1. LLC Income Tax Overview
2. Types of Flow-Through Entities

Updated November 25, 2020:

LLC flow-through is a business structure that passes the profits, losses, credits, and expenses to the owners of the company. Flow-through entities are common businesses to help reduce taxes and avoid double-taxation, which is generally incurred by a C corporation.

In an LLC, or Limited Liability Company, the owners are taxed on their personal income tax returns; for that reason, the LLC doesn’t file corporate income taxes. Instead, the LLC will file an information tax return along with a K-1 statement, which will indicate how much of the profits/losses are to be reported on each member’s individual tax return.

Such entities are also referred to as pass-through entities; such entities include sole proprietorships, limited partnerships, general partnerships, limited liability partnership, trusts, and LLCs. Even the S corp is taxed as a flow-through entity. Essentially, the only business structure that isn’t taxed as a flow-through entity is the C corporation.

LLC Income Tax Overview

An LLC isn’t considered a separate tax entity from its owners. Don’t get this confused with the fact that the LLC is in fact considered a separate and distinct legal entity from its owners. Therefore, LLC owners can’t be held personally liable for the debts and obligations of the business. With that said, the LLC isn’t a separate tax entity. For this reason, the LLC operates as a flow-through entity.

There are many advantages to operating as a flow-through entity, including the following:

  • Income is subject to being taxed only once
  • Members can deduct business losses against their income

While a C corporation is subject to double-taxation, the LLC is not. Specifically, a C corporation must pay corporate income taxes on its profits (up to 35 percent). Thereafter, any profits that are paid to shareholders in the form of dividends are then taxed again on the shareholders’ personal tax returns (at a rate up to 23.8 percent). The LLC, however, is only subject to being taxed at the member’s personal income tax rate, depending on how much of the profits have to be paid by each member.

Another benefit of the flow-through entity is the fact that members can deduct business losses against their income, although there are some potential limitations in terms of passive losses.

C corporation losses can’t be used to deduct the income of any of the shareholders. Therefore, such business losses can only be deducted on the corporate income tax return. With that said, the C corp losses can potentially be carried back (for a period of two years) or forward (for a period of up to 20 years) against profits earned in previous or future years. To that extent, the tax benefit from such losses is delayed and could even be reduced in terms of the present monetary value of such loss. An example of this would be the fact that $5 in 2018 will have the same value as $5 in 2038.

Types of Flow-Through Entities

As previously mentioned, there are several types of flow-through entities, including the sole proprietorship, partnership, and LLC.

The sole proprietorship is a business owned and operated by one person. For that reason, this individual will report all profits and losses from the sole proprietorship on his or her individual tax return (Schedule C). Furthermore, all net income is subject to self-employment payroll taxes.

Partnerships file Form 1065, which is an informational tax return. It identifies how the profits are to be allocated on the partners’ tax return (to be reported on Schedule E).

S corporations also don’t file corporate income taxes. Instead, they file Form 1120S, which also indicates the percentage of profits to be reported on the shareholders’ personal tax returns.

Notably, S corporations can’t have more than 100 shareholders, all of whom must be either U.S. citizens or permanent residents. S corp shareholders can’t be other businesses; so all shareholders, must be individuals. With regard to all shareholders in the S corp, any shareholders who are also employees of the business must pay themselves a reasonable compensation, which is subject to personal income tax, along with Medicare and Social Security Tax. But such compensation isn’t subject to self-employment tax.

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