Table of Contents
- What Is a Flow-Through Entity?
- Why It's Called a Disregarded Entity
- Understanding a Flow-Through Entity
- Types of Flow-Through Entities
- Important Note on Filing
- Advantages of Flow-Through Entities
- Disadvantages of Flow-Through Entities
- Is a Flow-Through Entity the Same As a Pass-Through Entity?
- Does a Disregarded Entity Pay Taxes?
- Is a Single-Member LLC Automatically a Disregarded Entity?
- Can a Disregarded Entity Have Employees?
- The Bottom Line
What Is a Flow-Through Entity?
Let me explain what a flow-through entity is: it's a legal business setup that passes any income it generates directly to its owners, shareholders, or investors. You, as an owner, get taxed on that income, not the entity itself. This is a straightforward way to sidestep the double taxation that hits regular corporations.
Why It's Called a Disregarded Entity
You might hear flow-through entities called disregarded entities because the IRS basically ignores them for tax purposes. The tax burden flows straight to you—the owners, shareholders, or investors—who report and pay taxes on that income.
Key Takeaways
- A flow-through or pass-through entity passes all its income to the owners or investors.
- It's designed to avoid double taxation on earnings.
- Income is taxed only at the owner's individual rate; the business pays no corporate tax.
- Types include sole proprietorships, partnerships (limited, general, limited liability), LLCs, and S corporations.
- The IRS treats them as disregarded entities.
Understanding a Flow-Through Entity
Both businesses and individuals are taxable, right? You pay income tax on your wages, and companies pay corporate tax on revenues. But if you set up as a flow-through, your business skips the corporate income tax. The income flows through to you as personal income, and you pay taxes on it at your ordinary rate. You can even apply business losses against your personal income.
These entities follow similar tax rules as C corporations for things like inventory, depreciation, and profit measurement, but they're taxed only once. C corps face double taxation—first at the corporate level, then again on dividends or capital gains to shareholders.
Types of Flow-Through Entities
You'll find flow-through entities in forms like sole proprietorships, S corporations, income trusts, limited liability companies, and various partnerships—limited, general, or limited liability.
If you're a sole proprietor, you report all business income on your personal tax return; the IRS sees it as a flow-through since the business isn't taxed separately.
For S corporations, profits flow to shareholders who report them on Schedule E of their personal returns. You don't pay SECA tax on profits as an S corp owner, but you must pay yourself reasonable compensation subject to Social Security tax.
In Canada, this could be an investment corporation, mortgage investment corporation, mutual fund corporation, partnership, or trust.
Important Note on Filing
Remember, even though flow-throughs are disregarded for taxes, partnerships and S corporations must file an annual K-1 statement, just like public companies.
Advantages of Flow-Through Entities
The main benefit is the tax treatment. Regular corporations pay corporate tax on profits before distributing to owners, who then pay personal tax on dividends— that's double taxation.
With a flow-through, you skip the corporate tax. Earnings go straight to you, taxed only once at your personal rate. Plus, if the business loses money, that loss passes through to reduce your taxable income. In some cases, you get extra deductions on your personal taxes.
Disadvantages of Flow-Through Entities
Here's a key downside: you might get taxed on income you don't actually receive. If the business reinvests profits instead of distributing them, you still report and pay taxes on your share.
Also, some owners in pass-through entities face self-employment tax, even while avoiding corporate tax.
Is a Flow-Through Entity the Same As a Pass-Through Entity?
Yes, they're the same thing.
Does a Disregarded Entity Pay Taxes?
Yes, but if it's a single-person business, it's not taxed separately from you. You report the income on your personal return. It pays self-employment tax at a flat rate and income tax based on your bracket.
Is a Single-Member LLC Automatically a Disregarded Entity?
Yes, but you can request different taxation.
Can a Disregarded Entity Have Employees?
Yes, it can. The disregarded status is only for federal income taxes; it doesn't impact employment. If you have workers, you might pay employment taxes. Note that a single-member LLC can't treat its owner as both employee and partner, per IRS rulings.
The Bottom Line
Flow-through entities let you avoid double taxation on profits. If you're in a sole proprietorship, partnership, LLC, or S corp, you get pass-through taxation. But watch out—you could be taxed on income reinvested in the business. Sole proprietors and similar might also owe self-employment tax, so understand your specific tax setup.
Other articles for you
Operations management involves planning and overseeing business processes to maximize efficiency and profitability.
Government-wide acquisition contracts (GWACs) enable multiple federal agencies to jointly procure IT solutions at reduced costs through shared contracts.
Bankruptcy is a legal process for debt relief through asset liquidation or repayment plans, offering a fresh start but with significant financial consequences.
Housing starts measure the beginning of new residential construction projects in the U.S., serving as a key economic indicator.
A window guaranteed investment contract is a low-risk investment where investors make installment payments to an insurance company for guaranteed returns over time.
Activist investors acquire minority stakes in public companies to influence management and drive changes for better performance or value.
The debt ratio measures a company's leverage by comparing its total debt to total assets, indicating financial health and risk levels.
A statute of limitations sets deadlines for initiating legal actions in civil and criminal cases to ensure timely proceedings and preserve evidence.
Uneconomic growth refers to economic expansion where negative social and environmental costs exceed the benefits, leading to reduced overall quality of life.
This text provides a biographical overview of Ben Bernanke, focusing on his tenure as Federal Reserve Chair and his responses to the 2008 financial crisis.