on a gain that partly evaporated, recovering it through a loss in the following year.
For traders who flatten their positions before December 31, phantom income rarely appears, because there is nothing open to mark. It is mainly a consideration for those who deliberately or accidentally carry positions across the calendar boundary, and it is a reason to plan year-end position management with taxes in mind.
You hold an open contract bought at 20 cents that sits at 80 cents on December 31. Under mark-to-market you recognize a 60-cent gain and owe tax on it this year, even though you have not sold and received no cash. If it later settles at 40 cents, you book the offsetting loss next year.
Frequently asked questions
What is phantom income?
It is income you are taxed on without receiving cash. In trading it typically arises from year-end mark-to-market on open Section 1256 positions, where a paper gain becomes a taxable event.
How do I avoid phantom income?
Closing your positions before year-end removes open contracts to mark, which avoids recognizing unrealized gains. Carrying positions across December 31 is what creates the exposure.
Do I lose the money if I pay tax on phantom income?
Not permanently. It is a timing difference: if the position later falls, you book an offsetting loss in that year. You may, however, pay tax sooner than you receive the cash.